“Mate… how did you pass your ATO review?” — Why Small Businesses Can’t Ignore Tax Governance

Doc and Marty operate their own businesses and catch up every year at their local pub. At previous catch‑ups, Marty had often spoken about his detailed documentation processes. Although they were time‑consuming, he accepted they were part of running a business.

Doc, on the other hand, laughed it off every year—boasting that he did the bare minimum such as simply putting journal entries through for his company’s Division 7A loans without any supporting paperwork.

Fast‑forward to their next catch‑up.

Both had recently heard from the ATO.

Marty explained that his review went smoothly: the ATO looked at the last two income years, requested some supporting documents, asked a few questions, and closed the review with no issues. Doc spits out his beer in confusion as he was hit hard by the ATO for having no loan agreements, lack of substantiation in declaring dividends to offset the loans and using the same benchmark interest rate each year was unacceptable. To top it off, he was hit with penalties for recklessness!

Marty pats him on the back, orders something from the top shelf while Doc quietly nurses his schooner, eventually asking: “Mate… who’s your accountant?”

That small exchange captures a big truth:

Tax governance is not just for big business — it can make or break a small business when the ATO comes knocking.

Why Small Businesses Should Consider Tax Governance

Many Small-Medium Enterprises (SMEs) assume tax governance is only for large corporates, but the ATO’s current compliance posture says otherwise.

The ATO has shifted firmly back towards:

• enforcement and substantiation based reviews
• evidence‑based testing of tax positions

and SMEs who are not updating their processes so they can provide proof are suffering similar fates to Doc.

SMEs must now be able to demonstrate:

• documented processes
• supporting evidence for tax treatments used
• timely preparation of required documentation
• consideration of tax consequences before transactions occur

Being able to demonstrate processes, providing relevant and compliant documentation and considering tax outcomes as part of operational and passive transactions before they arise sends a message to the ATO — there is a tax governance framework in place. Those who don’t have this risk poor substantiation, subjecting themselves to compliance activity with probable adverse outcomes and penalties.

The broader compliance environment is also tightening. The ATO is actively increasing analytics and data sources, audit resourcing and focus areas — particularly where documentation or reporting inconsistencies appear. Even if some small businesses assume informal practices are sufficient, the ATO’s current compliance posture makes it clear that this is no longer accepted by it. Unfortunately, trying to fly under the radar becomes even more risky with the ATO’s 2025–26 compliance programs having funding specifically aimed at small business non‑compliance and documentation gaps, including cash economy behaviour, GST variances and mismatches between records and reported data.

What the ATO Expects — Even from Small Business

ATO guidance outlines seven principles of effective tax governance, emphasising clear processes, documented procedures, accountability and evidence to support tax positions. These principles apply across all taxpayers — not just large corporates — because the ATO is concerned with the quality of decision‑making and substantiation. Even with this, we would however expect that the level of governance documentation required of a small business would be far less than that of the ATO’s ‘Top 500’ taxpayer group (but not nil, or close to it as per Doc’s approach).

Back to the Case Study: How Simple Documentation Can Save a Business — Division 7A Loan Sub‑Accounts

To show how getting to a better governance outcome overall can be achieved, let’s look at one specific aspect of Marty and Doc’s example — annual Division 7A loan sub‑accounts.

Bad governance — Doc’s approach

Doc treated all private-company loans as one ever-moving loan account, with no tracking of each annual loan amount and no evidence supporting repayment allocations. When reviewed:

• The ATO treated repayments as wholly applying to the oldest loans first, resulting in repayment of an old loan but failing to meet the minimum yearly repayments of all subsequent year loans.
• As a result of breaching Division 7A:
  •  deemed dividends (unfranked) which increased assessable income.
  • Imposed penalties for recklessness (due to absent documentation to which his tax agent acted recklessly by ignoring the requirements to make minimum repayments to each year’s loan).

If Doc hadn’t even bothered to have a written loan agreement, then the above approach would mean that each year’s new loan was all a deemed dividend, and the repayments made (of older, already taxed loans) were completely ineffective in reducing the amount of each dividend.

Good governance — Marty’s approach

Marty (with a competent tax adviser) had:

• Separate sub‑accounts for each income year’s Division 7A loan, with newly loaned amounts being posted to the new account each year.
• Loan agreements executed on time.
• Repayments allocated to the correct loan.
• Evidence of calculations, schedules, director minutes and ASIC reporting requirements.

When reviewed, his positions aligned with the ATO’s governance principles and the ATO accepted his documentation was sufficient to show that Marty complied with the requirements.

Why this matters and how we can assist

In 2026, taxpayers who cannot quickly produce accurate and complete documentation upon request are already on the back foot. The ATO increasingly treats poor or absent governance as a tax risk in its own right, and inadequate substantiation can directly influence the scope, intensity and outcome of a review.

If this article resonates with your clients’ circumstances and they are unsure where to begin, we’re here to assist. Our team can attend your client’s business, review their current processes, identify governance and tax risk areas, and help design a governance framework proportionate to the size and nature of the business. Equally, we can assist tax agents in looking at their processes and help the tax agent improve how they service all their clients.

Contact Webb Martin Consulting for tailored guidance and make 2026 the year your clients strengthen their tax governance, reduce risk and improve compliance confidence.

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