You may have noticed or read that the ATO is currently in the process of writing to a number of taxpayers who are providing personal services, to clarify if provided as a business or individual. A bit confused about the difference then read on..
Employee or Independent Contractor - What's Your Status?
In talking with lots of physios over the past 18/12, there is some degree of confusion in regards to the status of individuals either as employees or contractors. As a result of this I have asked Workforce Advisors Group to help provide some clarity in this area. Due to the volume of the information I have divided this into 2 parts.
The first part will provide background information and the various options. Part 2 will cover answer some common questions via a Q & A section. Please note that this information is provided in good faith, AAP Education is receiving no reward from Workforce Advisors Group and that you should seek professional advice, as you deem personally appropriate before making any individual decisions.
In basic terms, if more than 80% of the income an individual derives for providing a personal service comes from one source, then they will be regarded as an employee of that payer for tax purposes.
The Personal Services Income (PSI) Legislation was introduced to stop individuals from claiming to be in business as an Independent Contractor (IC). This legislation was also designed to prevent individuals from gaining significant taxation benefits by claiming business deductions and minimizing the payment of personal income tax at their marginal tax rates. Since the introduction of the PSI legislation (15 years ago), there have been an assortment of schemes, largely based on accounting principles, designed to “get around” the PSI legislation. Here we outline four different scenarios in which an individual could be considered operating as an IC, rather than an individual under the PSI legislation.
Method 1 - The Unrelated Clients Test
To not be considered an individual earning income under the PSI legislation, they would need to pass the Unrelated Clients test and one additional subset Test. In the Unrelated Clients Test, the individual has two or more unrelated clients and no one client’s revenue generates more than 80% of the individual’s total income.
For example, one client provides 70% of the individual’s personal services income and two other unrelated clients provide a combined 30% of the revenue.
If the individual passes the Unrelated Clients Test they also have to pass one of two subset tests;
- They must operate from a business premises (an office at home does not qualify)
- Or they must advertise and effectively market their services to the open marketplace and be seen to acquire new client’s from so doing
- Alternatively they would be considered in business if they have employee/s, who contribute at least 20% of the income earning revenue activity (a partner who does the books doesn’t count)
If they do pass the Unrelated Clients Test and one of the subset test, they could be classified as operating a Personal Services Business and deemed an IC.
Method 2 - The Results Test
An individual who is offering up a personal service can be considered to be in business if they pass this test when;
- The individual is engaged to achieve a Result. This assumes they have generally quoted for a body of work and have an element of both business and commercial risk
- They provide tools of trade. In other words they provide any tools and equipment necessary to perform the task they are undertaking
- They are responsible for rectifying any defects in the outcome. This means the must fix any issues in their own time, at their own cost
A simple example would be an IT expert quotes for a job – the individual is paid the quoted sum irrespective of how long it takes to complete the task.
Method 3 - Personal Services Determination
A third way is that individuals can seek a Personal Services Determination (individual ruling about classification of employment) from the ATO after supplying all information required for a decision or ruling to be made. This is specific only for the individual situation.
Method 4 - Common Law Alternative
If an individual cannot pass the relevant tests as prescribed by the ATO as set out above, the only way to legally gain status as an IC is to become engaged via the Common Law contractor engagement model.
This takes away the ATO requirement to meet the Personal Services Income (PSI) tests. It also moves the engagement outside Industrial Relations and award inhibitors and removes issues such as unfair dismissal. The individual’s status is one of a legally compliant IC operating their own business, with all the attendant benefits.
Trust this was informative. The second part in this series contains a number of Q & As, plus links to useful downloadable information kits.
All the best,
Doug Cary FACP
Specialist Musculoskeletal Physiotherapist (awarded by Australian College of Physiotherapy, 2009)
PhD Candidate Curtin University
Clinical Director AAP Education
ph/fx: 08 90715055
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