In simple terminology Cash and Hidden Economy means that you accept/pay cash for selling/buying product or services and do not declare that income/expense on your tax return.
- Do you run a pizza shop, café, grocery store, restaurant or any other business in which you accept cash at point of sales?
- Do you report all sales on your business tax return?
- Do you pay expenses such as salaries and wages on cash basis and not declare on your business tax return?
Businesses who deliberately conceal income to evade tax or superannuation are part of cash and hidden economy in terms of ATO. Businesses mainly do this by not reporting all their income and expense transactions.
How does it affect a customer?
Customers paying cash for a product or service and not obtaining a receipt, risk having no evidence:
- In the event of a claim for a refund if the goods or services purchased are faulty
- To prove who was responsible in cases of poor work quality.
- Claim a deduction on their tax return if the item was used for income producing activity.
How does it affect community and other businesses?
- It reduces the amount of money available to fund community services such as education, health and other government initiatives.
- Businesses face unfair competition from businesses who participate in cash and hidden economy as they often sell their products/services at discounted prices, thereby attracting customers from other businesses who are selling same products/services at a higher price and are not participating in cash and hidden economy.
Catching the culprits
ATO has a number of strategies to detect and take corrective action against businesses participating in cash and hidden economy.
Small Business benchmarks
The benchmarks are key financial ratios designed to help businesses compare their performance against similar businesses in their industry. Benchmarks provide guidance on what businesses in an industry are reporting on their tax returns.
ATO has developed and published benchmarks for businesses with different turnover ranges across more than 100 industries. ATO utilizes benchmarks to help detect businesses that may be avoiding their tax obligations by not reporting some or all of their income, especially cash transactions. If business is able to provide evidence to substantiate income and deductions claimed on their tax return, generally ATO will take no further action. If business doesn’t maintain accurate records to substantiate figures reported on their tax return, ATO will then rely on benchmarks to make a default assessment.
Example: Benchmarks used to calculate default assessments
A restaurant was selected for an audit after reporting income that was significantly outside the benchmark range for the industry.
A review of the business’s records showed the owners had failed to maintain the appropriate records as required by law. A number of errors were identified, including:
- failure to keep cash register rolls or point-of-sale system printouts
- failure to show evidence of regular till reconciliations to support daily sales records
- Inaccurate and incomplete sales records relating to business income, such as missing sales records for significant trade periods.
The owners were unable to explain how the income reported in the business’s tax returns was calculated and they did not have the necessary records to support their reported income.
As part of the audit, the ATO auditor used the benchmarks to recalculate the business’s income. The auditor then adjusted the business’s tax return and the owners’ personal returns based on the recalculated income. ATO subsequently issued the business and both owners individually with default tax assessments.
The business owners had to pay tax based on the higher income calculated in the default assessments. The owners also incurred penalties, including penalties for failing to take reasonable care to meet their legal requirement to maintain accurate records.
Example – Paying employees on cash basis
A restaurant declared gross sales of over $500k and showed only 3 employees on payroll including the owner. Owner was paying some of the employees on cash basis at a rate lower than minimum wage rate and also not declaring them on the books that subsequently reduced superannuation liability. Business owner was receiving significant amount from sales in cash that he used to pay some of the employees on cash basis.
Business was picked up for audit by ATO. ATO asked for explanation how business owner was able to manage business without sufficient employees considering business was operating 7 days a week 7am to 9pm and only 3 employees including himself were declared on the payroll. ATO assumed minimum number of employees were working in the business at a minimum wage rate and asked business to disclose employee details and pay their superannuation and PAYG tax liability to avoid penalties.
By paying employees on cash basis and not reporting their salary on books, businesses effectively do not comply with ATO legislation by not withholding tax from their salaries and also not reporting income on business tax return. In addition, they also avoid meeting their superannuation and work cover obligations. In case if one of the employee gets injured, he/she may not be able to lodge a compensation claim.
When ATO detects businesses engaging in fraudulent and evasive cash and hidden economy activities, following options are available to ATO for taking corrective action –
- prosecuting them under the Taxation Administration Act 1953 (civil prosecutions)
- Referring them to the Commonwealth Director of Public Prosecutions for prosecution under the Criminal Code Act 1995 (criminal prosecutions).
Penalties can include fines and, in the case of criminal prosecutions, imprisonment. These consequences can have a significant impact on the viability of a business.
For further assistance contact Expert Tax on 0449 952 855 or alternatively send us your query via our website – www.expert-tax.com.au
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