2024 ATO Top 1,000 Findings Report

In September 2024, the Australian Taxation Office (ATO) released its sixth findings report and the first Findings Report since the ATO’s March 2024 announcement of a new differentiated approach to the Top 1,000 Combined Assurance Review (CAR) program.

The data in the 2024 Findings Report covers CAR reports finalised in the 12 months ended 30 June 2024, and accordingly does not include commentary or findings related to the new differentiated approach. Nevertheless, we have already seen many medium and high assurance taxpayers receive ‘lighter touch’ ATO requests for information consistent with the ATO’s differentiated approach.

Specifically, we have already seen a number of medium and high assurance taxpayers receive ATO requests for information (RFIs) that:

• limit certain queries to only the last year of the review period, instead of the prior approach of requesting objective evidence for all years in the review period (For completeness, we note that requests for objective evidence of significant transactions, events or risks flagged to market continue to cover all years in the review period); and
• include a reduced number of tax governance questions, noting we have observed taxpayer experiences may be inconsistent in this regard.

For low assurance taxpayers, and taxpayers undertaking their first ATO review, we are continuing to see the ATO raise queries related to (and request objective evidence for) all years of the review period.

This long foreshadowed lighter touch approach now provides an incentive for taxpayers to obtain or retain at least medium overall assurance in future years. In this regard the key focus for taxpayers:

• with medium or high overall assurance should be the implementation of any next steps identified by the ATO in their previous ATO review(s). To the extent any ATO findings and recommendations have not been implemented, the ATO will expect an explanation. In our experience, “business as usual” or “lack of resources” are unlikely to be considered sufficient reasons for lack of improvement based on the ATO findings from a previous CAR.
• with low overall assurance should be to uplift their tax governance and respond to ATO concerns to achieve medium or high assurance and therefore obtain the benefit of lighter touch reviews.
• in the $250m to $350m total business income (TBI) category will likely be to engage with the ATO on specific tailored questions as part of a risk-based review in the Medium Public and Multinational Business Engagement Program.

The ATO’s lighter touch approach appears to be reflected in their September 2024 announcement that businesses previously subject to a GST review and obtained a GST assurance rating (including those who obtained a medium or high assurance rating), will be required to prepare a supplementary annual GST return for the 2024-25 year. Although this imposes a new compliance obligation on this pool of taxpayers, the ATO’s approach may be seen to align to the differentiated approach to managing CARs as it is expected that the information provided in the annual return will enable more targeted and less resource-intensive justified trust reviews for many taxpayers going forward.

This Tax Alert will focus on key commentary in the Findings Report and changes as compared to prior years. For a detailed explanation regarding the background to the CAR program and ATO Findings Reports, please refer to our prior update.

Income tax findings

A majority of taxpayers have now achieved an overall high or medium assurance outcome for income tax as at their most recent review, rising to 24% and 52% for high and medium overall assurance respectively. 

The ATO notes that improvements in assurance ratings are largely driven by taxpayers subject to second-time reviews implementing Next Actions identified in respect of specific issues in historical CARs, and achieving improvements in tax governance.

Transfer pricing

Transfer pricing remains the most common area requiring assurance, with about 66% of taxpayers undergoing ATO review of their non-financing related transfer pricing arrangements and 51% of taxpayers having a financing area of insurance, with the majority involving related party arrangements. The findings report outlines ‘common issues’ that continue to arise in relation to transfer pricing matters including:

• inadequate and non-contemporaneous transfer pricing documentation (and a lack of linkage to, or availability of, underlying evidence supporting key aspects of the transfer pricing position); and
• material changes in transfer pricing policies without changes to the functional profile of the taxpayer and/or the selection of inappropriate transfer pricing methodologies.

Consistent with last year’s Findings Report, specific arrangements of concern cited in the findings report include:

• Licence fees and royalties - focused on the ability to evidence benefits obtained from licenced assets and the implications of Australian DEMPE (Development, Enhancement, Maintenance, Protection and Exploitation) activity relating to intangibles.
• Inbound and outbound supplies of goods and services - focused on distribution arrangements and the ongoing presence of high-risk disclosures made in the RTP schedule for these arrangements, having regard to PCG 2019/1.
• Financing - focused on a range of financing arrangements, including interest bearing loans, cash pooling and interest free loans. Notably, other than transfer pricing on license fees and royalties, financing had a higher proportion of low and red flag assurance ratings than other assurance areas reviewed, with the most common arrangements that attracted low or red flag ratings related to interest bearing loans, redeemable preference shares, cash pooling and convertible notes.

Importantly, about 40% of the ATO’s Next Actions audits (escalated either directly from a Top 1,000 review or from a Next Actions review) include transfer pricing issues. This figure excludes financing (which, as noted above, attracts a relatively higher number of low assurance ratings), so total Next Actions reviews or audits involving transfer pricing matters are likely to be significantly higher. 

As a result of a recent amendment to the transfer pricing law applicable for income years commencing from 1 July 2023, general class investors are now required to confirm that the quantum of their cross-border borrowings are arm’s length (previously, the transfer pricing rules did not apply to the quantum of debt for borrowers that were subject to the thin capitalisation rules). Therefore, we expect that the transfer pricing treatment of cross-border financing arrangements will continue to be an area of ATO scrutiny, with future reviews placing an additional focus on whether a taxpayer has arm’s length support for the quantum of its borrowings.

Hybrid mismatch rules

With regards to the hybrid mismatch rules, 25% of taxpayers received a low assurance rating (trending down slightly from 26% last year), with 41% receiving a high assurance rating and 34 a medium assurance rating (compared to last year’s 35% and 38% respectively).

The ATO identified that low assurance ratings were more likely where taxpayers did not have evidence of any substantial efforts made to comply with obligations in respect of the hybrid mismatch rules, and in particular, the imported mismatch rule.

The findings indicate that these hybrid mismatch rules will continue to be an area of focus for the ATO, which is also reflected in-market with the ATO’s hybrid mismatch letter campaign. This reinforces the broader theme that cross-border transactions continue to contribute to lower levels of assurance.

Thin capitalisation

Historically, thin capitalisation has been an area of high assurance, and while the findings in this report are consistent with that history (with 75% of taxpayers obtaining high assurance over this area), this is likely to change in future with new, complex and uncertain rules.

The ATO has flagged the following factors contribute to lower assurance ratings in regards to thin capitalisation:

• lack of evidence for the safe harbour calculations or incorrectly calculated the safe harbour,
• concerns with the application of the arm’s length debt test, including contrary interpretative positions, inadequate documentation and evidence, and/or
• concerns with the application of the worldwide gearing method.

As the new thin capitalisation and debt deduction creation rules are likely to have a significant impact on Top 1,000 taxpayers, this will likely be a key focus area in upcoming CARs. For more detail on the new thin capitalisation rules, please refer to previous tax alerts.

Given the new thin capitalisation and debt deduction creation rules bear little resemblance to the thin capitalisation rules applicable for the review periods covered by this Findings Report, taxpayers that have received a high assurance and hope to maintain that level of assurance going forward will need to carefully reassess their compliance based on the new rules, including a review of their arrangements based on new ATO public advice and guidance (for example, the recently published Draft PCG 2024/D3).

Losses

The key behaviours that are now becoming the expected ‘norm’ in relation to loss utilisation include:

• preparation of detailed workpapers, contemporaneous documentation and tracing back to underlying evidence that supports the continuity of ownership and business continuity tests as relevant
• transfer of losses and utilisation of losses within a tax consolidated group - preparation of available fraction calculations that are supported by market valuations, and also capture capital injection events; and
• ensuring adequate historic information that contextualises and evidences the origination or source of the losses.

If you have capital or revenue losses, we recommend checking that you are meeting the requirements above and considering if your tax compliance processes are sufficiently adequate, and whether sufficient supporting documentation is prepared in ‘real time’ to lessen the burden of preparing for Justified Trust reviews.

Tax consolidation

The ATO has flagged tax consolidation as an area that continues to be examined closely due to its inherent complexity. Some of the more common areas noted by the ATO as tripping up taxpayers are related to the allocable cost amount (ACA) calculations and include a lack of documentation (i.e. the ATO expects clearly presented ACA calculations with supporting market valuations and technical analysis), omission of transaction costs in Step 1 of the entry ACA and incorrectly spreading cost base to intangible assets. These matters could mean the difference between a high assurance rating and a medium rating.

As the above is now a minimum expectation, the ATO’s focus has shifted to specific scenarios, such as restructures that use the consolidation regime for various advantageous purposes, and inversions or the use of eligible tier-one companies, amongst other things. If you have any fact patterns that involve any of these examples, we recommend reviewing your positions and documenting them.

Capital allowances

When assessing capital allowances, particular attention has been paid by the ATO to governance processes and systems that taxpayers have in place. The ATO identified the following as the main areas that resulted in a lower assurance rating:

• inadequate documentation to support self-assessed effective lives of Division 40 depreciating assets and disclosure errors in tax returns
• incorrect asset classification and deductions claimed in relation to Division 40 and Division 43 capital works
• capital improvements versus repairs and maintenance; and
• incorrect low-value pool deductions.

Our experience is that automation tools have been, and continue to be, an effective way to review and understand whether the tax fixed asset register is functioning well and picking up on any potential errors if fixed assets are an area of concern. The ATO have responded positively to automation of fixed assets and tax processes more generally as they are a desirable control and included in ATO guidance (MLC 4 Per the ATO Tax Risk Management & Governance Review Guide).

Capital gains tax (CGT)

Where taxpayers have received low assurance for CGT events, the issues flagged by the ATO included:

• concerns around the rollover exemptions or reductions
• market valuations supporting the cost base of assets (such as goodwill and intangible assets)
• active foreign business asset exemption (Subdivision 768-G); and
• the calculation (or evidence) of proceeds and insufficient evidence to support the CGT calculation.

Similar to other areas, the main issue flagged appears to be evidence, especially in areas where there is complexity.

Income tax governance

Since the release of the Supplementary Guidance for Top 1,000 taxpayers preparing for a combined assurance review, which provided additional guidance on income tax risk management and governance, there has been a significant increase in taxpayers achieving a Stage 2 or 3 rating for governance.

Of those taxpayers that had a second review, 50% obtained a rating of Stage 2 (up from 48% last year) which requires a board endorsed commitment to test income tax controls to be in place.

The ATO noted the following areas of focus for taxpayers to improve their income tax risk management and governance frameworks:

• Board reporting templates must include the minimum matters to be considered by the Board or delegate (see commentary related to BLC 3 of the ATO’s Supplementary Guidance for further details in this regard).
• Taxpayers must be able to evidence a Board-endorsed commitment to undertake periodic testing of tax controls (see BLC 4 in the Supplementary Guidance).
• In terms of testing, the testing scope, testing reports, documentation of actions taken to address any exceptions identified during testing, as well as Board reporting of test results, should be prepared in accordance with ATO expectations (see BLC 4).
• Documented income tax procedures should include steps related to the preparation and review of the tax return and the reconciliation of the tax calculation prepared for financial statements to the completed return, particularly in regards to steps taken:
  • to prepare information submitted to the external advisor,
  • to prepare the return by the external advisor, and
  • when the external advisor provides the return for review and sign off.

In our experience, ATO expectations in regards to the above can be specific, detailed and may require taxpayers to tailor their existing documentation and processes to align with evolving ATO expectations. In this regard, and in addition to the above focus areas documented in the Findings Report, we have observed taxpayers receive ATO feedback during CARs that testing plans should include coverage of all key subcontrols (and not just key controls) in the ATO’s self-assessment procedures. This may require taxpayers to review their testing plans to ensure appropriate coverage.

Separately, with the anticipated public country by country reporting (PCBCR) measures coming soon, taxpayers will be required to publicly release a description of the group’s ‘approach to tax’ and may wish to consider providing additional information to contextualise PCBCR disclosures. Improvements to tax governance frameworks should appropriately encompass these requirements, and taxpayers may wish to review existing CBCR disclosures in advance of the PCBCR measures being enacted. This exercise may also assist in evaluating whether the CBCR is a ‘qualifying CBCR’, which is a necessary eligibility requirement to satisfy the Pillar Two transitional safe harbours.

GST findings

There has been an increase in taxpayers obtaining an overall high assurance outcome as at their most recent review, rising from 31% last year to 37% this year. The ATO note this has been primarily attributable to significant improvements in GST governance, including more taxpayers achieving a Stage 2 rating for governance which is required to obtain an overall high assurance rating. The ATO also saw an increase in the number of taxpayers achieving Stage 3 ratings, which the ATO expects to continue to see as it further reviews the population.

Notwithstanding the above, the majority of taxpayers obtained an overall medium assurance outcome (59% this year versus 69% last year), with this being primarily as a result of obtaining a Stage 1 rating for GST governance.

The ATO identified the following as key GST risk areas that result in corrections to returns and lower assurance ratings:

• Financial supplies: monitoring the Financial Acquisitions Threshold, the availability of Reduced Input Tax Credits, the application of the reverse charge provisions to cross-border transactions, and the calculation of apportionment methodologies.
• GST classification: monitoring the GST treatment of products by suppliers/wholesalers, including the adoption of different technical positions to the ATO view.
• Property: monitoring the GST treatment of sales, transfers, and leases for construction and development businesses (e.g. the margin scheme, short-term accommodation, residential premises).
• Recipient-created Tax Invoices (RCTIs): whether valid RCTI agreements are in place and whether suppliers with no GST registration have been issued RCTIs.

GST governance continues to be a core focus of the ATO, and the clear expectation is that taxpayers should continue to develop their GST risk management processes and be at a Stage 2 rating before an overall high assurance rating can be achieved. The ATO considers the GST governance and tax control framework is one of the most significant focus areas for a GST assurance review because incorrectly reported transactions can often lead to significant GST effects over time. In addition, as more taxpayers are reaching a Stage 2 rating for their income tax risk management and governance framework, and commence carrying out periodic internal control testing, the ATO expects taxpayers will also commence testing their GST controls.

In order to assess your GST controls to ensure they meet the requirements for design effectiveness, we recommend undertaking some form of internal and/or external review to confirm controls are comprehensively documented and any gaps rectified, including:

• BAS preparation processes
• controls in place for GST and periodic testing procedures (including any data and transaction testing); and
• reconciliation processes between the BAS and audited financial statements (e.g. with the assistance of the GST Analytical Tool).

For those taxpayers that have received a prior review and are still within the Top 1,000 population, we recommend reviewing the findings report from their previous review to identify any Next Actions and recommendations that were made by the ATO as part of the first review. Taking action on any of these items could mean an increase in the rating received on a second review and a smoother experience during any future ATO engagement. In this regard, the ATO has observed an increase in high assurance ratings in subsequent reviews, with 53% of these taxpayers achieving an overall high assurance rating compared to 22% in their first review.

GST Next Actions

Upon the conclusion of a CAR review, the ATO will identify any concerns and make recommendations, which in some cases will include an expected timeline of when taxpayers should advise the ATO of how recommendations have been addressed. While this is the most frequently used approach to address concerns identified in respect of GST, the ATO may undertake intervention through a formalised Next Actions product. Approximately 2% of taxpayers reviewed in 2024 were escalated for further ATO action (risk review or audit) in respect of GST. This was due to concerns identified with the attribution of input tax credits, and the GST treatment of related party transactions.

The supplementary annual GST return

Separately to the CAR program, on 23 September 2024, the ATO announced that they are now introducing a supplementary annual GST return for large businesses who have received a GST assurance review.

According to the ATO announcement, the information provided in the annual return will enable more targeted and less resource-intensive justified trust reviews for many taxpayers. Taxpayers that have achieved high levels of assurance are expected to be the key beneficiaries as they have already adopted best practice governance and systems practices.

For additional information regarding the supplementary annual GST return, refer to our earlier Tax Alert.

Top 100 findings report

On 18 September 2024, the ATO also released its sixth findings report from the Top 100 assurance program. The ATO’s report looks at the continued investment into maintaining assurance over the tax affairs of the largest taxpayers. In this regard, the ATO reaffirmed its focus for 2024 as building on the assurance already attained in the income tax program and progressing the remainder of the initial Top 100 GST assurance reviews.

As with the Top 1,000 population, the ATO saw an increase in taxpayers obtaining high assurance for both GST (30% this year compared to 23% in 2023) and income tax (59% this year compared to 52% last year).

Substantial improvements were also observed in:

• taxpayers achieving Stage 3 ratings for income tax governance (increasing from 20% in 2023 to 35% in 2024); and
• ratings for the GST Analytical Tool (GAT), with a Stage 2 or 3 rating attained by 86% of taxpayers who had the GAT applied.

Notwithstanding the above, the ATO identified issues or concerns with correct GST reporting in 44% of reviews. Areas of continued focus include GST food classification, financial services and investment as well as real property, accommodation and retirement villages, echoing many of the themes from the Top 1,000 findings report.

In addition, the ATO noted that periodic independent governance control testing continues to be a control that Top 100 taxpayers find challenging for GST. Taxpayers have been seen to design GST testing plans which cover only the three fundamental controls and not the common controls, and without sufficient documentation of controls in place for data. In addition, the ATO has strongly encouraged taxpayers to develop procedures to explain significant differences between BAS reporting and financial statements.

Practical outcomes of Next Actions

Taxpayers who have follow up actions/recommendations or red flags/low assurance items included in their CAR are at risk of further ATO engagement. This is especially relevant to those taxpayers who have low assurance/red flags or recommendations/red flags in the following areas:

• transfer pricing
• hybrid mismatches
• governance
• taxpayer alerts or other risk areas flagged to market
• inbound supplies of goods/services
• financing; and
• restructures and acquisitions.

Taxpayers selected for further ATO engagement may be subject to an array of ATO products from a ‘lighter touch’ follow up engagement to a full length audit (where appropriate), depending on the risks identified and the ATO’s view of the likelihood of resolution of the matters identified.

In our experience, the ATO is likely to move the engagement to a detailed risk review or an audit where the taxpayer does not materially adopt the ATO’s preferred approach to the identified risk. In these engagements, to the extent that the ATO is considering the application of the anti-avoidance provisions, the ATO is increasingly using their formal powers, whether or not the engagement has proceeded to an audit.

In addition, the ATO is increasingly adding consideration of the deductibility of share-based compensation recharge payments to audits and risk reviews, especially for inbound distributors.

Where taxpayers are selected for further ATO engagement, the ATO’s information requests will likely be extensive, and taxpayers should be aware that if they are selected for a Next Actions engagement, the ATO team dealing with this Next Action engagement will be a different team to the CAR team. Additionally, during this further ATO engagement, the new ATO team can use any of the other ATO specialist teams (e.g. Economist Practice and Tax Counsel Network) to support their review/audit. Contemporaneous evidence supporting your positions continues to be important to a successful engagement with the ATO in a risk review or audit.

A number of observations in the findings report refer to first time reviews, which have generally received lower ratings than their ‘top up’ review counterparts. A potential reason for this flagged by the ATO is that new entrants to the program may not have the familiarity with the comprehensive nature and expectations of the program.

The typical 28-day turnaround time for information requests can place significant pressure on resources. In practice we are also seeing limited willingness for the ATO to oblige requests for extensions beyond agreed tranches. There are a number of proactive steps taxpayers can take in preparing for a CAR, including:

• If you are subject to a first time review, potentially seek consultation on the comprehensive nature of the CAR and the expectations on the level of evidence required so as not to risk a lower rating due to providing insufficient responses or evidence.
• Consider the typical CAR questions published by the ATO in advance of a review notification and ensure you are able to respond.
• Consider any ATO recommendations stemming from a prior (completed) CAR or earlier Top 1,000 review.
• Review your governance documentation. If you have been reviewed previously, check that progress has been made from where the ATO rated you in the prior review period. If you are new to the program, ensure that you have sufficient documentation in place to support the desired outcome/rating.
• Review significant transactions, ensuring that sufficient documentation exists in relation to capital gains/losses and consolidation. Potentially speak to your adviser about documentation of significant transactions procedures and controls.
• Ensure that transfer pricing documentation with appropriate economic analysis (and underlying source evidence) required to substantiate your position is available. Notably, the years covered under the latest round of CAR activity may also include income years impacted by the COVID-19 pandemic, which may have had an abnormal impact on transfer pricing positions during this period and thus require further analysis and consideration of previously released ATO guidance.
• Consider and come prepared to support any non-‘low risk’ positions in relation to the ATO’s tax risks flagged to market e.g. under Practical Compliance Guidelines relating to financing arrangements (PCG 2017/4) and/or inbound distribution arrangements (PCG 2019/1).
• Monitor the publication and finalisation of ATO guidance (e.g. PCG 2023/D2, TR 2024/D1 and PCG 2024/D3), which will be the subject of future CAR activity and retain evidence to support any arrangements within the scope of these.
• Review hybrid mismatch arrangements and documentation to support positions taken in your tax returns, including having regard to ATO views in TD 2024/4.
• Review recent ACA calculations and confirm that documentation has been prepared to support valuations where they are needed.
• Ensure that you have sufficient documentation in place to support the generation and the utilisation of losses (under the continuity of ownership test or business continuity test), and the transfer and utilisation of losses within a tax consolidated group.
• Review your R&D claims, ensuring that you have sufficient detail and evidence to support claims. Speak to your adviser about putting more documentation/process documents in place if needed.
• Review and update your GST controls and process documentation to ensure it has sufficient detail surrounding control testing procedures, BAS preparation processes, and relevant reconciliation processes to identify and understand variances between accounting figures reported in your audited financial statements and the annualised GST figures reported on the BAS.