The ATO’s recent release of draft taxation ruling TR 2021/D2 has reinforced the difficulty that Australian small businesses have dealing with personal services income tax, says Tax & Super Australia (TSA).
A major reason for this is because the ATO persists with its long-held view that the general anti- avoidance provision of the tax law (Part IVA) can still apply — even when all of the anti-avoidance tests in the personal services income rules (Part 2-42) have been passed.
Thousands of small businesses that offer personal services often structure their business through a company or trust rather than accept the risk of being a sole trader. The corporate or trust structure can protect assets from being caught up in a business lawsuit and can present a more professional image than operating as a sole trader. Depending on the particular family situation, there can also be tax saved using these structures.
Personal services income can be earned by a very wide range of people who do not provide their services as employees. These can include carpenters, electricians, doctors, accountants, lawyers, beauticians, hairdressers, professional sportspeople and many others. There are hundreds of thousands of people in Australia that earn personal services income.
Just over 20 years ago, the Federal Government introduced a set of anti-avoidance provisions that related to individuals diverting (alienating) their personal services income through business structures and having some or all of that income taxed to taxpayers on lower tax rates. This legislation, in Part 2-42 of the Income Tax Assessment Act 1997, is complicated and is widely misunderstood. If the law applies, broadly, the income earned by the business entity will be taxed to the individual that has earned the personal services income rather than the entity or other taxpayers being taxed on the income.
Part 2-42 contains four tests. A “personal services entity” must pass one of these four tests to become a “personal services business”. If the personal services entity is treated as a personal services business, then Part 2-42 has no application and, on its face, taxation of the income will not be forced on the individual who actually provided the services.
Most small business operators and tax agents think that when a business has been deemed to be a personal services business (and therefore Part 2-42 has no application) that there is nothing further to worry about.
However, TSA tax counsel John Jeffreys says this is not the case, according to the ATO’s views expressed in draft tax ruling TR 2021/D2. He says the ruling reinforces that such personal services business must then still run the gauntlet of the general anti-avoidance provision, Part IVA.
“It is high time that the ATO dropped its insistence that Part IVA can still apply to an arrangement where personal services are provided through an entity, even after the specific anti-avoidance tests in Part 2-42 have been passed,” Mr Jeffreys said.
“Tax & Super Australia calls on the ATO to make Part 2-42 an exclusive code in relation to anti- avoidance provisions that apply to the derivation of personal services income. This will enable people who run small business and provide services through an entity to have clear rules and no concerns about what is an acceptable structure for tax purposes.”
“It is time for the ATO to remove the sword of Damocles, in the form of Part IVA, from hanging over the heads of small business people who think they are doing the right thing after having passed the stringent tests of Part 2-42, only to find out that this is not the case.”
For further comment, please contact TSA senior tax counsel John Jeffreys
Mobile: 0416 250 461
Tax & Super Australia (TSA) is a not-for-profit organisation that provides practical tax, super and accounting information for about 3,600 members and a broader tax community of more than 15,000 people