What's that?
These days more
people are contracting themselves
out to employers instead of going
on the payroll. It may be because
you don't want a regular job or
your "employer" may insist on this
arrangement because it suits them
better. But if you're using some
sort of structure, such as a
company, trust or partnership, the
Australian Taxation Office (ATO)
will be looking at how the income
is earned and distributed.
You may remember that as part
of the tax reform process the
Federal Government released new
rules a couple of years back on
what constitutes a personal
services business. These
businesses can file separate tax
returns and are allowed a wider
range of tax deductions than are
available to employees.
Consultants or contractors who
don't meet the personal services
business requirements can still
operate through a trust, company
or partnership, but they must
declare the income in their own
name and the available deductions
are more limited.
However, Paul Drum, the senior
tax counsel with CPA Australia,
says many people have assumed
that if they meet the personal
services business requirements,
the rules have given them carte
blanche to split their income with
other people through the
company, trust or partnership.
And that's not true. In fact, the
ATO has recently released a fact
sheet on how it believes the
general anti-tax avoidance
provisions apply to personal
services income.
What does that mean?
In a
nutshell, the ATO reckons that
income earned from providing
personal services is different from
income earned by businesses.
That's the case even if you're
deemed to be operating a personal
services business. (Confusing, isn't
it?) So while a normal business
can decide how much of its
income to pay to each of its
employees, and can retain profits
within the business, personal
services income should be taxed in
the hands of the person who did
the work. The ATO is concerned
that some people are earning
income and then directing part of
it to other people – usually family
members – to benefit from their
lower tax rates.
In some cases, it says, the
"benefits" to family are often made
mostly through super
contributions and in other cases
profits are retained in the
company structure where they
benefit from the lower company
tax rate and may be split in the
future. The fact sheet is an
attempt to warn taxpayers that
they may be in breach of the antiavoidance
provisions if they do so.
Does that mean I can't employ
my spouse in my business?
Not
necessarily. The ATO says you can
pay an associate for services that
are related to your earning of the
income if the amount paid is
reasonable. But it says you'd be
smart to keep records on the work
done, the hourly rate of pay and
how the work relates to the work
undertaken by the principal
contractor. Drum says this is not a
clear area of law and each case
will be judged on its merits. But
the ATO will look at where the
money is earned and to whom it is
eventually paid.
Is the ATO on firm ground here?
Not entirely. The anti-avoidance
provisions deal with the intent of
arrangements as well as their form
and substance. Not all the cases
heard on income splitting have
gone the ATO's way. In its recent
decision on the Mochkin case, for
example, the Full Bench of the
Federal Court held that a taxpayer
did not run foul of the antiavoidance
provisions by setting up
a corporate trustee to receive
commission income. Even though
there were clear income-splitting
tax benefits, it said, the dominant
purpose of the arrangement was to
protect the taxpayer from personal
liability – not to avoid tax.
The ATO has said it wants to
conduct a number of test cases to
sort out any grey areas in the law.
But Drum says that this will take
time and it won't be easy to find
cases that cover all the
arrangements people are entering
into. "Taxpayers need to be aware
that if they take this path [income
splitting] they could end up in
litigation," he says. "They need to
weigh up the level of risk against
the benefits."
