10 January 2002, updated August 2010
If you pass the Personal Services Income (PSI) legislation ‘results test‘ you achieve an entitlement to be treated as a business for tax purposes. The process of passing the results test is relatively clear.
Court case update: August 2010
A recent court case tested the ‘unrelated clients test’. The case involved a specialist engineering doing a 12-month contract with BHP. The ATO had not allowed the contractor to pass PSI because he only worked for one company in the tax year. However, the court found that the contractor normally worked for many different companies. Just because the particular work in this year was for just one company did not mean the contractor failed PSI. The court found the contractor passed PSI. The case is reasonably short and readable.
The following practical steps should help.
1) Make sure you are not an employee
If you are an employee you definitely fail the PSI legislation.
Many people will try to force you to be an employee—not because it’s in your interests, but because it suits them.
- Managers in some companies only want employees because they believe this gives them more control over the business. If you are content to be controlled in an employee-like manner, that’s fine. But if you want the independence of thought and professional business-type relationship that comes with independent contracting, then don’t be duped into being an employee. Often managers are happy to use you as an independent contractor if the option is explained to them and you express your intent.
Unions usually try to force people into employment. They do this because their power and income comes through industrial relations regulation which only has authority over employees.
In a free society, you have a right to work as an independent contractor if you wish. Make sure that the way you are engaged is a choice that you are given and one that you have freely entered.
2) Make sure you are clearly an independent contractor at common law
If you are an independent contractor you should according to ICA’s assessment pass the first section of the results test.
First, ensure that you are an independent contractor.
You can do this in two ways:
- When engaged direct, make sure that the procedures and processes under which you are engaged point to independent contracting. Use ICA’s common-law, swinging pendulums as a check list and particularly focus on the 9 common-law indicators used by the ATO in tax rulings TR2001/8.
OR
Use labour hire services where the systems used have been legally tested and proven to secure independent contracting. The particular type of labour hire that achieves this is explained by the ATO under PAYG. This is different to labour hire where you are an employee. Specific assistance can be provided by specialist accountants, solicitors, labour hire companies and consultants.
3) Make sure that you are responsible for rectification (This is a common law test)
Simply explained, this means that you are prepared or expected to fix errors you may make. This is, however, subject to the realities of ‘common and practice’ within the industry and for the particular type of work you are doing.
For example, a builder may normally be liable to fix bad work, whereas a computer programmer may not. Everything will depend on individual circumstances. You need to comply with normal industry practice in the area in which you work.
4) You must supply your own plant and equipment (This is a common law test)
This is also subject to custom and practice It will be necessary for you to ensure that, in the area in which you work, the plant and equipment you supply is what is required under the normal arrangements for independent contractors for that industry and job.
For example, it may be common in the building industry for a painter to supply ladders but for the client to supply high-reach mechanical hoists. If all independent contractor painters supply their own paintbrushes, then this is what you would need to do too.
Self-Assess and the 75% Rule
These 4 steps (above) should enable you self-assess your capacity to pass the results test. All 4 need to be satisfied. Once satisfied you pass the PSI legislation and are entitled to be treated as a business for tax purposes.
Remember you only need to pass the results test for 75% of your income in any year to secure an entitlement to business-tax treatment for all of your income in the same year.
A qualification! Result = Result?
The PSI legislation states that in addition to rectification and plant and equipment you need to produce a ‘result’. ICA believes that this is confusing because the word ‘result’ in the PSI legislation refers to the ‘results test’. ICA suspects that ultimately this may mean no more than to work for a ‘result’, you need to pass the ‘results test’. This area will need further legal clarification.
Comment and Monitoring
ICA believes that the results test is perhaps one of the easiest and fairest business-tax tests in use in developed economies. It is certainly fairer than the situations in the United Kingdom and the Unites States of America. There are, however, some areas that may be subject to clarification. These include:
- How the Commissioner of Taxation interprets ‘custom and practice’ within each industry and for each job.
Whether producing a ‘result’ within ‘custom and practice’ has any meaning beyond the ‘results test’.
These are comparatively minor issues. ICA will, however, seek to monitor how the Commissioner of Taxation applies these tests and will seek to work with government to ensure that the intent of the PSI legislation is reflected in practice.
I pass the results/common law test. How does this affect my tax?
Every person’s tax situation is different. If you pass the PSI results test, what you do know is that you have an entitlement to be treated as a business for tax purposes. Your accountant is the best person to assess how this impacts on your personal tax situation.
80/20 rule. ICA Comment
ICA is interested in the rights of independent contractors. The PSI results test is very close to a common-law test and, as such, most independent contractors should pass.
There are, however, people who would potentially be common law independent contractors, but who fail the results test because they fail on the rectification and/or plant and equipment issues. These people may still be able to pass PSI if they earn less than 80% of their income from one source.
If you are not an employee, but an independent contractor, and if you fail the results test, but have two or more clients in a year where no client contributes to more than 80% of your income, then you still have entitlement to business-tax status.
But you also need to pass one of the following:
- Have unrelated clients
- ‘Employ’ another person/s
- Have a separate business premises.
The detailed rules on each of these are extensive and beyond the current scope of this Website. Refer to professional tax advisers for further information on these issues.
In general, ICA believes that the vast bulk of independent contractors should be capable of passing the results test and not need to consider the 80/20 rule. Given that rectification and plant and equipment are such important common law sub-tests for independent contracting, if an independent contractor failed either of these, ICA would strongly recommend reviewing and improving engagement arrangements to ensure that these sub-tests would be passed.
Try Our 20 Point Checklist
Are you sure you are an independent contractor? ICA has produced a simple, one-page checklist for members as a guide. Click here to download the PDF.