The Australian Taxation Office (“ATO”) has announced that it is currently writing to large businesses about the ATO’s assessment of their level of tax risk and that it is looking to meet with the senior executives of those taxpayers to explain their assessment. These tax risk assessments address issues relating to income tax, goods and services tax and excise.
The ATO has categorized large taxpayers (generally defined as taxpayers with a turnover in excess of A$250 million) into four groups:
• Higher risk taxpayers;
• Key taxpayers;
• Medium risk taxpayers; and
• Lower risk taxpayers.
These categorizations are based on the ATO’s assessment of:
• The taxpayers likelihood of non-compliance (which is further defined as having a tax outcome with which the ATO disagrees); and
• The consequences of non-compliance (taking into account the amount of dollars, the risk to reputation and the potential precedential value).
While the risk rating attributed to a taxpayer does not pre-determine the outcome of any tax review by the ATO, it does influence the likelihood and regularity of a review, as well as its formality and intensity.
The ATO’s Risk Differentiation Framework
In assessing the risk associated with all large businesses, the ATO:
• Examines the relationship between significant transactions and financial outcomes, identifying any inconsistencies between tax and economic outcomes;
• Specifically looks at potential profit shifting activities through non-arm’s length transfer pricing, thin capitalization and debt generation; and
• Reviews material transactions such as mergers and acquisitions and business restructurings that may result in “opportunistic” tax planning.
The ATO uses a range of risk filters, reviewing the taxpayer’s prior-period financial data and comparing those results against other taxpayer’s data. It also considers:
• The taxpayer’s past compliance profile;
• The taxpayer’s tax risk management governance processes and history;
• The taxpayer’s tax outcomes as compared to its business performance;
• The taxpayer’s material events and transactions;
• Industry data and trends;
• Other intelligence sources where material risks may be identified (including information shared by other Australiangovernment agencies and foreign governments);
• Potential risks arising out of new tax laws; and
• The level of international dealings and their tax outcomes, relative to the taxpayers functions, assets and risks.
The expanded disclosure requirements in taxpayers’ tax returns (such as the new international dealings and the reportable tax positions schedules) are examples of the increased transparency of taxpayers’ businesses to the ATO, and of the ATO’s attempts to increase the efficiency and effectiveness of its compliance management programs.
Risk assessment consequences
“Higher risk taxpayers” will be subject to real time and continuous risk reviews that will be designed to enable the ATO to identify and assess risks as they arise. The ATO expects that given these taxpayer’s risk profiles, it is more likely to use its formal information gathering and review powers. The ATO expects that this group of taxpayers will be relatively small. Determinative factors for this categorization are likely to include the taxpayer’s relative size, the nature and complexity of the transactions that they undertake, their apparent effective tax rate and/or their compliance history.
“Key taxpayers” will also be monitored continuously. The ATO expects that most large businesses will be in this category as they have a significant influence on the tax system and the amount of tax collected. The ATO encourages these taxpayers to continue to work with the ATO in relation to their tax affairs, including where appropriate seeking tax rulings and entering into annual compliance and advance pricing arrangements. The ATO expects less formality in the management of these taxpayers and for issues to often be resolved through alternative dispute resolution methods.
“Medium risk taxpayers” are likely to receive periodic or specific-issue reviews. These specific issue reviews (such as transfer pricing) are likely to be as part of industry-specific or issue-specific ATO compliance programs.
“Lower risk taxpayers” should be subject only to periodic monitoring which likely involves targeted information about specific issues, normal internal risk reviews and monitoring as well as periodic meetings. Such taxpayers are unlikely to be subject to significant compliance activities unless the ATO has particular cause for concern about an issue.
What does this mean?
Large taxpayers will either have received or be about to receive a letter (and visit) from the ATO to discuss their risk assessment. Large taxpayers will need to assess how to either improve or maintain their risk rating, taking into account the ATO’s key criteria and the ATO’s views on the relevant issues.
Small to medium enterprises (SMEs are generally defined as taxpayers with a turnover of between A$10 million and A$250 million) need to take the ATO’s views on risk into account in assessing their own risk profile. A number of SME taxpayers will be considered to be material with respect to the integrity of the tax system and will therefore need to manage their tax risk profiles accordingly. Although there is no indication that the ATO will follow this same process with SME taxpayers, such SME taxpayers should take the time to review and understand the ATO’s approach and adjust their compliance practices (if necessary) to reduce their risk.
Transfer pricing, thin capitalization, debt structuring and business restructuring remain high on the ATO’s risk assessment profile. The ATO has provided a range of guidance on these issues in its tax rulings program. The proactive management of these issues should remain high on taxpayer’s agendas, irrespective of their size and should take into account the ATO’s stated interpretations of these issues.
This would include preparation of annual transfer pricing documentation in accordance with the ATO’s recommended “Four-Step Process”, and detailed economic analysis to test the arm’s length nature of all material international related party transactions.
Taxpayers with complex and high value issues and an aversion to tax risk should consider using the ATO’s tax rulings, annual compliance arrangement and advance pricing arrangement programs.