This is the story of a case decided in the Administrative Appeals Tribunal (AAT) in April 2024.
Dennis and Nina, a Queensland couple, were partners in a building partnership that carried out construction and maintenance work. They also owned a private company, Beta Leigh Pty Ltd, which was involved in land development, building and selling homes, selling land, and renting out developed properties at times.
This case centred on transactions between the company and the partnership, and how poor recordkeeping and documentation led to major issues with small business tax compliance. After an ATO audit, the company faced tax, penalties, and interest totalling over $1 million.
When bookkeeping lets you down
Nina handled the bookkeeping for both the company and the partnership using MYOB. While she acted honestly, the records were poorly reconciled. External accountants were engaged but failed to insist on proper reconciliations, resulting in a critical oversight in ensuring small business tax compliance.
What went wrong with trading stock
The ATO alleged that Beta Leigh had understated its taxable income by $704,000 due to incorrect calculations of trading stock, specifically land and construction costs. These costs can only be deducted when the property is sold and must be calculated based on the proportion of the property sold.
Beta Leigh argued there was a compensating adjustment in the previous year, but the AAT rejected this, stating that the company needed to prove the ATO was wrong in the year being assessed. Without accurate records, it couldn’t.
The management fee dispute
Another key issue involved a $350,000 management fee paid by Beta Leigh to the partnership. Dennis and Nina claimed this was compensation for their past management services. However, there were no written agreements, no explanation of how the amount was determined, and no evidence of services rendered.
The AAT denied the company a tax deduction for the amount, stating that it had not been proven to be incurred in deriving the company’s income. Although not directly addressed, the partnership likely still had to declare the $350,000 as income, creating a tax mismatch.
Lessons in small business tax compliance
This case highlights how easy it is for small business owners to fall short of ATO expectations when recordkeeping and inter-entity arrangements aren’t properly managed. Inaccurate balance sheets, missing source documents, and informal transactions between entities can all trigger audits and hefty penalties.
To ensure your business is compliant:
- Regularly reconcile all balance sheet accounts to source data.
- Keep clear records of stock values, payments, and transactions.
- Have formal agreements in place for services or payments between entities.
- Ensure your bookkeeping software and processes are accurate and up-to-date.
When the ATO investigates, your ability to respond quickly and accurately is key to avoiding penalties.
Get small business tax compliance advice from Geelong accountants
Poor documentation and informal processes can quickly escalate into serious tax consequences. The experienced Geelong accounting team at MacMillan Cowan & Co can help you manage inter-entity arrangements. Additionally, we can help strengthen your bookkeeping, and stay ahead of compliance obligations.
Get in touch today for practical, expert support with small business tax compliance.