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Wednesday, 31 May 2000
Page: 16649


Mr ANDREW THOMSON (11:38 AM) —I am interested in this development in our tax law, especially because before being elected to parliament and for part of the time I worked in Australia I found myself in much the same position as the taxpayers at which this attempt to codify common law is quite obviously aimed. The term `alienation of personal services income' sounds very dry but, if you think about it in real terms, it is what you see when you drive or wander around any of our large cities—people going from place to place pursuing opportunities to earn an income from their clients. They are the contractors, the men or women who work in a physical sense or, increasingly, who work in a more cerebral way, especially in the more vigorously growing sectors of the economy—information technology and so forth. There are changes in the way Australians are earning their income, and necessarily our tax law must adapt to meet those changes in order to ensure the integrity of the tax system. On the other side of that coin, there are some profound dangers of government inflicting damage on the necessary growth in our community if a government, via legislation, seeks to go too far and perhaps discourages entrepreneurial activity within the economy.

These business tax system bills deal with people who operate with their clients through an interposed entity—that is, a company or a trust. That is, they render some service and the invoice they provide to their client is not a personal invoice but that of a company or trust. There are many genuine reasons for doing this, not necessarily at all to avoid or take advantage of some aspect of the tax acts. There is an increasing tendency for large entities, whether government or private, to outsource work, and this has led to a number of people working on their own, in a sense meeting the needs of these large clients much more efficiently than if they were full formal employees of the company, the department or whomever the client might be. It also provides more flexibility. It reduces the oncosts of such entities. These all have very good flow-on effects for the economy.

The purpose of these bills is to remove any tax advantages that may apply where the actual working situation is employee-like. This is a very old distinction under common law. We learned in law school the difference between a contract of a service and a contract for services. There was many a sleepy afternoon in the lecture hall, and a lot of us here in the chamber have spent time getting a grip on the difference between the two. The old common law rule was that the difference really depended on the degree of control that the employer or client had over the taxpayer in that case—and, of course, the more control, the more likely that they were, in a sense, an employee or a servant, according to the old master-servant relationship. One good guideline to use in a modern context to try to draw this distinction is in section 87-60(5), which gives the tax commissioner the discretion to make a determination, to declare somebody a contractor for the purposes of the act, and the test is that the taxpayer must actually be paid not on the basis of the hours worked but on the result. That is a very commonsense way of expressing the actual situation of an independent contractor.

There are advantages that a person might derive in a taxation sense were they to satisfy these tests. The previous speaker enumerated that there are things like income splitting where a company might take advantage of tax-free thresholds to be claimed—family members and so forth may be members of the company or beneficiaries under the trust and then they are assigned incomes split among them. In my view, `income splitting' is not a dirty word. For example, in a family where one parent stays at home and does not earn an income, a sacrifice is being made for the benefit of children in that circumstance. Therefore, it is not just a black and white case to say that, where income is split between a husband and a wife where the wife may contribute in some fashion to the business, although not on a full-time basis, it is a terrible thing. I do not think it is. Secondly, there is the opportunity to deduct expenses—travel expenses, expenses of business premises or tools of trade. Of course, there is also the possibility of deferring a tax liability. So, where a company or a trust retains profits instead of distributing them by way of a dividend or whatever, tax is not payable in that year.

You have to weigh up those tax advantages against the economic disadvantages of earning income in this way. There is no doubt that outsourced work is more vulnerable to the economic cycle. A person working in these circumstances does not attract the protection that an employee does under some common law rules and certainly under a lot of statutory rules in Australia. So you have to balance the tax advantages with the reduced security of income. In the Ralph report there was an interesting expression of what they were trying to do in proposing these reforms. They said that economic transactions having the same economic substance should be taxed similarly, regardless of their legal form.

It sounds very fair; I think it is very fair. Certainly it sounds like a very sensible way to approach equity in the taxation system. But it seems to introduce a new concept to the debate about this aspect of tax law, and that is economic substance. What does that really mean? Is it the same as the common law rule where, if the employer has perhaps more control than less, the taxpayer is deemed to be an employee? Control, you might say, implies some obligation on the employer to provide security to the employee. If you take a dim view of the world, you might say that that is being a little too optimistic in these days with so much downsizing and so forth.

Very few employers appear to voluntarily bear any obligation to their employees. They seem to act sometimes, it is said, in a very ruthless way to satisfy the voracious demands of their shareholders. These are often superannuation funds that are fiercely scrutinised by consultants who make ferocious recommendations to the trustees of funds, and therefore fund managers compete with great pressure on management of corporations. Hence the old-fashioned feeling between employees and employers has perhaps gone the way of the draughthorse. But that is not always the case. There are many businesses in Australia, large and small, where I think there is very good feeling between employer and employee. These obligations that provide security to employees are really quite real. There are many employers who will put away money, resources and profits in good times in order that they may keep on their employees during bad times. They value their loyalty, skills and so forth. I think there really are clear disadvantages, in a sense, to earning one's income in the form of a contractor. The balance is quite real.

The Ralph report recommended that, in a sense, we try to codify more effectively the common law rules. They proposed various tests. One interesting one was this notion that, if 80 per cent or more of the income of a so-called contractor in a particular year was derived from one client, really they were acting in an employee-like manner and hence should not be allowed to alienate income, or be treated as alienating under the act. What does `employee-like manner' mean? There are other elements to the test for that—for example, the degree of control. Were the services contracted to the public, or were they really only available to one particular client? Does the entity have substantial income producing assets such that the income from personal services is really just incidental? Also, are there one or more personal service providers—that is, one or more people—working for the entity providing the services? A more general test is the degree of entrepreneurial risk. I would like to be in the court room when the judge tried to define that. Anyway, they are trying to help us, as a parliament, deal with their recommendation to codify these rules more effectively.

The general rule then under this bill is that personal services income is to be included in assessable income, even where it is earned through an entity, unless an exemption applies. How do you express the exemption? They say that, if the income is gained from a personal services business, it should be exempt and it can be treated as being allowed to be alienated. What is a `personal services business'? There are three tests under section 87-15: the unrelated clients test, the employment test and the business premises test. The unrelated clients test in section 87-20 says that, where there are two or more clients that are not associates of each other being provided services by the taxpayer, that satisfactorily proves that the taxpayer is a contractor. The employment test means that, if the entity employs other people who undertake at least 20 per cent by market value of the individual's principal work for that year, likewise they will be deemed to be a contractor. Lastly, and in a more complicated way, under the business premises test, where the individual maintains and uses business premises which are physically separate from his or her private residence, private premises, or, also, if they are physically separated from their clients' business premises, likewise they will qualify.

I think this is going to prove very difficult when the commissioner seeks to apply it. For example, imagine a house with many rooms on a fairly substantial piece of land in urban Australia. A person is doing contracting work for a particular client in, say, the information technology area. He or she may take a room within that house and set it up as a workroom, even having the electricity separately billed and separate telephone lines. They put a lock on the door to keep out the dog and the cat, and to keep out their hungry children who in the afternoon might come and ask mummy or daddy for biscuits or sweets and disturb the working atmosphere. Those business premises are obviously not physically separate in an ordinary sense, yet in reality they are business premises.

So, if that is not allowed, what happens if the person goes out to the garden shed, down the bottom of the garden, sets that up beautifully with different electricity and telephone services and so forth, and then conducts the business from there? That seems pretty obviously to qualify under this test. Yet, in reality, it is barely different from doing it in a front room which has all sorts of design features to very clearly make it separate—it may even have a different entrance on the side. That would fail and yet the shed would qualify. This is going to be difficult to deal with, but I think it is a genuine attempt.

Another interesting and quite useful attempt to introduce some reality into this whole legislative scheme is subsection 87, subsection 60. It provides further grounds for the commissioner to make a determination that a person should be allowed to alienate their income. It states:

(5) However, the Commissioner may make the determination if satisfied that:

(a) the individual's personal services income is for producing a result; and

(b) the individual is required to supply the plant and equipment, or tools of trade, needed to perform the work from which the individual produces the result; and

(c) the individual is, or would be, liable for the cost of rectifying any defect in the work performed.

There was some concern among government members as to what plant and equipment or tools of trade would mean. For those members who are particularly interested to see the IT industry, in which there are many individuals often working for one client, develop, the question arose: does a laptop computer constitute tools of trade? This is the device obviously by which software is designed, databases constructed and so forth. The answer was, yes, of course that would qualify as a tool of trade. It need not simply be shovels, chisels—the old-fashioned tradesmen's tools. The more modern instruments would likewise qualify. I think the scheme does go so far in that it allows the commissioner a discretion to include new forms of contractors to be included within these provisions.

One thing regarding deductions that are allowable for people who qualify under these exemptions which intrigued me is contained in section 85, subsection 15. It prevents deductions for the running expenses of a room in a private home that is used by a contractor to earn assessable income. The business premises test is very strict, very tough, that you have to be outside your home. You do not qualify even if you determine physically a part of it to be your working or business premises. The act does not prevent you deducting the cost of heating or lighting a room within your private home if you use it from time to time to earn assessable income. I do not know that this will cause such trouble in the future. It has always been the case in the past that a person who is behaving as a contractor and not an employee in earning their assessable income has been allowed to do this. Perhaps this is just a provision which saves that rather sensible aspect of the tax law that has always been the case.

Generally speaking, I think we can say that parliament must always take great care not to err too much to one side where there are two very important competing interests to be satisfied. In this case it is the integrity of the revenue collecting mechanism of this country. The other interest is the right of every red-blooded Australian to organise their affairs in whatever damn way they want, whatever the tax consequences might be. We must never allow those rights to be reduced other than by legitimate attempts to protect the integrity of revenue collection. We must not be overcome with jealousy, envy or resentment of people who, by dent of their daring, imagination, diligence, go out and seek to earn income by themselves.

There are a lot of unfortunate and profoundly wrong notions around these days in modern public debate about how private enterprise is damaging the planet—this David Suzuki rubbish you hear from time to time where people are warned against entrepreneurial activity because it is ruining the future for our children. This kind of rubbish has done terrible damage to parts of the Commonwealth in the past. I think the state of Tasmania has suffered particularly from this sort of rubbish. It should have been given the opportunity to develop more of its resources and earn more income for its people. The David Suzuki theory, as I call it, has done terrible damage. That aside, we have to stand up for the rights of people who want to work on their own. There is huge restructuring going on in the world economy. If Australia is to make its way and maintain its income standards, we need freedom and more freedom. At the same time, we must do what we can to protect our tax system so that the notions of fairness still obtain. (Time expired)