We all want to stay on the ATO’s good side. No one wants to invite a tax audit. But, at the same time, it is prudent to investigate all opportunities to minimise the amount of tax we pay.
This often requires a balance between minimising taxes wherever possible, but not being too aggressive that you risk getting into trouble with the ATO. My view is that you always stick within the black letter of the law – never transgressing into any grey areas – as it’s never worth it in the long run.
The ATO has made some significant changes lately that I want to bring to your attention. These changes might encourage you to review how to manage your finances.
ATO: 90% of property investor tax returns have errors
The ATO announced in April that it will double the number of audits of property investor tax returns to 4,500. It said that its data indicates that 90% of property investor tax returns contained errors. The ATO found four main errors:
Errors included incorrectly claiming interest that was not tax-deductible (i.e. debt was not used to produce taxable income e.g. home loan) and/or loan purpose was not able to be proven by the taxpayer e.g. they mixed purposes in one loan.
It is likely that interest is your largest tax deduction, so you must take care in not compromising it. Make sure your loans are correctly structured as I have previously described here. And keep good records i.e. you can demonstrate what investment asset each loan relates to.
In short, separate loans by asset i.e. separate loan/s for each property or investment – avoid having one loan for multiple purposes. And if you refinance and/or loan amounts change, keep thorough records.
Claiming improvements as repairs
In short, a repair brings an asset back to the same condition it was in when you first acquired the property. An improvement on the other hand is improving the asset beyond its original condition and/or changing the nature of an asset.
The cost of repairs can be claimed in full in the year they are incurred whereas an improvement must be depreciated over its useful life.
The ATO does provide some guidance in its website here but sometimes its not easy to ascertain whether a cost is a repair or improvement or both, so in that situation you should obtain tax advice.
The ATO’s main concern is making sure that any deductions claimed in respect to holiday homes that are rented out for part of the year are correctly apportioned. Apportionment of expenses must take into account whether the property was rented at a rate below market (to friends or family), whether it was available for rent during peak periods, if the owners unreasonably refused tenants and whether the owners genuinely took steps to find tenants during periods it wasn’t occupied.
If you own a holiday house that is partly rented out and partly occupied, ensure you use the services of an experienced registered tax agent.
The onus is on the taxpayer to prove a tax deduction is legitimate. In the absences of said proof, the ATO will simply deny the deduction. The ATO found that many taxpayers failed to produce sufficient evidence of expenses claimed e.g. receipts.
I always recommend that you ask your managing agent to pay for all expenses from the rental income they collect. To do this, change the delivery of all bills or forward each bill by email. Doing so means you no longer need to take responsibility for the record keeping. At the end of the financial year, the agent can provide you (and your accountant) with a report itemising all income and expenses for the year. This saves you a lot of time, hassle and extra work.
The ATO will receive descriptions for the first time
For the first time, the ATO will receive the line entry data for all deductions, including work-related expenses. Previously, the ATO would only receive the dollar value deduction total for each section in your tax return (e.g. D1 is work-related car expenses, D2 work-related travel expenses and so on). From 1 July 2019, the ATO will receive an itemised listing. This will have two consequences.
Firstly, the ATO will be able to use artificial intelligence software to crawl through all tax returns to identify the returns that they would like to audit. They will compare your deductions to the average for your occupation, to identify large or unusual claims. Its system will then automatically generate audit letters.
Secondly, it is important to use the correct descriptions in the correct section. For example, here are a few suggestions:
- Do not use generic descriptions such as “various receipts” or “general home office expenses” in your returns; and
- Ensure you claim the right expenses under the right labels. For example, parking and tolls should be recorded under “D2 – work related travel expenses” rather than “D1 – work related car expenses”. And work-related education expenses should not be claimed under D5.
ATO may ask for a letter from your employer
The ATO has begun writing to taxpayers requesting a letter from their employer verifying any work-related tax deductions. For example, if you have claimed car expenses, it will request you to provide a letter from your employer confirming how you are required to use the vehicle in the course of carrying out your employment duties. This also applies to other common work-related expenses such as mobile telephone and internet expenses.
The ATO has increasingly powerful data matching and analysis capabilities which means its even more important that you are especially careful with the deductions that you claim. For example, to claim internet costs you should have a letter from your employer and/or maintain a usage logbook for four weeks of the year. I doubt many taxpayers would currently be doing this. This page on the ATO’s website provided more information about work-related deductions.
Remember, the taxpayer carries all the risk
You, the taxpayer, carries all the risk for any errors in your tax return. This means, assuming your tax agent hasn’t been negligent in providing their professional services, if the ATO audits you and denies a tax deduction, you will have to bear the full cost of any interest and penalties.
What are the penalties and interest?
If the ATO amends a previous assessment, not only will you have to pay more tax, but you may also have to pay penalties and interest.
The interest you pay is in respect to the tax that you should have otherwise paid and is called the shortfall interest charge. The current shortfall interest rate is 4.54% p.a. (see here).
The amount of penalties that the ATO seeks to charge will depend on your circumstances. If it deems you have ‘failed to take reasonable care’ it will charge 25% of the tax payable as a penalty. If you have been ‘reckless’, the penalty will be 50%. And if you ‘intentionally disregarded the law’ you will pay 75%.
If you do receive an audit letter
Make sure you consult with your tax agent as soon as you receive a letter from the ATO. It is important that you comply with all information requests on a timely basis. It is also important that an experienced tax agent represents you so that all legitimate tax deductions are correctly verified. And if penalties are payable, the tax agent may be able to negotiate with the ATO on your behalf.
You can obtain tax audit insurance to cover the cost of accountancy and legal fees if you are audited by the ATO. This cover is worth considering, especially if you are self-employed or have complex tax affairs. Ask your accountant about this.
Start preparing now for the 2019/20 financial year
Talk to your tax agent over the next few months to ensure you will be able to legitimately claim any expenses you think you are entitled to. Your tax agent will be able to stipulate what information the ATO will require. You then have 10 months left in the financial year to organise it. Leaving it until June 2020 might be too late.
Astute tax planning advice that doesn’t cause you problems
The ATO’s digital tools and information are greatly enhanced each year. This means you and your advisors must ensure you keep on top of all your taxation compliance matters. It is equally important that you receive strategically astute advice in respect to income and investments to legally minimise your current and future taxation liabilities. Of course, we’re here to help.