CONTRACTORS risk falling foul of the Australian Tax Office’s Alienation of Personal Services Income provision even if their business entity passes the results test.
CONTRACTORS risk falling foul of the Australian Tax Office’s Alienation of Personal Services Income provision even if their business entity passes the results test.
While businesses that pass that test may think they are entitled to the same business deductions and income splitting provisions as a normal business, this is not the case.
They are deemed to be running a personal services business but even though they will not be treated as an employee for tax purposes, their ability to limit tax through means open to other business is limited.
The ATO will not allow a contractor to reduce his/her tax liability through making excessive salary or superannuation payments to a spouse or by retaining profits in a company structure.
If profits are retained in the company structure they are only subject to a tax rate of 30 per cent.
Income can only be split with the contractor’s spouse if they are working in the business. That rate of income splitting is limited to the commercial rate of pay for the work the spouse is doing.
The benefits of income splitting are obvious. If a contractor’s business earns $120,000 a year and the income is not split, the tax bill is $43,780. If the contractor splits the income with his/her spouse equally then the tax bill on the two incomes of $60,000 is $31,680.
Jackson McDonald tax partner Graham Harrison said there were two key problems tied up with the alienation provisions.
“The first is people are incorrectly applying the results test to their income when they don’t have to,” Mr Harrison said.
“Alienation is the definition of whether income is the reward largely for the person’s exertion or skill.
“But some businesses may be deriving sources from areas other than personal services such as through a profit yielding business structure, from the sale or supply of goods, the use of plant and equipment or even from passive investment such as interest or dividends from public companies.
“Most owner-driver couriers, for example, fall into this area. Their contract fees are usually more than 50 per cent towards the use of their motor vehicle.”
Taxation Institute WA chairman Graeme Cotterill said the results test itself posed a problem for contractors.
The ATO introduced the results test to help businesses self-assess whether they were carrying out a personal services business.
To pass the test contractors need to show they have been contracted to produce a specified result, they are providing their own tools of trade and that they bear commercial risk – including liabilities arising from defective work.
“At the end of the day it is hard to know if you are on the right or wrong side of the test,” Mr Cotterill said.
“The disadvantage with the results test is that it can be a matter opinion as to whether the business has passed the test. The other rules such as the 80 per cent rule provided more certainty.”
The 80 per cent rule deemed that if contractors earned 80 per cent of their income from the one source, they were earning personal services income and would be treated as an employee for tax purposes.
To get a business classified as a personal services business under that rule, a contractor had to satisfy the unrelated clients test, the employee test or the business premises test.
“Those tests were an administrative hassle but still provided certainty,” Mr Cotterill said.
Barrington Partners partner Roger Sullivan said the ATO’s new alienation of personal services income legislation meant only the most blatant tax cheats would be caught.
“They brought out the results test and then the commissioner turned around and said the old rules still applied,” Mr Sullivan said. “The ATO can still decide a contractor has personally derived the income.”
While businesses that pass that test may think they are entitled to the same business deductions and income splitting provisions as a normal business, this is not the case.
They are deemed to be running a personal services business but even though they will not be treated as an employee for tax purposes, their ability to limit tax through means open to other business is limited.
The ATO will not allow a contractor to reduce his/her tax liability through making excessive salary or superannuation payments to a spouse or by retaining profits in a company structure.
If profits are retained in the company structure they are only subject to a tax rate of 30 per cent.
Income can only be split with the contractor’s spouse if they are working in the business. That rate of income splitting is limited to the commercial rate of pay for the work the spouse is doing.
The benefits of income splitting are obvious. If a contractor’s business earns $120,000 a year and the income is not split, the tax bill is $43,780. If the contractor splits the income with his/her spouse equally then the tax bill on the two incomes of $60,000 is $31,680.
Jackson McDonald tax partner Graham Harrison said there were two key problems tied up with the alienation provisions.
“The first is people are incorrectly applying the results test to their income when they don’t have to,” Mr Harrison said.
“Alienation is the definition of whether income is the reward largely for the person’s exertion or skill.
“But some businesses may be deriving sources from areas other than personal services such as through a profit yielding business structure, from the sale or supply of goods, the use of plant and equipment or even from passive investment such as interest or dividends from public companies.
“Most owner-driver couriers, for example, fall into this area. Their contract fees are usually more than 50 per cent towards the use of their motor vehicle.”
Taxation Institute WA chairman Graeme Cotterill said the results test itself posed a problem for contractors.
The ATO introduced the results test to help businesses self-assess whether they were carrying out a personal services business.
To pass the test contractors need to show they have been contracted to produce a specified result, they are providing their own tools of trade and that they bear commercial risk – including liabilities arising from defective work.
“At the end of the day it is hard to know if you are on the right or wrong side of the test,” Mr Cotterill said.
“The disadvantage with the results test is that it can be a matter opinion as to whether the business has passed the test. The other rules such as the 80 per cent rule provided more certainty.”
The 80 per cent rule deemed that if contractors earned 80 per cent of their income from the one source, they were earning personal services income and would be treated as an employee for tax purposes.
To get a business classified as a personal services business under that rule, a contractor had to satisfy the unrelated clients test, the employee test or the business premises test.
“Those tests were an administrative hassle but still provided certainty,” Mr Cotterill said.
Barrington Partners partner Roger Sullivan said the ATO’s new alienation of personal services income legislation meant only the most blatant tax cheats would be caught.
“They brought out the results test and then the commissioner turned around and said the old rules still applied,” Mr Sullivan said. “The ATO can still decide a contractor has personally derived the income.”
