Management
May/June 2003

ª Print this Page ªClose this Window

Income Splitting
By Geoff Coy, Certified Practising Accountant

I

n this article, Accountant Geoff Coy looks at another threat to many small business owners as the ATO looks to further target income splitting arrangements.

Income splitting, despite being an effective and legally sound tax planning strategy for many small business people, is still a grey area of Australian tax law.

Income splitting strategies have been in the sights of the ATO for a number of years and are about to come under further attack.

Back in July 2000, the ATO introduced controversial measures to catch hundreds of thousands of contractors with its Personal Services Income (PSI) legislation. This caught contractors who earned more than 80% of their income from one client.

ATO Test Cases
Now the ATO is set once again to target other forms of income splitting even further by introducing a series of test cases through the courts to challenge some of these commonly accepted grey areas.

Many small business owners use family partnerships, proprietary limited companies and family trusts as vehicles in which to operate their businesses. Income splitting is a means whereby the income of the primary income earner is spread across other persons so that a lower rate of tax applies.

The tax office now intends to select a number of taxpayers with differing income splitting scenarios, reject there tax returns and then offer to fund their legal and accounting costs to challenge the ATO rulings. When the cases are decided the ATO will further search business taxpayers involved in those income splitting scenarios with a view to amending their tax bills.

Likely Targets
Those who are likely to be targeted will come from the following situations:
· Husband and wife partnerships that split income 50-50 when there is only one real worker or one partners works or generates extensively more than 50% of the income;
· Where the principal worker is underpaid by industry standards;
· When excessive remuneration, particularly superannuation is paid to a spouse or associate;
· Personal Services Income is reinvested back into the business;
· Trusts were established before personal services were begun;
· Checking the distinction between personal services income and business structures;
· Income from many clients during an income year as opposed to many clients.

Some promoters have even set up schemes known as "arranged partnerships". These schemes offer to arrange partnerships between unrelated people who earn their income by providing professional services.

Participants in these partnerships continue to receive income generated by their own services less any fees paid to the promoter. The effect of this arrangement is to re-characterise the income being earned as income of a partnership so it can be split with spouses and other related parties.

The ATO is now attempting to seek clarification on these grey areas of the law as it is potentially losing millions of dollars of revenue each year.

Due to the effect of bracket creep, small business taxpayers also seek to split business income amongst family members and associates. This is because Australia's peak income-tax rate of 47% cuts in at $60,000 which is one of the lowest salary levels in the world.

In recent years there has been a significant increase in self employed persons. This has been brought about by retrenchments. As a results, those affected - mostly middle aged middle managements - are forced to "buy a job" or become self employed consultants. When this occurs those affected usually set up family partnerships, companies and trusts to minimise tax.

Australia's income-splitting tax rules are a nightmare - they were set up in a different era when most people worked nine to five for large corporations. The tax commissioner has not been vigorously enforcing them and so a large number of Australians in small enterprises tend to ignore them.

The biggest problem of all is that it could take years for these test cases to work through the system. In the mean time the uncertainty remains and business owners will continue to take the risks whether they realise it or not.

ª Print this Page ªClose this Window