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ECONOMICS LEGISLATION COMMITTEE
23/05/2000
New Business Tax System (Alienation of Personal Services Income) Bill 2000 and two related bills

CHAIR —I welcome the representatives from the Australian Chamber of Commerce and Industry. Do you wish to make an opening statement, Dr Kates?

Dr Kates —If I could, thank you. I would like to thank the committee for providing the opportunity to discuss this aspect of the reform of the Australian taxation system. I would just remind the committee that the ACCI is the peak council of Australian business. Our members are employer organisations only and they are in all states and territories and all major sectors of Australian industry. Through our membership we represent 350,000 businesses across the country, including the top 100 companies, over 55,000 enterprises employing between 20 and a hundred people and over 280,000 enterprises employing fewer than 20 people. We are the largest and most representative business organisation in Australia. We would also note that the Master Builders Association, who have already appeared before you, and the Housing Industry Association, who are to appear after us, are two of the most important members of ACCI.

ACCI had given qualified support for the measures announced on 11 November by the Treasurer in relation to the alienation of personal services income. Our concerns were to ensure that abuses are addressed without undermining genuine independent contractors and, of course, this balance is the key issue in all of this legislation. The Ralph report indicated that payments with respect to personal services to interposed entities did pose a growing threat to the tax base, while also raising significant issues of equity as individuals in similar working conditions were paying significantly different levels of taxation. We were in complete agreement with these concerns. However, in our view the proposed test put forward by the Treasurer in November had the potential to place financial penalties on a significant number of genuine independent contractors. These businesses are structured for legitimate business reasons and the provision had the potential to make those affected by the measure uncompetitive in the market place.

In contrast, ACCI believes that the current bill before the Economics legislation committee can, if applied properly-and I emphasise if applied properly-reduce avoidance while protecting genuine independent contractors. The committee has called for submissions to appraise the effect and impact of these bills and we would make the following statement: it is important in our view that you should not look at this measure in isolation. The provisions of the New Business Tax System are but one of a raft of new measures proposed by the Ralph report to improve the equity and efficiency of the business tax system. The New Business Tax System Bill provides a framework that targets those who are using an interposed entity to alienate income and gain deductions that would otherwise be unavailable to ordinary wage and salary earners. However, it will be the practical application of these provisions, especially at the boundaries, that will determine the impact on genuine independent contractors and its effectiveness as an anti-avoidance measure.

The definition of `personal services income' posed a number of problems. The definition in the bill is similar to the already defined term `income from personal exertion', except it used the word `mainly' instead of `predominantly'. If the tax office and the courts construe personal services income in this way it will remove a lot of the uncertainties surrounding this new term. However, those cases at the border will continue to cause difficulties as the `all or nothing' nature of the provisions will mean that those rejected at the end of the year after self-assessing will face significant monetary penalties. This leaves the contractor in the highly undesirable situation of being uncertain as to the ultimate taxation liability during the year. Therefore, in the absence of the ability to seek determinations from the commissioner there need to be clear guidelines which business can use to determine whether the income they receive makes them subject to these measures.

The legislation allows business entities that receive personal services income an exemption if they satisfy the personal services business tests. They are the three self-assessed tests available to those under the 80 per cent threshold: the unrelated client test, the employment test and the business premises test. Each of these are appropriate for determining whether or not an entity is operating a personal services business. However, ACCI believes that the three tests do not cover the full range of cases of genuine independent contractors. The legislation itself recognises this fact and allows a fourth test to be used by the commissioner in making a personal services business determination. This test, however, is not available for a business to use on a self-assessment basis, it is only available to businesses which cross the proposed 80 per cent threshold. Those who receive 80 per cent of the personal services income from a single entity must seek a personal services business determination from the Commissioner of Taxation rather than self-assess.

In making a personal services business determination, the Commissioner of Taxation must apply the three tests used in self-assessment, but may also apply the additional fourth test. In making a determination reliant on this fourth test, the commissioner is able to have regard to industry, custom and practice. ACCI supports the four tests as set out above. We consider that these tests will effectively discriminate between those who are running a genuine business and those who are not. However, ACCI considers that the legislation should allow all four tests to be used in self-assessment. ACCI has no quarrel with the proposition that those who derive less than 80 per cent of their income from a single source can self-assess, but they should have access to all four tests.

Another difficulty with the bill is that the commissioner is not permitted to make any determination unless satisfied that 80 per cent of the individual's personal service income was from a single entity. The Ralph review contemplated that the Commissioner of Taxation would be able to give a private ruling on whether any taxpayer was running a personal services business and made such a ruling mandatory if the person derived 80 per cent or more of their personal service income from that source. However, the bill restricts the ability to apply for a personal services business determination to only those taxpayers who derive 80 per cent or more-taxpayers who derive 79 per cent or less simply cannot apply for a determination. There may be a class of persons who will fail the first three tests on self-assessment or on an ATO audit and because they derive less than 80 per cent of their income from one source cannot seek a determination from the commissioner which will allow the fourth test to be used.

In conclusion, we would say that the draft legislation seeks to remedy a genuine problem but does have the potential to create a different sort of problem of its own. The legislation may not be able to discriminate appropriately in all cases between genuine contractors and those attempting to minimise tax by creating an interposed entity. The tests which have been provided go much of the way towards a solution but there should be consideration given to providing access to tax self-determinations to those who are under the 80 per cent barrier.

Overall, this legislation has ACCI support. We also note that the tax system should not drive industry structure and must appreciate the risks to output from an inappropriate tax legislation. Nevertheless, we support the objective of this legislation and the amendments and we are less concerned about the economic impact with the current amendments.

CHAIR —Thank you very much, Dr Kates. The points you have just made, have you made them direct to the department or the government?

Mr Quach —No, not on this legislation. After having a look at the Treasurer's announcement, we made a number of representations to the Treasurer.

CHAIR —Are there any questions?

Senator MURRAY —Dr Kates, we earlier had evidence from the IT people that for a variety of reasons numbers of employees had been forced out of an employment relationship. It seems to me that you can break the outsourcing imperative, if you like, into two categories when you are looking at `forced out': one is that there is an on-cost in having an employee and the other is that there is the administrative cost. However, there is increasingly developing a facility for businesses to use administrative organisations—in other words, they make one payment and that organisation does PAYE, workers comp, superannuation payments, the whole lot. The administration side of things can be dealt with by other companies and companies can avoid that. But the other issue is the on-cost issue. The IT people indicated that people forced out are now carrying their own on-costs; in other words they make their own provisions for superannuation, insurance, leave, those sorts of things. If I understand your submission correctly, your proposition was that this legislation will result in some increase in costs for business by pushing people back into a business relationship and therefore, I assume, increasing the on-cost and the administrative side of things. Is my assessment correct or do you have a different view?

Dr Kates —I do not think we said that explicitly, Senator. If that was partly implied from what we said, I do not think that was intended. The intention of the legislation is to discriminate between various groups of independent contractors, if you will, so we would not like to see the independent contractor relationship actually broken down. It is nonetheless the case that on-costs do have a large bearing on the decision to employ. I think part of the reason for the casualisation in the labour market has been the growth in on-costs over the past few years-the super guarantee, as I remember, was one of those where there was suddenly a tremendous benefit to a business to use independent contractors rather than having employees. I think that is something of a concern but also something that is probably now built right into the system.

Senator MURRAY —I think at the heart of my question is probably the issue that while I have not found anybody anywhere who does not agree that tax avoidance should be stamped on and taxes should be collected where people are avoiding them, nevertheless in the year 2001-02 the estimates are that the revenue gained will be $480 million. My question really is do you think that will simply come out of disposable income or will it end up being added as an additional cost-in other words, it will be passed on?

Dr Kates —I think with almost all of these things it will be divided between the two. You would have to do a much wider study to actually know the proper incidence. There is no doubt that some of it will be passed on and some of it will be absorbed by the individuals themselves. It is in the nature of the way any market works that if there had been in the past certain forms of tax avoidance, which we are now going to stomp on, then there will be an increased reluctance from individuals to provide those services. To that extent there will be an attempt to pass those costs on. There will be some movement out of providing those certain services and other forms of restructuring of how the market works will take place. But in terms of your central question, yes, there will be some attempt to pass those costs on and they will find their way into the market in general.

Senator MURRAY —I got the impression from witnesses both from the building association and the IT industry that it is a highly competitive industry. As an economist, I assume you would respond by saying the greater the degree of competition the less likelihood of passing the costs on and the more controlled the industry the more likely they will pass it on. Would that be a correct view?

Dr Kates —It is tricky. It will be an economy-wide change so you need a general equilibrium solution rather than any individual market solution. But I would say that, yes, it will be harder in a more competitive industry such as this one than, say, in others. So the relative balance that takes place in the economy will shift; I agree with that.

Senator MURRAY —You have another proposition which is intrinsically attractive and that is the idea that the four tests which were in the legislation should all be part of the self-assessment scheme. How would you react to the view that if that were so persons doing the self-assessment would have to comply with two of the four tests, not just one of the four?

Dr Kates —Do I understand that for both sides of the 80 per cent divide it would be two of the four but then it would be open to everybody? Is that the -

Senator MURRAY —You are not the only witness who has said, `Look, effectively there are four tests. Why not just lump them together and have them all in the self-assessment scheme,' but obviously with the commissioner able to have an audit capacity over them. But having said that, the view might be that it is too easy to manipulate the circumstances so that people will not be caught within the legislation. Then the option would be for the parliament to consider making it two out of the four-any two-to be complied with. If you do not have an immediate view on that you might want to come back to us and say whether you think that is a reasonable proposition. The alternative if you just follow your route and put all the four together is that it may open up the gates so wide that the purpose of the legislation is defeated.

Dr Kates —I accept that, Senator, and if it is all right I will go back and consult and provide you with a written answer to that. I certainly think that making the four tests inclusive would be of benefit, and the arbitrary 80 per cent is an obstacle. But I would like a closer look at the four additional subcomponents before making a statement on that. I think it is possible that we would agree that there may be benefit in going in that direction.

Senator MURRAY —The question of the transition period worries some witnesses. I personally think there is little argument that a one year transition is necessary, in view of the pressure the ATO is under, and indeed those who would be affected by the legislation are under. But I am less persuaded as to the second year. I would make the remark that if you have $500 million worth of revenue as a possible consequence you can always afford to employ a few more people to bring in the money. Speaking personally, at this stage I am not inclined to the second year of transition but I would be interested in your view as to whether you think that second year of transition is really material.

Dr Kates —We heard that the Master Builders are interested in that second year. It is again one of those things that on general principles we would rather have it sooner than later, that the one-year transition period seemed appropriate. Nevertheless, I think there are individual circumstances for individual industries so there may well be a situation where having only a single year transition period may be insufficient. You would really want to have a closer look at the individual circumstances of particular industries, such as, for example, the construction industry. It may be that their circumstances do warrant that they have that second year.

Senator MURRAY —My question has been driven in part by their response, because it struck me that their response relied upon an assumption that the tax office could not cope, as opposed to their arguing that they needed it. That seemed to me a weakness.

Dr Kates —This is going to be one of those extraordinary muddle through into the trenches things that we are going through with this tax transition. I think the benefits of tax reform are so overwhelming that we are best to push forward as quickly as we can with it. We would rather have it sooner than later, but the concerns over the ability of the tax office to cope I think are warranted. I certainly have heard nothing to dissuade me of that. Nevertheless, if there are concerns I think they should be looked at. If it is not able to be done in a single year then we should think about doing it in two. But as I say, in general we would rather get tax reform in place as quickly as possible.

Senator MURRAY —Thank you.

Senator CONROY —ACCI have been one of the champions of tax reform, both the ANTS reforms and the Ralph reforms?

Dr Kates —That is right.

Senator CONROY —The Treasurer announced at the beginning of the Ralph package that the package would be revenue neutral. Did you agree with that at the time and did you support that position?

Dr Kates —I am certain that it is something that they bent over backwards to try to achieve but it was something that we thought was not as necessary as they made it. I think at the time our own view was we would rather they went further and did more. Even if you could say on some kind of short term basis that there would be more tax relief to business than might otherwise have been the case in the longer term, we thought that it would be more than recouped by the efficiencies of the economic system in general. So we understood the principle which was imposed on Ralph but we did not entirely agree with it and did not think it was necessary.

Senator CONROY —So you are comfortable with the half a billion revenue loss from this measure as opposed to the originally announced measure?

Dr Kates —I think the problem of applying the rules as they were originally designed is that it would have caused enormous efficiency losses in the economy and what you would have ended up with was having deemed people as employees who were in no sense employees. The final analysis would have been that the effect on the economy and industry would have been extremely negative. So I think the changes that have been made are all to the good, even though there is a notional revenue loss, if you like, relative to what was originally thought.

Senator CONROY —Notional?

Dr Kates —Well, it has not been collectable one way or the other yet. I think the difference is one in which it was recognised the problems that would be caused for industry if the original legislation was put in place.

Senator CONROY —You support the government's reforms in the welfare area to stop welfare recipient fraud, do you not?

Dr Kates —I think anyone would support legislation that stops fraud.

CHAIR —That is the end of questioning. Thank you very much, Steven, and Mr Quach.

Senator MURRAY —Can I ask a question through you, Mr Chair? How soon do you think you can come back to us.

CHAIR —The end of this week?

Dr Kates —Yes, I think so.

CHAIR —We have to report by 5 June.

Dr Kates —Okay, I will certainly do that.

CHAIR —Thank you for appearing.

Proceedings suspended from 10.21 a.m. to 10.58 a.m.