Tax Commissioner clamps down on phoenix activities and ‘consultants’

Directors to be personally liable for unpaid superannuation guarantee contributions

Chasing business debts for a fairer system sees the Australian Tax Commissioner Michael D’Ascenzo setting his sights on superannuation. Now the directors’ penalty regime will see all directors made personally liable for any unpaid superannuation guarantee contributions.

While the Tax Laws Amendment (2011 Measures No. 7) Bill 2011 is designed to target phoenix schemes, the provisions could have serious implications for companies that engage with independent contractors if the Commissioner subsequently determines that contractors are in fact deemed employees for superannuation law purposes.

The proposed legislation extends the current director penalty regime for unpaid PAYG and aims to prevent companies engaging in phoenix activities — liquidating a company with significant debts and transferring the assets of the company to a new corporate entity, generally at significantly less than market value.

The new corporate entity then rises from the ashes to conduct the previous business with the same or similar directors and shareholders.

Importantly, directors will be liable for more than the mandatory 9 per cent superannuation guarantee contribution. They will instead be liable for the superannuation guarantee charge (SGC), which is calculated as follows:

  • 9 per cent of each employee’s total salary or wages, instead of just their ordinary time earnings (shortfall amount);
  • Interest on the shortfall amount from the beginning of the quarter in which the contribution was required to be made (ie 1 January) until the later of the lodgement of a superannuation guarantee statement outlining the shortfall amount or the 28th day of the second month after the end of the relevant quarter (ie 28 May for the quarter ending 28 March);
  • An administration fee for each individual employee currently set at $20 per quarter.

The SGC is not deductible and the Commissioner of Taxation has no discretion to remit all or part of the SGC. Employers cannot contract out of their superannuation guarantee obligations.

The draft legislation gives the Commissioner power to immediately commence recovery without notice of any outstanding superannuation guarantee contributions from directors personally. The amount will be recovered as a director penalty where superannuation guarantee contributions are unpaid and unreported for three months.

The Commissioner will also have the right to issue a notice of unpaid liabilities and commence proceedings to recover that amount after 21 days.

The benefit of the 21-day notice period is that it gives directors the opportunity to extinguish the director penalty by paying the liability, causing the company to pay the liability, appointing an administrator, or commencing the winding up of the company.

If the outstanding superannuation guarantee contributions have not been paid within three months and the director places the company into liquidation or voluntary administration, the director will remain personally liable.

The usual process is for the Commissioner to issue assessments to the company and for the company to either pay the superannuation guarantee charge or object to the assessment.

Making directors personally liable for the superannuation guarantee charge and allowing the Commissioner to commence proceedings immediately is likely to impact on the ability of a company to object to the imposition of the superannuation guarantee charge because of the financial pressure being placed on directors.

If the legislation is enacted in its current form, it will apply not only to superannuation guarantee obligations that arise from 1 July 2011, but will also apply to unpaid superannuation guarantee contributions as at 1 July 2011.

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As the Commissioner’s practice is to recover unpaid superannuation guarantee amounts (plus an administration fee and interest) for the current year and previous four years, directors could potentially be liable for up to five years of the superannuation guarantee charge.

This is a significant retrospective penalty to impose on directors.

There are few options for directors being held personally liable. First, directors may get a reprieve if they can establish that because of illness or another satisfactory reason they were not involved in the management of the company. Second, they took all reasonable steps to ensure that the directors complied with their obligations, or finally, that no such steps were available to them.

Insufficient company funds will not be adequate to establish there were ‘no reasonable steps’ available. A director must raise a defence to personal liability within 60 days of receiving a notice from the Commissioner.

A new director will be liable for any unpaid superannuation guarantee contributions 14 days after they start as a director.

Therefore, it will be important for all new directors to conduct a thorough due diligence of the company before they are appointed as a director to ensure they are aware of any potential personal liability for unpaid SGC.

The proposed legislation could have serious ramifications for companies that engage independent contractors.

While independent contractors are generally excluded from the operation of the Superannuation Guarantee (Administration) Act 1992, they may be caught by the deeming provisions, which expand the common law meaning of employee to include individuals who work under a contract that is wholly or principally for their labour.

‘Labour’, in this context, is commonly understood to include intellectual and artistic effort as well as physical labour.

In these circumstances, directors will be personally liable for the SCG despite the genuine belief that the workers engaged were contractors and the higher fee generally paid to contractors to compensate them for not receiving superannuation contributions.

Key to this issue is the difficulty in weighing the relevant factors to determine whether a worker is engaged as a contractor or deemed employee for superannuation law purposes.

No single factor will be determinative, making it necessary to consider the totality of the relationship between the principal and contractor. The following should be considered when defining the relationship between the parties:

  • Method of remuneration, such as time based or fee for service;
  • The ability to delegate and work for other principals including competitors;
  • Legal control of the method of carrying out the required task;
  • Who bears the commercial risk and has the potential to profit from the transaction; and
  • Who provides the materials, tools and/ or equipment required to complete the task.

Further, it is not sufficient that a contractor has an ABN to avoid the application of the deemed employee provisions as the contractor may still be considered an employee for the purposes of the superannuation law.

This inevitably provides scope for opinions to vary with potentially serious consequences for directors.

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Deemed employees

To assist in determining whether contractors are deemed employees for the purposes of the superannuation law, the Commissioner has stated in SGR 2005/1 that a contractor will fall within the extended definition where the contractor is remunerated wholly or principally for their personal labour and skills, must perform the contractual work personally (there is no right of delegation), and is not paid to achieve a result.

The crucial factor in determining whether the deemed employee provisions apply is whether the contract is a ‘contract of service’ (the performance of labour) or a ‘contract for services’ (for the production of a result).

In discussing this distinction in Hollis v Vabu[1], a majority of the High Court quoted the following statement by Windeyer J in Marshall v. Whittaker's Building Supply[2]: ‘... the distinction between a contract for service and a contract of service is ‘rooted fundamentally in the difference between a person who serves his employer in his, the employer’s business, and a person who carries on a trade or business of his own.’

The level of control exercised by the principal over the contractor is also key factor in determining the true nature of the relationship between the parties, which was reiterated by the Commissioner in SGR 2005/1.

In determining the degree of control exercised, the Commissioner and the Courts look to the extent to which the employer has the right to control the manner in which the thing is to be done.

Control includes the power to specify the thing to be done, the way in which it is done, the means to achieve it and the time and place where it will be done. The Commissioner does not require strict day-to-day control but the legal right of control.

It is necessary to assess all the circumstances of the relationship between the parties to determine whether the contract is a genuine results-based contract.

The payment structure will not be determinative as the fee under a results-based contract may be calculated on an estimate of the time and labour cost that is necessary to complete the task.

Incorporated contractors

The general view is that if the contractor is a company or trust there is no employment relationship, either at common law or under the extended definition of an employee. However, the individual engaged by the interposed company or trust may be an employee of the company or trust, depending on the terms of the engagement.

This view is supported by SGR 2005/1 but has been called into question by a recent case run by Hall & Wilcox, Roy Morgan Research Pty Ltd v Commissioner of Taxation[3] where the Full Court of the Federal Court held that the Administrative Appeals Tribunal was correct in concluding that the fact Roy Morgan Research Pty Ltd paid money to ‘someone other than the individual interviewer for that interviewer’s assignments does not change the fact that Roy Morgan engaged the individual.’

The Court noted that the Tribunal considered ‘the ability of an interviewer to incorporate as a factor entitled to little weight because the entity selected to do the work (conduct interviews) was the individual interviewer, and the company featured only as the recipient of the fees that would otherwise have been paid to the interviewer. No error has been shown in the Tribunal’s treatment of this factor.’

In light of the Roy Morgan Research case, this issue is now the subject of some uncertainty. Depending on the specific facts, incorporating may not be sufficient to take a contractor outside the scope of the superannuation law if they would otherwise be caught.

It is important that directors consider the risk of being personally liable where the company does not make superannuation guarantee contributions on behalf of contractors. The degree of risk will generally depend on the evidence available to support the view that contractors engaged by the company are carrying on their own independent business.

The Commissioner’s focus on superannuation, and by default phoenix activities and contractors, should give company directors a reason to consider the degree of risk to which they are exposed.

The starting point for directors is to review the superannuation arrangements of their business regarding employees and contractors, and consider whether any changes to their current practices need to be made. In particular, directors should determine whether cross indemnities from other directors are required.

Mark Payne is a partner and Rebecca James is a senior associate at Hall & Wilcox lawyers.