Alienation of PSI – Fact or Fiction
Back in 1981, the then Treasurer, John Howard, introduced Part IVA of the Tax Act
to stop tax cheats. Part IVA is against arrangements ('schemes') that minimise
tax. This is because they are “works of fiction”. Such scheme are punishable by
Twenty years later we now have Treasurer Peter Costello championing 'A New Tax
System' ('ANTS'). Costello claims that ANTS is so good that it renders
Part IVA obsolete.
At the core of ANTS is the Alienation of Personal Services Income ('Alienation')
provision. Alienation argues that there are really only two kinds of taxpayers -
employers and employees. Everyone has to be slotted into one category or another.
This makes it much easier to collect tax.
If you are an employee, you are not entitled to 'business' deductions and
concessions. Further your employer withholds money from you to cover your estimated
tax liability. What if you are self employed and your income is mainly a reward
for “personal efforts and skills"? Bad luck you are presumed to be an employee
- unless you can pass these tests:
Results test (you have to pass all 3)
- the income is paid to achieve a specific result (not just provide hours of labour)
- if tools or equipment are necessary to do the work, you have to provide them yourself;
- you must be liable to rectify the defects in your work.
Have you passed? If not, then you may still be an Employer under the '80% rule'.
If 80% or more of your income is from one client, you fail - you're an employee.
If you pass, you still have to pass one of the following:
- 'unrelated clients' test - You must "have personal
services income from two or more clients who are not associated with each other
or with you (or the individual, if you are a personal services entity)". The
clients must come from direct advertising or word of mouth, not an agency.
- 'employment' test - You must "have employees or engage sub-contractors
who perform at least 20% (by market value) of the principal work" or "apprentices
for at least half the income year". You can count related persons who perform
principal work but you can't count companies, partnerships or trusts associated
with you. If you operate through a personal services entity, you can't count
yourself as an employee for this test.
- 'business premises' test – The business premises must be:
- owned or leased by you;
- used more than 50% of the time by the individual doing the work;
- used exclusively by you;
- physically separate from the private residence of the individual or their associates;
- physically separate from the business address of your clients or their associates.
Confused? Costello isn’t. Besides, if you aren’t sure, you can still have all the
fun of applying for a determination from the ATO. (Or risk the penalties for making
a mistake. – Ed.)
ANTS has caused considerable consternation in the business sector. There is still
great uncertainty over what effect Alienation will have. Industry groups such as
Financial Advisers have lobbied to be able to decide for themselves how to proceed
until such time as all the facts are on the table and the law can be applied fairly
For others? Well - time will tell, but you may want to think about booking an appointment
to see your Adviser and Accountant to discuss restructuring your affairs. However,
beware, The taxman is sure to closely watch what you do to make sure you don’t fall
in breach of good old Part IVA.
Pre-emptive rights – A low hand in a high stakes game
Late 2001, an Adviser presented me with a difficult situation. Apparently, years
ago, the Adviser asked her clients if a Business Succession Plan was documented
and put in place for the business. The clients dutifully answered "Yes"
- they had such a plan. They said that they had "pre-emptive rights" in
their Memorandum & Articles for the company. Pre-emptive rights generally give
the remaining owners the right to purchase the outgoing owner's equity on terms
no worse than those offered by an outside (unrelated) purchaser. Soon after the
Adviser had made her inquiry, one of her clients suffered an accident. The client
was unable ever to work again. The remaining owners checked their "pre-emptive
rights". They had the standard clause in their company documents. Sadly "pre-emptive
rights" only operate upon death. They are useless for sickness.
Years passed. Chaos ensued.
Recently, the sick individual died.
The "pre-emptive rights" now operate in the absence of any agreement between
the business owners. The client's spouse attempted to sell the shares to the
remaining owners. The Accountant did an excellent and unbiased valuation of the
The client's spouse didn't care. She "knew" the business was worth
more. More likely, she knew that she needed more to uphold the lifestyle of her
and her children. Besides, even at "proper" value the remaining business
owners had no spare cash and an already-unhappy bank manager. Apparently, the bank
manager was concerned that the business would have to buy out the dead man's
estate. Given that he owned 70% of the shares in the business, the bank manger felt
that the business could fail. After all, the business had to fund the buyout some
way, and the profitability had declined since the majority shareholder found himself
unable to work. The business was not doing all that well.
Seeking legal advice, the deceased’s spouse discovered that the shares could be
offered to the public. The shares were broadly advertised. Eventually, an offer
was made for the shares by a member of the public who did not want to pay top dollar,
but offered cash.
Naturally, when you get a hot purchaser on the line you want to close the deal.
With "pre-emptive rights" you can't quite do that. You have to take
whatever offer is on the table and offer the exact same deal to the remaining partners.
Under these "pre-emptive rights" the remaining owners had 28 days to accept
the offer. After 28 days if you hear nothing then you can accept the offer made
by the member of the public.
Well - 28 days came and went. I don't know the real reason why, but the remaining
owners apparently didn't even respond. The dead man's spouse went back to
the willing purchaser. Sadly the willing purchaser was not quite as willing any
more. Financial considerations meant that a 3 month settlement was needed. This
was a new deal. The new offer had to go back to the remaining owners. Any variation
has to be offered to the remaining owners on the same terms. The same 28 day provision
applied. The business was always volatile, and the business had to be revalued every
time an offer was made. Each valuation was less than the last.
Ensure you get the best advice when drawing up your Succession Plan
The matter is not yet resolved. The remaining owners claim that cash is hard to
find. The public buyer has gone cold, and the bank is unwilling to advance more
borrowings on a business that is under threat.
Be warned! There is no substitute for your Accountant, Adviser and Tax Lawyer working
together with you as the business owner to ensure that your business will not die
For your peace of mind, ask yourself the following:
- What happens if one of the partners becomes of unsound mind, divorces, becomes a
bankrupt, suffers stress, dies, or gets cancer? What do the spouses of the insured
business owners think will happen?
- Have you had a letter of advice concerning the taxation consequences of the plan?
- Do you have to rely on the pre-emptive rights in the company documents, or is there
a way to introduce more certainty into the process, along with some insurance proceeds
to enable a fuss-free buyout?
- Has the issue of Keyperson insurance been considered, and have the taxation consequences
of the company receiving proceeds for capital or revenue purpose been documented?
These questions are only part of the process of putting in place the building blocks
of sound business succession planning. Certainty, the ready availability of funding,
and the painless progression of the company are the fundamentals of sound business
succession planning that should be available to every business owner in the country.
John left his Super to his Mistress. His wife was upset...
Is the Superannuation Complaints Tribunal bound by a valid Binding Super Nomination?
How effective was John’s binding nomination in his Super Fund?
The Federal Court looked at this question in the recent case Collins v AMP. The
Court held that the complainant could not appeal to the Superannuation Complaint
Tribunal (SCT). The SCT had no power to overturn a binding death nomination. A disgruntled
wife doesn’t even have standing to appeal under section 14 and 15 of the Superannuation
(Resolution of Complaints) Act 1993.
However you can appeal to the SCT on the Trustee's discretion on the validity
of the nomination and the trustees’ discretion on the type of benefit that is paid.
Therefore the disgruntled wife can argue that the binding nomination was not valid.
Did John fill out the binding nomination form correctly? Was John dotty and not
of sound mind? Was there a correct witness (no beneficiaries)? Did the nomination
comply with the law (i.e. older than 3 years)? The disgruntled wife can only overturn
a binding nomination on these grounds.
What if John had a Self Managed Super Fund?
SMSFs are a power to themselves. Generally the SCT has no power to hear SMSF issues.
In particular the SCT has no jurisdiction to hear these matters for SMSFs. A binding
nomination forces your Trustee to follow your wishes. Again your disgruntled wife
can get around this by challenging the validity of the binding nomination. With
the SCT out of the picture, this means a trip direct to the Supreme Court. (Lots
of money for lawyers - Ed.)
Afraid to get married for fear of being taken to the cleaners?
Do you live in a defacto or homosexual relationship? Currently, Western Australian
law treats legally married couples differently to such defacto couples. With reforms
to State laws in the offing, this situation may not last for much longer. Legal
rights for defactos in the case of break-up or death are about to change.
Don't panic. Before the law comes into effect, you can still:
- redo your Estate Planning documents
- move assets into new structures
- complete a pre-nup (Binding Financial Agreement)
- bail out of the relationship (Easier said than done – Ed.)
- do nothing and cry about it later
So how does my legal position change?
It all depends on whether you’re dead or dumped.
Die before the law takes effect
- Married (boy and girl) - your spouse can challenge your Will. You can leave your
spouse $1,000 in your Will. Your spouse can still challenge your Will. You can even
leave your spouse 99% of what you own and still your spouse can challenge your Will.
- Ex-spouse - your ex-wife or ex-husband can still challenge your Will if you are
paying maintenance or have still time left to complete a property settlement.
- Heterosexual defacto - if you are "maintaining" your defacto partner then
they can challenge your Will. (What constitutes "maintaining" changes
with each Court case. If you keep a mistress, (or toy-boy – Ed.) then that
is probably enough. If you live with someone then that is probably also enough to
- Homosexual defacto. If your homosexual partner dies then currently under WA law
you have no rights to challenge the Will.
Die after the law takes effect
Both homosexual and heterosexual defactos will be in exactly the same position "as
if you were married". This means an automatic right to challenge your Will.
There is no way out.
Break-up with your partner – now
If you are married then your spouse gets maintenance and a property settlement when
you separate. Everyone else (all defactos - homosexual and heterosexual) generally
get nothing. You walk away with no property and no maintenance.
Wanted: Meal ticket. Must be Fin/Sec, DTE, G/L and have GSoH. Marriage not
Break up with your partner – after the law takes effect
Everyone (married, not married, same sex, whatever) is treated like a married couple
breaking up. You get your chance to seek maintenance and a property settlement via
the Family Court.
Is anything safe?
Everything in your family trust and company, your Mercedes, the money from your
mum's Estate, your sewing machine, even part of your Super is put in a big bucket.
The Family Court then decides on who gets what. Your ex-partner may get your Merc
even though they can't even drive it! Welcome to the world of married couples.
How do I protect my financial interests?
It is important that you talk to your Adviser and Accountant. They can work with
you and arrange for a Tax Lawyer to review your Estate Planning documents, prepare
a pre-nuptial agreement and move the assets into more effective business structures.
If you break up after the law takes effect, your only recourse is to the gladiatorial
Family Lawyer. At this point, you probably won’t even care about saving tax or planning
for the future. Your priority will be to "make that ##### pay for all those
wasted years". If you don't address these issues with your Accountant and
Adviser now, you may fall to the Family Lawyer’s axe later.