18 Sep 2011 | Income Tax
Benchmarking is often used to improve performance. In sport AFL clubs compare their marks, handballs and inside 50’s with that of other teams. In the NRL it is tackles, line breaks and all run metres. Benchmarking is also used by the ATO to select businesses for audit.
The ATO has been collecting information included on tax returns and business activity statements for years. In addition industry and trade associations provide performance information to the ATO. The main benchmarks used by the ATO are cost of goods sold, wages, motor vehicle costs and rent paid as a percentage of turnover.
The ATO has benchmark ratios for more than 100 industries broken down into three sizes. These are small businesses with turnover of between $75,000 and $500,000, medium with turnover of $500,000 to $2,000,000, and large with a turnover of more than $2,000,000.
For each size of business a benchmark ratio range is produced that the ATO uses to detect taxpayers that may not be meeting their tax obligations. The benchmark ratios are used in two ways by the ATO. Firstly to target businesses that warrant further investigation in some form, and secondly to determine how much a business should be turning over and comparing that to what has been declared.
An example of this is the Labour ratio, which is the cost of wages for employees divided by sales. For restaurants with a turnover under $500,000 the labour ratio is between 11 and 21 per cent. If a business showed wages of $50,000 on their tax return, and showed a turnover of $200,000, the ATO can calculate that the turnover for the business should be between $238,000 and $454,000.
When the results for a business are outside of the averages it can be selected for further action by the ATO. In some cases this can take the form of a letter to the business owner advising them that a ratio for their business is below the benchmark ratio for their industry.
The letter warns the taxpayer that “reporting below the benchmark ratio may be an indication that you have not correctly reported all of your cash transactions “. The taxpayer is then given a choice. If they are satisfied that they are meeting their tax obligations they don’t have to do anything. If on the other hand they have made an error or omitted income the taxpayer is urged to complete a form to voluntarily correct the situation.
By voluntarily amending a tax return the taxpayer is advised that they could receive a reduction in the penalties for having lodged an incorrect return. They are also advised that they should take this action before an audit commences as penalties will be higher in these cases.
Just because a business falls outside of the benchmark ratios does not mean they are automatically cheating the tax system. It could be an indication of a business under financial stress.
The lesson to learn from this is that it makes sense to regularly compare your business performance ratios with at least the ratios produced by the ATO. For owners concerned about improving the profitability of their business more detailed ratios should be used. These can be obtained from industry bodies and companies that offer benchmarking services.
By failing to benchmark the performance of your business against at least the ATO ratios you could become embroiled in an ATO compliance program. Of even more importance is a business owner becoming aware that their ratios are below industry averages, and then taking steps to improve the situation before the business gets into financial difficulty.