By Anne Lampe

October 11, 2005

If you're in the process of setting yourself up as a contractor to provide services to other businesses, and you believe you can avoid having income from contracted work attributed to you as personal income, think again.

You may want to take note of a recent finding by the Administrative Appeals Tribunal.

Contractor status is preferable to being taxed as an individual because the company providing the service has its profit taxed at the corporate tax rate of 30 per cent and that rate is applied after a whole heap of expenses are written off against the company's revenue. Those expenses include work-related car parking and travel, superannuation, rental of premises and salaries, including those of family members.

A growing number of former employees are therefore either choosing to operate under business service provider entities or are being forced to set themselves up in business after falling victim to the current fashion for the outsourcing of functions by corporations and almost permanent downsizing programs.

Computer consultant Thanh Liem Nguen discovered, however, that if the company set up to provide the services does not satisfy the results test and the 80 per cent test required for such business service entities to be recognised by the Tax Office, the taxpayer could receive a nasty shock following an audit.

In Nguen's case, his company, Vivi PC Supplies and IT Consultants, was found not to have provided the consultancy services. Instead it found that he, Nguen, personally provided them.

Ironically, Vivi was providing services to the Tax Office at the time Nguen was pinged with two amended assessments, as well as penalties following a visit from an auditor.

Vivi had entered into a contractual agreement with Icon Recruitment as a consultant. Icon Recruitment was unrelated to Vivi and appears to have been used by the Tax Office to find contractors.

Under that arrangement Nguen worked as a contractor to the Tax Office from 1998 to March 2003, when he became an employee of the Tax Office.

While under contract the Tax Office paid fees to Icon, which in turn paid fees to Vivi.

Under Vivi's corporate structure, Nguen was paid $61,939 gross in 2001-02 and $79,702 in 2002-2003. His wife was paid wages as an administrative officer.

All went well until the Vivi audit, when the Tax Office determined that the company was not carrying on a personal services business and that the fees it derived between 2001 and 2003 were instead the personal services income of the consultants concerned.

As a result of this view, Nguen had an additional $54,241 in income attributed to him in 2001-2002 and a further $44,738 in 2002-2003. In addition, penalties were imposed.

Unhappy with this result, he went to the Administrative Appeals Tribunal.

It backed up the Tax Office's view that during the two years in question the income earned by Vivi under the Icon arrangement was mainly a reward for the taxpayer's personal efforts and skills, and was therefore his personal services income.

It then turned its attention to whether Vivi was carrying on a business and, if so, whether the income earned by Vivi would not be attributed to the taxpayer.

This is where it got complicated.

The tribunal determined that as more than 80 per cent of the taxpayer's personal services income came from the one source - the Tax Office - Vivi would be considered as carrying on a personal services business only if it satisfied the results test.

Under this test, the personal services company would be required to finish a specified job within a given time frame, rather than merely hiring out its employees on an hourly or weekly basis until the job was finished.

On the evidence provided, the tribunal decided that the relevant contracts were for work done and not for producing a "result", and therefore the results test was also not satisfied.

Backing that decision were a number of factors.

These included:

• The contracts specified the taxpayer was to provide consulting services in consultation with the client.
• Fees were payable at a specified hourly rate on the basis of fortnightly timesheets signed off by the client.
• The work the taxpayer performed on a day-to-day basis was at the direction of his supervisor, to whom Nguen reported.
• The taxpayer had little discretion in carrying out his work, that there was no scope for substitution or delegation of services provided to someone else.
• The taxpayer was subject to an annual performance evaluation process that applied to him in the same way as it did to Tax Office employees.