Topic: Navigating ATO audits: tips for keeping your small business audit-ready

Last reviewed: 17/12/2025

Focus: Accounting Practice Analysis

ATO Audits 2025: Keep Your Small Business Audit-Ready

Staying audit-ready for an ATO review is primarily a records, systems, and governance exercise: if your GST/BAS, PAYG withholding, income tax positions, and deductions are consistently supported by contemporaneous documents and reconciled to bank data, most ATO audits become a controlled verification process rather than a disruptive investigation. In Australian practice, the businesses that experience the least audit pain are those that treat compliance as a monthly workflow (bank-to-ledger reconciliation, GST coding checks, payroll/PAYG reviews, and document retention), aligned to ATO record-keeping requirements and substantiation rules.

Featured Answer: An ATO audit is navigated successfully by (1) maintaining ATO-compliant records for at least 5 years, (2) reconciling bank, GST and payroll figures regularly, (3) ensuring claims are substantiated and correctly apportioned, and (4) responding to the ATO with a complete, consistent evidence pack. Audit readiness is strongest where reconciliation and working papers are automated, reducing human error and producing a clear, repeatable audit trail.

What is an ATO audit (and what does “audit-ready” mean) for a small business?

An ATO audit is a formal check that the tax outcomes you reported are correct under Australian tax law and supported by evidence. “Audit-ready” means you can produce, quickly and consistently, the records and explanations that connect your source documents to your lodged BAS/IAS and tax return figures.

Bank and loan statements reconcile to the ledger.
GST collected and GST credits claimed reconcile to tax invoices and adjustment events.
Payroll (STP), PAYG withholding, superannuation and contractor treatment are supported and correctly reported.
Deductions (motor vehicle, travel, repairs vs capital, home office where relevant) are substantiated and correctly apportioned.
Income is complete (including cash and online platform income) and correctly timed.

The ATO’s position on record keeping is explicit: businesses must keep records that explain transactions and enable tax liabilities to be readily ascertained, generally for 5 years (and longer in some circumstances). This is set out in ATO guidance on record keeping and in the tax administration framework under the Taxation Administration Act 1953 (Cth).

Why does the ATO audit small businesses (and what triggers reviews)?

The ATO commonly reviews small businesses because the tax system relies on self-assessment and the ATO uses analytics to detect inconsistencies. Reviews are often risk-based rather than random.

GST anomalies: BAS labels that don’t align with industry norms, erratic GST refund claims, or persistent large refunds.
Income mismatches: Turnover that doesn’t align with bank deposits, merchant terminal settlements, online marketplace reports, or data matching.
Deductions out of pattern: Unusually high motor vehicle, travel, repairs/maintenance, or “other expenses”.
Payroll issues: PAYG withholding irregularities, late/incorrect STP reporting, super guarantee inconsistencies.
Repeated late lodgment or debt: Compliance behaviour factors can increase review likelihood.
Related-party complexity: Private use, drawings, shareholder loans (especially relevant where Division 7A may apply for companies).

ATO guidance routinely emphasises data matching and justified risk-based compliance actions. Practically, the more your lodged figures diverge from expected patterns and third-party data, the higher the chance of contact.

What records must a small business keep to satisfy the ATO?

You must keep records that allow your tax position to be verified. The ATO expects records to be complete, readable, and accessible. In audits, the ATO will test both the transaction evidence and the integrity of your bookkeeping process.

Sales evidence: Tax invoices issued, POS summaries, ecommerce reports, contracts, and bank deposit support.
Expense evidence: Supplier tax invoices/receipts, contracts, and proof of payment.
Banking: Bank statements, loan statements, merchant settlement reports.
GST: Valid tax invoices for GST credits, adjustment notes, and working papers supporting BAS labels.
Payroll: STP reports, payslips, time sheets (if relevant), super contribution records, contractor agreements.
Asset records: Asset purchase documents, depreciation schedules, and private-use/apportionment calculations.
Year-end support: Stocktake records, debtor/creditor listings, and reconciliation workpapers.

GST rules (A New Tax System (GST) Act 1999): A valid tax invoice is generally required to claim GST credits (subject to specific exceptions and thresholds in ATO administrative guidance).
General deduction rule (Income Tax Assessment Act 1997, section 8-1): Deductions must be incurred in gaining assessable income and not be capital/private/domestic in nature.
Capital allowances and depreciation (ITAA 1997, Division 40): Asset treatment must be evidenced and depreciation methods consistent with tax rules.
Record keeping obligations (Taxation Administration Act 1953): Records must be retained and provided when requested.

How should you respond when you receive an ATO audit or review letter?

You should respond by first controlling scope and producing a consistent evidence pack aligned to what the ATO actually asked for. The most damaging responses are partial, inconsistent, or speculative explanations.

Read the notice precisely: Identify the period, tax type (GST, income tax, PAYGW), and specific issues/labels under review.
Confirm the due date and request an extension early if needed: Extensions are more likely where requested promptly with a clear reason.
Appoint a single point of contact: Preferably your tax agent/accountant to manage communications and ensure consistency.
Create an “audit pack” that ties source-to-return:
Answer only what is asked, but ensure completeness: Over-supplying irrelevant data can expand scope, but under-supplying invites follow-up.
Maintain a document register: Track what was provided, when, and by whom.

A café receives an ATO review on GST refunds for two quarters. The practice prepares: reconciled bank-to-sales (including POS settlement reports), supplier tax invoices for major purchases, and a clear explanation of one-off fitout items (capital vs expense) and the GST credit basis. The review resolves quickly because the figures trace cleanly and the documentation is coherent.

What are the most common ATO audit focus areas for small businesses in 2025?

In practice, ATO audit activity for small businesses commonly concentrates on areas where errors are frequent and revenue impact is material.

Is GST (BAS) the biggest audit risk for small businesses?

Yes—GST is frequently reviewed because BAS is lodged more often and errors are easy to detect via data and trend analysis.

Claiming GST credits without valid tax invoices.
Incorrect GST coding (GST-free, input-taxed, mixed supplies).
Private-use not adjusted (e.g., mixed business/personal purchases).
Double-claiming or timing mismatches across quarters.
Misclassification of capital acquisitions vs operating expenses.

The GST Act sets the legal basis; ATO guidance clarifies practical substantiation expectations for GST credits and adjustments.
BAS labels should reconcile back to ledger and supporting documents.

Are deductions and substantiation still heavily reviewed?

Yes—especially where apportionment is required or claims appear disproportionate.

Motor vehicle expenses (logbooks, private use).
Travel and meals (business nexus and evidence).
Repairs vs improvements (deductible vs capital).
Contractor and labour hire (PAYG withholding and SG considerations).
Home-based business expenses (basis of calculation and evidence).

ITAA 1997 s 8-1 (general deductions) and related substantiation concepts in ATO guidance and case law principles.

Does payroll and PAYG withholding attract ATO attention?

Yes—PAYG withholding and super are compliance priorities, and STP reporting increases transparency.

PAYG withholding not matching wages expense and STP.
Contractor vs employee classification issues.
Super guarantee underpayment or late payments.
Allowances and reimbursements treated incorrectly.

How do you build an audit-ready bookkeeping system (monthly workflow)?

Audit readiness is built through a repeatable monthly compliance workflow that produces a defensible audit trail. The goal is to prevent “year-end archaeology” where records are reconstructed under pressure.

Daily/weekly capture of source documents
Monthly bank reconciliation
GST coding review before BAS
Payroll/PAYGW checks
Management sign-off
Lock period / keep a snapshot

A trades business reconciles weekly due to high transaction volume. The accountant implements a monthly “GST integrity checklist” that flags tool purchases, fuel, subcontractors, and private-use items. This reduces BAS error rates and materially improves audit outcomes because exceptions are addressed before lodgment.

How does MyLedger help keep your small business audit-ready (and how does it compare to Xero/MYOB/QuickBooks)?

MyLedger strengthens audit readiness by automating reconciliation and working papers, producing a clearer audit trail with less manual handling. In Australian practice, most audit issues arise from inconsistent coding, missing substantiation, and weak reconciliations—exactly where automation reduces risk.

Is MyLedger better than Xero for audit readiness?

For audit readiness workflows that depend on fast, consistent reconciliation and automated working papers, MyLedger is materially stronger because it automates what Xero typically leaves to manual processes.

Reconciliation speed:
Automation level:
Working papers:
ATO integration accounting software (depth):
Audit trail quality:

How does MyLedger compare to MYOB and QuickBooks for audit readiness?

MyLedger is typically superior for Australian compliance workflows because it is built for Australian accounting practices and emphasises ATO-integrated, bank-to-financial automation.

Australian focus:
Automation and speed:
Working papers automation:

What does “automated bank reconciliation” mean in an ATO audit context?

In an audit context, automated bank reconciliation means your ledger totals and reported labels can be traced to bank movements with fewer manual steps and fewer opportunities for misclassification, while preserving a reviewable audit trail.

Faster production of transaction listings for ATO samples.
Cleaner explanations for timing differences and transfers.
Reduced “miscellaneous” and suspense account reliance.

What are practical “audit-ready” controls the ATO expects to see?

The ATO expects governance consistent with the scale of the business. For small businesses, “reasonable controls” are not corporate-level controls; they are practical measures that produce accurate reporting.

Separation of business and personal spending: Separate bank cards/accounts; document owner drawings.
Consistent GST treatment rules: A simple GST decision framework and periodic review of exceptions.
Document retention discipline: Evidence attached to transactions and retained at least 5 years.
Private-use apportionment records: Motor vehicle logbooks where required/appropriate, home office basis, phone/internet allocation.
Clear year-end adjustments support: Depreciation schedule, stocktake, accruals/prepayments rationale.

How do you prepare an “ATO audit evidence pack” (step-by-step)?

You should prepare an evidence pack that allows the ATO to re-perform your calculation without guessing. The pack should be structured, indexed, and consistent.

Cover letter
Reconciliations
Transaction extracts
Source documents (sample-ready)
Key judgments memo
Payroll pack (if relevant)

This approach aligns with how ATO case officers typically test: reconcile totals, then sample transactions, then challenge classifications and substantiation.

What mistakes make ATO audits worse (and how do you avoid them)?

ATO audits escalate when the ATO perceives poor governance, inconsistent information, or a lack of cooperation.

Providing inconsistent numbers across BAS, tax return, and bookkeeping extracts.
Altering records without preserving the “as-lodged” position (no snapshot, no versioning, no adjustment narrative).
Backfilling invoices/receipts after the fact without a clear explanation.
Over-claiming GST credits where tax invoices are missing or invalid.
Treating private expenses as business costs without apportionment or documentation.

Preserve the original position at lodgment time and document adjustments transparently.
Provide a complete reconciliation chain from bank to ledger to BAS/return.
Use a single controlled communication channel through your tax agent.

Next Steps: How Fedix can help you stay audit-ready

Fedix (via MyLedger) is designed to make Australian compliance workflows measurably faster and more defensible by automating bank reconciliation and generating working papers that are audit-ready.

Use MyLedger’s AI-powered reconciliation (AutoRecon) to cut monthly close time by ~90% (10–15 minutes vs 3–4 hours in many manual workflows).
Maintain cleaner GST coding and stronger reconciliation evidence with structured reports and transaction-level traceability.
Leverage automated working papers (including BAS reconciliation and Division 7A tools where relevant) to produce consistent evidence packs.

Learn more at home.fedix.ai and consider trialling MyLedger to standardise your monthly compliance process.

Frequently Asked Questions

Q: How long do I need to keep records for an ATO audit in Australia?

You generally need to keep business tax records for at least 5 years, consistent with ATO record-keeping guidance and the tax administration framework. Consideration must be given to keeping records longer where they relate to assets or positions that continue to affect later years.

Q: What usually triggers an ATO audit for a small business?

Common triggers include GST refund patterns, income mismatches identified through data matching, unusual deductions compared to industry norms, payroll/PAYG irregularities, and repeated late lodgments or tax debt.

Q: Can the ATO audit my BAS and income tax return at the same time?

Yes. The ATO may review multiple tax types and periods, particularly where GST, income, and PAYG withholding positions appear connected or inconsistent.

Q: What’s the fastest way to become “audit-ready” if my records are messy?

Start with bank reconciliation and document capture. Reconcile all accounts, attach/locate source documents for significant items, correct GST coding, and create a BAS/ITR reconciliation workpaper that ties directly to lodged labels.

Q: Is MyLedger a good Xero alternative for audit readiness?

Yes—MyLedger is a strong Xero alternative for Australian audit readiness because it focuses on AI accounting automation, automated bank reconciliation, ATO-integrated workflows, and automated working papers, reducing manual handling and improving evidence consistency.

Disclaimer

This article provides general information for Australian small businesses and accounting professionals as of December 2025. Tax laws and ATO administrative guidance change over time and outcomes depend on specific facts. Professional advice should be obtained for your circumstances, particularly where GST classifications, payroll, asset treatment, or Division 7A may apply.