By John Vaughan-Williams, Lawyer

In recent years, state payroll taxes have been a commonly litigated area in the not-for-profit sphere, with some charities and public benevolent institutions (PBIs) challenging assessments worth multiple millions of dollars in payroll tax.

Payroll tax is a state and territory tax payable by an employer on employee wages, if the amount of those wages is above a certain monetary threshold.

Each state and territory’s payroll tax statute contains some form of exemption for charitable entities, but the law and interpretation varies across jurisdictions. The requirements for charitable payroll tax exemptions are arguably stricter than for other taxes, as the exemption not only considers the nature of the organisation, but also the types of activities that its employees are engaged to perform.

The recent New South Wales Supreme Court case of KinCare Community Services Limited v Chief Commissioner of State Revenue [2019] NSWSC 182 (KinCare Case) was a dispute over an assessment of $3.2 million in payroll tax under the Payroll Tax Act 2007 (NSW) (NSW Payroll Tax Act), over a period of five years. The case revealed some useful insights as to the legal definition of a “non-profit organisation”, as well as the types of employee roles which are accepted as qualifying for the exemption. This article will discuss this case.

1. Overview of exemption

In New South Wales, the payroll tax exemption for newly-created charities and PBIs (that is, incorporated from 1 July 2007 onwards) is contained in section 48 of the NSW Payroll Tax Act (New Exemption). For charities and PBIs incorporated before 1 July 2007, the exemption is contained in clause 12 of schedule 2 of the NSW Payroll Tax Act (Transitional Exemption).

The two exemptions are similar, but differ slightly on the requirements for the objects clause and the activities performed by staff. Although the KinCare Case concerned the exemption under clause 12 of schedule 2, the objects clause was not one of the legal issues in dispute, so most of the law in the KinCare Case can apply to both exemptions.

The relevant elements of the charitable exemption under the NSW Payroll Tax Act are as follows:

1. the taxpayer must either be:
   1. a PBI; or
   2. a non-profit organisation with:
      1. under the New Exemption (affecting organisations incorporated from 1 July 2007 onwards), its sole or dominant purpose a charitable, benevolent, philanthropic or patriotic purpose; or
      2. if under the Transitional Exemption (affecting organisations incorporated before 1 July 2007), one of its purposes a charitable, benevolent or philanthropic purpose; and
2. the wages which are exempted must be paid or payable:
   1. under the New Exemption (affecting organisations incorporated from 1 July 2007 onwards):
      1. for a kind of work which is “ordinarily performed” in connection with the charitable, benevolent, philanthropic or patriotic purposes; and
      2. to a person who is engaged exclusively in that kind of work; or
   2. under the Transitional Exemption (affecting organisations incorporated before 1 July 2007), to a person engaged in charitable, benevolent, philanthropic or patriotic work.

2. Facts of KinCare Case

KinCare Community Services Limited (KinCare) is a public company limited by guarantee, which was incorporated in 1998. It is registered with the Australian Charities and Not-for-profits Commission (ACNC) as a charity and a PBI. Notably, registration with the ACNC has little to no bearing on whether an organisation will be deemed to be eligible for a state or territory tax exemption.

KinCare provides home care services to the elderly, the disabled and also to Aboriginal and Torres Strait Islander people. There are also several for-profit entities which are related to KinCare (KinCare Group), and which entered into a series of transactions with KinCare, relating to KinCare’s provision of services.

KinCare had previously been granted an exemption from payroll tax as a non-profit charitable organisation, but the Chief Commissioner of Taxation in New South Wales determined that between 1 July 2008 and 1 April 2014 (Relevant Period), KinCare was not entitled to the exemption for its wages. This led to an assessment of a liability of $3.2 million in payroll tax.

The arrangements between KinCare and the KinCare Group included the following:

1. KinCare paid fees to the KinCare Group, in exchange for the KinCare Group providing KinCare with nurses and other medical staff;
2. KinCare’s administrative staff performed services for both KinCare and the KinCare Group, and the KinCare Group paid KinCare a fee for the administrative services which were provided to the KinCare Group; and
3. KinCare provided loans to the KinCare Group, and also a guarantee to a bank to allow the KinCare Group to purchase assets.

3. Legal issues in question

In making its payroll tax assessment, the Commissioner had alleged the following regarding KinCare:

1. the arrangements between KinCare and the KinCare Group meant that KinCare was not a “non-profit organisation”, as it conferred private benefits; and
2. by the administrative staff of KinCare providing administrative services to both KinCare and the KinCare Group, this meant that the wages paid to administrative staff were not in connection with charitable or benevolent work.

Accordingly, there were four issues for the Court to determine in the KinCare Case:

1. Was KinCare a “non-profit organisation” during the Relevant Period?
2. If yes, were the wages paid by KinCare to administrative staff during the Relevant Period in connection with its charitable work?
3. Was KinCare a PBI?
4. If yes, were the wages paid by KinCare to administrative staff during the Relevant Period in connection with its public benevolent work?

Generally, the requirements to be a PBI at law are more difficult to satisfy than the requirements to be a charity, as a narrower range of purposes and activities are recognised. KinCare conceded that the third and fourth questions were largely academic, as KinCare could probably not be successful in relation to those questions if it was unsuccessful in relation to the first two questions.

Consequently, the Court focused on the first two questions, with only a minor consideration of the third and fourth questions at the end of the judgment.

4. First issue – overview – was KinCare a “non-profit organisation” during the Relevant Period?

The question of being a “non-profit organisation” is commonly thought to be restricted to the contents of an organisation’s constitution. However, in the KinCare Case, the Court referred to and applied a two-limbed test from the recent payroll tax case of Grain Growers Limited v Chief Commissioner Of State Revenue [2015] NSWSC 925:

1. Does the taxpayer’s constitution prevent the payment of dividends to its members, both during its lifetime and on winding up?
2. Is the taxpayer, in its day-to-day operations, carried on for the benefit or gain of particular individuals?

The limb as to the constitution was uncontroversial, as it was accepted that KinCare was restricted from paying dividends to members, both pursuant to its constitution and also the Corporations Act 2001 (Cth).

The limb regarding the day-to-day operations was where the Commissioner contended that KinCare did not qualify as a “non-profit organisation”. The Commissioner argued that, through KinCare’s arrangements with the KinCare Group, KinCare existed for the benefit or gain of particular individuals.

The Court analysed each of the arrangements between KinCare and the KinCare Group, in turn.

4.1 Payment for services

The Court first considered KinCare paying the KinCare Group for the services of nurses and other medical staff. The Court held that the services were sourced and paid for on an arms’ length basis, and were comparable with what KinCare would have paid to an independent third party for those services. For this reason, the Court held that the procurement of these services was in fulfilment of KinCare’s purposes, and was not for the purpose of the benefit or gain of private individuals.

4.2 Administrative staff

The second arrangement which the Court considered was KinCare’s administrative staff performing services for both KinCare and the KinCare Group. The Court considered the entirety of the arrangement, and deemed that the arrangement had the effect of furthering KinCare’s objects, and was not for the purpose of conferring benefits on private individuals. The Court held this because:

1. the fees paid by the KinCare Group were at a market rate; and
2. KinCare actually received more money in the fees which the KinCare Group paid KinCare for the provision of these administrative staff, than KinCare paid for its own administrative staff.

The Court held that this meant the arrangement was commercially viable for KinCare, and was for the objective of furthering its own objects, through generating fees to channel back into its charitable services.

4.3 Loans and guarantee

The final arrangement which the court considered were loans and a guarantee which KinCare provided to the KinCare Group.

With respect to the loans, the Court held that since a commercial rate of interest was paid on the loans, and also since it matched the corresponding rate of interest on money which KinCare borrowed from the KinCare Group in separate loans, the transaction was at arms’ length and was not for the purpose of conferring private benefit.

In relation to the guarantee, KinCare had provided a guarantee to a bank to allow the head entity of the KinCare Group to purchase a business. The Court accepted that the KinCare Group would have been unlikely to secure a loan to purchase the business in absence of this guarantee. However, the Court did not accept that this meant a private benefit was conferred on the KinCare Group. Rather, the Court held that it was advantageous for KinCare if the entities in its corporate group were in a strong financial position, and that there was no evidence that the provision of the guarantee had prevented funds being used on KinCare’s charitable purposes.

4.4 Court’s determination

Arising from the Court’s analysis of all of these factors, the Court considered that KinCare qualified as a “non-profit organisation”, and rejected the Commissioner’s assertions.

The Court then had to consider the second issue – being whether the wages of administrative staff were in connection with KinCare’s charitable services.

5. Second issue – were the wages paid by KinCare to administrative staff during the Relevant Period in connection with its charitable work?

When considering the types of employees which a charity engages, there are three broad types. Those are:

1. employees involved directly in the provision of charitable work (for example, in KinCare’s case, the nurses);
2. employees involved in commercial activities used to generate funds for a charity’s charitable work (for example, employees of a business owned by a charity); and
3. employees who perform administrative work.

The first category of employee has been held by Courts to be in connection with charitable work (and, therefore, their wages are eligible to be exempt from payroll tax), whereas the second category has been held by Courts not to be in connection with charitable work (meaning that their wages are not eligible to be exempt from payroll tax).

The treatment of the third category is more difficult. While a literal interpretation could mean that administration falls outside of direct charitable work, Courts have taken the approach that so long as the administration work relates to the charitable work of an organisation (as opposed to being related a commercial activity, such as a business operated by the charity), it will still be considered to be in connection with charitable work.

In the KinCare Case, the Court held that it was conceptually possible for the administrative employees’ wages to be proportionally allocated as follows:

1. the portion performed directly for KinCare, which would be exempt; and
2. the portion performed for the KinCare Group, which would not be exempt.

However, on the facts in the KinCare Case, there was insufficient evidence in order to determine how much time had been spent by those administrative employees in each capacity. The KinCare Group paid its annual fees to KinCare for the provision of administrative staff based on a reasonable estimate and apportionment based on the number of staff directly employed by each entity in the KinCare Group.

While the Court held that this was an acceptable method of calculation, the Court also held that it made it impossible for the Court to determine what portion of the wages was exempt. Therefore, the Court held that none of the wages payable to administrative staff during the Relevant Period were exempt. The Court noted that charging an hourly rate, with records kept of the number of hours worked in each capacity, may have sufficed.

Notwithstanding this result, the administrative staff wages were only a portion of the wages being litigated, and KinCare was successful regarding all other wages, which were exempted from payroll tax. The Court noted in its judgment that KinCare had been successful on the major issue of the litigation, and also found in its favour for costs.

6. Third and fourth issues – PBIs

The Court only gave limited attention to the third and fourth issues regarding PBIs, because the Court held that they would not produce a different result from a pure consideration of the first two issues.

The Court accepted that KinCare was a PBI, as it focused on providing benevolent relief to the disadvantaged (the main requirement of PBI endorsement), and held that the majority of wages were exempt from payroll tax during the Relevant Period on this ground. However, the Court encountered the same issue regarding the administrative staff wages, and held that they were not exempt.

7. Take-away points

There are three main points that charities should take away from this case.

Firstly, the case should be a warning to charities as to being very careful when entering into transactions with related parties. All of the transactions between KinCare and the KinCare Group were carefully scrutinised by the Court, and had KinCare failed to adequately document the reasoning for the arrangement (for example, through board minutes), the result may have been different.

Secondly, the Court held that it was conceptually possible for the administrative staff’s wages to have been exempt, but the exemption was ultimately unsuccessful due to inadequate record-keeping. If staff are employed in multiple capacities, charities should be able to clearly demonstrate the portion of time which relates to each capacity.

Finally, KinCare had previously been exempted from payroll tax, but this exemption was later revoked by the Commissioner. Charities should not simply assume that their payroll tax exemptions will remain in effect in perpetuity, and should be regularly reviewing their eligibility.