Justified Trust: COVID tax lull over for private groups and wealthy individuals

ATO compliance activity went into a COVID lull for many taxpayers during 2020. But that hiatus has now ended, and private groups and wealthy individuals are under renewed scrutiny.

Late last month, the ATO released a findings’ report in relation to its ‘Top 500’ private groups tax performance program. This assurance program is part of the wider Justified Trust initiative to ensure all Australian corporate taxpayers pay the right amount of tax and involves regular one-to-one engagement with a dedicated ATO team tracking compliance from year to year.

The Top 500 program is an intensive information-gathering exercise focusing on four pillars: the effectiveness of tax governance; tax risks flagged to the market by the ATO; significant and atypical transactions; variances between accounting and tax results.

The headline findings were that, as of 28 February 2021, 403 private groups have been approached by the ATO to undertake the Top 500 Program:

  • 13 percent have achieved Justified Trust; (52)
  • 30 percent have engaged and progress towards Justified Trust; (121)
  • 46 percent have engaged but no evidence to support Justified Trust; (187)
  • 6 percent have engaged but not yet committed to attain Justified Trust; (26)
  • 2 percent are unwilling to work towards Justified Trust; and (6)
  • 3 percent have not engaged. (11)

The ATO report identifies low levels of tax governance maturity as the main reason why only a small number of groups (52) have obtained Justified Trust status.

The areas of concern, requiring improvement, include lack of documentation of frameworks and procedures, but also quite significant concerns in integrity of data being relied on for tax calculations and insufficient management of key people risks.

So what does this mean?

On the positive side, for those taxpayers that have achieved Justified Trust the result is a lighter touch “monitoring and maintenance” approach over a period of three years in which ATO review is limited to verifying significant new transactions and any other material changes.

But for the large number of taxpayers which have failed to do so, the ATO will approach their review from a position of much lower assurance.

This potentially means a lengthier and more detailed review from the ATO because they don’t have comfort that the taxpayer has governance frameworks in place. So, rolling reviews could be more onerous, more time-consuming and more expensive.

Importantly, the ATO findings report identifies common tax risks:

  • inappropriate revenue versus capital characterisation (particularly in the property development industry);
  • wealth extraction – Division 7A (for example, payments, loans or debt forgiveness by a private company to a shareholder or a shareholders’ associates) and misuse of trusts and SMSFs (for example, non-arm’s length transfers);
  • inappropriate Research and Development tax incentive claims (particularly in the building and construction, and agricultural industries);
  • misuse of tax concessions, for example, the small business CGT concessions and associated manipulation of an entity’s turnover or control; and
  • related party international dealings – particularly for those groups with significant overseas operations that give rise to cross-border dealings whose pricing requires assurance.

KPMG Enterprise research has previously indicated a degree of wishful thinking among taxpayers – many believed they were prepared for the ATO yet nearly two-thirds do not have documented tax risk management frameworks. This is a key part of proper tax governance as the ATO sees it and an integral focus of each review program.

For those taxpayers in the Top 500 – or the Next 5,000 private wealth populations – generally those groups with net wealth over $50 million – KPMG recommends taking the following steps before being approached by the ATO:

  • Prepare early – we suggest an early assessment of where there are gaps against ATO guidance and the four pillars of Justified Trust listed above, paying attention to the identified risks areas
  • Governance – create a documented and operational tax governance framework, having regard to the size and complexity of the private group. Consider how systems and testing models can be an efficient means of achieving higher levels of both comfort and performance

The pause in ATO compliance activity last year is firmly over. Private groups and mid-market companies need to take the Justified Trust program very seriously.

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