Do you operate through a company or other entity that derives income mainly from your personal efforts and skill? Do you obtain work through a labour hire firm or other job placement agency? The Australian Taxation Office (ATO) has announced a data-matching exercise to target personal services income being paid to a company or other interposed entity by labour hire firms, placement agencies and computer consultancies. Individuals in this situation should be aware of the personal services income rules.
What Is Personal Services Income?
Personal services income is income generated mainly as a reward for the personal efforts or skills of an individual. Examples include income derived by a computer technician for fixing a computer, or by a doctor for treating a patient.
There is a general principle that the person who earns income by providing personal services should be the person liable for tax on that income. Where an individual, trust, partnership or company derives income mainly from the personal efforts and skill of one individual, the personal services income rules may apply to ensure that the individual pays the tax on that income, and to limit the deductions available.
What Are The Exceptions?
The personal services income rules do not apply if you can satisfy the results test, or you are carrying on a personal services business. The rules will also not apply if the entity promptly pays you a salary or wage for the income derived from your personal efforts.
What Is The Results Test?
The results test requires the individual or company to be acting like a true contractor in that:
- the work is for producing a result;
- the individual or personal services entity supplies the equipment or tools necessary to do the work; and
- the individual or personal services entity is liable for the cost of rectifying any defective work.
Individuals, companies and other entities obtaining work through job placement agencies may find the results test difficult to satisfy because these agencies often place people in existing work situations, where materials are supplied.
What Is A Personal Services Business?
A personal services business exists if none of the clients of the individual or personal services entity pays that individual or entity 80% or more of its personal services income and one of the following three tests are satisfied:
- The Unrelated Clients Test: the individual or personal services entity derives income from 2 or more unrelated clients directly as a result of public advertising;
- The Employment Test: the individual or personal services entity employs others who carry out at least 20% of the principal work, or engages an apprentice for at least half the year;
- The Business Premises Test: the individual or personal services entity maintains business premises at which the individual mainly conducts the activities which give rise to the personal services income.
How Does This Apply To An Entity Contracted By A Labour Hire Agency?
An individual or personal services entity will not be treated as having publicly advertised simply because they have signed up with a labour hire agency. This means that even if an individual or personal services entity performs work for a number of different clients over a year, if that work is all arranged through a labour hire agency, the personal income services rules will apply unless the employment test or business premises test can be satisfied.
What Is The ATO Doing?
The ATO is seeking information from around 34 labour hire and computer consultancy organisations in relation to the current financial year. The ATO will seek information such as the ABN of clients making payments, the ABN of companies, partnerships and trusts receiving the payments, and the individuals associated with those entities. The ATO will identify trends from its data-matching exercise and will target those taxpayers who fall outside the trend. The ATO has stated that taxpayers falling outside the trend will initially be provided with an opportunity to verify or explain their information. It can be expected that the data-matching exercise will lead to audits of taxpayers who cannot provide adequate explanations.
What Does This Mean For You?
If you think you, or an entity such as a company, trust or partnership, are receiving personal services income, you need to ensure you comply with the rules. If you fall within the ATO's data matching exercise you should pay particular attention as you are unlikely to slip unnoticed through the tax net.
If you have not properly completed a tax return or if you are unsure whether the personal services income rules apply to you, you may wish to take pre-emptive action to review your situation and advise the ATO of any breach of the law. Pre-emptive action limits the time for which interest may be charged, and the ATO is less likely to impose penalties where a taxpayer volunteers information, rather than waiting for the ATO to find it in an audit.
How Can Deacons Help?
The Deacons tax team can advise you regarding the personal services income rules, and whether you need to take action to correct information supplied to the ATO.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.