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How superannuation laws administered by the Australian Tax Office discriminate against self-employed people

Update: February 2011

In October last year, we chronicled the example of an Australian accountant who'd been denied tax deductibility of his superannuation contributions because the ATO claimed he was an employee (see below). He'd received a massive tax bill going back several years. You can see his original correspondence with the ATO here.

We encouraged him to appeal. His lawyers said he wouldn't win. He's just informed us that he has won. The ATO has accepted that he's self-employed. Here's his letter from the ATO. Commonsense has prevailed!


October 2010

Background

We're all reaching for something in life. As self-employed people we want the right to be our own boss. This is our striving to control our own business destiny, to do things our way---even if it's a bit different. This is entrepreneurship and creativity.

Yet the formal institutions of our society mostly say this is wrong. Sure, they don't say this directly, yet they impose this entrepreneurship-killer through administrative processes backed by legislation.

At Independent Contractors Australia we're dedicated to defending people's right to be their own boss. This leads us into all sorts of legal and administrative 'nooks and crannies' of government activity. One of these is the way the Superannuation Guarantee Levy (SGA) discriminates against self-employed people, denying them/us equitable tax treatment, forcing them/us to be employees when we want independence. It's effectively the enforcement of sham employment.

Here's how it works

It's a sophisticated tax trick. There are three pieces of law:
  1. Superannuation Guarantee Levy: This law says that if you are an 'employee', your 'employer' must pay an additional 9% (currently) of your wages into superannuation.
  2. Personal Superannuation Contribution: This law allows you to make additional personal contributions to your own superannuation and claim the contributions as a tax deduction against your income. You can currently claim up to $25,000 a year under the age of 50 and $50,000 a year over the age of 50. This is designed to encourage all Australians to save for their retirement.
  3. 10% rule. This is the 'trick': This law says that if you are only an employee or only a contractor in a year, you can make the additional allowed superannuation contributions. BUT If you work as a mix of employee and contractor in a year, you do NOT receive tax deductions for any personal contributions you make to your superannuation retirement nest egg.
Comment: The 10% rule is a blatant case of tax discrimination against self-employed people preparing for their retirement. It is quite common for many self-employed people to have a mix of employment and self-employment when they work. When they do have a mix, they are denied normal legal and legitimate tax deductions for their retirement savings. We have asked people at the ATO and Treasury why this is so. They agree that it is discrimination. We have asked why this discrimination exists when the point of superannuation is to encourage people to save for their retirement. The (unofficial) reply we received is that the 10% rule saves the government money. Outcome? It's a sneaky money-making trick by the government. (Note: The 10% rule has been in place for a long time and is not a new law imposed by the current federal government.)

Aggressive Super Auditing by the ATO: Money-making government grab
For some time now the ATO has been aggressively auditing businesses to see if they are paying the Superannuation levy. It's good that they do this, and in fact the ATO is required to do this under legislation. The audits need to be conducted to ensure that all employees receive their proper entitlement to superannuation from their employers.

But, lately, we are seeing cases where we must question the audits. What's happening is that people who look very much like self-employed people are being 'declared' employees for superannuation purposes. The ATO 'victories' are presented in the media as a 'win' for employees. But are they?

The cases we have seen are where people are most likely operating as self-employed people most of the time, but find the ATO declaring them employees for some of their work. The unseen and unpublicized discrimination means that these people are suddenly subject to the 10% rule and denied otherwise legitimate tax deductions for their personal superannuation contributions. What looks on the surface to be the ATO's protecting employees turns out to be a money-making grab by the government.

Cases

There are two legal wins by the ATO that raise concerns:
1. Translators [Associated Translators and Linguists Pty Limited and Commissioner of Taxation [2010] AATA 260]
    A translators' booking agency has operated for many years, taking bookings from clients (the courts, etc.) and sending translators on their books to do the translation. The client pays the agency who pays the translator a fixed fee for the hours of work they have done. On the surface, the translators have all the elements of being self-employed. They bring their personal and professional skills to the job and are not and cannot be controlled by either the clients or the agency. Yet the ATO decided that the translators are employees and the Administrative Appeals Tribunal has agreed. The booking agency is appealing to the Federal Court.
2. Roy Morgan Research [Roy Morgan Research Pty Ltd v Commissioner of Taxation [2010] FCAFC 52 (26 May 2010)]
    Roy Morgan Research uses many people to conduct research, a large number of whom are employees and for whom the company pays superannuation and other obligations. However, Roy Morgan Research also has researchers who visit homes asking questions of residents. Roy Morgan Research has considered these people to be self-employed and treated and paid them accordingly. The ATO declared the people to be employees and the Federal Court has agreed. The main argument for the claim that the people are employees rests on the fact that Roy Morgan Research gives the researchers the questions that are to be asked. The ATO/Court view is that this means Roy Morgan Research 'controls' the researchers.
Comment: Both the translators and researchers cases display significant features where the people involved would be said to be self-employed. But there are other indicators where the courts have found employment. But look at the tax and cost implications for the people concerned as well. These fall into two categories:
  1. Double dipping of superannuation costs: Normally, where businesses genuinely engage self-employed people, it's clearly understood that the payments contain an inbuilt component for superannuation. That is, a self-employed person is receiving more money within the package than they would as an employee because an amount for superannuation is included. Where this occurs and the ATO then declares the person to be an employee, the business that engaged the person then has to pay superannuation again. The business could (although it's probably not feasible) seek to readjust the worker's previous pay, claiming back the superannuation component built into the previous pay rate. It's a bit of 'the dog chasing its tail' situation.

    The outcome, however, is that businesses become scared about engaging individuals as self-employed people for fear of being caught in this ATO cost pincer movement. This is demonstrated in the email from a self-employed person (below).
  2. Denial of superannuation contributions: This is where the real tax sting comes into play. People who thought they were self-employed and who wish to be self-employed suddenly find their self-employed status for superannuation tax purposes denied to them. It's presented in the ATO public relations pitch as a 'win' for these people. But it's not. Where they have made voluntarily contributions to their superannuation (which is what we want people to do!) they suddenly find their tax deductions are rejected by the ATO under the '10% rule' and they have a large new tax bill. Who wins? The government---because it has just used its administrative and legal power to maneuver additional tax revenue for itself against the direct intent and spirit of superannuation. This is no theoretical assessment. Look at the following case.

Self-employed accountant slammed

A self-employed accountant recently brought us a problem over superannuation. This person is approaching retirement and putting as much into superannuation as the tax laws allow. The accountant is doing exactly as the community would want and the tax laws encourage---that is, for people to maximize their retirement savings so as to be as self-sufficient as possible in retirement.

But look at what's happened.
  • Quite recently, the ATO sent a letter claiming the accountant is an employee, simply because most of the income currently comes from one client.
  • The ATO has sent a huge additional tax bill and require payment within a very short time frame. Payment must be made before the ATO will consider an appeal. The tax bill is based on the ATO's assertion that the accountant is working partly as a self-employed person and partly as an employee---(i.e. the 10% rule).
The accountant has supplied us copies of the correspondence, given us approval to publish and it's all here. We've blacked out any identification of the accountant and persons handling the file at the ATO.

We're publishing this because it really gives a true understanding of how the superannuation tax system is rigged to discriminate against self employed people. And it's done it by stealth. Very few people understand or even know of this 10% rule and how it's used in conjunction with superannuation rules to rake in revenue for the government. This is done while the government blows a loud trumpet about wanting people to save for their retirement. If you, as a self-employed person become caught in this snare, what this accountant is going through is what you will face.

Here are the documents:
  1. Letter received by the self-employed accountant from the ATO asserting employment status.
  2. Tax bill the ATO sent to the self-employed accountant.
  3. Reply from the self-employed accountant to the ATO.
  4. Copy of the ATO website decision tool used by the self-employed accountant to verify being self-employed.
  5. Letter from the self-employed accountant's client verifying that the accountant is self-employed.
Comment:
Some points that come out of this are:
  • On our view, the ATO's justification for saying the accountant is an employee breaches the ATO's own formal legislative requirements for assessing if someone is an employee. An individual is not, at common law or under statute, an employee simply because his or her income comes predominantly from one source.
  • The ATO tax form has sneaky triggers in it for the honest and unsuspecting individual that dispose the ATO to declare a self-employed person to be an employee. It's almost as if the tax form has been designed this way. That is, if you fill out the wrong boxes in the wrong way, the ATO claims you're declaring yourself to be an employee.
  • The self-assessment tax tool on the ATO website cannot be trusted. The tool is supposed to help you clarify if you are self-employed or not. Yet the ATO seems to ignore this and has its own (hard-to-fathom) rules applying in a different way.
  • The ATO is able to impose its 10% rule 'trick' through a process of commercial intimidation. It is very difficult and expensive for an ordinary self-employed person to know and understand these strange rules, let alone have the money to dispute and fight the ATO in the courts.
The best tax systems maximize voluntary compliance. This 10% rule/superannuation process makes voluntary compliance almost impossible because it's almost impossible to know what the rules are. The rules seem to be oriented towards catching honest people in a trap.

The best explanation

The system described above scares business from allowing self-employed people to be self-employed, even when that is the wish of both parties. It works against entrepreneurship, creativity, better business and a better society.

While we were investigating the issues discussed above we received an email from 'Judy.' Her words really sum up the outcome of this institutionally created problem.

    Received 23 October 2010

    Hello,
    I wonder if I can ask for your advice in deciding if I can claim independent contractor status? I've checked the ATO website & contacted Fair Work Australia without a clear and concise answer.

    I'm a Bookkeeper, I have a Diploma in Business, a Cert IV in Financial Services (Bookkeeping) and I've been granted a License as a BAS Agent by the Tax Practitioner's Board. I have an ABN. I have my own insurance. I advertise my bookkeeping services in work wanted local newspapers, have a business card and I'm actively seeking other bookkeeping work.

    The reason I ask is one of the Company's Accountants have given a Director of a business advice that they are at risk of being fined & having to pay me superannuation. This is causing both the business I am working for and me a great deal of anxiety.

    I value my freedom as a contractor & believe I am perfectly within my rights to call myself an independent contractor.

    Yours sincerely,
    Judy

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Submitted Comments

On 29 October 2010, Michelle commented:

I am in a similar situation to Judy. In fact, my original decision to become self employed was based on the fact that I was not receiving any training or direction as an employee. I have since completed a Certificate IV in Financial Services (Bookkeeping) and any training I do in order to keep abreast of changes in relation to the work I do is done at my expense. I have also accessed the decision tool for employee versus self employed and find it surprising that this aspect of self employment does not rate a mention


In October 2010, Alex wrote:

Hi Ken,
First like to say thanks for making yourself available.

I'm a little confused at the moment about my working arrangement and the rights that I have.

My 'employer' considers me a contractor and pays me based on the invoices I submit to them. I also have an ABN. I do not get paid any benefits such as sick/holiday leave.

However I was told the other day that I have no right to refuse work or to set my own hourly rate. I have fixed working hours and fixed pay rates. It seems like these are what conditions a normal 'employee' would work under.

Anyways I have just told the company that I will no longer be working for them and that I will finish my last job tomorrow.

They seem to think that I can't just terminate like that and expect me to stay on for another 2 weeks. The reason that I am leaving is due to health reasons and I am not about to aggravate my problems anymore just because someone tells me to.

The contract I signed with them asked for two weeks notice. In normal circumstances this would be fine but because my health is suffering I cannot give 2 weeks notice.

I really am not sure what rights I have in this situation.

Thanks again,
Alex

Ken Phillips replied:

Alex It sounds like the people you are working for want everything their way. Frankly from what you have told me you sound very much like an employee, but it's hard to tell.

Give me a ring if you'd like.

Rgds
Ken Phillips

Alex responded:

Hi Ken,
Thanks a lot for getting back to me. Since I sent you the email I have completed the checklist you have on your website and gone through the ATO test. The ATO regards me as an employee too so I think you are right.

From what I can see the company is employing people as 'independent contractors' so they don't have to pay any benefits or payroll taxes. I think they are breaking the law. But I'm not interested in that. That's a matter for the ATO.

And they are nobody's friend!

Thanks again,
Alex


In October 2010, John wrote:

Hello Ken,
I am a member, a sole trader migration agent. I was chasing down "what is a fair rate of pay for a sales manager", when I came across this webpage:

http://www.fairwork.gov.au/employment/sole-traders/pages/default.aspx

"From 1 January 2010, sole traders, partnerships, other unincorporated entities and non-trading corporations in New South Wales, Queensland, South Australia and Tasmania join the national workplace relations system".

I follow you writings pretty closely, but cannot recall seeing this mentioned.

John

Ken Phillips replied:

John
This only covers sole traders, partners and unincorporated entities when they become an employer and 'employ' employees. It does not apply to any of those people if they do not employ anyone.

Does that make sense?

Ken Phillips


On 27 October 2010, Bret commented:

G'day Ken ..... not sure I enjoy reading these scare stories, but good to be informed nevertheless! A point that seems to be missed in the debate is that Indpendent Contractors collect 10% GST on their billings, and even though this is offset to some extent by claimable GST on expenses.... there is a net tax return to the Government which is undermined if they forced ICs into employee relationships....