|Submission No. 291||Back to full list of submissions|
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|Submission of the Construction, Forestry, Mining and Energy
to the Review of BusinessTaxation Preventing tax avoidance:
The use of interposed entities in the construction industry
2) THE CONSTRUCTION INDUSTRY EXPERIENCE WITHIN THE CURRENT TAX SYSTEM
3) A NEW TAX SYSTEM
4) PERSONAL SERVICE COMPANIES
Appendix A : Review of Government Proposals For a New Tax Withholding System Willis, Ralph 9/6/99
Attachment A - Taxation of Alienated Personal Services Income. 18/10/1995, Government Discussion Paper.
Appendix B : The Submission of the CFMEU to the Senate Select Committee on a New Tax System
Appendix C : Transcript of evidence before the Senate Select Committee On a New Tax System.
1.3 As a result of these time constraints this submission will be brief. For background and data we refer readers the paper prepared by Ralph Willis, former Treasurer of Australia, (Appendix A); to the more detailed submission the CFMEU prepared for the Senate Select Committee on a New Tax System (Appendix B) and to the transcript of our evidence before that Committee (Appendix C).
1.4 This submission argues that the corporate veil must be lifted and where work is being performed by an individual in a manner analogous to that of an employee, that person must be taxed as an employee. The use of a corporate structure by individuals performing contracts wholly or substantially for their labour should not automatically entitle that individual access to the corporate tax structure.
2. The Construction Industry Experience Within the Current Tax System.
2.1 Due to the Prescribed Payments System (PPS) applying in the construction industry flight from the PAYE System has occurred through 2 main methods :
2.1.1 Switching from PAYE to PPS
Employees continue to do the same work but simply switch tax systems. They are able to do this despite that fact that PPS should only be used by non-employees. This switch may occur at the instigation of the employer or the employee. The employer avoids statutory requirements such as workers compensation and the employee gains access to more generous business deductions. Under PPS, 20% of the payment is withheld and forwarded to the ATO.
2.1.2 Interposed Entities
Individuals are paid for their labour through an interposed entity. They then have access to income alienation through income splitting and other measures. A stark example of the use of interposed entities in the construction industry is in one particular sector where workers were told by the suppliers for whom they worked that if they did not take the form of an incorporated company they would no longer receive work.
2.2 In the construction industry there have been many examples in trades such as plastering or bricklaying of companies informing their employees on a Friday that when they return to work on Monday they will be treated as sub-contractors and they will change from the PAYE system to PPS.
2.3 It is also common for two workers to be completing identical tasks for the same company, yet for one to be paid as an employee and the other as a sub-contractor.
2.4 For a detailed discussion of the deficiencies of the present system we refer readers to section (1) of the paper prepared by Ralph Willis, former Treasurer of Australia, that has been attached as Appendix A of this submission.
The CFMEU argues that the same economic transaction must attract the same tax treatment, regardless of the form it takes. We concur with comments contained in the discussion paper A Strong Foundation released by the RBT at 2.13; "The same economic transaction should be taxed in the same way regardless of its form."
3. A New Tax System
3.1 The Abolition of PPS
The Government has announced that it intends to abolish PPS and PAYE, however at the time of writing, the Bills for these measures had not been released. The abolition of PPS would return the construction industry to the pre-1983 system, where there were no withholdings and the cash-economy was rampant. As widely abused as PPS has been, it has at least ensured that some revenue is collected from payments to sub-contractors.
3.2 The Australian Business Number Bill
The Government has introduced the ANTS (Australian Business Number) Bill 1998 into the Parliament. This Bill will ensure that any payments made to payees without an Australian Business Number (ABN) will be subject to PAYE tax. This is a welcome reform.
3.3 However, the Bill outlines that all Corporation Law companies will be entitled to an ABN. You will also be entitled to an ABN if you are carrying on an enterprise (section 8). The Bill defines an enterprise in Section 38 and states that an enterprise does not include "..an activity or a series of activities, done as an employee or other PAYE earner..". It further defines a PAYE earner as an employee as defined by section 221A of the Income Tax Assessment Act 1936.
3.4 The CFMEU is concerned that relying on a definition of employee that has been read down by the courts will not prevent the erosion of the PAYE base. We feel that unless the test for the entitlement of an ABN is tightened, we will see even more employees applying for ABNs and setting up as companies.
3.5 Interposed Entities
The Government has not recommended any action to deal with the growing problem of interposed entities. Indeed the new system may actually make it even more desirable to move away from the PAYE system. Not only will payments to contractors in the construction industry be free from the withholding that currently applies, but there may be a possibility of businesses earning GST credits on the cost of running home offices and other expenses.
The CFMEU believes that increasing compliance within the taxation system must be a major focus in any reform process. Preventing the use of corporate structures to cloud what is essentially an employer/employee relationship should therefore be an integral part of the current legislative changes.
4. Personal Service Companies
4.1 The CFMEU believes that where a corporate structure is being used to receive payments for the performance of contracts wholly or substantially for the labour of the controllers of the corporate structure, the Government should concentrate on the substance of the relationship in question rather than the form. If two people are doing the same work, for the same employer, it is inequitable to allow one to pay less tax simply because they have set up as a company.
4.2 We argue that if a corporate form is being used to receive income, that wholly or substantially would have been paid in the form of a wage but for the existence of that corporate form, then that income should be subject to PAYE tax or its equivalent. Such a corporate form should be defined as a personal services company. To fail to tax these companies at appropriate PAYE levels is to encourage the continued flight out of the PAYE system by thousands of Australian workers.
4.3 Where a business entity other than a corporate form is being used to receive payments that are analogous to wages, the following tests could be used to determine when those payments should be subject to PAYE tax:
(a) if the payment was wholly or substantially a payment for the labour of the controller of the entity; or
4.4. Other nations have attempted to regulate personal service companies, which are defined in subsection 125(7) of the Canadian Income Tax Act as being:
"a business of providing services where
(a) an individual who performs services on behalf of the corporation [referred to as an incorporated employee], or
(b) any person related to the incorporated employee
is a specified shareholder of the corporation and the incorporated employee would reasonably be regarded as an officer or employee of the person or partnership to whom or to which the services were provided but for the existence of the corporation, unless
(c) the corporation employs in the business throughout the year more than five full-time employees, or
(d) the amount paid or payable to the corporation in the year for the services is received or receivable by it from a corporation with which it was associated in the year".
4.5. The United States Tax Code defines a company as a personal services company;
(1) substantially all of the services of a personal service corporation are performed for (or on behalf of) 1 other corporation, partnership, or other entity, and
(2) the principal purpose for forming, or availing of, such personal service corporation is the avoidance or evasion of Federal income tax by reducing the income of, or securing the benefit of any expense, deduction, credit, exclusions, or other allowance for, any employee-owner which would not otherwise be available,
then the Secretary may allocate all income, deductions, credits, exclusions, and other allowances between such personal service corporation and its employee-owners, if such allocation is necessary to prevent avoidance or evasion of Federal income tax or clearly to reflect the income of the personal service corporation or any of its employee-owners".
Example of a personal service company;
Before Friday, the taxpayer is employed by a construction company (the payer) as a plasterer in a common law employment relationship. The plasterer is paid wages by way of remuneration and PAYE deductions are made from those payments. On Friday the employment relationship is terminated.
On Monday, the payer contracts with a company of which the plasterer and her spouse are the directors and only shareholders, for the provision of plastering services on an ongoing basis for an all-up hourly rate. The services are provided on the same basis as when the plasterer was an employee, that is, under the direction and control of the payer.
5. Recommendations for Legislative Change
5.1 It is clearly inequitable that some taxpayers should be reducing their tax liability by using interposed entities to alienate income and gain access to business deductions while other taxpayers, including ordinary wage and salary earners, pay the correct amount of tax. In addition to the tax consequences, income alienation can result in highly remunerated individuals being able to claim a range of income-tested Government payments, such as Family Payments and Austudy.
5.2 The CFMEU proposes that we should look through the company structure and concentrate on the actual relationship between the parties. This is not a radical approach. On occasions smaller companies have successfully requested that the Courts disregard the actual legal form of the entity and regard owner-operated enterprises as individuals. (see Mauger v Krcmar Engineering Pty Ltd 47 IR 359 and WorkCover Authority of NSW v Idofan Pty Ltd 59 IR 295)
5.3 The preferred position of the CFMEU for dealing with personal service companies (as defined in 4.2 of this submission) is contained in the following two options. One option is to tax the income in the hands of the individual who controls the interposed entity and who actually does the work. This would effectively reverse the interposed entity arrangement, as occurs when the existing general anti-avoidance provisions are applied. Therefore this option would be consistent with the intent of the present legislation and provide the conceptually correct outcome.
5.4 The second option is to tax the personal services income to the interposed entity at a rate equal to the applicable marginal PAYE rate plus the Medicare levy. This would have some administrative advantages, given that this would tax the body legally receiving the payments. However, this option would not require the income to be allocated to an individual controlling the entity.
5.5 Taken together, these proposed new rules will essentially have the same effect as applying the existing general anti-avoidance provisions to interposed entities. To ensure appropriate remedies are available in all cases of tax avoidance, the existing general anti-avoidance provisions would continue to operate in conjunction with the new rules.
5.6 In most circumstances, the application of the new provisions will provide a much simpler and less costly way of determining the correct taxation treatment. For instance, where an individual ceases work as a employee one day, and on the next day performs exactly the same work as a contractor operating through an interposed entity that splits the income with the individuals relatives, the new rules will provide very clear guidance. Setting out specific legislative rules will ensure that taxpayers in such circumstances are left in no doubt as to their tax obligations.
5.7 Under the new rules we propose, the PAYE system would be extended to cover payments made that are analogous to wages. As can be seen in the attached documents, our recommendations are largely based on the contents of an Australian Tax Office discussion paper from 1995 entitled Taxation of alienated personal services income.
5.8 We refer readers to the proposals prepared by Ralph Willis in Appendix A and to the options formulated in the ATO discussion paper that he attaches.
5.9 It is the submission of the CFMEU that this material shows that current legislation could be amended to prevent interposed entities being used to avoid PAYE tax obligations.