From the 2019–20 income year, a business taxpayer cannot claim a tax deduction for a payment that it makes to a worker — whether an employee or a contractor — unless it has complied with all Pay As You Go (PAYG) withholding obligations that apply to that payment. These payments are ordinarily deductible under the general deduction provision (s. 8-1 of the ITAA 1997).
New s. 26-105 of the ITAA 1997 — which denies a deduction for ‘non-compliant payments’ — was introduced by Schedule 1 of the Treasury Laws Amendment (Black Economy Taskforce Measures No. 2) Act 2018 (the Act), which received Royal Assent on 29 November 2018 as Act No. 141 of 2018. This legislative change implements recommendation 7.5 of the Black Economy Taskforce Final Report, and was intended to create a disincentive to businesses making payments to workers operating in the Black Economy.
A summary of the PAYG withholding rules
Payments subject to withholding
Under the PAYG withholding system in Subdiv 12-B in Schedule 1 to the TAA, entities must withhold an amount from certain payments for work and services.
These relevantly include a payment:
- of salary, wages, commissions, bonuses or allowances to an employee (s. 12-35);
- of directors’ fees (s. 12-40);
- to a religious practitioner (s. 12-47);
- under a labour hire arrangement (s. 12-60); and
- for a supply of services where the payee (i.e. a contractor, or an interposed entity) has not quoted its ABN (s. 12-190).
Division 14 of Schedule 1 to the TAA requires an entity to withhold from the provision of non-cash benefits in circumstances where an amount of withholding under s. 12 would have resulted if such a payment had been a payment of money.
A payer must pay an amount — calculated based on the market value of the benefit — to the Commissioner before providing the non-cash benefit.
Division 14 does not apply to the provision of fringe benefits, exempt fringe benefits and employee share schemes.
‘No ABN’ withholding
The ‘no ABN withholding’ rules (s. 12-190) require an entity to withhold, at the top marginal rate (47 per cent including the Medicare levy), from payments made to another entity where the other entity does not quote an ABN.
There are a number of exceptions, namely where:
- the payment is not made in the course or furtherance of an enterprise;
- the GST-exclusive amount of the payment does not exceed $75;
- the supply is made in the course or furtherance of an activity as a member of a local governing authority;
- the supply is wholly input taxed;
- the payment is subject to rules relating to certain investments and TFN quotations; or
- the payment is made to an individual who has provided a written statement to the effect that the supply was made in relation to a private recreational pursuit or hobby, or the supply is wholly of a private or domestic nature.
Amount to withhold
The Commissioner has general powers to make withholding schedules under s. 15-25 of Schedule 1 to the TAA. These schedules provide the rules for calculating the amount to be withheld.
The ATO has published a range of tax tables to help employers work out how much to withhold from employees and other payees. The ATO has also provided tax withheld calculators.
The ATO’s tax tables (QC 16945) are available here:
The ATO’s tax withheld calculators (QC 16944) are available here:
Payment and reporting obligations
Entities that are required to withhold must:
- pay the withheld amount to the Commissioner; and
- notify the Commissioner (including if the amount withheld is a nil amount).
Withholding and remittance
For payments to employees and contractors, the amount required to be withheld must be withheld at the time of making the payment (s. 16-5 of Schedule 1 to the TAA). The penalty for failing to withhold is 10 penalty units (i.e. $2,100).
Section 16-70 of Schedule 1 to the TAA requires an entity that is obliged to withhold an amount to pay that amount to the Commissioner in accordance with the rules in Subdiv 16-B of Schedule 1 to the TAA.
The rules for how and when amounts are to be paid vary depending on the status of the withholder:
|Withholder status||Criteria — amounts withheld for year||How and when withholding must
be remitted to the Commissioner
|> $1 million
(for the income year ending at least two months before the current month)
|Electronic payment is mandatory.
Depending on the day of the week on which the amount was withheld, payment required — within 6 to 8 days — on the first or second Monday or Thursday after the day of withholding (see s. 16-75(1)).
|> $25,000 and ≤ $1 million
(for the financial year ending before the current month)
|Electronic payment is required unless the Commissioner permits, in writing, some other method to be used.
Monthly on the 21st day after the end of each month (see s. 16-75(2)).
|Neither large nor medium||Electronic payment is required unless the Commissioner permits, in writing, some other method to be used.
Quarterly on the 21st day after the end of each quarter (see s. 16-75(3)).
An entity that fails to pay PAYG withholding to the Commissioner by the time required will be liable to pay the general interest charge (GIC). The GIC will be levied on the unpaid amount for each day beginning on the day the payment was due to be paid and ending on the day when final payment is made of the unpaid amount or any general interest charge levied on the unpaid amount.
An entity that must remit amounts to the Commissioner must notify the Commissioner of the relevant amount on or before the day that the payment is required. The amounts are reported on an activity statement for the relevant period.
Single Touch Payroll
For most employers, certain withholding payments — including salary and wages paid to employees — must also be reported to the ATO electronically at the time that the payment is made, under Single Touch Payroll (STP).
The ATO is working on:
- pre-filling labels W1 and W2 of the activity statement for small and medium withholders with amounts reported through STP; and
- showing opening and closing balances for the employer’s activity statement account.
Employers also have annual obligations to:
- provide annual payment summaries to employees in respect of payments from which they have withheld amounts — by 14 July after the end of the income year (s. 16-155); and
- lodge payment summary annual reports (PSARs) with the ATO — by 14 August after the end of the income year (s. 16-152).
However, employers that report under STP are exempt from these annual obligations, except where they do not choose to report reportable employer superannuation contributions or reportable fringe benefit amounts through STP.
Consequences of non-compliance
Penalties apply for not complying with the PAYG withholding obligations. Broadly, where a business fails to withhold a PAYG or no-ABN withholding amount, the penalty is equal to the amount that should have been withheld. There are also penalties for failing to lodge the required information under STP or through the required reports.
The latest measure which denies a tax deduction for non-compliant payments is an additional punitive measure to encourage taxpayers to comply with their withholding and reporting obligations.
New rules for ‘non-compliant payments’
What is a non-compliant payment?
A ‘non-compliant payment’ is a payment specified in s. 26-105(1)(a) to which the PAYG withholding regime applied, and the payer did not:
- withhold the amount from the payment as required; or
- notify the Commissioner when required:
- for payments — under the PAYG withholding or the STP provisions (as applicable); and
- for non-cash benefits — under the PAYG withholding provisions.
- Withholding an incorrect amount — and/or notifying an incorrect amount — will not affect the entitlement to a deduction.
- No deduction will be denied if the business fails to pay (i.e. remit) withheld amounts (although other penalties apply, such as GIC). The non-deductibility arises from the failure to withhold from the payment as required.
- No deduction will be denied if the business fails to report payments on a Taxable payments annual report (TPAR) or a PSAR. The non-deductibility arises from the failure to notify the Commissioner of withholding amounts via activity statements and/or STP.
What types of payments are affected?
Not all withholding payments fall under the new rules.
Only the following payments are affected:
- a payment:
- of salary, wages, commissions, bonuses or allowances to an employee;
- of directors’ fees;
- to a religious practitioner;
- under a labour hire arrangement; or
- for a supply of services — excluding supplies of goods and supplies of real property — where the payee (i.e. a contractor, or an interposed entity) has not quoted its ABN; and
- a non-cash benefit provided in lieu of a cash payment referred to above.
The terms ‘goods’ and ‘real property’ take on their definitions in s. 195-1 of the GST Act:
- goods — any form of tangible personal property; and
- real property — (a) any interest in or right over land; (b) a personal right to call for or be granted any interest in or right over land; or (c) a licence to occupy land or any other contractual right exercisable over or in relation to land.
What are the exceptions?
There are three statutory exceptions to the non-deductibility rule.
Where the withholding amount is a nil amount
A deduction is not denied if the amount required to be withheld — or the amount required to be paid to the Commissioner — is a nil amount (s. 26-105(4) of the ITAA 1997).
Where an ABN is quoted by a misclassified employee
An employer that makes a payment or provides a non-cash benefit to an employee they believe to be a contractor is not denied a deduction if — had the employer been correct in characterising the employee as a contractor — the employer would not have been required to withhold (assuming the worker quoted their ABN).
If the misclassified worker did not quote an ABN and the employer failed to withhold, the deduction is denied.
The Explanatory Memorandum to the Act (para. 1.18) states that this exemption reflects the Government’s recognition that there are situations where an employer honestly believes their employees are contractors — and has complied with the no ABN withholding rule that would apply in that scenario — but this position is not upheld by the Commissioner.
This neatly side-steps the need to correctly classify the worker for the purpose of these rules. There may be other tax implications for mis-characterising a worker as a contractor instead of an employee, but the business won’t be denied a deduction under these measures if they failed to withhold and report PAYG withholding for that worker because they ‘honestly believed’ the worker was acting as a contractor.
The requirement for an ‘honest belief’ that the worker is a contractor is only present in the Explanatory Memorandum to the Act and is not a criterion in the legislative provision, which broadly requires only that the payer has no reasonable grounds to believe that the worker does not have an ABN. The ATO will need to decide how it will administer those situations where it considers that the employer had deliberately misclassified the worker and entered into an arrangement for the employee to provide an ABN.
This exemption from the non-deductibility rule does not in any way affect any other consequences — for both the employer and the worker — of misclassifying the employee as a contractor.
Example — Incorrectly classified employee payments
|Super Express Deliveries Pty Ltd carries on a business as a bicycle courier service. Super Express Deliveries engages around 30 bicycle couriers to enable it to fulfil orders from its customers.
Super Express Deliveries seeks legal advice about the engagement of the bicycle couriers. The advice concludes the bicycle couriers are independent contractors and are not employees. To this end, Super Express Deliveries requires each of its bicycle couriers to obtain an ABN and provide it to the company. Super Express Deliveries concludes that it did not have to withhold any amounts from the payments it made to couriers.
The Commissioner conducts an audit of Super Express Deliveries and decides that the bicycle couriers are employees of Super Express Deliveries. After considering the Commissioner’s reasons and legal authorities, Super Express Deliveries does not dispute this conclusion and agrees to begin fulfilling its withholding obligations on this basis.
The deduction available to Super Express Deliveries for its previous payments to bicycle couriers is not affected by its failure to withhold.
Super Express Deliveries is still subject to penalties for its failure to withhold.
Example 1.1 in the Explanatory Memorandum
Where the employer makes a voluntary notification
A deduction that would otherwise be denied is restored — in the original income year — if the employer voluntarily notifies the Commissioner of their mistake before the Commissioner tells the entity that an examination is to be made of its affairs relating to a taxation law (ss. 26-105(7) and (8) of the ITAA 1997).
According to the Explanatory Memorandum to the Act (para. 1.22), this exemption is intended to encourage employers to come forward and comply with their withholding obligations.
Example — Voluntary notification
|Caleb carries on a business as a mechanic. Caleb does not have any employees until he hires an apprentice, Bianca, in May 2020.
Caleb is not aware that he must withhold an amount from Bianca’s wages.
Caleb visits his accountant in September 2020 to prepare his 2019–20 income tax return. He mentions his expenditure to pay Bianca’s wages. Caleb’s accountant advises Caleb he should have been withholding from the wage payments.
Caleb notifies the Commissioner of his mistake. Caleb may still be subject to penalties for his failure to withhold. However, he is entitled to claim the deduction for the cost of Bianca’s wages in his 2019–20 income tax return.
Example 1.2 in the Explanatory Memorandum
Guidance for business that failed to withhold or report
A business that failed to withhold from a payment, or withheld from a payment but failed to report any amount to the ATO, will lose its deduction for that payment unless they make a voluntary disclosure before the ATO commences an audit or other compliance activity.
|Failure to withhold||Failure to report|
|Where a business did not withhold PAYG withholding amounts from a payment, this mistake is corrected by making a voluntary disclosure in the approved form.
No amount that the business failed to withhold should be included on either an original or a revised activity statement unless advised to by the ATO.
|Where a business withheld the correct amount of PAYG withholding but failed to report it when they should have, they need to lodge a revised activity statement.|
ATO guidance on how to correct PAYG withholding mistakes is set out in QC 33789.
Activity statement guidelines
More than ever, businesses will need to meet the deadlines for lodging their activity statements, because a failure to report withheld amounts through activity statements (and/or STP) will result in payments to workers being non-deductible, unless the mistake is corrected before the ATO detects the non-compliance.
Business generally qualify for an extra two weeks to lodge and pay quarterly activity statements if they are lodged online (conditions apply).
Agents generally qualify for an extra four weeks to lodge and pay clients’ quarterly activity statements if they are lodged online (conditions apply). The concessional due date is automatically updated online, after the agent has lodged the activity statements electronically.