Tax affairs 101

Some boards make the mistake of not worrying about tax until something goes wrong. However, as Christopher Niesche discovers, being proactive about tax issues can help directors plan their organisation’s tax affairs better and head off potential problems.

The Australian Taxation Office (ATO) knows more about individual businesses than ever before, which is something small and medium-sized enterprises (SMEs) need to remember when they approach their tax affairs.

More and better real-time data from Australia and overseas, and advances in computing mean the ATO is making more use of analytics to track businesses’ financial and tax performance, and to compare them with industry benchmarks.

“The message I’m always giving to my clients is don’t assume that the ATO doesn’t know, so make sure you’ve got all your paperwork in place and all your compliance up-to-date,” says Pitcher Partners’ tax partner Theo Sakell.

“The data analytics is a lot more robust and detailed. The ATO has a lot more information available to it which it is now using effectively to risk profile SMEs to the point where we’re getting information put to us that even our clients are not aware of.”

This has increased the pressure on SME directors to ensure that their company’s tax affairs are in order and that they are up-to-date with changes that will affect their company.  The ATO is also being more aggressive in its policing and enforcement of SMEs’ tax compliance. Under laws that came into effect in 2012 and are still working their way through Australia’s boardrooms, directors may be personally liable for unpaid staff superannuation contributions, adding to their existing liability for unpaid Pay As You Go tax. Associates of directors, such as family members, can also be affected – for example, if the ATO collects the director’s penalty by removing PAYG tax credits to associates.

“The changes to the director penalty notices regime and extra activity from the ATO in imposing director penalties, particularly on SMEs, have been notable over the past two years,” says Joanne Dunne MAICD, a tax partner at Minter Ellison Lawyers. “For tax related matters, a director’s fiduciary responsibility to a company can result in a personal liability.”

Further, several court judgments over the past few years, such as the James Hardie and Centro cases, have demonstrated that relying on expert advice does not abrogate a director’s duty to ensure that a company is complying with its tax and legal obligations.

“The ATO has leapt onto that sort of thinking and has specifically stated that directors are ultimately responsible to test and assess the tax positions taken by their companies,” says Dunne. “The ATO is really emphasising that the board should understand and test the advice it gets and it shouldn’t just blindly rely on it.”

Dunne says boards should use more than one tax adviser. “Don’t just rely on one accountant’s view for 20 years. Get that view tested every now and then,” she says.

Also, directors should insist that their advisers give them regular updates on tax changes through seminars and newsletters to ensure that they are across issues that might affect their businesses.

“Good advisers do that stuff for free because they care about your business,” she says.

The ATO is very clear that it sees tax oversight as a core responsibility of the board. It says directors must check that their business has a sound framework in place to manage tax risks and comply with tax obligations. Directors’ governance and process obligations include:

• Demonstrating an understanding of their risk categorisation.
• Ensuring a well-resourced in-house tax governance capability exists to mitigate tax risk and provide a capacity to regularly audit tax governance systems.
• Having appropriate review and sign-off procedures for material transactions and reporting requirements, which ensure that significant tax risks are elevated to the board.
• Having systems to identify, assess, monitor and approve material tax issues.

Anita Paddock, a partner in tax management consulting at Deloitte, says directors need to satisfy themselves that management is dealing with the day-to-day compliance and operational issues. “Directors should be putting into place what’s called a tax governance policy – basically a high-level document setting out for the organisation what the framework is for managing tax risk; where the responsibilities lie for tax governance and tax risk; and what is the overall appetite for tax risk in that organisation. For example, what sorts of transactions are acceptable and what sorts aren’t acceptable,” says Paddock. “They should then ensure the policy is rolled out and understood by the finance managers and the tax managers, if the organisation has tax managers.”

Paddock says there has been a lot of focus on tax in the media over the past couple of years, covering the political debate and concerns about companies such as Google and Apple not paying their fair share of tax in Australia. This increased attention means there is a risk that directors can get too involved in the day-to-day tax affairs of their companies while perhaps not fulfilling their oversight function. “The overriding message in relation to tax is that the director’s overall role is still to provide the strategic framework and the overall governance of the organisation and to be able to take a step back,” she says.

“The environment is ever more complex and more rapidly changing and there’s a lot to take in from the directors’ point of view this year.”

Some of the changes to tax legislation are sufficiently minor and technical for directors to leave them to the company tax experts. However, one change directors need to be aware of is that under laws to take effect from the 2013-14 financial year, companies with a total income of more than $100 million will have their total income, taxable income and income tax payable disclosed by the ATO.

“This is a big change from the past, because up until now companies’ tax affairs have all been bound by secrecy arrangements,” says Vince Tropiano, a tax partner at Grant Thornton Australia. “This implies a change in mindset and possibly an attempt to put the spotlight on medium and larger companies suspected of not paying their fair share of tax.”

While the change won’t affect companies’ tax strategies or how much they pay, directors will need to consider how the release of this information could affect public perceptions of their company. “Our discussions with companies in that space have revolved around getting on the front foot, maybe highlighting the position yourself, putting something on the website and highlighting the contribution that the company makes to the economy in terms of other tax payments, the employment of staff and the tax it has generated,” says Tropiano. “A situation where there might be a release of two or three bald pieces of data will not give a true indication of a company’s contribution to the tax network, so it’s important that directors consider the public relations aspect of this to highlight what the company’s doing in a more positive manner.”

Directors also need to monitor their business’ ongoing funding structure to ensure they do not fall foul of recent changes to thin capitalisation rules, which put limits on how much debt a business is able to claim as a tax deduction.

“Directors should be actively reviewing their balance sheets to ensure they’re not over-geared,” says Sakell, although he notes that the new rules will apply only to those businesses with $2 million or more in debt deductions.

The changes come at a time when the media is paying more attention to the tax affairs of large companies – particularly the local arms of international companies – and are a reminder that it is more important than ever that directors stay on top of tax affairs.

Greg Travers, head of tax at professional services firm William Buck, says most directors do not have a background in tax and sometimes their companies – particularly if they are private – will not have a dedicated tax function in their finance team. As a result, they need to find the skill-set to consider complex issues and will often have to look outside to external advisers. However, private businesses often do not even get this far, simply because they do not have tax on the board agenda. Instead, they deal with tax on a reactionary basis – for example, after an audit or query from the ATO.

“Unless you’re proactively managing your risk, you are quite likely to run into problems,” says Travers, stressing that to understand their current risk profiles, directors should ask their tax advisers where their risk issues lie and what might trigger a tax office audit.

When there are significant and out of the ordinary transactions, directors need to feel confident that these are being brought to them for their review and consideration of the tax implications. Other events to watch out for include selling overseas into a new market or launching a new product.

Directors need to ask early on in the process about the tax implications of any of these events. They should also diarise filing dates and check that they have not been missed, rather than just assume the accountants have done it.

For SMEs and private companies, transactions with shareholders or related parties – covered under Division 7A of the Income Tax Assessment Act 1997 – can trigger a query from the tax office. This is a key focus of the ATO and is likely to attract even more attention in the coming years. This issue is likely to feature prominently in the Abbott government’s upcoming white paper on tax and it is unlikely that the government will make any wholesale changes to the tax system before then.

The government promised to release the paper in its first term, but has not yet released terms of reference or a date for the inquiry to start. Nonetheless, directors should follow the debate so they can prepare for any tax changes.

“We encourage people to look at the issues the government and the tax office are talking about and to pay attention to those,” says Travers.

International transactions, the minimisation of tax through arrangements with associates and transfer pricing are major issues which are likely to feature in the paper, as are trusts which operate businesses or are owned by shareholders. Anti-avoidance rules, known as Part IVA, may also feature. “Know what is coming up, because then you can be looking for it, asking questions and understanding it,” says Travers.

While the tax system might well change in the future, many of the principles of tax governance of a company remain the same.

Directors should be doing everything they can to avoid being audited by the ATO. Even if their company is found to have done nothing wrong, audits are expensive and time consuming.

Although it sounds obvious, making sure the annual tax return is correct is the first step. Travers says a company’s tax return should not be considered just as a compliance obligation, but also as one of the main ways an SME communicates with the ATO. The tax office checks for internal consistency between wages and superannuation, as well as any international transactions – and these are the sorts of things that can trigger an audit.

There are a few things that will catch the ATO’s attention, which boards should be aware of.

The first is filing dates. A company needs to stay on top not just of its annual tax return filings, but also of its GST and superannuation filings. It is worth remembering that a company with a good compliance history is much less likely to be audited than one which has in the past missed key filings or payments.

Second, directors should be told if there are any queries or inquiries from the ATO. They should also check how good their organisation’s relationship with the tax office is in general.

Some boards make the mistake of not worrying about tax until something goes wrong or until the annual tax return is due. But not taking a proactive approach means companies can miss opportunities to plan their tax affairs better and to head off any potential problems.

Boards should try to talk to their tax advisers a couple of times a year to ensure they have their fingers on the pulse.

Dunne says a very good resource for directors is the ATO’s compliance program – an annual update from the tax office detailing its areas of focus for the coming financial year, issued around July each year. Boards can use the program as a basis for questioning their tax advisers as to whether any of the issues identified might affect their company and their risk profile.

The ATO notes that around 98 per cent of medium-sized businesses – those with a turnover of $2 million to $250 million – are privately owned. As a result, in the current 2013-14 compliance program it is paying close attention to complex business structures which aim to avoid tax and superannuation obligations.

“Compared with public companies, not all private groups are required by corporation law to fully disclose their financial activities and this may provide opportunities for inappropriate tax planning,” the ATO has warned. “We have developed ‘data-mining’ tools that help us understand the relationships between individuals, trusts, partnerships and companies within a group. We then focus on these groups and key decision makers to detect all income, assets and any compliance irregularities.”

The ATO will also be chasing up medium-sized businesses for outstanding lodgements, particularly trusts, partnerships and entities within privately owned groups.

“Compliance issues among privately owned groups include shareholders accessing tax-free company funds through inappropriate shareholder loans; individuals using business funds for personal expenses; and shareholders using the business’ lifestyle assets for private purposes,” the ATO says.