Payments to building contractors under scrutiny

Assistant Treasurer Bill Shorten recently released a consultation paper on the budget proposal to introduce a reporting regime for payments made to contractors in the building and construction industry.

In broad terms, the regime would require businesses in the building and construction industry to report annually to the Australian Taxation Office payments they have made to contractors in the industry. The reporting regime is proposed to start on July 1, 2012.

The introduction of this regime is intended to help ensure that all contractors comply with their taxation obligations. By helping to improve compliance, the Government believes the changes would also help create a level playing field in the building and construction industry.

There are more than one million independent contractors currently operating throughout Australia. They operate as self-employed businesses across a range of industries, with high concentrations in building and construction, financial and insurance services, agriculture and other professional services industries.

The Government says that while the ATO has made an effort over the years to educate and support contractors in respect of their taxation obligations, ATO data indicates that compliance with taxation obligations by contractors is poor and presents a systemic risk to revenue collection.

In support of this, the paper says the ATO has identified a high level of non-compliance by contractors in the building and construction industry. This includes issues in complying with GST requirements, record-keeping requirements, and the complex personal services income rules.

Other issues include businesses engaging contractors that may actually be employees (ie. “sham contracting”), incorrect reporting of ABNs, and involvement in the “cash economy”. The paper also indicates that increased ATO efforts to address such problems (eg. audits, education programs, etc) in the past have met with limited success.

Recent ATO research has shown that the building and construction industry was the least compliant of the six largest industries in the micro market (ie. businesses with annual turnover of less than $2 million). The other industries were financial and insurance services; professional, scientific and technical services; rental, hiring and real estate services; agriculture, forestry and fishing; and retail trade. ATO analysis also showed that the construction industry accounted for $1.58 billion (or 20.73%) of all debt owed to the ATO in the micro market.

The ATO’s current audit program showed that based on the 2009 data, approximately 10% of all tax invoices could not be matched to a payee on ATO systems due to non-quotation or invalid quotation of an ABN. Of the approximately 11,500 matched entities in the initial analysis, 34% were contractors in the building and construction industry.

The Government considers that the entrenched non-compliance by contractors in the building and construction industry may indicate that it is the contractors’ unwillingness to comply that contributes to the higher rates of non-compliance. This leads to the existence of the “cash economy”.

In an industry with high levels of non-compliance, compliant taxpayers are often at a competitive disadvantage, being undercut by competitors who are able to charge less for their goods or services because they pay less or no tax. Hence, the budget announcement in May this year to target contractors in the building and construction industry.

A related, but nevertheless separate issue the Government identified is that, in practice, many contractors appear to approach their work as if they were employees rather than contractors, either unaware of, or disregarding, their broader business tax obligations. As a result, some contractors can find themselves with a considerable tax debt, which often results in business failure.

The aim of the reporting regime is to improve compliance with taxation obligations of contractors in the industry by providing the ATO with sufficient information to allow data-matching for review and targeted audits.

Under the regime, businesses will report annually to the ATO any amounts paid to contractors in the industry, along with each contractor’s ABN. The regime will only require businesses to report information they are already required to collect and record under the existing taxation law. The information is also intended to allow the ATO to focus its resources in order to provide assistance and education to those identified as having a problem with compliance, based on a lack of knowledge or awareness.

The budget proposal is not intended to introduce any new requirements for contractors to report payments made to them. According to the Government, contractors will only be required to report on payments they make to sub-contractors in the building and construction industry, and otherwise comply with existing obligations in respect of reporting of taxable income.

The paper suggests the reporting regime could operate through the existing payment, ABN and identification verification system. The proposal utilises the “transaction reporting by purchasers” component of this system. Under this component, the legislation would operate to require a “purchaser” to report details to the ATO of “suppliers” who they have paid for a “supply”. The paper also suggests that the existing penalty provisions within the system would provide purchasers with the “incentive” to meet their reporting obligations.

An example would be where a plumber has been contracted to install several toilets in a housing estate. His contract includes payment for his labour and payment for the toilet parts and fittings. The plumber’s contract would constitute a “supply” under the proposed measures, as it is a contract in part for a supply of services.

Under the proposed regime, the “purchaser” would be the entity required to report. For example, a small bricklaying company that supplies and lays bricks for housing developments would be considered to be a purchaser as it is a business and its core activity is the supply and laying of bricks (which is a building and construction service).

However, where for example, a pie shop engages contractors to build an extension to its premises, it would not be a purchaser because, although it is a business, and is engaging a contractor from the building and construction industry to build the extension, the business’s core activity is selling pies.

The Assistant Treasurer said the outcomes of the consultation would help the drafting of regulations to introduce the reporting regime. The outcomes would also assist a further public consultation on options to introduce a similar reporting regime for payments to contractors in the commercial cleaning industry, to be conducted by the Government in 2011-12.

Obviously the regulations themselves will require some close attention. SMEs that may be affected should keep an eye on developments.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions .

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