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New Business Tax System (Alienation of Personal Services Income) Bill 2000 and two related bills

CHAIR —Welcome. Mr Willis, I know you are no stranger to these forums. Do you have a short opening statement, Mr Sutton?

Mr Sutton —Yes, if I could make a few opening comments, supplemented by Mr Willis. My organisation has long been concerned about the damage that tax rorting is doing to the construction industry and we have been putting in submissions on this issue for a long period of time raising our concerns. With the new tax system that has been in the air for some time now we took a strong position in the early part of last year about the need for the ABN system and the issuing of ABNs to be a rigorous process in which only genuine businesses got the ABN. That fell on essentially deaf ears and we were told that the Ralph review would have a close look at tax rorting in the building industry and that would address a lot of the concerns.

Sure enough, the Ralph review did that, and I would have to say that we were essentially pleased with the outcome of the Ralph review. We are here today to say that the substance and the recommendations of the Ralph review on this issue stand a much greater chance of addressing the epidemic of tax rorting in the building industry.

If I could go briefly to what we now have before us in terms of the proposed bill. We believe that the three tests that are now suggested are very flimsy indeed. The notion that you only have to meet one of the three tests is incredibly flimsy, I guess is the word that comes to mind. It will not be too difficult for lots of creative people with all their accountants assisting them to en masse avoid the so-called crackdown on the tax avoidance in our industry. So we believe that even if the tests were cumulative and you had to meet the whole three it would still be fairly easy for most people who are currently rorting the system.

There was some dialogue earlier about the magnitude of the issues. Let me say that of the $2.7 billion that was collected from PPS in the last reporting period more than $2 billion of that came from the building industry, so the bulk of the PPS collection has come from the building industry. The PPS system was one where most people had to pay a 20 per cent amount up-front. The tax office used to always say to us that in an industry where prior to PPS there was a massive cash economy at least during the years of PPS they were getting a 20 per cent increment from hundreds of thousands of these workers. I have to say to you now that as of 1 July the 20 per cent increment goes and I warn people now that there will be a very major loss in tax collections in the building industry. The cash economy that I knew well prior to 1983—because I have been around in the union for a long time now—I predict that cash economy will be back in a very big way in the building industry.

Coming back to the matters before us, we see no reason for the two-year tax holiday—as I might put it if I wanted to be pretty cynical—for people in the industry. There are various rationales for the two-year holiday: that the tax office are very busy implementing the new GST system and they will not be able to turn their mind to all of the applications from the building industry. If there is any merit to that argument you might say that one year or six months is a more tenable period. Two years seems wholly connected with political considerations and to have very little to do with the merits of the arguments before us. The Ralph review seemed to have a fair bit of integrity—no-one is going to suggest that John Ralph and his committee were bedfellows of the likes of the CFMEU—and I could think of some very good quotes from the Ralph review where he said that unless this is brought under control it will burgeon into a massive problem and a massive denuding of the PAYE system. I say to this committee that these new measures are just about laughable and the building industry will have a good old chuckle.

In closing, I will say to you that where it is very unfair is on legitimate contractors in our industry who actually comply with the laws of the land and who are trying to compete with other businesses that not only manipulate all this stuff and do not only not comply with the letter of the law but do not comply with the spirit of the law. Lots of good businesses that want to employ apprentices and train people and do all the rest of it cannot because of all this tax mess and there is nothing that I can see here that is going to address that.

Mr Willis —Mr Chairman, if I might supplement those remarks by just stressing that as I see this legislation, and as the CFMEU sees it, it is significantly weaker than was proposed by the Ralph report. In that circumstance, we believe that the revenue forecasts are somewhat extraordinary in that they only show a loss of revenue in respect of the transition arrangements, as has been discussed with the Treasury officials earlier, the $440 million resulting from the two-year tax holiday, as Mr Sutton called it, and the capacity of the government to maintain revenue at the Ralph report levels as is forecast in the year 2003-04. That the legislation says they will net $515 million from this, as was forecast in the Treasurer's statement in November where he was endorsing the Ralph report in full, seems to me to be quite extraordinary.

I say that because it seems to me that the approach taken in this legislation is quite different from that taken by the Ralph report. The Ralph report was concerned to ascertain whether the supposed contractor was operating in an employee-like manner. This legislation applies the opposite test: whether the contractors are acting in a businesslike manner. The Ralph report approach to testing whether a supposed contractor with less than 80 per cent of income from one source was acting in an employee-like manner was a comprehensive test, as has been discussed with the Treasury officials, based on the payroll tax legislation of the states—particularly of Victoria—and involved testing against a detailed list of criteria and the tax commissioner forming an opinion. The government's approach is rather to apply three simple tests for ascertaining whether the contractor can be regarded as a personal services business and providing that they need only pass one of them. It seems to me that that approach is clearly less demanding for contractors than Ralph was recommending, and especially so given that almost everyone will be able to pass the unrelated clients test.

I would ask the committee to really focus on this test. This test requires them to simply earn some income, no matter how small, from two or more unrelated sources. The mere fact that these contractors are earning less than 80 per cent of income from one source and associates of that source would seem to me to say that they are highly likely to be earning income from more than one source—that is, by definition of earning less than 80 per cent of their income from one source you would think that they are earning their income from two or more sources. The only way that that would not be so would be if somehow or other those two sources were related, although, of course, those sources include associates of the source in the legislation. But even if they were related, it would be so easily gotten around—all they would have to do is work on a couple of weekends for someone else and they have met the legislation.

Anyone who cannot pass this test is not trying. This is a walkover. This is a complete pushover of a piece of legislation. I never saw anything less likely to stop anyone avoiding tax in my life. The requirement that the work come from public offering or invitation by the contractor—for instance, by advertising—is also no barrier. It does not describe what that is: is it a sign in your garden, is it a sticker on your car, a sign on your house? Even if it is a small notice in the paper, it is a small price to pay to avoid a lot of tax. So it is terribly easily to get around.

So with almost everyone passing this test, the other two tests become almost irrelevant. As I see it, under this legislation virtually no-one with less than 80 per cent of income from one source will be affected, so how come the government's response to the revenue estimates is the same as Ralph? I just cannot see how that can be so and that is a matter that the committee should pursue much further with Treasury.

For those who have 80 per cent or more of their income from one source and its associates, the legislation provides that a contractor can avoid being taxed as an employee if he can achieve a Personal Services Business Determination from the tax commissioner. In this regard the legislation is almost falling over itself to help contractors to continue to avoid tax. It provides for four tests, as is being discussed, only one of which has to be passed. So there are three tests for a personal services business—the ones we had before—and a fourth for those who fail all those: that the contractor is contracting to produce a result, not just work for a certain period, that he supplies his tools of trade and is liable for the cost of rectifying defective work.

So, again, every effort has been made to minimise the impact. If you compare that with what the Ralph report said, it clearly was saying that it was up to the contractor to demonstrate that the interposed entity is conducting an independent trade or business, clearly putting the onus on him in a substantial way. I do not think that they could possibly have conceded that it could be as easy as this legislation makes it. Also, unbelievably, this legislation provides that even if they fail one of the three personal business tests they can then claim `unusual circumstances'. So if in some extraordinary way you fail the unrelated clients test, you are then able to say, `Well, I met this test in some past year and I'll probably meet it in some future year.' I never saw a softer piece of tax legislation in all my time in parliament.

I think one further point that I would like to stress is that the committee should also note that the ease with which contractors will be able to be classified as personal services business has implications not only for the tax treatment of their income but also for those sections of the legislation designed to limit deductions that individuals posing as businesses can make. The legislation makes it quite clear that its detailed restrictions on such deductions do not apply if the individual or entity is conducting a personal services business, so if you can meet the unrelated clients test you score on both points—your income is treated as though you are a business and you can claim the business deductions—and you win all around. And it is going to be so easy to do.

For these reasons, and all the other reasons mentioned by Mr Sutton and the CFMEU, I submit that this committee must conclude that the Costello legislation is substantially weaker than that envisaged by the Ralph report and accordingly it should also conclude that the revenue forecast by the Treasurer, which after the transition period is the same as for the Ralph report, has been very substantially overstated. Thank you, Mr Chairman.

CHAIR —Are there any questions?

Senator MURRAY —Perhaps I could kick off. Mr Willis, the Treasurer's press release of 11 November 1999 envisaged income over a five-year period, from 2000-05, of $2.42 billion. The explanatory memorandum now reduces that to $1.43 billion, a difference of $990 million. Treasury earlier said that if they brought the transitional period forward by a year it would have an effect of about $200 million—that is an estimate, it is not a forecast—so it would reduce the difference between those two sets of figures to $790 million. You are suggesting in your submission that the projected revenue figures are overstated anyway—in other words, that less revenue will be produced.

Mr Willis —It would seem to me that that is certainly the case.

Senator MURRAY —Is that a judgment based on an analysis of what you regard as the loopholes in the prospective legislation or were you able to do some modelling or analysis of it?

Mr Willis —No, I did not do any modelling. As I stated, it was based on the fact that it will be so easy for anyone—virtually anyone—to pass the unrelated clients test. When Mr Smith was speaking earlier he stressed that the other two were fairly tight but did not say much about that one, and that is because that one is terribly open, I presume. It is just obvious that almost anyone could pass that test in the ways that I mentioned. If that is the case then the whole legislation basically falls over. I do not know whether this is something that Treasury is aware of but were not able to stop, but the whole thrust of this legislation seems to me to be providing ways that taxpayers can avoid the impact of the legislation. Tax legislation is usually all the opposite way, it is trying to rope you in; this is trying to give you a multitude of ways to get out.

Senator MURRAY —One of the propositions you put is that the fourth test should be part of the evaluation. The prospect then would be perhaps that rather than one out of three, or one out of four, self-assessment would require more than one—say, two out of four. Would it still be very, very weak and very poor legislation in your opinion if that was so?

Mr Willis —As I said, I think the approach taken is different from the Ralph report in that it seems to focus on looking at it from a business side rather than whether the services are being provided in an employee-like manner. I think if it adopted that approach then the whole thrust of this legislation would be much stronger. It may be that not every aspect of the legislation that the states use for payroll tax would be appropriate in these circumstances, but something like a comprehensive test would seem to me to be a much better way to go. That might be a little more complicated and perhaps provide a bit more difficulty in the administration, but the way we are going with this people will just be able to walk their way through the legislation. The $440 million reduction in revenue as a result of the two-year transition period will be just the start of the revenue loss.

Can I just add to that, Senator. In the fourth year the revenue projections are the same for the Treasurer's statement in November and the legislation now introduced. As far as I can see the government has only factored in a loss of $440 million resulting from the transition period. There is no other reduction in revenue contemplated as a result of this legislation.

Senator MURRAY —Of your three recommendations—which you have described as the minimum amendments—one was that the Victorian payroll tax legislation test, or a version of that, should be applied. In questions to the Treasury they indicated that was a very subjective test and would imply really that you are asking the commissioner to make a case by case ruling rather than the self-assessment system working. Is that a proper summation of your views?

Mr Willis —As I said, it may require some modification for these purposes, but I think an approach of that kind would be much more appropriate to the circumstances. If what you want to do is stop people who are delivering services in a supposedly businesslike manner when they are not really businesses from doing that then you need something like that approach. This approach, which provides massive loopholes, will not stop them doing that. You should not let administrative ease override the need to prevent massive tax avoidance.

Mr Sutton —Can I add to that? The Victorian payroll test has been considered for quite some time now as about the most robust test around. Of course, it covers a significant population in Victoria and the people administering that tax are able to apply it to a broad population there successfully so I do not see how it could not be applied to a somewhat larger population. It is considered to be the test that has the most integrity around the place. At the heart of it is still the relationship—and I take issue with the tax office about this—of control and dependency and that relationship is still, and always will be, probably the most essential of all the tests. But there are a lot of other tests that hang off that and they are all important if you want to really catch people who can be very creative. There are lawyers who are following hard on the heels of every change here and are devising devices and manipulations, but the Ralph committee people are not dills and they spotted the fact that that is the test that has the most integrity around the place.

Senator MURRAY —Thank you, Mr Chairman.

Senator CONROY —Notwithstanding your concerns of why we would need a fourth test when it was impossible to fail the third test, I want to talk about the fourth test. I am interested in the section that says:

In making the determination, the Commissioner may have regard to whether it is the normal custom or practice, when work of that kind is performed by an entity other than an employee:

.for the income from the work to be for producing a result.

I get the impression from that that as long as you do not pay an hourly rate, or a truck driver's kilometre rate—returning to my past—and you say, `We are not going to pay you per kilometre between here and Sydney but here is a fixed amount of dollars to drive to Sydney and deliver this good,' you are complying. In your case where you get paid by the brick you lay, you do not say, `We will pay you by the brick. There is a house, when you finish building the house, that is the finished product.' They would seem to be two perfectly simple and straightforward ways of complying with this fourth test without substantively making any change to the way anybody is actually doing anything on the ground today.

Mr Willis —I think the use of that terminology has to do with past tax law in which courts have found, as I recall it, that where a contract was to produce a result then the legislation that had been around to try to prevent the business being seen as a business could not get through. The use of that terminology is, I think, for specific legal purposes. I do not quite follow the example that you gave.

Mr Wainwright —Can I add to that. The problem that we have identified in that final section is that it is far too complex. You start with matters with which the commissioner must be satisfied—and that is based on the weak tests in the first section—and then the commissioner has a range of other devices that he may use, if he so chooses, in order to grant the determination. What we are saying is the important approach that the commissioner has is the discretion to grant a determination as long as he is satisfied of the three tests that are currently in the legislation under `further grounds for making the determination'. We see that as being robust enough for the commission to base a decision on. But the commissioner has the overriding discretion.

CHAIR —If there are no further questions, thank you very much for your submission and also for appearing in person. I now call the Tax and Treasury officials back to the table.

[12.32 p.m.]