Despite the considerable audit powers enjoyed by the Australian Taxation Office (ATO), it’s often taxpayers themselves that cause the most damage during an audit process. This can range from the failure to cooperate or the provision of (innocently or not so innocently) incorrect answers to seemingly innocuous questions from the ATO at the very beginning of the audit process.
This article is Part 1 in a three part series outlining key tips in managing an audit by the ATO – the most important of which is to obtain appropriate advice and representation from the very beginning.
Understanding the wider regulatory environment
Since 2005, tax enforcement has come to the forefront of public consciousness in Australia. Project Wickenby, a multi-agency taskforce, has exhausted extensive public resources in pursuit of persons who have established, are engaged in or who have benefited from tax avoidance schemes. The public has watched with interest as the Australian Crime Commission has initiated prosecutions against well-known figures, such as Glenn Wheatley, and the Commissioner of Taxation has commenced tax recovery proceedings against others, such as Paul Hogan, Phillip Egglishaw and Robert Agius. The role of Project Wickenby means that proper management of the audit process from the very beginning is critical for containment.
There has been criticism of Project Wickenby’s capacity to achieve results and some have questioned its continued viability. However, recent reports and events suggest that, to paraphrase Mark Twain, “[t]he reports of [Wickenby’s] death are greatly exaggerated”, with the ATO announcing that Wickenby will investigate a further 500 persons in connection with overseas tax havens.
Project Wickenby, combined with other developments such as anti-money laundering measures, has significantly increased the ATO’s enforcement armoury. The days of believing that the ATO won’t notice your non-compliance are over. Given the tools it has available to it, often the ATO knows more about your own affairs than you do.
In light of the continued, and possibly permanent, role of Project Wickenby on the tax landscape, a reminder of good practices, and things to avoid, in managing an ATO audit is timely.
The outcome achieved in a taxation dispute is often determined by how it’s managed from the very beginning. This starts with the way in which the matter is controlled and how the interaction with the ATO auditors is handled. Consequently, all interaction with the ATO should be handled with great care and consideration. It is, in our opinion, essential that a careful review of the legal issues is undertaken and based upon fully frank and detailed instructions by the client; problems often arise when advisers unwittingly make statements to the ATO which aren’t strictly correct. The maintenance of legal professional privilege is absolutely essential in the process and we have addressed this matter separately below. As a matter of policy, the ATO will always investigate leads and potential sources of possible serious non-compliance with the Australian revenue laws.
Accordingly, this means that the pre-audit stage is often the most critical stage of a tax audit and that legal advice should be obtain prior to any communications with the ATO.
Initial review of taxation affairs
Planning should start with forming an initial understanding of any weak areas in terms of tax compliance. This should preferably be done by taxation lawyers in consultation with other professional advisers, but subject to always ensuring privilege over instructions. The appropriate approach to be taken is subject to the type of potential non-compliance. Compliance problems can arise in two forms:
- Potential non-compliance - where it’s not clear whether an arrangement is in compliance with the law. These often involve questions of the technical application of the law;
- Blatant non-compliance - usually involving blunt tax avoidance arrangements, including the holding of funds in off-shore bank accounts maintained in “secrecy havens”.
Blatant non-compliance – the merits of a voluntary disclosure
In the case of more blatant tax non-compliance, clients should (in appropriate cases) give strong consideration to making a voluntary disclosure in accordance with Division 284 of Schedule 1 to the Taxation Administration Act 1953 (Cth), but based upon advice and following careful legal assessment of the applicable risks. Making a voluntary disclosure may be a useful way of containing and managing the ATO and the way that the matter is to proceed.
Experienced legal advisers will provide guidance as to both the content of the information that should be given to the ATO and how it should be presented. This can be the difference between the imposition of an administrative penalty and the commencement of criminal prosecution. A carefully managed voluntary disclosure will significant reduce the risk of a criminal prosecution.
Apart from reducing the risk of criminal prosecution, a voluntary disclosure will also lead to a significant reduction in any shortfall penalties to be imposed. The law provides whether a voluntary disclosure is made prior to the commencement of audit, there will automatically be a reduction of 80% in the penalty to be imposed.
Protection of legal professional privilege
The issue of legal professional privilege (LPP) is critical given the wide nature of the Commissioner’s information access powers during an audit. LPP protects:
- confidential communications between a client and the client's legal adviser for the dominant purpose of obtaining or giving legal advice; and
- confidential communications between a client, the client's legal adviser and third parties, for the dominant purpose of use in relation to pending litigation or contemplated litigation.
However, it should be noted that a document is not protected by the doctrine of LPP if it’s part of preparing for, or furthering, a crime or fraud, including a “sham contrivance”.
Systems for the protection of LPP should be implemented in the pre-audit stage if possible. A simple method is to ensure that any non-lawyers (such as the client’s accountants or other financial advisers) that are engaged to provide services in relation to the issues are engaged by the lawyers as opposed to directly by the client. This assists in preventing a dispute as to whether work was undertaken for the dominant purpose of contemplated litigation or giving legal advice.
Communications between an accountant and a client will not generally benefit from LPP and will expose the client to a considerable risk to prosecution in respect of statements as to wrongdoing or knowledge of matters. However, the ATO has adopted a policy of respecting privilege between accountants and clients. This has been referred to as the “accountants’ concession”.
The first thing to note in respect of the accountants’ concession is that it is only a policy of the ATO – it has no basis at law. Further, the privilege under the accountants’ concession is quite limited in comparison to LPP. In a recent decision of the Federal Court, Stewart v Deputy Commissioner of Taxation  FCA 402, the limitation of the accountant’s concession was noted when Perram J stated:
“The concession is not, and could not be, a rule of law. It is plain that no other party apart from the Commissioner is affected by it. In particular, it was not, and it could not have been, suggested that the material seized by the ACC under warrant was immune from production under that warrant for the concession in no way bound the ACC.”
Clearly, the “accountant’s concession” would not impact upon the CDPP or participants in Project Wickenby, including the ATO in that taskforce. The limitations of the accountant’s concession and the importance of maintaining privilege over documents was further emphasised in Perram J’s more recent decision in the same case (see Stewart v The Deputy Commissioner of Taxation  FCA 336 (8 April 2011). His Honour observed that the ATO didn’t need to comply with the requirements of the accountant’s concession, as the ATO had formed the view that the concession didn’t apply to documents for the reason “that Mr Hogan’s solicitors had asked the ATO to obtain all documentation relating to Mr Hogan from the ACC and had, therefore, waived the guideline.”
When a taxation compliance issue arises, particularly where it involves possible evasion, and whether or not a tax audit is imminent or expected, we strongly recommend that arrangements be put into place to ensure that all communications in relation to the work undertaken, whether by a lawyer or an accountant, be subject to LPP. A tax lawyer should be engaged to work with the accountant in managing the audit.
In this Part 1 of our three part series outlining our key tips to managing taxation audits and disputes, we have explored the wider regulatory environment in which the ATO operates and emphasised the importance of managing the pre-audit stage as it will often determine the final outcome of the audit or dispute.