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:

1. Simple tax laws that ordinary people in business can understand. (The PSI laws are too complicated for ICA’s liking, but they are workable.)
2. 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)
3. 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.