House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Glossary

The following abbreviations and acronyms are used throughout this Explanatory Memorandum.

General outline and financial impact

Industrial safety equipment

The modification Bills modify the operation of the ST (E&C) Act, as modified by any other Act, to ensure that industrial safety equipment is only exempt from sales tax if it is of a kind that is mainly used to protect persons engaged in industrial operations.

Date of effect: The modification applies to dealings on or after 1 January 1993.

Proposal announced: The proposal was announced in Assistant Treasurer's Press Release No. 47 of 5 October 1999.

Financial impact: The measure protects the existing sales tax revenue base by ensuring that credits cannot be claimed in respect of goods that were never intended to be exempt from sales tax. It will also ensure that sales tax will continue to be paid on these goods from 5 October 1999.

Compliance cost impact: There will be some compliance costs for taxpayers who lodged credit claims prior to 5 October 1999 and who will now have to establish that the benefit of any credit is passed on to the final consumer.

Industrial safety equipment - transitional provisions

This Bill provides for transitional measures for the modification to Item 20 in Schedule 1 to the ST (E&C)Act, made by the following modification Bills:

•

Sales Tax (Customs) (Industrial Safety Equipment) Bill 2000;

•

Sales Tax (Excise) (Industrial Safety Equipment) Bill 2000; and

•

Sales Tax (General) (Industrial Safety Equipment) Bill 2000.

Date of effect: Royal Assent.

Proposal announced: The proposal was announced in Assistant Treasurer's Press Release No. 47 of 5 October 1999.

Financial impact: The measures ensure that certain credits paid or exemptions claimed in respect of dealings prior to 5 October 1999 are not subject to sales tax as a result of the modification made by the modification Bills. It will also ensure that sales tax will continue to be paid on these goods from 5 October 1999.

Compliance cost impact: There will be some compliance costs for taxpayers who lodged credit claims prior to 5 October 1999 and who will now have to establish that the benefit of any credit is passed on to the final consumer.

Summary of Regulation Impact Statement

Regulation impact on business

Impact: Low.

Main points:

•

This modification will correct the unintended consequences of the 1992 legislation which aimed to streamline the sales tax law. The explanatory memorandum to the ST (E&C) Act stated that the new Item 20 represented 'no substantive change' from the previous exemption when using the phrase 'of a kind ordinarily used' in place of 'of a kind used exclusively or primarily and principally'. There was a clear intention by the Parliament in 1992 that the exemption for industrial safety equipment was not intended to be widened from its original narrow scope. However, several Federal Court decisions have not adopted this view. The result is that a wide range of goods that were not intended to be exempt may now qualify for the exemption.

•

There are 2 options available to implement this measure. While both would result in effectively the same outcome, the second option would result in a significant additional administrative burden on the ATO and therefore has not been adopted.

•

The most significant impact group from the implementation of this measure are wholesalers (as the principal taxpayers), although retailers, end users and the ATO are also affected.

•

The revenue at risk if this modification is not enacted could be in excess of $2 billion. This figure assumes that without a modification to give effect to the Government's announcement on 5 October 1999, substantial claims for credits could be lodged by taxpayers involved in a significant number of industries for dealings over the previous 3 years. This modification will see these risks reduced significantly by limiting the circumstances in which credit claims can be made.

•

The benefits of removing the unintended access to the Item 20 exemption by implementing this measure significantly outweigh the costs. As the majority of those potentially affected by this measure have dealt to date on the basis of the Parliament's intended application of the sales tax law, the obligations imposed on them as a result of this proposal are limited. However, the potential risk to revenue if the Government did not seek to redress this anomaly is significant.

Chapter 1 - Industrial safety equipment

Outline of Chapter

1.1 The modification Bills modify Item 20 in Schedule 1 to the ST (E&C) Act, which deals with industrial safety equipment. The modification has the effect that, to be exempt from sales tax, industrial safety equipment must be of a kind that is mainly used to protect persons engaged in industrial operations.

Background to the legislation

1.2 On 5 October 1999 the Government announced that it would amend the sales tax law to ensure that exemption from sales tax for industrial safety equipment will only apply to equipment which is of a kind mainly used to protect persons engaged in industrial operations.

1.3 The Government's announcement followed decisions of the Federal Court that have meant that goods which would not ordinarily be regarded as industrial safety equipment, have been held to be exempt from sales tax.

1.4 In the decision Commissioner of Taxation v. NSW Cancer Council (1999) FCA 1146, the Federal Court held that sunglasses were exempt as safety equipment because it could be demonstrated that some outdoor workers used them to protect their eyes from glare and cancer. The effect of that decision is that all sunglasses that meet Australian Standard AS 1067.1 and that are not fashion spectacles would be exempt from sales tax, even though most sunglasses are used as personal protection in activities unrelated to industrial operations or used as fashion accessories. That decision is also in direct conflict with the policy underlying the sales tax exemption for spectacles in Item 85 in Schedule 1 to the ST (E&C) Act which specifically excludes sunglasses from the exemption.

1.5 This modification will restore the position that applied before the sales tax law was streamlined in 1992 and which was intended to be the position under the current law. Under the pre-1992 legislation, industrial safety equipment had to be of a kind that was used 'exclusively, or primarily and principally' as industrial safety equipment to be exempt from sales tax. This meant that only goods which had the predominant purpose of protecting persons engaged in industrial operations were exempt from sales tax.

1.6 Examples of the types of goods intended to be covered by the exemption are masks, respirators, shields, goggles, visors, helmets, belts and machine guards. The explanatory memorandum to the ST (E&C) Act stated that the new Item 20, using the phrase 'of a kind ordinarily used' in place of 'of a kind used exclusively, or primarily and principally', represented 'no substantive change' from the previous exemption. There was a clear intention by the Parliament in 1992 that the scope of the exemption for industrial safety equipment was not intended to be widened from its narrow scope.

1.7 If the Government does not ensure that this modification has effect back to the commencement of the ST (E&C) Act, there is potential for a significant loss of sales tax revenue in granting credits in relation to equipment that was never intended to qualify for sales tax exemption as industrial safety equipment.

1.8 The threat to the revenue base is significant because taxpayers are entitled to claim credits going back 3 years from the date of the claim. The scheme of the sales tax legislation requires that credits can only be claimed where the sales tax has not been passed on by the person claiming the credit. This ensures that manufacturers and wholesalers do not obtain windfall gains from credits where they have passed the sales tax on in the price charged to their customers. However, in many cases their customers and the ultimate beneficiaries of any sales tax credits are retailers who have also passed on the sales tax in the price charged to their customers who are the end users of the goods.

1.9 There is no obligation under the sales tax law for a retailer in those circumstances to pass on the benefit of any sales tax credit to the final consumers. Given that the types of goods which could potentially qualify as industrial safety equipment have always been subject to sales tax, it is clear that in many cases the benefit of any credit of sales tax would not benefit the final consumers who have effectively borne the cost of the sales tax.

1.10 The Constitution requires that a law imposing taxation should only deal with one subject of taxation. Sales tax is therefore imposed by 4 Acts, the sales tax imposition Acts. There are separate Acts imposing sales tax to the extent that it is a duty of customs, a duty of excise, a tax on in situ swimming pools, or a tax that is none of these. The Constitution also requires that a law imposing taxation should only deal with that imposition, and a part of the law relating to any other matter will be invalid.

1.11 There is a view that the measures contained in the modification Bills impose taxation. For this reason, they have been included in separate Bills. Each Bill will modify the effect of the ST (E&C) Act in so far as it applies to sales tax imposed by the corresponding sales tax imposition Act.

1.12 The modification Bills modify the effect or operation of the ST (E&C) Act, but do not amend it. It will therefore be necessary to read the ST (E&C) Act together with earlier modifying Acts, and these Bills, to discover how the sales tax laws are to be applied in relation to the goods affected by these measures.

Detailed explanation of new law

1.13 Item 1 in each of the modification Bills modifies the effect of Item 20 of Schedule 1 to the ST (E&C) Act by substituting the word 'ordinarily' with 'mainly'. This will have the effect that an item of equipment must be of a kind that is mainly used to protect persons engaged in industrial operations to be exempt from sales tax.

1.14 Subsection 3(2) of the ST (E&C) Act defines mainly to mean to the extent of more than 50%. In the context of Item 20 an item of equipment will have to be of a kind that is used more than 50% of the time for protecting persons engaged in industrial operations. Where an item of equipment has a number of uses, these will have to be compared to determine whether the mainly used test is satisfied. Most goods commonly described as industrial safety equipment will have a clear use in protecting persons engaged in industrial operations and will easily satisfy the 'mainly' test.

1.15 There are many goods which can be said to protect persons engaged in industrial operations. For example, an ergonomic chair can be said to protect workers from poor posture and its related health problems. Clearly, this is not the main purpose for which these chairs are used, being to seat the person using them. Therefore, a chair does not satisfy the test of being of a kind mainly used to protect persons.

1.16 By way of contrast, a welding shield has a main purpose of protecting the welder's eyes from damage. As it is of a kind that is mainly used to protect persons engaged in industrial operations it is exempt from sales tax under Item 20. Not only is this type of equipment mainly used by persons engaged in industrial operations, it is also mainly used to protect persons.

1.17 Item 4 ensures that the modification is taken to be an amendment for the purposes of section 129 of the STAA 1992. Section 129 has the effect of deferring a liability imposed by an Act that amends the sales tax law to 28 days after the sales tax amendment Act receives the Royal Assent.

1.18 Item 5 defines 'first taxing day' as having the same meaning as in the STAA 1992. The first taxing day for the STAA 1992 was 1 January 1993.

1.19 Item 6 provides that the modification made by Schedule 1 to this Bill applies to dealings with goods on or after the 'firsttaxing day', being 1 January 1993.

Application and transitional provisions

1.20 The modifications will apply to dealings made on or after 1 January 1993.

1.21 The Sales Tax (Industrial Safety Equipment) (Transitional Provisions) Bill 2000 deals with transitional issues to ensure that the modifications made by this Bill do not affect certain credit claims lodged before 5 October 1999, or liabilities for certain dealings before 5 October 1999. This Bill therefore needs to be read in conjunction with that Bill.

Chapter 2 - Industrial safety equipment - transitional provisions

Outline of Chapter

2.1 This Bill provides transitional measures for the modifications made to Item 20 in Schedule 1 to the ST (E&C) Act by the following modification Bills:

•

Sales Tax (Customs) (Industrial Safety Equipment) Bill 2000;

•

Sales Tax (Excise) (Industrial Safety Equipment) Bill 2000; and

•

Sales Tax (General) (Industrial Safety Equipment) Bill 2000.

The measures relate to credit claims that were lodged before 5 October 1999 and also to liabilities for certain dealings that occurred before 5 October 1999.

Background to the legislation

2.2 On 5 October 1999 the Government announced that it would amend the sales tax law to ensure that exemption from sales tax for industrial safety equipment will only apply to equipment which is of a kind mainly used to protect persons engaged in industrial operations.

2.3 The Government's announcement followed decisions of the Federal Court that have meant that goods which would not ordinarily be regarded as industrial safety equipment, have been held to be exempt from sales tax.

2.4 The Government's announcement also indicated that the sales tax law would be amended to deny credit claims made on or after 5 October 1999 that do not meet the 'mainly' test. In addition, credit claims that were made before 5 October 1999 that do not meet the 'mainly' test would only be allowed where the benefit of the credit will be passed on to the end consumer.

2.5 The Government's intention was that these measures would restore the sales tax law to the position that the Parliament always intended. The measures would prevent the possibility of refunding large amounts of sales tax already paid for items that were always intended to be taxed.

2.6 The modification made to Item 20 by the modification Bills applies to dealings made on or after 1 January 1993. This means that, in effect, any dealings made on or after 1 January 1993 will only be exempt from sales tax under Item 20 if they meet the 'mainly' test. Any credit claims lodged after 5 October 1999 in respect of dealings before that date will now have to satisfy the 'mainly' test. The provisions contained in this Bill ensure that the Government's announcement in respect of credits relating to dealings prior to 5 October 1999 is also implemented.

Detailed explanation of new law

Credit claims made before 5 October 1999

2.7 Item 5 ensures that the modifications made by the modification Bills do not apply to certain credit claims made before 5 October 1999, in relation to dealings that satisfied the requirements of Item 20 before the modification. Item 5 imposes an additional requirement on credit claims made before 5 October 1999 in respect of these dealings before that date. The Commissioner must be satisfied that the benefit of the credit has been, or will be, passed on to the end user of the goods that were the subject of the dealing, before the credit can be paid.

Example 2.1 A wholesaler lodged a claim before 5 October 1999 for a sales tax credit in respect of goods sold that it believes are of a kind that satisfy the requirements of Item 20. The goods were sold to a retailer for a price that included sales tax. The retailer has subsequently sold the goods to end consumers. The normal requirement for the wholesaler claiming a credit in these circumstances is that it must show that the sales tax has not been passed on to the retailer. To obtain a credit the wholesaler will have to refund the sales tax to the retailer. For goods that satisfy the 'ordinarily' test but do not satisfy the 'mainly' test, the wholesaler will now have to ensure that the benefit of the credit passes to the end consumers before a credit can be paid by the Commissioner.2.8 Where the goods that are the subject of a credit claim have lost their identity as goods because they have become an integral part of property, the end user is taken to be either the lessee of the property or the owner of the property. The person claiming the credit can choose either the lessee or the owner as the end user.

Example 2.2 Alfred sells electrical goods including extractor fans mainly by wholesale. He claims a credit in respect of the sale of a fan made before 5 October 1999 to an electrical contractor. The fan was subsequently installed in a restaurant. Alfred claims a credit on the basis that the fan is of a kind that satisfies the requirements of Item 20, including the 'ordinarily' test. As the extractor fan is not of a kind that satisfies the 'mainly' test, Alfred must satisfy the additional 'passing on' requirement before the credit can be claimed. Alfred determines that the electrical contractor dealt directly with the restaurant owner who leases the premises in which the fan was installed. Alfred chooses the restaurant owner as the appropriate person to benefit from the credit claim and ensures that the benefit is passed through the electrical contractor or directly to the restaurant owner.

Credit claims made after 5 October 1999

2.9 As this Bill does not deal with credit claims lodged after 5 October 1999 they will be determined in accordance with the provisions of the STAA 1992 and the modification made to Item 20 by the modification Bills. As the modification to Item 20 will apply to dealings made on or after 1 January 1993, a claim for credit made after 5 October 1999 must meet the 'mainly' test regardless of whether the dealing occurred before or after that date. While the normal passing on provisions must be satisfied, there is no requirement that the benefit of the credit has been passed on to the final consumer.

Dealings that occurred before 5 October 1999

2.10 Item 6 operates to ensure that dealings that occurred before 5 October 1999 which met the conditions of Item 20 before modification, but which would now not meet the 'mainly' test, are not subject to sales tax as a result of the modification Bills. This will include dealings before 5 October 1999 where sales tax was not paid or where credits were subsequently paid, on the basis that the dealings satisfied the requirements, including the 'ordinarily used' test, of Item 20.

Example 2.3 As a result of the Federal Court decisions a wholesaler commenced treating particular goods as being exempt from sales tax on the basis that the goods were exempt under Item 20. The goods were sold by the wholesaler at prices that did not include sales tax. As a result of the modification these goods sold on or after 5 October 1999 will be subject to sales tax if they do not meet the 'mainly' test in Item 20. However, the modification will not impose a sales tax liability on the goods that were sold prior to 5 October 1999. These dealings will continue to be treated as exempt from sales tax providing that they were covered by Item 20 before the modification. Item 6 ensures that the modification does not apply to these dealings.

2.11 Where sales tax was paid on dealings before 5 October 1999 that do not satisfy the 'mainly' test but which may have satisfied the requirements of Item 20 following the Court decisions, credits cannot be claimed. In these cases the amounts that were paid in purported payment of a liability that did not actually exist at the time, but that now exists because of the modification, are taken to have been applied against that liability and cannot therefore be claimed back.

Chapter 3 - Regulation Impact Statement

Policy objective

3.1 This modification will correct the unintended consequences of the 1992 legislation which aimed to streamline the sales tax law. The explanatory memorandum to the ST (E&C) Act stated that the new Item 20 represented 'no substantive change' from the previous exemption when using the phrase 'of a kind ordinarily used' in place of 'of a kind used exclusively or primarily and principally'. There was a clear intention by the Parliament in 1992 that the exemption for industrial safety equipment was not intended to be widened from its original narrow scope. However, several Federal Court decisions have not adopted this view. The result is that a wide range of goods that were not intended to be exempt may now qualify for the exemption. Additionally, retailers may obtain a windfall benefit if credit claims are allowed in respect of goods that were not intended to be exempt.

Implementation options

3.2 The following 2 options include the modification proposed by these Bills and the major alternative. In both cases, the options feature the introduction of a 'mainly' test from the date of announcement (in Option 1 the test applies from an earlier date) as there is no alternative implementation option to this. However, the options explore the 2 alternative treatments of claims for credits in relation to dealings before then.

Assessment of impacts

Option 1

3.3 This option will modify from 1 January 1993 the relevant sales tax provisions by restricting the exemption to goods mainly used as industrial safety equipment. In addition, claims for credits lodged before 5 October 1999 will be allowed if the taxpayers can show that the benefit of the credits have, or will be, passed on to the end users of the goods. Finally, for taxpayers who have not paid sales tax on a self-assessment basis in relation to dealings before 5 October 1999 and who satisfy the 'ordinarily' test, there will be no additional obligations.

Impact group identification

Wholesalers

3.4 Wholesalers can be broken down into 3 main groups based on the impact this option will have upon them as detailed below.

•

Wholesalers who have been collecting and remitting sales tax in relation to the equipment in question (i.e. those who have adopted the Parliament's intended application of the exemption provision) and have not claimed credits in relation to these dealings will not be noticeably impacted by this measure. This group represents the majority of wholesalers.

•

Wholesalers who have not paid sales tax on a self-assessment basis in relation to dealings before 5 October 1999 and who satisfy the 'ordinarily' test, will be subject to no additional obligations. However, for dealings on or after 5 October 1999 there will be a requirement for them to remit the relevant sales tax unless they satisfy the 'mainly' test.

•

Wholesalers who have claimed a credit of sales tax paid in relation to dealings before 5 October 1999 will be allowed this credit if they lodged the claim before that date, can satisfy the 'ordinarily' test and can show that the benefit of the credits have, or will be, passed on to the end users of the goods. This may impose merely an evidentiary burden on relevant taxpayers who have already passed on the benefit but may also lead others to establish sales tax refund arrangements for end users. The wholesalers in this group comprise mainly those in the sunglasses, air conditioning and scaffolding industries.

Retailers

3.5 In instances where wholesalers have claimed credits prior to 5 October 1999, retailers may find that they become involved with end user refund arrangements aimed at ensuring that wholesalers are able to satisfy the requirements of the credit scheme proposed by the modification Bills.

End users

3.6 Given that goods that satisfied the 'ordinarily' test would be exempt if the taxpayer lodged a claim for a credit before 5 October 1999 and could show that the benefit of the credits have, or will be, passed on to the end users of the goods, some end users may benefit from a refund of the proportion of the sale price that represented sales tax.

ATO

3.7 The ATO will experience an increase in requests for advice as a result of the modification Bills being enacted. It will also be required to investigate claims for credits where the claimant asserts that the criteria have been satisfied.

Private sector tax professionals

3.8 This group may experience an increase in their workload as they attempt to understand the modifications and provide advice to affected clients.

Analysis of costs / benefits

Compliance costs

3.9 As outlined in paragraph 3.4 the majority of relevant taxpayers will not be noticeably affected by this proposal as they adopted the intended narrow view of the Item 20 exemption. However, other taxpayers may wish to establish end user refund arrangements, which may be costly and may also involve retailers. It is unlikely that such arrangements will be established for such items as sunglasses, due to the high volume of transactions, comparatively low cost of individual items and the difficulty in providing refunds to end users who will not be readily identifiable from retail records.

3.10 The compliance costs for this measure cannot be reliably quantified because it is uncertain how many people will be affected to the extent that they will incur compliance costs.

Administration costs

3.11 The administrative costs to the ATO of this proposal relate mainly to advising clients on the application of the proposed modifications and to processing those credit claims that were lodged before 5 October 1999. However, as the number of people affected cannot be quantified, the administrative cost is also not possible to quantify.

Government revenue

3.12 The revenue at risk if this modification is not enacted could be in excess of $2 billion. This figure assumes that without a modification to give effect to the Government's announcement on 5 October 1999, substantial credit claims could be lodged by taxpayers involved in a significant number of industries for dealings over the previous 3 years. This option will see these risks reduced significantly by limiting the circumstances in which credit claims can be made. The value of credits that will be paid depends on the individual circumstances of the relevant taxpayers and it is not possible to quantify.

Option 2

3.13 The second option to give effect to the Government's policy would be to impose the 'mainly' test prospectively from the date of the Government's announcement on 5 October 1999. In addition, claims for credits lodged before the Government's announcement would be allowed if the taxpayer proved that the benefit of the credits have, or will be, passed on to the end users of the goods. In order to address those claims for credits in relation to dealings before 5 October 1999 but lodged after than date, a windfall tax would apply wherever a credit was paid. The amount of the windfall tax would be 100% of the credit claimed.

Impact group identification

3.14 The groups impacted under Option 2 are the same as under Option 1.

Analysis of costs / benefits

Compliance costs

3.15 The compliance costs of Option 2 are essentially the same as Option 1, except that the legislation would be more complex and therefore would require a greater need for professional advice.

Administration costs

3.16 The ATO would be further burdened by Option 2 than it would be by Option 1 because Option 2 would require claims for credits to be notionally paid and then the windfall tax would have to be imposed. There would be a requirement to establish an accounting system for such credits and debits on the accounts of taxpayers. It would also be necessary to produce notices that advise taxpayers of these transactions. The fact that the taxpayers may pre-empt the inevitable result of their credit claims and therefore not lodge such claims would not preclude the ATO having to provide appropriate systems.

Conclusion and recommended option

3.17 The benefits of removing the unintended access to the Item 20 exemption by adopting Option 1 outweigh the costs of this measure. As the majority of those potentially affected by this measure have dealt to date on the basis of the Parliament's intended application of the sales tax law, the obligations imposed on them as a result of this proposal are limited. However, the potential risk to revenue if the Government did not seek to redress this anomaly is significant.

3.18 In relation to the 2 implementation options, Option 1 is recommended. While both options would effectively have the same result, Option 2 would involve a more complex legislative solution than Option 1. Option 2 would also require significant additional administrative resources.