The Information Technology industry has traditionally been project driven, leading to a great demand for contractors and specialists. Today, more and more accountants, lawyers and other professions are being offered contract positions. This is often driven by outsourcing and corporate downsizing.
When you are offered a contract through an agency, they are often prepared to payroll you but may charge or withhold an administration fee (typically 2.5-3%) as well as an insurance levy for Professional Indemnity insurance. Some agencies prefer not to “employ” you and request you to arrange your own structure, or to provide an ABN (Australian Business Number) and GST registration. When the contract offer is from an end user company, then you will be required to have a company structure an ABN and GST registration. There are several payroll structures available for an independent professional:
- PAYG/PAYE (Pay As You Go/Earn) payment through an agency
- Your own Company Structure or Sole Trader
- Management Company
If an agency is prepared to process your pay; they generally cover you for the compulsory insurance (i.e. workers compensation) make the deduction and payment of taxes and superannuation, issue of pay advice and payment summaries. Through this structure you are generally paying the maximum tax and government surcharge which defeats the purpose of contracting. There is not automatic cover for public liability or professional indemnity insurance, so this may be charged extra, and some agencies charge or withhold an administration fee. Generally this is not the best option.
You can register your own company name as a sole trader (or a Trust) and receive an ABN and GST registration. The company using your service will require the ABN and proof of GST registration, Workers Compensation insurance, Public Liability insurance and, sometimes, Professional Indemnity insurance. Tax is not deducted at source BUT if you work for only one organisation at a time in Australia and New Zealand, the tax office will deem you an employee of that organisation and require the structure to pay PAYG/PAYE tax on the total amount billed. The Alienation of Personal Services Income (APSI) legislation, (also referred to as the 80/20 rules) and Avoidance Legislation in NZ, is specifically targeted at preventing income splitting and tax advantage for individuals. Contractors who use their own company must make themselves aware of this legislation. The compliance is very strict and quarterly Business Activity Statements are required. If you have an accountant do this for you, it will cost several thousand dollars (and many hours of your time in preparation) each year. It may be a viable option in some cases where the earnings exceed $120,000 per annum. These high end cases require care in set-up and can be administered on your behalf by a management company if you choose this option.
Contractor Management Company
Contractor Management Companies are specialists in payroll, administration, tax minimisation and visa processing for contractors. They constantly update their knowledge so that they work within the tax laws of the country, and strive to provide the most tax efficient methods available to receive salary through maximum cash and benefits. Typical services through a management company include all administration processes, including invoicing, collection of fees, calculation and payment of the relevant taxes, superannuation, workers compensation, public liability insurance and professional indemnity insurance if required, vehicle leasing, tax returns and independent investment and financial advice. Some also provide additional client services which include paid annual ACS membership, training programs, discounted travel, wholesale superannuation funds and a member benefit programs that provide discounted services and goods like travel, accommodation and entertainment. This method of contracting is a good option for those with high or multiple sources of income. The major benefit is the face-to-face consultation, expert guidance in all areas, and your own personal contact to discuss your personal situation. When contracting through a management company the tax savings generated will invariably cover the tax-deductible management fee. (CXC typically charge 3.5% plus insurance cost for this service www.cxc.com.au)
In the past 2 years, most revenue and tax collectors around the world have chosen to target the contractor sector. In Australia there has been the Alienation of Personal Services Income Act 2000 which accompanied the GST legislation, in New Zealand we have seen similar Avoidance Legislation (also based on the same “Ralf Report used in Australia), and in the United Kingdom we have seen the introduction of IR35 legislation.
In these changing times and tough tax climate worldwide. The use of private or individual contracting companies and entities is being phased out in most tax regimes. Contracting, as we knew it in the past decade will remain in the past decade. The new millennium will see a far more mobile global contractor workforce to service the new global economy, and management company services need to cater for this across all borders.
MORE INFORMATION ON CONTRACTING
Contracting is alive and well in the western world, but it is a constantly changing opportunity. All industry in the free world is driven by supply and demand. There is an ever-growing demand for specialists in most fields. There is a shrinking population in the western world, and this demand for skills may never be met. The problem solving and project nature of industry today will always demand specialists for varying lengths of time on these projects and problems, and contracting of these specialists is the most cost effective option. Conversely, contracting is challenging, varied and lucrative for the specialist.
The global economy continues to drive the demand for these specialists up, and they have to become global to service these demands. To keep them focused on their area of specialty, “management companies” need to provide the required administration services AND financial benefits. Selection of these types of companies is complex and care need to be taken to ensure continuity of career contracting **(see suggested selection criteria at the end of article). It is also prudent to consider international investment options to park funds until retirement.
Contracting is far more acceptable in most western countries today. More and more professionals are realising that there is no such thing as a “permanent job”. Contracting enables professionals in all walks of life to maximise their earnings during their prime working life. It is absolutely essential that these professionals invest wisely, and an integral part of this is smart tax planning. Being aware of the tax laws around the world may enable far more effective long-term investment and financial independence.
There are not many “TAX FRIENDLY” countries, however, if the above principles are effectively applied, contracting can ensure a highly rewarding career. Smart global management companies can assist in planning an early retirement.
TAX workings around the Asia Pacific
Australian tax is very complex, one of the highest in the western world, and is applied at various levels. The top marginal personal tax rate is 47% kicking in at $75,000 (+/-US$55,000), and a 1.5% to 2.5% Medicare levy applies. Australia also has a Goods and Services Tax of 10%. It does not end here. Superannuation (pension) is compulsory, at 9%, Workers Compensation insurance is compulsory and ranges FROM 1% and many contract require you to have Professional Indemnity insurance. Superannuation contribution is concessionally taxed at 15% on contribution and 15% on withdrawal, EXCEPT for high income earners. This tax on superannuation increases by 1% for every $1000 earned over Aus$100,000, and peaks at 30% going in on all contributions for income earners of over $95,000 p.a. This compulsory Superannuation has to remain in Australia until your retirement age of 60 plus (that is if there is any left after administration fees are deducted!).
In June 2000, Australia introduced a new tax system, based on the “Ralph Report” prepared for government. An integral part of this legislation is the Alienation of Personal Services Income Bill, which effectively prevents contractors who derive their income from their “own personal exertion” from gaining any advantage by using a company, sole trader or similar structure to reduce tax liabilities. New Zealand used the same report to create their own Avoidance Legislation.
Small contractor companies, where the bulk of the income is earned from the personal exertion of the director/shareholder, are being severely disadvantaged. The Alienation of Personal Services Income Bill 2000 legislates that if 80% of your income is from a single source, then you will be treated a as “Personal Services Entity” and this limits the expenses you are able to claim to less than those of a PAYG employee. In the application of this test, they look at the end user as the “employer” NOT the agency. Working for multiple agencies at the same end user does not get around the legislation.
There are several ways to justify running your own company, provided that it operates as a bona-fide software services company, responsible for producing a “result” and taking the responsibility for “rectification”. If one is reliant on the income produced from ones own labour only, one must pass the 80/20 test, and/or other tests.
- The “Enterprise Test” to apply for registration for GST requires;
- That you control the services offered, including the risk
- That you have multiple concurrent clients
- That you have “substantial” investment in equipment
- And then the business entity needs to pass ONE of these tests;
- Unrelated Client
A personal services BUSINESS must have multiple and unrelated clients. This negates inter company invoicing and use of investment income.
- Employee Test or
A personal services BUSINESS must employ people to deliver the service other than the principals
- Separate Business premises test.
A personal services BUSINESS is expected to have its own premises, not a home office or a serviced office.
- Unrelated Client
Note: This legislation and these tests are well drafted and will not allow evasion by simply joining with others (there are specific streaming provisions which prevent this option) or simple evasion tactics./p>
Contractors who choose to use their own companies will need to undertake a self-evaluation. They are personally liable for severe penalties if they get this wrong.
There is no doubt that the situation is now far more complex, and the options for tax minimisation have been significantly reduced. The preparation of the quarterly BAS statements have been a time consuming and confusing burden. The Australian Tax Office has removed the option for individual contractors to gain much advantage from running their own company. The “Enterprise Test” and the Personal Exertion tests will negate many personal exertion companies, if not in the first round, then in subsequent audits. The “Results” test will enable trades people and those who operate on a fixed price basis to receive a “Personal Services Business Determination”, allowing normal business operations and expense claims.
New Zealand had one of the simpler tax systems until recently when both personal and company tax was capped at 33% and a Goods and Services Tax of 12.5% applied. The recent introduction of a higher rate of personal tax (39% from NZ$60,000, +/-US$26,000) compared to company tax (33%) opened the way for tax avoidance, which in turn has created a need for the new Avoidance Legislation, introduced in the 2001 tax year. Personal service companies are under attack from the tax department in all countries. New Zealand is no exception, and the Inland Revenue Department is looking to contractors to provide additional revenue. They have obviously read the Ralph Report (Review of Business Taxation) prepared for the Australian government and have chosen to implement some of those recommendations. In NZ, the Employment Relations Bill is further complicating the contracting market.
NZ Avoidance Legislation
On the 30th March 2000, the Government released details of new avoidance rules intended to prevent high-income earners from avoiding the 39% tax rate. The proposed legislation introduces an income attribution rule. This means that income derived by the company, trust or partnership (referred to as the “interposed entity”) will be required to be attributed as income of the individual who provided the service and only limited expenses are claimable as for a PAYE employee.
The Income Attribution Rule will apply where;
- An entity is interposed between a service purchaser (client) and the individual who provides the service (e.g. a company or sole trader)
- The interposed entity and the individual are related
- During the income year, the interposed entity receives 80% or more of it’s income from a single source, or associated sources
- During the income year, 80% or more of the income relates to the personal services provided by an individual and /or associated persons, and
- Significant and substantial assets do not form a structural part of the income earning process of the interposed entity (i.e. major plant and equipment).
There is little doubt that NZ contractors trading in their own limited companies will also have to radically rethink how they structure for the Avoidance Legislation. This legislation will be BACKDATED to April 2000. The impact of the new legislation is that many contractors will pay PAYE tax on ALL their contractual income, subject to minimal expense allowances. One-person service companies have traditionally been able to benefit from income splitting and business expense claims for all related expenses. This legislation will negate those avenues and options.
Again, it is important to understand that the intent of the proposed new rules is to remove the scope for avoidance of tax through the use of intermediaries, and specifically, income splitting to reduce tax liabilities. Many contractors use company structures to facilitate the payment of salaries or dividends to family trusts or their spouses. This where the main thrust of the avoidance legislation is aimed. Evasion tactics will not work for many in the long run.
In the UK, USA and Australia, there are management companies, sometimes referred to as “umbrella companies”, which operate to provide structures for contractors to work through. These organisations vary greatly in their method of operation and fees charged; not to mention services offered. Should you choose to go this way, it is important to ensure that the organisation chosen does operate within the laws of the countries contracting in. It would also be wise to ensure that they also operate in other countries you may wish to contract in to provide continuity.
The chosen organisation should take care of all the accounting as well as ensure that you benefit from all the advantages of salary packaging so that you can maximise your income within the constraints of this new legislation. Fees seem to range from US$50 per week to 20% of gross income. At the end of the day, the net CASH IN HAND gain is the most important factor, not the fee. The fees charged should be funded by tax savings, and should not come from your pocket. Care should be taken in the selection process, as this organisation could provide you with years of service in the new economy.
In any event, a specialist independent professional will require a contract of employment with the end user or agency. Agencies generally have their own agreement they will require you to sign. Be sure to check liability clauses, termination periods, and look for any other requirements, like the insurance mentioned above. If you are NOT presented with a contract, and wish to use your own, there are two sample options available;
1) A two way agreement between your company or the management company
2) A THREE way agreement between the end user, the management company and you, the “nominated specialist”.
SOME USEFUL WEB SITE
- www.cxcglobal.com - Global Management Company, Australia, Asia, UK, USA
- www.visaconnections.com.au - Visa processing to and from UK, Australia, New Zealand
- www.usa-immigration.com - Visa processing to and from USA & Australia
About the author
Dave Thomas is the founder and Managing Director of Consultants Exchange (CXC), a global IT contractor management company. He started his career in accounting and was seconded to the Information Technology area where he spent the next 30 years as a contractor, and entrepreneur. He is also founder Softpac, AustalAsia Tax Services and JobNet.com.au, a member of the Australian Computer Society (ACS) and National Tax and Accountants Association (NTAA), founding member of Australian Contract Professions Management Association (ACPMA), Associate member of the Information Technology Contract Recruiters Association (ITCRA) and the Recruiters and Consulting Services Association (RCSA).
** HOW TO EVALUATE MANAGEMENT & UMBRELLA COMPANIES
Some evaluation criteria and a checklist follows;
There should be no
• company start up cost
• annual company fees
• illegal or dubious transactions
All statutory requirements should be met
• In Australia, they should have a PSBD from the ATO
• Company Registration Returns
• GST/VAT & Tax returns
• Tax File No. Registration
• Payroll Tax Registration
• Fringe Benefits Tax Registration
• Withholding Tax Registration
• GST/VAT Registration
• LAFHA Declaration
• Quarterly BAS/Tax Statements
All administration should be done
• Banking + costs of
• Distribution of funds
• Tax paid
• Salary paid (multiple accounts)
• Superannuation/Pension and Medical cover paid
Tax returns compiled and submitted
There should be an increase in net income
• Salary Packaging
• LAFHA interstate and O’seas
• Company Reimbursement of Bus Exp (Education, Laptops, Airfares)
• Novated Leases
• Finance for non-residents
• Fleet Card
Insurances should be covered
• Workers Compensation
• Public Liability
• Professional Indemnity if required
• Your existing fund? Transportable?
• Check their fund
• Flexible investments
• Life insurance without medical examination
• Income Protection
Computer Society membership available? provides
• Professional status
• Skills assessing (for residency)
• Discounted education & training
• Discounted insurance
Membership Benefits Program available
• Discounted Accommodation
• 2 for 1 meal deals
• Tourist attractions
• Accounting matters (accountants in every state)
• Finance and investment through authorised advisors
• Contracts Checked against industry standard
Visa Processing & Sponsorship
• Seamless transfers overseas
One Employer, many contracts
• Bank reference letters
• Real Estate & Medical Insurance referrals
No Exit costs and zero cost whilst not billing
Free CV Publication and/or distribution available?
Check that the company belongs to a relevant association
e.g. contract professionals association, IT recruiters association, accounting body like chartered accountants