Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 7 - Personal services income
Outline of chapter
7.1 Schedule 6 to this bill explains amendments to Part 2-42 of the ITAA 1997 which is about the tax treatment of personal services income. Part 2-42 broadly limits the entitlement of individuals and entities to deductions that can be claimed against personal services income. It also attributes personal services income paid to an entity, to the individual who is performing the services. Part 2-42 applies from the 2000-2001 income year. Part 2-42 does not apply if the individual or entity is conducting a personal services business.
7.2 The amendments provide special rules for certain agent-principal relationships. They also provide that all taxpayers earning personal services income will be able to self-assess whether they are independent contractors against the results test. Independent contractors (as opposed to contractors who work in essentially the same way as employees) are treated as personal services businesses and will therefore not be affected by the measure. In addition all taxpayers will be able to apply to the Commissioner for a personal services business determination.
7.3 The amendments also include a consequential amendment to the additional PAYG withholding provisions for personal services income, which are in the TAA 1953.
Context of amendments
7.4 The measures contained in Part 2-42 were recommended by the Review of Business Taxation. The amendments explained in this chapter are designed to ease the compliance burden of certain taxpayers affected by those measures, and to allow certain agents to be excluded from the measures.
Summary of new law
7.5 The amendments will have the effect of treating certain agents as having received their results based income directly from the customers of the principal, as a result of providing services to those customers. This may allow certain agents to be treated as obtaining less than 80% of their personal services income from each source and to satisfy the unrelated clients test. Consequently they are treated as conducting a personal services business, without having to apply to the Commissioner for a personal services business determination.
7.6 As well, the amendments will allow all individuals or entities whose ordinary or statutory income would include an individuals personal services income to self-assess whether they are personal services businesses against the results test (previously the further grounds in subsections 87-60(5) and (6) and 87-65(5) and (6)). This includes those individuals who earn 80% or more of their personal services income from one source. Previously, the measure would have applied to these individuals unless they obtained a personal services business determination from the Commissioner. If an individual or personal services entity can meet the results test which is based on the traditional tests for determining independent contractors they will be outside the measure.
7.7 If those individuals who earn 80% or more of their personal services income from one source do not satisfy the results test, they will still have to obtain a determination from the Commissioner to be outside the personal services income measure. They cannot self-assess against the other personal services business tests.
7.8 Those individuals who earn less than 80% of their personal services income from each source can continue to self-assess against the existing 3 personal services business tests as well as the results test.
7.9 The amendments also provide that all taxpayers are able to apply to the Commissioner for a personal services business determination, regardless of whether 80% or more of their personal services income comes from one source. Previously, individuals who earned less than 80% of their personal services income from each source could not obtain a determination from the Commissioner.
7.10 Neither Part 2-42 nor these amendments to it preclude the operation of Part IVA of the ITAA 1936 (the general anti-avoidance provisions). Part IVA may still apply to income splitting arrangements or to the retention of personal services income in a company beyond the end of the income year, even when an individual or personal services entity is conducting a personal services business for the purposes of Part 2-42.
| New law | Current law |
|---|---|
| For the purposes of the 80% test, an agent who satisfies certain conditions will be able to treat the income they receive from the principal on a look through basis - that is, as though it were earned directly from the customers of the principal. If the agent represents the principal to multiple customers, the agent will generally obtain less than 80% of their personal services income from each source. Consequently, the agent will be able to self-assess against all the personal services business tests, including the unrelated clients test. | An agent representing a principal receives income from that principal (and has rights and obligations in respect of that principal under general agency law). If an agent represents only one principal they will necessarily obtain 80% or more of their personal services income from one source. Consequently, the agent will be subject to the personal services income regime unless they obtain a personal services business determination from the Commissioner. |
| For the purposes of the unrelated clients test, an agent who satisfies certain conditions will be treated as providing services directly to the customers of the principal they represent. If the agent provides these services to the customers of the principal as a result of making offers or invitations to the public at large (or a section of the public) the agent will satisfy the unrelated clients test. | The agent provides services to their principal. The agent can only provide services to the principals customers on the principals behalf, not on their own behalf.
Moreover, the unrelated clients test is generally unavailable for an agent who works for one principal because 80% or more of the agents personal services income is from one source. |
| All taxpayers will be able to self-assess against the results test, to determine if they are an independent contractor. Meeting the results test means the taxpayer is conducting a personal services business. This is regardless of whether 80% or more of their personal services income comes from one source. | Taxpayers who earn 80% or more of their personal services income from one source will only be a personal services business if they obtain a determination from the Commissioner. Those taxpayers who earn less than 80% of their personal services income from each source do not currently have access to the results test. |
| All taxpayers can seek a personal services business determination from the Commissioner, regardless of whether 80% or more of their personal services income comes from one source. | Currently, only those taxpayers earning 80% or more of their personal services income from one source can obtain a personal services business determination from the Commissioner. |
| The general anti-avoidance rules in Part IVA can still apply to income splitting arrangements, or the retention of personal services income in a company beyond the end of the income year, even when an individual or personal services entity is conducting a personal services business. | The general anti-avoidance rules in Part IVA can still apply to income splitting arrangements, or the retention of personal services income in a company beyond the end of the income year, even when an individual or personal services entity is conducting a personal services business. |
Detailed explanation of new law
PART 1 - AGENTS
7.11 The amendments, in particular section 87-40, will modify the way in which the personal services business rules in Division 87 apply to certain agents.
7.12 Section 87-40 modifies the application of Division 87 for those agents who satisfy the following conditions (set out in subsection 87-40(1)):
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- receive income from the principal that is for services the agent provides to customers on the principals behalf [Schedule 6, item 2, paragraph 87-40(1)(b)] ;
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- at least 75% of that income is commissions, or fees, based on the agents performance in providing services to the customers on the principals behalf [Schedule 6, item 2, paragraph 87-40(1)(c)] ;
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- the agent actively seeks other entities to whom the agent could provide services on the principals behalf [Schedule 6, item 2, paragraph 87-40(1)(d)] ; and
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- the agent does not provide any services to the customers, on the principals behalf, using premises that the principal, or an associate of the principal, owns or has a leasehold interest in, unless the agent uses the premises under an arrangement entered into at arms length [Schedule 6, item 2, paragraph 87-40(1)(e)] .
7.13 These conditions take into account that agents acting in this manner assume a degree of entrepreneurial risk.
7.14 This is intended to apply to both individuals and personal services entities who act as agents. However, it does not apply to employees [Schedule 6, item 2, paragraph 87-40(1)(a)] . Agent has its ordinary meaning of acting for or representing another.
7.15 At least 75% of the agents personal services income from the principal must be income based on the agents performance in providing services to the customers on the principals behalf, such as a percentage of income generated or fees for service. The agent may have up to 25% fixed remuneration, such as retainer or salary like payment, and may still satisfy these conditions. The object of this condition is that most of the agents income must be at risk, for example if the agent does not perform well enough, or bring in enough customers, they will not receive that income. [Schedule 6, item 2, paragraph 87-40(1)(c)]
7.16 The agent must also actively seek other entities to which they could provide services on behalf of the principal. There is no requirement that the customers to whom the agent does provide services on behalf of the principal be obtained by these methods, or that the methods that the agent uses actually result in services being provided to any customer. However, the agent must be able to demonstrate that they themselves are making an active effort (e.g. by advertising) to obtain customers, and that they are not merely receiving referrals from their principal or other parties, or allowing the principal to take all the responsibility for obtaining customers. [Schedule 6, item 2, paragraph 87-40(1)(d)]
7.17 If an agent satisfies this condition it will not necessarily mean that they will satisfy the unrelated clients test in section 87-20. That test requires a further condition to be met, namely that the services are provided as a direct result of the agent making offers or invitations.
7.18 The agent will not satisfy these conditions if they provide services from the premises of the principal, or an associate of the principal, unless the agent has an arms length agreement for the use of the agencies.
7.19 An arms length agreement will be one entered into on terms, and for a consideration, that could be expected if the agent entered the agreement with a completely independent third party on a commercial basis.
7.20 This condition does not require that the agent has commercial premises. The agent could satisfy this condition by working from home, or from their car for instance. This condition does also not preclude agents from entering the premises of the principal for the purposes of negotiating, organising or administering arrangements solely between the agent and the principal, such as negotiating the agency agreement, rates of commission, or collecting commissions, receiving training, attending sales strategy meetings.
7.21 If any part of the services provided to the customer are performed on the premises of the principal, or an associate of the principal, other than premises that the agent uses under an arms length arrangement they will not satisfy this condition. This will depend on what services are actually provided.
7.22 Section 87-40 will apply only where there is a relationship of agent-principal which will be determined by reference to all relevant circumstances.
7.23 If an agent satisfies the conditions in subsection 87-40(2), then there will be 2 special rules to use when applying Division 87 to the activities of that agent as an agent. These are contained in subsections 87-40(2) to (4).
7.24 The first special rule in subsections 87-40(3) and (4) relates to whether 80% of an individuals personal services income comes from one source. If an agent satisfies the conditions set out in subsection 87-40(2), then the income that the agent receives from the principal during the income year for services provided to customers on behalf of the principal is treated as though the income were from the customers. [Schedule 6, item 2, subsections 87-40(3) and (4)]
7.25 Although the income is received from the principal, and the agent would normally have no contractual right to recover the income from anyone other than the principal, this special rule allows the agent to look through the principal to the customers to whom they provide services on behalf of the principal. They are treated as though the customers were customers of the agent and as though the personal services income received from the principal for providing services to those customers was personal services income from the customers.
7.26 In many cases an agent may work for only one principal, and would therefore not have satisfied the 80% test if not for this special rule.
7.27 The second special rule is in subsection 87-40(5) and relates to the application of the unrelated clients test. The unrelated clients test in section 87-20 has 2 requirements. The first requires that the individual or personal services entity gains or produces income from providing services to 2 or more entities that are not associates of each other, or associates of the individual or personal services entity. The second requires that the services be provided as a direct result of making offers or invitations to the public at large or to a section of the public. If this test is satisfied, the individual or personal services entity will be considered to be conducting a personal services business.
7.28 Agents provide services on behalf of the principal, and therefore would generally not satisfy the unrelated clients test themselves. However, the special rule in subsection 87-40(5) provides that where an agent satisfies the conditions in subsection 87-40(2), the services the agent provides on behalf of the principal will be treated as though the agent, and not the principal, provided the services to the customer. [Schedule 6, item 2, subsection 87-40(5)]
7.29 This is a look through for these agents, as it allows them to treat the customers of the principal, to whom they provide services, as their customers.
7.30 This special rule will assist these agents to satisfy the first limb of the unrelated clients test, however they must still be able to demonstrate that the services were provided as a direct result of the agent making offers or invitations to the public at large or to a section of the public, to provide the services. This is the second limb of the unrelated clients test in paragraph 87-20(1)(b). An agent may fail to satisfy that limb if all of its commissions come directly from referrals by the principal, for example, even though the agent may have actively sought customers for the principal.
Example 7.1
Gordon is a financial planner who holds a proper authority under the Corporations Law to act as agent for Champagne Financial Services, a licensed securities dealer. Gordon receives 85% of his income from Champagne as commissions, dependent on the level of services Gordon provides to customers of Champagne. Gordon advertises his services once a month in financial papers, and in journals of professional associations.
Champagne operate from 5 floors of an office block which they lease, and one of those floors is dedicated to offices for Champagnes proper authority holders. Gordon uses an office on this floor under an agreement on commercial terms. Gordon does not have access to any other facilities of Champagne.
Gordon would satisfy all of the conditions set out in subsection 87-40(1), and therefore he would have access to the special rules for agents. Gordon would be treated as having less than 80% of his personal services income from one source as he has provided services to 50 of Champagnes customers, and he can treat the income he receives from Champagne that can be attributed to services he has provided those customers, as income directly from those customers. Gordon would also satisfy the unrelated clients test, as he can treat the services he provided to the customers on Champagnes behalf as though they are services provided directly by Gordon to the customers. Gordon would also satisfy the second limb of the unrelated clients test, as he provides the services to the customers as a direct result of his advertising. He does not receive referrals from Champagne.
Therefore Gordon would be considered to be conducting a personal services business, and would not be affected by the personal services income measure. He does not need to obtain a determination from the Commissioner to be outside the measure.
7.31 Of course, these agents can also consider the other personal services business tests, however, the operation of these tests is not amended in any way for these agents.
PART 2 - PERSONAL SERVICES BUSINESS TESTS
7.32 The primary rules about what is a personal services business are contained in section 87-15. The section will be amended to reflect the proposed changes to allow self-assessment of the results test for a personal services business and to allow the Commissioner to grant personal services business determinations regardless of whether 80% or more of an individuals personal services income is from one source.
7.33 The amendments to subsection 87-15(1) reflect the fact that all individuals and personal services entities will be able to apply for a personal services business determination. Therefore anyone who has a personal services business determination will be carrying on a personal services business. [Schedule 6, item 4, subsection 87-15(1)]
7.34 Taxpayers may self-assess whether they are conducting a personal services business against the results test, which is included in the list of personal services business tests in subsection 87-15(2). This will ensure that independent contractors are treated as conducting personal services businesses and therefore, are outside the measure. Subsection 87-15(3) is amended to reflect the fact that, regardless of whether 80% or more of an individuals personal services income is from one source, the individual or personal services entity can self-assess against the results test. In contrast, a taxpayer cannot self-assess against any of the other tests if 80% or more of an individuals personal services income is from one source. [Schedule 6, item 4, subsection 87-15(3)]
7.35 If 2 or more individuals gain personal services income through one entity, section 87-15 looks at the personal services income of each individual. This prevents people escaping from the provisions simply by teaming up.
7.36 These amendments to section 87-15 reflect the new structure of the legislation.
7.37 Proposed section 87-18 contains the results test. The conditions that make up the results test were previously contained in subsections 87-60(5) to (7) and subsections 87-65(5) to (7) as the further grounds on which the Commissioner could make a determination. These amendments will make those same conditions into a new personal services business test. [Schedule 6, item 4, section 87-18]
7.38 As a personal services business test, if an individual or personal services entity meets the results test, they will be conducting a personal services business. There is no need to obtain a personal services business determination although an individual or entity could apply for a determination if they were unsure. In addition, taxpayers could apply to the Commissioner for a private binding ruling about the potential application of Part IVA to their activities.
7.39 The results test is also the only personal services business test that is available for self-assessment where 80% or more of an individuals personal services income is from one source. If 80% or more of an individuals personal services income is from one source and the individual or personal services entity does not meet the results test, they will be a personal services business only if they obtain a personal services business determination. Without these amendments, if 80% or more of an individuals personal services income is from one source, the individual or personal services entity is conducting a personal services business only if they obtain a personal services business determination.
7.40 The existing conditions for the results test, in subsection 87-60(5) and subsection 87-65(5) (which are traditional tests for determining whether a taxpayer is an independent contractor), are not being changed. The 3 conditions are:
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- the individuals personal services income during the income year is for producing a result (whether or not it is received by a personal services entity);
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- the individual or personal services entity is required to supply the plant and equipment, or tools of trade, needed to perform the work from which the individual or personal services entity produces the result; and
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- the individual or personal services entity is, or would be, liable for the cost of rectifying any defect in the work performed.
7.41 Previously the conditions in the results test were only relevant to a personal services business determination. As a result of these amendments, taxpayers will now be able to self-assess against them. The discussion of these conditions can be found in the explanatory memorandum to the bill that introduced these provisions, the New Business Tax System (Alienation of Personal Services) Bill 2000.
7.42 The results test applies over the whole income year, as do the other 3 personal services business tests. Therefore, the 3 conditions must be satisfied for the personal services income gained throughout the income year. [Schedule 6, items 4 and 5, paragraph 87-18(1)(a) and subsection 87-18(2)]
7.43 If some of an individuals personal services income is not for producing a result (or one of the other conditions is not satisfied for some of the income year), they may be able to obtain a determination from the Commissioner based on unusual circumstances that prevented them from meeting the results test (see Example 7.3).
7.44 Item 6 repeals section 87-55 as it is no longer necessary. Section 87-55 explained the effect of obtaining a personal services business determination, however this is being incorporated into subsection 87-15(1). This new subsection will provide that a taxpayer conducts a personal services business if they have a personal services business determination in force in relation to the individuals personal services income, or if they meet one of the 4 personal services business tests. This supersedes section 87-55. [Schedule 6, item 5]
PART 3 - PERSONAL SERVICES BUSINESS DETERMINATIONS
7.45 Currently an individual or personal services entity can obtain a personal services business determination only if they obtain 80% or more of an individuals personal services income from one source.
7.46 The proposed amendments will remove this restriction, and allow all taxpayers earning personal services income to apply to the Commissioner for a determination.
7.47 Items 7 to 9 amend subsection 87-60(3) which deals with personal services business determinations for individuals. The amendments ensure that the Commissioner can make a determination based on the fact that the taxpayer is an independent contractor who met (or could reasonably be expected to meet) the results test, or that unusual circumstances prevented them from meeting the results test. [Schedule 6, items 7 to 9]
7.48 As well, items 12 to 14 amend subsection 87-65(3) in a similar manner in relation to personal services entities applying for a personal services business determination. [Schedule 6, items 12 to 14]
7.49 To allow all taxpayers earning personal services income to apply for a personal services business determination, items 10 and 15 repeal paragraphs 87-60(3)(c) and 87-65(3)(c) which currently limit the availability of determinations to where 80% or more of an individuals personal services income is from one source. [Schedule 6, items 10 and 15]
7.50 The amendments will allow all individuals or personal services entities earning an individuals personal services income to apply for a personal services business determination from the Commissioner. The determinations are still subject to the conditions in section 87-60 (for individuals) and section 87-65 (for personal services entities).
7.51 The amendments also repeal subsections 87-60(5) to (7) and subsections 87-65(5) to (7). These contain the further grounds for the Commissioner to make a determination. These provisions are no longer necessary as they have been incorporated into the new results test in section 87-18. [Schedule 6, items 11 and 16]
PART 4 - OTHER AMENDMENTS
7.52 PAYG withholding arrangements (Division 13 of Schedule 1 to the TAA 1953) details withholding arrangements for personal services entities. That Division contains rules that require the personal services entity to remit amounts to the Commissioner if it is a personal services payment remitter and certain other conditions are satisfied. An entity that starts providing personal services during the income year is a personal services payment remitter if there is a reasonable expectation that its personal services income is not from conducting a personal services business.
7.53 Subsection 13-15(3) provides that that expectation will not be met if it is reasonable to expect that the entity will receive at least 80% of that income from one entity and that entitys associates. The subsection is being amended to add a further requirement that it is reasonable to expect that the entity will not meet the results test. [Schedule 6, item 17]
Application and transitional provisions
7.54 The amendments will generally apply to the 2000-2001 income year and later income years [Schedule 6, subitem 19(1)] . However, the amendment to the special PAYG withholding rules for alienated personal services income (Division 13 of Schedule 1 to the TAA 1953) will apply to amounts received on or after 1 July 2000 [Schedule 6, subitem 19(3)] .
7.55 These amendments accord with the original application rules. They thus ensure that taxpayers get the benefit of the proposed amendments from when the provisions commence.
7.56 The declaration made by the Commissioner which has the effect that prescribed payments system entities are excluded from the measure until the end of the 2001-2002 income year, applies to the provisions in Part 2-42 of the ITAA 1997 as amended by this bill. [Schedule 6, subitem 19(2)]
Policy objective
7.57 The amendments to the alienation of personal services income legislation are intended to reduce compliance costs for taxpayers and provide access to personal services business determinations for all taxpayers.
7.58 The amendments were announced by the Treasurer following concerns expressed by industry associations and commentators about the potential compliance burden imposed by the legislation on independent contractors.
Implementation options
7.59 These amendments allow certain commission agents to satisfy the requirement that less than 80% of their personal services income comes from services to each customer of their principal, even though the income is received from the principal. Agents will satisfy the requirement if at least 75% of that income is achievement or results based, they actively seek customers for their principal and do not provide services to the customers from the premises of their principal (or principals associate) except under an arms length agreement with the principal or associate.
7.60 These amendments allow all taxpayers to self-assess their status as a personal services business against the results test, regardless of the proportion of income they receive from each income source, rather than seek a determination from the Commissioner.
Amendments giving access to determinations to all taxpayers earning personal services income
7.61 These amendments allow all taxpayers that earn personal services income to apply for a determination from the Commissioner. Previously only taxpayers that earned more than 80% of personal services income from one source were required to apply for a determination.
Assessment of impacts
7.62 The amendments have been proposed following discussions about the impact of the original legislation on various groups. The amendments are intended to reduce compliance costs.
7.63 It is estimated that there are more than 15,000 taxpayers in the principal/agent category.
7.64 It is difficult to estimate the number of taxpayers affected by these amendments.
Amendments giving access to determinations to all taxpayers earning personal services income
7.65 All taxpayers that derive personal services income are affected by these amendments. The estimate of taxpayers in this category is 166,000. This is made up of 46,000 companies, 47,000 partnerships and trusts and 73,000 sole traders.
7.66 The amendments in this bill are intended to reduce compliance costs for affected taxpayers.
7.67 Taxpayers in this category will be able to look through their principal in determining the source of their income for the purpose of the measure. For the purposes of satisfying the 80% test income will be treated as having come from the customers rather than from the principal. Where this look through results in an agent having less than 80% of their personal services income from each customer, that agent will be able to self-assess against the personal services business tests. They will no longer need to seek a personal services business determination from the Commissioner and will no longer have to fill out the application form. The benefit of self-assessment is reduction in time taken to fill out the determination.
7.68 These taxpayers will continue to have the option of applying for a determination from the Commissioner. It is difficult to estimate how many will do so.
7.69 All taxpayers may self-assess against the results test, regardless of the proportion of income they receive from each income source. They will continue to have the option of applying to the Commissioner for a personal services business determination on the basis of the results tests or the other tests if they so desire. Taxpayers who self-assess will not have to fill out the determination request form. The benefit of self-assessment is reduction in time taken to fill out the determination.
Amendments giving access to determinations to all taxpayers earning personal services income
7.70 All taxpayers who are affected by the alienation of personal services income measure and who previously were able to self-assess their status against the personal services business tests will now also be able to apply to the Commissioner for a determination. The benefit of a personal services business determination is certainty for the taxpayer.
7.71 The amendments will be administered by the ATO with the resources currently allocated to administering the alienation of personal services income legislation.
7.72 The amendment relating to individuals operating under principal/agent relationships is estimated to cost $35 million per year.
7.73 The other amendments will have no impact on revenue.
Other issues - consultation
7.74 These amendments have been developed following extensive consultation with various industry associations and have their support.
Conclusion and recommended option
7.75 This option is expected to significantly reduce compliance costs for taxpayers affected by the alienation of personal services income legislation.