This paper was presented to The Tax Institute Victorian 2nd Annual Tax Forum on 9 October 2014.

Transcription

1 Independent Contractors - Personal Services Income This paper was presented to The Tax Institute Victorian 2nd Annual Tax Forum on 9 October Introduction Overview The independent contractors industry has been the subject of focused review by the ATO, the SRO and the FWO. The Coalition Government has confirmed its commitment to independent contractors, has stated it will not change the current laws relating to the treatment of personal services income and has criticised government agencies for an attack on the self-employed. Where that leaves needed PSI legislative and tax administration reform is unclear. Independent contracting can be driven by the end user s desire to reduce employment payroll tax, workers compensation and SG Charge on-costs, workplace relations regulation and outsourcing worker administration and compliance costs and procedures rather than the tax advantage to the worker. 1 Independent contracting can be driven by the worker s desire to avoid PAYG Withholding, packaging SG Charge and tax planning opportunities including retaining the income in a corporate interposed entity at corporate tax rates and deferring personal tax rates until dividends are paid, claiming business deductions not available to an employee and distributing the income to owners and beneficiaries other than the worker. 2 The end user s and the worker s differing objectives are largely aligned encouraging independent contracting arrangements. The Federal and State taxation and regulation of labour is complex, inconsistent and uncertain. Incorrectly classifying the relationship between the end user, any intermediary and the worker can have significant tax consequences for each of these. The end user or intermediary may have unexpected PAYG Withholding liabilities, SG Charge liabilities, payroll tax liabilities, long service leave liabilities, WorkCover obligations and Fair Work obligations. 1 BOT PSI review at [3.25] - [3.28]. 2 BOT PSI review at [2.2] and [2.4].

2 The worker may have an unexpected income tax shortfall, penalty and interest on ineffectively alienated income. This paper discusses the complexities of navigating the independent contractor laws from a tax law and employment entitlement perspective including: 1. the employee, dependent contractor 3 and independent contractor distinction; 2. PSI - remuneration, PSI rules and Part IVA; 3. PSI withholding - employers, labour hire, labour hire trusts and partnerships; 4. SG Charge - employers and dependent contractors; 5. director penalty notices; 6. Victorian payroll tax - grouping, employees, contractors, labour hire and labour trusts or partnerships; and 7. Victorian long service leave and WorkCover. PSI Taxation 101 Introduction The various tax systems have a preference for the taxation of labour payments. Labour payments include remuneration (wages, employer superannuation contributions and fringe benefits tax), certain self-employed and business income and certain wealth transfer payments. 4 Historically, there has been a distinction between receipts from labour and receipts from investment. 5 For example, income tax is imposed at: 1. progressive marginal rates on remuneration and business income of individuals and on discounted capital gains on investment income; and 2. proportionate corporate tax rates on business and investment income of companies. Fringe benefits tax is imposed on non-cash receipts from labour, but with various concessions or exemptions for business use. Payroll tax is levied on salary and wages of employees and dependent contractors, but not on independent contractors making business supplies. These disconformities in taxation encourage independent contracting and the alienation of income by the transfer of personal services income and business income into corporate, trust or partnership structures so that the interposed entity derives the income. Tax planning and non-compliance are of significant concern to revenue authorities since personal income tax accounts for 37% of total Federal tax revenue 6 and payroll tax accounts for 46.6% of total Victorian tax revenue. 7 3 Henry review at A Contractors in employee-like circumstances. 4 Henry review at A BOT PSI review at [5.5]. 6 Henry review at A1.4 & VSRO ANN-016 Annual Review 2013, Pg. 14. Ron Jorgensen 2014 Page 2 of 41

3 Income Tax & PAYG Withholding The income tax system has a statutory preference for progressive taxation of individuals. 8 Relevantly, a worker is taxed on: 1. remuneration paid to the worker 9 or applied or dealt with on behalf of or as directed by the worker (e.g. paid to an interposed entity); cash benefits provided to the worker in relation to employment or services; attributed income of the interposed entity where the interposed entity derives a significant part of business income from the personal services of the owner-worker (i.e. the PSI rules); 12 or 4. attributed income from a tax avoidance scheme (i.e. GAAR). 13 The collection of the worker s tax is supported by the PAYG withholding regime, which requires payers to withhold and remit tax to the FCT on: 1. the payment of salary, wages, commission, bonuses or allowances it pays to an employee (whether of that or another entity); the payment of cash benefits provided to the worker in relation to employment or services (whether of that or another entity); attributed alienated personal services payments of the interposed entity under the PSI rules; 16 or 4. the payment by a labour hire arranger made under an arrangement that involves the performance of work or services by the individual directly for the client of the entity or of another entity. 17 Incorrectly classifying the relationship between the end user, any intermediary and the worker may have unexpected PAYG Withholding liabilities, SG Charge liabilities, payroll tax liabilities, long service leave liabilities, WorkCover obligations and Fair Work obligations for the end user or intermediary. Also, the worker may have unexpected income tax shortfall, penalty and interest on ineffectively alienated income. SG Charge The 9.25% SG Charge applies to an entity in respect of remuneration it pays to an employee within the ordinary meaning 18 or to a person under a contract that is wholly or principally for the labour of the person (whether of that or another entity). 19 SG Charge is a non-deductible penalty equal to the shortfall in minimum superannuation contribution plus interest and administrative penalty and administrative charge. The FCT also applies the SG Charge to intermediaries. 20 The shortfall component of the SG Charge is applied by the FCT for the benefit of the relevant worker to the superannuation fund of the relevant worker Henry review at A Sec. 6-5 ITAA Sec. 6-5 ITAA Sec ITAA 1997; Case l54 79 ATC Henry review at A Sec. 77F ITAA Sec TAA 1953; TR 2005/16; NB: sec TAA 1953: payment to company director. 15 Sec TAA Sec TAA Sec TAA Sec. 12(1) SGAA Sec. 12(3) SGAA SGR 2005/2. 21 Sec. 65 SGAA Ron Jorgensen 2014 Page 3 of 41

4 Payroll tax 4.85% payroll tax is levied on the Victorian wages (or deemed wages) payable by an employer (or group employer) to the employees, directors, certain former directors and designated contractors, 22 if the total taxable Australian wages exceeds $500,000 per annum. 23 Payroll tax is levied on payments by employment agents arising under employment agency contracts. Each State and Territory levies payroll tax on wages (or deemed wages) within their jurisdiction. NSW, NT, SA, TAS and VIC have enacted harmonised payroll tax legislation and QLD and WA have aligned payroll tax provisions with the harmonised jurisdictions in certain key areas. These initiatives have reduced, but not eliminated, the inter-jurisdictional disconformities in the payroll tax system. The $500,000 wages threshold encourages the use of independent contractors since these payments and labour on costs are not included in calculating the threshold and withholding is not required from independent contractors (as opposed to dependent contractors). PSI Reviews & Taskforces The distinction between employee, dependent contractor and independent contractor has been the subject of a number of reviews and taskforces with the intention to clarify, simplify and align structural disconformities between taxation regimes. Banks taskforce The Banks Taskforce considered the complexity of the definitions of employee, salary and wages and contractor for Federal and State legislation and recommended that: 1. the definitions of employee, salary and wages and contractor for Federal taxes be aligned and rationalised and the narrower PAYG withholding concepts should be applied to the SG Charge; 24 and 2. the payroll tax base and administrative provisions be aligned across the States and Territories. 25 The PAYG withholding and SG Charge recommendations have not been implemented. Since 2007, NSW, NT, SA, TAS and VIC have enacted harmonised payroll tax legislation. QLD and WA have aligned payroll tax provisions with the harmonised jurisdictions in certain key areas. Each CSR has committed to harmonised payroll tax administration. The harmonisation initiatives have reduced, but not eliminated, the inter-jurisdictional disconformities in the payroll tax system. BOT PSI review The BOT PSI review considered the PSI rules did not provide an acceptable level of integrity and equity 26 because: 1. the PSI tests do not focus on employee-like situations so the legislative objectives are unclear; the concept of personal services income and the results test are difficult to apply, so workers liberally interpret the tests; Sec. 7 PTAV pro-rated for each calendar month. 24 Banks taskforce Recommendations 5.43 and Banks taskforce Recommendation BOT PSI review at [4.20]. 27 BOT PSI review at [3.6]. 28 BOT PSI review at [3.7] - [3.8] & [4.16]. Ron Jorgensen 2014 Page 4 of 41

5 3. the PSI tests disadvantage knowledge workers as compared to workers producing tangible property and do not accommodate industry standards and commercial practices of remuneration models, duration of projects or provision of equipment; the PSI tests do not adequately distinguish between dependent contractor workers and independent contractor workers; the PAYG withholding rules are complex, difficult to apply and impose significant compliance costs; there is a significant underreporting of PSI in the labour hire sector and generally; 32 and 7. the under-reporting of PSI results in the FCT relying heavily on the GAAR. 33 The BOT recommended apportionment of income derived by labour and as a return of investment capital such as by: 1. imputing a rate of return on business assets and attributing the residual business profits as PSI to the worker; or 2. attributing a minimum remuneration to the services of the worker as PSI under a domestic transfer pricing rule, with the residual business profits being the return on business assets. The BOT also recommended more robust reporting obligations to facilitate PSI data matching, 34 PAYG withholding obligations on contractor payments, 35 compulsory GST registration for contractor payments, 36 adopting the Ralph Report employ-like test, 37 amending the results test 38 and clarifying the deduction rules. 39 The BOT PSI review was submitted to the Henry review to address the structural issues and options. Henry review The Henry review considered the alienation of PSI and recommended that consideration be given to a revised regime to prevent alienation of PSI and the imposition of an arm s length rule for deduction by all entities earning a significant proportion of their business income from the personal services of their owner-worker whether or not in employee-like cases. 40 The Henry review recommendation would treat all personal services income similarly and otherwise in accordance with the BOT PSI review recommendations. ANAO PSI review The ANAO PSI review considered the ATO s administration of the PSI rules and determined that: 1. the ATO has effectively administered many key areas of the PSI rules implementing sound governance arrangements, business planning, risk management and reporting processes; and 2. the ATO program has increased the number of individuals declaring PSI, 41 decreased the number of interposed entity 42 and increased net PSI declared. 43 The ATO s PSI administration program changes implemented from 1 July 2012 are still developing. General observations include: 29 BOT PSI review at [3.11] - [3.12] & [4.18]. 30 BOT PSI review at [3.14]. 31 BOT PSI review at [3.9] & [4.19]. 32 BOT PSI review at [3.20] - [3.21] & [4.3]. 33 BOT PSI review at [4.8]. 34 BOT PSI review at [5.16]. 35 BOT PSI review at [5.26]. 36 BOT PSI review at [5.34]. 37 BOT PSI review at [5.37]. 38 BOT PSI review at [5.45]. 39 BOT PSI review at [5.55]. 40 Henry review Recommendation ,000 in YE 2001 to 434,500 in YE 2012: ANAO PSI Review at [17] ,000 in YE 2001 to 28,000 in YE 2012: ANAO PSI Review at [17]. 43 $1.0b in YE 2001 to $3.1b in YE Ron Jorgensen 2014 Page 5 of 41

6 1. the strike rate of audit activities resulting in adjustment has improved; % of PSI audits indicate a failure to correctly declare the personal services business status and resultant income; there would be benefit in the ATO better developing the ATO online employee-contractor decision tools; 46 and 4. the number of PSI business determinations have decreased significantly 47 and there continues to be a relatively high proportion of unfavourable outcomes. 48 The ANAO PSI review provides some interesting ATO administrative statistics, but does not assess the cause for those statistical changes. The statistical improvements may be caused by a more liberal application of the PSI rules by the ATO as alleged by the Coalition Government. Government Position The Coalition Government has confirmed its commitments to independent contractors, has stated it will not change the current laws relating to the treatment of PSI and has criticised government agencies for an attack on the self-employed. The coalition will not change the current laws relating to the treatment of personal services income and will resist the current government s attack on contractors and the self-employed. 49 We ve also committed to protecting the rights of independent contractors and the self-employed. A systematic and coordinated Government-union campaign seeks to force more and more self-employed people into the traditional employer-employee relationship governed by a workplace regime where unions exercise disproportionate influence and control.the tax office continues to overreach on tax law interpretation and to put to one side the legislative intent of the independent contractor determinations the parliament has agreed on and that should be implemented as intended. 50 There was a dirty deal between the former Labour government and the unions to crack down on independent contractors, to keep more people in the traditional employer/employee rile and help union membership. Self-employed is a legitimate form of business and independent contractors make an extraordinary contribution to this economy. We found example after example of independent contractors wrongly being decreed as employees, with no scope to challenge the findings. So we moved to ensure the law about who is an independent contractor was implemented as intended. 51 Where that leaves needed PSI legislative and tax administration reform is unclear. The Tax White Paper will hopefully address PSI reform. Relationship Classification Introduction Incorrectly classifying the relationship between the end user, any intermediary and the worker can have significant tax consequences for the end user, any intermediary and the worker. The distinction between an employee and independent contractor is rooted fundamentally in the fact that when personal services are provided to another business, an independent contractor provides those services while working in and for his or her own business, whereas an employee provides personal services while working in the employer s business. 52 Various aspects of tax legislation distinguish between an employee, a dependent contractor that is treated as an employee equivalent and an independent contractor % in YE 2011 to 78.9% on YE 2013: ANAO PSI Review at [26]. 45 ANAO PSI review at [25]. 46 ANAO PSI review at [29]. 47 1,800 in YE 2001 to 155 in YE 2013: ANAO PSI Review at [29] % in YE 2012 to 21% in YE 2013: ANAO PSI Review at [30]. 49 Media Release, Coalition reaffirms its support for independent contractors and self-employed, 3 June B. Billson, The Coalition national strategy to restore small business hope, reward and opportunity, Council of Small Business of Australia, 7 March Australian Institute of Company Directors Magazine 1 February 2014 Q & A with Bruce Billson. 52 On Call Interpreters & Translators Agency P/L v FCT (No 3) [2011] FCA Hollis v Vabu P/L [2001] HCA 44; SGR 2005/1 at [25]. Ron Jorgensen 2014 Page 6 of 41

7 Employee classification In determining whether there is a contract of service (employment) or a contract for service (contractor), the totality of the circumstances must be considered having regard to: 1. the degree of authority and control that may be exerted by the end user over the worker; the degree of integration of the worker into the organisation of the end user; whether the substance of the contract is to achieve a specified result; whether payment is for completion or fulfilling the contractual conditions or hours worked, 57 however, calculation of the payment by estimated hourly rates and completion times is consistent with a results contract; whether the worker must perform the service or can delegate or subcontract the performance of the services; whether the end user reimburses the worker for expenses and allowances; the degree of commercial and financial risk the worker has arising out of injury or defective work; the number, type and value of tools provided by the end user or the worker to perform the service; whether the end user or the worker is liable to pay for the delegated or subcontracted services; whether the service contract arose because of an employer or labour hire advertisement or because of the contractor advertising; whether the worker performs tasks which require special qualification; whether the end user has: 66 (a) rights to suspend or dismiss the worker; 67 (b) rights to exclusive services of the worker; 68 (c) obligations to pay annual, sick and long service leave; or (d) obligations to provide other benefits prescribed under an industrial award; 69 and 13. whether the worker is presented to the public through the end user s uniforms and branding. 70 There has been an evolution from reliance on the formality of the contractual relationship to the day-to-day facts of the relationship. The objective and real substance of the relationship between the end user, the intermediary and the worker must be considered. 71 A deemed contractor relationship clause in an engagement contract cannot override the substance of the relationship, 72 but can resolve any ambiguity as to the true nature of the relationship. 73 As a result, careful legal drafting of engagement contracts can support, but not override, the day-to-day facts of the relationship. Arguably, there has also been an evolution in the approach to applying the principles of the relationship. 54 Hollis v Vabu P/L [2001] HCA 44 at [43]-[44]; SGR 2005/1 at [33]; TR 2005/16 at [26] and [28]. 55 Hollis v Vabu P/L [2001] HCA 44; SGR 2005/1 at [40]; TR 2005/16 at [32]. 56 World Book (Australia) P/L v FCT (1992) 27 NSWLR 377; SGR 2005/1 at [42]; TR 2005/16 at [17]. 57 Neale v Atlas Products (Vic) P/L [1955] HCA 18; SGR 2005/1 at [44]. 58 SGR 2005/1 at [45]. 59 Stevens v Brodribb [1986] HCA 1; SGR 2005/1 at [48]; TR 2005/16 at [41]. 60 SGR 2005/1 at [57]. 61 SGR 2005/1 at [51]; TR 2005/16 at [44]. 62 SGR 2005/1 at [52]; TR 2005/16 at [45]. 63 SGR 2005/1 at [49]. 64 The Roy Morgan Research Centre P/L v CSR (Vic) (1996) 33 ATR 361 at ; (1997) 37 ATR 528; SGR 2005/1 at [31]. 65 Hollis v Vabu P/L [2001] HCA SGR 2005/1 at [58]. 67 TR 2005/16 at [51]. 68 TR 2005/16 at [51]. 69 TR 2005/16 at [51]. 70 SGR 2005/1 at [59]; TR 2005/16 at [52]. 71 On Call Interpreters & Translators Agency P/L v FCT (No 3) [2011] FCA 366 at [189] & [193]. 72 CSR (SA) v The Roy Morgan Research Centre P/L [2004] SASC 288; SGR 2005/1 at [28]. 73 Australian Mutual Provident Society v Chaplin (1978) 18 ALR 385 at ; SGR 2005/1 at [29]; TR 2005/16 at [22]. Ron Jorgensen 2014 Page 7 of 41

8 The entrepreneur test appears to be the central question in applying the principles. 74 Viewed as a practical matter : (i) is the person performing the work an entrepreneur who owns and operates a business; and, (ii) in performing the work, is that person working in and for that person s business as a representative of that business and not of the business receiving the work? If the answer to that question is yes, in the performance of that particular work, the person is likely to be an independent contractor. If no, then the person is likely to be an employee. In determining whether the worker is conducting a personal service business, the elements of the entrepreneur test are: Do the economic activities of the putative business involve the taking of risk in the pursuit of profits?... Does the putative business engage in a repetitive and continuous manner with purchasers of its services?... Does the putative business employ or engage persons other than the owner/operator to carry out its economic activities?... Is goodwill (name, brand and reputation) being created by the economic activities of the putative business? Is the putative business promoted as a business to the public through advertising or other promotional means? Does the putative business have tangible assets such as buildings and equipment which are utilised to support its economic activities?... Does the putative business have the basic transactional systems that are common of a business of that kind? For instance: invoicing systems; standard rates and terms and conditions of trade; insurance coverage; payment and debt collection systems; appropriate financial records; budgeting or forecasting systems; business based arrangements with a bank or other financial institution? Do the services provided by the putative business involve the provision of labour of sufficient skill to be suggestive of the pursuance of a profession or trade through a business?... Are the regulatory requirements of a business (including business name registration, taxation, GST and ABN registration and compliance) being met by the putative business? In determining in whose business the activities are being performed, the elements of the entrepreneur test are: Does the provision of the economic activity provide an opportunity for profit and involve the risk of loss or is the payment made largely consistent with the remuneration that an employee would have received for providing the activity? In that respect and in relation to profit: to what extent is the reward for the provision of the activity negotiable and negotiated commercially? to what extent does the putative owner/entrepreneur have the capacity to manage the activity so as to maximise the potential for profit? In that respect and in relation to risk: to what extent is the agreed payment contingent upon the person providing a satisfactory result (i.e. are there financial consequences for poor performance)? who bears the risks associated with providing any equipment or assets required for the performance of the economic activity? Does the putative business or the putative employer s business control and direct or have the capacity to control and direct the manner in which the economic activity is carried out? Is the economic activity represented or portrayed as the activity of the putative business or that of the putative employer s business? To what extent is the person providing the economic activity integrated with the business receiving the activity? To what extent is the person providing the economic activity financially self-reliant from, as opposed to, economically dependent upon or organisationally tied to, the business receiving the activity?... Exclusivity is suggestive of an employment relationship However, it does not follow that a person who provides casual or part-time work to multiple purchasers is not an employee. Is the person providing the economic activity free to employ his or her own means (employees or contracted agents) to produce the activity or must that person personally perform the work? To whose business does any goodwill created by the economic activity enure? In contracting to provide the economic activity has the person agreed to provide an outcome or result? To what extent is the person providing the economic activity doing so with his or her own tools and equipment? If the person is providing their own equipment, to what extent can the person be directed in the management and control of that equipment? Have the parties involved characterised the economic activity as that of the owner/entrepreneur being performed in and for that person s business, or alternatively as part of the receiving business, and to what extent does that characterisation reflect the reality? The application of these tests continue to raise uncertainties. After proper weighing of these principles, reasonable practitioners can still differ on whether the same worker is a contractor or an employee. It is difficult to draw a clear dividing line separating an employee from an independent contractor On Call Interpreters & Translators Agency P/L v FCT (No 3) [2011] FCA 366 at [208] - [209]. 75 On Call Interpreters & Translators Agency P/L v FCT (No 3) [2011] FCA 366 at [5]. Ron Jorgensen 2014 Page 8 of 41

9 The tests are applied for each worker and it is not possible to extrapolate any findings across an end user s workforce. 76 Accordingly, there are difficulties in structuring independent contractor arrangements for end users with certainty and the supporting engagement documentation will not override the day-to-day substance of the relationship. The ANAO PSI review recommended the FCT improve the Employee/Contractor decision tool. 77 The FCT s Employee/Contractor decision tool 78 is extremely basic and does not emerge all the issues regarding the employment relationship principles or the GAAR PSI principles. For example, we have experience of an end user providing a print out of the favourable Employee/Contractor decision tool results to a PAYG withholding and SG Charge audit case officer and being very surprised when the case officer distinguished the results based on various employment relationship principles and GAAR PSI principles that were not expressly tested by the decision tool. The Employee/Contractor decision tool requires urgent amendment to reflect all the employment relationship principles and GAAR PSI principles because it is misleading end users and workers. Dependent contractors To address difficulties with delineating employees from contractors that are employee-like, various legislation has been enacted that has extended the definition of employee to treat dependent contractors as employee equivalents. Under the PSI rules, income derived by an individual or entity mainly from the personal efforts or skills of an individual is treated and taxed similarly to employment income, unless the individual or entity is conducting a personal services business. 79 The SG Charge extends the definition of employee to a person under a contract that is wholly or principally for the labour of the person (whether of that or another entity). 80 Payroll tax applies to relevant contracts under which a designated person (i.e. contractors) in the course of a business supplies to or receives from another person services for or in relation to the performance of work..81 WorkCover obligations apply to contractors where the provision of materials or equipment are not a principal object of the arrangement, at least 80% of the work by gross contractual income is performed by the same individual and at least 80% of the work by gross contractual income is earned from the same end user. 82. Long service leave does not generally apply to independent contractors. Accordingly, a number of contractor relationships relevantly dependent on an employee like relationship are taxed as employees for some, but not for other legislative purposes. 76 On Call Interpreters & Translators Agency P/L v FCT (No 3) [2011] FCA 366 at [226]. 77 ANAO PSI review at [29] Sec ITAA Sec. 12(3) SGAA Sec. 33 PTAV 2007; Ruling PTX-019; Ruling PTX Sec. 9 WIRCAV Ron Jorgensen 2014 Page 9 of 41

10 Odco Tri-partite Structuring A common planning approach was to enter into a tri-partite relationship between the worker, end user and intermediary to diffuse the employment relationship principles. In order for there to be an employment relationship, there must be a contract for services between the end user and the worker 83 and an entitlement for the worker performing the services to be remunerated in respect of the services performed. 84 In a tri-partite arrangement, there is generally no contract between the worker and the end user and the employment relationship principles are diffused, so do not establish that the worker is an employee of either the end user or the intermediary. In some arrangements, the worker provides negative pledges and obligations only and the end user and the worker do not, as between them, provide positive employment obligations. To address the structure, intermediary provisions have been enacted for PAYG withholding 85 and payroll tax. 86 The FCT also applies the extended definition of employee for the SG Charge to intermediaries. 87 The broad scope of these intermediary provisions mean they are not limited to Odco structures, but apply to common contracting relationships. Independent contractors If a worker is not subject to the above regimes, then the worker will be an independent contractor. An end user or intermediary may have a PAYG Withholding obligation where: 1. the independent contractor fails to quote an ABN or exemption entitlement; 88 or 2. the independent contractor has entered into a relevant voluntary withholding agreement. 89 Many end users assume that a worker must be an independent contractor if the worker quotes an ABN or is registered for GST (or both). The quotation of an ABN may evidence, but does not establish, an independent contractor relationship. 83 Drake Personnel Ltd v CSR (Vic) [2000] VSCA BWIUA v Odco P/L (1991) 29 FCR 104, 114; ACC v Odco P/L [1990] HCA Sec TAA Pt. 3 Div. 8 PTAV SGR 2005/2. 88 Sec TAA 1953; Ruling TR 2002/9. 89 Sec TAA 1953; ATO Fact Sheet NAT Ron Jorgensen 2014 Page 10 of 41

11 Under the current systems, the end user must verify the independent contractor status by applying the employment relationship principles. Even robust verification procedures cannot delineate employees, dependent contractors and independent contractors with certainty. End users are relying on labour hire intermediaries to manage the risks of engaging workers and the broad scope of the intermediary provisions regulates workers that would otherwise be entitled to treatments as an independent contractor. Accordingly, the PSI regulation of independent contractors has expanded in recent years. Income Tax Introduction During a PSI or PAYG Withholding audit, the FCT invariably asserts that a payment is remuneration, or, alternatively, subject to the PSI rules and for completeness, the GAAR applies. Because reasonable practitioners can differ on whether the same worker is a contractor or an employee and the matter will usually have a mix of favourable, unfavourable and indeterminate employment relationship principles, it is very difficult to advise and structure taxpayers or cost effectively defend audits in this area. Remuneration Remuneration (salary, wages, bonuses etc) paid to the worker 90 or applied or dealt with on behalf of or as directed by the worker (e.g. paid to an interposed entity) 91 is taxed to the worker. Once an employment relationship is established, the relevant remuneration paid to the worker is taxable to the worker. However, there is some uncertainty regarding payments to an interposed entity or related entity being deemed remuneration for services of the worker applied or dealt with on behalf of the worker Income according to ordinary concepts (ordinary income) (2) If you are an Australian resident, your assessable income includes the *ordinary income you *derived directly or indirectly from all sources, whether in or out of Australia, during the income year. (4) In working out whether you have derived an amount of *ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct. It is unclear whether an existing right to a present or future receivable of remuneration or some degree of control over the payment or the amount of the payment is a precondition to sec. 6-5(4) ITAA 1997 applying. 93 Sec. 6-5(4) ITAA 1997 does not deem derivation, it deems constructive receipt by a cash basis accounting taxpayer who assigns a receivable. 94 The better view is that a right to a present or future receivable of remuneration must exist as a precondition to sec. 6-5(4) ITAA 1997 applying. The FCT accepts that under a valid salary sacrifice arrangement, there is no right to a receipt of remuneration where the remuneration is sacrificed before becoming entitled to the remuneration Sec. 6-5 ITAA Sec. 6-5 ITAA Sec. 6-5(4) ITAA R Parsons, Income Taxation in Australia, at R Parsons, Income Taxation in Australia, at TD 2001/10. Ron Jorgensen 2014 Page 11 of 41

12 Similarly, the crediting of an amount in the records of the payer does not create a receivable. The crediting of an amount does not necessarily mean that the amount has been received and sec. 6-5(4) ITAA 1997 does not apply to deem the receipt. 96 FCT v Mochkin 97 can be seen as an example of the taxpayer having no receivable of remuneration since the contract was with the interposed entity. 127 The Commissioner submitted, both to the primary Judge and on the appeal, that the fees or commissions paid to Ledger by the various brokers should be regarded as income derived by the Taxpayer within the meaning of s 25(1) of the ITAA. Reference was made to s 19 of the ITAA as emphasising the difference between derivation of income and entitlement to receive income. 128 The primary Judge rejected the argument. His Honour pointed out that the Commissioner had disavowed any suggestion that the arrangements between Ledger and the various brokers had been a sham. Ledger could have sued in its own name to recover the fees and commissions and was responsible to the broker for client defaults. It followed that fees and commissions payable pursuant to the arrangement constituted income derived by Ledger. No income was derived by the Taxpayer otherwise than as an employee of Ledger, until a determination was made to distribute income to him as a beneficiary of the relevant trust. 131 Secondly, as Mr Maxwell frankly acknowledged, his submission was inconsistent with the decision of the Full Court in Tupicoff. In that case, the taxpayer, an insurance agent, procured the appointment of a company, controlled by him, as an agent in his stead. Commission was thereafter paid to the company rather than to the taxpayer. The Full Court rejected the Commission's submission that, independently of the anti-avoidance provisions of s 260, the arrangement between the taxpayer and the company should be ignored as an ineffective attempt by the taxpayer to assign future earnings which were the product of his exertion. Beaumont J, with whom Fisher and Jenkinson JJ agreed, said this (at 519): "But here, whatever practical importance the parties attached to the continued participation of the taxpayer in the affairs of the company, the legal source of the company's income, in the form of remuneration or commission earned by it, was the contract of agency made between National Mutual and the company. If, in accordance with that contract, commission becomes payable to the company by National Mutual, then, at law, the operation of s 260 apart, it is income derived by the company: it is not technically income derived by the taxpayer, however instrumental he may have been in the performance of the company's contract with National Mutual." [132] Section 19 of the ITAA does not advance matters from the Commissioner's perspective. Section 19 does not say that income is deemed to be derived whenever it is dealt with as a taxpayer directs. As was pointed out by the High Court in Permanent Trustee Co of New South Wales v Commissioner of Taxation (1940) 6 ATD 5 at 12, the section "says that it shall be deemed to be derived income on the assumption that it is income and in other respects is derived notwithstanding that there is no actual payment over but a capitalisation or other dealing on behalf of the taxpayer or under his direction". (Emphasis added.) However, statements in FCT v White 98 indicate that the scope might be wider. FCT v White held that a payment to an employee incentive trust expressed as gross remuneration, 99 calculated by reference to market value salary for services 100 was in effect a payment for services rendered, 101 so constitute remuneration. The court noted: 41 As the Commissioner submitted, which hat he wore when he directed Troy White Engineering to make the payment to the employee incentive share trust plan is irrelevant. Section 6-5(4) of the ITAA 1997 applies when, as a matter of fact, the payment is applied or dealt with as the taxpayer directs or on his or her behalf. The analysis does not expressly establish the antecedent requirement of: 1. an existing right to present or future receivable of remuneration; and 2. some degree of control of, or capacity to control the amount that is to be received. One uncertainty about the case in FCT v White 102 is that the Tribunal described the YE 1999 payment as gratuitous and not in recognition of any particular services rendered so on this basis it seems that there was no present or future receivable of remuneration then existing in the taxpayer at the date of payment to the employee benefit trust as a precondition to sec. 6-5(4) ITAA Similarly, in respect of the YE 2000 payment, there was no clear finding by the Tribunal that there was a present or future receivable of remuneration then existing in the taxpayer at the date of payment to the employee benefit trust. The scope of sec. 6-5(4) ITAA 1997 is unclear regarding whether control of, or the capacity to control, an amount that is receivable is precondition to sec. 6-5(4) ITAA Clarke v FCT [1992] FCA FCT v Mochkin [2003] FCAFC FCT v White [2010] FCA FCT v White [2010] FCA 730 at [6]. 100 FCT v White [2010] FCA 730 at [9]. 101 FCT v White [2010] FCA 730 at [19]. 102 FCT v White [2010] FCA 730 at [6]. Ron Jorgensen 2014 Page 12 of 41

13 FCT v White appears to have held that any payment as a matter of fact on behalf of the taxpayer is subject to sec. 6-5(4) ITAA Arguably, the court s statement in FCT v White must be read down in light of the Tribunal s conclusion that the worker controlled the payer and the recipient entities. In a transaction where the worker controls the payer, it is easy to infer that the worker directed the payment (whether as worker or payer). However, where the worker is unrelated to the payer so has no control, sec. 6-5(4) ITAA 1997 may not apply unless a direction by the worker is established. Acquiescence by the worker may be insufficient. The FCT regularly asserts that a payment to an interposed entity or related entity is applied or dealt with on behalf of as directed by the worker so the worker is taxed on the payment before receipt by the interposed entity or the related entity and the PSI rules do not apply. The FCT appears to be applying the broader interpretation so that any payment to the interposed entity or related entity would be derived by the worker under sec. 6-5(4) ITAA 1997 even if the payer is not controlled and there is no direction from the taxpayer. If the payment is not remuneration for services under the above rules, then the personal services income (PSI) rules apply. 103 Valid assignment of property or future income right There will be no derivation or constructive receipt by the worker where there is a valid assignment of property or future rights to income to an interposed entity. Examples of a valid assignment include: 1. FCT v Purcell income producing farm assets transferred to interposed entity to conduct farming business; 2. FCT v Mochkin stockbroking commission contracts entered into between interposed entity and broker firms; and 3. FCT v Everett part partnership interest assigned to a non-partner. The FCT closely scrutinise assignments of property or future rights of income to an interposed entity. The FCT considered that the GAAR would not apply where the assets of a business (plant, trading stock, goodwill etc.) are transferred to the interposed entity because the income does not flow solely from the services of the worker Div. 86 ITAA FCT v Purcell [1921] HCA 59; IT 2121 at [20]. 105 FCT v Mochkin [2003] FCAFC FCT v Everett [1980] HCA 6; IT IT 2121 at [18]. Ron Jorgensen 2014 Page 13 of 41

14 Many of the cases do not expressly or adequately analyse whether the right to property or future income was derived before assignment to the interposed entity or related entity. Personal Services Income Introduction The Ralph Report recommended PSI rules for interposed entities. 108 Income derived by an individual or entity mainly from the personal efforts or skills of an individual is treated and taxed similarly to employment income, unless the individual or entity is conducting a personal services business. 109 The results test, unrelated clients test, employment test and the business premises test determine whether a personal services business is being conducted. Even if the law would consider a worker an independent contractor, if any conditions of a test are not satisfied, the PSI rules will apply. 110 The FCT may make a personal services business determination. Personal services income Personal services income is ordinary or statutory income derived mainly (more than half) 111 from the personal efforts or skills of an individual 112 and does not include income from assets (dividends, interest, rents, royalties etc.) or supply of goods. 113 Payments to a resident or a non-resident 114 interposed entity to provide the services of a worker constitutes personal services income. 115 Results test A personal services business is being conducted if the results test is satisfied, which is The results test for a personal services business (3) A *personal services entity meets the results test in an income year if, in relation to at least 75% of the *personal services income of one or more individuals that is included in the personal services entity s *ordinary income or *statutory income during the income year: (a) (b) (c) the income is for producing a result; and the personal services entity is required to supply the *plant and equipment, or tools of trade, needed to perform the work from which the personal services entity produces the result; and the personal services entity is, or would be, liable for the cost of rectifying any defect in the work performed. The results test is satisfied in an income year if, in relation to at least 75% of the personal services income, the income is for producing a defined result and the individual or entity is responsible for providing any necessary plant, equipment and tools and for rectifying any defective work Ralph review at [7.2] - [7.4]. 109 Sec ITAA IRG Technical Services P/L v FCT [2007] FCA Sec ITAA 1997; TR 2001/7 at [25]. 112 Sec ITAA 1997; TR 2001/7 at [4]. 113 Sec ITAA 1997; TR 2001/7 at [29] & [30]. 114 Russell v FCT [2011] FCAFC Scimitar Systems P/L v FCT [2004] AATA 720; Dibarr P/L v FCT [2004] AATA 720; Nguyen v FCT [2005] AATA 876; Fowler v FCT [2008] FCA IT consultants; Skiba v FCT [2007] AATA electrical engineer; Clark v FCT (2010) 74 ATR overseas contract manager; The Engineering Company v FCT [2008] AATA director. 116 Sec ITAA 1997; Ruling TR 2001/ Sec ITAA 1997; TR 2001/8. Ron Jorgensen 2014 Page 14 of 41

15 The results test is not failed because no plant, equipment and tools are required to perform the services, provided it is not customary in the industry to provide plant, equipment and tools. 118 With respect to the requirement that the income is for producing a result, the following factors have been considered relevant in case law: 1. the consequences of early termination of the contract; payment on termination for services which are incomplete indicating the contract is not for producing a result; whether payments are made for the achievement of milestones; payments for milestones being achieved indicating that the contract is to produce a result; 120 and 3. whether the work can be delegated and who bears the risk of costs associated with defective work; the ability to delegate and the acceptance of risk indicating a contract for producing a result. 121 In relation to fees calculated based on time spent, in Taneja v FCT 122 the Tribunal determined that: [24] We also note that in the context of s 87-18(3)(a) it is not how your fee is calculated, but what you are paid for, that is important. It is possible for a person who is contracted to produce a result to choose to charge hourly rates as the means of remuneration, without altering the fact that payment is made for producing a result. In saying this, we are mindful of the comment of Allsop J in IRG at [43] that the method of payment may be important but there is nothing in what his Honour said to suggest that a fee based on time spent will necessarily exclude the possibility of being paid for producing a result. With respect to the requirement that the individual or personal services entity provide the equipment or tools of trade, TR 2001/8 states: 34. The 'results test' will be met where: (b) (c) You provide the equipment and tools, if any, necessary for doing the work; and You bear the commercial risks, including liability for defective work. 35. Paragraphs 87-60(5)(b) and 87-65(5)(b) are not failed merely because plant and equipment, or tools of trade are not needed to do the work. These paragraphs require the provision of the equipment or tools, if any, necessary to perform the work where, having regard to custom and practice in that particular industry, it would be expected that the equipment normally used to undertake the work will be provided by whoever performs the work. Where no plant and equipment or tools of trade are necessary to perform the work, this condition would be satisfied. With respect to the requirement that the individual or personal services entity bear the commercial risks, including liability for defective work, TR 2001/8 states: 36. Paragraphs 87-60(5)(c) and 87-65(5)(c) will be satisfied where there is a liability for the cost of rectifying any defect in the relevant work performed, including situations where action is taken to rectify the error at the individual's or personal services entity's own cost prior to completion of the task or prior to the taking of legal action. This sort of voluntary action reflects the custom and practice in some industries, and is indicative of the entrepreneurial risk of an independent contractor in contrast to the "employee-like" contractor. 37. In addition, being liable for the cost of rectifying any defect is inclusive of rectification achieved by the service acquirer pursuing a legal remedy for damages, in circumstances where the defect is incapable of physical repair. In several cases, the taxpayers have failed the results test. 123 The FCT considers courier owner-drivers will generally pass the results test TR 2001/8 at [35]. 119 Skiba v FCT [2007] AATA 1705 at [79]. 120 Metaskills P/L v FCT [2005] AATA 647 at [33]. 121 IRG Technical Services P/L v FCT [2007] FCA 1867, [44]. 122 Taneja v FCT [2009] AATA 87 at [24]. 123 Scimitar Systems P/L v FCT [2004] AATA 720; Dibarr P/L v FCT [2004] AATA 720; Nguyen v FCT [2005] AATA 876; Fowler v FCT [2008] FCA 528; Taneja v FCT [2009] AATA 87; BRMJCQ P/L v FCT [2010] AATA 311; Park v FCT [2011] AATA IT consultants; Skiba v FCT [2007] AATA electrical engineer; Clark v FCT (2010) 74 ATR overseas contract manager; The Engineering Company v FCT [2008] AATA director. 124 Media Release NAT 01/72 (21 August 2001) & NAT 01/75 (31 August 2001). Ron Jorgensen 2014 Page 15 of 41

16 Income Concentration Restriction The worker cannot apply the unrelated clients test, the employment test or the business premises test if 80% or more of the personal services income is derived from the same entity (or the entity s associates). 125 An associate is defined broadly. 126 The associate provisions are complex, especially where the associate relationship is established though chains of entities of by sufficient influence over the entity. Often it would be difficult for a worker to determine if entities are associates. To relieve this burden, the FCT considers that: 48. If an independent contractor does not know or could not reasonably be expected to know that the service acquirers are associates, then the fact that the clients are associates of each other will not of itself be regarded as causing the test to be failed. Federal and State and Territory government agencies are generally not treated as associates of each other. 127 So contractors that deal primarily with government agencies are not disadvantaged. Unrelated Clients Test A personal services business is being conducted if the unrelated clients test is satisfied The unrelated clients test for a personal services business (1) An individual or a * personal services entity meets the unrelated clients test in an income year if: Note: (a) (b) during the year, 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, and are not associates of the individual or of the personal services entity; and the services are provided as a direct result of the individual or personal services entity making offers or invitations (for example, by advertising), to the public at large or to a section of the public, to provide the services. Sections and affect the operation of paragraph (1)(a) in relation to Australian government agencies and certain agents. (2) The individual or *personal services entity is not treated, for the purposes of paragraph (1)(b), as having made offers or invitations to provide services merely by being available to provide the services through an entity that conducts a *business of arranging for persons to provide services directly for clients of the entity. The unrelated clients test is satisfied in an income year if, 80% of the personal services income is not derived the same entity (or associated group of entities), and the individual or entity providing the services offers services to the public at large. 129 Making offers and invitations to the public (in a non-legal sense) includes any form of solicitation of the public or a selection of a public such as advertising, competitive tendering, 130 Being available to provide services through a labour hire intermediary arranger does not satisfy the requirements for making offers and invitations to the public within the PAYG Withholding concept. 131 The scope of the labour hire PAYG Withholding obligation is uncertain, so can apply to intermediaries that are not traditional labour hire firms. 132 The taxpayers have passed the unrelated client test. 133 In several cases, the taxpayers have failed the unrelated client test Sec (3) ITAA 1997; TR 2001/8 at [41] - [42]. 126 Sec. 318 ITAA Sec ITAA Sec ITAA 1997; TR 2001/ Sec , 87-15(3) ITAA 1997; TR 2001/8 at [41] - [42]. 130 TR 2001/8 at [50] - [51]. 131 TR 2001/8 at [43] & [52]. 132 Metaskills P/L v FCT [2005] AATA 647; [2003] FCA 766; Discussed under Labour Hire Intermediaries below. 133 Yalos Engineering P/L v FCT [2010] AATA consulting to a small number of offshore exploration entities. 134 BRMJCQ P/L v FCT [2010] AATA IT consultants; Skiba v FCT [2007] AATA electrical engineer; The Engineering Company v FCT [2008] AATA director; Cameron v FCT [2012] FCAFC 76 - draftsman. Ron Jorgensen 2014 Page 16 of 41