Taxing times - October 2007

Failing to pay as you go

If a company fails to pay a 'pay as you go' (PAYG) deduction debt to the Australian Tax Office, the directors of the company might each be personally liable to pay that debt (sections 222AOB and 222AOC of the Income Tax Assessment Act 1936).

What normally happens is that the Tax Office will seek out directors who have the most resources or who are the easiest to chase, and will pursue them. In turn, if that director pays the PAYG, it is up to him or her to chase the other directors (without any assistance from the Tax Office) to get them to pay their share of the PAYG cost.

However, a director will not have any liability for unpaid PAYG if, before the due payment date, the directors of the company made an agreement with the Tax Office as to the payment of PAYG, appointed an administrator to the company, or started the winding up of the company.

Sections 222AOB and 222AOC would at first glance appear to be inconsistent with section 1318 of the Corporations Act 2001.

That section allows a court in 'any civil proceeding against [a director] for negligence, default, breach of trust or breach of duty in a capacity as such a person' to excuse the director from such negligence, default or breach, if they have acted honestly.

One might think this is a most fair section and should be applicable to tax law. Unfortunately, however, fairness has nothing to do with tax law.

The New South Wales Court of Appeal made this quite clear in DC of T v Dick (New South Wales Court of Appeal, 3 August 2007). There the court held as matter of legal interpretation that section 1318 (of the Corporations Act 2001) does not limit the liabilities imposed by section 222AOB (of the Income Tax Assessment Act 1936).

This was because as Justice Santow said quoting from the decision in Refrigerated Express Lines (A/Asia) Pty Ltd v Australian Meat and Livestock Corporation (No 2) (Federal Court,17 April 1980): 'As a matter of general construction, where there is repugnancy between the general provision of a statute and provisions dealing with a particular subject matter, the latter must prevail and, to the extent of such repugnancy, the general provisions will be inapplicable to the subject matter of the special provisions.'

This is correct as a matter of law. The fact remains, however, that section 222AOB and section 222AOC (and other related sections) are unduly onerous. As an example I have seen the Tax Office extract PAYG from an innocent spouse where the default was caused by the actions of a wayward and untraceable husband.

The Tax Office would most probably respond to this criticism by pointing to section 222AOJ of the Income Tax Assessment Act 1936, which in particular states that a director has a defence to an action taken by the Tax Office to recover PAYG from that director if 'because of illness or for some other good reason, the [director] did not take part in the management of the company' at the time the PAYG obligation was incurred.

That is true but that section has been very narrowly construed, and one director would not be excused - say because that director was a spouse of the other - if that director simply left the running of the company to the other.

Perhaps now that it’s possible to form sole-director companies accountants might be doing their clients a favour if they converted multiple-director companies to sole- director versions. But they should considered the consequences of this should the sole director die.

Personal services income does not yield results

It’s illogical that in a business one spouse can income split with another (whether that spouse is a silent partner or not) but the tax law (including perhaps Part IVA ) prohibits the splitting of personal services income.

But the law is the law, and the Income Tax Assessment Act 1997 contains specific rules designed to stop persons alienating personal services income. However – and this is important for these notes – those rules do not apply if an entity or person satisfies the 'results test'.

Alternatively, the rules preventing the alienation of personal services income do not apply if less than 80 per cent of a person’s personal services income comes from just one client, and if one or more of an 'unrelated clients test' , an 'employment test' (meaning that people unrelated to the taxpayer perform work that has a market value of at least 20 per cent of that person’s personal services income) or a 'business premises test' (meaning that the taxpayer has business premises separate from his or her client) is satisfied.

However, if more that 80 per cent of someone’s personal services income comes from just one client and if that person does not satisfy the 'results test' the alienation of personal services income rules will apply unless the Tax Office has provided the taxpayer with a determination saying that they will not apply. And before it issues a determination it will look to see if one of those tests has been satisfied. Even where less than 80 per cent of personal services income is received from just one client a determination can be sought if the taxpayer is loath to self-assess.

What has not yet been tested is whether, given the specific alienation of personal services income rules, there is still room for Part IVA to apply, notwithstanding that a taxpayer might have satisfied those rules. I see this as being particularly pertinent to medical practitioners - traditionally they have not been able to split their incomes. I believe, however, that this should no longer be the case.

Results test

The 'results test' will be satisfied (see section 87–18 (1) of the Income Tax Assessment Act 1997) if the person’s personal services income is for producing a result, the person or that person’s entity is required to supply the plant and equipment or tools of trade needed to produce the result, and the entity or the person is, or would be liable for the cost of rectifying any defect in the work performed.

The decision in Skiba v FC of T (Administrative Appeals Tribunal, 27 August 2007) is an example of an application of the 'results test'. For the Tax Office this is probably a most important decision, since I believe that it has always seen the 'results test' as primarily applying to tradespeople such as plumbers and electricians and not to professionals.

Skiba was an engineer. He was employed by Marketcroft Pty Ltd (presumably a family company associated with him).

Marketcroft derived income from contracts it entered into to provide Skiba’s services to other entities. It also operated a restaurant. This, however, was not relevant because the alienation of personal services income rules can apply to income from services, irrespective of whether the entity providing those services derived income from other sources or not.

Here the tribunal member (Mr Andre Sweidan) held that Skida could not rely upon the 'results test' to avoid an application of the alienation of personal services income rules.

This was because he believed:

Marketcroft was not paid for producing a result.
Skiba had to provide 'deliverables', which were described as 'measures of engineering design performance and are outcomes of the provision of engineering services'. It was also said that 'The completion of those deliverables verifies the performance of the contract in accordance with the schedule [to the contract].'

However, Sweidan did not believe this meant that Marketcroft was paid to produce a result. He said 'a result- based contract usually has a negotiated contract price for the result achieved and not merely an hourly rate for hours worked' and that the words 'for producing a result' required that income not be paid to Marketcroft 'until and unless the result was produced'.

One might say that this is not necessarily so; the mode of payment is indicative but not necessarily determinative of the reason for the payment, and it is quite common for payments to be made in instalments pending completion of a project (or indeed as any home renovator will admit, before even knowing whether or not the result has been achieved).

Marketcroft did not supply the plant and equipment or tools of trade needed by Skiba.
Sweidan said here Marketcroft should have provided the desk and workstation, storage unit, chair, computer programs, telephone, fax machine, printer, photocopy machine, calculator, and instruments needed by Skiba to perform the work.

Here one might argue that Sweidan adopted an unrealistically wide view of the meaning of 'plant and equipment' and 'tools of trade' needed to perform the work. Indeed, his view – given tax ruling TR2001/8 – is even wider than that which the Tax Office could be expected to take.

There the Tax Office (see paragraph 35) said that this test was not failed merely because plant and equipment, or tools of trade are not needed to perform the work. It said that the test requires 'the provision of the equipment or tools, if any, necessary to perform the work where, having regard to custom and practice in that particular industry, it would be expected that the equipment normally used to undertake the work will be provided by whoever performs the work. Where no plant and equipment or tools of trade are necessary to perform the work, this condition would be satisfied.'

'The practical reality was that the personal services entity (Marketcroft) was not liable for rectifying any defect in the work performed'. However, this was not so as matter of law.

One matter that was not considered in the Skiba decision was how the alienation of personal services rules interacts with the tax legislation generally.

This was a question implicitly raised by the taxpayer’s representative in Fowler v FC of T (Administrative Decisions Tribunal, 21 September 2006) but not considered there.

The tribunal’s decision in Fowler is likely to be considered by the Federal Court (an appeal has been lodged with the Federal Court). This means that persons who wish to object against the application of the alienation of personal services income rules (or any other provision - such as the controlled foreign companies provisions - which assess one person on the income of another) should in their objection argue that those rules do not interact with the general assessment provisions.

It was not necessary for me to read the Skiba decision to guess the result. Before reading a decision, I like to see the name of the counsel who argued the matter. If competent counsel argued the matter, it is normally the case that all the relevant issues will have been considered. But if a taxpayer appears on their own behalf (as was the case here) more often than not the tribunal (people rarely appear for themselves before a court) will decide the case against the taxpayer. That does not mean that the tribunal makes an incorrect or biased decision.

Rather, its decision would normally reflect the merits of the case. But what it does mean is that the tribunal might not have been asked to consider all the relevant nuances to an argument (and a layperson obviously could not be expected to have the same appreciation of the law as experienced counsel would have). I suspect that this might have been the case here.

It is unlikely that this decision will be appealed; taxpayers who represent themselves before the tribunal rarely appeal a decision. This may be a matter of costs. However, this decision should be appealed. It involved some fundamental issues of law that should definitely be resolved, and the Tax Office should fund that appeal.

Robert Richards CPA is a solicitor specialising in tax matters.

Reference: October 2007, volume 77:09, p. 66

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