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| IT professionals and GST |
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Contact: Peter Hill
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Overview
This article explores the practical issues IT professionals face in the GST environment, using as its framework three different ways an IT professional can operate:
- as an individual contracting directly with organisations requiring their services, on a fixed term or project basis;
- the same as above but with a company or trust owned or controlled by the professional which contracts directly with the organisation; and
- via the use of a placement agency.
The article touches on the Federal Government's plan to attack by specific income tax laws the diversion of income through the use of companies and trusts. But the main focus is on GST.
The information contained in this article is current as at 31 March 2000. The article was created for Integrated Publishing and originally published at www.itcontracting.com.au in April.
Individual IT professionals
There are many good reasons for contracting as an independent IT professional.
The demand for the expertise is strong, the work varies, the money is good, and you can develop a strong sense of business acumen from being in control of the professional path you take.
There are also good tax reasons for being a contractor and not an employee. And its no surprise the ATO does not like the relative ease by which IT professionals, and other qualified people, can capitalise on the opportunity not to be an employee tagged and bagged by PAYE.
Getting registered
GST represents a front-end opportunity for the ATO to address what it sees as unjustified leakage of the tax base through the use of contractor arrangements.
It is really quite simple. To participate in the GST system you need an ABN. And the ABN Registrar (the Commissioner of Taxation!) needs to be satisfied you are not an employee before he is obliged to issue you with an ABN.
The Commissioner has released guidelines for determining whether an employment relationship exists.
These guidelines are based on the same principles the courts have developed over the years in cases where the ATO targeted arrangements which attempted to avoid PAYE. So nothing new there.
The difference, however, is that now the ATO has the ammunition to attack these arrangements before the event rather than several years after.
This is because an IT professional acting as a "sole trader" but with no ABN to their name will face income tax of 48.5% being withheld from their contract payments under the PAYG rules. It's all nicely synergistic - for the ATO that is.
Staying registered
However individual IT professionals applying for and obtaining ABN and GST registrations should not rest easy. It may well be that the ATO has simply deferred scrutiny of your entitlement to GST registration until a later point in time.
Lately the ATO has been more prepared to simply process ABN and GST applications just to achieve the 1 July 2000 deadline. They are on a critical timeframe and, unlike software deliverables, the deadline can't be failed.
At the start of the registration process back in November 1999, the ATO estimated that it would only be rejecting 14,000 (1%) of applications. This has proved to be grossly optimistic. At the point in time that 1 million applications had been received, the ATO had already rejected 40,000 applications for want of an enterprise being carried on by the applicant. (Being an employee means you can't be carrying on an enterprise in respect of the activities carried on as an employee.) This is a rejection rate far higher than 4% because hundreds of thousands of applications had not yet been processed when the 1 million mark was reached.
Any IT professional therefore obtaining an interim ABN needs to be prepared to respond after 1 July 2000 to any questions from the ATO as to their status as an independent contractor. Failure to satisfy the ATO on this point will result in retrospective deregistration and quite possibly penalties and interest.
You're in
Once past the registration hurdle, what are the issues?
Mainly two. Cash flow and compliance. Your services will be taxable supplies. More importantly, all that stuff you've heard and read about charging your clients GST is complete nonsense!
This is what the individual IT professional needs to understand:
- You have no legal right to "charge GST".
- You have no legal obligation to charge GST.
- As a person making taxable supplies, liability to GST rests on your shoulders and your shoulders alone. That is the law.
- The only way you can recover your GST liability from the organisation you are providing services to is to incorporate an amount matching your liability into your fee.
- If your contract is silent on GST, your fee will be deemed to be inclusive of that GST amount. If this is not what you intended, you effectively will lose one-eleventh of your income as GST.
- If your contract is silent on GST, and you attempt to invoice your client for a fee, as stipulated in the contract, but with an extra 10% "GST" your client can justifiably refuse to pay the extra 10%.
There are two methods of calculating GST liability when filling out your GST return for each tax period - the cash method or the accruals method.
If you choose the cash method, you are only liable to GST as and when you get paid. But consider this scenario:
You billed the client $1,000 plus an extra 10%. The client pays $1,000 and refuses to pay the extra $100. The reason given is that your contract does not provide you with the right to do this because it doesn't say anything about GST. Does this mean you have no GST liability?
The answer is no. Absolutely no. The unpaid $100 is simply a commercial debt issue. The ATO will expect you to account for GST of one-eleventh of $1,000 in the interim. So it is very important to make sure your contract spells out exactly what your fees are, in terms of GST. What does it currently say? Does it say something like:
The hourly rate specified in clause X does not include GST. The fee payable by [the client] will be the hourly rate plus an amount equal to 10% of the total hourly rate per invoice.
OR
The hourly rate specified in clause X is inclusive of GST, being an amount equivalent to the GST liability of [you] in respect of the services.
Should you choose the cash method?
Probably yes. This is because an IT professional would normally have far less input tax credits to claim than GST to pay. By also keeping a tax period of three months (rather than one month) you get to keep the GST component of payments you receive from your client a little longer before having to account for it to the ATO.
You have no legal right to "charge GST", and you have no legal obligation to charge it.
How do you account for income tax? If you currently do so on the cash basis, there is probably no reason to use the accruals method for GST.
This is because your GST liability under the accruals method arises in the GST tax period in which you issue the client with an invoice. So if you don't get paid in the same tax period, you may end up accounting for the GST before you get paid.
But if you account for income tax on an invoice basis does this mean you can't use the cash method for GST? Definitely not! If your turnover is less than $1 million you have the automatic right to use the cash method for GST, even if you use the accruals method for income tax purposes. Think about this option.
Using a company or trust
If an IT professional has a family company which contracts directly with the client, it is the company that will register for GST.
Companies already have an Australian Company Number (ACN). Getting an ABN is an automatic process, as the ABN is essentially an expanded ACN. It is the same number with two extra check digits. By around 1 July 2001, the ABN will replace completely the ACN.
For income tax purposes, the ATO as a general rule expects companies to use the invoice method for accounting for income. But for GST purposes, and as noted above, a company has the automatic right to use the cash method if turnover is less than $1 million.
If an IT professional uses a family trust, it is the trust that is the entity for GST purposes. But because a trust is not an entity at law, the trustee needs to be the holder of the ABN and GST registration. It is important to recognise this distinction:
- If you are the person actually performing the services and you also are the trustee of the family trust, you will be registered for GST as trustee and not as an individual in your own right.
- If your trustee is a company, the company will be registered as trustee. The company will also be capable of being separately registered for GST if it carries on an enterprise in its own right .
Whether a company or trust is used, it will still be the case that the contract with the client is the first and only opportunity to protect that entity's right to charge an extra amount for the actual services performed to match the GST liability.
Adding 10% - the big bite
Since IT consulting does not currently attract sales tax, it will often be the case that being registered for GST, either as an individual or a company or trust, your fees will need to be increased by 10%.
If you time this increase with another increase, make sure you document the reason for the larger increase. The ACCC is on the look-out for any business that uses the GST as an excuse or reason to take profits that would not have otherwise been available. Several businesses have already been nabbed for increasing prices higher than 10% simply to increase profit margin.
The ACCC is adamant margins should remain constant. So if an increase in, say, an hourly rate, is more than 10% you need to document the commercial reason why. In the IT consulting market, where the demand for services is high, it may well be simply a case of higher fees being justified on supply/demand grounds. That's OK from the ACCC's point of view, just so long as you can demonstrate this to be the case.
It would normally be the case that your client is entitled to an input tax credit for the 10% extra fee, so the level of market resistance should not be great.
Should you worry about having to compete against other IT professionals not charging the extra 10%? Probably not, but be on the lookout for people charging GST who are not registered. And if they are bona fide not registered for GST it means their turnover is less than $50,000. In addition, any IT professional choosing to not even obtain an ABN will lose that 48.5% income tax on their contracts fees under PAYG.
The only real issue for IT professionals is if the services are being performed for a bank or other financial institution. In this situation, the client will not ordinarily be entitled to an input tax credit for the extra 10%. This is because banks will generally be making exempt supplies for GST purposes (called input taxed supplies) and any costs incurred in making those supplies carry no entitlements to input tax credits.
This very situation has lead many observers to predict that banks and the like will seek to bring in-house the services that IT professionals and others currently provide to them on an external basis. By bringing these costs in-house the banks will convert their costs to salary and wages, which attract no GST.
IT professionals currently consulting to this market as a specialty may therefore face some market pressure to come on-board as a short term employee instead of an independent contractor.
Using a placement agency
This is where things get messy. It is absolutely vital that the IT professional is clear on what arrangements are in place before their tax reformed exposure can be ascertained.
The first rule is this:
If work is allocated by a specialist agency for a client, and the IT professional is paid directly by that agency (with no contract being entered into between the IT professional and the client), then you can forget about GST.
In this scenario, the IT professional cannot get registered for GST, and the payments from the agency to the professional will be subject to PAYG.
The second rule is this:
If work is sourced from a specialist agency, and the IT professional contracts directly with the client and is paid directly by the client, then the above PAYG issue does not arise and the IT professional can register for GST.
Again, the proviso to this scenario is that in being engaged directly by the client the IT professional does not actually become an employee.
Simple!
Normally in this scenario, any fee charged by the agency is payable by the client, not the IT professional. That is a separate GST issue of no concern to the IT professional. However, if an agency does charge a commission or fee to the professional, it will normally be a taxable supply and therefore the amount would ordinarily include a GST component. If the IT professional is registered for GST, this cost will be claimable as an input tax credit.
Subsequent legislative and regulatory changes may have impacted upon the subject matter of this article.
Peter Hill
BBus MTax FTIA
Managing Writer - ATP
ATP - GST
April 2000
March, 2001
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