Photo by Blake Wisz on Unsplash

From time to time, there have been various reviews into whether taxable income should be aligned with accounting income in order to reduce some of the complexity and compliance costs associated with the Australian tax system.

Such reviews usually reject the idea, citing the need to preserve the different purposes for which accounting and tax have been created and the administrative effectiveness required of a tax system.

As these reviews occurred quite some time ago, they never had the benefit of observing the ever-increasing accumulation of small business tax compliance costs nor digital take-up rates amongst small business.

The Australian Small Business and Family Enterprise Ombudsman (ASBFEO) estimates that small businesses tax compliance costs are about $90 per $1,000 of turnover, or about 225 times more than the cost for big business ($0.40 per $1,000 of turnover).

According to the Australian Bureau of Statistics (ABS), the proportion of small businesses (0-19 employees) using paid cloud computing continues to grow, with 42 per cent of all businesses reporting the use of cloud computing compared to 31 per cent in 2015‑16.

Time to change how small businesses calculate their income tax

Against this backdrop, the Government should revisit the idea of allowing small businesses to align their income tax liability with their accounting income. Such a change would see income tax based upon information taken directly from their digital accounting packages rather than the current practice of requiring small businesses to make complex income tax calculations.

Currently, the income tax position of a small business is calculated by using the business’ accounts as a starting point. A series of increasing and decreasing tax adjustments are made to arrive at their income tax position. Some of those adjustments are referable to the various small business tax concessions like the instant asset write-off and the various small business capital gains tax (CGT) concessions.

The magnitude of small business tax compliance costs raises the question of whether small business would be better served with much simpler arrangements that dispense with the complex income tax calculations, including the small business tax concessions, and simply calculate their income tax from their accounts. (Noting, too, that the Government’s tendency to rollover the instant asset write-off from one year to the next together with the Board of Taxation’s small business CGT recommendations would likely see the small business income tax base align more closely with digital accounting notions of income in any case.)

The increasing take-up of digital accounting packages allows this to be more feasible as the accounting income is readily accessible and transmissible.

The principles here are that the tax calculations should ‘follow the accounts’ and that the data be captured once: if small businesses have digital accounting packages that they use to prepare their accounts, the work that they put in should suffice to deal with their income tax calculations with only minimal additional input.

A recent survey of the tax profession conducted by the ANU Tax and Transfer Policy Institute revealed that nearly 53 per cent of respondents agreed with the statement that ‘small businesses should be able to use their accounting income as revealed by their accounting software to determine their income tax liabilities’.

A pathway forward

An initial step in this direction would be to apply accounting income to calculate Pay-As-You-Go instalments (PAYGI).

Small businesses currently provide for future income tax liabilities by paying instalments of tax (usually quarterly unless very small) through the PAYGI system. The instalments are aggregated and offset against the actual year-end income tax liability. Quarterly PAYGI instalments are generally calculated by reference to the previous year’s income tax with an inflationary uplift and divided by four.

Applying accounting income to calculate PAYGI instalments leverages natural business systems and ensures that the instalments are based on a more accurate and up-to-date perspective of a small business’ actual financial position. In this way, it assists small business cashflow and better reflects their capacity to pay.

Moreover, it better handles those small businesses with income streams that are volatile (natural disasters or COVID-type epidemics) or seasonal (farmers). Additional spin-offs, including reductions in small business tax disputes, small business tax debt, and the small business tax gap, are also likely to emerge.

To ensure integrity, the digital accounting software should be approved by the Commissioner of Taxation to ensure the software arrives at calculations that are in accordance with sound accounting and tax practices. This would allow the Commissioner to focus compliance on an ex-ante basis, rather than the traditional approach of ex-post compliance based on historical data.

In turn, small businesses using the approved software could be provided an assurance that their income tax affairs will not be subsequently reviewed or audited (apart from in fraud or evasion cases) in much the same way as Advanced Pricing Agreements and the Justified Trust arrangements are struck between large corporates and the Commissioner.

This feature alone could stem the flow of small business complaints and the scale of the dispute mechanisms required. This includes internal mechanisms at the Australian Taxation Office (ATO), for example the ATO’s independent review service, as well as other external mechanisms, such as the Administrative Appeals Tribunal (AAT) (Small Business Tax Division), the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) (tax concierge and mediation functions) and the Inspector-General of Taxation and Taxation Ombudsman (IGTO) (systemic small business tax complaints).

In other words, the proposal deals with the root cause of why small businesses get into difficulties with the income tax system in the first place, rather than the myriad of arrangements to deal with downstream complaints.

Our neighbour has been doing it

The prospect of aligning income tax with accounting income is not mere folly. It is already being deployed in New Zealand through its Accounting Income Method, a system which could provide some useful design cues for an Australian equivalent.

The Prime Minister, in his address to the Institute of Public Administration in 2019, challenged the Australian Public Service to pursue ‘a culture of regulatory congestion busting’ and to ‘grasp the productivity opportunity of the digital economy’. Moreover, the Prime Minister expressed the view that ‘harnessing the power of digital technology is not an option for the Australian Government. It’s the future of it.’

The reform proposal set out above fits squarely into this agenda.


Haydn has been on secondment to the TTPI and conducted research into the interface between accounting and taxation notions of income.


Further reading

Daw, H 2021, ‘The tax and accounting interface: How to build a transformational tax system for small businesses using technology as a pathway to reform’, Working Paper 3/2021, Tax and Transfer Policy Institute, Crawford School of Public Policy, Australian National University.

Leave a comment

Your email address will not be published. Required fields are marked *