---------------MdU Library Gopher Header Information-------------- Title : Review of Western Australian State Taxes - : Payroll Tax Author : Tax Policy Elective 1993 Organisation : School of Law, Murdoch University Language : English Keywords : PAYROLL TAX, TAXATION, WESTERN AUSTRALIA, : EQUITY, EFFICIENCY, SIMPLICITY, REFORM Abstract : See abstract to Preface and Introduction Contact Name : The Editors, E Law Contact Address : Murdoch University Law School, PO Box 1014, : Canning Vale, Western Australia, 6155 Contact Phone : +61 09 360 2976 Contact Email : elaw-editors@csuvax1.murdoch.edu.au Last Verified : Last Updated : Creation Date : File Size : 61,498K File Type : Document File Format : ASCII Publication Status: Final COPYRIGHT POLICY : Material appearing in E Law is accepted on the basis that the material is the original, uncopied work of the author or authors. 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ISSN: 1321-8247 URL: gopher://infolib.murdoch.edu.au:70/00/.ftp/pub/subj/law/ jnl/elaw/comment/watax/chap4.txt --------------------------------------------------------------- 1 INTRODUCTION Payroll tax is a state tax levied on wages paid or payable by an employer in Western Australia. Presently the tax accounts for approximately 40% of the state's total tax revenue and is a source of potential growth available to the State. The tax was first introduced by the Federal Government during the period of the Second World War. It was used to raise revenue for the purpose of building arms. In 1971 the Federal Government handed payroll tax over to the states. Payroll tax is self assessed by the employer using a complex rate schedule under the provisions of the _Payroll Tax Assessment Act 1971_. The rate of payroll tax applied to any one employer depends upon the amount of wages paid in the financial year. Currently in Western Australia the rates of payroll tax range from 3.95% to 6.00%, dependent on the level of wages paid.(1) A minimum threshold of $395,000 exists where in any year the total taxable wages of an employer fall below this amount, the employer is exempt from paying payroll tax. The provisions of the _Payroll Tax Assessment Act 1971_ are complemented by the _Payroll Tax Act 1971_, an act which sets out the intricate calculation methods. It has been recognised that the economic burden of the tax does not in fact fall solely on the employer, rather "the true economic incidence will be spread between employers, consumers and employees in a manner which is largely independent of where the legal tax burden falls"(2) While payroll tax is a major source of state revenue, it has been widely criticised as being a tax which pays little or no regard to capacity to pay and for discouraging employment.(3) Thus the tax is often considered to be lacking in terms of equity, efficiency and simplicity; the three factors used in determining an ideal tax. After defining some of the more significant terms employed in the legislation, the following chapter will analyse the West Australian system of payroll tax under the heads of equity, efficiency and simplicity. Problems in the existing system will be highlighted and finally recommendations for reform will be made. 2 DEFINITIONS The _Payroll Tax Assessment Act 1971_ provides that "payroll tax shall be paid by the employer by whom the taxable wages are paid or payable".(4) Prior to analysing the system it is therefore necessary to define two of the most significant terms used in the legislation, these being "employer" and "wages". Under section 3, "employer" is defined as any person who pays or is liable to pay any wages and includes the Crown in right of the State of Western Australia and also a person who is an employment agent. An expanded definition of employer was added to the Act(5) in 1975 when the West Australian Government passed amendments to provide that certain classes of employers be grouped together as one for the purposes of payroll tax. The grouping provisions are complex,(6) the basic effect being that where corporations are related,(7) employees of one employer perform duties for a business carried on by another person, businesses are commonly controlled,(8) or one of the businesses is a branch, agency or subsidiary of a head or parent business, and the head or parent business exercises managerial control over the branch, agency or subsidiary, such businesses constitute a group for payroll tax purposes. Under the West Australian legislation, "wages" are defined to include wages, salary, commission, bonuses, allowances or other benefits paid or payable to an employee as such. "Wages" is therefore not restricted to monetary payments but may also extend to a variety of non-cash benefits that may be conferred upon the employee in the course of his/her employment. It is interesting to note that section 3 of the _Payroll Tax Assessment Act 1971_ does not include a definition of employee. The significance of this omission will be highlighted at a later stage. 3 SIMPLICITY The first criteria in determining an ideal tax is simplicity. A tax will be considered simple if the administrative costs involved in collecting and complying with the tax are small, in terms of both money and effort.(9) As payroll tax is self assessed by the employer, it is simple for the State Taxation Department in that there is little work required in relation to assessing and collecting the tax. There is, however, a greater emphasis on ensuring compliance and time and effort must be spent on checking employer returns and investigating any employers who may be avoiding the tax. As discussed above, payroll tax is assessed according to a sliding rate scale. Such a method requires complex calculation to determine what tax bracket an employer falls within and the exact percentage of tax to be paid. While the State Taxation Department does provide employers with guidelines on how to complete these calculations, it is nonetheless a difficult task for many employers. We have been led to believe that many employers get the calculations wrong. The tax is therefore not a simple one for employers to comply with. As mentioned previously, employers are exempt from paying payroll tax where the total of their taxable wages falls below the threshold of $450,000 per annum. As noted by the NSW Tax Task Force in its recent review of the tax system in NSW, this exemption removes many smaller firms from the ambit of the tax, thus reducing both administration and expense burdens on the smallest businesses. As mentioned above, the State Taxation Department must expend both time and money in ensuring compliance. With the exemption excluding many smaller employers, this task is made simpler in that fewer employers must be monitored. Under the present system, employers are required to furnish returns to the State Taxation Department on a monthly basis. This makes it difficult for large employers with many branches or centres and employers which are combined as a group as such employers must combine payroll figures to determine taxable wages paid or payable within the group and hence their total payroll tax liability. Some effort has been made to reduce this apparent simplicity problem. Employers with large payrolls have the option of applying to the Taxation Department for an estimate of monthly payrolls so that the employer can pay the tax on that estimate rather than actual figures. This makes it simpler for the employer in that it is not necessary to combine wage figures within the group. On the part of the State Taxation Department however, it creates additional administrative costs and duties. The Department must first calculate accurate estimates based on prior payroll figures of the group, a process which is time consuming. In addition to this, at the end of each financial year, the Department must compare the estimates with the employer's actual payroll figures to determine whether refunds or additional taxes must be paid. Hence what is normally a self assessed tax on the part of the employer becomes one that is primarily assessed by the Taxation Department. 4 EFFICIENCY The second criteria to be considered in assessing the West Australian payroll tax system is efficiency. Efficiency requires "economic decisions and resource allocation to be made on the basis of market factors, not government biases."(10) Therefore the tax system will be inefficient where certain taxes encourage individuals to substitute business processes which are less profitable for those which are more profitable. Payroll tax is not only an influence within the Australian market, it also impacts on the competitiveness of Australian exported goods. As mentioned previously, the burden of payroll tax is shared by the employer, the labour market and the consumer. It will therefore be a cost reflected in the price of a good and will increase the price at which Australian producers can sell their goods overseas. As a result, it is difficult for an Australian producer to compete on the world market, where the price of many foreign goods will not include a payroll tax component(11) and this may discourage producers from exporting goods. The most well recognised inefficiency in the payroll tax system stems from the fact that payroll tax is a tax on the payment of wages. It therefore "discriminates against labour intensive industries and employment and encourages capital intensive industries and unemployment."(12) This inefficiency can influence an employer's decision in that they may consider it more appropriate to expand into capital related industries rather than labour related expansion. Because labour intensive industries are discouraged by the payroll tax, an over supply of available labour is caused and, as a result of this excess, the price at which labour can be obtained falls. In addition to the above, the present payroll tax system can also cause inefficiencies _within_ an industry. Smaller firms and large capital intensive firms are provided with a competitive advantage over large labour intensive firms as they are not so heavily burdened by payroll tax. Payroll tax is an expense to an employer that must be paid in addition to wages. It is therefore a factor taken into account by an employer in determining an employee's remuneration package. Remuneration packages will often be reduced in an effort to counteract the effects of payroll tax hence an inefficiency is created as a result of the payroll tax system. Inefficiencies have arisen as a result of the treatment of fringe benefits under the current payroll tax legislation. Under the _Payroll Tax Assessment Act 1971_, fringe benefits given to employees are only liable to payroll tax if they are specified in the contract of employment and assigned a monetary value. To give an example, where one employee's remuneration package includes a salary of $60,000 and a car to the value of $10,000, the employer will be liable to payroll tax on $70,000. On the contrary, where a second employee's remuneration package includes $60,000 salary and he or she also receives the use of a car, although this is not included in the written remuneration package, the employer will be liable to payroll tax on the $60,000 alone. The exclusion of fringe benefits from the payroll tax base where not included in the remuneration package creates a distortion in the method of payment to employees. Because payroll tax can be reduced merely by increasing the component of certain fringe benefits, employers are more likely to confer benefits on employees in the form of fringe benefits not included in the remuneration package than pay higher wages or assign written values to those benefits. The West Australian payroll tax system is also inefficient as a result of the lack of a definition of "employees" in the legislation. Because there is no definition, common law tests must be relied upon to determine exactly who will fall within the category of "employee". As a result, there is scope for certain classes of people to be excluded from the category and therefore remain unaffected by payroll tax legislation. Courts have traditionally applied two tests where determining whether a person is an employee. The first of these is the "control test", which assesses the ability of the 'employer' to instruct the person on what to do, for example what hours to work, where to work and so on. The second is known as the "integration test" which is satisfied where the work of the person in question is an integral and essential part of the employers business. In many cases, work undertaken by contractors such as bricklayers and carpenters does not satisfy the Common Law tests and money paid to such workers will not be included as wages for the purposes of payroll tax. An illustration of this problem occurred recently in an unreported case involving a motor company. The State Taxation Department claimed the defendant was liable to payroll tax on monies paid to panelbeaters who performed work on cars sold in the defendants business. The court applied the two tests and found the panelbeaters to be contractors and not employees. The defendant was found not to have had sufficient control over what the workers did. They could choose their own working hours and even paid rent for the space they used in the defendant's workshop. They did not therefore fall within the provisions of the payroll tax legislation. The result of this lack of definition is that employers will be less inclined to employ staff full time but rather will contract work out so as to avoid paying payroll tax. While inefficient in many respects, it should be noted that the payroll tax legislation has previously been amended in an effort to increase efficiency. With the introduction of grouping provisions, companies are no longer encouraged to separate or fragment into smaller units solely to avoid payroll tax. This is due to the fact that regardless of the number of smaller units, they will all be grouped together for the purposes of payroll tax. Where as prior to 1975 employers could avoid payroll tax by employing this fragmentation method, grouping provisions have solved this problem and made the tax more efficient. 5 EQUITY The final criteria in analysing a tax is that of equity. Equity is divided into the components of horizontal equity and vertical equity. Horizontal equity requires individuals in the same economic situation to be treated equally, while vertical equity requires people in different circumstances to be treated differently, with those in more favourable situations bearing a greater share of the tax burden.(13) The major problem in terms of equity within the West Australian payroll tax system is that the tax is in no way determined by a person's ability to pay. Rather it is wholly calculated in reference to the amount of wages paid by an employer and thus bears no relation to an employer's economic situation. Horizontal equity is offended in that employers in the same economic situation are not necessarily treated equally as one may be paying more wages than the other and hence have a greater payroll tax liability. Vertical equity is also offended. A company with a large payroll may be paying payroll tax in the highest bracket. However their profits may be small; they may even be operating at a loss. A small company, on the other hand, with no payroll tax liability, could be making a larger profit. In addition to the above, the fact that payroll taxes are a deduction for income tax purposes suggests that companies with the least capacity to pay, that is those with small or nil profits, will incur a proportionally higher net cost as a result of payroll taxes than profitable companies.(14) This occurs because of the high rebate that the more profitable companies will receive compared to the lower rebate that companies with lower incomes will receive. Thus in real terms the companies with the smaller incomes will be paying more payroll tax than the more profitable ones with the same payroll tax liability. The fact that there is no payroll tax to be paid on money paid to contractors results in a further inequity. From the employer's point of view, there is a horizontal inequity as employer's will be subject to payroll tax on their employees while those who use contractors will not be subject to payroll tax. Further this may theoretically result in employees being paid a lower salary than contractors in an effort by employers to counteract the effects of the tax, adding to the horizontal inequity problems. As mentioned previously non-cash benefits are not included in the assessment of payroll tax unless they are mentioned in the contract and assigned a monetary value. This is horizontally inequitable in that employers effectively paying employees to an equal value may be liable to differing amounts of payroll tax depending on the ratio of non-cash benefits given. This also results in a vertical inequity as employers paying larger effective salaries may not necessarily be paying more payroll tax than employers paying smaller salaries as the former may be paying a greater ratio in non-cash benefits. Section 10 of the _Payroll Tax Assessment Act 1971_ provides that wages paid by persons such as "a religious, public benevolent, or charitable institution" are exempt from payroll tax. Such exemptions are horizontally inequitable in that these institutions are treated differently from other employers paying the same figure in wages. Although the payroll tax system is quite inequitable, amendment to the legislation(15) has increased the equity of the tax to some degree. The grouping provisions outlined above have made the tax more equitable in that employers are now treated the same for payroll tax purposes regardless of whether they consist of a number of small companies or one large company. 6 RECOMMENDATIONS The above analysis has highlighted a number of problems existing in the present West Australian system of payroll tax in terms of equity, efficiency and simplicity. The current West Australian government has suggested the abolition of payroll tax and its replacement with a broader based tax such as a Federal consumption tax. This is not feasible due to the fact that the consumption tax was a policy of the Liberal Government, whom do not presently have power at the Federal level. In any event we recommend this course not be followed as the economic effects of the latter would be very similar.(16) While a number of problems do exist, payroll tax raises a huge amount of revenue. Rather than recommend the payroll tax be abolished completely, we recommend improvements be made to the current system. Firstly it is recommended that there be some sort of harmonisation achieved between the states. By this it is envisaged that all States should change their policies toward the same direction. This would solve the problems for many of the larger national companies who would no longer have to determine their payroll tax liability using different calculations and legislation. Although they would still have to determine their liability separately between the states, the task would be made simpler. Unfortunately, this is not practical in reality as it is unlikely that the States would be able to achieve such uniformity. Such a measure could only be achieved if the payroll tax system once again became a Federal tax, an unlikely event as the revenue raised by payroll tax accounts for approximately 40% of most State's revenue. The idea behind using a sliding rate scale to determine payroll tax is that it is more equitable. This is based on the erroneous assumption that the more wages employers pay, the more profits they are making, and thus the more they can therefore afford. As has been outlined above, this is not necessarily the case and the tax is in fact highly inequitable. We therefore recommend that the rate scale presently used in assessing payroll tax be abolished and a flat rate method be implemented in it's place. In addition to dealing with equity problems, a flat rate system would also improve simplicity. Employers will no longer face the complex and difficult task of calculating the rate of payroll tax applicable to the amount of taxable wages they have paid. Following from this, the Taxation Department will not be required to expend as much time and money in ensuring the tax has been calculated correctly. It is recommended for simplicity reasons that a minimum threshold of $450,000 be retained. A flat rate of tax would make the task of calculating payroll tax for employers who are members of a group simpler as there would be no need to regularly combine payroll figures so as to determine the groups rate of tax. Instead, members of the group could individually assess the tax. A flat rate of payroll tax would also be advantageous in terms of efficiency as it removes the disincentives of employing labour so as to pay a lower percentage of payroll tax, or no tax at all. The _Payroll Tax Assessment Act 1971_ contains no definition for "employees" and instead the Common Law has had to be relied upon. This has excluded from the realm of employees contractors, consultants and direct sellers, causing problems in both equity and efficiency. To overcome these problems, we recommend the legislation be amended to add an expansive definition of "employees" which includes contractors. Finally, we recommend that to prevent the inequities and inefficiencies caused by the present treatment of fringe benefits, the legislation be amended so that all such benefits fall within the provisions of the payroll tax legislation. We also recommend that the method used to value these benefits be that used for the purposes of Commonwealth Fringe Benefits tax. Notes: 1 0-$450,000 - nil; $450,000-$1,500,000 - 0-3.95%; $1,500,000-$2,500,000 - 3.95%-$.95%; $2,500,000- $3,125,000 - 4.95%-6.00%; Over $3,125,000 - 6% 2 Economic Planning Advisory Council, _The Economic Effects of Payroll Tax_, October 1985 at 11. See also NSW Tax Taskforce Report at 203. 3 Ibid at p3. 4 _Payroll Tax Assessment Act 1971_; s8 5 _Payroll Tax Assessment Act 1971_ 6 Part IVA _Payroll Tax Assessment Act 1971_ 7 Corporations are related for payroll tax purposes if they are by reason of the _Corporations Act 1990_ deemed to be related to one another. This refers to holding and subsidiary companies or subsidiaries of a common holding company. 8 Section 16D of the _Payroll Tax Assessment Act 1971_ provides that where the same person or persons have a controlling interest in each of two businesses, the persons who carry on those businesses are a group where: (i) a director or majority of directors of a corporation can exercise a majority of voting power at directors meetings; (ii) a person has or persons have a controlling interest in a corporation where that person or those persons acting together can influence 50% or more of the voting power attached to the voting shares of that corporation; (iii) a person or persons have together a controlling interest, if that person owns, or those persons together own 50% or more of the capital of, or entitled to 50% or more of the profits of a partnership; or (iv) a person has a controlling interest in a business carried on under a trust if he is a beneficiary in respect of 50% or more of the value of the interest in the trust. 9 Asprey Committee, _Taxation Review Committee Preliminary Report_, June 1974, Australia at p17 10 Krever, R "Companies, Shareholders and Tax Reform", September (1985) _Taxation in Australia_ 163 at 165 11 Ibid at 4 12 Supra Footnote 2 at 6 13 Commonwealth of Australia, _Reform of the Australian Tax System (Draft White Paper)_, June 1985, Australia at 14 14 Supra Footnote 2 at 6 15 _Payroll Tax Assessment Act 1971_; Part IV 16 See New South Wales Tax Taskforce, _Tax Reform and New South Wales Economic Development_, Sydney 1988 at p203 and Supra Footnote 2 at 7