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Disclaimer

This is not advice. Items herein are general comments only and do not constitute or convey advice per se. The information contained in these articles is for guidance only and should not be relied upon without obtaining professional advice having regard to your direct circumstances.

 

Personal Services Income - Avoiding Common Mistakes

Recently the ATO published a fact sheet.  There are eight mistakes that companies, partnerships or trusts (personal services entities) commonly make in relation to personal services income.

These have been divided into four common mistake areas:
• Personal services business tests
The tests that determine whether personal services income is affected by the personal services income measures are often incorrectly applied.
• Retaining profits
Profits from personal services income, which should be attributed (or treated as belonging) to an individual, are often incorrectly retained by companies.
• Pay as you go (PAYG) withholding
Frequently the additional PAYG withholding obligations for personal services income are not met
• Tax returns
When a tax return is lodged, often the required personal services income schedule is not completed and deductions are incorrectly claimed.

Personal Services Business Tests

There are four tests against which you can self assess whether the personal services income measures apply. These are the:
• Result test
• Unrelated clients test
• Employment test, and
• Business premises test

Four mistakes are commonly made in relation to the tests.

Results Test

Common mistake: self assessing that the first condition of the results test has been passed when paid on an hourly basis or daily rate.

To pass the first condition of the results test, the income you receive under a contract or arrangement must be paid to you as a result of achieving a specified result or outcome. This means that you must be:
• Engaged to complete a specified job, and
• Paid on completion of that job.

If you are paid on an hourly basis or daily rate for the services you provide, it is unlikely you’ll pass the first condition of the results test.

Example – Meeting the first condition of the results test

A government department enters a contract with Consultant Co for the provision of services by a named individual. The individual is required to develop a product for the department’s IT system, to the functional specifications nominated by the department.

The contract specifies a daily rate of payment to Consultant Co for developing the product, with payments to be made on a weekly basis.

This contract does not satisfy the first condition of the results test as payments are for work done during the week and not upon completion of a specified result.

The 80% Rule

Common mistake: Not obtaining a determination (or applying the measures) when you don’t meet the results test and 80% or more of the income is from one client.

When using the four tests to work out if the personal services income measures apply to your income, the results test is used first.

If 80% or more of your personal services income in the income is from one client (80% rule), you cannot self assess whether you meet the other personal services business tests. In this situation you need to obtain a personal services business determination from the Tax Office, otherwise the personal services income measures will apply.

Unrelated clients test

Common mistake: Self assessing that the unrelated clients test has been met when the services provided are not a direct result of making offers to the public.

A condition of the unrelated clients test is that the services must be provided as a direct result of making offers to the public.

To make an offer to the public, there needs to be a definite connection between the offer of services and the engagement for the work. Making offers to the public includes:
• Advertising in a newspaper, magazine or business directory
• Maintaining an internet web site, or
• Word-of-mouth referrals

Offering services through a labour hire firm or registering with an agency is not considered offering services to the public under the unreeled clients test.

Example – Offering services to the public under the unrelated clients test

A computer programmer operates through a company. One client provides 65 per cent of the company’s income (the programmer’s personal services income) and the other client provides the balance. Both contracts were obtained though a labour hire firm.

As the contracts were obtained via a labour hire firm, these clients cannot be counted for the purposes of the unrelated clients test.

If the services had been provided as a direct result of the company advertising to the public, and not through a labour hire firm, this part of the test would have been passed.

Applying the tests

Common mistakes: Applying the personal services business tests to the whole entity and not to the individual(s). If you channel the income of more than one consultant or contractor through your entity, you cannot apply the personal services business tests to the whole entity. You need to apply the tests on an individual by-individual basis. This requires that you must keep records of the separate streams of income and expenses for each consultant or contractor.

Example – Applying the personal services business tests

Two management business consultants operate through a company. They provide services to the public under separate contracts. Neither consultant works on the contracts of the other.

As there are separate streams of personal services income (i.e. each consultant is providing exclusive services under separate contracts), the personal services business tests must be applied separately for each individual consultant.

That is, if the employment test is passed in relation to one individual consultant (only), this cannot be applied to the personal services income of the other consultant. The other consultant must also pass a personal services business test, or hold a personal services business determination from the Commissioner, in order for the personal services income measures not to apply to their personal services income.

Retaining Profits

Common mistake: Retaining profits from personal services income. If your company makes a profit from personal services income, you need to promptly:
• Pay this profit as salary and wage, or
• Attribute it to the individual who performed the services

Example

Retaining profits

A computer consultant earns a personal services income to the consultant as salary and wages. As a result, the net personal services income needs to be attributed to the consultant. For tax purposes only, the consultant’s personal services income less any allowable deductions is included in the assessable income of the consultant (attribution) and tax is paid by the consultant on this net income. For instance, the consultant cannot contribute 70% to themselves and retain 30% in the company (for tax purposes). The total amount of personal services income (i.e. 100%) less allowable deductions at the end of the year must be attributed to the individual.

If the company had promptly paid some of the personal services income as salary and wages throughout the year, it would only need to attribute the remaining personal services income less any allowable deductions at the end of the year.

Pay As You Go (PAYG) Withholding

Common mistake: Not complying with the additional PAYG withholding obligations.

If you are affected by the personal services income measures, you will have additional PAYG withholding obligations, unless you are already paying out the personal services income to the relevant individual as salary and wages.

Companies and trusts must:
• Apply normal PAYG withholding rules to any of the income that is promptly paid out to the individual as salary or wages within 14 days after the end of the relevant period (i.e. monthly or quarterly); and
• Report and pay additional PAYG withholding on the attributed income (i.e. personal services income that has not been promptly paid as salary or wages).

Partnerships must:
• Attribute the personal services income to the individual who generated it (partners can’t receive salary or wages); and
• Report and pay additional PAYG withholding on the attributed amount.

Tax Returns

Two mistakes are commonly made in relation to tax returns.

Personal services income schedule

Common mistake: Failing to complete and attach the personal services income schedule to the tax return.

When you lodge your tax return you must:
• Answer the relevant questions about personal services income,
• Complete and attach the personal services income schedule.

The personal services income schedule must be lodged even if you satisfy one of the personal services business tests.

Claiming deductions

Common mistake: Claiming deductions for personal services income where there is no entitlement.

When you claim deductions for your personal services income, you need to be aware of your tax obligations and entitlements to ensure you are claiming the correct amount.

Generally, you can claim a deduction for an amount you have paid or incurred only if it relates to gaining or producing your assessable income.

However, if you are affected by the personal services income measures, there are certain deductions you cannot claim. These include:
• Rent, mortgage interest, rates or land tax for your home (or your associate’s home) that is a place of business, or
• Payments to your spouse (or other associate) for support work such as secretarial duties.

Source: The Taxation Examiner’s Bi-Monthly Newsletter, March-April 2008

 


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