Now that the 2013 income year has ended, and taxpayers and tax agents start to prepare for the yearly lodgement of income tax returns, it is critical for taxpayers and their advisers to understand when they might be failing to declare income and the costly consequences of doing so.
A taxpayer can fail to declare income in a number of situations and in our experience, sometimes without even knowing it. These include:
- Receiving money or property which is assessable as income. The taxpayer knows this but deliberately chooses not to declare the receipt as income.
- Receiving money or property which is assessable as income. The taxpayer believed that the receipt is not assessable and does not declare it as income.
- Receiving money or property which is not assessable as income. The taxpayer did not keep sufficient records and evidence to support the position that the income is not assessable. Accordingly, upon being reviewed or audited by the ATO, the taxpayer cannot disprove the ATO’s assertion that the receipt is undeclared income. The taxpayer and not the ATO has the burden of proving that the ATO’s assessment is incorrect (per Section 14ZZK(b)(i) of the Tax Administration Act 1953 (Cth)).
- The taxpayer not knowing that he or she became an Australian tax resident during the income year and is therefore subject to Australian tax on worldwide income. The taxpayer thereafter declared income on an incorrect understanding that it was an Australian tax non-resident who is only subject to Australian tax on income earned in Australia.
Why should I care? What are the consequences?
If the ATO concludes that a taxpayer has undeclared income, the taxpayer is generally liable for tax on the undeclared income plus interest charges and penalties.
Assuming that the taxpayer is an individual, he or she is liable to pay tax at individual marginal rates on the undeclared income. Interest charges accrue at a daily compounding rate of 9-10%p.a. since the year that the undeclared income should have been declared. Penalties of up to 75% of the undeclared income might be imposed if the taxpayer knew that a receipt was income but deliberately chose not to declare it.
As an example, the ATO asserted that one of our clients did not declare income of approximately $300,000. This resulted in a total tax debt of approximately $600,000 (including shortfall tax on the undeclared income, interest charges and penalties); a financial burden that could have been easily avoided.
Fortunately, we were able to provide evidence to demonstrate that these amounts were not in fact income, and the total tax debt was eliminated.
Will I be caught?
ATO information gathering powers and resources are wide and freely used.
In recent income years the ATO has focused its resources on identifying taxpayers who have undeclared income. The ATO collects information from various sources, both with and without the taxpayer’s knowledge, including banks, share registries, employers, merchants and government departments and compares this information with a taxpayer’s income tax return.
If the ATO identifies discrepancies (for example, discrepancies in a taxpayer’s spending habits and income as declared in income tax returns, or discrepancies in total cash received by a taxpayer in its bank accounts and income as declared in income tax returns), the taxpayer may be examined by the ATO and may subsequently be formally audited.
For the coming income year of 2013-2014, the ATO has indicated that it will continue to focus its resources to identify taxpayers who have undeclared income. In particular, the ATO intends to expand its information collection processes.
Remember that the ATO can review a taxpayer’s income tax returns for the past two to four years (and can go back indefinitely if the Commissioner considers there is fraud or evasion).
What can I do now?
Inform your clients of:
- The severe financial and perhaps even criminal consequences of deliberately under declaring income.
- Seek professional tax advice if they are unsure if money or property received should be declared as income.
- Consider whether your clients which are based in or posted overseas are Australian tax residents – the ATO has been looking closely at this question for many individuals who move funds to and from Australia. If they are unsure whether they have become an Australian tax resident, seek professional tax advice.
- The importance of keeping records and evidence in support of the nature of a receipt.