Tony Ince, Mostyn Consulting

This issue deserves some real consideration. Of course, the devil is in the detail (which we haven’t seen yet) but the concepts are worth looking at.

The idea of a State Income Tax does not appear out of nowhere, and it is worth looking briefly at the history of this issue.

Headline reads: “Government considering a State Income Tax”

For many years, I have been an advocate of this being considered. In November 2012, I wrote a small piece entitled “What Price a State Income Tax?”. With pressure on the States and Territories to raise more of their own income, what are the chances that a state income tax could be reintroduced?

At a broad theoretical level, it has some appeal. The States complain of “vertical fiscal imbalance”, a term that we know reflects that the States are committed to much more expenditure than revenue they raise, with the balance coming from the Commonwealth in the form of various grants.

The introduction of the GST was supposed to overcome this to some degree, but recent and continuing events suggest that Commonwealth/State financial relationships are back where they were pre 2000.

History

Back in the day (at the time of Federation), the States levied their own income taxes and the Commonwealth raised most of its revenue by way of customs and excise duties. In 1942 during the Second World War, the Commonwealth introduced such a high rate of income tax and gave itself priority for collection that it made it impossible for the States to continue to levy their own income tax.

This measure was a temporary one for the duration of the war (where have we heard that before?), and the States were given compensation by way of what are now known as Commonwealth grants. These grants were to continue for five years after the cessation of the war.

Upset at the loss of their access to income tax, a number of States (most notably South Australia) took their case to stop the Commonwealth to the High Court in 1942 in what was called “the first Uniform Tax Case”. They lost. This meant that the Commonwealth was allowed to raise income tax and take priority in collection even though it effectively meant the States could not also apply their own income tax.

In 1957, some States again took the Commonwealth to the High Court on a similar issue (boringly called the second Uniform Tax Case) and, unsurprisingly, lost.

These decisions do not mean that the States cannot apply their own income taxes; it seems that they are Constitutionally allowed to do so. What it means, I think, is that the Commonwealth calls the shots. If the Commonwealth wants to apply an income tax and take priority, it can. But there does not seem to be anything to stop the Commonwealth from allowing the States to levy their own income taxes.

On 19 January 1970, the Premiers of all States signed a document entitled The Financial Relationships of the Commonwealth and the States. This document envisaged a scheme whereby the States should have access to income tax. At the subsequent Premiers’ Conference in February 1970, the Prime Minister, John Gorton, rejected this proposal, citing a number of objections. These included macro-economic policy-making considerations, the “equitable” treatment of all Australians brought about by uniform taxation, the budgetary problems that would be faced by the States as income tax receipts fluctuated and the problems that would arise in the process of calculating equalisation grants by the Commonwealth Grants Commission

In 1976, as part of Malcolm Fraser’s “New Federalism” policy, income tax sharing arrangements with the States were introduced. As part of those arrangements, the Income Tax (Arrangements with the States) Act 1978 was passed which enabled the States to levy marginal income tax surcharges or rebates. The Act was repealed in 1988 and, during that ten year period, none of the States took up the opportunity to levy their own income tax. This may have been in part because the Commonwealth was not prepared to make room by lowering its rates.

In 1991, the Working Party on Tax Powers to the Special Premiers Conference noted that addressing vertical fiscal imbalance would “involve fundamental changes to the relationships between the various levels of government as well as the tax system of the nation. Changes of this nature have far-reaching effects on the community and, while that is no reason for avoiding change, it does argue for very careful consideration”.

In 2000, the Commonwealth introduced the GST, with revenues hypothecated to the States.

In 2010, the review of Australia’s Future Tax System (the “Henry Tax Review”) noted that:

“VFI may lead to accountability problems in regard to expenditure and taxation decisions made by governments. A closer matching of revenue and expenditure responsibilities at each level of government may increase the accountability of governments by making government financing more transparent.”

The Current Problem

Put simply, the States have limited capacity to raise revenue. They have inefficient taxes like (stamp) duty which raise a considerable chunk of their revenue. There is also the unpopular payroll tax (a tax on employment) and land tax. States have varying access to mining royalties and gambling taxes but the raising of royalties effectively reduces their access to Commonwealth grants.

While some level of vertical fiscal imbalance has been in place since the start of Federation, there are some significant issues which arise from the current extent of vertical fiscal imbalance in Australia:

• the States do not face the real costs of raising the revenue which they spend, which can make their service delivery less efficient; and
• there is a lack of accountability and associated blame-shifting between the Commonwealth and the States, as both parties are responsible for funding service delivery across a wide range of government functions.

So in spite of many variations on revenue sharing over a long period, vertical fiscal imbalance continues to get worse. In his paper “Vertical Fiscal Imbalance in Australia: A Problem for Tax Structure not for Revenue Sharing” Bhajan Grewal makes the following observations.

(T)he current system of revenue sharing has produced a situation in which :

• the Commonwealth Government appears to believe that the centralisation of economic and fiscal decisions is necessary for the achievement of national economic objectives, and the Commonwealth grants to States are an indispensable instrument of centralisation;
• the Commonwealth has on occasions used the blunt instrument of Commonwealth grants to starve the States financially in order to achieve their agreement on specific issues;
• the States have shown, except on a few occasions when the tax powers were pursued with unanimous support, generally a preference for Commonwealth grants, and have been opposed mainly to conditions attached to specific purpose grants:
• the States have often been content with blaming the Commonwealth for not giving them enough funds, instead of going seriously for additional tax powers; and
• the institutions of fiscal federalism largely waste their time and effort on the determination of the level, the distribution and the composition of Commonwealth grants, instead of playing a constructive role in policy development and co-ordination.

Although this was written in 1995, many of these observations still seem valid. I do note, however, that the States are playing a more constructive, if largely individual, role in tax policy development.

The States say that they want more certainty in their funding without having to negotiate constantly with the Commonwealth on how much they will get from the Grants Commission via complex formulae.

The Commonwealth is continuing to put pressure on the States to get rid of a plethora of small taxes as well as inefficient taxes like (stamp) duty. We are now considering the possibility of the Commonwealth giving a certain level of income tax responsibility to the States.

Exactly what this State income tax would look like is part of the detail to be determined. It could be on all taxpayers, an addition to the current income tax (although the current rate would presumably be reduced because the Commonwealth would have less expenditure to the States). This would seem to be the most efficient method but no modelling has been done on this to my knowledge. Perhaps it would be a business income tax only. This would need to be resolved. Those States seeking to encourage businesses could apply a lower rate, the tradeoff being that they raise less income.

The vertical fiscal imbalance would also be overcome to some extent with reliance on the Commonwealth being reduced. Presumably efficiencies would arise as there would be a significant reduction in the blame-shifting game.

Political opportunists will come up with catchy slogans as to why it won’t work, and people smarter than me will have arguments against the proposal. Some of these are addressed.

It won’t be revenue neutral. My comment: if it makes the tax and allocation system more efficient, it will hopefully save money. Notwithstanding that, there is currently big demand on revenue which can only be resolved by cutting expenditure, increasing revenue or a combination of both. The current system does not lend itself to revenue neutrality.

It will disadvantage the smaller States. My comment: I haven’t seen the economic modelling on this but have no problem in accepting this. If each State and Territory is free to levy its own income tax rates (within parameters presumably), smaller States may find it difficult to compete with larger States. Perhaps some form of compensation could be built in to any model.

It is double taxation. My comment: This is just scaremongering. While technically income may be taxed “twice”, it is just a substitute for the current rates. So instead of income being currently taxed at, say 35 cents in the dollar, the new rate would be (say) 20 cents in the dollar for the Commonwealth and (say) 15 cents in the dollar for the State. How is that double taxation?

It would produce nine different tax regimes. My comment: We have not seen any detail about the proposal, but all models to date have simply used the existing Income Tax Assessment Acts, with the tax being separately allocated. Also, don’t forget that we currently have separate State Duty Acts, Payroll Tax Acts and Land Tax Acts. Hopefully some or all of those will go in the transition.

So What?

The proposed State Income tax is, to quote Sir Humphrey Appleby from Yes Prime Minister, “very brave, Prime Minister”. It will be difficult to sell to electors who traditionally do not trust politicians of any persuasion, State or Federal.

But surely it is worth considering, especially as more details come out.

If it makes States and Territories more responsible for raising the money they spend, and adds efficiencies to the system, then surely it will be a good thing. Will everybody be better off? Probably not, but if it is for the greater good and compensation is put in place to minimise the downside, it is worth serious consideration.

Two recent cases have brought to light the difficulties that businesses, tax practitioners and even the tax authorities have in determining possible payroll tax liability.
This is of critical importance to affected businesses because retrospective assessments can go back up to six years. Add penalties to this and you can see the implications for businesses that had no idea that they may have had a payroll tax liability.
The issue is not the perennial employee/contractor issue (although that continues to cause lots of problems) but the “employment agent” provisions. That’s OK, I hear you say, I am not an employment agent. But the Act does not require you to be an employment agent as you and I understand the meaning. The relevant provisions of the Payroll Tax Act 2007 are in Division 8 of Pt 3. Division 8 define an employment agent contract as follows:
“Division 8 Employment agents
37 Definitions
(1) For the purposes of this Act, an employment agency contract is a contract, whether formal or informal and whether express or implied, under which a person (an employment agent) procures the services of another person (a service provider) for a client of the employment agent.
(2) However, a contract is not an employment agency contract for the purposes of this Act if it is, or results in the creation of, a contract of employment between the service provider and the client.
(3) In this section:
contract includes agreement, arrangement and undertaking.
I should also note that, although each state and territory has its own Payroll Tax Act, the “employment agent” provisions are, for all intents and purposes, the same.
So let’s break that down.
• Under an arrangement, a person procures the services of another person (the worker/subby).
• The services are provided to a third person.
• The worker does not become an employee of either party. That is, they can be an independent contractor in their own right.
In a previous article (insert link?), I referred to a recent case where a radiology clinic operator was held to be an employment agent because it “procured” independent radiologists to provide services to patients. I had (and still have) serious reservations about that decision but my understanding is that it is not being appealed.
An even more recent case, however, came to a different decision on facts that I would have thought were more likely to lead to an “employment agent” decision. I guess it’s lucky that I’m not a judge.
The case (UNSW Global Pty Ltd v Chief Commissioner of State Revenue) was decided in the NSW Supreme Court. Briefly, the facts were as follows.
UNSW Global is wholly owned by the University of New South Wales. It has a business unit called Unisearch that arranges the provision of expert opinions. Its first service line is called Expert Opinion Services. It maintains a database of experts comprising academics employed by the University of New South Wales and experts external to the University. The areas of expertise cover many areas including analytical chemistry, medicine, civil, electrical and mechanical engineering, occupational health, architecture, aviation, school education, metallurgy, lighting, and actuarial science. Experts are added to the database either by making an application on Unisearch’s website or by being selected by staff employed by Unisearch.
Typically a law firm whose client was involved, or expected to be involved, in litigation would make an inquiry of Unisearch as to the availability of an expert in a relevant field. Staff employed by Unisearch would consider the request and obtain more information from the law firm if necessary to enable the identification of a suitable expert or experts. An expert would usually be identified from a search of the database. The Unisearch employee would contact the person who had been identified with relevant expertise and ask him or her if he or she were willing to take the job.
There was no question that the experts retained by Unisearch to provide services in the form of an expert opinion were independent contractors. It was not suggested that the moneys payable by Unisearch to the expert could be characterised as wages in the ordinary sense of that term. The Commissioner was seeking to levy payroll tax on UNSW Global as an “employment agent”.
The Court held that UNSW Global were not “employment agents” for the purposes of the Payroll Tax Act. My understanding is that OSR will be appealing the decision.
Why did the Court reach that decision?
This where it gets a bit tricky.
Both Winday and UNSW used very similar arguments. Trying to de-clutter them, they go something like this.
The late Justice Hill in a paper in 2001 “How is tax to be understood by the Courts?” for the Taxation Institute of Australia 2001 South Australia State Convention stated that the following principles could be extracted:
(a) The fundamental rule of interpretation is to ascertain what Parliament intended as expressed in the words it has used.
(b) Context is vital. Sections are not to be construed in isolation
(c) Where the language if a statute is clear and unambiguous and consistent with context it must be given its ordinary and grammatical meaning, even if the result is inconvenient
(d) Where two constructions are open the court will prefer the construction that avoids inconvenience or injustice
(e) Where the literal meaning of words is to be departed from it must be clear that the literal meaning does not give effect to the intention of the legislature and that a departure from the literal meaning will achieve that intention
(f) The literal meaning will be departed from where it gives rise to an operation that is capricious or irrational
Senior Member Isenberg in the Winday case applied these principles. He concluded that the literal meaning of the provisions were clear, and found that Winday made an offer pursuant to its advertising to provide services to the public with the implied undertaking that it would procure the services of qualified radiologists to provide the required medical services. Accordingly, patients receiving those services were clients of Winday.
White J. in the UNSW Global case applied the same principles and came to a different outcome. He concluded:
“… the provisions should be construed so as not to apply to all arrangements that could fall within their literal terms, but should be construed in accordance with the legislative intent as ascertained from the statutory context, including the juxtaposition of the employment agency contract provisions with the relevant contract provisions, the legislative history, and the extrinsic materials.”
So while it seems that the principles outlined by the late Justice Hill have been applied in both cases, how those principles have been interpreted leaves us none the wiser.
• What did Parliament intend in bringing in the “employment agents” provisions?
• Should the “employment agent” provisions extend the legislation to workers who would not otherwise be included (like the radiologists)?
• Is the language of the provision clear and unambiguous?
• Which construction avoids inconvenience or injustice?
• Does the literal meaning give effect to the intention of the legislature?
Where to from here?
As I said earlier, my understanding is that the Winday decision is not being appealed (pity) but the UNSW Global one is. Watch this space.
But the thing to take out of this for all businesses is that the “employment agent” provisions of the Payroll Tax Act can be read very broadly. Businesses should review all their arrangements to ensure that there is no risk. If there is, it may be possible to refine the arrangements to make any payroll tax liability less likely.