In addition, we have commenced new engagements with a significant number of Next 5,000 groups under the program. These engagements are a combination of:
- streamline assurance reviews
- risk based reviews.
Our key observations of Next 5,000 groups reviewed to date are that:
- A high proportion have governance processes and procedures, but most are not documented.
- Clearly documented roles and responsibilities lead to good tax governance.
- Documentation of the tax return preparation, review process and identification of material transactions helps groups to recognise tax risks and issues to avoid errors.
- Private groups that seek tax advice for material risks and issues are more likely to make correct disclosures and adopt correct tax treatments.
Correctly reported activities
Through our finalised streamlined assurance reviews, we have confirmed that private groups have correctly reported amounts relating to significant activities, events and transactions totalling over $29 billion. This amount comprises:
- $16.5 billion in verified income
- $6.7 billion in verified deductions
- $5.8 billion in other verified items, including
- $2.2 billion in loans to shareholders and their associates
- $1.2 billion in additional balance sheet items, franking account balances, franked dividends paid and net foreign income
- $1.3 billion in tax reconciliation items
- $502 million in tax deductions and tax losses, both deducted and carried forward
- $242 million in capital losses, both applied and carried forward
- $66 million in tax offsets, rebates and credits
- $228 million in GST and other taxes.
Common tax issues
Our key findings in relation to the common tax issues are that some Next 5,000 groups are making errors in their tax returns that could be otherwise prevented. The errors we have observed are due to a lack of documented governance processes, procedures and poor record keeping.
Common tax issues we have observed where we were not able to obtain assurance include:
- Correct reporting matters
- Business as usual – expenditure
- Intra-group transactions – loans or payments to shareholders and their associates
- Sale of significant assets
- Trust distributions
- Related party transactions
- Goods and services tax (GST)
Correct reporting matters
We continue to identify issues with correct reporting. In this regard we have observed a correlation between:
- no documented tax governance processes and procedures
- disclosure errors
- late lodgment
- no lodgment of accompanying schedules to the income tax return.
In these circumstances we request more detailed information to obtain assurance over certain tax issues. We recommend documenting tax return procedures, including a tax return review process, which could also include a lodgment calendar to ensure income tax returns and accompanying schedules are lodged on time.
Business as usual – expenditure
We were unable to obtain assurance over tax deductions in certain circumstances due to a lack of governance processes, procedures and poor recording keeping. Certain expenditure could not be substantiated and a nexus between the expense and assessable income could not be evidenced. A high proportion of these expenses are related party transactions where the reported income derived by a related party was less than the deductions claimed by the other related party. We recommend having clear processes and procedures setting out record keeping requirements for related party transactions.
Intra-group transactions – loans or payments to shareholders and their associates
We found a correlation between poor record keeping, lack of documented governance processes and procedures and not taking enough steps to satisfy Division 7A of the Income Tax Assessment Act 1936. This included loans made through interposed entities. In these reviews, we identified no written loan agreements or minimum yearly repayments and a lack of appropriate record keeping. We recommend that affected clients:
- review their group’s Division 7A compliance
- create a Division 7A annual end of year checklist to ensure accurate and consistent reporting of these loans in
- ledger accounts
- financial statements
- tax returns.
Sale of significant assets
We were unable to obtain assurance over a range of property disposals for the following reasons:
- Insufficient evidence supporting the valuation of capital proceeds and elements of the cost base.
- Miscalculation of cost base including amounts omitted or inclusion of amounts that do not form part of the cost base such as development costs.
- Timing of disclosure of capital gains tax events resulting in the capital gain being reported in the wrong year.
- Mischaracterisations of the sale of property as revenue or capital.
- Incomplete documentation provided to the tax agent resulting in miscalculation of the capital gains tax event.
We recommend implementing processes and procedures to identify material transactions and ensure that these transactions are communicated to your tax agent where applicable.
Trust distributions
We were unable to obtain assurance over trust distributions leading to next actions where there were concerns over beneficiary entitlement to trust distributions, such as distributions paid to the incorrect beneficiary and section 100A. In relation to family trusts we were unable to obtain assurance in the following circumstances:
- distributions made outside of the family group
- inconsistency of documentation regarding individuals set out in the family trust deed and the interposed entity election forms.
In some reviews we concluded that a lack of governance processes and procedures resulted in omitted trust distributions for some beneficiaries within the group.
Related party transactions
We were unable to obtain assurance over revenue recognition relating to related party transactions. In these circumstances we observed a lack of governance processes and procedures potentially resulting in poor record keeping. Some examples include:
- No documented management service agreement.
- Omitted or understated income where incomplete records were provided.
- Aggregate of related party deductions claimed by one related party exceeded income returned by the other related party.
- No formal lease agreement between related parties.
- Unable to assure related party rent as no lease agreement in place and no rental valuation conducted.
Goods and services tax (GST)
We also undertake integrated streamline assurance reviews. Our key observation is that Next 5,000 groups in most instances correctly report GST on significant income tax transactions, events and activities. Over the last year we have expanded the scope of our integrated streamline assurance reviews to look at a broader range of potential GST issues arising from significant activities, events or transactions. We have observed that there are Next 5,000 groups that lack a basic understanding of GST, how GST applies to related party transactions and correct reporting resulting in voluntary disclosures. This includes requirements for registration, tax invoices and classification.
From the GST integrated streamline assurance reviews undertaken to date, we have observed:
- where we see significant omissions or errors at business activity statement (BAS) disclosure labels, the errors and omissions typically relate to
- export sales
- input taxed supplies
- related party recharges
- GST-free items more broadly
- there is a strong correlation between the BAS disclosure errors that we see and a lack of or insufficient governance processes and procedures
- some discrepancies in the income tax return to BAS reconciliations. We found sales reported in BAS being materially higher than sales reported in income tax returns and insufficient explanations provided for the variance. While we do not review GST governance as part of these reviews, this finding does identify governance issues resulting in incorrectly reported disclosures in the BAS and errors in the GST reported
- in several reviews of retail business activities in private groups, increasing adjustments were not made on face-value vouchers where these were unredeemed or expired
- incorrect classification of GST on food items resulting in voluntary disclosures
- incorrect reporting of GST on related party transactions and charges such as management fees resulting in voluntary disclosures
- incorrect calculation of reduced input tax credit entitlements that arose from
- acquisitions from group restructures
- the recovery of GST incurred on expenditure from the acquisition or disposal of investments and merger and acquisition activity.
Tax risks flagged to market
In addition, the most common tax risks flagged to market arising for review as part of streamlined assurance reviews are those described in:
- Practical Compliance Guideline PCG 2017/4External Link ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions
- Taxation Determination TD 2022/11External Link Income tax: Division 7A: when will an unpaid present entitlement or amount held on sub-trust become the provision of 'financial accommodation'?
- Practical Compliance Guideline PCG 2017/2External Link Simplified transfer pricing record-keeping options
- Taxation Determination TD 2007/2External Link Income tax: should a taxpayer who has incurred a tax loss or made a net capital loss for an income year retain records relevant to the ascertainment of that loss only for the record retention period prescribed under income tax law?
- Taxation Ruling TR 2018/3External Link Income tax: tax treatment of long term construction contracts.
Voluntary disclosures
Since the program began, we have received over 290 voluntary disclosures from Next 5,000 groups that total over $86 million in tax, penalties and interest from streamlined assurance reviews.
We have observed a correlation between no documented governance processes and procedures and the most common tax issues resulting in a voluntary disclosure. In these cases, we have made recommendations as to how the group can improve its tax governance framework to prevent such as errors.
Intra-group transactions – loans or payments to shareholders and their associates
Based on the voluntary disclosures received and processed, there was no loan agreements, no minimum yearly repayments or no interest charged at the benchmark rate. In these cases, we recommend record keeping procedures to track the loans and implementing an annual end of year Division 7A check list.
Income and expenses relating to real property
We received voluntary disclosures in relation to overclaiming of real property expenses, such as:
- depreciation
- renovation expenses incorrectly claimed
- capital expenses claimed on revenue account such as acquisition costs and development costs.
We received voluntary disclosures in relation to reporting of real property income, such as:
- omission of rental income from related parties
- wrong entity claiming rental income from related parties.
Sale of significant assets
We received voluntary disclosures relating to the following capital gains tax issues:
- Typo and arithmetic errors in the capital gains tax calculation.
- Undeclared net capital gains tax for the sale of related entities.
- Capitals gain misreported on revenue account.
In these circumstances we recommend:
- A robust review process once the income tax return has been prepared.
- Separation of duty between the preparer and the reviewer of the income tax return.
- Process to ensure significant transactions are identified and your tax agent is notified of these significant transactions.
Trust distributions
We received voluntary disclosures relating to:
- Distributions made that were not in accordance with the trust deed.
- Family trusts with valid elections making distributions outside of the family group.
- Beneficiaries omitting trust distributions.
Personal services income (PSI)
We received voluntary disclosures relating to the application of personal services income (PSI) where the application of the PSI laws was overlooked during the tax return preparation process.
Goods and services tax (GST)
The most common issues in received voluntary disclosures relating to GST include:
- incorrect calculation of reduced input tax credit entitlements arising from investment activity
- incorrect reporting of GST on relation party transactions such as supplies, management fees, division of costs between economic group members
- Division 129 adjustments for change of use relating to property development
- errors in calculation of cost base under the margin scheme provisions.
Tailored technical assistance
In addition to one-to-one engagements, we provide tailored technical assistance as requested by our clients. Between September 2022 and August 2023, Next 5,000 groups made 95 requests for tailored technical assistance, with 75 of those relating to private rulings. This shows that Next 5,000 groups and their advisors are proactive, identify where they need a greater level of certainty and take a conservative approach by seeking our view on the tax treatment of a broad range of issues.
More than 50% of the requests related to domestic structuring tax issues, for example issues relating to domestic transactions within the group or business structure and transfer of assets. More than half of those requests related to succession planning with 21 requests related to trust resettlements where advice was requested in relation to the impact of proposed trust deed amendments.
In addition, we received 9 requests relating to Division 7A, specifically loan agreements and exercising the commissioner's discretion.
The remaining requests related to:
- withholding obligations and other international issues
- deductibility of expenses such as legal expenses and cryptocurrency exchange losses
- asset roll-overs
- general trust and trust losses issues.
This is a similar trend to what we observed in the prior year. It is also a similar trend to the issues we are observing through our one-to-one engagements with the Next 5,000 sub-population and the broader privately owned and wealth groups.
We encourage Next 5,000 groups to approach us to obtain tailored technical assistance where you are not certain or are seeking a greater level of certainty on how our view of the law applies to your circumstances.