This article is Part 2 in a three part series outlining the key tips in managing taxation audits and disputes. Part 1 examined the pre-audit stage and noted how the pre-audit stage of a taxation dispute can often be the most critical. In this Part 2, we examine the audit stage and explore the ways in which taxpayer is able to contain and manage the process.
Cooperation – the soft factor
It sounds obvious, but many people fail to do it. The outcome of a tax audit can very much be shaped by the level of cooperation that the ATO officers feel the taxpayer is giving them. Respect and politeness carry a lot of weight. If the ATO officers feel that the taxpayer is being uncooperative, then they’re likely to explore the use of their strong powers of coercion, which are discussed in detail below.
Cooperation doesn’t mean raising the white flag or allowing the ATO to trawl through your records. Rather, it simply means providing the ATO with what it requests in a timely fashion, providing an explanation for any delay as soon as it becomes clear you won’t meet the deadline, and treating the officers courteously.
An ATO audit often involves managing a battle between perception and reality. The ATO may, understandably, form a view based on the level of cooperation of the taxpayer or an isolated piece of information taken out of context. Perception can be decisive.
Periods of review – the hard factor
Under section 170 of the Income Tax Assessment Act 1936 (Cth), the Commissioner of Taxation (Commissioner) is generally only permitted to review a Notice of Assessment within four years from when it was first issued. This means that many tax audits are confined, or at least the taxpayer attempts to confine them, to a four year period. There are a number of situations where the Commissioner can extend the period of review. The most common situation is where the Commissioner makes a determination that there is “fraud and evasion” – in such circumstances the Commissioner has no limitation on its power to review assessments for past years.
Accordingly, half the battle in managing a tax audit and the risk of an amended assessment is ensuring that there is no basis for a finding of “fraud and evasion” so as to enable the Commissioner to go back indefinitely. This can be achieved by management of the way information is presented to the Commissioner. Further, there is less likely to be a finding of fraud and evasion where a taxpayer makes a carefully and considered voluntary disclosure of the tax shortfall. The process, however, needs to be very carefully balanced so that the disclosure is sufficiently detailed as to bind the ATO, which can refuse to accept that a disclosure has been made where relevant facts are withheld.
In cases where the ATO obtains information or material that leads to (or may lead to) a finding of fraud or evasion, this not only opens up the power for indefinite past years’ review but also the almost certain involvement of the CDPP. Every ATO audit group either has a staff member who is an Audit Prosecution Case Officer or who is responsible for this role.
It’s very important to note that the limitation on the power to amend assessments for past years outside the four year period requires that an assessment must have been issued for a year. In the event that no taxation return has been lodged for a year, there will generally have been “no assessment” and the Commissioner is free to issue an assessment at any time.
ATO access to information
The Commissioner has statutory search warrant powers that, when exercised properly, entitle him to full and free access to all buildings, places, books, documents and other papers; he may make extracts from or copies of any such books, documents or papers. It should be noted that the Commissioner is not entitled to remove original copies of documents under section 263. The following principles apply to such inspections:
- The Commissioner’s powers do not extend to documents to which LPP applies;
- There is no requirement that prior notice be given;
- The information that is sought is not limited to the taxable income of the occupant;
- Where reasonable assistance is not provided, the ATO are entitled to use reasonable force to access documents;
- The common law privilege against self-incrimination is not a valid reason to not provide the required assistance.
The ATO’s powers of access are extremely wide and are statute based. In practical terms, the ATO’s powers may be thought of as a statutory search warrant that does not require any involvement of a court. Every audit officer carries what is effectively a statutory search warrant in the form of an identity card that entitles access pursuant to this power.
Relevant Australian case law on this issue has not only interpreted the ATO’s powers very widely but have also determined that an “occupier” of premises (whether or not that person is the taxpayer) have significant obligations to provide “assistance” to ATO officers who are exercising this power. Typically the ATO would seek to use these powers in gaining access to records from the premises (home or office) of a client’s accountants, bankers or other advisers.
In addition to the extensive power to exercise what is effectively a statutory search warrant, the ATO also has a very wide power to compel the attendance of persons to give evidence and produce documents and records. The Commissioner can require a person, whether or not a taxpayer, to provide it with any requested information and to attend to give evidence in respect of that, or another, person’s income or tax assessment. In practice, such interviews are one of the most effective methods that the Commissioner has in obtaining information.
The Commissioner may exercise these powers in a wide fashion, including for “fishing” exercises. The only real restriction is that the power be exercised for the purpose of administering the tax laws. The ATO can also compel a person (under threat of prosecution) to answer questions notwithstanding the fact that the answer to the question may expose the person to criminal prosecution. The self-incrimination defence at common law is specifically abrogated by the relevant statutory provisions. Accordingly, it’s absolutely vital that great care is taken in these examinations. It’s imperative that a person called to give evidence in accordance with such powers obtain legal advice prior to the interview being held. The Commissioner commonly utilises false or misleading evidence provided at such interviews to make a subsequent finding of “fraud and evasion” in an assessment. In our extensive experience, it’s an area where significant expertise must be brought to bear. We often see cases where problems arise that could easily have been avoided. The ATO officers who conduct these examinations usually come well prepared. Taxpayers are advised to be similarly prepared.
Legal professional privilege – a requiem
We discussed the most important aspect of managing a taxation dispute is to manage the information flow with ATO. Communications with your accountant or other professional or any colleague are not privileged. That is, the substance of the communication or even the commentary that has been exchanged is susceptible to be grabbed by the ATO or other State or Federal Government body. As noted above, the ATO, in particular, has express powers under the tax laws to seek documentation from your accountant and to require them to attend and answer to an interview. The failure to comply with such requests or to answer their questions truthfully is a criminal offence. Providing instructions to your accountants may force them to choose between “dobbing you in” and protecting you.
For these reasons, it’s critical that a client’s instructions to their adviser be protected during a tax audit. For this reason, it’s proper for the client to give instructions to a tax lawyer as opposed to an accountant. If the services of an accountant are required for the conduct of the audit, which is often the case; the accountant should be engaged for the purpose of the client obtaining legal advice or in contemplation of litigation. This will enable the communications in relation to the work undertaken by the accountant to be subject to LPP.
In this Part 2 of our three part series we emphasised that the key to managing a taxation dispute is controlling the narrative and the information flow during the audit stage. In Part 3, we explore the post audit stage.