The program is conducted by the ATO via its Streamlined Assurance Reviews (“SAR”). This framework generally involves a review of the group’s tax returns for the two most recent years lodged, and is focused on entities within the group with significant activities or transactions.
In the next 5,000 program, the ATO uses information obtained from taxpayers’ Income Tax Returns and Business Activity Statements matched against other data at its disposal, to identify risks specific to the taxpayer’s business.
How justified trust applies to Next 5,000 reviews
Like the Top 1,000 program, the Next 5,000 program utilises the ATO’s justified trust methodology in order to obtain assurance that a taxpayer group has paid the right amount of tax with respect to the main trading entities within the taxpayer’s group. This will include any significant transactions or events affecting the group.
The justified trust methodology is applied to the following four areas:
- Tax Governance;
- Tax Risks Flagged to Market;
- New and Significant Transactions; and
- Book to Tax adjustments.
Key ATO observations of the Next 5,000 Program
- A high percentage of taxpayer groups had tax governance procedures and processes;
- Most taxpayer groups tax governance was poorly documented or undocumented;
- A clear correlation was found between good tax governance and clearly documented roles and responsibilities with respect to the tax function;
- Groups that seek advice from a tax advisor for material issues and transactions are more likely to correctly address their tax risks, resulting the correct amount of tax being paid; and
- Formal processes to identify and address risks results in less errors.
Common issues identified by the ATO
The ATO has identified the following recurring issues in its reviews to date:
- Division 7A non-compliance;
- Significant discrepancies between BAS and income tax return information;
- Disposals of assets incorrectly recorded on capital account, rather than on revenue account;
- Tax loss recoupment and lack of records relating to prior year losses; and
- Related party arrangements designed to reduce the overall tax of the group.
We have been involved in many Next 5,000 SAR (“SAR”) to date. While many of the themes are consistent with the common issues identified by the ATO, we have also observed an emphasis on the following issues:
- Transfer pricing/mispricing;
- Offshore assets and income;
- Domestic related party transactions and use of loss entities;
- Restructures and disposals; and
- Tax consolidation.
The ATO has made it abundantly clear in its administration of the program, that it places a high degree of emphasis on a taxpayer group’s tax governance framework when applying the justified trust methodology. This is similar to its approach to the Top 1,000 program, but acknowledging that the sophistication of Next 5,000 taxpayers is not at the same level as for the Top 1,000 taxpayers.
When reviewing a group’s tax governance framework, the ATO will assess the framework by reviewing the documentation around policies and procedures and their effectiveness. The ATO recognises that the sophistication of a tax governance framework should be proportionate to the size and complexity of a business.
A good tax governance framework will clearly document the roles and responsibilities with respect to how the group manages its tax function. Where responsibility for tax compliance is shared with an external tax advisor, the scope of those services should be clearly set out in the tax advisor’s engagement letter, so that it is apparent as to when the taxpayer or the advisor is responsible for a particular function.
The ATO will provide feedback on the effectiveness of a taxpayer group’s tax governance framework and provide suggestions for improvement, where appropriate.
Tax governance is key in the ATO achieving justified trust in a taxpayer tax affairs. Successfully achieving justified trust means that the ATO will focus more on controls, rather than transactions, when undertaking future reviews, knowing that the taxpayer group’s tax governance framework ensures that it is likely to pay around the right amount of tax. As a result, this reduces the burden that a transaction based review imposes on the business in dealing with the ATO. Documenting via a formal tax governance framework is key in demonstrating good tax governance.
The ATO will expect that not only does a tax governance policy exist, but that it is embedded in the operational processes of the business, and the processes are consistent with those policies. This includes day to day transactions and also the identification and dealing with tax risks arising from more irregular transactions. The tax governance framework should deal with income tax as well as any other taxes that are relevant to the business.
A few key areas that the ATO expects will be part of a good tax governance framework include:
- Appropriate material thresholds are set in the context of the size and complexity of the business;
- Clearly defined roles and responsibilities allocated to deal with all tax related areas that are relevant to the business;
- Internal controls are in place to identify and deal with tax risks as they arise, including on new and significant transactions;
- Internal controls are in place to identify tax risks flagged to the market by the ATO;
- Detailed procedures dealing with all of the tax functions relevant to the business, including income tax and indirect taxes such as GST;
- Clear communication of the tax risks and tax functions in the business to management and/or the owners;
- Endorsement of the tax governance framework by management and/or the owners; and
- A mechanism to provide for the periodic review of the tax governance and being able to demonstrate that this does occur in practice.
We have seen in Next 5,000 reviews that we have been involved with, that having an effective tax governance framework makes the review process much smoother and is acknowledged in the ATO’s exit letters.
Tax risks flagged to market
The ATO publishes Taxpayer Alerts to advise taxpayers of issues to which it believes are higher risk arrangements and which it is targeting. The ATO also publishes Practical Compliance Guidelines which provide guidance as to how the ATO will administer certain areas of the tax law, as well as setting out how it assesses compliance risk in those areas, i.e. when it would assess an arrangement as low risk and not likely to have compliance resources directed to it, as well as arrangements to which it considers is higher risk.
It is important that a taxpayer group’s tax governance framework incorporates the identification of tax risks flagged to market that are potentially applicable to it, as well as providing the framework to determine how it fits within the ATO’s risk scale. Once identified, the framework should govern how the business then deals with the risk, e.g. by seeking external advice, preparing a reasonably arguable position paper or seeking a private binding ruling with the ATO.
We have considerable experience in assisting businesses to be ATO review ready, as well as guiding them through the process of establishing a suitable documented tax governance framework and are here to help.