Tori Sullivan: Taxman using technology to home in on the hospitality sector

COMMENT:

With many hospitality businesses seeing a decrease in sales as a result of diminishing tourism from China (with some even forced to close their doors for two weeks), increased regulatory compliance costs and another hefty $1.20 spike in the minimum wage looming, many restaurant, cafe, bar and takeaway owners probably won't welcome an ominous warning that the taxman may be around for a visit.

With recorded sales of more than $11 billion in 2018, this sector has long been viewed by Inland Revenue as high risk of under-reporting cash sales and making under-the-table payments.

But as the cash economy diminishes due to the increase in card transactions, the Inland Revenue opens a new front on the war against suspected evasion. It will now focus on ensuring hospitality business owners know they need to show transactions through electronic trading and mobile payment apps.

Interestingly, Inland Revenue has pitched its focus as a positive for the sector. It explains the virtues of making sure all income is properly returned. These benefits include:

"Accurate bookkeeping makes it easier to see what's going on in your business, to get a loan, and to keep track of your tax records. It also means your business will be worth more if you decide to sell."

This final point is interesting as, anecdotally, businesses that suppress their income by hiding cash or exaggerating expenses may reduce their tax in the short-term but are equally "talking down" the value of their business when it comes time to sell.

Prospective purchasers conducting due diligence on a business can only rely upon the financial accounts and tax information prepared by the current owner – which obviously excludes the extra undeclared cash profits.

Although under-reporting income may make it harder to sell a business, these positive affirmations are unlikely to prove much of an incentive with the industry having a high turnover – in 2017, although 2739 hospitality businesses opened, 2232 closed. Many hospitality business owners complain about not being able to make a capital gain on sale, regardless of the level of reported income.

So, not surprising for the hospitality businesses that won't nibble on Inland Revenue's carrot, Inland Revenue' scampaign also contains a heavy stick. It explains:

"We know the signs of businesses that aren't following the rules, and we will prosecute."

Those "signs" are based on Inland Revenue's increasingly automated audit operations, following its new computer system upgrade.

The new technology is able to drift net Inland Revenue's vast data-lakes of taxpayer information to identify specific factors and ratios that it believes fall outside the acceptable range. This allows Inland Revenue to very quickly find the "crooked needle" in the haystack of compliant taxpayers, assuming of course that the systems have properly defined what makes up a crooked needle.

While Inland Revenue is quick to stress that computers do not conduct the audits and individual investigators vet and review the results thrown up from these new data sweeps, the trend is clear – increasingly taxpayers will be identified for audit based on their industry features or specific risk factors in their business or financial accounts.

Inland Revenue's reliance upon "random audits" is therefore decreasing as its intelligence about taxpayers and their behaviour becomes more detailed.

Just last year, Inland Revenue was successful in a high-profile prosecution of 11 restaurateurs that operated a chain of Thai cafes around Wellington.

Inland Revenue alleged evasion based on what it described as the deliberate suppression of cash sales of up to $9 million. Eventually, five of those individuals were convicted of evading $2.3m in tax.

The scale of that evasion by a small number of cafes has obviously demonstrated to Inland Revenue the risk that sector poses.

While you would not expect such a high tax take from the average establishment, the ease with which Inland Revenue can now catch non-compliance, means that it won't take long before the hospitality sector starts paying dividends on Inland Revenue's $1.5b computer upgrade.

• Tori Sullivan is a director of EY Law