The Ralph Review looked at the growing trend in alienation of personal services income (PSI) as taxpayers sought the use of incorporated entities (the traditional family company structure) through which to conduct their business. The ATO then sought legislation to stop what it saw as a significant loss of tax revenue by business operators they deemed to be ‘employees" by implementing recommendations 7.2 to 7.4 of A Tax System Redesigned. It was aimed at re-dressing previous lack of success by the ATO in using the anti-avoidance provisions of Part IVA of ITAA 1936 on a case-by-case basis.

There is no doubt that many companies, in recent times, have sought to have their workforce incorporate themselves as personal services businesses (PSB) to minimise tax for both entities. This was the classic case of Friday night employee and Monday morning contractor and the original test case involved couriers (which the Commissioner lost). The building industry is often cited as a typical area where entities (which may or may not be PSBs) flourished amongst bricklayers and carpenters; as is the financial planning industry, where operating through a company was required by law. These measures ignore the legitimate situations where an entity or person works through an agency to service many different clients but the ATO’s rules deem them to have only one source of income.

Hence, the Treasurer sought legitimacy for his plans by using the supposedly uncontestable justification that it was aimed at "improving the integrity and equity in the tax system". However, removing the ‘case-by-case’ approach (amongst many other concerns discussed below) could be seen, by many reasonable taxpayers, as a retrograde step that achieves the opposite.

Simply put, the ATO sought, through the new legislation, to deem these PSBs as merely personal services entities interposed between an employer and an employee to avoid tax.. If you are not able to pass a number of very specific and stringent tests to self assess your entity as a PSB; or be granted a Determination by the ATO after making an application, you are an "employee" for tax purposes and you are denied many business tax deductions previously available to you as a business. Note that you still have the nature of business for many other purposes (mostly these add costs to your operations, but you are denied the areas of cost saving).

I first warned of this proposed counter-productive legislation in The Bulletin and the MICA Newsletter last year, but the actual legislation (New Business Tax System[Alienation of personal Services Income] Act, passed in May 2001) is worse that expected. Of course politicians and Treasury/ATO say you had it coming and that we were all warned about it by the Treasury Press Release No 74 of 11 November 1999.

It is not intended here to repeat the abundant information available on the Internet and in the media. However, some of the issues will be noted for the benefit of AusIMM/MICA members. It is essential that readers become very familiar with the following four tests to be classified as a PSB and "escape" the legislation. The ‘devil is in the detail’. The four tests are:

1. Income Test - <80% PSI from one source.
2. Unrelated Client Test – have two or more unrelated clients and advertise to public.
3. Other Employee Test – employees do >20% market value of PSI ‘principal work’.
4. Separate Business Premises Test – exclusive use of separate, securable business premises.

What has caused the furore (now increasingly discussed in the media and by possible AusIMM/MICA victims) is that it starts with the just passed 2000/01 tax year, even though everyone has only started to get real details from the ATO only in May 2001. See in particular ATO Draft Tax Ruling TR201/D3 (in the ATO Legal Database), which explains the way the four tests work to assess whether or not the entity is a PSB. The short education time frame exacerbates problems with the GST BAS form and PAYG submittals due by mid July 2001. If you find that you do not have a PSB upon self assessment, or do not get a Determination in time, you must not retain earnings in your incorporated entity and you must not claim business deductions.

You are now deemed to earn income as if an individual employee and you must have adjusted your PAYG payments accordingly. If not, the ATO will follow up and pursue with appropriate action those who leave paying their new higher PAYG obligations (if not a PSB) to the end of the year just past. This is despite the fact that the actual specific legislation passes was not known until May 2001, yet it is to apply back-dated to income received from 1 July 2000. Many tax agents and advisers are also not yet fully aware of the implications and applicability of these new PSI measures, too. Thus, agency arrangements appear to be now struck down although if your representative body is influential you may get exempted (like the financial planners).

At first glance, it is hard to argue against striking down schemes of arrangement that are simply entered into to avoid income and other taxes. The Treasury’s/ATO’s seductive argument implies that poor ordinary employees bear the tax burden, whilst the clever, rich ones incorporate and get the best of both worlds by remaining tied to one PSI source (ie, >80% comes from one source). However, even if you passed this test you have to pass one of the remaining three tests to be a PSB.

By focusing upon the >80%-PSI-coming-from-one-source-test, these measures simply fail to address the key issue of whether or not the personal services provider is exposed to real risk (or receives an assured regular income) and truly acts as a business. In reality this is the only test that should be passes to be a PSB and it can be determined on the facts. Also relevant (but not addressed in the legislation) is just how material is the amount of income received as PSI in a person’s global taxable position?

An independent contractor/consultant is distinguished from an employee by the following matters, despite income being derived from the personal services and expertise of that individual. The key element of a consultancy is that the client/payer exercises no control over the consultant, ie if the client/payer has no right to direct HOW, WHEN, WHERE and WHO is to perform the work. Essentially consultants offer to try and achieve a desired outcome for an agreed price, for some commercial risk, being effectively paid on results not time spent. Also, they offer the same services to the public at large, not being tied to any one client, though they may work through an agency or marketing joint venture arrangement with other consultant PSBs.

Consultants provide their own materials and tools/equipment to perform and complete the work (ie assets and equipment, maintain their own office facilities, provide their own capital or loan funds). Examples include drafting table/planimeter, airphoto stereoscopes, mobile communication facilities (eg e-mail/ISP, mobile phone), office desks/chairs, bookcases, filing cabinets, office decorations, computers/printers/modems, heaters/fans, professional library, safety and field/camping equipment, cars, etc (and insure them themselves). They also provide their own computer software (technical, accounting and office productivity software) and training. They pay (and choose) their own memberships of professional societies (including the grade of membership), and maintain their own continuing education. Thus, the client/payer generally provides little or no infrastructure support, except at remote mining and exploration sites.

Those contractors/consultants in the minerals industry, trying to cope with its well known cyclical nature and the retrenchments and lack of employment opportunities due to globalisation and the irreversible change in the nature of work, are justifiably not happy with its negative impact. They reasonably argue that it is an issue that the Boards of AusIMM and MICA must speak out on this measure which has the potential to affect the fragile economic well-being of many of its members. Both the AusIMM President (using the Past President and the President Elect) and the MICA Chair must take the lead on this issue, assisted by the CEO and his staff. Alliances must be forged with AIG, IEAust and the MCA (even the Recruitment Contracting Services Association and Financial Planners Association) to strongly lobby in this election year. This should ensure that the minerals industry does not loose further expertise overseas because of well-meaning but poorly designed new taxation measures that catch the wrong people. The media is full of reports of action undertaken by other professional bodies and we must join them. This is why we signed a MOU with IEAust and joined the ACP.

The following suggestions should appeal to a Liberal/Country Party Government intent upon re-election. It has already upset its natural small business constituency with the GST/BAS debacle. If it makes the changes below, but is not re-elected then it is Labor that has to deliberately "punish" small business by trying to re-introducing them. If it cannot be changed before the election because of the Labor/Democrat opposition, then it is the latter parties which will face a hostile electorate of small business people who will favourably view the present Government at the ballot box as one trying to be responsive. Backbenchers, especially those in marginal seats have to be particularly targeted by AusIMM/MICA.

Individual members should be provided with appropriate draft letters of complaint to sent to their local member and the Prime Minister/Treasurer. Talk-back radio must be utilised now since it determines policy more that letter writing. Also copy in the footnoted journalist already critical of this legislation to give them ammunition and gain exposure.

Key points to make are set out below.

The ATO’s own research in 1988 and the Ralph Report clearly state that alienation of personal services income is a comparatively very minor problem. Why attack consultant/contractor small business in this way? See various recent AFR and The Australian articles condemning the measures. According to ABS, 20% of taxpayers are self-employed contractors (ie, 1.7 million).

The preferred position is to defer the application of this legislation to a future date to allow better education of those affected and to allow more time for consultation with affected parties so that unintended consequences can be properly addressed. There is abundant evidence that the tax agents and the accounting profession are hardly able to even help taxpayers deal with the GST/BAS. Related to this approach is to re-visit the transition rules and re-work them since everyone admits that the issues are more complex than first thought and they are inadequate in their present form.

If wind-back is impossible, then it must properly identify the main targets (ie, those who have simply swapped their employee status to that of an incorporated contractor for the mutual tax benefit of the employer and employee). These are not commonly professionals, who provide high level advice, but those in the general workforce providing labour.

The four PSB tests have to be watered down, yet catch the real cheats. The ‘unusual circumstances’ test must be liberally applied. They all must be interpreted loosely and after looking at the whole context of the business and not just applied like an robot. If interpreted literally they could be impossible to comply. For example, the PSI legislation notes that business premises must be maintained and used for PSI continuously during the tax year (though they do not have to be the same premises) and occupied exclusively (ie, not shared, so have a separate lease and be physically securable space); premises have to be physically separate from the client(s) providing the sources of income; and the ATO requires advice if the premises are zoned commercial or residential. Legitimate PSBs might suffer for a reasonable time gap between occupying premises or producing PSI; for having at any time shared office facilities (with any other entity, related or otherwise) that are fully paid for by the PSB; and/or for running a business from a technically zoned residential premise for over a decade, although no complaint has ever been lodged with the Council, even if it passes the separate-from-private-use area test (ie, not run a business from home residence).

Why not start with exempting those incorporated entities that are, say, more that 5 years old? Apparently the huge growth in incorporated companies started only in the mid-1990s. Look at the history of their operations.

Whatever is done, there must be no back-dating of the effect of this legislation as presently envisaged. It must commence from 1 July 2001. It will cause undue hardship if it is not, especially if penalties are applied.

It must be explained that consultants in the mineral industry provide the services of specific individual who provide expert consultancy services, not simple contract labour services. These independent professional technical services are related to the specific individual's competence (educational qualifications and work experience) and repute. These matters are attested by the individual being admitted to internationally recognised professional associations that registered/accredited the individual as someone possessing particular high levels of skill and probity. These are not to be confused with the duties of an employee's position. MICA, at least, should seek exemption for their 300 odd members because they are already accredited consultants.

The very nature of high-level expert work means that it is likely that fees charged will be high, compared with normal wage levels. If the consultant is particularly talented and has built a reputation (eg, as an expert witness or project engineer), it is mathematically logical that >80% of PSI may come from one source at various times (ie, various tax years). The consultant may still have a myriad of small clients who pay only a low rate for obtaining more basic services. However, the consultant may not be determined to be a PSB. There must be the opportunity to average such PSI over 3 to 5 tax years for the income test.

It is essential that mineral industry professions do not have to rely on ‘special circumstances’ provisions to be a PSB that are sought each tax year. Certainty must be gained in any lobbying. Even bad news can be worked through. The current objection to the present timetable is that there is too much uncertainty and determinations are at ATO’s sole discretion. A real business cannot tolerate yearly licences to operate like this mechanism envisages.

Hence, the Minerals Industry professionals must argue just as strongly as the Construction Industry and Financial Planning Industry participants for relief. Surely the Head Office talent supported by the AusIMM/MICA President/Chair can lobby hard that the legislation should not catch genuine consultants and contractors/subcontractors. Taking only the position of the geoscientists, there are already only some 3000 left out of the 5600 in 1996 (having lost 46% due mainly to government policy), claim the Mining Industry Action Group. Only 14% have secure employment. If these PSI measures are introduced Australia will lose even more highly skilled professionals (educated at great public expense) and/or restrict opportunities for re-employment or fuller employment for many more. Hardly the "Knowledge Nation Plan" of either political party!

MJ Lawrence
6 July 2001