News from Independent Contractors of Australia highlight a recent and important Federal Court decision regarding income splitting by independent contractors. Read on to ensure this doesn't happen to you!

Overview
Whether independent contractors can split income with a spouse and claim business-like tax deductions has been an ongoing tax debate in Australia for many years. A Federal Court decision on 5 December last year (2007) has brought more clarity to the issues.

The Federal Court has upheld the position of the Australian Taxation Office that two independent contractors---one working through his own company and the other working through his discretionary family trust---did not pass the results test under the Personal Services Income tax laws. This means that all income earned by the two independent contractors will be taxed as if it were their personal income. They will not be able to split their incomes with their spouses or claim business-like tax deductions.

Some will claim that this is a disaster for independent contractors and for the status of independent contractors. ICA does not share this view. In fact, the Federal Court's decision is strongly consistent with the position that the ATO has taken for a long time. Those who predict tax 'disaster' for independent contractors are making comment based on outdated views of the tax laws---laws which have been changed under the PSI rules.

In fact, the Court's decision does not change access to business tax deduction for most independent contractors, nor does it alter the capacity to split income legitimately with a spouse for many independent contractors, depending on their circumstances.

The following points are relevant:

• Many tax lawyers and accountants have often argued that income can be split with a spouse by working through a company or discretionary trust structure. The ATO has always been wary of such arrangements and has made it clear that such arrangements could be subject to investigation and possible rejection.
• Tax structuring through companies and trusts has been the basis of allegations in the past that some independent contractors access tax deductions to which they would not ordinarily be entitled. These allegations were investigated by the Ralph Review around 2000.
• The Personal Services Income tax laws were introduced to address this allegation and to create some clarity for independent contractors.
• The PSI rules were largely successful in creating clarity with one exception. That exception was for company and trust structures.
• In 2006, the ATO released a ruling which stated that it would normally accept income-splitting for independent contractors structured through partnerships. It stated sensible reasons for this.
• In 2003, the ATO announced that it would conduct a test case programme through the courts in relation to company and trust arrangements. ICA supported this test case programme. The December 2007 Federal Court decision is the first outcome of the test case programme of which ICA is aware.

ICA's conclusions:

• Individuals: The case doesn't affect independent contractors who operate on an individual basis.
• Partnerships: Independent contractors who work through a partnership are unaffected and should normally be able to split income with their spouses.
• Companies/trusts: Independent contractors who work through companies or trusts need to be careful about splitting income, retaining profit and claiming many business-type tax deductions.

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