Tony Ince, Mostyn Consulting

Welcome to the first Indirect Tax Update for 2025! This edition is dedicated to Tax Audits. As an indirect tax advisor, much of my assistance is required when tax authorities come knocking. While this is often not what businesses want to hear, seeking advice on proposed or existing arrangements before a tax audit can alert them to potential issues.

Initially, I planned to address payroll tax audits, GST audits and Fuel Tax credit audits in one update. However, due to the different approaches by the ATO and various Revenue Offices, it’s better to handle them separately.

Read the Update here – Indirect Tax Update 24 PDF

Common sense and common experience; one man’s meat is another man’s poison.

The Classification of Food Products for GST purposes

The Tax Office has published a draft determination GSTD 2024/D1 which aims to clarify how GST applies to food which is marketed as a prepared meal.

The ruling implements a definition of ‘prepared meal’ drawn from a recent Federal Court decision which determined that certain frozen foods were not GST free. (See Simplot Australia Pty Limited v Commissioner of Taxation).

In Simplot, the Federal Court considered the GST treatment of a range of frozen food products supplied or imported by Simplot Australia Pty Limited. The products each contained a mix of vegetables along with spices or seasonings, and some also included grains. Some products were labelled as ‘sides’ or provided express or implied serving suggestions, including through pictures that displayed the products served with added protein (for example, chicken or pork).

The Court found that all of the products were food of a kind marketed as a prepared meal (other than soup) and therefore they were not GST-free.

In an interesting attempt to shed some light or a moonless subject, the Commissioner has an almost impossible task. While understanding the basis for the comment, I am not sure that the last sentence in paragraph 31 adds to our understanding:

“Where a product is marketed as a prepared meal, it would be rare that the product would not be food of a kind marketed as a prepared meal.” Riddle me that one.

Having said that, I am not sure that the Draft Determination has advanced the cause for taxpayers when the basis for deciding if food is GST-free or not comes down to “a product will be food of a kind marketed as a prepared meal if it is the kind of food that, as a matter of common sense and common experience, is marketed as a prepared meal.”

Common sense and common experience – one man’s meat is another man’s poison.

So, the Draft Determination sets out the guidelines for determining whether a product is marketed as a prepared meal. Those guidelines, relying on the decision in the Simplot case, require the manufacturers of food the determine if, as a matter of common sense and common experience, the food is marketed as a prepared meal.

The problem is that one person’s meal (taxable) could be another person’s side dish (GST-free).

So I road tested the guidelines with my family.

What about Birds Eye Steam Fresh In Cheese Sauce Broccoli, Cauliflower & Carrot? Definitely not something that any of us would eat as a meal in itself, so GST-free?? But we have very good friends who are vegetarians who would eat it as a meal in itself, so subject to GST?? One person’s side dish is another person’s main meal.

The proverb: what’s one man’s meat is another man’s poison means that things liked or enjoyed by one person may be distasteful to another.

The Roman poet and philosopher Lucretius (circa 94-circa 55 BC) had expressed the very same idea in De Rerum Natura (On the Nature of Things):

Ut quod ali cibus est aliis fuat acre venenum.

That which to some is food, to others is rank poison.

I am sorry to report that I am no closer to resolving the issue.

In a recent article in Australian Tax Forum, Gordon Brysland Assistant Commissioner, Tax Counsel Network, Australian Taxation Office, provided a very detailed and erudite article about the application of AI tools to tax classification issues.

While the article was looking specifically at food classification issues for GST purposes (another blog for another time), it raised some interesting aspects of the current use of AI in tax matters around the world.

The article noted that closed-end legal classification problems are the focus of Professor Ben Alarie and colleagues at the University of Toronto. This team is at the frontier of machine learning research in the tax classification and prediction spheres. Closed-end legal classification refers to a system where items are classified into predefined categories, and each item can only belong to one of these categories.

The employee/contractor dichotomy is currently one of those closed-end legal classification issues. For a number of tax purposes, the worker must be categorized as either an employee or a contractor.

Out of the University of Toronto work came Blue J Legal, which operates as an international start-up. It has developed a wide range of tax classifier tools on the back of enhanced algorithms.  

One Blue J Legal case study seeks to resolve whether a particular massage therapist is an employee or an independent contractor. The Canadian situation is a “classic grey area” where there is no bright line, no single dispositive fact and courts apply a “total relationship” test. Australia has now seemingly moved away from this test with recent High Court cases, but the underlying factors are still relevant. The dataset for the model includes over 600 decisions over a 20-year period. For each of these, the researchers isolated 21 discrete variables or factors. The article explains what happens next:

But how do courts weigh these variables to arrive at their decision? How do the different variables interact with each other? To put it simply, we do not know. We don’t use a simple formula. That is, we don’t simply count the factors that favour one classification and weigh them against the factors favouring the other. Nor do we use standard regression techniques that require us to set the structure of the relationship between all the variables and the predicted outcome.

Instead, we let the computer find the right answer. We use machine learning technology to figure out the best way to assign weights to each of our variables and to figure out how the different variables interact with each other. This task is practically impossible for a human. Neural networks find hidden connections between the variables that we, as empirical modelers, do not specify and – probably – could not have identified even with unlimited time and resources using conventional approaches to legal research.

Blue J (the Toronto system’s judicial alter ego) found the “right answer” in over 90% of cases. Filling in the 21-feature survey for the massage therapist took five minutes. Blue J compared these facts to all other decisions in the database and was 87.1% confident the therapist was an employee. Blue J provided its own “reasons”:

Although the worker and hirer intended to characterize this relationship as an independent contractor relationship, there are a number of other factors that outweigh the intention in this case.

The article describes various methods for improving the efficiency of the model. One of them, based on a “wisdom of crowds” idea (one of what Brysland calls Aristotle’s children), involves having multiple operators training the system. The basic idea is that, in a binary situation, the more participants, the more the randomised errors of individual coding perceptions and practice will be cancelled out. The average coding judgment of all operators will likely be more accurate than that of the wisest coder alone. Blue J is said to provide a “mechanism through which private decisions and judgments can be turned into one collective answer”. The researchers say that “Blue J continues to learn and gets better and better over time”.

For someone who has grappled with (and continues to grapple with) the exercise of determining the category of worker, I would love to have 87.1% certainty.

It seems that, like the introduction of computers all those years ago, if we can get the right information in, we can get a reliable output for these classification issues. But the use of algorithms by government departments like the ATO can be confronting.

French CJ in the UNSW Law Journal said:

… the use of automation points us to a dystopian future of inscrutable exercises of statutory power by artificial intelligences deep learning their skills through the discernment of patterns in big data and developing unreadable algorithms to apply that pattern learning to individual cases.

Other aspects of the rule-of-law also condition the potential use of algorithmic classifiers in public decision-making. The fact that decisions must be transparent and that some human be legally accountable for them raises the need for reasons being given to those affected.

For those with time and the interest, I thoroughly recommend Gordon Brysland’s article to you. It is a glimpse into the not-to-distant future of tax consulting.

Employee/ contractor – two High Court decisions.

On 9 February, the High Court handed down two decisions relating to the issue of whether certain workers were employees. The cases were unrelated but heard on consecutive days, with the decisions released on the same day.

The first was the decision in Construction, Forestry, Maritime, Mining and Energy Union v Personnel Contracting Pty Ltd [2022] HCA 1 (9 February 2022). This looked at whether a labourer engaged as a contractor to a labour hire firm and on-hired to a construction company was an employee of either the labour hire firm or the construction company. The High Court held that he was an employee of the labour hire firm.

This case is significant because it overturns many previous decisions that held than an employment relationship did not exist in these circumstances. Indeed, the one dissenting Justice (Steward J.) did so largely because overturning the Full Federal Court’s decision in this case and previous cases (including Odco, a 1991 decision) would expose businesses to significant penalties on a retrospective basis.

Unsurprisingly, the High Court set out the reasons in considerable detail. The employee/contractor issue has a long history and there was much to consider. The High Court also accepted that there was a contract in writing between the worker and the labour hire company, and that the contract reflected the actual arrangements. The contract explicitly stated that the worker was not an employee.

This decision will have a far-reaching impact on labour hire arrangements nationally.

The High Court noted that the worker, an English backpacker (Mr McCourt), supplied nothing but his labour (and some minor PPE) and that both the labour hire company (Construct) and the construction company had the right to direct him in his work.

There was discussion by the High Court about the concept of contractors working in their own business as distinct from working in the business of their employer. The High Court said:

“That promise (for Mr McCourt) to work for Construct’s customer, and his entitlement to be paid for that work, were at the core of Construct’s business of providing labour to its customers. The right to control the provision of Mr McCourt’s labour was an essential asset of that business.”

Given the nature of the work undertaken by the labourer, the decision seems a sensible one. The main obstacle was the plethora of previous cases which restricted the lower courts in their ability to overturn those decisions.

The second decision was ZG Operations Australia Pty Ltd v Jamsek [2022] HCA 2 (9 February 2022). That case concerned a truck driver who had worked on a contract basis continuously for the one employer for more than 30 years. The contract required him to supply his own vehicle, which he updated over time. The case was an appeal from the Full Federal Court which had held that he was an employee of the transport company.

The High Court overturned that decision and held that he was an independent contractor. Again, the High Court set out reasons in considerable detail. It seems that the supply of a significant vehicle was the critical factor for the High Court. It was also noted that, from the very beginning of the arrangement, the driver had been engaged via a partnership he had with his wife.

The High Court noted:

“The services provided by the partnerships involved, compendiously, the truck‑driving skills of the respondents and the use of the trucks owned by the partnerships. The provision of such services has consistently been held, both in Australia and in England, to have been characteristic of independent contractors, not employees. In the present case, there is no reason to reach a different conclusion.”

These cases make a couple of things clearer, for us:

1. The supply of labour, especially unskilled labour, by an individual where they are told what to do is likely to result in an employer/employee relationship, regardless of any labour hire arrangements and written contracts to the contrary.
2. Where a worker is required to provide a significant piece of machinery or equipment to undertake the task, the arrangement will usually be a contract arrangement, even where the work is subject to management controls.

Both cases will provide plenty of background for those considering the employment relationship. Despite this, there continues to be a great degree of uncertainty, which makes it difficult for businesses (see below).

The decision in the CFMEU case will potentially have significant retrospective financial implications for labour hire companies.

Problems in identifying an employer/employee relationship

I note with interest that the Tax Institutes “urgent outstanding tax issues” highlights the issue with determining who is an employee across a range of taxes. That issue is identified as follows.

• Introduce an all-encompassing concept of ‘worker’ that covers both Federal and State Governments, to reduce the compliance costs and keep up with the recent changes and trends in the labour market (such as the ‘gig economy’).

As I recall, the ATO set up a similar project in the late 1990’s, led by an Assistant Commissioner, Graham Harrison.

The result was that it proved too big a task for a mere mortal, but some changes to the withholding regime were undertaken and the Personal Services Income test was introduced. It was also hoped that the introduction of the GST and ABN requirements would alleviate some of the problems.

Many Australian jurisdictions tried to solve this problem with their “relevant contract” provisions for payroll tax purposes. This resulted in many pages of legislation, some black and white rules but not much in the way of clarifying the position of the worker.

As far back as 1991, the Federal Court in the Odco decision noted that it was getting increasingly more difficult to distinguish between an employee and a contractor, and perhaps a third category of worker was required. This is even more so now with workers in the gig economy.

Indeed, the Commissioners of State Revenue look at what they consider “employee-like contractors”.

The problem is the absolute dichotomy between an employee and a contractor. As it currently stands, you need to be either one or the other. Perhaps we need to consider a third category.

The concept of employee (or worker) has its origins in the past, stemming from the master/servant principles. The concept is found in a range of State and Federal laws. It would certainly be better for everybody if they knew exactly where they stood in this regard. As much as anything, the difficulty arises as sometimes the parties are on the same page in wanting an outcome as contractor/subcontractor, and sometimes they are at odds, hence the Sham Contracting legislation as an attempt to overcome this.

Whiles an all-encompassing concept of “worker” is the holy grail, perhaps we need to be more creative in our solutions arising from this binary concept of employee or independent contractor, realising that any solution we may come up with will not be perfect.

Nearly 200 countries have made an unprecedented and historic pledge at the COP26 climate summit to speed up the end of fossil fuel subsidies and reduce the use of coal. Until COP26, coal and fossil fuel subsidies have never been explicitly mentioned in 26 years of treaties and decisions at UN climate talks, despite fossil fuels being one of the key drivers of global warming and $5.9 trillion of subsidies being given annually to coal, oil and gas.

This has been further raised as an issue in Australia by Fortescue founder Andrew Forrest who has privately lobbied government to phase out the multibillion-dollar diesel fuel subsidy and use the funds to support green hydrogen.

Trying to remain political neutral on Australia’s likely response to COP26, it would seem that the immediate future of Fuel Tax Credits is not in jeopardy, but that pressure will be on in the medium term to phase out the fuel tax credits.

The history of Fuel Tax Credits

Fuel excise was introduced in Australia in the 1920s for the specific purpose of road funding. It was extended to diesel in the late 1950s to help cover the cost of road building and maintenance.

The fuel tax credits for eligible businesses have been around in various forms since the beginning.

The excise on fuel is a tax on business inputs as well as on final use by households. Businesses using fuel as inputs into production processes pay excise of 43.3 cents per litre at the time of writing. According to the Australian Taxation Office, in 2021 the total excise collected on all petroleum products was $19.2 billion, but around $7.6 billion of this was rebated. The main recipient industries were mining (about 40%), transport, postal and warehousing about 20%) and agriculture, forestry and fishing (about 13%).

But despite the growing population, vehicle fleet and total vehicle kilometres driven, revenue from fuel excise continues to decline in real terms as newer, safer vehicles with reduced fuel consumption hit the roads. It has fallen 68 per cent as a share of federal government revenue over 20 years and now contributes only about 2 per cent.

It raises a bigger question about how, with the introduction of electric vehicles, the government will (eventually) replace the funds it receives from the Fuel Tax excise

Are Fuel Tax Credits a subsidy or tax relief?

Under the fuel tax credits scheme, eligible businesses can claim a rebate, in full or in part, of the excise that they have paid.

It is the view of Treasury that the fuel tax credit scheme is designed to relieve industries of the excise that they pay on the petrol and diesel they use. As they note “… fuel tax credits are not a subsidy for fuel use, but a mechanism to reduce or remove the incidence of excise or duty levied on the fuel used by businesses off-road or in heavy on-road vehicles“.

The Productivity Commission prepares annually a Trade and assistance review. The reviews identify and, where possible, quantify government assistance to industry. The reviews do not include the rebates paid under the fuel tax credits scheme as a form of assistance.

In summary, the view of Treasury is that the rebate for excise paid on fuel that eligible businesses use as inputs is not a subsidy to fuel use. Rather, the rebate is designed to relieve businesses of input taxes that can reduce output and living standards. The Productivity Commission does not consider the rebate to be a form of assistance.

The Australian Conservation Foundation, on the other hand and unsurprisingly, says:

“The time is right to remove costly government handouts that prop up a fossil fuel-based economy and invest this money in helping small and medium sized companies access technology that doesn’t require polluting diesel fuel to drive and power their businesses.”

So, whether you consider the fuel tax credits a subsidy for fossil fuels or a rebate to increase living standards may ultimately be a question of semantics and your particular point of view. Maybe the truth is somewhere in the middle.

What is the effect of removing fuel tax credits?

While miners are the biggest beneficiaries of the fuel tax credits, many other smaller businesses across a range of industries rely on the credit. The does not make the credit “right”, but it does mean that any move to phase it out must be done appropriately.

I was speaking to a client in the fishing industry who, while accepting the need to move away from fossil fuels (and they have been actively looking at this for several years), lamented the options available for them, especially for fishing fleets away from port for prolonged periods. The technology just does not currently exist.

What is the future for Fuel Tax Credits after COP 26?

COP26 appears to have been a turning point in the international acceptance of the need to phase out the use of fossil fuels. The Australian Government has been equivocal in its comments after the conference, but it seems to me that the writing is on the wall.

Sooner or later, we will have to prepare ourselves for the phasing out of the fuel tax credits.

Contractor or chimera?

Bona fide contract agreement or chimera?

A recent decision in the Full Federal Court is the latest to add to the growing list of employee/contractor decisions. It raises issues for a lot of working arrangements, including those in the gig economy.

In Jamsek v ZG Operations Australia Pty Ltd [2020] FCAFC 119, the court held that the truck drivers who supplied their own trucks were employees for the purposes of the Fair Work Act 2009 and Superannuation Guarantee (Administration) Act 1992 and were workers for the purposes of the Long Service Leave Act 1955.

This is unusual because traditionally the courts have treated the supply of significant equipment as a prime factor in contracting arrangements.

As a result of the decision, for the three drivers ZG Operations is currently up for:

• four weeks of paid annual leave for each year of their (alleged) employment since 1986.
• loading of 17.5% of the minimum rate they were paid.
• leave accrued and not taken in the period 1 January 1986 to 20 January 2017.
• 10 days of personal leave per year for each year of service.
• paid designated public holidays each year.
• overtime for all hours worked outside of ordinary working hours.
• 12 weeks of redundancy compensation.
• superannuation contributions.
• long service leave.

Ka-ching!

The employer, ZG Operations Australia Pty Ltd, was granted special leave on limited grounds to appeal to the High Court, so watch this space.

Chimera??

Perram J in his decision said:

“It may have been strictly correct to say, as the primary judge did, that after 1986 the men “in principle” could have used their trucks to “serve others”.  Yet that was no more than a chimera.” 

A chimera; what’s that?

In Greek mythology, it is a fire-breathing female monster with a lion’s head, a goat’s body, and a serpent’s tail.

More relevantly to whether the arrangement in question was actually a contractual arrangement, it is a thing “which is hoped for but is illusory or impossible to achieve”.

Important Take Out from the Decision.

It was a unanimous decision of the three judges. Unsurprisingly there were numerous case references; this area is littered with cases. But perhaps the main point I took out of the decision was the emphasis the three judges put on the inequality between the parties when it came to negotiating the contract.

Even though there was a written agreement with the drivers (at least for much of the time), the court noted that there were three main reasons why the agreements could be disregarded or read down. They referred to the plurality judgment in Fair Work Ombudsman v Quest South Perth Holdings Pty Ltd [2015] FCAFC 37, where North and Bromberg JJ described various avenues in which a court might reconcile a disparity between the face of a contract and the reality of the relationship the subject of that contract. 

1. The first is that the contract may be a sham—a product not intended by the parties to have substantive effect but rather to deliberately deceive third parties.
2. The second is that the contracting parties, by their conduct subsequent to the execution of the contract, impliedly varied their contract.
3. The third is that the relative bargaining power of the parties must be taken into account in deciding whether the terms of any written agreement in truth represent what was agreed and the true agreement will often have to be gleaned from all the circumstances of the case, of which the written agreement is only a part.

Significantly for this case and in a lot of arrangements, particularly in the gig economy, the court concluded:

“The pertinent point for present purposes is that, where the court must determine whether a relationship subject to a contract is one of employment, the relevance and weight of the parties’ intentions in entering into that contract must be characterised in light of the reality of the respective bargaining positions of each party. 

Although the entry into that contract indicates that the parties’ possessed a common intention to enter into those terms, the reality is that there was little, or no, room for negotiation in respect of the formation of the terms of the contract.”

Employers will have to be very careful when entering into agreements with workers that the agreement is not seen as a chimera – “a thing which is hoped for but is illusory or impossible to achieve”. If there is not some bargaining power by both parties, the courts may decide that the worker is an “employee”.

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.

Almost 20 years on from the introduction of GST in Australia by then-Prime Minister John Howard and who’d have thought that robust deliberation on its application continues.

Rule of thumb? Identify exactly who is providing which service for consideration to whom to determine the GST implications of the transaction.

Who’s doing what for whom and who pays?

A recent case has highlighted how all-pervasive the GST can be. In what could be considered a most curious case, involving a brothel and a sex worker (HKYB and FCT [2018] AATA 4770), there was much conjecture about whether it was indeed the bordello providing the services or the lady of the night herself (as the facts show that all the workers were female, if not ladies) who was subject to GST.

The crux of the case was the issue of assessments totaling about $5m, on the basis that each time a sexual service was provided at the brothel, there was a single supply by the taxpayer of a sexual service to a client giving rise to a GST liability.

The taxpayer, however, contended that the supply of each sexual service (for GST purposes) was by the relevant sex worker and that it provided only the facility where that service was conducted.

The outcome? No happy ending for the taxpayer. The Administrative Appeals Tribunal (AAT) concluded that a sex worker supplied a service to the taxpayer so that the taxpayer could in turn fulfil its obligation to the client. Since the sex worker did not quote an ABN (assuming the worker was not an employee), the taxpayer should also have withheld an amount under the PAYG system.

Putting aside the salacious nature of the services, this is a clear example on the importance of determining who is providing services to whom, and who is paying.

Akin to any modern-day romance novel, the Tribunal went into a lot of detail about the nature of the arrangements; we suspect not as much to hold our interest but to ensure the factual circumstances were correct.

Some of the intrigue in reading the decision has to be the pseudonyms which the Tribunal adopted for the applicant, the Trust, the establishment and the various persons referred to in their reasons. Thus, the high-class brothel is not really “The Cytherean” and HKYB is not really the trustee of the (also pseudonym-ed) Dog and Duck Equity Trust which operates the brothel in Brydges Street (on the corner of Drury Lane), Covent Garden; however the similarities to a “guide” published in the 1700s on sex workers in London are curiously uncanny. I can only presume “The Cytherean” is in Brisbane, that being the location of the Tribunal hearing.

Back to the facts. The nature of the arrangements was critical for determining the outcome.  The taxpayer argued that the workers were all independent contractors. Somewhat unusually, it said that it rented the room to the client who then undertook separate arrangements with the worker.

However, the Tribunal noted that all services were costed by the taxpayer and there was little scope for the worker to negotiate a different price. It also noted that it would be unlikely that the client would know that the amount they paid was supposedly partly for the service and partly for the rent of the room.

In the circumstances, the Tribunal found that it was the taxpayer supplying the service (and the room) to the client, with the workers supplying their labour to the taxpayer in order for the obligation (and presumably the client) to be fulfilled.

This is despite other tax cases of similar operations coming to a different view.

In addition to the interesting reading, the outcome carries warnings for external tax advisers. In the case, the external accountant “Mr Derrick” (presumably another pseudonym) advised the taxpayer that they were correctly meeting their GST and PAYGW obligations. It seems that he based this on a Private Binding Ruling he managed to find on a similar arrangement. For those interested, that was Commissioner’s Private Binding Ruling Authorisation Number 72326.

The lack of detailed investigation of the arrangements by the accountant before coming to his view didn’t sit well with the Tribunal – it was critical of his understanding of the way the taxpayer actually operated. It said:

“Mr Derrick’s answer that he did not look at the applicant’s website because that would not have been approved of by the firm was not, with respect, credible at all, much less persuasive. We were left to wonder whether this answer had recently been invented. Be that as it may, viewing the applicant’s website could hardly have been regarded as gratuitous, much less prurient, given the professional service he was rendering to the applicant.”

Having a full and complete understanding of a client’s business, and the consequences of supposed arrangements, is a major takeaway for tax advisors. Another lesson; documented arrangements must reflect actual arrangements.

Application to other Business Models

An obvious parallel (to me) is medical practices. The medical practitioner is often not an “employee” of the medical practice but an independent contractor. This may be an issue, depending on the written agreements between the parties. The agreements should reflect what is actually happening and provide the basis for the GST position.

Keep in mind that the GST legislation is very specific about when a health supply is GST-free.

One requirement for the supply to be GST-free as a health supply is that it must be to the recipient of the supply. Taking the example of HKYB (with all jokes aside regarding its qualification as a health supply), the Tribunal found that it was the taxpayer, not the worker providing the service. If it is the medical practice rather than the doctor making the supply to the patient, it is arguable that the supply will not be GST-free.

It is critical to get all arrangements in place in order to achieve the desired result.

Of note, the payroll tax implications of these arrangements should be considered following recent cases around medical practices.

Newest Jobs

Following from the title of this piece, I will now segue seamlessly into the GST implications of one of the world’s newest professions, the sharing economy. The sharing economy can also be referred to as the ‘gig economy’ where the online seller is predominately offering a service on a short-term basis.

In 2018, the Organisation for Economic Co‑operation and Development (OECD) described the ‘gig economy’ as:

‘a labour market characterised by the prevalence of short-term and often non-standard contracts or freelance work as opposed to permanent jobs and standard labour contracts’

The burgeoning gig economy has resulted in challenges for all involved in determining who is supplying which services to whom. We note that this is also an issue for payroll tax purposes, but I don’t have the bandwidth to further address that here.

The cases to date tend to result in varying outcomes about whether or not the worker is an employee, an independent contractor or something else.  While this reflects the many different variations to the arrangements, it is also, we suspect, partly as a result of the arrangements and contracts being poorly worded or not reflecting the actual working arrangements.

In the case of ride sharing arrangements for example, is it the platform operator providing the service to the customer using either a contractor or an employee driver? Or is the platform operator simply providing an operating system allowing the independent driver to provide the service to the customer? Is the passenger a customer of the platform or the driver?

It may boggle the mind, but back to my rule of thumb and the answers to these questions will help determine who has the GST liability.

With an increasing amount of the workforce headed down this path, it is important that all parties have a good understanding of exact arrangements. The exact nature of the arrangements (both in terms of the contract and the actual arrangements) will provide the GST result.

As each arrangement may produce a different GST outcome, it is important to consider all issues.

We are starting to pay the price for a short-sighted approach to our GST legislation when it was written in 1999. The Australian GST was simply an existing value added tax with some minor variations. No attempt was made to take account of the emerging e-commerce or cross border economies. That short sightedness is now coming home to roost.

The problems were well known at the time. See, for example “OECD, Electronic Commerce: The Challenges to Tax Authorities and Taxpayers” published in 1997.

Two recent GST issues have exposed the weakness in our system. In order to try to overcome them, the government has proposed changes that are badly designed legislative quick-fixes that attack the very basis of the GST. Under these proposed changes, it is no longer the seller who will be responsible for collecting and remitting GST on sales that it makes, but the responsibility of buyers and facilitators.

How these two very different issues will be resolved is yet to be seen.

How the GST works

The GST (or any VAT) works in the same simple way; that is part of its appeal. The ATO website describes the GST as follows.

Generally, businesses and other organisations registered for GST will:

• include GST in the price they charge for their goods and services
• claim credits for the GST included in the price of goods and services they buy for their business.

As a GST-registered business, you need to issue tax invoices to your customers, collect GST and send it to us with your business activity statement (BAS).

The leading judgement of Hill J in HP Mercantile Pty Limited v Commissioner of Taxation [2005] FCAFC 126 refers to the design of the Australian GST as a value added tax with the universal international feature of seeking simplicity to avoid cascading of tax by including only businesses in the GST net.

“The genius of a system of value added taxation, of which the GST is an example, is that while tax is generally payable at each stage of commercial dealings (“supplies”) with goods, services or other “things”, there is allowed to an entity which acquires those goods, services or other things as a result of a taxable supply made to it, a credit for the tax borne by that entity by reference to the output tax payable as a result of the taxable supply.  That credit, known as an input tax credit, will be available, generally speaking, so long as the acquirer and the supply to it (assuming it was a “taxable supply”) satisfied certain conditions, the most important of which, for present purposes, is that the acquirer make the acquisition in the course of carrying on an enterprise and thus, not as a consumer.  The system of input tax credits thus ensures that while GST is a multi-stage tax, there will ordinarily be no cascading of tax.  It ensures also that the tax will be payable, by each supplier in a chain, only upon the value added by that supplier.”

Two recent proposed changes strike at the very heart of the ”simple” GST system.

The first is a potential extension of those with a GST liability (currently the sellers) to those that are essentially facilitators.

The new “low value imports” draft legislation is a version of a “vendor registration” model. While GST liability usually rests with the seller, the proposed new tax extends liability to the electronic platforms, such as eBay and Etsy, who simply provide the platform for buyers and sellers to connect, but never hold or own the goods themselves.

The second deals with so-called “reverse charges”, which shifts the onus of remitting GST from the seller to the buyer. While the concept is not new, the proposal outlined in the 2017 Budget to require purchasers of newly constructed residential properties or new subdivisions to remit the GST directly to the ATO as part of settlement extends the reach significantly.

Making the Facilitator liable

Under the provisions of the Treasury Laws Amendment (GST Low Value Goods) Bill 2017, electronic distribution platforms will be treated as suppliers, and liable for GST on all the sales that pass through the platform. This is a quantum leap from making the seller liable to GST. eBay and Etsy in particular expressed disquiet to the recent Senate Standing Committees on Economics that they will be liable for GST on goods which they have never owned, held, tracked or traded. They liken it to a landlord or a shopping centre being liable for GST on goods sold by tenants.

Etsy made the point that:

“Etsy does not own, store, produce or warehouse these goods in any way. We provide a platform to connect sellers and buyers, but each Etsy seller individually can adopt their own Etsy shop policies. They fully control their own product pricing. They are fully responsible for the delivery of that product. Etsy does not hold, ship or deliver any of our sellers’ goods…Our business model does not currently support, nor was it ever built to support, the collection of GST.”

Despite this real change in the way the GST operates, the Senate Standing Committees on Economics concluded:

2.76 The committee accepts that the role of electronic distribution platforms is different from that of sellers. However, it believes that the bill represents a pragmatic solution to a difficult problem. It notes that the platforms have been able to make arrangements for a variety of situations in other countries.

There is still a lot to be played out in this area, I suspect. While Australia is one of the “early adopters” in this area, the Committee has recommended that implementation be delayed until 1 July 2018.

There is also a lot of work being undertaken at the OECD level. Any conclusions at that level will likely be considered in Australia.

Making the Buyer liable

The existing reverse charge provisions make certain GST-registered businesses liable for GST on some imported intangibles.

For example, when an Australian business procures services from a local supplier, GST is chargeable and the local supplier must account for output GST on the taxable service rendered. However, if the exact same services are acquired from an overseas supplier, the GST-registered recipient may be liable to account for output GST on the service consumed locally. This is known as the “reverse charge”, where the liability to account for output GST shifts from the non-resident supplier to the GST-registered recipient. Examples of such imported services can include the acquisition of intangible rights, intellectual property and software licences from an overseas supplier.

This was the thin of the wedge with the GST “reverse charge” mechanism currently being extended to GST registered buyers of valuable metals in an attempt to overcome fraudulent activities in this area. I suspect it will merely add a level of complexity to those law-abiding businesses currently not involved in fraudulent activities but do little to stop those who want to rort the system.

Of more concern are imposition of proposed GST “reverse charge” provisions on Mums and Dads.

Changes proposed in the 2017 Budget potentially extend this “reverse charge” responsibility to all of us, even those not registered for GST or even carrying on a business. The proposal outlined in the 2017 Budget will require all purchasers of newly constructed residential properties or new subdivisions to remit the GST directly to the ATO as part of settlement.

As well as a fundamental shift in the way that a GST operates and a threat to its simplicity, there are a number of issues that arise from this change. Unlike existing “reverse charge” provisions, it will bring everyday people into the GST net as they will be the ones responsible for remitting the GST. It also raises a number of issues that require a good knowledge of the GST legislation.

1. How will everyday buyers know when they have the responsibility for the GST?
2. How will buyers know whether or not the seller has a GST liability, especially if they are buying land?
3. How do they know how much GST is included in the amount, as the seller may have calculated the GST liability using the margin scheme?
4. Even if they do use a conveyancing service to complete their purchase, how is the amount remitted, and how is the amount matched with the seller’s liability?
5. Who will be liable if the GST remitted is incorrect?
6. The cost to purchasers of conveyancing will likely rise as lawyers and accountants sign off on possible GST issues.

About half of all GST cases that come before the courts relate to property matters. One can only see this increasing as those with no GST knowledge and no other exposure to GST are brought within the GST net.

The other issue with this proposed change is that it is driven by seeming ATO inability to track taxpayers who are rorting the system. Rather than fix their own internal problems, they pass the responsibility to innocent and unwary consumers.

Apparently, fraudulent property developers are ripping off the GST system to the tune of more than $1.6 billion (yes, billion!!) over the forward estimates period.

What this suggests is that developers are currently registering for GST, claiming input tax credits when they undertake residential construction and property developments, but not remitting GST on the sale. If the ATO knows about this and can estimate that such a large amount of revenue is being effectively fraudulently pocketed, surely there is compliance work they can do to recover the amounts and stop the rorting.

It also seems to me that, if somebody is going to rip off the ATO, I can’t see any reason why they wouldn’t give misinformation to Mum and Dad buyers, who have to remit the GST.

Conclusion

So it seems that pragmatism once again trumps good tax design.

It is easier to make us all GST collectors than for ATO auditors to track down fraudulent property developers.

It is also easier to get the electronic distribution platforms to collect GST from a myriad of small sellers (many of whom would not otherwise have a GST liability), than to keep integrity in the system. All in the name of keeping bricks and mortar retailers happy. Anecdotal evidence would suggest that a 10% increase in on-line prices will not change Australian on-line shopping habits.

Could these changes escalate dangerous GST precedents? If ATO advice to the Government says other areas of the GST law are difficult to police and result in loss to the revenue, could we see similar measures announced in the future?