Tony Ince, Mostyn Consulting

Calls for increase in Payroll Tax threshold

“Many people believe that where taxes are concerned, they are victims, held hostage by an inevitable process that allows them no input, no control. This passive approach becomes something of a self-fulfilling prophecy; where people believe that they lack control, they seldom try to assert control.”

Richard Carlson

Summary

Any increase in the payroll tax threshold is to be supported but it ignores the real issue. Until there is major reform of Commonwealth/state financial relations, we will simply be tinkering at the edges and masking the real tax problem.

An increase of the payroll tax threshold will provide only very moderate relief to small to medium sized businesses while exacerbating the underlying tax problem; the inability of state governments to get a reliable source of taxation.

So rather than a call for less payroll tax, we should be screaming from the rooftops for real reform in Commonwealth/state financial relationships. Unfortunately, there is little is any political will for this, but it shouldn’t stop us pursuing it.

Payroll Tax Thresholds

Recent calls for an increase in the payroll tax threshold are certainly to be supported but mask the real issue. Until there is major reform of Commonwealth/state financial relations, we will simply be tinkering at the edges and masking the real tax problem.

Western Australia does have one of the highest payroll tax collections in Australia. This was increased when the government of the day snuck through In the 2017-18 State Budget a “temporary” progressive payroll tax scale on large employers for a 5 year period from 1 July 2018 to 30 June 2023. This effectively increased payroll tax collections (and increased complexity) while not changing the threshold or the rate.

When payroll tax was handed to the states by the Commonwealth in 1971, the threshold was $20,000 per annum. This was about 4.5 times the average annual salary at the time. Currently the threshold in Western Australia is $850,000 per annum, which is about 10 times average annual earnings. This seeming “improvement” could be offset by the rate which was 2.5% in 1971 and currently sits at 5.5% in Western Australia.

An increase of the threshold will, however, provide only very moderate relief to small to medium sized businesses while exacerbating the underlying tax problem.

The Problem – Vertical Fiscal Imbalance

The states have limited ability to raise taxes. Due to a number of High Court decisions, the states have been left with three main sources of their own income; payroll tax, (stamp) duty and land tax. They are therefore heavily reliant on the Federal government for funding. This imbalance of income and spending is called “vertical fiscal imbalance”, which is a very inefficient way of providing government services.

A recent paper by Treasury NSW sets out the issue of “Vertical Fiscal Imbalance” and the effects of changing payroll tax collections.

“It is impossible to consider the issue of state tax reform without looking at the issue of Vertical Fiscal Imbalance (VFI) and the problems it creates. Australian states are responsible for 42 per cent of total government outlays (note that it was 38.1% in WA in 2017/18) but raise only 17 per cent of government revenue. By weakening the nexus between government expenditure and revenue collection, VFI blurs the responsibilities and accountabilities of both state and Commonwealth governments. To the extent that payroll tax reduces VFI, it plays a vital role in the Australian Federation. Additionally, as a source of state revenue, payroll tax provides a mechanism for tax competition between the states contributing to competitive federalism.

Payroll tax is the broadest tax base Australian states have access to. Without payroll tax state governments would have to reduce their services or find alternative revenue sources. Empirical analysis supports the use of payroll tax. Han (1998) estimates that payroll tax is more efficient than most state and Commonwealth taxes, with only personal income tax estimated to be more efficient (land tax and company income tax were not considered).

The net effect of replacing payroll tax with most existing state taxes would be to reduce the overall efficiency of the tax system.”

There have been a number of papers by various state Treasuries defending payroll tax, including the one referred to above and a more recent Federal Treasury Working/Technical Paper released on 12 April 2018. While they come from a position of certain self-interest, it seems that tinkering with either the rate or threshold amount of payroll tax will have little economic effect.

Instead of getting front page headlines demanding very modest payroll tax relief, we should be insisting that our governments, both state and Federal, get fair dinkum about reforms in Commonwealth/state relations. Unfortunately, history has shown that this is way to big a political issue for any government of any political persuasion to tackle.

Fresh from another Federal election dogged by claims of negative advertising, any real shifting of tax mix will be easily shot down by scare campaigns targeting the (perhaps well based) fears of voters about politicians taxing them more. We are always wary when the politicians say “trust me” when it comes to changing the tax mix or introducing new taxes.

But if we want to get rid of taxes like payroll tax, we need to be able to replace them with more efficient taxes. Increasing the threshold is just re-arranging the deckchairs.

The Office of State Revenue (OSR) has been very active lately in issuing assessments to so-called “employment agents”. The assessments arise where a service provider gets workers from another supplier of temporary workers. That supplier of labour undertakes to meet all tax liabilities, including payroll tax, but OSR ignores this and assesses the service provider.

The assessments are invariably detailed explanations of the payroll tax legislation, citing case law and Commissioner’s Rulings, leaving the service provider with a feeling that any resistance is hopeless.

While taxpayers may see the position as futile given the seemingly watertight case presented by OSR, this is definitely not the case.

Background

The history of activity in this area is interesting. You may recall that recently, the former Australian Taxation Office Deputy Commissioner, Michael Cranston, was found not guilty of misusing his position to help his son, who was allegedly involved in a tax scam.

That scam was huge in itself and seems to be the basis of many of the current payroll tax assessments. In just 11 months before it collapsed, the group managed to convince government departments and prestigious IT companies to funnel as much as $1.3 billion in payments to tens of thousands of workers through a series of “straw companies” run by nobodies who the conspiracy controlled.

The cash was destined to be legitimate salary payments for the workers, but the trick was that those involved in the conspiracy held back for themselves as much as 40 percent of the $400 million that was supposed to be paid as income tax. Their desperate gamble was that by the time the ATO caught up with them, the conspirators would have long since vanished and only the straw directors would be left holding the baby.

It seems that there are (or were) some copycat labour hire businesses out there.

Payroll Tax implications

While income tax may have been the main driver, non-payment of payroll tax was also seemingly involved. Anecdotal evidence would suggest that a number of other “labour hire” companies have operated in a similar manner around Australia.

We have been approached by a number of legitimate businesses who, in good faith, out sourced the employment of workers to a third party labour hire business. Those third parties undertook to meet all the tax obligations, including payroll tax but, in many cases, apparently didn’t. The legitimate business is none the wiser until visited by OSR auditors.

Rather than pursuing those third parties who have fraudulently not remitted payroll tax as they undertook to do, OSR has chosen to enact a strict interpretation of the legislation to reef the payroll tax liability back to the legitimate business. The written explanation that the business gets from OSR leaves them with little hope.

The Payroll Tax position

The OSR position is a very narrow interpretation of the legislation and one-sided presentation to the taxpayer. It involves the business being considered an “employment agent” for the purposes of the payroll tax legislation, ignoring existing and legal employment relationships and relying on the Commissioner’s discretion in assessing the business.

We consider that there are several grounds on which the assessments can be challenged. It is possible that the matter may ultimately decided by the courts, but, given the number of legitimate business that have been harshly treated by an OSR who see them as an easy target, they will not be fighting alone.

The outcome, of course, will depend on the facts in each case, but the remarkable similarity of a number of instances brought to our attention in recent months means that it is certainly worth reviewing.

Don’t be bullied into accepting the Commissioner’s position.