New guidance on “personal services income” rules

OzLedger • June 2, 2021

The ATO has recently updated its guidance material on the operation of the personal services income (PSI) and personal service business (PSB) rules. These highly prescriptive rules took effect from the 2000-01 income year, after the government became concerned that the income tax base was being eroded through what it saw as an excessive incidence of individuals posing as contractors, splitting their income with associates, using another entity (usually a trust or a company) and claiming a greater range of deductions than those available to ordinary employees generally.

Why the PSI lure?

You can claim deductions against PSI if an expense occurred earning this income. For example, you could claim:

the cost of gaining work, such as advertising, tenders and quotes
registration and licencing fees
account-keeping fees, including bank fees
some insurance costs, including public liability and professional indemnity insurance fees
salary or wages and super contributions for an employee engaged at arm’s length (not an associate)
reasonable amounts paid to an associate for principal work
a portion of home office expenses, such as heating, lighting, phone and internet. Do not claim rent, mortgage interest, rates or land taxes

You may be eligible for other deductions depending on what your business is and your contracts.

The updates

The ATO has updated its previous rulings to reflect various court and tribunal decisions that have shed light on the PSI and PSB provisions over the last 20 years. It has also freshened up the examples used to explain the rules (there are 40 of them).

The PSI and PSB rules can apply in virtually any business sphere, but the more common examples would be lawyers and accountants, medical practitioners, architects and engineers, business consultants and IT professionals. With the gig economy on the rise, the numbers potentially affected can only increase.

The 50% test

The PSI rules involve a series of tests to work out first, whether the arrangement is in substance an employment-like arrangement. The initial test is simply whether more than 50% of the consideration received in respect of a particular contract represents a reward for an individual’s efforts and skills. That is a “fact and circumstances” question to be determined on a case-by- case basis.

The new guidance includes a number of examples of how to determine whether the 50% threshold is met. If it is, the income will be on the face of it PSI, unless the person being tested passes the results test (more below) or, failing that, the application of a further series of tests determines that an interposed entity (a PSE) is carrying on a personal services business (PSB).

Personal services income is not:

Income from the supply or sale of goods. While some personal effort is associated with the sale of goods, sales income is derived mainly from the transfer of title in goods and is not regarded as PSI. The guidance includes a fairly straight-forward example of a partnership that designs and manufactures bespoke furniture and sells those items online and at trade fairs. The sales proceeds are from the sale of the furniture and not mainly from anyone’s personal efforts and skills.
Income from the supply and use of income-producing assets. Here the question is whether the income mainly represents a reward for the operator, or is for the use of equipment required to carry out the work. Relevant factors include:
the relative market value of the supply of the equipment as compared to the value of the operator
the basis for calculating the contract price
the significance or uniqueness of the equipment
the value of the asset, and
the role the equipment plays in generating the income.

An example used involves the supply of trench digging services using a backhoe with special attachments controlled by a licensed operator. The backhoe is transported on a truck, which is also owned by the business. In these circumstances, the income from the contract is regarded as being mainly for the supply of the truck and the backhoe rather than for the efforts and skills of the operator.

Income generated by the business structure. The new guidance provides that where income is derived by a firm or practice that has

substantial income-producing assets, or a number of employees, or both, the income is more likely to be generated by the profit-yielding structure of the business rather than from the rendering of personal services by one or more of the principals. As a rule of thumb, the threshold is where the entity has at least as many non-principal practitioners (excluding support staff) as principal practitioners.

The results test

An individual with what on the face of circumstances would seem to be PSI is excluded from the regime if they can satisfy the results test. The results test requires that, for at least 75% of the total PSI, the individual satisfies each of the following three conditions:

is paid to produce a specific result
is required to provide whatever tools and equipment are required to carry out the work, and
is required to rectify any defects in the work at their own expense.

An example used involves an IT consultant who is paid on an hourly basis, mainly uses the client’s equipment and other resources (apart from their own laptop), works under the direction of the client and is not liable to rectify any faulty work — the results test is not met in these circumstances. However, another example used by the ATO provides details about a different IT consultant. They are paid by results when the work is completed to specifications, use primarily their own tools and equipment, and are also responsible for rectifying any defects without being able to charge any additional amounts under the contract. The conditions of the results test are met in that case, and the PSI rules do not apply.

The PSB rules

Where the individual has PSI and does not pass the results test, there is still scope for escaping the application of the PSI rules. This involves the PSB rules, which amount to a rough and ready test of whether the interposed entity (usually a trust or a company) is carrying on a business. The first leg of the PSB regime is the 80% rule — no single client can represent more than 80% of the individual’s total PSI. Where that is the case, the individual or entity must also satisfy at least one of three further tests:

The unrelated clients test. The PSI is sourced from two or more non-associated clients and must be a direct result of the entity making offers to the public (or sections of the public). The unrelated clients test will not be met if the entity registers with a labour hire firm or similar arrangement, because the invitation has not been made by the entity to the public.
The employment test. At least 20% of the principal work by market value (not incidental administrative work) must be performed by others and/or they have at least one apprentice for at least half the year of income. Test individuals, including other partners who carry out principal work, are not counted towards the 20% employment test.
The business premises test. The individual owns or leases separate business premises and uses these for the work more than 50% of the time.

The tests have to be carried out every year there is evidence of PSI, and where the interposed entity has several persons with PSI, the tests need to be applied separately for each individual.

Impact of the PSI rules

Where the PSI rules apply (and the PSB rules do not) the PSI and related deductions are attributed to the individual whose personal efforts gave rise to the income (and those amounts are excluded from an interposed entity).

There are also limitations on the types of deductions that can be claimed by the individual in respect of the attributed PSI. Non-deductible expenses include:

deductions that could not be claimed if they were incurred as an employee (such as the cost of travel between home and a place of business)
mortgage interest, rent, rates and land tax on the individual’s residence (or an associate’s residence), and
payments, including superannuation contributions, made to associates for non-principal work performed.

Can anti-avoidance rules apply?

The general anti-avoidance provisions in the ATO’s arsenal can theoretically apply to an arrangement to negate any tax benefit that arises from splitting income among associates with a lower tax rate. However there is more usually an issue regarding asset protection in most instances rather than obtaining a tax benefit, which could be recorded from the outset, as well as the fact that in many cases having an incorporated entity fronting the business presents more professionally to prospective clients.

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NEWSLETTER DECEMBER 2022

By OzLedger • December 1, 2022

CLIENT INFORMATION NEWSLETTER Exclusive to OzLedger clients Tax, Super, SMSF Compliance, Work from Deductions and more Click the Report to download and read offline Total read time: 10 mins (9 pages)

The SMSF annual audit

By OzLedger • September 3, 2022

All SMSF trustees or directors must appoint an approved SMSF auditor to audit their fund every year. Not only is an annual audit mandatory but it must be conducted by an approved SMSF auditor who is registered with the Australian Securities and Investments Commission (ASIC). But who is an approved SMSF auditor and what do you need to consider when appointing one for your SMSF? Who is an approved SMSF auditor? An SMSF auditor is responsible for analysing your fund’s financial statements and makes sure that your fund is compliant with superannuation law. They must report any non-compliance issues to all fund trustees and the ATO. To qualify as an approved SMSF auditor, a person must demonstrate: • they hold the necessary academic qualifications, such as a degree (minimum three years) in accounting which included a course in auditing • they have at least 300 hours experience auditing SMSFs in the previous three years under the direction of an approved SMSF auditor • they have passed a competency exam, and • ASIC is satisfied that they: ‒ are unlikely to contravene the ongoing obligations of an approved SMSF auditor ‒ are capable of performing the duties of an approved SMSF auditor ‒ are a fit and proper person to be an approved SMSF auditor ‒ hold adequate and appropriate professional indemnity insurance ‒ are an Australian resident ‒ are not subject to an enforceable disqualification or suspension order. To maintain their approved SMSF auditor status, auditors must satisfy continuing professional development requirements, maintain adequate and appropriate levels of professional indemnity insurance and report to ASIC annually.

Hiring employees

By OzLedger • September 3, 2022

With unemployment at historic lows, workers are in demand and are also switching jobs at record rates. There are a range of issues employers should be aware of when hiring. Know the law Before hiring a new employee, make sure you know your rights and responsibilities. The minimum terms and conditions of employment come from an award, registered agreement and contract of employment, and also the National Employment Standards (NES). An employment contract or registered agreement can’t provide for less than what is in the NES. To find the right award, and if an enterprise agreement applies, visit the Fair Work Commission website. Getting pay right To work out the right pay when hiring a new employee, you need to decide on the person’s employment status – whether they will be a full-time, part-time or casual employee. Visit the Fair Work website or ask us for guidance. On the Fair Work website, you can also locate the minimum pay rates, penalties and allowances that apply using their Pay and Conditions Tool. Employment contracts It’s important that your employment contracts protect your business and your staff. To help you get things right, use the business.gov.au – Employment Contract Tool to create an employment contract that’s tailored to your business needs and complies with workplace laws. To use this tool, your employee must be full-time, part-time or casual, covered by an award, paid an hourly or weekly wage.

Consolidate your super

By OzLedger • February 4, 2022

Did you know that there are approximately 10 million unintended multiple super accounts, which represents around 35% of all member accounts held by funds? While in some cases this outcome may be intended, more often than not the creation of multiple accounts is unintended and mainly occurs when employees change jobs and do not nominate the same (or any) account for their super guarantee to be paid into. These multiple super accounts are costing Australians an extra $690 million in duplicated administration fees and $1.9 billion in insurance premiums per year, which is eroding many Australians’ hard earned super benefits. If you are one of these individuals with multiple super accounts, there may be benefits to rolling your accounts onto one super fund. The benefits of consolidating funds There are a number of benefits of rolling your accounts into one fund, including: Prevent duplicated fees – having one super fund means one set of fees, potentially saving you hundreds and thousands of dollars over your lifetime. Easier to manage – having all your super in one account makes it easier to manage as there is less paperwork and administration to worry about. Maximise your investment returns – once you have consolidated your funds, it will be easier to manage your investment strategy and you’ll be able to maximise the funds to invest.

Inheriting rental properties jointly A dilemma?

By OzLedger • September 30, 2021

Imagine you’re lucky enough to inherit, say, four post-CGT rental properties from a deceased parent – but what happens when your sibling also inherits a half-share of these? While you both acquire a very valuable 50% interest across four properties, it’s safe to say that in most scenarios, you’d both rather have a 100% interest in two of them. CGT triggered Assuming both siblings desire a 100% interest in two properties each (rather than a 50% interest in four properties), they’re going to have to do a bit of “horse trading” between them. This means that each sibling has to give up their 50% interest in two of the four properties, in exchange for acquiring a 50% interest in the other two properties. It’s important to note that such an exchange of interests will trigger CGT consequences. This is because the interest exchanged (or disposed of) is a CGT asset with a particular cost base (under the inherited asset rules in s 128-15), and the capital proceeds for this CGT event will be the market value of the interest acquired in another property. However, the benefit of the CGT discount should be available. Moreover, because none of the properties are a main residence or a pre-CGT dwelling, the full CGT exemption rules in s 118-195 cannot be brought into play. Even so, there may be a couple of solutions to this problem that allow both siblings to get their desired 100% interest each in two properties – without triggering any CGT consequences. Solution 1: A broadly written will If the will’s been written in broad enough terms, the executor could use their power/discretion to treat the properties as a pool of assets that can be divided equally between the siblings (ie, so they can get two each). While this presents one solution, adjustments may still be required if some of the properties have a greater contingent CGT liability attached to them than others (at least at the time of distribution) – and this would have to be accounted for in some way to keep both siblings happy. At any rate, this becomes a matter of the interpretation of the will – a complex topic that’s beyond the scope of this article – and other issues relating to trustee powers may need to be factored in.

Home as a place of business during COVID: CGT implications

By OzLedger • September 30, 2021

The COVID-19 pandemic has resulted in more employees working from home than ever before. This, in turn, has resulted in such people being able to claim a range of deductions for various “running expenses” associated with working from home. These expenses include electricity, phone service, cleaning, decline in the value of equipment, furniture and furnishing repairs, and so on. To make things easier, the ATO even provided several “short-cut” options to claim “working from home” expenses (as opposed to claiming the relevant proportion of the actual costs). In addition, many people who operate a business (eg, as a sole trader or in partnership) have been required to use part of their home as a place of business – or may have been doing so for many years anyhow. They, too, are entitled to claim various “running expenses” associated with working from home. Moreover, if part of the home has the character of a place of business and is set aside as such, then such persons would generally also be able to claim a portion of occupancy expenses (such as mortgage interest or rent, council rates, land taxes, house insurance premiums) in addition to running expenses. This is because part of the home is an asset that is used in carrying on their business. However, where part of a home is being used as a business to generate assessable income, the homeowner will not be able to sell their home CGT-free. Instead, a partial CGT main residence exemption will apply on the basis that part of the home has been used to produce assessable income (in the same way it would apply if part of the home had been rented at arm’s length).

Claiming GST credits for employee reimbursements

By OzLedger • September 5, 2021

If you are an employer registered for goods and services tax (GST), you may be entitled to claim GST credits for payments you make to reimburse employees (including company directors) or partners in a partnership for certain work-related expenses. If you are running a business, you will be entitled to a GST credit for an employee-reimbursed expense if the following criteria are met: the employee’s (or associate’s) expense is directly related to their activities as your employee or the reimbursement is an “expense payment benefit” the sale of the item bought by your employee was taxable (that is, not “input taxed”), and your employee is not directly entitled to a GST credit for the expense The ATO says a business can claim GST credits where it has relevant documents such as receipts or tax invoices issued to the employee. These will need to be provided to substantiate claims for reimbursement. A business that is entitled to a GST credit can claim it in a Business Activity Statement once it has been provided with this documentation. An “expense payment benefit” is made, according to the ATO, when a business makes a payment to, or reimburses, another person “in whole or in part, of an amount of money spent by your employee as part of their employment with you”. Fringe benefits tax (FBT) may apply however. A business is not entitled to a GST credit if it has: reimbursed “non-deductible expenses”, such as the portion of expenses relating to entertaining clients (usually only half of such expenses are deductible for the provision of entertainment)

Buying a new home before selling the old one: The ins and outs

By OzLedger • September 5, 2021

Sometimes an individual or couple decide to buy a new home before selling their existing one. In such cases, a concession exists that allows for both houses to be treated as a main residence for up to six months – but only if certain conditions are met. Section 118-140 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that both the old and new dwellings can be treated as the taxpayer’s main residence for the lesser of: The six-month period immediately before the sale of the existing home, or The period between the purchase of the new home and the sale of the existing home. So if it takes a taxpayer less than six months to settle on the sale of their original home after having settled on the sale of their new home, then both homes can be treated as the taxpayer’s main residence during this period. On the other hand, if more than six months passes between the settlement of the new home and the (later) settlement of the original home, both dwellings will only be treated as a main residence for a maximum period of six months before the settlement on the original home. In the latter instance, a partial CGT exemption will apply during the excess period (i.e. after the maximum six months) to either the original or new home. Which of them it is will depend on which did not qualify as the taxpayer’s main residence. Other than the fundamental requirement that the new home must become the taxpayer’s main residence, the other two key requirements that must be met for the concession to apply are: The existing home must have been the taxpayer’s main residence for at least 3 of the 12 months before the taxpayer’s “ownership interest” in it ends, and

Where do reward programs stand in regard to tax?

By OzLedger • August 22, 2021

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Trust losses: Keeping them in the family

By OzLedger • August 22, 2021

Who can (and can’t) be part a family group for the purpose of making a family trust election (FTE)? As you can see by the diagram below, the ‘family group’ is dependent on the choice of the ‘test individual’. Once that person is chosen, the family group includes the person’s spouse, plus any of their children, grandchildren, parents, grand- parents, brothers, sisters, nephews, or nieces. The spouses of any of these people are also included. The family group can include a de facto spouse, stepchildren and half-brothers and half-sisters, but not aunts and uncles, cousins, great-grandchildren, or stepbrothers and stepsisters. The spouse of a deceased test individual will continue as a member, but not if they partner up again. And where a married test individual is divorced, the family group membership of their former spouse is ended. However, the former spouse is still in the family group in relation to distributions. Importantly, if the test individual dies, the trust remains a family trust and the family group continues to be worked out by reference to the test individual. Where an FTE is made, the rules that limit the deductibility of prior year and current year losses and bad debt deductions are much less onerous. Only the income injection rule applies, and then only where a person outside the family group is involved. Otherwise, there is also a 50% stake test, a control test and a pattern of distribution test that have to be satisfied. Having an FTE also relaxes the company loss tracing rules, the holding period governing access to franking credits and the application of the trust beneficiary reporting rules. Keep the diagram handy when confirm who the beneficiaries of a family trust can be, without paying family trust distributions tax.