During 2010 the Tax Office identified around 110,000 taxpayers who it believes may be participating in the cash economy. In August, the Tax Office revealed that it had sent letters to each of these taxpayers and presumably a number of them will be subject to a full scale tax audit. How does the Tax Office decide whether someone is operating in the cash economy? This article looks at some of the Tax office methods.
The Tax Office has developed a number of small business benchmarks that it uses to identify whether small businesses are operating within a particular industry average. If you are operating outside that average it is a red flag that you may be operating in the cash economy.
58 industry benchmarks have been released by the Tax Office. The benchmarks are grouped into categories based on the business industry codes in the tax return.
Let's have a look at an example of a business operating in the tiling Industry. Assume Barry runs a tiling business as a sole trader called B&B Tiling. Barry generally does all the work himself including installing the tiles, pitching for work and the accounts. Occasionally he utilises a sub-contractor to help with deadlines. The business installs ceramic, clay, slate and glass tiles and it charges between $40 and $120 per sq metre (all inclusive).
Let's assume that a review of Barry's work diary reveals that B&B Tiling completed 44 jobs in 2010 with most lasting about a week. Barry worked a total of 204 days during the 2010 income year. Most of these jobs would have been in excess of 50 sq metres.
In the "total business income" label in the 2010 Tax Return, Barry declared $149,000. From this Barry deducted expenses incurred in obtaining that income, including the cost of materials, expenses for sub-contractors ($17,000 in payments), lease expenses for a small warehouse where he stores the tiles, depreciation of plant, motor vehicle expenses and repairs. As Barry lives in a rural community and often travels long distances between jobs his motor vehicle expenses are high.
Barry's total net income as declared in his Tax Return is $92,000. Will Barry receive a "cash economy" letter? In all probability the answer is yes.
This is because the ATO Tiling Industry Benchmarks indicate that one tradesperson completing 44 jobs per year that average 50sq metres should obtain a gross income figure of between $154,000 and $275,000.
In addition Barry's labour costs are too high as a percentage of his total turnover which should come in at less than 10% (rather than 11.3%) of total turnover.
Finally the ATO also say that because of the itinerant nature of tiling work, only a small number of tillers actually have rent expenditure so this is another reason that the Tax Office may choose to have a closer look at Barry's position.
Of course, just falling within the industry benchmarks is not enough to keep you off the Tax Office radar. The Tax Office also has a motor vehicle data matching program. Under this program they request details from relevant state RTAs on motor vehicles sold, transferred or newly registered for more than $10,000.
So if Barry had actually declared total net income of $200,000 but had purchased a $80,000 BMW in 2010, he could still be subject to ATO questioning notwithstanding that he is well within the industry benchmark range.
Norman Elliott
Divisional Leader, Business Services
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