Indirect tax developments in Australia - August 2017

What you need to know

GSTD 2017/1: When is a supply of a credit card facility GST-free under paragraph (a) of Item 4 in subsection 38-190(1) of the GST Act?

The ATO has released GSTD 2017/1 - When is a supply of a credit card facility GST-free under paragraph (a) of Item 4 in subsection 38-190(1) of the GST Act?, outlining the Commissioner's view on when the supply of a credit card facility will be GST-free as a supply made in relation to rights for use outside the indirect tax zone.

Item 4 paragraph (a) of section 38-190(1) of the GST Act provides that a supply is GST-free if it is a supply that is made in relation to rights and the rights are for use outside the indirect tax zone (broadly, Australia). The supply of a credit card facility is a supply made in relation to rights. That supply will be GST-free to the extent that those rights are for use outside Australia.

According to GSTD 2017/1, the fact that the credit card facility allows overseas use is not sufficient to render it GST-free without further evidence that it will actually be used outside Australia. Further, the location of the merchant accepting the credit card facility as payment is not considered relevant. What is considered by the ATO to be relevant is whether or not the facility is to be used by cardholders while they are physically outside Australia, whether they are using the card in standard "card-present" transactions (eg over the counter purchases) or "card-not-present" transactions (eg online or over the phone). As the actual use of the facility will not be known when the credit card is issued, the issuer must determine, on a fair and reasonable basis, the extent the card will be used by cardholders while physically outside Australia based on historic usage of that type of card or a similar card.

Deputy Commissioner of Taxation v Arora [2017] NSWSC 1016

Summary

The Supreme Court of NSW has imposed a $1.9m penalty on a director of two companies for unpaid PAYG withholding tax and superannuation guarantee charges (SGC).

The fact that the companies may have been in a position to satisfy the liabilities in the future was not a defence to the director's liability. The director's pleaded defences of either having taken all reasonable steps to cause the companies to comply, or being unable to manage the companies by reason of illness, were unsuccessful because they related to a period of time after the liabilities had accrued. The director's obligation to cause a company to comply with its PAYG and SGC obligations is ongoing. A director pleading either of these defences must show that the defence is satisfied throughout the entirety of the period in which they are being held responsible.

Background

Mr Ajay Arora was the director of Arora Markets Pty Ltd (Arora) and Arora International Markets Pty Ltd (Arora International) over a period of time, during which the companies failed to pay to the ATO over $1.1m in amounts withheld from salary and wages under the PAYG withholding scheme, as well as over $650,000 in SGC. Broadly, SGC accrues where an employer fails to make sufficient superannuation contributions in respect of salary and wages paid to its employees (the minimum contribution rate is currently 9.5%).

Section 269-15 of Schedule 1 of the Taxation Administration Act 1953 (Cth) (TAA) imposes a personal obligation upon the directors of a company to cause the company to comply with certain obligations, including the obligations to pay to the ATO SGC and all amounts withheld under the PAYG withholding regime. The director's obligation applies up until either the company complies with its obligation, an administrator is appointed, or the company begins to be wound up. Where this obligation is not complied with, section 269-20 of Schedule 1 of the TAA imposes a penalty upon a director equal to the unpaid amount of the company's liability. However, section 269-25 prevents the Commissioner from commencing proceedings to recover a penalty from a director until 21 days after issuing a Director Penalty Notice (DPN).

Section 269-35 of Schedule 1 of the TAA provides a number of defences for directors, including relevantly: where a director has taken all reasonable steps to cause the company to comply with its obligation and where because of illness or some other good reason, a director is unable to, and it would be unreasonable to expect the director to, take part in the management of the company.

The ATO issued six DPNs in respect of the amounts and upon their expiry sought to recover penalties personally from Mr Arora. Mr Arora pleaded two defences.

1. Some of the underlying PAYG and SGC liabilities would be met in the future because:

• Arora and Arora International were in liquidation and there was a possibility that the liquidators would have sufficient funds to satisfy the liabilities; and/or
• the liquidators had sold some assets to buyers who had assumed responsibility for accrued superannuation entitlements.

2. Mr Arora is entitled is entitled to a defence under section 269-35 of Schedule 1 of the TAA either because:

• by attempting to arrange a loan which was to be used to satisfy the liabilities, he had taken all reasonable steps to ensure that the company met its obligations; or
• by reason of illness, he was unable to, and it would have been unreasonable to expect him to, take part in the management of the companies.

Decision

The first defence failed because section 269-15 imposes a liability upon a director from the day that the company's obligation is due to the ATO. If the company's obligation is not complied with, section 269-20 imposes a personal liability upon the director until the obligation is complied with. It is not relevant whether the obligations may be satisfied in the future by the company.

The second defence failed because it related to a period of time after the two companies had already failed to comply with their obligations. The director's obligation applies throughout the entire period of the company's obligation. One attempt to arrange a loan after the company had spent two years accruing the debts did not rise to the standard of taking "all reasonable steps to ensure that the company met its obligations".

Similarly, Mr Arora's evidence in relation to his illness was that the proceedings with the ATO had put strain on his relationship with his wife, ultimately leading to the breakdown of his marriage, hypertension and emotional turmoil, rendering him unable to manage the companies. As his illness was claimed to be caused by the ATO audit, it naturally post-dated the period during which the company accrued the obligations by failing to make PAYG and SGC payments. The Court also questioned whether the claim that he was unable to manage the companies was inconsistent with the claim that he took reasonable steps to ensure the companies met their obligations.

Deputy Commissioner of Taxation v Stuart Grant Smith [2017] NSWDC 102 (12 May 2017)

Summary

The District Court of NSW has held a director personally liable to pay a company's unpaid PAYG withholding liabilities. Despite taking substantial steps to cause the company to enter into a payment arrangement with the ATO after becoming aware of the company's non-compliance, the director failed to establish the defence of having taken "all reasonable steps" to cause the company to comply with its obligation. He was required to take all reasonable steps for the whole period between the due dates of the PAYG instalments and expiry of the relevant DPN, and his actions prior to being made aware of the unpaid liabilities – relying upon statements from the company's other director and Chief Financial Officer that the company's liabilities were "under control" – did not meet this standard.

Background

Cancer Care Institute of Australia Pty Ltd (CCIA) and CCIA Employees Pty Ltd (CCIA Employees) were two companies incorporated as part of the Medica Group, which operated a hospital called the Medica Centre in Hurstville, New South Wales. CCIA purchased medical equipment, and CCIA Employees retained workers who were intended to operate the equipment owned by CCIA. CCIA Employees had two directors: Mr Smith, who was responsible for managing the operations of the Medica Centre and diagnostic imaging, and Mr McGrath, who was responsible for managing the operations of CCIA and CCIA Employees.

For various reasons, CCIA entered into Voluntary Administration on 21 August 2012 followed by liquidation on 1 March 2013. Despite this, the CCIA Employees workers' wages continued to be funded from financial facilities or from other companies in the Medica Group. This process was managed by Mr Pu, Chief Financial Officer of the Medica Group, and it was accepted at all relevant times the company was able to meet its PAYG withholding obligations (ie was not insolvent).

Just prior to April 2013, Mr Pu informed Mr Smith that CCIA Employees was behind in paying to the ATO amounts that it had withheld under its PAYG withholding obligations, and had been so since sometime commencing in 2012. Mr Pu and Mr McGrath assured Mr Smith that these liabilities were "under control" and Mr Pu informed Mr Smith that he had been negotiating a payment arrangement with the ATO to satisfy the liability (the Arrangement). Mr Smith directed Mr Pu to continue to negotiate the Arrangement, which led to CCIA Employees paying 50% of the liability upfront while negotiations continued regarding payment of the remainder. On 22 April 2013, the ATO issued a DPN to Mr Smith.

While negotiations for the Arrangement continued, Mr Smith repeatedly requested that Mr McGrath attend a director's meeting to discuss the future of CCIA Employees, which Mr McGrath refused to do. Eventually, Mr Smith informed Mr McGrath that if a director's meeting could not be arranged, he would resign as director. Mr McGrath did not attend the proposed meeting and Mr Smith resigned as director on 31 August 2013.

Shortly before resigning, Mr Smith arranged for $130,000 to be made available to Mr Pu, expecting this to be sufficient to meet the obligations of CCIA Employees under the terms of the yet to be finalised Arrangement. Ultimately, CCIA Employees and the ATO agreed on terms and entered into the Arrangement. However, CCIA Employees did not make any of the payments under the Arrangement. On 20 January 2014, the ATO issued a second DPN to Mr Smith.

As noted in the summary of Deputy Commissioner of Taxation v Arora above, section 269-15 of schedule 1 of the TAA imposes a personal obligation upon a director to cause the company to comply with its obligation to remit withheld PAYG amounts. Where the company fails to do so, section 269-20 imposes a penalty on the director equal to the unpaid amount, subject to certain defences in section 269-35, including taking all reasonable steps to cause the company to comply with its obligation. Additionally, section 269-15(3) prevents the Commissioner from taking any steps to enforce an obligation or recover a penalty from a director if a payment arrangement is in force.

By failing to make the instalment payments under the Arrangement, CCIA Employees failed to comply with its obligation to pay amounts withheld under the PAYG withholding regime. Accordingly, Mr Smith failed to cause CCIA Employees to comply with this obligation. As 21 days had expired from the date of the first DPN (as required by section 269-15(3)), the Commissioner sought to recover the unpaid amounts personally from Mr Smith.

Mr Smith's defence included four main arguments:

1. the Commissioner failed to bring the unpaid PAYG withholding liabilities to his attention prior to issuing the DPN;
2. at all times while he was a director, CCIA Employees had a binding payment arrangement with the ATO;
3. he had taken all reasonable steps to ensure that the company met its obligations; and
4. he was only liable to pay one half of the total amount owed by the company, the other half being owed by Mr McGrath.

Decision

First, the ATO is not required to inform a director that the company has outstanding tax liabilities before issuing a DPN. While in some circumstances, a failure by the ATO to do so or to issue a DPN promptly may justify remission of pre-judgment interest, that was not the case here where Mr Smith's duty as a director to ensure that the liability was met was not "distant or quiescent" because companies in the Medica Group controlled by him were funding the wages that gave rise to the liability.

Secondly, the Arrangement was entered into on 4 September 2013, while CCIA Employees was in breach of its withholding obligations since sometime in 2012. Therefore, CCIA Employees was not under a binding payment arrangement with the ATO in respect of the obligations at all times while Mr Smith was director.
Thirdly, to succeed in the defence of having taken all reasonable steps to ensure that CCIA Employees met its obligations, Mr Smith must have taken all reasonable steps for the whole of the period between the due dates and expiry of the first DPN on 17 May 2013. The Court accepted that after being informed of the company's liability in April 2013, the steps that he took to achieve compliance by causing CCIA Employees to enter into the Arrangement were "substantial and perhaps all reasonable steps". However, prior to April 2013, his reliance upon statements from Mr McGrath and Mr Pu that all obligations had been complied with did not rise to the standard of taking "all reasonable steps". It was incumbent on Mr Smith to take steps to ascertain what the company's obligations were and to ensure that a system was in place to produce compliance.

Finally, the Court held that the clear wording of section 269-20 imposes a liability upon each director to pay a penalty equal to the entirety of the unpaid amount of the company's liability under its obligation. Therefore, that the ATO was entitled to pursue Mr Smith for the entirety of the liability and was not required to pursue Mr McGrath.

Chief Commissioner of State Revenue v Smeaton Grange Holdings Pty Ltd [2017] NSWCA 184

Summary

The Supreme Court of NSW Court of Appeal has held that a retrospective disclaimer of interest under a discretionary trust purporting to be retrospective was not effective to prevent the operation of grouping provisions in the Payroll Tax Act 2007 (NSW) (Payroll Tax Act) and Taxation Administration Act 1996 (NSW) (TAA). The case was a successful appeal against the decision in Smeaton Grange Holdings Pty Ltd & Ors v Chief Commissioner of State Revenue (NSW) [2016] NSWSC 1594, covered in our September-November 2016 Human Resources Tax Bulletin.

The Court held that a focus on the effect of the retrospective disclaimer under general law principles failed to consider the importance of the statutory regime. Under the statutory regime, a liability to pay tax was imposed on the group members at the time of default, and a subsequent disclaimer could not expunge this liability.

Background

Tri-City Trucks (NSW) Pty Ltd (Tri-City Trucks) was a company in liquidation that was liable for outstanding payroll tax, interest and penalty tax. The Chief Commissioner issued assessments in respect of the outstanding liabilities to the first two respondents, Smeaton Grange Holdings Pty Ltd (Smeaton) and Tri-City Smash Repairs Pty Ltd (Tri-City Smash Repairs), on the basis that they were members of a group of companies of which Tri-City Trucks was a member. The third respondent, Ifould Holdings Pty Ltd (Ifould) was joined as a plaintiff to the initial proceedings as it also sought a review of a decision of the Chief Commissioner to include it in a group comprising Smeaton and Tri-City Trucks.

The Chief Commissioner contended that the three respondents were members of a group with Tri-City Trucks by operation of the grouping provisions in sections 72 and 74 of the Payroll Tax Act (and equivalent provisions of the TAA). The grouping provisions operated by virtue of a combination of Mr Michael Gerace's directorship and direct and indirect interests in the three companies. However, the grouping relied upon Mr Gerace's beneficial interests under two discretionary trusts: the Smeaton Trust and the Gerace Family Trust.

Prior to the assessments being issued, Mr Gerace executed various deeds poll which purported to retrospectively disclaim his interest under the Smeaton Trust and the Gerace Family Trust. At trial, the Supreme Court held that these disclaimers were capable of operating retrospectively, with the consequence that the taxpayers were not members of a group with Tri-City Trucks and were not liable for its outstanding tax debts. Key to the trial judge's decision was a reliance upon the general law principle that once a person disclaims a gift, the disclaimer operates from the time the gift was made. The trial judge held that as a disclaimer of a gift could operate retrospectively, and therefore so could a disclaimer of interest under a discretionary trust.

The Chief Commissioner appealed the decision, arguing that the primary judge erred in reasoning by analogy from the law governing the disclaimer of gifts. The Chief Commissioner argued that while an object under a discretionary trust can disclaim the benefit of a particular exercise by the trustee of a power in favour of the object – it is this exercise of power that is akin to a gift – the principles applying to disclaimer of gifts do not apply to the creation of a discretionary trust with nominated objects.

Decision

The Court held that both parties' focus on general law principles failed to take into account the importance of the legislative scheme. While taxation legislation is to be construed having regard to general legal principles, the key task at hand was the interpretation of the terms of the Payroll Tax Act and the TAA.

The Court found that various provisions of the legislation recognised that a group could come into existence, cease to exist, and change in composition from time to time, including during a financial year. Therefore, the grouping provisions could apply at various times during a year.

The relevant provisions of the Payroll Tax Act required Tri-City Trucks to pay payroll tax within 7 days after the end of each month (except for June, which was payable within 21 days after the end of the month). When Tri-City Trucks failed to make these payments, section 81 of the Payroll Tax Act applied to make "every member of the group [of which Tri-City Trucks is a member] liable jointly and severally to pay that amount to the Chief Commissioner".

At the time of Tri-City Trucks' default, the grouping provisions imposed a liability upon the group members to pay the unpaid amount. At this point in time, the respondents were members of a group with Tri-City Trucks. The subsequent disclaimer may have retrospectively affected the rights and obligations of Mr Gerace as between himself and the trustees (and possibly the rights of other discretionary objects), but they did not retrospectively expunge the liabilities of the group members under the Payroll Tax Act.

Telecommunications Industry Ombudsman Ltd v Commissioner of State Revenue [2017] VSC 286

The Supreme Court of Victoria has held that all wages paid by the Telecommunications Industry Ombudsman (TIO) were exempt wages under section 48 of the Payroll Tax Act 2007 (Vic). Relevantly, section 48 provides that wages are exempt wages if the Commissioner is satisfied that the wages are paid or payable: 

• by a non-profit organisation having as its whole or dominant purpose a charitable, benevolent, philanthropic or patriotic purpose (section 48(1)(a)(iii)); and
• to a person engaged exclusively in work of a religious, charitable, benevolent, philanthropic or patriotic nature for the institution or non-profit organisation (section 48(1)(b)).

The TIO's stated purpose is "to provide a fair, independent, and accessible dispute resolution service for the telecommunications industry". Its members are the telephone and internet service providers, and it operates a free-of-charge dispute resolution service under a statutory scheme which provides it with authority to make decisions that are binding on service providers up to the value of $50,000 and recommendations up to the value of $100,000. Other functions include conducting research and investigations into systemic issues, releasing publications and making policy submissions about issues in the industry. However, its core function is dispute resolution.

The Court held that "charitable purpose" in section 48 was to be understood as a reference to the common law, being in this case, the four heads of charity and the spirit and intendment of the preamble of the Statute of Charitable Uses Act 1601. The Court rejected the Commissioner's contention that the main purpose of the TIO was regulatory rather than charitable, and held that its main purpose was both beneficial to the community and within the equity of the preamble. In doing so, the Court reiterated that the law of charity develops over time, and considered the importance of the telecommunication industry both to businesses and individuals as well as the inevitable power imbalance that exists between large telecommunications service providers and their customers. Finally, neither the quasi-statutory nature of the TIO nor the fact that the TIO pursued a government objective operated as a barrier to its purpose being charitable.

With respect to the second limb of section 48(1), the Court held that because all of the activities of the TIO were related to its charitable purpose, to the extent that staff were involved in activities that were not intrinsically charitable – such as administrative support – these activities were still charitable because they were carried out in furtherance of a charitable purpose.