Written by Jerome Tse, John Boyagi and Stefania Maccarrone.
With the Top 1,000 Tax Performance Program ("Program") continuing through the events of COVID-19, the Australian Taxation Office ("ATO") has published guidance (dated 29 June 2020) to help large public and multinational companies improve their assurance ratings.
While the guidance is targeted to businesses covered by the Program (see below), the ATO offers insight on what all taxpayers should consider doing to give the ATO assurance that they are paying the right amount of tax.
Based on the work we have done for clients over the last 12 months, and having regard to the ATO's refreshed guidance, the key takeaway can be reduced to this:
Robust contemporaneous documentation and tax governance are increasingly essential components of effective tax risk management for FY2021 and beyond.
The Top 1,000 Tax Performance Program – where are we now?
The Program was established in July 2016 to enhance, extend and bolster the ATO's compliance activity efforts by reviewing large public and multinational economic groups with an annual turnover above $250 million. Under the Program, the ATO engages with each taxpayer to gain assurance that they are reporting and paying the right amount of tax.
The ATO plans to start the new Top 1000 streamlined assurance reviews in October this year. Given the current climate, the ATO has signalled that it will "continue to be empathetic" to taxpayers' needs and will understand "the continuing adverse impacts of COVID-19" on their business operations.
How to gain ATO assurance
The published guidance helps large and multinational companies understand what attracts the ATO's attention and sets out the standard of information and documentation the ATO looks for to obtain assurance.
The guidance is based on the ATO's observations from the Top 1,000 streamlined assurance reviews and covers capital allowances, Research and Development ("R&D"), tax losses and consolidation (among others).
Capital allowances
Insufficient supporting information and documentation is the most common reason the ATO does not gain assurance for capital allowance claims. To gain assurance, taxpayers need to have detailed supporting documentation which shows that the deductions claimed are correct.
The guidance provides a list of documentation that the ATO looks for. Examples include:
- detailed fixed asset registers;
- internal policies and procedures that determine tax depreciation;
- evidence that supports the original costs of assets; and
- detailed analysis that supports any self-assessed effective lives.
When it comes to exploration expenditure, the ATO encourages taxpayers to maintain project and tax level governance that is consistent with PCG 2016/17: ATO compliance approach – exploration expenditure deductions, as well as contemporaneous documentation that evidences the tax characterisation process and deductions claimed. Whilst this can be practically difficult to achieve, especially in hindsight, we have had some successes for our clients in this industry by assisting clients to piece together and synthesise contemporaneous documentation to support tax claims and processes.
R&D
The most common issues the ATO finds with R&D tax incentive claims are:
- notional deductions that are claimed under the R&D tax incentive 'to the extent that' the expenditure is incurred on R&D activities that are registered with AusIndustry;
- ineligible expenditure that is related to ordinary business activities and inappropriate apportionment methodology;
- poor corporate governance that results in taxpayers claiming R&D offsets for activities that are not eligible R&D activities; and
- contract expenditure and salary expenditure.
Once again, the ATO has signalled that robust supporting evidence and documentation will help achieve assurance. The ATO considers that taxpayers should have a corporate governance framework with controls that:
- review registered activities and claims made under the R&D incentive;
- distinguish ordinary business activities from eligible R&D activities; and
- identify when R&D activities have transitioned to ordinary business activities.
Taxpayers should also be prepared to provide the ATO with sample 'contract expenditure' and details of salary amounts (including any supporting documentation).
Tax losses
The ATO frequently reviews the application of the Continuity of Ownership Test ("COT") and the Business Continuity Test ("BCT") in connection with the utilisation of carried forward losses. Under both tests, the common reason the ATO does not obtain assurance is that the information and documents provided are incomplete, insufficient, or cannot be verified. Unfortunately, this is not surprising given the level of detail that is be required to support COT or BCT positions. In reviewing how the carried-forward losses are used, the ATO may also look for the origin of the losses, which may require a review going back many years.
| a. | Continuity of ownership test |
When it comes to COT, the ATO looks for a detailed and complete COT analysis having regard to the legislative provisions and contemporaneous supporting information that helps substantiate the taxpayer's COT analysis. This includes, for example:
In practice, it may be difficult to trace through shareholdings of interposed entities. We frequently assist with (and also prepare) detailed COT analysis for our clients. In doing so, we usually work closely with clients and relevant stakeholders to ensure that the appropriate trace through to the ultimate beneficial shareholders is achieved. |
| b. | Business continuity test |
| The ATO recognises that it is difficult to obtain assurance that taxpayers have satisfied the BCT. This is because the BCT requires 'a rigorous qualitative assessment' of the taxpayer's BCT analysis and 'verification of the facts and assumptions underlying the analysis'. Therefore, the ATO looks for a detailed and complete BCT analysis having regard to the legislative provisions and factors outlined in TR 1999/9 Income tax: the operation of sections 165-13 and 165-210, paragraph 165-35(b), section 165-126 and section 165-132 and LCR 2019/1 The business continuity test - carrying on a similar business. The ATO looks for sufficient contemporaneous supporting information and documentation. This includes, for example:
As with COT testing, we frequently assist (and also prepare) BCT analysis for our clients that supports their carry-forward loss utilisation, having regard to the legislative requirements and ATO guidance available. |
| c. | Losses and consolidated groups |
In the context of consolidated groups, the ATO recognises that it is difficult for the ATO to obtain assurance where there is a significant period between the transfer of losses into a consolidated group, and the utilisation of those losses. Taxpayers should expect to provide the ATO sufficient analysis and supporting information which verifies that the relevant transferred losses were transferred and utilised in accordance with the legislative provisions. The ATO will also review the taxpayer's available fraction calculations. According to the ATO, the most common reason for not achieving assurance for available fractions is the 'deficiencies in or, an absence of, information and documents to verify a taxpayer's calculations.' This includes, for example, no analysis to support the joining entity's market value. Examples of the documents and information that the ATO looks for in this context includes:
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Consolidation
In the context of consolidated groups and multiple entry consolidated ("MEC") groups, the most common issues the ATO finds relates to:
- tax cost setting on entry and exit;
- valuations for calculating allocable cost amounts ("ACAs") and tax cost setting amounts ("TCSA"); and
- restructures involving MEC groups.
Not surprisingly, most issues identified by the ATO in this context relate to a lack of supporting documentation, particularly in the context to TCSA calculations and market valuations. Other common issues include:
- incomplete ineligible CGT assets being recognised on entry;
- non-recognition of goodwill of an acquired entity; and
- a lack of commercial rationale for MEC group restructures.
The ATO provides a detailed list of the documentation required to obtain assurance under each of the common issues. Some examples include:
completed entry/exit ACAs;
executed share purchase agreements;
documentation supporting non-recognition of goodwill;
valuation documentation for all (significant) reset cost base assets;
to the extent relevant, copies of restructure step plans;
copies of advice, reports and documents produced in relation to any restructure.
Taxpayers should carefully review the documentation requirements expected by the ATO, especially given that MEC interactions with the COT/BCT loss recoupment provisions are extraordinarily complex.
What to do next
Carefully prepared documentation and a robust tax governance framework will help the ATO obtain assurance. This is important because a high assurance rating means that the ATO is unlikely to contact the taxpayer again in relation to income years reviewed (unless something new comes to the ATO's attention).
In preparing for the reviews, taxpayers should therefore ensure that they are ready to engage with the ATO. At a minimum, taxpayers should ensure that their information and documentation are at a standard prescribed by the guidance.
Tax governance frameworks should already be in place, but they are not stagnant documents and require regular maintenance to ensure best practice.
If you require any assistance in preparing for the Top 1,000 assurance review, or if you would like us to review or prepare your tax governance frameworks, please reach out to us.
