Why small business fears contractor chaos: Gottliebsen

The big response to my revelation that Assistant Treasurer Nick Sherry was endorsing a plan that would plunge large segments of the Australian small business community into chaos has added a new dimension to discovering whether there is a fundamental change brewing in the Rudd Government.

The Rudd government that we elected in 2007 was pragmatic and saw unions as a significant force, but not the only driver. The unions have had a huge win in industrial relations, but the Sherry-endorsed tax plan picks up on a much wider union agenda – to classify large numbers of private contractors as employees.

What better way of doing that than tax the returns from a shovel differently from the person using it? Or to turn a contractor into an employee if that contractor gets a major contract which means that 80 per cent of the revenue for the business comes from one source? Or to require small businesses have two staff?

We received many comments from readers and the people I have spoken to say that if the government proceeds with the Sherry-endorsed plan to decimate large segments of small business in order to help union mates, it will confirm their worst fear – that the 2007 pragmatism is increasingly being replaced by union-driven agendas.

For what it’s worth I don’t think that is right. So let’s reserve judgement and classify the Sherry decision as simply a monumental blunder by one minister. Indeed a number of government ministers will be just as horrified as the small business community.

My guess is that what Nick Sherry is endorsing is so stupid and so damaging to the country that it will be squashed by the government heavies. Nevertheless, no-one can be sure. With hours of my commentary yesterday the Abbott camp began researching this magnificent opportunity to make Tony Abbott Prime Minister.

Strangely, contractor tax legislation is one of the clearest and best running areas in the Australian taxation landscape. To be classed as a contractor a person, partnership, company or trust must pass what is called a results test. The results test is not difficult to pass for genuine contractors, but difficult for employees.

One of the tests is whether you are responsible for ‘rectification’ which asks whether you are required to fix errors you may make. Another test is whether you own plant and equipment and, of course, you must make sure that you don’t have an employee status. If you fail the results test then you are prima facie not a contractor.

However, there is a second level of testing for those that do not pass the results test, which includes the 80/20 test which means that if more than 20 per cent of your business is spread among a variety of clients then you can be regarded as a contractor.

The Australian Taxation Office has been thoroughly professional and conducted, at government expense, a series of test cases to clarify the law. The area that is the most dangerous is where independent contracting is being conducted by a trust or company. When the legislation was being debated in the late 1990s, many in the tax office thought there were a vast number of sham contractors out there, so they tested an incredible 65,000 businesses which on the surface seemed in danger of creating an employment relationship. Less than a thousand of these people were found to have a problem and small amounts of tax were collected from them. It was clear to the Australian Taxation Office that sham contracting was not widespread.

Two readers said their accountant advised them that if more than 80 per cent of their business came from one client they would be regarded as an employee. I must advise those people that they should consider changing their accountant. Assuming the facts were as described, the accountants’ advice was simply wrong or badly explained because as set out above, it is the results test that is the first hurdle that any business must pass. The 80/20 rule is not in the results test and is in the second layer of testing for those that fail the results test.

It is worth reminding readers that when in charge of superannuation, Nick Sherry set up what I called a potential “kangaroo court” to examine superannuation. He selected a panel of good people headed by Jeremy Cooper, but they had with no experience with self-managed superannuation funds. There was great danger that the self managed funds would come out badly in this committee’s reports.

A new minister, Chris Bowen, took control of superannuation and appointed a person expert in self-managed funds to the committee. The first report from the Cooper panel was a good one and well run self-managed funds got a tick. This time the Sherry endorsed plan for small business has gone to the Henry tax review. Maybe Ken Henry will be Nick Sherry’s saviour this time around. Tony Abbott and his supporters are on the edge of their seats.

This article first appeared in Business Spectator.