Financial statement disclosure of climate-related and other emerging risks

If you are a director or financial statements preparer in an industry impacted by climate-related risks, guidance has been issued which indicates that climate-related risks are a financial statement consideration, not just a matter of corporate social responsibility.

The Australian Accounting Standards Board has issued a Practice Statement (AASB Practice Statement 2 – Making Materiality Judgements), which whilst not mandatory, represents best practice on determining what climate-related risks are sufficiently material to be disclosed in financial statements.

Determination of the content of financial statements is based on an assessment of what is material to users of the financial statements.  Given investor statements on the importance of climate-related risks to their decision making, directors and preparers need to ensure financial statements are prepared with climate-related risks in mind.

Key recommendations are:

  • Determine whether investors would reasonably expect that climate-related risks have a significant impact on the entity and would that risk qualitatively influence investors decisions?
  • Disclose climate-related risks and adjust balances accordingly, if necessary, in the financial statements.
  • If no climate-related risk impacts have been disclosed, consider disclosing why there has been no impact, if it is believed that investors could have expected climate-related risks to be significant.

For more information on your reporting obligations, talk to your adviser today, and they can introduce you to a financial reporting expert.

Malcolm Matthews – Partner

Malcolm is a Partner in our Tasmanian Audit team.  He has more than  25 years’ experience in financial reporting.  He is a Fellow of Chartered Accountants Australia and New Zealand and a Registered Company Auditor.




ASIC focus areas for December 2018 Financial Reports

No surprises in the release of ASIC’s focus areas for December 2018 with the number one item being the impact of the new accounting standards.

Financial reports for December year-ends and December half-years, are implementing AASB 15 and AASB 9 for the first time.  ASIC Commissioner, John Price said, “We are concerned that some companies may not have adequately prepared for the impact of new accounting standards, that can significantly affect results reported to the market by companies, require changes to systems and processes, and affect businesses. We will monitor these areas closely and will take action where required.”

Preparers should ensure sufficient disclosure is made regarding the impact of both AASB 15 and AASB 9, as well ensuring the new disclosure requirements of AASB 15 and AASB 7 are complied with.  Adequate disclosures will provide comfort to the reader that the new recognition and measurement requirements have been applied appropriately even if there have been no significant changes. Without sufficient disclosure, readers will not know that the new requirements have been adequately considered.

The other focus areas continue to include the usual suspects that we’ve seen for the past few reporting periods, showing that ASIC is still identifying issues with fundamental items such as impairment and revenue recognition. A couple of topics have returned including the Operating and Financial Review (OFR) and Non-IFRS financial information, which serve as a reminder to ensure that the OFR should provide meaningful information and be consistent with the financial report, as well as ensuring that any non-IFRS information is not misleading and is presented appropriately. This also serves as a reminder of regulatory guides RG 247Effective disclosure in an operating and financial review, and RG 230Disclosing non-IFRS financial information.

ASIC focus areas for December 2018 are:

  1. Impact of the new standards
  2. Impairment testing and asset values
  3. Revenue recognition
  4. Expense deferral
  5. Off-balance sheet arrangements
  6. Tax accounting
  7. Operating and financial review
  8. Non-IFRS financial information
  9. Estimates and accounting policy judgements

Read ASIC’s media release 18-364MR for full details on the focus areas for December 2018. The release also includes links to information sheets providing useful information for preparers and directors on financial reporting and impairment of non-financial assets.

Christine Webb

IFRS Specialist




Aspects of Negative Gearing Australian Real Estate

Negative gearing will again be a political issue during the lead-up to the next Federal election.

What is Financial Gearing

A combination of debt and equity is commonly used to fund investment in assets, such as rental properties, shares or business assets.

A leveraged investment refers to the method of using borrowings plus an investor’s own funds to purchase an asset; the higher the leverage, the greater the debt.  Gauging the mix of an investor’s debt to equity is referred to as the gearing ratio.

Leveraged investment is often expressed in terms of being positively or negatively geared.  Positive gearing occurs when net income derived from an asset exceeds borrowing costs (mainly interest).  Conversely, negative gearing arises when the net investment income derived is exceeded by interest outgoings (and other funding costs).

Negative Gearing Real Estate

Negatively geared residential or commercial property occurs when rental (or lease) income, less the costs of owning and managing the investment (such as depreciation, insurances, repairs and maintenance, council rates, land tax, travel costs and agent management fees) is exceeded by mortgage interest costs.

For tax purposes, the resulting rental tax loss can be deducted from an investor’s income derived from other sources, including salary and wages, other net rental income, dividends, interest and/or business income.  Other deductions and considerations come into play where property is located outside Australia.

Is it feasible to Negatively Gear?

Investments in real estate that generate an annual rental loss will be a tax deduction against other income. A tax refund to an individual investor generally arises at the individual’s marginal tax rate(s). The higher the marginal rate, the greater the refund. The tax refund reduces an investor’s net cash outflows from an investment. Notwithstanding the tax refund position, unless the value of the real estate out paces an investment’s cumulative after-tax losses, the investor will not be ahead financially. That is, an investor will lose money over the real estate ownership period.  Of course, if the investment does increase at a rate greater than the after-tax loss position, then an investor will make money.

Key Incentives

(i) Cash flow: For individuals, tax refunds are generated at the relevant marginal tax rates which assists cash flow. For example:

(a) If the top marginal tax rate applies to a salary and wage earner, 47% of the tax rental loss can be refunded by the Australian Taxation Office.  Lower marginal tax rates apply if an individual’s taxable income is less than $180,000.

(b) Rather than wait to lodge an annual income tax return, an individual can apply, to the ATO, to permit their employer to deduct less PAYG throughout the year which boosts monthly after-tax cash flow to better align with loan repayments.

(ii) CGT Discount – Currently, any capital gain on disposal will attract a 50% general discount for resident individuals and trusts (with resident individual beneficiaries) provided the asset is held for more than 12 months.

(iii) Rent Increases – Initially, a negatively geared investment may be justified if the net rental stream is expected to rise or interest costs are expected to reduce.

(iv) The potential ability to claim depreciation on plant and equipment and 2.5% of the construction cost of the building (including alterations and improvements) provide a cash free deduction against rental income each year.

(v)  New Opportunities – The use of internet-based booking platforms such as Airbnb and Stayz has significantly increased an investor’s ability to generate greater financial returns from residential property investments.  In these situations, a question arises as to whether the investment is more of a business operation, especially where there are several rental properties and staff are employed to attend to bookings, cleaning, etc.  If a business does exist, it will be important to consider whether the small business CGT concessions and GST applies.

Key After Tax Outflow Considerations

An important consideration before embarking on a negative geared property investment is to consider the impact that after-tax cash outflows will have on after-tax income.  The after-tax cash flow position differs from the rental loss result.  This is due to non-deductible principal loan repayments and deductions being funded on initial purchase, such as capital works and capital allowance deductions as detailed below.

(i) Deductions for capital costs

A capital allowance deduction may be available on items of plant and equipment that have formed part of the purchase price of a property.  However, since 9 May 2017, this deduction has been restricted on items of plant and equipment forming part of old residential properties (refer below).

Additionally, the construction cost (not purchase price) of the property including any improvements can generally be claimed at 2.5% over a maximum 40-year period.  Therefore, it is important to obtain that information from the vendor, or alternately you can engage a quantity surveyor to provide an estimate of those costs.

(ii) Principal repayments

Importantly, it is necessary to consider the cash flow impact of loan principal repayments to a financier.  Generally, the interest rate associated with principal and interest loan facilities is lower than interest only, as financial institutions perceive the risks of lending to be lower.  However, if an investor is using a principal and interest loan facility, it is necessary to also take into consideration the cash flow impact of principal repayments each year.  Any cash flow shortfalls would need to be met from other funding sources such as after-tax salary.  Currently, there is a definite move away from the provision of interest only loans by Australian banks.

Before embarking on a negatively geared investment, a realistic cash flow analysis should be prepared.

Developments in the Past

Prior to 1985 the Courts provided certain boundaries on acceptable negative gearing scenarios, especially in situations displaying an underlying private or domestic motivation.  For instance, in Ure v. FCT 81 ATC 4101 (FCA), the taxpayer borrowed monies at commercial interest rates of up to 12.5% and on-lent the borrowed money to his wife and family company at 1% interest.  The funds were eventually used to discharge a home mortgage, to purchase a house (that was let to the taxpayer and his wife by a private company) whilst the balance of funds was invested.  The Commissioner of Taxation only allowed an interest deduction to the taxpayer equal to the 1% interest income and the Court confirmed the Commissioner’s stance.

In FCT v. Groser 82 ATC 4478 (S.C.V.) the taxpayer was denied a deduction for part of a rental loss as the rental income charged to his brother was not being levied at a market rate.  Similarly, in FCT v. Kowal 84 ATC 4001 SCG the taxpayer rented a house to his mother at less than a market rate.  He was denied a deduction for part of his rental loss, which reflected the undercharging.

1985 Tax Summit

Following the tax summit in June 1985, the Hawke government introduced anti-negative gearing legislation effective from 17 July 1985.  The law applied to new investments in real estate by individual, company, partnership or trustee investors.  Under these rules, negative gearing interest expenses were quarantined to the extent that they would otherwise create a rental loss (apart from a carve-out for 4% building depreciation deductions).  Rental losses were quarantined so they could not be offset against other income.  Instead, losses were carried forward to future tax years to be offset against property income.  Negatively geared real estate acquired prior to 20 September 1985 continued to fall outside the CGT tax net on disposal but not for property purchased after that date.

After extensive lobbying by the property industry, and possibly for other macro economic reasons, the Hawke government revoked the negative gearing rules during July 1987.  At the same time, the building depreciation rate was dropped from 4% to 2.5% to minimise the impact on revenue collections.

Post Repeal of the 1985 Negative Gearing Legislation

Since the repeal of the negative gearing legislation in 1987, tax cases impacting on negative gearing scenarios have involved split loans.  The use of split loan facilities was the subject of a general anti-avoidance High Court decision in FCT v. Hart (2004) HCA.  The case centred on the level of tax deductible interest that was capitalising on an investment loan at a relatively high rate of interest.

The taxpayers had a debt wrap platform which allowed them to maintain a home loan (non-deductible interest) and an investment account balance (deductible interest).  Security for both loans was the two properties.  All loan repayments were directed towards the home loan.  The tax-deductible interest therefore compounded on the investment loan, which ended up having a balance more than the value of the investment property.  The taxpayer claimed 100% of the investment loan interest as a tax deduction.  The High Court’s order required principal payments to be applied in a pro-rata manner to both loan accounts, whereby reducing the amount of tax deductible interest.

The use of a line of credit facility by an investor is handy for separating borrowings relating to non-income and income producing assets and it is easier to calculate deductible interest. It also provides flexibility to an investor.  However, care needs to be exercised when using split loan funding platforms.

The ATO has issued several tax determinations and rulings concerning the use of these types of financial facilities.  The takeaway message is that deductible compounded interest is fine, provided there is a genuine commercial reason for the compounding.

2017 Legislation Changes

For second-hand residential properties purchased after 9 May 2017, a depreciation deduction is not available for second-hand plant and equipment acquired with such properties.  However, any investor who purchases a brand-new property can claim depreciation on plant and equipment forming part of the investment property.  Non-residential properties are unaffected by the changes.

From 1 July 2017, new legislation provides that travel expenses relating to residential property investment are no longer deductible and cannot be included in a property’s cost base for CGT purposes.  This restriction does not apply to taxpayers carrying on a business of letting rental properties or to certain taxpayers, including companies.

Future Developments

As mentioned, negative gearing will be a leading issue during the lead up to this year’s Federal election.

The coalition’s platform is to leave negative gearing in place, whilst Labor’s position is to apply changes to negative gearing across all new investment asset acquisitions, not just real estate.  Labor is proposing that existing properties are fully grandfathered and therefore unaffected.  That is, tax concessions for negative gearing will cease to be available from a date yet to be determined, although it is proposed that losses from new investments can be used to offset net income from other asset investments and against certain capital gains.

Labor plans to halve the CGT discount rate from 50% to 25% from a date to be determined.  The CGT discount will not, however, change for small business assets.

* * * * * *

Geared investments in a balanced investment plan pre-retirement may be worthwhile pursuing.  However, it must be remembered that there are potential pitfalls and the strategy can end up costing an investor money.

Given the extent of the tax and financial planning issues associated with geared investment strategies, we recommend that you discuss your specific circumstances with your Crowe Horwath tax adviser or financial planner.

Peter Nevell

Partner – Tax




Red tape reduction for large proprietary companies

The Federal Government has recently proposed a change to reporting thresholds, which will reduce the ASIC reporting obligations of some large proprietary companies.

Large proprietary companies are required to lodge audited financial statements annually.

The thresholds for determining whether a proprietary company is large have not changed since 2007.  The Federal Government is planning to double the thresholds as follows:

Tests Current threshold Proposed threshold
Consolidated revenue $25m $50m
Consolidated gross assets $12.5m $25m
Employees (FTE) 50 100

A large proprietary company is defined as a company which meets two of the three tests listed above at the end of their financial year.

These changes are proposed for reporting periods commencing on or after 1st July 2019.  Thus for a 30th June balancing company, the first year of application would be the year ending 30th June 2020.

The Government expects about a third of all large proprietary companies will not meet the revised definition of a large proprietary company.  This will save companies the cost of preparing financial statements and having them audited, which averages approximately $37,000.

Action required – this potential change to regulations is only at the public consultation stage.  Large proprietary companies who expect to benefit from this red tape reduction should continue to monitor their reporting requirements to ascertain whether they are entitled to any reporting relief from 1st July 2019 onwards.

For more information on your reporting obligations, talk to your adviser today, and they can introduce you to a financial reporting expert.

Malcolm Matthews – Partner

Malcolm is a Partner in our Tasmanian Audit team.  He has more than  25 years’ experience in financial reporting.  He is a Fellow of Chartered Accountants Australia and New Zealand and a Registered Company Auditor.




CGT hitting home while living abroad

Most Australian homeowners are quite familiar with the Capital Gains Tax (CGT) exemption that is generally available to individuals on the sale of their main residence. However, for Australians (both citizens and permanent residents) that are currently living overseas and considered a foreign resident for tax purposes, there is currently a frustrating state of uncertainty as to how they will be taxed if they sell their home while living abroad.

Background

The 2017 Federal Budget included an announcement that the CGT main residence exemption would cease to apply as of 7.30pm on 9 May 2017 for foreign residents of Australia for tax purposes (subject to a transitional period for any properties held as at that date, which are sold by 30 June 2019).

The legislation that was subsequently drafted to introduce these measures, results in what is widely viewed as an extremely harsh outcome for many Australians that sell their family home while still living overseas and who are considered a foreign resident for tax purposes.  This “unfairness” is largely due to the fact that there is no recognition of the period that the property was previously occupied by the taxpayer (when they were considered a tax resident of Australia).  Therefore, the legislative change can apply on a retrospective basis to gains derived on properties acquired from as far back as 20 September 1985.  For many people affected, this would be a substantial tax hit and could adversely impact on their ability to get back into the Australian property market at a similar level on returning to Australia.

Status of the legislation

The legislation to introduce the new rules has still not been passed by Parliament, despite it first being introduced into the House of Representatives back on 8 February 2018. The legislation was scheduled for debate in the Senate on 16 October 2018, however it was withdrawn from discussion by the Government, so it is now unclear how this legislation will proceed.

The fact that the legislation was withdrawn from the Senate schedule provides some hope that there will be amendments to the legislation.  Part of the problem appears to be that these CGT changes were part of a wider suite of changes, that are generally aimed at reducing the pressure on housing affordability in Australia. It may be that some of the unintended consequences for Australian citizens and permanent residents in the drafting of the legislation are now being acknowledged, we just hope that it is not too late.

What could some of the amendments be?

There are a number of options in terms of possible amendments to the legislation to provide a fairer outcome for Australian taxpayers.  Some possible changes were outlined in a Submission[i] by CPA Australia to the Senate Economic Legislation Committee including:

  • Excluding individuals who retain their Australian citizenship or permanent residency from the legislation;
  • Exempting property that was already owned when the announcement was first made on these changes in the Federal Budget on 9 May 2017;
  • Allowing a deemed market value cost base for the main residence at the time the taxpayer becomes a non-resident taxpayer; or
  • a partial exemption is to be provided for the number of days the taxpayer was actually living in the main residence.

Another option could be to extend the “grandfathering rule” discussed below.

The urgency of the issue

The longer that this uncertainty remains, the more stressful these changes are for the many thousands of Australians currently living overseas, that would be affected by the proposed changes.  This is particularly in light of the “grandfathering” rule in the proposed legislation, that will allow properties that were owned on 9 May 2017 to potentially be sold prior to 30 June 2019 and retain the CGT exemption.

If the legislation does end up being passed at some point as it is currently drafted, there may not be sufficient time for taxpayers to adequately plan their affairs to sell their home prior to 30 June 2019.  This is becoming increasingly unrealistic, considering that there will only be 10 more scheduled Parliament sitting days through to the next Federal election.

Even if taxpayers are able to meet this deadline, many will now be impacted by reductions in property prices in many parts of Australia that have occurred since the Budget announcement was made. So, it could be a case of obtaining the grandfathered tax exemption but accepting a sale price in a market that may not be optimal for selling (pre 30 June 2019) or holding the property and being hit with the tax consequences.  Either way, it is strongly recommended that affected taxpayers continue to monitor any developments and seek appropriate advice in relation to their specific circumstances.

[i] Letter from Stuart Dignam, General Manager Policy & Corporate Affairs CPA Australia, to Senate Standing Committees on Economics (dated 5 March 2018)

Paul Wastell – Partner, Business Advisory




Managing Cyber Risks and Insider Threats

Worldwide losses from cyber-attacks are estimated to be in the order of 1 per cent of GDP, which makes the crime in Australia worth close to $17 billion.  Regardless of its value, one only needs to read the press to have some idea of how pervasive cybercrime has become in our society. The extraordinary growth in the ‘Internet of Things’ over the past several years has created a larger cyber-attack surface, increasing the prevalence of destructive attacks, improved counter forensics, attacks aligned with geo-political conflicts and cyber espionage, all of which show no signs of slowing.  What’s more disturbing, is that we are seeing more attackers moving to the cloud; hosting command-and-control servers on pop-up cloud virtual machines and using social media channels for communications to avoid detection.

Cyber security threats come in many forms, and typically fall into two categories; external and internal.  External threats usually come from a competitor, organised criminal elements or a foreign government, and should obviously be taken very seriously.  However, with advancing technology and significantly improved perimeter defences against accessing confidential information, the insider threat is now more pervasive, evasive and disastrous than ever. The threat is no longer just an external one; it could be inside your business or via a trusted third party with access to your systems.  The ability to expose trade secrets, confidential information or proprietary documents over the Internet is at the fingertips of just about every individual in your organisation.  With the number of cyber incidents on the rise, as well as an increased legislative and regulatory focus on information protection, SMEs need to turn their attention to cyber risk and make it a priority.

No business is immune from attack.  Recent high-profile cases have highlighted the need for organisations to further strengthen their strategies to prevent, detect and respond to incidents thereby minimising their risk of attack. The consequences of cybercrime in all its forms – phishing, malicious software, hacking, e-mail spoofing, Distributed Denial of Service attacks or cyber extortion – can be devastating, leading to significant financial consequences, not to mention the damage caused to brand and reputation.

It is the incumbent responsibility of every company director to exercise their duty of care and diligence. This extends to assessing and addressing the risk of damage to the company from external cyber-attacks and internal unauthorised access to or disclosure of company data.  ASIC produced a “Cyber resilience: health check” publication back in March 2015, which helped guide thinking for corporate Australia.  It said that directors need to take head of their advice and evaluate if their company is properly managing cyber risk, including whether adequate resources are devoted to cyber security.

ASIC suggested that key questions should be asked of management by the Board such as:

  • Which systems, if disabled, would create the most business risk?
  • What data, if stolen or corrupted, would result in serious business risk?
  • How is protection of these high-value assets prioritised?
  • What is the current level and business impact of cyber risk and how is the executive leadership team informed on the issue?
  • How many and what types of cyber incidents do we detect in a normal week? What is the threshold for escalation to our executive leadership?
  • What is our plan to address identified risks and how do we preserve the integrity of data residing on our network?
  • Do we have cyber security insurance that covers data breaches?
  • What is the cyber security budget?  Is it adequate?
  • Do existing risk management and governance processes address cyber risk and is there an annual company-wide awareness campaign around cyber security?
  • Are our policies and procedures for responding to cyber incidents robust?
  • How many detected security incidents have involved insiders? Are employees monitored for malicious activity?
  • Do the company’s outsourced providers and contractors have cyber controls and policies in place? Do they align with the company’s expectations?
  • How are industry standards and best practices reflected in our cyber security program and how do we compare with our peers?
  • How comprehensive is our cyber incident response plan? How often is it tested? If we were breached tomorrow, who would we call?
  • What constitutes a material cyber security breach?  How will those events be disclosed to the regulators and investors?

A well-designed and effectively implemented cyber resilience program will not eliminate external and internal risks, but it can assist in mitigating the likelihood of compromise and reduce the fallout from incidents, if and when they occur.

Training employees is a critical part of any cyber resilience program. Employees need to understand the value of protecting corporate, customer and colleague information, and their role in keeping it safe.  They also need a basic grounding in other risks and how to make good judgments when online.  Most importantly, employees need to know the policies and practices you expect them to follow in the workplace regarding the use of devices connected to the internet.

Importantly, when dealing with cybercrime there are a few considerations:

  • Understand your threat
  • Evaluate your maturity
  • Assess your critical risks
  • Develop your security roadmap
  • Monitor employee behaviour
  • Test your capability to respond
  • Transform your environment.

In the ‘hyperconnected world’ where smart systems are merging everything digital and physical, cyber threats and the inadvertent disclosure of confidential information have a greater potential of occurring.  The challenge for owners of small to medium businesses is to understand the complexity of their systems, what they are doing and more importantly what they’re interconnected with. The number of Notifiable Data Breach notifications being made to the Office of the Australian Information Commissioner suggests that Australian business needs to have a better grip on their data and tighter controls over it than ever before.  Maintaining an inventory of data assets and implementing secure network and process structures will go part way to helping your company keep ahead of potential compromises and minimise exposure to negative consequences from the interconnectedness of things.

It’s worth remembering that even the best cyber resilience programs still rely on human interaction; it is critical that staff understand the cyber issue and the threats they face and their organisation faces, as well as their role in the corporate response.  Help your staff understand the risks, make them accountable for controls to manage the threat, have a plan in place to respond to an event, test that it works and ensure that everyone in the organisation remains vigilant and remember, don’t be lulled into a false sense of security!

About the Author

Scott Goddard is the Partner leading Crowe Horwath’s Forensic, Cyber and Data Analytics practice for Australia and New Zealand. He has over 30 years of experience working for professional services firms and industry in various assurance, regulatory compliance and consulting capacities.




AASB release proposed changes to accounting for peppercorn leases

On 23 November 2018, the AASB released an exposure draft which proposes to provide temporary relief to Not-for-Profit Entities (NFPs) from fair valuing Right-of-Use Assets as required by AASB 16 and AASB 1058.

The proposed changes are a result of feedback received by the AASB on the difficulties associated with valuations of NFP’s specialised assets.

AASB 16 and AASB 1058 will be mandatory for NFPs for reporting periods beginning on or after 1 January 2019. Under the existing version of these standards, NFPs that have a peppercorn lease (or a lease that is significantly less than fair value), are required to measure the right of use asset at fair value on commencement of the lease.  This results in a day one income, recognised in profit or loss.  The requirement to fair value the Right of Use Asset may provide significant challenges to an NFP and would likely incur significant cost as an external valuer will be required in most instances.

The AASB are acknowledging that the ACNC legislative review is still on-going.  The outcome of which is currently unknown, but it may result in thresholds being increased such that some NFPs may no longer be required to apply Australian Accounting Standards.  In addition, there is an ongoing project to develop guidance to assist NFP entities in fair valuing assets.  As a result of these ongoing projects, the AASB is proposing to provide temporary relief until these projects are finalised.

It should be noted that the relief is both temporary and optional.  NFPs wishing to fair value Right of Use Assets can continue to apply the requirements of AASB 16 and AASB 1058.

NFPs that elect to apply the relief will be required to include additional disclosures to explain the impact of the peppercorn leases on their financial position and results.  The extent of these disclosures is set out in the exposure draft, ED 286.

Due to the imminent effective date of the standards effective, the exposure draft only has a 14 day comment period.  Comments are due to the AASB by 7 December 2018. We encourage affected NFPs to provide comments to the AASB directly, or reach out to your Crowe Horwath adviser to include your comments in our submission to the AASB.

If you are engaging external valuers for this purpose, we recommend this is put on hold until further notice.

Christine Webb

IFRS Technical Manager




Prudential Tax Audits & Tax Systems Reviews

Our article from 6 August 2018 entitled Are you prepared for a review by the ATO? highlighted that tax governance is a key focus area for the Australian Taxation Office (ATO) when reviewing both privately held groups and large public and multinational businesses.

The article covered the importance of your business being able to demonstrate its tax control framework (documented in the form of a Tax Risk Management Charter) is working in practice.  This is vital to achieving the ATO’s highest rating for tax governance of “justified trust”.

The ATO encourages all large private and public companies to achieve this rating, but to do so you must be able to demonstrate that your tax control framework has not only been designed effectively, but is also operating as intended.  Practically, this can be achieved by undertaking periodic testing of the tax controls of your business with evidence of the testing program to include conducting a:

  • Prudential Tax Audit; or
  • Tax System Review.

How Crowe Horwath can assist

Prudential Tax Audit

Over time, a significant proportion of large businesses can expect an ATO audit and our experience has shown that most businesses are not well prepared.  Very often, this means the process can then become drawn-out which adversely impacts on the day-to-day running of the business.

 

To prepare for the inevitability of an ATO audit, Crowe Horwath regularly assists clients by conducting Prudential Tax Audits.  In addition to properly evidencing the Tax Risk Management Charter of the business is working in practice; such exercises also provide executive management with the comfort of knowing they are better prepared for a tax audit in any tax area.

Our prudential audit program deals with many facets of taxation, including income tax, goods and services tax (GST), fringe benefits tax (FBT) and superannuation guarantee (SG).  Given the activity of the Office of Sate Revenue (OSR), many businesses are also receptive to a prudential audit covering payroll tax.

A typical Prudential Tax Audit commences with an initial interview with the managing director and key senior staff within the finance and administration groups of your business.  At this interview, a detailed questionnaire (customised to meet the specific needs of your business) is used to gather information regarding your internal business systems for the taxes under review.

The initial interview is followed by substantial field work; a manager, along with an experienced senior consultant from our Taxation Advisory group, undertake the field work.  This generally consists of checking taxation information through the internal systems of the business to source documents.  Upon completion of the field work, significant time is then dedicated to analysing the information collected, identifying potential taxation issues, researching solutions to these issues and formulating recommendations and strategies where necessary.

After this analysis has been undertaken, we provide executive management with a detailed report of our findings and recommendations.  The report will include a detailed review of the operation of each of the taxes, and will identify any issues, outstanding taxation liabilities and identify opportunities to minimise tax exposures..

Benefits of a Prudential Tax Audit

The main advantage of carrying out a Prudential Tax Audit is that it allows us to identify past tax technical issues and problem areas.  Not only does this allow us to help ‘fix’ the problem on a prospective basis, it allows us to perform a risk assessment in advance of an audit and enables us to inform executive management of any potential adverse tax consequences that may result from audit or review by the ATO or OSR.

Tax Systems Review

Adequate systems are an essential part of ensuring compliance with the tax risk management policies of a business.  We strongly believe that a Tax Systems Review is a critical step to ensuring ongoing compliance with the tax risk management objectives of your business.  Businesses with demonstrably watertight systems and processes are far more likely to achieve a “justified trust” rating from the ATO, compared to those with inadequate systems in place.

Whilst a Tax Risk Management Charter alone provides a solid foundation for managing tax risk, a key factor of risk management is ensuring adequate systems are in place to deal with meeting the tax objectives outlined in the charter.  Once a documented tax risk management policy is in place, adequate systems are an essential part of ensuring compliance with these policies.  It follows that a Tax Systems Review is an essential step to ensuring ongoing compliance with the Tax Risk Management Charter of your business.

The aim of such a review is to determine if information relevant to correctly paying each of the taxes under review is captured and documented correctly.  The review will identify any shortcomings of your systems and where appropriate, make recommendations to ensure systems and procedures are adequate and robust to assist with compliance of your taxation obligations.

The purpose of a Tax Systems Review is not to identify past tax technical issues and problems, as is the case with the Prudential Tax Review above.  Rather, a Tax Systems Review is a review of the extent to which your systems are being used effectively to record and retrieve tax information.  To this end, we do not analyse in detail the taxation treatment of past transactions, but rather, review and make recommendations to the process involved in capturing and recording tax information.

A Tax Systems Review can cover all Federal taxes including income tax, GST and employment taxes, as well as State taxes such as payroll tax.

Benefits of a Tax Systems Review

The aim of a Tax Systems Review is to provide you with recommendations for improvements to the systems and processes of your business, to ensure that you are well placed to meet your future taxation obligations and objectives.  Where significant risk areas are identified, we incorporate these risks into the Tax Risk Management Charter.

We also examine what procedures are in place to ensure complex tax technical issues are dealt with appropriately, and under what circumstances external advisers are engaged to resolve a problem.  Our reviews also include establishing what risk management procedures are in place, and are therefore closely paralleled with the Tax Risk Management Charter of the business.   Overall, the benefits of undertaking a Tax Systems Review can be summed-up as a way of ensuring:

  • A potential decrease in the frequency of tax audits and therefore a reduction in time and cost of complying with ATO tax audit requirements.
  • Tax risk management becomes embedded into the culture and operations of your business as a whole.
  • A systematic approach to tax risk management is an integral element of planning and performance management;
  • Your level of tax risk is minimised and to manage tax risk in accordance with best practice.
  • Executive management is alerted to changing legislative requirements or changes to the business that may affect the level of tax risk.

In addition, a major benefit of conducting a systems review is a reduced risk of errors in tax compliance systems and processes where our recommendations are implemented and adequate systems are in place for capturing and reporting tax information.

If you would like more information, please speak to your adviser, or contact a member of your local tax team.

Martin Whyte

Partner – Specialist Taxation Services

This article contains general information and is also not intended to constitute legal or taxation advice. If you need legal or taxation advice, we recommend you speak to a qualified adviser.

The views and opinions expressed in this article are those of the author/s and do not necessarily reflect the thought or position of Crowe Horwath (Aust) Pty Ltd.




The “Trusted Employee” Syndrome

He had it all in front of him. At 27, he was a management accountant in a successful company, happily married with a two-year-old and another on the way. But his interest in American sports – and more importantly, gambling on them – was too much. When he was in a hole after maxing out his credits cards and mortgage, he quite literally “borrowed” up to $550,000 from his employer to fund his gambling habit. And was caught – quite by accident. He used a variety of methods to extract cash from the business including the use of fictitious computer-generated invoicing, abuse of online payment processes relating to a divested entity and the manipulation of accounting balances to cover his trail. The ease at which this employee committed the fraud was alarming when you consider the entity was supposed to be dormant and yet it was still linked to the Group’s main trading account via a bank sweeping facility. The employee was also the Treasurer of his local sporting club and was using their account to launder the proceeds. The fraud was only discovered when a diligent employee of the club noticed an unusually large balance in the account when he deposited the weekly bar takings.

In many ways, the fraud was not that surprising. The ability to disguise the electronic transfer of funds may be reserved to those few with access, but what about the potential exposure of confidential information or proprietary documents over the internet which is at the fingertips of almost everyone in your organisation.

It should be the responsibility of everyone in the company to assess what critical assets are at risk of internal theft or fraud, but thankfully there are several options available to minimise fraud and ‘abuse of trust’ practices taking root in the office. It is good practice to develop a sound ethics policy linked to a Code of Conduct and to provide clear reporting guidelines in the event someone does the wrong thing. Importantly, employers need to communicate their expectations and should provide ongoing training to all employees that ensures adequate understand, compliance and clear escalation guidelines.

Many organisations have well established risk management strategies in place. However, there’s been a slew of new legislation governing how organisations manage and secure their confidential information. With Australia’s Notifiable Data Breaches Scheme and the European Union’s General Data Protection Regulations now in place, as well as Consumer Data Right legislation looming, Australian organisations can no longer be complacent and need to have much tighter control over their confidential customer information regardless of whether they have an online presence. There are now significant penalties for those who choose to run the gauntlet in the hope that it never happens to them.

The Office of the Australian Information Commissioner (OAIC) has recently released its second report into notifications under the Notifiable Data Breach scheme. Of the 242 notifications in the last quarter, 142 (59%) related to criminal or malicious conduct, followed by 88 (36%) caused by human error and the remaining 12 (5%) caused by system faults. The most common human errors were emails sent to the wrong participant with personal information, unintended release of personal information and physical mail sent to the wrong recipient containing personal information.

It is fair to say that reliance is being increasingly placed on operating and system controls to prevent and detect instances of fraud and misconduct in the workplace, particularly in the face of a de-layering of middle management and withdrawal of internal audit and risk management resources. This trend seems to be abating partly due to recent high profile corporate incidents, both here and overseas, and a tightening of the regulatory noose around those charged with the governance of companies. Whilst cost management is necessary in the face of increasing pressure on margins, it is advisable to retain corporate security and fraud prevention initiatives to mitigate the risk of fraud and misconduct occurring.

Those of us who are involved in helping companies get through new requirements, as well as investigating breaches, are too familiar with stories such as that at the top of this piece. ‘Red flags’ were obvious. There was no management supervision of the employee concerned, and poor segregation of duties; he had access to raising and authorising vendor payments, whilst recording and reporting the same transaction in the accounts. A number of key controls were absent including independent monitoring of movements against provisions and review of intercompany adjustments through the sweep account, not to mention monitoring of employee access to online gambling sites.

In another investigation, the Company Secretary of a large publicly listed company decided to take a holiday. While he was away, the company’s bankers telephoned accounting staff expressing concerns about the state of company’s overdraft facility. They were keen to understand likely future collections in order to calculate the repayment of the current overdraft limit which had reached $10 million. Further internal investigation revealed that over an 18-month period, the Company Secretary had influenced a junior accountant to electronically transfer significant funds to external sources controlled by him for his own personal benefit. These transfers were disguised by an over-statement in debtors and other similar accounting irregularities.

Unfortunately, when an employee has a strong motive to steal they tend to rationalise their actions as being acceptable. When you combine this with poor internal controls and little likelihood of detection, you have a recipe for financial and reputational disaster.

The number of corporate fraud investigations continues to steadily increase, so greater emphasis needs to be placed on prevention, particularly as it is a lot cheaper to prevent than to investigate. Business owners and managers need to raise their level of awareness about the techniques used by workplace criminals, in order to better understand their organisation’s vulnerabilities. In doing so, they can strengthen the organisation’s resistance to fraud. The result will hopefully be early detection, efficient investigation (if necessary) and a better more cost-effective outcome for all concerned.

So, in summary, organisations should consider the following:

1. Risk assess the business and manage those high risks identified
2. Make a plan to tackle fraud and serious misconduct
3. Undertake pre-employment checking and ongoing screening
4. Consider annual conflict of interest declarations
5. Raise employee awareness and assign accountability
6. Monitor systems for ‘red flag’ warnings
7. Take appropriate action when issues are uncovered
8. Communicate investigation outcomes to employees.

Scott Goddard, Partner – Forensic and Data Analytics

Scott is the Partner leading Crowe Horwath’s Forensic, Cyber and Data Analytics practice for Australia and New Zealand, He has over 30 years’ experience working for professional services firms and industry in various assurance, regulatory compliance and consulting capacities.




ASIC is on-board with changes to Special Purpose Financial Reports

The Australian Accounting Standards Board (AASB) is currently undergoing a consultation process which will see significant changes to Special Purpose Financial Reports (SPFR) as we know it.

Today we see a variety of SPFRs.  Some SPFRs comply with the recognition and measurement principles of Australian Accounting Standards while others are prepared on a different basis such as modified accruals, which is not a specified framework.

Recent changes by the International Accounting Standards Board (IASB) to the Conceptual Framework will impact the definition of a reporting entity in Australia.  If the AASB adopts the Revised Conceptual Framework (RCF) as issued by the IASB, all entities that are required by legislation to prepare a financial report will be required to prepare a General Purpose Financial Report (GPFR).  This includes every company that currently lodges a financial report with the Australian Securities and Investments Commission (ASIC) and entities that are required to lodge a financial report with the Australian Charities and Not-for-profits Commission (ACNC).

The AASB is proposing a two-phase process to adopt the RCF. At its recent board meeting in September 2018, the AASB approved the first phase to go ahead.  In the short-term, the AASB will operate two conceptual frameworks to maintain IFRS compliance, where the new RCF will apply to all for-profit publicly accountable entities, or entities which are stating IFRS compliance.  There is no significant impact to these entities as they are already preparing GPFRs and all other entities can continue preparing SPSF.

Furthermore, the AASB decided to limit the phase two consultation to for-profit entities and conduct separate research on the impacts to the not-for-profit industry.

In September, ASIC announced their support of the proposals by the AASB stating the following:

“ASIC fully supports the consultation to remove special purpose financial statements for entities regulated by ASIC and remove the subjective ‘reporting entity’ test under SAC 1 facilitating a comparable, consistent and transparent framework for preparation of financial statements in Australia.”

This comes as no surprise as the self-assessment for entities, as well as the varying basis of preparation of SPFRs, has been a concern of ASIC for a number of years.

The AASB are currently seeking comments on Phase two of the project.  Comments are due by 9 November 2018.  We encourage all those affected to provide comments to AASB directly or to us for inclusion in our submission to the AASB.

Christine Webb

IFRS Technical Manager