In this is Part 3 in a series of articles by our State Tax Team we examine whether payroll tax is payable on business profits and distributions. Payroll tax is a state-based tax imposed on a business where taxable wages exceed relevant state or territory thresholds. Despite a harmonisation process across Australia the provisions remain a complicated area of state taxes. Legislative references in this article are to the Victorian Payroll Tax Act 2007.
Are distributions of profit subject to payroll tax?
It is common for many shareholders to also be workers and/or employees of a business. However, as a general rule, payments made to the persons in their capacity as shareholders are not subject to payroll tax.
In W.A Flick & Co Pty Ltd v FC of T (1959) 103 CLR 334 the Court noted that, in order to attract payroll tax, the critical question is whether the payment is one which the employer makes to the employee because of something done in the service of the employer. Distributions of profits and are not in respect of services rendered by the shareholder but are instead referrable to their ownership interest in the business.
Revenue offices require taxpayers have appropriate evidence to support that payments are indeed returns of profit and not payments for services rendered. Key evidence businesses should consider keeping include:
Formal agreements of the profit distribution arrangement, particularly if it is uneven between shareholders;
Ensuring the payments are correctly reflected as distributions of profit in the company’s balance sheet rather than expenses; and
Applying the correct tax treatment to the distributions. Wages are necessarily incurred in carrying on the business for the purpose of producing assessable income and as such are deductible for tax purposes. By contrast a distribution of profit is an after-tax payment.
Formalising profit distribution arrangements and ensuring their correct treatment in accounts and tax returns, becomes even more important when arrangements are entered into between business owners that stray beyond the “normal” return of profit.
If we return to our example of Sparky from our Part 2 article, the two owners are Tom and Zoe. Tom established the business and several years later Zoe acquired a 25% stake. At the time of acquisition, the two parties discussed an appropriate value for this stake noting that it must recognise the significant value Tom had generated in the business prior to that time.
It was agreed that Tom, for the following 5 years would receive a flat payment of $50,000 prior to a distribution of profit between the two shareholders. The purpose of the payment was to recognise a return of capital he had generated in the business prior to Zoe joining the business.
Whilst this is a legitimate arrangement between the two parties it would be, in line with SRO guidance, advisable that this arrangement be formalised. This would include a formal agreement clearly stating the and conditions and highlighting this is a return of capital rather than any sort of payment in respect of, or contingent on the provision of, services provided by Tom.
Are trust distributions subject to payroll tax?
Trust distributions are generally not subject to payroll tax when paid to beneficiaries in their capacity as beneficiaries. This is the case even where the beneficiary is also an employee of the trust which carries on the business. As with distributions of profits to shareholders these payments are not related to services rendered. Evidence of the nature of such payments should be kept and correct accounting records made.
Nevertheless, where trust distributions are referrable to employment then they will be subject to payroll tax. This position was confirmed in the High Court decision of Murdoch v. Commissioner of Pay-roll Tax (Vic) (1980) 143 CLR 629 (Murdoch).
Murdoch concerned payments made by the trustee of the estate of George Adams in accordance with provisions of the deceased’s will. The deceased’s will referred to the recipients of distributions as “Employees for the time being engaged in the said business”. The will further stated that amounts to be paid to recipients should be determined with reference to the value of that individual’s contribution to the making of the profits of the business.
The majority of the High Court held that the payments were taxable wages and therefore subject to payroll tax. This finding was on the basis that the amounts were found to be referrable to the service provided by the recipients’ as employees of the business. The Court noted:
“They were payment made by an employer to employees, they were made ‘because of something done in the service of the employer’ and they were voluntary additions to their regular remuneration. Again, I consider it immaterial that the recipients may have been entitled to be considered for such payments by virtue of the will of the deceased. The fact is the employees were considered but considered and paid (as the trustees were so empowered) on the basis of their service as employees and that is what seems to me to determine the issue here”.
When making distributions to individuals who are also employees of the business it is therefore important to consider the true basis for making the distribution. A starting point should be for taxpayers to ask, and objectively consider, whether the payments are being made on the basis of their service as employees of the business. This is of course only a starting point and a further critical and impartial assessment should be made on all trust distributions to employees.
Questions?
If you have any questions about how payroll tax should apply in your circumstance, please contact our specialist team at:
Laura Spencer
Senior Associate
T +61 3 9611 0110
lspencer@sladen.com.au
Denise Tan
Senior Associate
T +61 3 9611 0160 | M +61 438 714 965
E: dtan@sladen.com.au
Phil Broderick
Principal
T +61 3 9611 0163 l M +61 419 512 801
E: pbroderick@sladen.com.au
