From 1 July 2000, a new tax measure applies to income earned from providing personal services (personal services income). The measure affects consultants and other contractors.
Individual contractors affected by the measure generally have the same deductions that would be available to someone earning the income as an employee.
If contractors operate through a company, partnership or trust to earn this type of income, payments to their entity (personal services entity) are still taxed as their personal earnings. The deductions that the entity can claim are limited. Partnerships will, and companies and trusts may also have additional Pay As You Go 9PAYG) obligations where any personal services income is not paid out to the contractor as salary or wages within 14 days after the end of the PAYG payment period.
However, if a contractor (of their entity) qualifies as a personal services business their personal services income is generally not affected by the measure.
There are three tests for determining whether an individual or a personal services entity is conducting a personal services business in an income year. Generally, at least one of these personal services business tests must be met.
When does the new measure apply?
The new measure applies from 1 July 2000. If you had a payee declaration under the former Prescribed Payments Scheme in force and lodged with the Commissioner as at 13 April 2000, you will not be affected by the new measure until the income year commencing 1 July 2002.
Why is it being introduced?
The new measure seeks to ensure a consistent and fair taxation treatment for people who earn their income from providing personal services. It is designed to ensure that personal services income will be taxed in the same way if it is paid directly to an individual or channelled through a company, partnership or trust.
What is personal services income?
Income is personal services income if the client is mainly paying for your personal skills or effort. If does not include income where the client is paying mainly for:
- the supply of goods, or
- the use of an income-producing asset.
NewIT Pty Ltd provides computer programming services, but Ron does all the work involved in providing those services. Ton uses the clients’ equipment and software to do the work. NewIT’s ordinary income from providing the services is Ron’s personal services income because it is a reward for his personal efforts or skills.
Joe builds reproduction furniture, which he sells through a friend’s shop. The income from the sale of the furniture is not Joe’s personal services income because the buyers are paying for the supple of furniture not for the personal skills and effort of Joe in building the furniture.
Ian’s company, Ian Pty Ltd, has a contract to supple an excavator to level uneven surfaces. The income mainly comes from the supply and use of the income-producing equipment, namely the excavator. The income is not personal services income.
What is a personal services business?
There are three tests for a personal services business:
- the employment test,
- the business test, and
- the unrelated clients test.
The employment test relates to whether you engage others to do at least 20% of the principal work, which you are paid to provide. It also relates to whether you have apprentices for at least half of the income year.
The business premises test relates to whether you use and maintain physically separate business premises to conduct the activities that gain or produce the income.
The unrelated clients test relates to whether you have 2 or more clients to whom you provide services to as a direct result of offering your services to the general public or a section of the public, eg. As a result of advertising.
What if you pass one of the tests in an income year?
If less than 80% of your personal services income in an income year is from each client (including associates of the client), and you meet all the requirements of one of the tests, you can self assess and rely on that test.
Even if the test is met in an income year, a personal services entity may still have an additional PAYG withholding obligation regarding the income during that year. This obligation will apply if, in the previous year, the entity received personal services income, but did not meet any of their personal services business tests. In 2000-01 income year, the obligation to pay applies quarterly. For small withholders, the first payment is due 11 November 2000 with their quarterly obligations.
How do you rely on one of the tests if 80% or more of the personal services income is from one client?
If 80% or more of your personal services income in an income year is from one client (including associates of the client), you will not be taken to be conducting a personal services business unless you obtain a personal services business determination. If you apply for a determination, the Commissioner may consider who applies the test.
When considering whether to make determination, the Commissioner may consider the employment and the business premises test. The Commissioner cannot consider whether you meet the unrelated clients test. The commissioner may also make a determination if any unusual circumstances exist that prevent you meeting any of the three tests in a particular income year. Applying for a determination is optional.
Until a determination is in force, personal services entities may have an additional PAYG withholding obligation in respect of the income. An Application for Determination and Instructions are available from the Tax Reform web site www.taxreform.ato.gov.au or by calling 1300 137 619.
What are unusual circumstances?
Unusual circumstances are one-off situations affecting your business for a limited time. If you expect them to continue indefinitely, this suggests that they are no longer unusual. Your business may encounter unusual circumstances if it has only started up, or if it encounters an economic downturn.
How do you rely on the test if each client provides less than 80% of the income?
If in an income year, each of your clients (counting associated clients as one client) provides less than 80% of the income, you apply the test yourself under a self-assessment process. A Personal Services Income Self-Assessment Guide is available from the Tax Reform web site www.taxreform.ato.gov.au or by calling 1300 137 619.
Will contractors need to become employees?
The measure only applies to how the income is taxed. This means that if you are a contractor who provides personal services to a client, you do not become an employee of that client. The measure does not affect the legal, contractual or workplace arrangements you have with your clients. Your entitlement to an ABN and to registration GST will also not be affected.