Setting up a Business Structure for a Contractor or Consultant

When you are starting a contracting or consulting business it is important to determine the correct status of the work arrangement and apply the rules relating to income derived and the deductibility of relevant expenses.

Definition of a contractor

A contractor is a person who undertakes to perform a task or provide services for a negotiated fee and offers his or her services to the general public.

The contractor could be an individual, partnership, company or trust. There are common indicators which determine the rights and obligations of a contractor such as:

  • High level of control of how the work is done
  • Remuneration is for their personal labour, skills and usually the use of their own tools and equipment where the remuneration is on an hourly basis
  • Responsibility for the work performed
  • Work is performed and invoiced under an ABN
  • Freedom to delegate the work done

Income derived by a contractor or consultant and the taxation consequences

It is important to be aware of the various rules related to income derived by a contractor.

The fact that the income is received under a contract does not stop the income from being mainly rewarded for personal efforts. For example, income of a professional person received for labour or services is regarded as salary and wages.

If income is channelled through a company, partnership or trust it is still recognised as the individual’s personal services income (PSI) for taxation purposes. An entity that derives personal services income (PSI) is a Personal Services Entity.

Where personal services income (PSI) is received, there are specific tax rules that limit deductions of expenses against this income. As a result of this rule, deductions for business expenses will be denied where the individual does not pass four tests (the personal services business (PSB) rules.

An individual or personal services entity carries on a personal service business must meet one the following four tests:

  • the results test
  • the unrelated client test (does 80% or more of the income comes from 1 client)
  • the employment test
  • the business premises test

If the taxpayer meets the results test, the entity will be treated as a personal services business (PSB), otherwise the taxpayer can self-assess under the remaining three tests if he passes the 80% test.

Therefore, before setting up an entity for contracting or consulting work it is necessary to determine which rules apply to that particular situation. In many cases it may not be necessary to incur set-up costs to create a structure that is not tax effective.

It is highly recommended that you discuss your particular requirements with a professional to ensure that your business is set up correctly right from the start. Should you require more information related to this matter please do not hesitate to contact us.