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

CHAIR —Welcome back. Mr Smith, given what we have just heard, do you want to make any response or will you just take questions?

Mr Chapman —Perhaps, Mr Chairman, I will just make one comment and then I might ask Mr Smith to make one further one. Just to clarify the issue around determinations where income of over 80 per cent is sourced from one provider, that is not an exclusion test. Under the normal arrangements, businesses earning less than 80 per cent from the one source may approach the commissioner and request a private binding ruling on the commissioner in respect of that matter. The nature of the test is to say that if you earned over 80 per cent of income from that one source and want to put yourself forward as a business you do need to come to the commissioner for a determination on that matter. I think there may have been a degree of misunderstanding around that matter. I would ask Mr Smith to make a comment as well.

Mr M. Smith —There may be a perception that if you have more than two clients you automatically satisfy the unrelated clients test, even though you are over 80 per cent. The structure of the law, as it is, says that if you are over 80 per cent you really do not have access in the first instance to the unrelated clients test. In the previous submissions coming forward there was talk that a couple of weekends work would satisfy the unrelated clients test. That possibly would be the case if that weekend work resulted in 20 per cent of your annual income. The only time you can use the unrelated clients test if you are over 80 per cent is where you do have unusual circumstances—in other words, I think in his report Mr Ralph may have recognised someone who has landed a long-term contract but in the period before that they had lots of clients and in the period after that they will have lots of clients again. They are the sorts of unusual circumstances that are envisaged.

CHAIR —Thank you. We are back to questions now. Senator Watson.

Senator WATSON —I would like you to comment on the suggestion put forward by the Housing Industry Association that they believed there was just the one area which needed clarification in relation to the test. Do you have a response to that? Is that necessary?

Mr G. Smith —The proposition that I think they put was that the fourth test should be available for self-assessment. I made the point in our first session that we have concerns about self-assessing on that test, and I think Mr Chapman also made some comments about the application of that test under self-assessment. We would expect that the three tests would be satisfactory for self-assessment but we were not confident that the fourth test should be done on that basis. It was therefore restricted to the determination which is only available for an over 80 per cent case.

Senator WATSON —Could you give us reasons? You said that you were not confident that it—

Mr G. Smith —As I mentioned earlier, the concern was referring to a difficulty of a compliance kind. Essentially it is a test which is open to more judgment factors than the other three more objective tests and that is why it is preferred that that would be only available on determination.

Senator WATSON —It was suggested by the last witnesses that you have accepted the Ralph revenue estimates, yet the legislation has since been watered down somewhat.

Mr G. Smith —As you know, there are those who think that the legislation is too hard and those who think that the legislation is too soft, and I understand those viewpoints, but the Ralph position was a short discourse on a complex matter, as we all agree. It clearly stated that it was intended to exclude its application to business and, as I said earlier, essentially the tests that we have aim to do the same thing. There are certainly some differences in the approach to that but the outcome was the same so we do not have sufficient data to justify a change in the estimates. Mr Willis—quite correctly, I think—made the point that the estimates were changed for the transitional measure.

Senator WATSON —So you are happy about the robustness of the figures?

Mr G. Smith —We have no basis for changing them.

Senator CONROY —On the second source of income test, I just wanted to give you an example to see whether or not it would fit within your parameters. A school decides that teachers who used to be employees should now be contractors. If I am a teacher, as long as I have another client unrelated to the school then I pass the test? If I provide tutoring to children outside of school hours, which I obtain by placing an advertisement in the local paper, can I then be treated as running my own business for the purpose of the employment with the school? Where will that get me?

Mr M. Smith —How much income do you get from these activities?

Senator CONROY —Let us say that it is less than 20 per cent.

Mr M. Smith —As I indicated before, if you get less than 20 per cent from your external tutoring you cannot self-assess yourself anyway because you are over 80 per cent from one source. Once you are in that domain you cannot use the unrelated clients test so the measures would apply to you.

Senator CONROY —And more than 80 per cent?

Mr M. Smith —You mean more than 20 per cent?

Senator CONROY —Yes, sorry, more than 20 per cent.

Mr M. Smith —More than 20 per cent you would need to show that in getting those incomes you satisfied the unrelated clients test.

Mr G. Smith —And in particular, Senator, you need to establish that you are not a salary or wage employee of the school in the first case. I think something that keeps getting forgotten is that in a very high percentage of the circumstances—and I appreciate you have to be very shorthand in the examples you throw up—they would not cease to be salary and wage circumstances in the first instance.

Senator CONROY —I am making the point that they now come back with an interposed entity as a contractor.

Mr G. Smith —I am sorry, I did not hear the interposed entity point. As you know, the majority of the people affected by this measure do not have an interposed entity. If it is an interposed entity, fair enough, there has been an effective alienation if that is the assumption.

Mr M. Smith —Just because these measures do not apply to you, that does not mean you are free to start splitting that income. The tax laws that have been applying for many years give clear guidance as to how that personal services income should be treated. Basically, if you have an entity and you have many clients and you get that income, which is your personal services income, that income has to be paid out of that entity to you as salary so that there is nothing left in the entity at the end of the day. There are rulings that give you guidance as to what sorts of deductions you can claim in that process. Just because you do not come within these measures it is certainly not a green card to start splitting income with spouses and associates and overclaiming deductions.

Senator CONROY —On the business premises test, can you just take me through what is a business premises and what is not. The garden shed is one I am particularly interested in because there seems to have been some confusion about the garden shed. Is the garden shed a business premises if I set it up and put my computer down the back?

Mr M. Smith —Maybe if we have a look at the test and work through it we might be able to give some guidance on that. I think the garden shed would be part of your business premises. Is it part of where you live?

Senator CONROY —It is my garden shed.

Mr M. Smith —Oh, it is your garden shed, so it probably would not come into play because it is not separate from where you live.

Senator MURPHY —It is on the same block of ground.

Senator CONROY —What if I rent a garage somewhere else?

Mr M. Smith —What do you do in the garage? The test requires you to be mainly carrying out that personal services activity in this separate premises.

Senator CONROY —I park my car there and—

Mr M. Smith —I don't think you are there. What is it that you rent the shed for? What is your activity?

Senator CONROY —I am the one trying to ask the questions so you can help me, not ask me to define a piece of legislation that I did not write.

Mr M. Smith —It is the same old case: we need to know the details. To satisfy the separate business premises test it has to be separate from where you reside and you have to mainly conduct the activities that generate your personal services income from that premises.

Senator MURPHY —Could it be on the same block of ground, for instance, as your home? Could you build an office?

Mr M. Smith —Like a doctor or something?

Senator MURPHY —Could you construct an office?

Senator CONROY —A one bedroom unit out the back—maybe grandma has died and there is an opportunity to move my business into the unit she used to look after.

Mr M. Smith —What is your business?

Mr Chapman —It is not so much the issue of having the shed, it is more what the shed might be used for.

Mr M. Smith —What are you doing in the shed?

Mr Butler —If you are conducting your medical practice—

Senator MURPHY —You could conduct a chiropractic business, office services, acupuncture.

Mr M. Smith —Those people are clearly out through the unrelated clients test, but if you just have your shed or your separate office to do your accounts and that is supporting your business activity, then, no, you are not conducting your personal services activity in there—whatever those activities are that you will not tell us.

Senator CONROY —You will send the tax office after me.

Senator MURPHY —But providing you were, it meets the test?

Mr Butler —As Mr Smith said, if you are conducting your business, like a medical practitioner, then you would not be under these provisions anyway.

Senator CONROY —Say you are an architect and you might actually physically be sitting there.

Mr Butler —If you worked for many clients then you would not fall under these provisions at all.

Senator CONROY —If you only work for one client?

Mr Butler —They would fall under the provisions unless there is some way of getting out of it. If he said, `Normally I have a lot of clients. This particular year I have one big job I am doing for you but next year I expect to be back to where I was before with a number of clients,' then he would not be impacted by these measures.

Senator CONROY —So my opinion of how I am travelling makes a big difference?

Mr Butler —The opinion would be relevant, as would the business history of the person, what are their plans for the future and that sort of thing.

Senator CONROY —So if you said, `What are your plans for the future?', you would expect complete honesty from somebody who said that they might have had 10 clients, now they are down to one but they are planning to go back to 10 clients next year?

Mr Butler —The commissioner's staff have to make decisions on those sorts of things on a daily basis. You just look at the facts and test the veracity of what is being said with whatever evidence you may have from elsewhere.

Mr M. Smith —There is an example, Senator, in the EM. Did you see that example about Rose leasing the shed in his back garden?

Senator CONROY —On what page?

Mr M. Smith —It is page 30, example 1.14.

Senator CONROY —It is a brother though; that is a related party, is it not?

Mr M. Smith —Yes. If it is a related party that is the same result as if it was a shed in your backyard. The example is showing that because it is a shed in an associate's backyard you still would not pass the test.

Senator CONROY —Do you think a builders' labourer should be able to just set up a business where they provide nothing more than labour and basic tools? Should they be caught by your bill or not? Is that the intent?

Mr M. Smith —It depends on how they operate. You could have builders' labourers advertising their services and going from job to job. If they have lots of clients then the normal law as it applies now would continue to apply; if they just had one source of income then these rules would come in and apply to them.

Senator CONROY —Do you think PPS should be withheld or retained during the transition period?

Mr Chapman —That is a matter of government policy. Just as an observation, it is difficult to have a tax regime built around a withholding from both ends of the transaction, as you would have in a GST and withholding environment.

CHAIR —Are there any further questions?

Senator MURRAY —This question is for the tax office. If the years were shortened from two to one, you would be able to cope, would you not?

Mr Butler —Can I answer that question. As I mentioned before, I am the project leader for the Ralph review of business taxation. There has been a lot of discussion today about the impact on the ATO of what is happening already but we should not forget what has been agreed to by government and publicly announced: the new entities regime, consolidated groups, a simplified tax system for small business, new depreciation regimes. There are a whole range of measures that are coming down the track. It is important not to forget those particular measures when you are looking at those sorts of issues. Similarly, there is a big impact on the tax profession and tax advisers of all those Ralph review recommendations.

Mr G. Smith —I would like to make the point that it was not just the tax office but also the implications for the taxpaying community and the tax advising community that was a factor in the decision to make it the two years.

Senator MURPHY —But they make adjustments a lot of times with less notice than that.

Mr G. Smith —It is the scale of the total change that the two major tax reform packages are having that led to this decision.

Senator MURPHY —There have been some fairly significant scaled operations in the past—

Mr G. Smith —I think the new tax system and the new business tax systems arguably are unprecedented.

Senator MURPHY —We are talking about a specific area here.

Mr G. Smith —But it is an additional one. The judgement was made definitely in the context of other things, not taken on its own. I would make that point as an objective fact: I know the judgment was made on that basis. It was with reference to compliance burdens as much as it was to the administrative challenge for the tax office.

Senator CHAPMAN —In response to the issue raised by the Housing Industry Association about the commissioner not being able to issue a determination for anyone who had less than 80 per cent of their income from one source, you said that in fact that was possible. I am a bit confused because I read the legislation and it says in 87.65(3c), `The commissioner must not make a determination ... unless 80 per cent or more of the individual personal services income can be reasonably expected or was from the same entity ...'

Mr Chapman —The point I was making earlier was that there is a regime of determinations associated with this measure. There has been a longstanding regime of advice being provided by the Commissioner of Taxation as we have the private binding ruling system and it is quite open for a taxpayer who is seeking certainty around their affairs to approach the tax office for such a ruling.

Senator CHAPMAN —And that can override this?

Mr Chapman —It is not so much overriding in that that regime sits within the system. In respect of cases where over 80 per cent of income is derived from one source, we would be encouraging those taxpayers to come to the office for a determination if they do not wish to be taxed under the regime built into this bill.

Senator WATSON —Could I comment on the examples. I believe they have been quite helpful in explaining to us the impact of the legislation so I would welcome the continuance of giving examples to clarify legislation.

CHAIR —Thank you, Senator. I think that completes the questioning and it completes this morning's hearing. Thank you very much to the officers from the tax office and Treasury. This committee will resume at 2 o'clock to look at the next bill, TLAB No. 11.

Committee adjourned at 12.50 p.m.