How the Personal Services Income tax can floor the self-employed
Independent Contractors Australia has a long involvement in lobbying on and monitoring the Personal Services Income tax laws.
The laws are not perfect, but do give some measure of clarity.
We've explained in our Ready Reckoner (put together in consultation with the ATO) that:
- If you operate as a sole trader or partnership, the PSI rules do not have any real impact on your ability to access business tax treatment.
- If you operate through a company or trust, you have to be very careful.
However, if you operate through a company or trust and you take a little time to understand the PSI rules, you should be able to pass them if you are genuinely self-employed.
We've summarised the laws here and the tests.
Further, the laws were fully clarified through two court test cases, the last occurring in 2009.
Does the ATO apply the laws correctly?
We have had concerns for some time that the ATO does not apply the PSI laws correctly. In fact, we have seen cases and assisted people where we felt that the ATO either lacked full knowledge of the PSI laws or applied their own 'smell test'.
We have supplied some guidance to several self-employed people on what the rules actually are by referring them our website.
They have subsequently used the information to argue their case successfully.
We can now report on a case where a self-employed person has failed. Because this person has been unable to afford to fight the ATO in court, the person has had to give up the case.
The case study
A self-employed person contacted ICA through our website in 2011. We discussed their situation and they supplied us full documentation on their case.
When we looked at the details we were not satisfied that the ATO was applying the PSI laws even remotely correctly.
We referred the person to the PSI information on ICA's website. They read all the information and responded that this was the first time they felt they understood the rules.
They then proceeded to bring this to the attention of their accountant and lawyer and to reargue their case with the ATO.
ICA wrote to the ATO in mid-2011 highlighting this case, suggesting it should be reviewed from the perspective of the ATO's reviewing its process. ICA has not received a response.
Ultimately the ATO would not budge with the self-employed person, leaving the only next step as litigation.
The individual could not afford the cost of going to court, which would easily be in the many tens of thousands of dollars.
They have had to give in. The ATO audit has already stretched out over almost five years.
ICA cannot speculate as to what the ultimate outcome of a correct application of the PSI rules would have been for this individual.
However, we do not believe that for this individual that justice has been done or has been seen to be done.
We do not believe the PSI rules have been applied correctly or, arguably, have even been applied at all by the ATO.
We believe the case highlights a serious flaw in the ATO PSI audit process giving us a low level of confidence in the integrity of process of the ATO on this issue.
Given that we have been involved in other cases that have concerned us, the failure by the ATO could arguably be described as systemic.
We want several simple things from the ATO:
- Simple tax laws that ordinary people in business can understand. (The PSI laws are too complicated for ICA's liking, but they are workable.)
- Correct application of those laws by the tax authorities. (On our evidence we have low confidence in the ATO to apply the PSI laws correctly and consistently)
- Speedy investigation and settlement of audits. (The ATO fails totally in this respect, imposing significant cost and damage on individuals because of the huge time delay.)
Details of the case
What follows is a summary of the sequence of events affecting this self-employed person. This is based on edited details supplied to us by the person.
We have taken out anything that might identify them. The sequence of events below, show how confusing and overwhelming the audit process is for a person running their own business. The audit was of a small business with a turnaround of $300k per year. It consisted of six staff at its height. The books were quite straightforward and very simple.
The audit should have been conducted within a 60-day period from late 2007. The first notice of assessment paper was received in late 2009.
This was around two years after the audit notice was first served. The ATO took three years (from 2007) to provide a basic response to letters of objection.
As of mid-2012 the audit is complete, but still requires some removal/review of interest and penalties.
This brings the audit and post processing to 4.5 years. This is way too long for a small business audit.
The business owner’s story
As the ATO started processing the audit in 2007, I had not filed any BASs or tax returns until the ATO clearly concluded the audit.
Unfortunately the audit took until 2011 to conclude. As a result, I had accumulated penalties and interest charges due to the ATO not meeting their baseline SLAs.
Further, the case changed through many ATO officers' hands, making things more complicated.
I have several thousands of dollars-worth of business penalties and other personal tax account fines awaiting remit at the moment.
These are not of my fault, occurring because of the huge slowness of the audit. These are currently under review and discussions have been positive regarding removal of these amounts.
- 2007: A letter was issued to me from the ATO regarding a PSI audit.
- I operated under a company/discretionary family trust structure with several directors associated with the company.
- Early 2008: An ATO representative attended the office of my then accountant to review all documentation relating to the audit years in question. The representative took the required documentation and no further correspondence was undertaken between my accountant and the ATO until late 2008. (Audit years were associated with a three-year period)
- The ATO informed my accountant in late 2008 that the original case officer had retired/moved on from the ATO and the case had been transferred to a case officer in another state. This then incurred additional cost to me as the new case officer requested the same information that was given to the original case officer at the start of 2008.
- The new case officer commenced to process the audit in early 2009. He requested documentation I did not have access to at the time as my accountant was on holidays until the end of January. I explained this to the officer and he continued to phone me daily throughout January and February 2009.
- My accountant supplied information to the officer from around February until June/July from memory. Again this was at additional cost to me as the original officer had this information back in 2008.
- Nothing was heard from the ATO until a notice of assessment paper was handed down in late 2009. As a result I employed the services of a lawyer.
- The notice of assessment outlined that I failed to qualify as a services business and should be processed under PSI legislation. The assessment did not clearly address the procedures (outlined on the ICA website information that I discovered in 2011) and how the ATO should approach such assessment. The 11-step criteria outlined in Taxation Ruling TR 2001/8, clause 10 regarding determination of a business or employee was not clearly referenced by the ATO. At the time, my lawyer and accountant missed this criteria, and when submitted again in 2011 the ATO asked why was this not submitted earlier? Hence rejecting the late submission.
- I had filed a notice of objection in late 2009.
- The ATO responded to the notice of objection in late 2010, around one year after the notice of objection was filed. Yet according to their own procedures they should have responded within 30-60 days.
- In late 2010 I filed with the AAT to have my case heard independently. The ATO agreed in early 2011 to remove penalties incurred since 2010. This was a positive outcome.
- New evidence was submitted pointing to the test cases and procedures outlined on the ICA website in mid-2011. The ATO asked why this evidence was not submitted earlier and rejected the submissions.
- I was left with the option of going to a full AAT mediation or court case, or drop the case. I dropped the case as I did not have the financial means to continue. Also, the ATO was charging interest and fines on late submission of returns, BASs, etc. These were late because I did not know where I stood because of the 4.5 years of the audit process.
- I have filed all returns to date and paid everything in full except for the penalties and interest charges. Some penalties and interest charges have been removed by the ATO, which has been a positive development.
Here are the lessons I have learnt about applying PSI:
- Group directors or individuals need to carefully review the actions of their accountant(s) and lawyer(s). Highly paid consultants are not always experts. Unfortunately, individuals will need to review the detail or legislation from time to time to best defend their position.
- Some lawyers and accountants (even with tax accreditation) have a very poor practical understanding of the PSI laws and audit process.
- The ATO processes are inefficient, drawn out, and not applied correctly.