There’s a fine line between minimising your tax and cheating the system, and it’s being crossed more often by more people intent on lowering their tax bills, say accountants. Rorting is more prevalent than most – including the Australian Taxation Office – care to admit.
The most common rort is business owners who buy personal items and write them off as a business expense, tax experts say.
Other common dodges in this area include depreciating cars and topping up petrol in a spouse’s (company-owned) car in the belief that it would be hard to prove it wasn’t for business use. The same goes for office supplies, mobile phones and computers.
“I’ve seen people who pump music through their offices claiming all their personal CDs,” says one accountant.
Magazine subscriptions are another popular attempted deduction.
Drivers, start your engines
Some tax experts feel that as the personal income tax rate of Joe Average – at 32.5 per cent, plus the Medicare levy – gets further out of kilter with the company tax rate of 30 per cent, there is increased incentive for people to funnel their affairs through incorporated entities to minimise their tax. This tax rate applies to those who earn between $37,000 and $80,000.
“As of July 1  once you include the [1.5 per cent] Medicare levy, the rate differential is 4 per cent. It is almost a case of saying ‘drivers, start your engines’,” says DBO tax partner Tony Sloane.
“The movement under the Gillard government away from Peter Costello’s ‘Holy Grail of alignment’ [where more than 80 per cent of taxpayers face a top marginal income tax rate equal to the company tax rate] encourages tax avoidance by incorporation.”
The concept is not new. A variation, used by high-income earners for decades, is “income smoothing” in discretionary trusts.
People establish a trust, install family members as beneficiaries, then allocate income to those in the lowest personal tax bracket (kids only get $416 tax free a year).
The ATO is trying to crack down on this by forcing trustees to allocate income before June 30, making it a bit harder for people to consolidate their position.
It also cracked down on distributions by trusts to corporate beneficiaries, where the company pays the 30 per cent rate but no cash actually changes hands – it stays in the trust and can be used by the business.
This used to be common practice and the change is causing angst, according to Deloitte tax expert Paul Hockridge. But companies are still likely to be used as beneficiaries, adds Hockridge, and trusts are favoured by the wealthy as the preferred asset-protection vehicle.
A favourite tax dodge among small and medium businesses is the practice of inflating deductions.
“You might buy $100,000 worth of paper but claim $200,000,” says one tax adviser (who adds that he would never encourage clients to do this).
In a similar way, a business might understate holding stock at the end of the year. It may have $10,000 worth of inventory but only report $5000 to get the deduction for the difference in the current year.
A better – and legal – alternative is to revalue holding stock at either historical cost, replacement value or market selling value.
Advisers say it is slightly easier for big businesses to cheat the system, especially if they have overseas subsidiaries, because there are so many places to bury things.
The Tax Office hopes to curb this activity by making directors personally liable for a company’s tax position.
This legislation was recently expanded to make directors responsible for payroll tax obligations and compulsory super contributions as well.
A simple dodge
Goods and services tax scams are another simple dodge. People set up bogus businesses, register for GST, put in a few business activity statements, collect the GST credits on false purchases, then shut up shop and disappear.
More often than anyone cares to admit. There is a surprisingly large amount of bogus tax file numbers in circulation.
The Tax Office identified 31,249 cases of potentially fraudulent use of tax file numbers in 2010-11, up from 12,669 the year prior. The growth rate is more concerning than the actual number.
“People with a second job get a separate tax file number by doctoring photocopied documents – in essence creating a false identity – so they come in under the tax-free threshold,” said one Sydney adviser.
Accountants say car enthusiasts (including an alarming number of white collar professionals) are still exploiting a loophole that allows them to buy prestige cars without paying tens of thousands of dollars in luxury car tax. They get a dealer’s licence – a relatively easy task – and side-step having to pay 33 per cent luxury sales tax on cars over $57,000.
Overseas students have found another loophole to exploit. They file a return on July 1 with inflated earnings and tax withholding, collect their return seven to 14 days later and leave the country before their employer has filed their tax return and the ATO marries up the two sets of data to discover the discrepancy.
People will frequently “forget” to declare rental or dividend income, or “mistakenly” claim interest deductions for personal loans.
“You have a line of credit for the business and draw $10,000 from it for a family holiday; people often claim the interest on that component when they shouldn’t,” said one tax adviser.
Better off not cheating
Ironically, many people who don’t declare dividend income or income from overseas investments for fear it will nudge them into a higher tax bracket are actually entitled to a rebate.
“People spend an extraordinary amount of time trying to cheat the system for $1000, when if they’d asked the right questions they could get more back in legitimate expenses,” says Chan & Naylor tax partner Ken Raiss.
The line between legitimate and illegitimate deductions can be subtle, which probably gives rise to the confusion.
For instance, life insurance purchased outside a superannuation scheme is not tax deductable, but inside it is.
You can’t claim interest and repair costs while you own a holiday home for private use, but you can use those expenses to reduce the profit and capital gains when you sell the property.
“You could hold a holiday house for 10 to 15 years and still end up paying no capital gains tax because of the offsets,” says Raiss.
He says taxpayers often overlook the scrapping schedule on investment properties – the cost of the kitchen they pulled out; travel expenses when they go to visit an investment property; or claiming interest when they invest via a trust.
“I’m amazed at the number of people over 60 still working who haven’t converted their super into pensions,” says Raiss.
As a result, they are paying 15 per cent tax when that income should be tax free.
See yourself after class
“Where deductions related to a person’s income are high relative to income earned,” says PwC’s Paul Brassil. Teachers get caught out by this a lot because good ones tend to buy a lot of resources out of their own pocket, he says.
“Lodging company returns that show loans made to shareholders is a sure-fire way to get the tax man’s attention,” says Deloitte’s Hockridge.
An interest in an offshore trust will also trigger alarms, he says.
The Tax Office constantly scans for claims above and beyond what’s considered normal for an occupation.
It is targeting plumbers, information technology managers and certain Defence Force personnel for scrutiny this year.
“The top 10 per cent of income earners are still paying the overwhelming majority of taxes,” said Kelly + Partners, chief executive Brett Kelly.
Taxman living the dream
Brassil says the dream taxpayer is not any particular subset of the community. It is the system itself.
“If you don’t give your tax file number to the bank, they withhold 46 per cent tax from your interest. The mainstay of the government’s revenue sources are third-party remittance systems.”