For more information click on the headings.
* Tax Reform Targets Contractors
* Personal Services Income
* Personal Service Business Exception
* Deductions
* Other Relationships
* PAYG On Personal Services Income
* PPS Transitional Issues
Tax Reform Targets Contractors
Consultants and other contractors will be dramatically affected by Personal Services Income amendments to the Tax Law that will be effective from 1 July 2000. These changes will prompt many contractors to weigh up the few remaining benefits of being a contractor against the additional requirements. In many cases contractors are likely to cease being contractors and become employees. Below is a brief summary of these changes.
Personal Services Income 
The Federal Government has recently introduced legislation that will restrict the tax deductions available to contractors and, where personal services income of an individual is derived by the contractor’s personal services entity, the income may be assessed to the individual who provided the services.
Personal services income of an individual is income of any entity (including individual) where the income is mainly a reward for the individual’s personal efforts or skill. This covers situations where the income is derived by either the individual contractor or by another entity. It also covers situations where a number of individuals provide their services through a single services entity.
Where the income of a personal services entity is attributed to an individual, that income is not assessable to the personal service entity. Any later payment or distribution of that income by the personal service entity will not be assessable to the recipient.
Personal Service Business Exception
These rules will not apply where the contractor can show that they or their personal services entity is carrying on a "personal services business".
An entity is carrying on a "personal services business" where it passes at least one of the following tests:
1. Unrelated Client Test – The income is gained from two or more unrelated entities and the services are provided as a direct result of the individual or the personal services entity making offers or invitations to the public.
2. Employment Test – The individual or the personal services entity engages one or more entities other than the individual to perform at least 20% of the individual’s principal work for the year.
3. Business Premises Test – The individual or the personal services entity maintains and uses business premises where:
| a) The individual or the entity mainly conducts activities from which the personal services income is gained. | |
| b) The individual or the entity has exclusive use of the premises. | |
| c) The property is separate from the private premises of the individual or their associates. | |
| d) The property is separate from the premises of the individual’s or entity’s customer to whom they provide the personal services. |
Where a contractor or their personal service entity passes one of these tests but receives 80% or more of the personal services income from one source, they will not be taken to be carrying on a personal services business unless they apply to the Commissioner of Taxation and are granted a personal services business determination.
When issuing a personal services business determination the Commissioner must take into account various factors including:
1. Whether the individual or entity could reasonably be expected to pass one of the personal service business tests or would have but for unusual circumstances (eg starting business or services are usually supplied to many customers but for one year only 80% of services are provided to one customer).
2. Whether the personal services income results from all of the following:
| a) from producing a result (eg where the payment is for the production of a report), | |
| b) the individual or personal services entity is required to use their own plant and equipment and | |
| c) the individual or personal services entity is or would be liable for the cost of any defect in the work performed. |
Deductions
The individual or personal services entity is restricted in claiming deductions against the personal services income. The deductions available are generally those deductions that would be available if the income was payable to the individual as an employee. In particular the following expenses are specifically excluded:
1. Rent, mortgage interest, rates and land tax for some or all of your or your associate’s residences.
2. Payments or liabilities incurred to associates unless it relates to engaging the associate to perform part of the principal work for which the personal services income has been received, eg if a computer consultant contractor employs their spouse to answer the phone and do bookkeeping, the expenses would not be deductible because it is not in relation to the principal work performed, but if the spouse were employed to perform some of the computer consulting work the amount would be deductible.
3. Superannuation contributions for associates except for contributions to meet superannuation guarantee obligations but only in relation to the salary or wages to perform part of the principal work. (refer item 2 above).
These new rules do not stop some deductions being claimed including:
1. Advertising, tendering and quoting for work
2. Insurance for sickness accident and disability
3. Public liability and professional indemnity insurance
4. Workers compensation premiums or similar payments
5. Payments to a non-associate to perform work
6. Payments to your associate to perform work that forms part of the principal work for which the personal services income is being derived
7. Superannuation contributions for an individual performing at least 20% of the personal services work
8. Entity maintenance expenses for a personal services entity (eg tax fees, bank fees, Corporations law fees, licences and approval fees)
9. Car expenses of a personal services entity for which there is no personal use or where there is personal use expenses for only one car that has personal use
10. Salary and wages paid by a personal services entity within 14 days after the entities PAYG payment period.
However, claims for these expenses still have to be deductible under the regular deduction sections before a deduction will be allowed.
Other Relationships
If a contractor or their personal services entity is subject to these new rules it does not affect the contractor’s or their entity’s ability to apply for an ABN or register for GST. Where applicable, the contractor or their entity will have to include GST on their invoices. The new rules do not affect the contractual relationship between the personal services entity and the service requirer (customer). The service requirer does not have to treat the contractor as an employee.
PAYG On Personal Services Income
Where, under these rules, the income of a personal services entity is included in the assessable income of an individual, the personal services entity must pay an amount of PAYG on that income together with any PAYG that is payable on the salary and wages that was promptly paid to the individual. This PAYG will be credited against the individual’s income tax assessment for the year.
PPS Transitional Issues
Some contractors under the PPS system as at 13 April 2000 may be given a 2-year exemption from these new rules. This exemption is subject to the Commissioner of Taxation issuing a declaration as to the class of entities that the exemption will apply to. This declaration has not been issued at the date of writing but it must be issued by the Commissioner before 1 July 2000 to be effective.