The ATO recommenced its ‘Next Actions’ compliance program

24 August 2020

In brief

The Australian Taxation Office (ATO) has completed nearly 800 of its 1,000 Streamlined Assurance Reviews for the largest 1,000 public and multinational companies and funds. Based on the outcomes of the completed Streamlined Assurance Reviews, the ATO has recently recommenced its 'Next Actions' program which will initially focus on those taxpayers who received an ‘overall low assurance’ rating or an ‘overall medium assurance with one red flag’.

Taxpayers should be mindful that the ATO is very well funded to complete its work under the Next Actions program. The 2019-20 Federal Budget provided the ATO with additional funding of AUD$1 billion to extend its Tax Avoidance Taskforce (which includes the Next Actions program) to the 2022-23 financial year.

In detail

Background

The ATO is responsible for administering Streamlined Assurance Reviews (also known as ‘Top 1000’ reviews). The object of this program is for the ATO to obtain evidence to achieve greater assurance that the largest 1,000 public and multinational companies and superannuation funds are reporting the right amount of income tax. These reviews are focused on the income tax affairs of taxpayers with Australian turnover above $250 million.

The ATO is specifically focused on obtaining assurance that:

• appropriate tax risk and governance frameworks exist and are applied in practice;
• none of the specific tax risks that the ATO has flagged to the market are present;
• the tax outcomes of atypical, new or large transactions are appropriate; and 
• any misalignment between tax and accounting results is explainable and appropriate, and the right amount of tax on profit from Australia-linked business is being recognised in Australia. 

The ATO has advised that it expects to have completed all income tax Top 1,000 reviews by approximately June 2021. 

A significant proportion of the Top 1,000 reviews have either been completed or are in the process of being completed (reviews currently in progress are expected to be completed by October 2020). Although the remaining reviews, which we estimate to be less than 100, have not yet commenced, the ATO recently announced that these reviews would commence from October 2020, with two tranches between now and mid-2021. We have observed the ATO being mindful of COVID-19 impacts on some businesses and we anticipate that the ATO may provide some flexibility with timeframes for these new reviews.

A Top 1,000 Findings Report is currently being drafted by the ATO and we expect that this will be released shortly. We will share insights on this once it becomes available. 

The “Next Actions” program

Which taxpayers will be part of the Next Actions program?

The following Top 1,000 taxpayers can expect to be part of the ATO’s ‘Next Actions’ program reviews:

• taxpayers that obtained an overall low assurance rating (i.e. the ATO has “specific concerns around the taxpayer’s compliance with the Australian income tax laws and the amount of Australian income tax paid for the income year(s) reviewed”); and
• taxpayers who obtained an overall medium assurance rating (i.e. the ATO “obtained assurance in relation to some but not all areas reviewed” but received at least one “red flag” in their Streamlined Tax Assurance Review report).

When will the Next Actions reviews start?

We understand that the ATO has already commenced reviews of almost half of the Low Assurance (higher risk) taxpayers in the form of follow-up reviews and audits. These reviews remain in progress. The remaining Next Actions reviews/audits will commence from August 2020. Taxpayers who will be the subject of the “first round” of these reviews are currently being notified by the ATO teams, or can expect contact from the ATO very shortly.

What is the Next Actions program?

Broadly, the Next Actions program can be described as the ATO’s large business ‘compliance pool’ for the foreseeable future. It is out of this pool of taxpayers that the ATO will select taxpayers for compliance activities. The ATO is still working through its approach to the Next Actions program, but we expect that these reviews may include:

• specific reviews (as the name suggests, a review of a specific issue(s));
• selected as part of a project review (reviews of the same or similar issue across a number of taxpayers);
• specific audits (an audit of a specific issue(s)); or 
• large business audit (audit of the entire business). 

In some cases, the ATO will offer public groups and multinational taxpayers the opportunity to resolve potential disputes by adopting the ATO’s preferred position on a particular issue or engaging in negotiations or some form of dispute resolution process.

What is likely to be the focus of a Next Actions review? 

For overall low assurance rated taxpayers, the ATO may revisit items which were medium assurance, low assurance or red flag items. In some cases, the ATO’s follow-up action is not limited to low assurance or red flags items (i.e. it may include other areas) as it seeks to increase overall assurance on these taxpayers.

For overall medium assurance rated taxpayers, we expect that the ATO may revisit items which were rated red flag. 

Common areas of focus

Taxpayers that have received overall low assurance or medium assurance with a red flag may have one (or more) of the following areas that are of concern to the ATO (not an exhaustive list):

International tax risks:

• relating party financing arrangements;
• changes in membership of Australian tax groups through internal transactions or decisions; 
• migration of Australian generated intangible assets to overseas related parties;
• use of partnerships or other entities to seek to avoid withholding tax or shift recognition of income; and
• transfer pricing.

Domestic tax risks:

• Capital allowances,
• Research and development (R&D) tax offset,
• utilisation of tax losses, and
• tax consolidation.

It is worth noting that the ATO recently published guides on the above ‘domestic tax risks’ to assist taxpayers in gathering information and documents to improve their level of assurance in relation to these topics. 

How might taxpayers prepare for a Next Actions review?

Taxpayers should be conscious that the ATO has generally undergone a significant review process as part of the Top 1,000 review and will approach the Next Actions review with high expectations that taxpayers are prepared. This may translate to short timeframes to respond to further information requests. 

It is possible that the Next Actions review process could quickly progress to audit, or even amended assessment.

In addition to making decisions on how to prepare for the next action review (i.e. strategic review and audit defence preparedness), taxpayers should actively consider steps they can now take to mitigate potential scheme penalties.

Taxpayers might wish to consider penalty mitigation strategies

Penalty mitigation is important because a very large number of taxpayers that will be subject to a Next Actions review will likely be classified as a ‘significant global entity’ (SGE). 

The classification as an SGE is particularly relevant because scheme penalties for SGEs are doubled unless the SGE has a reasonably arguable position. In the context of adjustments relating to transfer pricing benefits, this means that:

• where an SGE taxpayer has obtained a transfer pricing benefit and is found to have undertaken the scheme for the sole or dominant purpose of obtaining a transfer pricing benefit, the SGE taxpayer will be liable to a penalty of 100 per cent of the scheme shortfall (whereas if the SGE taxpayer has a reasonably arguable position in those circumstances, the SGE taxpayer will only be liable to a penalty of 25 per cent of the scheme shortfall); and
• where the SGE has obtained a transfer pricing benefit but is not found to have undertaken the scheme for the the sole or dominant purpose of obtaining a transfer pricing benefit, the SGE taxpayer will be liable to a penalty of 50 per cent of the scheme shortfall (whereas if the SGE taxpayer has a reasonably arguable position in those circumstances, the SGE taxpayer will only be liable to a penalty of 10 per cent of the scheme shortfall).

It is therefore important for taxpayers to consider documenting and otherwise evidencing why positions adopted are reasonably arguable to mitigate potential penalty exposure in the context of transfer pricing disputes.

These scheme penalties apply to any scheme benefit that an entity obtains in relation to an income year commencing on or after 1 July 2015 (whether or not that scheme was entered into prior to that date).

In addition to preparing to defend for a potential dispute relating to the primary tax issue, for taxpayers facing a Next Actions review, there are sensible penalty mitigation strategies that can (and should) be employed right now. It is clear the management of the potential financial exposure associated with SGE scheme penalties may - depending on the tax risk - be just as important as defence of the primary tax issue in dispute.

The options and decisions as to whether or not to take steps now should be explained to, and understood by, senior management and the Board. 

These observations should not be misconstrued as suggesting that companies should make a ‘voluntary disclosure’. Rather, it is to highlight that there are now emerging more sophisticated penalty mitigation strategies where the taxpayer seeks to contest the issue - the reasons for these strategies are consistent with comments by the Federal Court. The ‘old days’ of waiting to rebut the ATO’s penalty position at the end of an audit are (or should be) finished.

Importantly, these penalty mitigation opportunities lapse after a certain point in time in the dispute lifecycle and therefore the need to act usually has a high degree of urgency. Unfortunately, once that point in time has lapsed, so has the opportunity to act and some taxpayers may find themselves fighting two disputes of equal financial consequence - the primary tax issue and the scheme penalty issue. 

What are some of the other things to consider in the context of a Next Actions review?

In addition to questions about review/audit defence readiness and penalty mitigation strategies, there are a range of questions we are being asked by taxpayers and their stakeholders, including: 

• How does the company’s particular risk issue(s) compare to others in the market?
• What are the most common ATO risk areas/low assurance areas?
• What are the different types of ATO compliance activity that are likely to be undertaken (e.g. is the taxpayer’s risk area(s) a topic likely to be ‘1 on 1’ ATO engagement or part of a broader ATO project)?
• Does the risk profile of the business’ tax function align with senior management and/or the Board?
• How are other taxpayers responding to current or pending ATO activity and what steps are other peers taking?
• What audit defence strategies are most effective in engaging with the ATO and which approaches are less impactful?

The takeaway

Companies whose Top 1,000 review has been completed and received either a low assurance rating or a medium assurance rating with at least one red flag should expect follow-up action from the ATO shortly (if they have not already been contacted). We recommend these companies:

• reflect on the issues raised in the Streamlined Assurance Review report, particularly those that the ATO considers to be lower assurance in respect of the international tax and domestic tax risk areas highlighted above; and
• commence preparation for the ATO Next Actions review by gathering supporting information and documents to defend their position, contemplate a voluntary disclosure (where appropriate) or other ATO engagement strategies.

Please reach out to your PwC contact for insights from PwC’s recent experiences to discuss and how PwC can help you with preparing for a Next Actions review.