The ATO has contractors firmly in its sights. Data matching capabilities have expanded dramatically, audit activity has increased, and the penalties for non-compliance are severe. Understanding what triggers scrutiny—and how to structure your affairs appropriately—is essential.
The ATO's Data Matching Capability
The days of hoping the ATO wouldn't notice are over. They now receive data from:
- All Australian banks (every transaction over $10,000, patterns of smaller transactions)
- Sharing economy platforms (Uber, Airbnb, Airtasker)
- Cryptocurrency exchanges
- Government contractor payment systems
- State revenue offices
- Private health insurers
- Property transactions
This data is matched against your tax return automatically. Discrepancies trigger reviews. The process is increasingly algorithmic—human auditors focus on cases the system flags.
Common Audit Triggers for Contractors
Certain patterns reliably attract ATO attention:
Income/expense mismatches: Claiming business expenses that don't align with reported income. A sole trader claiming $50,000 in vehicle expenses on $80,000 income will be questioned.
PSI rule non-compliance: Claiming company tax benefits when Personal Services Income rules should apply. This is a major enforcement focus.
Unexplained lifestyle: Living beyond declared means. The ATO cross-references property purchases, vehicle registrations, and travel against reported income.
Cash-heavy industries: Some industries have higher audit rates simply due to historical non-compliance patterns.
Inconsistent patterns: Significant year-to-year variations without clear explanation. Dramatic income drops following company establishment raise flags.
Related party transactions: Payments between associated entities, income splitting arrangements, and family trust distributions receive scrutiny.
The PSI Enforcement Focus
Personal Services Income rules are the ATO's primary tool for addressing contractor non-compliance. The rules attribute company or trust income back to the individual if:
- The income is primarily a reward for personal services
- None of the PSI tests are passed (results test, 80% rule, unrelated clients test, employment test, business premises test)
The ATO has been increasingly aggressive in PSI enforcement. Contractors who incorporated based on simple tax calculators—without understanding PSI implications—are being caught.
Red flags for PSI audits:
- Single client arrangements
- Company established primarily for tax benefits
- No genuine employees or subcontractors
- Working on client premises with client equipment
- Fixed hourly or daily rates without project-based risk
Record-Keeping Requirements
Proper records are your best defence in an audit. Contractors should maintain:
Income records: Invoices issued, payment receipts, contract documents. Keep for five years minimum.
Expense records: Receipts for all claimed deductions, logbooks for vehicle use, home office calculations with supporting evidence.
Bank statements: Full records for all business accounts. Unexplained deposits or withdrawals create problems.
Contracts and agreements: Evidence of business relationships, terms of engagement, proof of genuine contractor (not employee) relationships.
Asset registers: Documentation of business assets, depreciation schedules, disposal records.
The ATO can demand records going back five years. If records don't exist, deductions can be disallowed entirely.
Structuring for Compliance
The goal isn't minimising tax at any cost—it's optimising within the rules while maintaining audit defensibility:
Genuine business substance: If operating through a company, ensure it has genuine business characteristics beyond tax benefits. Separate bank accounts, proper accounting, commercial arrangements.
Pass PSI tests legitimately: If you can genuinely satisfy PSI tests, document the evidence. If you can't, don't structure as if you can.
Consistent treatment: Apply the same approach consistently. Changing positions opportunistically invites scrutiny.
Conservative claims: Aggressive deduction claims that might be technically arguable but are practically risky often aren't worth the audit exposure.
Professional advice: Get advice from accountants who understand contractor-specific issues. Generic tax advice misses PSI implications.
When Audits Happen
If you're selected for audit:
Don't panic: Many audits result in minor adjustments or no change. Cooperation generally produces better outcomes than defensiveness.
Gather records immediately: The faster you can produce supporting documentation, the better.
Get professional help: Tax agents can deal with the ATO on your behalf and often achieve better outcomes.
Be honest: Providing false or misleading information during an audit dramatically escalates consequences.
Understand your rights: You can request reasons for ATO decisions, object to findings, and escalate to the AAT if necessary.
The Cnopy Approach
We built Cnopy to help contractors maintain compliance from the start—not scramble when the audit letter arrives. The platform tracks PSI status, maintains structured records, and models tax positions before they're taken.
Prevention is better than cure. Contractors who understand the rules and structure appropriately from the beginning rarely have serious ATO problems. Those who wing it and hope for the best are playing a game they'll eventually lose.