NSW Payroll Tax Audits

Introduction

A business’ liability for payroll tax is outlined in the Payroll Tax Act 1971 (NSW). As it is a state tax it is regulated and collected by the NSW Office of State Revenue (OSR) and not the Australian Tax Office (ATO).

Payroll tax, unlike income tax is imposed on an employer not an employee. The extent of an employer’s liability for payroll tax will depend on how much wages they pay to their employees.

As of 2006, only companies who pay over $600,000 in gross wages are obligated to pay payroll tax. The current payroll tax rate is 6%.

To prevent companies from avoiding payroll tax by subdividing their businesses into a number of subsidiary companies, detailed grouping provisions apply to ensure that corporate groups will be considered as one collective employer.

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Guide on Compliance

If a business pays wages above the monthly threshold of $50,000.00 it would be required to be registered for payroll tax with the OSR.

An employer must register within 7 days with the OSR after the first month their wages exceed $50,000.00. When registering they will be advised whether they need to pay the tax on a monthly or annual basis.

In addition to making monthly payments, businesses must also complete an annual payroll tax reconciliation. For the financial year ending 30 June 2007,a all annual payroll tax reconciliations have to be sent to the OSR by 21 July 2007.

Depending on which industry a company operates and how much tax they have paid in the past, the OSR will retain a discretion to audit a tax payer to ensure that they are accurately and truthfully declaring their paid wages and other associated wages. The OSR will also often audit a business if it uses a number of subcontractors, as the OSR can see this as a great opportunity to gain some extra revenue.

The OSR can audit a tax payer for all wages paid in the last 5 years and a business is therefore required to keep detailed employment records for all payments made to employees and contractors.

In general if a business is subject to an audit they will have to produce copies of their:

• Profit and loss statements
• Balance Sheets
• Tax Returns
• Group Certificates
• Any contractor invoices
• Anything else the auditor requests

Auditors retain a large amount of power to seize documents, enter premises and generally make life difficult for a taxpayer that does not cooperate with an audit.

The following sections deal with the payments an auditor will be looking for if they choose to audit your company:

• What payments are assessable for payroll tax?
• Which payments are exempt from payroll tax?
• Contractor Provisions

What payments are assessable for payroll tax?

Payroll tax is charged on all taxable wages. Section 6(1) sets out three categories of wages liable to tax:

• Wages paid or payable in NSW
• Wages paid pr payable outside NSW in respect of services performed or rendered wholly in NSW.
• Wages paid or payable outside Australia in respect of services performed or rendered mainly in NSW.

This provision is designed to cast the tax net as widely as possible within the overriding requirement that there must be a territorial nexus between the tax and the subject of that tax (see Woellner, Barkoczy, Murphy and Evans, Australian Taxation Law (16th ed, CGH Australia, Sydney, 2005).

Payroll tax is imposed on the employer by whom the taxable wages are paid or payable(s8). The term employer is defined very broadly in s3 to anyone who is liable to pay any wages, which, taking into account the broad definition of wages, could include a wide range of different people, including individuals, partnerships, trading trusts and companies.

The term wages is also defined in a very broad way to catch almost every form of payment. Section 3AA catches:

Such definitions also catch other amounts paid by an employer which might not ordinarily be regarded as wages/salaries such as:

• Allowances
• commissions and bonuses
• certain payments to independent contractors (this will be discussed below)
• fringe benefits
• gifts to a person in their capacity as an employee
• payments made by, or through employment agents
• prizes, staff holidays and staff discounts
• retirement or termination payments
• certain trust distributions to beneficiaries made in lieu of wages (see below)

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Which payments are exempt from payroll tax?

Wages paid by certain bodies are exempt from payroll tax by ss 10-10C of the Act. These include payments made by a relevant employer to:

• Public benevolent or religious institutions (see Ngurratiuta Pmara/Ntjurra Aboriginal Corp v Commissioner of Taxation (2001) ATC 4429 for discussions as to what bodies would be covered by this section).
• Public hospitals
• Municipal councils (e.g. council service fees/ annual rates)
• Charities
• Certain schools
• SES volunteers
• Apprentices

Particular formulas also apply to motor vehicle allowances and accommodation allowances. If an employer goes above a particular threshold such allowances will count for the purposes of payroll tax.

“Employees as such”

A key element in s 3AA definition of wages is that payment must be to an employee as such. In practice this phrase has been interpreted as applying to an ordinary employment relationship. Whether an employment relationship exists depends on the application of the common law test.

For the purposes of payroll tax relevant cases include:

Drake Personal Ltd & ors v Commissioner of State Revenue (Vic) (2000) ATC 4500

JA & BM Bowden & Sons Pty Ltd v Chief Commissioner of State Revenue (2001) ATC 4220

Hollis v Vabu Pty Ltd (2001) ATC 4508

Forstaff Pty Ltd & Ors v Chief Commissioner of State Revenue (NSW) (2004) ATC 4758

In each instance the efforts of employers to avoid tax liability by employing casuals or by organising for clients to employ their workers on temporary basis were all overturned on the basis that the employer controlled the majority of the employee’s work.

As will be shown below the importance of determining whether a worker is an employee or employer has somewhat diminished in recent years with the passage of contractor provisions which will capture most workers who would have been subject to such disputes.

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Contractor Provisions

Section 3A of the Act was inserted in 1986 to collect payroll tax from businesses that used contractors to provide employee like services.  This was a response to a general trend for increased flexibility and the corporatisation of much of the professional workforce which has resulted in many employee style functions being provided by another business.

In broad terms, s 3A provides that, where payments are made pursuant to such a contract, the person to whom services are supplied under the contract is deemed to be an employer, the person providing the services is deemed to be an employee, and the payments made under the contract are deemed to be wages for the purposes of the Act. Such a contract is known in the Act as a relevant contract.

Payroll tax is payable on contracts when:

• The contractor or subcontractor works exclusively or primarily for one person or business; and
• The object of the contract is to obtain the services of the contractor or subcontractor.

As can be seen both of these limbs are relatively easy to satisfy and the deeming provisions will apply whether the work is done by the contractor in house or goods are given out to a contractor who performs the work and re-supplies the goods (this would therefore cover outworkers). 

Special provisions exist to deem payments made for contract labor to be wages under the Act.

What this means in practice is that almost every payment made to subcontractors will be assessable for payroll tax unless it can be proven to fall within one of the exceptions outlined below.

• A contract where payment is made at a rate exceeding $800,000.00 (s 3A(1)(e)(ii))

This exception recognises that if you are paying a contractor more than $800,000.00 per year, the contractor must either be engaging other employees or providing services to the public generally.

• Where the contractor engages services and labor to perform the contract (s 3A(1)(f))

Contracts will not attract payroll tax where:

• the contractor is a corporation (or partnership including corporations) which engages two or more people to do the actual work under the contract;
• the contractor is a partnership of individual people and the work is performed by one or more partners, PLUS one or more people engaged by the partnership for this purpose.

Please note that where the work is done by at least two partners who are natural persons, it will be accepted that the contract is not a relevant contract; and

• the contractor who provides the services is a natural person and that person, together with at least one other person engaged by him or her, does the actual work required.

In all cases, the person engaged must perform the work that is the object of the contract. It would not be sufficient for a spouse performing purely clerical work, to satisfy the exemption provisions as he or she would not be engaged in the work to which the contract relates.

Businesses should be aware this exemption will not apply where the Chief Commissioner of State Revenue determines that any part of the arrangement was entered into with the intention of avoiding payment of tax.

• A contract in which the supply of labor is ancillary to the supply or use of goods owned by a contractor (s 3A(1)(d))

This exception recognises that a contractor may provide labor when supplying goods or the use of goods is the fundamental object of the contract.

• When the contract is for services that are not normally required by the business and are supplied by a person who ordinarily provides such services to the public (s 3A(1)(e)(i)).

This exemption recognises many contracts are for services you do not normally require. It applies when such work is done by someone who provides such services to other businesses and to the public generally. Success under this provision is therefore reliant on establishing that the contractor is providing services to you as part of their own business. It may also be useful to understand what are and are not your core business functions.

Similarly if a business hires painters and decorators to refurbish its premises once every five years, payments to those contractors are not liable to payroll tax. This is exempt because the business does not require those services as part of its business and the workers provide their services to the public generally.

• When under one or more contracts a contractor performs services for 90 days or less in any financial year (s 3A(1)(e)(iii))

This exemption applies to contractors businesses generally engaged by a business for a short term in one financial year.

However because this section can be prone to abuse the following safeguards have been introduced to minimise to what extent business’ can rely on this exception:

• For the purpose of this subsection, any days an contractor works for a business will count as a full day notwithstanding how many hours the contractor works for that business.  For example a contractor who provides service for 2 hours a day over 90 days has worked 90 days for the purpose of the 90 day rule.
• The work does not have to be over consecutive days to be included in the 90 days.
• If a contractor does a number of different, yet related jobs for a principal, those contracts will be considered as one contract for the purpose of the 90 days rule.

If a business can satisfy this section any payments made to applicable contractors will not be subject to payroll tax.

• Services normally required for less than 180 days in the financial year (s 3A(1)(e)(ii))

This exemption allows further concessions when a contractor performs services for you for more than 90 days but less than 180 days.

It recognises that businesses need certain services to help them function effectively, but need them so rarely, that permanent employees are not normally engaged.

These exemptions apply to subcontractors and not casual employees, who have always been subject to payroll tax.

It is important to note that this exemption rests on the number of days in a financial year that services of a particular type are required. The 180 day rule will not apply if the business uses services of that type for more than 180 days in a financial year.

• A contractor who does not qualify under the above headings but who provides services to the public generally

This exemption allows for cases not intended to be caught by the legislation. To qualify for an exemption, each case must be referred to the Chief Commissioner of State Revenue who will decide whether or not to grant an exemption.

In making a determination, the Chief Commissioner of State Revenue will review the nature of the contractor’s business and will consider various issues including the following:

• the nature of the task and degree of skill involved
• who provides the tools and equipment
• the use of a business name by the contractor
• the extent and nature of advertising undertaken by the contractor
• the extent and nature of plant and equipment provided by the contractor in execution of the services
• the potential for entrepreneurial risk; and
• the nature of the contractor’s business and type of services provided.

This list is not intended to be exhaustive and no one factor will be determinative. The provision basically gives the OSR a broad discretion to exclude various payments. However, in considering the detailed exception outlined above, presumably this exemption will only be granted under this provision in rare occasions.

• So what happens if the payments a business has made to a contractor is assessable for payroll tax?

A business is only liable for payroll tax on the labour content of a contract. When a contract does not distinguish between labour and other costs, the OSR will accept that the percentages as showing in the following table represent the labour content:

The operation of this section can be seen in the following example

• Are trust distributions assessable for payroll tax?

Trust distributions will be assessable for payroll tax if they are made to a beneficiary in lieu of wages for work they have completed for a trust (s 3AC(1)).

This can cause a problem for businesses as a beneficiary of a business trust may also be using distributions to take out profits from their business.

Hence in order to determine whether a trust distribution is in lieu of wages, the OSR will primarily look at the size of the payments. If the payments are below a certain amount (which depending on the industry will usually be between approximately $45,000-$50,000) those payments will be subject to payroll tax.

• How does a taxpayer appeal against an adverse finding from an auditor?

A dissatisfied taxpayer has 60 days to object to an assessment or finding of the Chief Commissioner of State Revenue from the date they receive notice of their assessment.

A further review will take place and the OSR will deliver their findings in writing and must deal with any issue raised by the taxpayer’s objection.

If a taxpayer is still dissatisfied they retain the right to appeal to the NSW Administrative Appeal Tribunal and from there to the Supreme Court of New South Wales.

• What happens if a company does not pay its payroll tax?

A business that does not pay its payroll as it falls due may be subject to severe penalties. 

For one they may be subject to statutory interests for unpaid payroll tax. The following table outlines applicable interest rates:

Interest will be charged on every month that the payments remain outstanding.

Taxpayers who are found to have intentionally tried to avoid payroll tax may be subject to pecuniary penalties above their liability for payroll tax. The size of this penalty will depend on the culpability of a taxpayer. The basic penalty for failing to take reasonable care is 25%. This can be reduced to zero or increased to 90% depending on the circumstances. A voluntary disclosure always results in an 80% reduction on any penalty tax.

Penalties may also be imposed personally on company directors and officers if they fail to keep proper employment records and give false and misleading information to the OSR. A company director may also be personally liable when a company is liquidated and it has outstanding payroll payments due and payable which the company cannot afford.

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