The ATO has warned employers that cash payments made to workers are no longer tax deductible from July 1, 2019. This also applies to payments made to contractors who have not provided a valid ABN.
From 1 July 2019, employers are only able to claim deductions for payments made to workers where they have complied with the pay-as-you-go withholding rule, or withheld on contractors without ABNs. The new rules apply for income tax returns lodged for the 2020 income year onwards.
Previous cash payment rules vs new system
The ATO believe that, under the old rules, businesses were paying staff in cash and then under-declaring their income. If the ATO later discovered the under-declaration, the penalty was effectively only equivalent to the amount that should have been withheld. As a result, there wasn’t a strong disincentive for businesses to do the right thing.
Under the new rules, if the tax office finds that employers have been under-declaring their income due to cash-in-hand payments, it intends to raise increased assessments and apply penalties for failure to declare this income and deny deductions for payments that failed to withhold PAYG.
Crack down on the black economy
The new rules stem from the Government’s response to recommendations from the Black Economy Taskforce. The Taskforce estimates that the black economy costs the Australian community up to $50billion a year, or 3% of Australia’s GDP. Disallowing deductions on cash-in hand payments should encourage the proper reporting of wages paid to staff and contractors.
The new rules probably won’t eliminate the common ‘discount for cash’ arrangements for tradespeople, but it should level the playing field between businesses that have been rorting the system to their own advantage compared to those that do the right thing.
It should be noted that the Tax Office has made it clear that cash payment transactions are legal. The crackdown only applies where cash is used to deliberately hide income and avoid paying the correct tax and superannuation.
What businesses should do
All businesses should check the currency and validity of ABNs provided by contractors, particularly when they’re transacting with individuals for the first time. The ABN Look Up tool is an easy way to check information provided by contractors or suppliers.
Cash and contractor-oriented industries such as construction, IT, entertainment and hospitality will need to take special care with cash payment transactions when declaring their income and also with classifying contractors correctly.
If you mistakenly misclassify an employee as a contractor, you will not lose your deductions as long as the contractor provided you with a current and valid ABN. Should your business make a mistake, the ATO is encouraging you to confess early and apply for reduced penalties. The longer an employer keeps trying to hide cash payments, the higher the penalties that will apply.
Please see our Contractors vs Employees article for an explanation of the factors that the ATO takes into account to determine contractor status. You can also use the ATO’s Employer vs Contractor Decision tool.
The new rules may give rise to grey areas in some situations. Please ask for your Accru advisor’s guidance to ensure you are compliant.