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The new contractors' legislation is a breakthrough for personal services contracting in Australia. For most, it will be easier to be a contractor under the new legislation than it was in 1999 before the infamous Alienation of Personal Services Income Act that was to operate from July 1, 2000.
The fairer tax rules for contracting could extend into setting precedents for industrial relations matters. However, as I explain below, the commissioner has set a new (but not unfair) trap for 'mum and dad' contractors but still has blatantly unfair provisions with considerable electoral implications that government back-benchers will need to tackle.
Nevertheless, it is a vast improvement on the position that existed on July 2 when The Australian published its first article highlighting the tax commissioner's 'retrospective bastardisation' of 1.4 million contractors.
The Government had passed what appeared to be innocuous contracting legislation which came into operation on July 1, 2000. But then, 10 months later, the taxation commissioner released a draft ruling backdated to July 1, 2000 that turned the Act into a monster.
The first Act pivoted on the source of income. If an enterprise had two or more independent sources of income and no one source delivered more than 80 percent of the total income, then the enterprise was declared a contractor. Relying on 80/20 produced bizarre results because associated contractors were not properly defined and genuine contractors who had their contract extended for too long were trapped.
Those who couldn't pass the 80/20 legislation had to seek a 'determination' or clearance from the commissioner by passing other tests. These tests included special circumstances, an employment test, a separate premises test and a results test.
The results test had been carefully drafted by the taxation department so almost no-one could pass it outside the building industry. The separate premises and employment tests were not much better.
Genuine Australian contractors faced being declared employees. They would be retrospectively robbed of business tax deductions that were not available to employees.
It took 60 days from the first article in The Australian to introduce the new legislation. Instead of pivoting on 80/20, the new legislation pivots on a completely rewritten results test.
Before July 1, 2000, the common law provided a series of tests that determined whether a person was a contractor or an employee. The first Act ignored the common law.
According to the spokesperson for Independent Contractors of Australia association, Ken Phillips, the new results test does not specifically mention the adoption of common law but, in his new rulings, the commissioner has in fact used the common law tests in the results test.
The new results test rulings set out 11 common law style tests that should be taken into consideration, including contractual obligations, how the work is performed, the risks, plant and equipment provisions, flexibility in hours of work and place of work, leave and other entitlements, payment terms, expenses, appointment, termination and delegation.
Like the old common law system the new legislation first assesses these criteria on an overall basis. But it then has an extra stipulation - two of the common law tests must be passed.
The first compulsory test is that there must be ability for rectification. In essence that means that the contractor has to replace the work or is liable for the cost in rectifying faults in any work performed.
The second compulsory common law test is that in most situations contractors supply their own equipment. But the new Act spells out that equipment supply can be consistent with industry practices.
In other words, if a software engineer has to use a client's equipment and if that is common practice, then the test is passed. Given the emphasis on common practice, most genuine contractors should not have a problem passing the equipment test.
All contracts will be subject to Part IVA, which is the catch-all for taxation schemes. So if anybody sets up sham contracts that pass the results/common law tests, he or she can be knocked back by the commissioner under IVA.
Subject to IVA, if you can pass the results/common law test you are declared a contractor. If you can't, you have a second chance - the old 80/20rule. That's what makes the new Act better than the 1999 position when there was no 80/20. The new Act provides better definition of who are associated people and there is a provision that if you genuinely didn't know of an association, then you are in the clear.
But labour hire firms get a rough deal. To be certain of being a contractor, people using labour hire firms need to seek their own clients and then channel them through a labour hire firm.
Like the whole Act, it will be backdated to July 1, 2000. In my view those labour hire firms that are genuinely providing contracting services need to arrange independent contracts that pass the results/common law test.
Alternatively they may act as agents. Of course, many labour hire groups are providing employee services and quite properly the people who work for them should be employees. For example, Skilled Engineering hires most of its people on an employee basis because of the nature of the work it provides.
Both the results test and the 80 / 20 test can be self assessed, although anyone who is unsure can seek a determination. If you can't pass either the results test or the 80 / 20 test you must apply to the tax department for a determination.
This brings into play three other tests. The first is special circumstances and the second is whether you have separate employees. Here the commissioner has learned nothing. He still thinks a spouse who provides non-contract administration, pays subcontractors, banks money, monitors costs, records times of work, pays progress claims and other activities is not doing principal work, so should not be an employee. This silly stipulation will raise little money and Liberal backbenchers will need to be prepared to take responsibility for it unless they change the Act.
But if a person has an apprentice they are regarded as having an employee and the new apprenticeship systems is included. Anyone needing to pass the employee test to become a contractor should consider taking on an apprentice under the new rules.
The second test is separate premises. If you have a third-party lease you are probably okay but, as with spouse employees, the commissioner picks on people who can't fight back.
He says there must be no entrance between the home office and the house and excludes garages unless they are on a separate title.
Again the backbenchers need to remind the commissioner that the Prime Minister says the jury is out. There is no doubt tax practitioners will want to go to the courts to make sure the results-based test and the common law requirements are the same, given that it is in the rulings and not spelt out in the legislation.
Most of the major contracting groups such as the building industry, the financial planners and the couriers are covered. Financial planners are covered provided no one group provides more than 80 per cent of their income; 75 per cent of their income is via commissions or fees; they seek their own clients and they have an arm's-length lease on their property.
Couriers will need to provide their own equipment and of course can easily rectify mistakes by redelivering a parcel. Where a courier could get caught is if the vehicle is a bike and the courier was required to work like an employee. In such a case the 11 common law tests might declare the courier an employee.
Couriers need to work with the independence of a contractor or have a big investment in equipment.
But there is a new trap in the Act for 'mum and dad' contractors. The commissioner will use common law tests, such as the number of employees, shareholders, directors and turnover, to determine whether a contracting company is really a business or a merely a personal services contractor.
A company that is a business is taxed at 30 per cent and can retain its surplus income. A company that is deemed merely a 'mum and dad' personal services contractor will be deemed to credit its surplus income to the main worker at personal tax rates. It's tough but in theory probably fair.
But just how this will happen does not appear to be spelt out. And salaries paid to spouses have to be at market rates. Small contractors will need to expand quickly so they can retain company income in their business.
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