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Government gets it wrong on small business tax review


Last week, on 16 December, Assistant Treasurer Senator Nick Sherry released a report of a review into the Personal Services Income tax laws. The review was conducted by the Board of Taxation for the government. The government has passed the report to the Henry Review of taxation for final recommendations. Senator Sherry's press release effectively endorses the report as integral to the government's programme to stop 'sham' contracting.

ICA considers the report to be extremely poor. It is badly researched, contains only cursory statistical data and analysis, and is based on outdated and erroneous assumptions about the nature of small business. The government's response---reflected in Senator Sherry's press release---has all the indications of an ALP throwback to the anti-small business agendas of the 1990s. It seeks to reintroduce a process which uses the taxation system to pursue industrial relations agendas. The report also displays an acute ignorance of the nature of business and how self-employed people operate as small businesses.

If any part of the report is implemented, it will result in major increases in small business red tape, substantially increase the levels of confusion over small business taxation, undo the immense progress made on the issue over the last decade, and will do nothing to address or fix sham contract arrangements.

Further, implementing this report will breach undertakings made by the Rudd ALP when in opposition. In July 2007, Independent Contractors of Australia asked the Federal ALP the following question:

    The ALP supports the principles behind the alienation of personal services income legislation. Does this mean that the ALP supports the existing personal services income tax legislation or are changes proposed? If changes are proposed, what would these involve?

The ALP replied (through the then shadow minister for small business Dr Craig Emerson)

    No changes are proposed.

This was a clear statement by the Rudd Opposition that, when in government, the PSI laws would remain as they are. This Board of Taxation report and Senator Sherry's press release indicate that the Rudd Government has every intention of changing the PSI laws---a direct breach of its 2007 undertaking.

This ICA analysis of the report is preliminary only. The report is long-winded and raises a vast array of issues that need to be responded to, point by point. We undertake this exercise and release a more detailed response in January 2010.

What follows, however, are some excerpts from the report and some of its recommendations.

The following is a direct quotation from the report about how to move forward with a new taxation agenda for small business.

    5.6 An approach that would make this distinction unnecessary is to not differentiate between personal services income and income from a business structure, or to treat some personal services income as generated in an 'employee-like manner', but instead to differentiate between income from capital and income from labour.

    5.7 Under this approach, the objective is to distinguish which part of an individual's income is derived from their labour and which part is a return to their business assets or capital. That part of the income derived from labour would be attributed to the person who supplied the labour. The return to capital could be returned to the owner(s) of the capital, which may differ from the person who provided the labour.

    5.8 In principle, there are two potential approaches for implementing this option: either starting by imputing a rate of return to business assets and treating the residual business profit as labour income (as it is done by the Nordic countries---see Appendix B), or starting by applying a domestic transfer pricing rule to any labour services provided by the self-employed worker to the entity and treating the residual business profit as a return to capital.

ICA comment:

This is typical of the tone, style and thrust of the report. It introduces vastly new and previously unexplored or considered concepts of what constitutes a business activity. Note, also, that the UK and EU (including the Nordic countries) are in a mess over taxation treatment of small business and hardly stand up as examples for Australia.

The report raises several specific options for action:
  1. Introduce a whole new regime of reporting on payers and payees. Require payers and payees to make an annual report to the ATO so that the ATO can match data to see how many clients an independent contractor had in a year.
  2. Introduce an entirely new form of withholding obligation on payers. That is, businesses would have to pay tax on behalf of other businesses.
  3. Introduce mandatory GST registration and remove the $75,000 threshold below which small businesses do not have to register for GST.
  4. Introduce the 80/20 rule which was proposed by the Ralph Review, thereby treating small business people as if they were employees.
  5. Change the results test so that a business must have at least two employees.

ICA comment:

We see each of these proposals as being an aggressive attack against the right of self-employed people to be self-employed by massively increasing small business administration and complexity. Larger businesses who engaged self-employed people would be saddled with substantial new levels of complexity when dealing with small businesses to the extent that they would not want to deal with small businesses.