Recently SV Partners was appointed to provide an independent expert report with regard to an alleged misappropriation of funds from a medical practice. Our initial role in the matter was to determine whether fraud had been perpetrated, and if so, produce a report that allowed a transparent and unbiased view of how the funds had been misappropriated and the quantum of funds stolen. The purpose of our report was not, in this particular case, to provide evidence to police to allow charges to be laid and proven, but rather to allow the practice to pursue the perpetrator for repayment of the funds stolen.
Whilst still investigating we were advised that the alleged perpetrator had made an offer of financial settlement. The settlement included repayment of the entire (known) fraud quantum, plus all costs. In fraud matters, such an offer of settlement is as rare as hen’s teeth.
It was at this point our engagement changed direction. Now, instead of providing our instructing solicitor and client on how the fraud was perpetrated and how much was missing, we were determining the tax ramifications of the receipt of this financial settlement.
Settlements are ordinarily taxable where the funds would have been otherwise taxable but for the event in question. In this instance, the funds had been earned as medical fees and were subsequently stolen by an employee. The thefts were disguised as legitimate business expenses, which reduced the profitability of the practice and reduced the tax payable by the holding entity. There are obvious tax consequences, but there are also a few nuances that might be overlooked by lawyers who are focussed upon providing a commercial outcome, and which could be utilised by the client to minimise the taxation payable in relation to the settlement.
Firstly, there is the artificial expenses that were generated by the perpetrator. In some circumstances she put the expenses through as being inclusive of GST and other times they were GST free. In the circumstances where the she claimed that GST had been paid on the fraudulent expenses, this created an input tax credit for the practice, thereby reducing the BAS instalment payable by the practice by this amount. A corrected BAS would therefore need to be lodged to ensure that the GST component of the fraud was remitted to the ATO.
Secondly, the fraud was perpetrated over a number of years and affected the income tax paid by the company to the extent that it artificially reduced the profit of the holding entity for each year. A simple solution to this matter would be to bring the entire settlement to account in the current financial year, pay income tax and be done with it. However, this would create income tax issues for the owners of the business if they should wish to extract a dividend from the entity, because it would be highly likely they would be pushed into the highest marginal tax rate (even through intermediary discretionary trusts) and pay a greater proportion of tax than had the profits been paid out in each of the relevant years in which the frauds occurred.
As a result, the settlement meant that our engagement morphed into a detailed breakdown of transactions by year so as to allow the practice’s existing accountants to lodge amended tax returns for the practice, the shareholding trusts, and ultimately the beneficiaries of those trusts back to 2011 as well as amended BAS returns for the practice over the same period. By conducting this analysis and giving timely advice, we saved our client significant tax and allowed the practice to understand their true performance over the last 5 years.
If you would like any Forensic accounting advice, please contact a member of our team on 1800 246 801.
Article written by Brett Goodyer, Director – Forensics.