In the Government’s response to the second stage of the Ralph Committee Review of Business Taxation it has signalled that it intends to introduce measures to limit the avoidance of income tax that occurs through alienation of personal services income thro
Under the measures the government has adopted, this type of income will be treated as the income of the individual and taxed accordingly.
The key features of the proposal are that:
• The measures will apply if 80 per cent or more of the personal services income received by the entity for the services of the personal service provider is from one service requirer (including associates of the requirer).
Entities that receive 80 per cent or more of their income from one service requirer will be able to seek a ruling from the Commissioner of Taxation that they are providing their services in the manner of a personal services business and are outside the scope of the measure.
• The measures will also apply to entities that receive less than 80 per cent of their income from one service requirer but do not
provide services in the manner of a personal services business.
• The measures will apply from 1 July 2000.
As the press release relating to this issue puts it: “The increased avoidance of tax through the alienation of personal services income poses a growing threat to the income tax base. The use of interposed entities to avoid or defer income tax raises issues of equity between those that can take advantage of these arrangements and other providers of personal services, including wage and salary earners, who pay the correct amount of tax.”
Currently, personal services income is defined as income that is earned by the personal exertion of an individual. This can be considered to have been ‘alienated’ when an entity is interposed between the individual earning the income and the person paying for their services to create a third party that is supposedly the entity earning the income.
If the interposed entity is a lower tax paying entity then savings can be achieved. For example, individuals earning income as an engineer could be in receipt of income well in excess of the threshold for the top marginal tax rate. By alienating this income through a company, it may be possible to achieve a considerable reduction in tax rates.
Given that the corporate tax rate is dropping over the next two years, this problem could well be compounded even further.
The change being proposed is nothing more than a tightening and codifying of the procedures that exist now and can already be used by the ATO.
It is to be commended that after considerable lobbying the Govern-ment has finally decided something needs to be done. The legislation is still to get to parliament and it is hoped the opposition parties will assist its passage.
• Economist Suresh Rajan is a director and proper authority holder with Smith Martis Cork and Rajan – financial planners.