Tax regulators aim to pull the plug on ESSTs

This article was current at the time of publication.

Thousands of small businesses across Australia and New Zealand now use digital point-of-sale systems to transact online with their customers.

But it’s the growing use of electronic sales suppression tools (ESSTs) by businesses aiming to deliberately under report their taxable income that’s attracting significant attention from the tax regulators in both countries.

ESST developers are actively marketing these tools to small business owners, often packing them as “all-in-one completion business solutions” with low commissions, website presence, and as online ordering tools.

Australia investigates

The Australian Taxation Office-led Serious Financial Crime Taskforce says it is seeing businesses using ESSTs or cloud-based software designed to enable them to avoid paying tax by permanently deleting, resequencing, or misrepresenting sales transactions, reducing sales values, or producing fake records.

ATO Assistant Commissioner Tony Goding says it has been illegal in Australia to produce, supply, possess, use or promote ESSTs since October 2018. The regulator currently has several ongoing investigations involving the use of ESSTs.

“ESSTs are certainly one of our areas of focus in our shadow economy program and it’s a relatively new approach for people trying to avoid their tax obligations.”

New Zealand sees threats

Likewise, New Zealand’s Inland Revenue [IRD] has identified the growing use of ESSTs as posing a significant threat to the integrity of its tax system.

“These tools create the electronic version of two sets of books. Using this software amounts to tax evasion, and an aggressive form of tax evasion at that,” says Inland Revenue segment lead Tony Morris.

“Inland Revenue has already identified a number of customers in New Zealand who may have been exposed to ESS tools. That number is expected to grow, so IRD is working hard to identify who else has been exposed. When we find them, we will come knocking.

“Anyone who believes they may have become involved with ESS tools should discuss the matter with their tax adviser or Inland Revenue. They should also consider whether they may need to make a voluntary disclosure.”

Detecting tax cheats

In Australia, the ATO uses its intelligence and a wide range of data sources including bank information, small business benchmarks, and tip-offs from the community to tackle businesses seeking to avoid their obligations using ESSTs.

Goding notes the ATO has been receiving close to 50,000 tip-offs every year around tax evasion including the use of ESSTs and cash payments that are not declared.

“We’re actively encouraging the community to make a tip-off, and they are. We’re receiving tip-offs from other businesses, customers, members of the community, employees, and even family and friends.

“We don’t just receive information about people ripping off the tax system, but also about employers not meeting their employment obligations.”

How should tax practitioners react?

Goding says that tax professionals have an important role to play in tackling the shadow economy as they are well positioned to recognise shadow economy behaviours including their clients using ESSTs.

“When someone is asking you to lodge an activity statement or a tax return, or perhaps provide some advice, it's really asking the right questions from the start; Why is your turnover so low? Are you using an ESST?,” he says. 

“If something doesn't add up, ask some more questions, and if you get to the point where something seems suspicious, let us know or encourage your client to talk to us.

“We have a number of resources that we share with tax professionals such as our small business benchmarks, whereby we have a fair idea that if you run a particular type of business, your income and deduction should relatively look like X and Y. Businesses that remain within industry benchmarks are less likely to be using an ESST and attract our attention.

“We use a wide range of data sources along with sophisticated analytical tools and software to identify and address shadow economy behaviours, including people who appear to be living beyond their means based on what they’ve declared to the ATO. And I think that's a real simple tell.” New Zealand has a similar benchmarking system, operated in partnership with Stats NZ. 

Significant penalties

The maximum penalty for manufacturing, developing or providing ESSTs in New Zealand is NZ$250,000, and where ESS tools are used to evade paying tax people can face prosecution and up to five years in prison.

“Where we identify specific instances of ESS tools being used to evade tax, Inland Revenue will require payment of any evaded tax, plus 150 per cent shortfall penalties and use of money interest,” Morris says. 

“Where payment is not made, the Commissioner will consider applying for the taxpayer to be put into bankruptcy or liquidation.”

Goding says the ATO will impose shortfall penalties of up to 75 per cent of the income that wasn’t declared for businesses participating in the shadow economy. Interest and tax shortfall will also need to be paid, potentially going back many years.

“It's clearly a very severe penalty and we only use it in those instances where people are deliberately doing the wrong thing,” he says.

“If people are participating in the shadow economy, the ATO does hold a lot of information, a lot of data. We work very closely with tax professionals and, of course, that is combined with the information that other government agencies and the community provide us.

“It's not just a matter of if, it’s a matter of when. If you are using not only these technologies but deliberately trying to do the wrong thing by the tax, super and regulatory system we will hold you to account.”

Banks aware

Mahesh Balakrishnan FCPA, who works for a major Australian bank, says a trigger point for regulators to conduct further investigations can be when a small business is undertaking unusual transactions.

“There are various ways, from a financial crime perspective, of picking up anomalies,” he says. 

“For example, if a bank customer provides information that creates doubt or if staff identify transactions that are inconsistent to the customer’s profile, banks have procedures to investigate and may report to AUSTRAC [Australian Transaction and Reports and Analysis Centre]." AUSTRAC is part of the Serious Financial Crime Taskforce.

“It will come through reports to AUSTRAC, although a suspicious transaction might not directly be as a result of the use of an ESST,” notes Balakrishnan.

ATO’s shadow economy tax injection

A key ATO compliance initiative is the $155.5 million being funnelled into the Shadow Economy Compliance Program. The program is tackling underreported income, worker exploitation, illicit tobacco trade and other activities that distort competition and erode tax revenues.