Beating the Bush Blues
Tax and Industrial Relations
Why should tax be of interest to the H.R. Nicholls Society? Simple! Income
tax collection processes and industrial relations powers have been intimately
connected for a long time. The core issue is, and has been, the legislative
power of the Tax Commissioner to collect income tax at source. This core
item usually becomes lost, however, in the debate over the related issues
of income-splitting and tax deductions.
My claim is that in the total social dynamic, the income tax collection
system has been more important to industrial relations coverage than has
the mafioso-like behavior of the unions. This dynamic is about to change.
Let me explain.
The capacity of the industrial relations system to rule over people's
working lives is limited to where people are working in a common-law, master-and-servant
employment relationship. That is, where one person, the employer, has the
legal right to control the other person, the employee. People working outside
the master--servant relationship are not ordinarily subject to the powers
of industrial relations authorities.
In the tax area, the way in which the Australian Tax Commissioner has
been able to collect income tax at source has been dependent on common-law
This common dependence of income tax collection systems and industrial
relations powers on determinations of master-and-servant employment has,
over time, caused tax-collecting authorities to become engaged in an alliance
with industrial relations regulators. These two authorities, with outwardly
different agendas, have found themselves in the same colluding bed.
This outcome has corrupted the integrity of the tax collection system.
The labour movement has understood this dynamic and has fought long and
hard to prevent effective income-tax collection reform. In so doing they
have been a significant contributor to the creation of alleged tax-loss
schemes against which they so piously complain. Their duplicity has been
cunningly masked by outpourings of moral indignation directed at contractors.
The current reform of the tax collection system has as one of its objectives
the breaking of the nexus between common-law employment and income tax collection.
The potential outcomes are liberty for the Tax Commissioner from common-law
employment problems and greater freedom for people to choose the nature
of the common-law status they wish to have when working.
The question to be answered is whether this intention---the breaking
of the nexus---is fully reflected in both the tax legislation and the administrative
processes and operational behavior of the Tax Commissioner.
Before examining that question, however, it is worth considering the
historical development of income tax collection.
Milton Friedman, with some regret, describes his work as one of the architects
of the income tax system in the USA. He says that US Federal income tax
was meant as a temporary measure to overcome the problem of funding the
Second World War. US Treasury concern in the 1940s was that massive debt
funding of the First World War, was a major contributor to the Great Depression.
Friedman bemoans the fact that temporary measures become permanent and grow
when government has its hands in the public's purse. Australia has followed
a similar course.
In the 1920s, '30s and '40s, the legal master-and-servant employment
model was perhaps at its dominant height as the method for organizing business
in capitalist societies. It was understandable that, in designing an income
tax system, tax legislation should tie the power of tax officials to collect
income tax at source to common-law employment. Common-law-employment dependent
tax powers, at the time, would have caught the near total of the working
population. This was the legislative model used in North America and Australia.
Around the late 1970s significant change in legal work-engagement methods
began to emerge and have since accelerated. People are deserting the master-and-servant,
wage-slave model for reasons unrelated to tax. But a consequence of this
has been a shortening of tax officials' legislative reach.
The scale of the social movement away from wage slavery has only recently
been authoritatively identified. In the first survey on this issue undertaken
by the Australian Bureau of Statistics (released in February 2000), as of
- 59 per cent of the workforce identified themselves as working in a
full-time employment relationship.
- 20 per cent of the workforce identified themselves as being self-employed.
By contrast, surveys by the South Australian Institute of Labour in 1989
put the self-employed figure at somewhere around 3 per cent.
My suspicion is that this trend away from employment began earlier, and
has been steeper in its growth, in the USA than it has in Australia.
These trends have alarmed tax authorities in USA, Canada and Australia.
Many tax commentators and designers have not understood or accepted the
social movement but have instead interpreted it as a massive and sinister
The Australian Tax Commissioner's approach to this loss of authority
has been a combination of accommodation and aggression. The domestic building
industry has been at the pointy end of the interface with the Commissioner.
The spread of independent contracting is, however, huge. It now dominates
the information technology and film industries and is penetrating traditional
areas of manufacturing, finance, education and even the public service.
Changes to the Income Tax Collection
Let us clearly understand the problem from the tax system and tax officials'
perspective. Tax officials are charged with fulfilling a legislative instruction
to collect tax. From an administrative angle, the most effective tax systems
are ones in which voluntary compliance is maximized and in which tax is
collected at source. Tax auditing and compliance activity is expensive,
not cost-effective and something tax designers seek to minimize.
In Australia, the PAYE arrangements have evolved as the primary 'at source'
collection system and it is around them that the ATO's administration systems
are constructed. But PAYE legislation only gives the Commissioner power
to collect an individual's income tax at source if the individual is in
a common-law, master-and-servant employment relationship. The key provision
is Section 211C of the Income Tax Assessment Act 1936, which requires
'employers' to deduct instalments of tax from payments of salary or wages
In an effort to overcome independent contractor leakage from PAYE, the
Australian Tax Commissioner has argued that the legislative powers under
section 221A(1) of the Act being 'wholly or principally for labour...',
extended the Commissioner's powers to contractors.
In various attempts to prove the point, the Commissioner has, in the
past, aggressively sought to enforce this extended view of his powers. The
Courts, however, have not agreed with the Commissioner. On ten separate
occasions during the late 1980s and 1990s, the High Court rejected the Commissioner's
view that PAYE legislative powers extended beyond common-law employees.
Another approach was to attempt to change the income tax legislation
to bring independent contractors into PAYE. The last time this was attempted
was under Federal Treasurer Willis in 1994. The problem was that the labour
movement, ever mindful of their dependence on tax legislation for their
own powers, saw the legislative change as an opportunity to destroy independent
contracting. The Willis amendments, known as Taxation Law Amendment Bill
No 5, were dropped when a change of government occurred.
In effect, the Willis amendments sought to deny independent contractors
the right to exist as such by legislatively declaring contractors to be
common-law employees. The approach had strong parallels to the 1999 Queensland
IR Act (Section 275) and its legislative attempt to turn free, independent
contractors into wage-slave employees.
Had the Willis tax amendments succeeded, they would have put the Tax
Commissioner on a collision course with a broad social movement toward freedom,
equity and justice. Bad for tax collection and bad for society!
The Tax Commissioner's other approach was to create an administrative
at source tax collection system for contractors called PPS. When developed,
the PPS system was limited to the building and related industries. PPS has
always been seen by the Commissioner as administratively messy and at best
providing a temporary plug to an expanding hole.
We come, then, to the state of the dilemma as it has stood through most
of the 1990s:
- PAYE has been declining as the dominant revenue base.
- As independent contracting has grown, there has been pressure to extend
PPS beyond the building industry.
- The Tax Commissioner has developed tests to limit people entering the
PPS system and prevent PAYE disintegration. In effect, the tests became
quasi-common-law rulings, a task for which the Commissioner has no legitimate
expertise or authority.
- Because the quasi-common-law tax tests largely sought proof of contractor
status on the basis of the existence of company structures, the impetus
for structuring has been enormous.
- In the Commissioner's view, structuring has enabled individuals to
split income and claim deductions so as to avoid tax.
- Lurking in the background has been the labour movement, in its many
chameleon disguises, consistently seeking to use the Commissioner's dilemma
for their own purposes, namely, to make life difficult for PPS payers and
to force people into PAYE wage-slavery employment.
In short, the linking of the Tax Commissioner's 'at source' income-tax
collection powers to common-law, master-and-servant employment relationships
has been a negative in times of vast social change:
- It has corrupted the tax collection system, making it an instrument
of the industrial relations system.
- It has limited the right of people to free themselves from the inequality
and injustice of the master-and-servant employment relationship.
With at least one in five of the Australian workforce not working in
a traditional employment relationship and with the trend growing rapidly,
the tax collection system has been forced to modernise.
The tax collection system has been in urgent need of updating to accommodate
a changed and changing society. The Tax Commissioner should not be forced
to be an arbitrator or commentator on the relationships people choose to
have when they work.
The Tax Commissioner's powers are silent on, and irrelevant to, the cohabitation
preferences of people. Whether people are married, defacto, transient, heterosexual,
gay, bi, swinging, open, religious, irreligious, eco-pure, eco-ravaging
or any other form of lifestyle is not of legislative concern to the Tax
Commissioner when it comes to the power to collect income tax. Equally,
the Tax Commissioner should not have to be dependent on common-law status
So we come to 1 July 2000 and the first true redesign of the tax collection
system undertaken since income tax was introduced. The design has as one
of its primary objectives the untying of the Tax Commissioner's collection
powers from common-law dependency.
The objective of neutralizing common-law employment dependency is central
to the new PAYG system, an objective generally not recognized and one that
has become confused in the debate over income-splitting.
The Government's intentions are made clear in two key documents:
1. Tax Reform not a new tax a new tax system (ANTS)
The 'ANTS' document, as it is known in Treasury, is the principal document
produced by the Federal Government that establishes the principles and structures
of the proposed reformed tax system and upon which the Government went to
the 1998 election. The PAYG components established in ANTS are substantially
intact in the 2000 legislative form. ANTS states that
... Australia's core withholding system---the Pay As You Earn (PAYE)
system---relies heavily on outmoded ideas of master and servant to define
obligations. It simply has not kept pace with labour market trends and
is falling further behind. Australia needs a modern, comprehensive withholding
system for payments to workers.
2. Treasury Fact Sheet No 703
Fact sheet 703 is the primary fact sheet explaining what the intent of
the Ralph Review was on income-splitting. In all the processes proposed,
Treasury states that
'It (the measures) will have no effect on the legal relationship
between the entity and the person paying for the services'.
If this intention is put into practice effectively, the government will
have achieved important reform with wide-reaching implications:
- The Tax Commissioner will have a clear legislative brief to collect
income tax, at source, without having to depend on lifestyle and managerial
choices made by people.
- The tax system will have the corrupting linkages to the industrial
relations system removed, thereby enabling debate and choices on our working
lives to be conducted specifically on the working life issues.
The big question is---are the
intentions reflected in practice?: Legislation and ATO operational practice
1. Does the new legislation remove the tie to
In assessing the implementation of the government's intentions, examination
of the legislation is the most important factor. If there is anything in
the tax legislation that could be considered by a court to declare the existence
of common-law employment, the reforms will have failed. (No doubt, labour
lawyers will be combing through the legislation searching for such a linkage!)
I am not a solicitor, so I cannot provide an authoritative assessment.
But I have read the legislation with an eye to finding fault and feel confident
about the following comments.
The key pieces of legislation to understand are the GST, ABN and PAYG
legislation. These first appeared in early 1999. The early versions are
pretty impressive at neutralizing the common-law employment issue. This
has been done largely through introducing new terminology that has specific
administrative tax meaning only. The terminology includes 'withholding',
'instalment income', 'instalment group', 'entity', 'activity statement'
and 'notional tax'.
The consolidated legislation has only been printed and available in the
last few weeks. On my reading, save for some reservations on the ABN registration
criteria, the legislation seems to be successful at removing the Commissioner's
dependence on common-law employment..
As for the proposed legislation resulting from the Ralph Review, it is
important to remember that the debate over income alienation was not directed
at the Tax Commissioner's powers to collect income tax. The Ralph proposals
cover how personal income tax rates are applied after tax has been collected.
2. Is the new tax collection administrative
system neutral on common-law employment?
Legislation is one issue, but if the administrative systems of the ATO
are biased against contractors, peace between the ATO and contractors will
not have been achieved.
The indicators at this stage are mixed---there are some grounds for optimism
but unanswered questions leave cause for concern.
We know the following:
- The battle between PPS and PAYE will no longer exist as both are consumed
in the new catch-all system, PAYG.
- Common-law employees are clearly caught within PAYG.
- Contractors who work through labour hire are caught within PAYG.
- Individual contractors who work direct and have an ABN can choose to
be caught within PAYG by signing a 'voluntary agreement'.
- Contractors who do not wish to enter PAYG can remit their own income
tax, at source, but will require an ABN if they don't want their client/s
to withhold 48.5 per cent of invoices.
This multi-pronged process is designed to maximize pressure on all income
earners to be within the PAYG system. It successfully and broadly captures
income earners no matter what their common-law work status.
There are some questions, however, for which answers remain unclear:
- What is the status of contractors who apply for, and are refused, an
- Does the ABN Registrar's discretionary power to award or remove an
ABN become a quasi-common-law employment/contractor test?
- Could future governments, who take a hard line against contractors,
direct the Registrar to refuse contractors an ABN?
The answers to these questions are not clear because a good deal seems
to be left to the Registrar's discretionary interpretation over what constitutes
a 'personal services business'. The debate over the Ralph recommendations
demonstrates how critical these questions are.
If there is failure in the new system, it is an apparent failure within
the legislation to give income earners 100 per cent clarity about what,
for tax purposes, constitutes a 'personal services business'. Leaving the
Registrar with discretionary powers opens the system to abuse and conflict
and puts at risk maximum voluntary compliance. Admittedly, the problem that
I see in the legislation is at the margins, but this does not alter the
principle that legislators have a duty to deliver clarity on this matter.
But perhaps the answers are best considered from the perspective of the
integrity of the tax collection system. If ABN registrations of individual
contractors were rejected, the PAYG system would be compromised.
The Tax Commissioner has a vested interest in tracing each and every
commercial transaction in the community and the ABN is the primary cross-reference
tool that will facilitate computer-generated tracing. If an anti-contractor
government changed the rules, or instructed the Registrar to use the interpretative
powers to refuse ABN registrations, the government would be stripping important
auditing powers from the Commissioner and creating tax avoidance.
The debate over income-splitting has generated great heat and accusations
that the government has wanted to get rid of contractors. I will make two
First, contrary to most accusations and on the best available evidence,
large-scale income-splitting in the community is unproven. In the only authoritative
and detailed investigation of income-splitting, the practice was shown to
During 1997 and 1998 the ATO conducted the 'Alienation of Personal Services
Project'. An ATO status report of December 1998 showed the following:
- 65,000 taxpayers were profiled for investigation as likely income-splitters.
- 55,000 notices were sent to taxpayers initiating review of tax returns.
- 5,403 taxpayers were specifically targeted for tax review.
- 1,104 tax agents were visited in the taxpayers' review process.
- 714 taxpayers were issued adjustments notices.
- Percentage increases in tax paid varied from 1.9 per cent to 11.6 per
cent per taxpayer.
Furthermore, it is understood that the additional tax raised was below
that expected of any random audit of taxpayers' returns. It is known that
the project was wound down because the additional revenue raised did not
cover the cost of the audit. The conclusion of the audit was that the vast
majority of people structure for legitimate business purposes and not for
I find it odd that the results of this, the only detailed, factual and
reliable audit undertaken, received no official coverage during the recent
debate on income-splitting.
My second comment is on the definition of income-splitting. Income-splitting
has been one of those issues that everyone seems to think everyone understands
but when it comes to precise definition, there is mute silence.
Those who continue to make accusations of income-splitting, and there
are many, have a responsibility precisely to define the point in a transaction
at which a payment to an individual from an entity ceases to be an expense
in earning an income and becomes a tax dodge.
Take a typical example: If the spouse of a carpenter contractor is a
partner in the contractor's business, at what point do payments to the spouse
cease to be legitimate partnership payments and become income-splitting?
Are partnerships to be disallowed? Are two-person companies to be abolished?
This simple question will, I suspect, not disappear and accusations that
contractors are income-splitting will continue. However, I repeat that income-splitting
issues do not relate to income tax collection but rather to the rate of
tax to be imposed on an income earner. Further, the answer to this critical
legal, social and economic question should not be left to the arbitrary
and discretionary powers of tax bureaucrats. Rather, it should be clearly
stated in legislation.
My discussion has focused on the at-source, income tax collection powers
of the Tax Commissioner and the nexus between those powers, common-law employment
and industrial relations.
When considering the new PAYG system from this perspective, the design
is looking impressive. Although some reservations remain, we can be optimistic
that collection of tax under PAYG will sever the relationship between the
tax collection system and industrial relations regulation.
If my assessment is accurate, the days of the exploitation of the tax
collection system for the enforcement of industrial relations regulation
may be numbered.