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Employee Fraud and unexpected tax implications

We often hear about cases of identity theft and consumer scams where organisations have large sums stolen, which despite best efforts, often remain unrecoverable. Another increasingly common type of fraud, which can go unnoticed (and when discovered is often quietly resolved internally without publicising the details), is Employee Fraud.

Employee Fraud can have far-reaching negative consequences for victim businesses, including on finances, reputation and staff morale. What many clients don’t often consider is the taxation implications.

We answer below some common questions relating to Employee Fraud and discuss the serious tax implications these incidents can have on your business.

What is Employee Fraud?

Employee Fraud is fraud or theft conducted by an employee (usually a senior employee, in a position of trust or authority) to gain a financial advantage without the business’ knowledge.

Examples of Employee Fraud are:

  • Financial statement fraud – where there is a deliberate misrepresentation of a company’s financial statements, whether through omission or exaggeration, usually to present the company as being in a more favourable financial position, performance and cash flow

  • Asset misappropriation – where employees steal from an organisation through fraudulent activity such as false expense claims, false invoices, embezzlement by altering accounts and payroll fraud by manipulating employee compensation and diverting payments

  • Corporate credit card fraud – where employees use company credit cards to purchase goods and services that are unrelated to the business, but rather are for personal gain, yet claim the expenses as expenses of the business.

How can Employee Fraud affect my business?

Employee Fraud, although often undetected, is becoming more common than most businesses think. In some cases, Employee Fraud can lead to business failure, destroyed relationships and unrecoverable careers.

The financial consequences of Employee Fraud on a business can result in:

  • Significant financial loss. If Employee Fraud goes undetected for a significant period of time, it may affect the businesses cash flow which in turn will affect the businesses overall success and its ability to continue its operations.

  • Serious implications on the taxation liabilities of a business and its directors.

    While in some cases, any loss incurred as a result of Employee Fraud may be tax deductible to the business, in others, Employee Fraud may result in company directors being personally liable and having to pay the company’s tax debts out of their own pocket.

    This is largely a result of the expansion of the Director Penalty Notices (DPN) Regime and the increased enforcement of the DPN Regime by the Australian Taxation Office (ATO) (see further below).

Can Employee Fraud be claimed as a tax deduction?

There are limited circumstances where a company may be entitled to a tax deduction as a result of fraudulent activity by employees.

Broadly, you can claim a deduction for a loss of money incurred by your business that was caused by an employee stealing, embezzling or misappropriating the funds for their own use, where that loss was included in your company’s assessable income.

For example, if your employee steals money from your company or misappropriates company funds, you may be entitled to a tax deduction for that loss. In some cases, however it may be that where an employee has stolen company funds and used those stolen funds to purchase property, that property may be deemed to be held on trust for the company (which has happened in the past). So if your company later receives the stolen or misappropriated money back in full, or is able to trace the funds back to property, then your company may result with extraordinary income for the year that the fraud funds are recovered.

My company’s tax return was lodged incorrectly as a result of Employee Fraud – what now?

Your options are specific to your circumstances. Employee Fraud could result in an underreporting or overreporting of your company’s taxable income in the relevant year. You may need to get in touch with the ATO to report and correct your company’s tax position, but navigating the correction is not always simple as Employee Fraud can trigger a variety of tax issues, including penalties and interest. We recommend you seek taxation advice before contacting the ATO to deal with the taxation consequences of Employee Fraud.

My company’s PAYGW, SGC and GST have been incorrectly reported as a result of Employee Fraud – what now?

Typically, the onus is on the company to meet certain liabilities relating to Pay As You Go Withholding (PAYGW), Superannuation Guarantee Charge (SGC) liabilities or Goods and Services Tax (GST) of the company.

If as a result of Employee Fraud, any PAYGW, SGC or GST liabilities of a company are reported incorrectly or remain unpaid, the directors of that company are at a risk of receiving a DPN.

Under the ATO’s DPN Regime, the Commissioner can make directors personally liable for SGC, PAYGW and GST liabilities of the company which remain unpaid by issuing a ‘Director Penalty Notice’.

The law surrounding DPNs is complex. Some director penalties (relating to unpaid PAYGW or net GST which is reported within 3 months of the due date or SGC liabilities reported by the due date) can be remitted by appointing an administrator or taking steps to wind up the company within 21 days of the DPN being received. These director penalties known as a ‘non-lockdown’ DPN.

If unpaid PAYGW or net GST is not reported within 3 months of the due date or SGC liabilities are not reported by the due date, then the only way to remit the director penalty is to pay the debt in full. These director penalties are known as a ‘lockdown’ DPN. Generally, directors are held personally liable for the debts owing under these ‘lockdown’ DPNs, even though the incorrect ATO lodgements arose by way of Employee Fraud.

In some limited circumstances a defence to a DPN may be available.

It is imperative that the Employee Fraud be identified and addressed as soon as possible after it occurs. This may help to mitigate the risk of DPNs (in particular lockdown DPNs) being issued.

If you have received a DPN, it is important to seek immediate legal advice.

I think my company is being subjected to Employee Fraud – what now?

Navigating Employee Fraud is an onerous task. There are many factors that need to be considered and many risks that need to be weighed up, including the likelihood of the Employee Fraud resulting in your company’s directors receiving a DPN and the application of penalties and interest by the ATO on outstanding tax debts.

Contacting legal and tax professionals can help ensure that you are aware of all the potential consequences and are taking the appropriate steps to address the situation.

How can my business do its best to avoid Employee Fraud?

By being proactive and taking steps to prevent Employee Fraud, businesses can help minimise resulting taxation consequences. In our experience, you should look out for and investigate the following:

  • Business expenses claimed by employees without evidence to support those expenses (e.g. credit card expenses without support receipts)

  • Sudden increases in business expenses which appear excessive compared to prior years and industry averages

  • Unreconciled bank account statements

  • Employee time records and any overtime claimed which don’t reconcile with their terms of engagement

  • Any anomalies in your company’s financial statements, no matter how minor they may seem. You should regularly review your interim and annual financial statements.

If you or someone you know are suspicious of Employee Fraud, you need to act immediately. Investigate your company records, gather the information which has made you suspicious of Employee Fraud and seek expert legal and accounting advice.

Bartier Perry’s Organisational Fraud, Corruption and Investigations team can be contacted here.

Authors: Chris Tsovolos & Joanne Doueihi