Good records minimise pain of audits

29 May 2010 by Murray McClennan -- One of the measures announced in last week's Budget was funds for the  Inland Revenue Department  to conduct tax audits, writes Murray McClennan in this week's Taxing Times.

A question we are often asked is: how does Inland Revenue decide who to audit?

Generally, one or more of the following factors give rise to a tax audit:

- The ex-factor. That is, an ex-spouse, ex-business associate or ex-employee has an axe to grind and sends details of alleged undeclared income to Inland Revenue. Often such information is incorrect. Inland Revenue is conducting audits of a given industry, trade or occupation
- The taxpayer in question is wealthy. This often generates a suspicion that the taxpayer has undeclared income or has used avoidance arrangements to reduce taxable income. Inland Revenue has a specialist unit that audits high net-wealth persons.
- Discrepancies between GST and income tax returns.
- A spin-off from the audit of a business associate or related entity or implied guilt by association
- Pure bad luck.

The rule of thumb is that a business can expect to be audited every five years or so.

Tax audits are a fact of business life. You can take steps to minimise both the disruption to your business and the cost of the audit (the tax and penalties and the cost of using an accountant or lawyer) by keeping good records (especially trustees' and directors' minutes) and maintaining good business standards and processes.

Of the funds allocated to Inland Revenue, $26.6 million is specifically for the audit of land and property sales. So far, Inland Revenue has collected  more than  $300m in back taxes, interest and penalties from unreturned income from land sales.

If you have concerns about any contingent liability and the risk of a tax audit, contact your usual business  adviser. If it is clear that there is a tax liability it would be prudent to make a voluntary disclosure to avoid potential shortfall penalties.

Queenstown based Murray McClennan is a tax director at WHK (Southland & Central Otago).