Being a contractor

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More responsibility |  Personal services income rules |  Alienation rules

Contractors have become one of the growing classes of workers, and for understandable reasons. For many businesses, highly skilled jobs (or on the other hand tasks that are not core services, or are temporary projects) are able to be outsourced in a more cost-effective way. And if a project is completed or work dries up, it is often easier to end a contract than cease an employment relationship.

Looking in from the outside, the working life of the independent contractor may seem a great way to go – you set your own hours (more or less), make the call about how the work will be done, pick up other jobs at the same time, and maybe sub-contract out the tedious bits.

But make sure this view isn't one of those 'grass is greener' suppositions. If you're looking at going into business as an independent contractor, go in with your eyes open, tax-wise.

An independent contractor can really be seen as no different to any other business, and just like any other business, you can operate as a sole trader, or through a company, trust or partnership. Unlike with an employment relationship however, a contractor invoices for services rendered, provides their own insurance cover for things like public liability or accidents, and will generally have to supply and maintain tools and other equipment.

More responsibility
The contract entered into is also one for a given result or specific task, which the contractor works to achieve by their own efforts and discretion. As such, the contractor stands to make a loss or a profit directly as a result of the project, and bears the commercial risk of doing so. Also there are no guaranteed minimum terms and working conditions, and tax obligations are the contractor's responsibility, such as GST and PAYG if you have employees.

When your services are taken on by a business however, it is not always safe to assume that you will be deemed as 'contractor' or as 'employee' by the Tax Office (see 'Employee or contractor?' for a third-party view of this distinction).

If you are definite that your services are being provided on an independent contractor basis, make sure that you quote your Australian business number (see how to get an ABN here) when submitting a tax invoice for work. Otherwise the employer is obliged to withhold tax at the top personal tax rate (currently 46.5%). You may need to be registered for GST and charge that 10% on the supply of services (if your turnover is greater than $75,000, but if less than that you can still choose to be registered to charge GST).

Personal services income rules
Contractors also have to be aware of the 'personal services income' (PSI) rules. PSI is defined as being 'a reward for an individual's personal efforts or skills'. This excludes simply providing goods, as with a retailer or manufacturer, or just using an asset like a truck to generate that income.

The PSI rules operate so that if the relevant tests are not passed, income the business earns from the contractor's personal work will be treated as being earned by the individual (see details of these tests here).

Alienation rules
The rules around PSI were designed to alleviate the proliferation of so-called '9-to-5' contractors, where businesses re-employ workers, who should be bona fide employees, as so-called contractors. These schemes exist because businesses try to escape their rightful employer obligations, and the individuals try to obtain the benefit of deductions that would not be available to them as employees.

The problem of 'fake' contractors hasn't gone away, and is one of the reasons why the Tax Office is so focused on getting the message across that what constitutes an 'employee' and a 'contractor' is all in the substance of the arrangement, and not simply the words on a signed contract. It uses more than one yardstick to measure the distinction (see 'Employee or contractor?').

This tax law ('alienation of personal services income') was drawn up basically to try to stop the 'tax leakage' that occurs from rewards for work undertaken by an individual on the basis of their skills and expertise (that is, PSI) being taxed at lower rates by streaming the income through a company, trust or partnership (and perhaps into the hands of members of the individual's family on lower tax rates).

BONUS: A government handbook for all things an independent contractor will need to know. Download 'Contracts Made Simple' or the earlier brochure 'Independent Contractors: The Essential Handbook' here (they're 89 and 84 pages, so you might like to order your free copy from the independent contractors hotline on 1300 667 850).

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