To contract or not to contract - that is the question.

Back to Articles

There are many issues to consider when thinking about joining the ranks of the contracting fraternity. One of the key ones being those of the taxation persuasion. The following is a brief introduction to items you should consider when weighing up your decision to either become a consultant on a per contract basis and/or continue as one.

The introduction of the new 'simplified' tax legislation from 1 July 2000, afforded the government the opportunity to tighten policy on the issue of contractors that has concerned it for some time. In particular the ATO has been of the view that there is a pool of 'contractors' who don't really fit their definition of a contractor. The real concern is that these contractors are really employees but as contractors they claim more deductions than an employee normally would (so the ATO is missing out on revenue) and they are also slipping through the workcover net in some instances but more importantly the compulsory superannuation net. There is presently no requirement for a legitimate contractor in a sole-trader or partnership arrangement to pay any superannuation on their behalf. If these contractors are really employees, their employer is required by law to pay superannuation for them.

As the ATO were concerned with the number of so-called 'contractors' so they have established a stringent set of tests for the purpose of ascertaining whether someone really is a contractor for taxation purposes. Their original intent was that a ruling was to be obtained from the ATO but due to lobbying ostensibly from industries like the courier business it is now up to an individual to 'self-assess' whether or not they are a contractor based on the following criteria:

• does 90% or more of an individual's income in a given financial year come form one source? If the answer is yes, then you are pretty well assured of being an employee of the entity paying that income. If no, you must satisfy one of the following tests
  

• separate premises test - does the individual carry on their business from separate premises that they up-keep? This does not mean the spare bedroom at home. The separate premises must be like an office, that has a separate clearly marked entry of the entity?
  

• does the entity employ other persons to assist in the completion of contracts/tasks?
  

• related entity test - does 90% or more of income, in a financial year, come from related entities? For example, if I do 50% of my work for a subsidiary & 50% of my other work in the same financial year for the holding company - I will not pass the 90% test detailed in 1. above.

So what does all of this mean? If I have self-assessed myself as a contractor for taxation purposes but cannot pass the above-mentioned tests to pass as a legitimate contractor and the ATO pick this up, they will treat me for taxation purposes as thought I am an employee. So any deductions that I have claimed that an employee could not claim - they will disallow & they will also address the compulsory superannuation issues.

If, on the other hand, I have self-assessed as a 'legitimate contractor' & I am confident that I would pass any ATO audit activity on same, what other issues do I then need to consider.

• the best entity (legal & taxation) under which to operate. This depends on an each individuals particular circumstances but should have regard to:
  • risk of being sued and the protection of individual assets (the protection of operating through a company structure for this purpose is constantly being reviewed due to cases like HIH)
  • the use of salary sacrificing techniques that can be advantageous through a company with things like motor vehicles
  • the benefits of superannuation deductions
  • partners in a partnership need to be aware that they are each equally & severally liable for each others work

• the issue of personal services income. If it is my skill that derives income then I am unable to income split this income with another individual who does not have this skill. All of this income after allowable deductions needs to find it's way back to my individual income tax return. Traditionally vehicles such as services trusts have been used as a conduit with personal services income but these services trusts or companies need to operate on a commercially based mark-up rates.

The life of a contractor for taxation purposes is relatively complicated these days especially in industries like the computer industry, so it is highly advisable to seek professional advice before commencing contract work to ascertain the best way forward. The above is intended for information purposes only.

(with many thanks to Jenny Wyatt of Wyatt Alexander for this information)

We would like to advise TMN has always adopted strict privacy principles, by keeping all client and database details secure and not disclosing any of this information to any party without prior permission.