Raw Deal for contactors

The Australian Financial Review

Wednesday 27 June 2001

Canberra possibly faces another BAS-style debacle,. warns Ken Phillips. 

When they complete their tax returns  in  the  next  few weeks, up to  1.4 million Australians are likely to discover that they may be denied tax deductions they received last year, not because they have done anything different but because the rules have changed. 

The Ralph review of tax estimated that  under  new  alienation  rules 75 per cent of unincorporated and 25 per cent of incorporated contractors  affected  by  the  legislation would be denied $3,000 a year in tax deductions. 

It also estimated that 75 per cent of incorporated contractors would be denied $6,000. 

If these figures can be believed, up to $5.5 billion in previously allowed deductions may be denied. Why is this occurring? Because Australian tax officials have successfully promoted the view to all political parties that the alienation measures clean up a huge and broad-based tax seam. 

But it's also probable that, like the initial implementation of the business activity statement, the Australian Taxation Office has got it wrong. And inaccurate perceptions by tax officials are likely to do political damage to the Government and future governments that fail to understand. 

According  to  the  Australian Bureau of Statistics, 20 per cent of working Australians are now self-employed, independent contractors. Of these, 590,000 are incorporated and 1,078,000 unincorporated. This is a huge increase from about 3 per cent 10 years ago. 

Can all these Australians be tax cheats? Or is the ATO, like King John's tax collectors, convinced it sees a Robin Hood behind every tree in Sherwood Forest? 

The old tax system was built on the administrative presumption that nearly every individual income earner was employed.  And  Australia's  tax administrators have historically displayed a near-obsessive fixation that contractors somehow are ripping off the system. This is reinforced by industrial  relations  attitudes  that illogically see evil in contracting. 

The outcome is that the tax system has a cultural problem. It's clashing with a rapidly shifting community culture in the work environment in which Australians are rejecting the managerial  authoritarianism  of employment. People want the freedom of controlling their own work. 

Tax officials are all "employed". Their life's view of work is experienced through the narrow prism of government employment bureaucracy. They understand the administration  of business  but  not  the dynamism of business. They understand the administrative process of big business but not the immense flurry  of  activity  that  is  small business. Their narrow view of the work world is the core problem that hit the Government in the BAS face. 

When the BAS was conceived, it had all the elements and intent of a simplified system. But in its application the ATO's desire for transaction cross-referencing consumed the simplicity. A one-page form masked the massive information gathering  and  collating  exercise needed to fill out each square. 

For big business, this was fine. But for small business, especially the shoebox brigade used to taking their paperwork to an accountant once a year, the task was overwhelming. Now this has been eased. 

But the problem is not over. After all, the tax-collection community still has not grasped the reality of the new work world. They still don't understand small business and contractors, and refuse to confront clear truths. 

The animosity to contractors had its seeds in the ATO's income tax-

collection  powers  being  tied  to common law employment. As people became contractors, the ATO could not collect tax at source. This problem has been fixed under PAYG to the benefit of all.

But the debate over contractors' entitlement to tax deductions continues. Tax officials say that contractors illegitimately split income

and claim unfair deductions. Is this view valid? 

Not according to the only authoritative  case  study  investigation  of

"The tax-collection

community still has not

grasped the reality of

the new work world. "'

contractors' tax claims and structures. In 1988, the ATO itself conducted an 18-month audit of 65,000 independent contractors profiled as likely tax avoiders. Only 714 were issued extra tax notices and with only small tax variations applied.

Shrimps were netted instead of tuna. The audit conclusion was that

contractors structure their affairs for legitimate business purposes, not for tax avoidance.

But this key audit report was buried in the Ralph review discussion on alienation. Is it that tax officials don't want the facts to interfere with their long-held bias? If so, any government of any political persuasion that takes an aggressive line against contractors

without honestly seeking the truth risks being bitten hard.

So while the ATO's own research says that the alienation problem is

comparatively minor, at the same time its application of the Government's legislative intent to close loopholes  looks  like  an  anti-contractor attack. 

Take the ATO's example on its website. A person building furniture

and selling it through a shop will be treated like a business and entitled to business tax deductions. But an IT consultant building    software programs for sale through an IT company will not be treated like a business and will be denied tax deductions.  The'  only  difference between the two is that the carpenter deals  in  tangibles  while  the  IT consultant deals in intellectual property.  The  problem  is  not the  IT consultant, but the ATO's inability to grasp a changing world of work. 

The Government may face another BAS-style debacle driven  by  the

frustration of up to 1.4 million voters. 

An authoritative analysis of the cultural shift away from employment

should be completed as the starting point to realistic policy progression.

As a player with a vested interest, the ATO is not impartial

 Ken Phillips is a specialist in independent contractor systems.

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