Every year, the ATO audits thousands of Australian businesses and individuals. While some audits are random, the vast majority are triggered by specific red flags in your tax return or financial data. Understanding what the ATO looks for is the first step to making sure you are not unnecessarily flagged. Here are the 7 most common audit triggers in 2025-26 — and what to do about each.
How Does the ATO Select Businesses for Audit?
The ATO does not audit businesses randomly. It uses sophisticated data matching and risk profiling to identify high-risk lodgements. Key methods include:
Industry benchmarking: The ATO compares your gross profit margin, labour cost ratio, and expense ratios against typical ranges for businesses in your industry. If your numbers fall significantly outside these ranges, your return is flagged.
Data matching: The ATO receives data from banks, share registries, third-party platforms (Uber, Airbnb, eBay), state revenue offices, and foreign tax authorities. If your reported income doesn't match what these sources report, you will likely hear from the ATO.
Tip-offs: The ATO has a formal tipoff program. Disgruntled former employees, business partners, or ex-spouses frequently report suspected tax evasion.
Random audits: A small percentage of audits are genuinely random — the ATO calls these "random stratified sample audits."
Red Flag 1: Your Numbers Don't Match Industry Benchmarks
The ATO publishes small business benchmarks for gross profit margins and labour cost ratios across dozens of industries. If your numbers fall more than 10–15% outside the typical range, your return will be flagged for review.
Examples of ATO benchmarks:
- Cafes and restaurants: GP margin 60–75%, labour 25–40%
- IT services: GP margin 60–80%, labour 30–50%
- Building and construction: GP margin 25–45%, labour 20–35%
If your cafe is reporting a 45% GP margin when the ATO expects 60–75%, they will want to know why. Legitimate reasons include high rent or premium ingredients — but you need documentation.
Check your own risk score using our free ATO Audit Risk Scorer, which compares your numbers against real ATO benchmark data across 14 industries.
Red Flag 2: Unusually High Motor Vehicle Expenses
Motor vehicle expenses are one of the most scrutinised deductions in Australia. The ATO flags businesses where motor vehicle expenses exceed approximately 8% of total revenue.
Common problems include:
- Claiming 100% business use for a vehicle that is also used privately
- Not keeping a logbook (required for the logbook method)
- Claiming for a vehicle not registered to the business or owner
- Fuel and repairs that don't match the reported business kilometres
What to do: Keep a 12-week logbook that accurately reflects your business use percentage. Your logbook must cover a representative period and be renewed every five years.
Red Flag 3: Large or Unexplained Cash Transactions
The ATO pays close attention to cash-based industries: cafes, restaurants, beauty salons, cleaning services, and any business that commonly handles cash. If your declared revenue seems low relative to your business activity (number of staff, premises size, industry turnover per employee), you will attract attention.
The ATO uses third-party data to estimate revenue — including rental data from commercial landlords, supplier sales data, and industry cost-per-employee ratios.
Red Flag 4: Home Office Expenses Above 5% of Revenue
With the rise of remote work, home office deductions have skyrocketed. The ATO monitors them closely and flags businesses where home office expenses exceed approximately 5% of revenue.
The ATO requires that home office claims relate to a dedicated workspace — not shared living areas. You must keep records of actual usage. The fixed rate method (67 cents per hour for 2025-26) is simpler but still requires hours records.
Red Flag 5: Net Profit Consistently Below Industry Average
If your business consistently reports a net profit margin below the industry typical range, the ATO may question whether all income is being reported. This is especially relevant in cash-heavy industries.
The ATO's concern is simple: if a hairdressing salon has three staff, is operating in a premium suburb, and claims high rent and wages, but reports a 2% net profit margin, the numbers don't add up. Either expenses are inflated or income is understated.
Red Flag 6: Discrepancy Between Lifestyle and Declared Income
The ATO's data matching capabilities now extend to property ownership, vehicle registrations, overseas travel, and share portfolios. If someone declares $50,000 in income but owns multiple investment properties and travels overseas regularly, the ATO has grounds to investigate.
This is sometimes called a "lifestyle audit." The ATO is legally entitled to question how you fund a lifestyle that appears inconsistent with your declared income.
Red Flag 7: GST/BAS Lodgement Irregularities
Inconsistencies between your BAS and your annual income tax return are a major red flag. Common issues include:
- Total revenue reported on BAS lodgements for the year not matching income tax return revenue
- Large swings in GST credits between quarters without explanation
- Late or non-lodgement of BAS (puts you on the ATO's watchlist)
- Input tax credits claimed for non-business expenses
The ATO cross-matches your BAS data with your income tax return automatically. Any material discrepancy triggers a review.
Check Your Own ATO Audit Risk Score
Before lodging your next tax return or BAS, check where your numbers stand relative to ATO benchmarks. Our free ATO Audit Risk Scorer compares your gross profit margin, labour ratio, motor vehicle expenses, home office expenses, and net profit margin against the ATO's published industry benchmarks — and gives you an instant risk score from LOW to VERY HIGH with specific recommendations for each red flag.
What to Do If You're Audited
If you receive a letter from the ATO requesting information:
- Do not ignore it. Failure to respond escalates the situation significantly.
- Get professional help. Engage a registered tax agent experienced in ATO reviews.
- Gather records. Collect receipts, invoices, bank statements, and contracts relevant to the period under review.
- Be cooperative but careful. Respond accurately and completely. Do not volunteer information not requested.
If you have made errors in previous lodgements, consider a voluntary disclosure to the ATO. Voluntary disclosures typically attract reduced penalties.
FAQs About ATO Audits
How long does an ATO audit take? Simple desk audits typically resolve within 1–3 months. Field audits (where the ATO visits your business) can take 6–12 months. Complex cases involving suspected fraud can take several years.
Does the ATO audit sole traders or just companies? The ATO audits all entity types. Sole traders are actually audited more frequently than companies as a proportion of their numbers, partly due to higher cash transaction risks and less formal record-keeping.
What are the penalties for failing an ATO audit? Penalties depend on the nature of the discrepancy. Unintentional errors typically attract 25% shortfall penalties. Reckless conduct attracts 50%. Intentional disregard attracts 75%. Interest (GIC at ~11.38% p.a.) also applies on unpaid amounts.
Disclaimer: This guide is for informational purposes only. For advice specific to your tax situation, consult a registered tax agent.