Question: Hi Brett, I’m a Queensland accountant. My broad client base includes FIFO (eg. fly in, fly out) workers, professionals, manufacturing business and retail shops. Have you got any inside information from the ATO about this year’s compliance program? Which of my clients do I need to especially watch out for in 2012?

Accountant, Gold Coast, QLD.

Answer: Small business and the independent contractors are always a problem when it comes to tax compliance. Generally speaking, their records are poor and there are too many cash transactions floating around for the ATO to be comfortable with.

What is going to happen next?

Any minute now, your client will receive an audit letter from the ATO. Where a tax agent is used, the agent may get a courtesy letter in advance to say some of their clients will be audited.

What do you need to know about your clients?

The starting point is what type of business structure they are using. Is it a sole trader, partnership, company or family trust?

Family trusts are popular with small businesses and professional services. Trusts allow income splitting to family members at lower tax rates. People come unstuck when the PSI rules are applied. Family trust income can be split where it’s not PSI or if the Trust gets paid to produce a result for another entity (results test).

Where the income is potentially caught by the PSI rules, there is plenty that the accountant can do to make the rules not apply.

If the client receives less than 80% of the PSI from one source, they qualify as a personal services business if they satisfy any one of these three tests:

1. unrelated clients test – you have 2 or more clients of your “business” as a direct result of offering your services to the general public.
2. employment test – you employ other persons or entities to do at least 20% of the principal work that you are paid to provide.
3. business premises test – you use and maintain physically separate business premises from your home to operate your “business” activities.

If 1 of these 3 tests are satisfied, then you have a ‘business’ even though it is based around ‘personal service’. You then are able to share the income and profit of the business with your co-business owners, such as spouse, children, Family Trust or company.

Our Platinum Members get the inside scoop on PSI rules.

What is wrong with operating as an independent contractor?

In theory there is nothing wrong with operating as an independent contractor. The ATO is concerned about two main things when it targets PSI, they are:

• That large businesses may take advantage of independent contractors to avoid their own taxation obligations – such as PAYG withholding and superannuation guarantee contributions; and

• That the government is losing money with independent contractors having a greater scope to claim work related deductions (than typical employees) and often employ related persons to assist manage their ‘business’ and therefore reducing the government’s revenue raised from taxation.

The ATO is not out to destroy every PSI business that exists. The ATO is merely trying to weed out (what it calls) the sham contractors – which are really employees in the ATO’s eyes. The problem is that many legitimate PSI business operators get swept up in the onslaught. It causes them to incur (sometimes) large bills for professional fees – from accountants and tax lawyers – just to convince the ATO that they are above board.

What can you do to be prepared?

Now is the perfect time for accountants and advisers to review their clients’ PSI businesses. If your client earns any personal services income – expect a knock at the door. Be proactive. Contact clients about the PSI Compliance Campaign. Prepare your clients for the impending audit review now.

Please let us know if you need a hand. Also these documents at LawCentral can help:

• Div 7A Loan Agreement
• Independent Contractors Agreement
• Family Trust
• Service Trust Agreement
• Build a Company
• Unit Trust

• ATO audits cash sales. Am I going to jail?
• ATO Data Matching to eBay
• Tax Planning vs. Tax Evasion - make sure you are doing one but not the other
• Asset Protection

I don’t do this sort of thing often. However, given the nature of the question above, it is only fair to bring some important information to the businesses on the other end of the PSI minefield.

They are; Labour Hire firms or On-Hire Firms.

What’s the big deal, you might be asking? It’s not like the labour hire firms are being audited for breaching the PSI rules. However, labour hire firms have their own set of rules to follow. Rules which go hand-in-hand with the ATO’s campaign to run PSI businesses out of town.

Briefly, a labour hire firm is one which has a client for whom they arrange a worker to perform a task. The client pays the labour hire firm for their services and the labour hire firm then pays the worker.

Sounds simple, however, it’s not always clear whether the worker is an employee of the labour hire firm, an independent contractor, or an employee of the end client.

In order to solve this little dilemma, the ATO has pushed the taxation compliance burden onto the labour hire firms. Regardless of whether the worker is an employee of the labour hire firm or an independent contractor, the labour hire firm is responsible for the PAYG withholding tax and the superannuation guarantee contributions.

Why should the labour hire firm cop that burden when they are just an intermediary?

Unfortunately the buck has to stop somewhere. The client doesn’t have to do it because they have merely purchased a service. The worker doesn’t have to do it because the ATO thinks they are too irresponsible to manage money and withhold their own income tax. So the poor labour hire firm cops it sweet.

Why is it an issue for labour hire firms?

Where it can become an issue for the labour hire firms is where they have not been withholding the correct amounts from payments to workers in the mistaken belief that it was not necessary. In those instances, the directors of the labour hire firms could become personally liable for any unreported and unremitted PAYG and superannuation guarantee contributions.

We recommend that our members conduct a review with any labour hire firms to ensure they are meeting their obligations. Remember it is always easier to get interest and penalties remitted if shortfalls are voluntarily disclosed to the ATO before they even start looking.

If you have a client that needs to make any voluntary disclosures to the ATO, feel free to contact me and our team of taxation specialists can assist you and your clients to achieve a positive outcome.

• Employment Contract
• Div 7A Loan Agreement
• Company Constitution (Add Div 7A)