Income tax for self-employed

The advantages of being self-employed

The business structure you choose when establishing a business is vital in ensuring that you pay no more tax than is necessary (most family businesses operate a family trust in order to reduce taxes).

Self-employed, as used in Australia, means a ‘ sole trader’ or someone in a partnership, and not a limited company or trust. If you have a limited company, you must pay corporate or company tax on your profits and need the services of an accountant to deal with this.

It’s important to obtain expert legal advice before establishing a business or starting work as a self-employed person in Australia. Like everything to do with tax law, the regulations applying to the self-employed are complicated and time-consuming, and are estimated to cost some $7 billion a year in lost time. Not surprisingly, some 90 per cent of the self-employed use a tax agent to complete their tax returns.

You’re generally better off being self-employed than employed, as you’re eligible to claim more allowances in legitimate business expenses such as telephone bills, travel to and from work, and work clothes or uniforms than employees paying PAYG tax. Another advantage for the self-employed is the delay between making profits (if they have any) and paying tax on them, as the self-employed and small businesses usually pay their tax under the PAYG Instalments system.

An estimated 75,000 people pretend that they’re self-employed in order to claim extra allowances. Recent court cases have declared that, under the current tax laws, airline pilots, bicycle/motorcycle couriers and taxi drivers are independent contractors and are therefore entitled to be treated as self-employed. In the light of these decisions, the ATO sidelined proposals that would have re-classified thousands of self-employed contractors as employees subject to PAYG tax.

However, small businesses are frequently targeted by tax inspectors investigating tax evasion. To be classified as self-employed, you must convince the ATO that you’re genuinely self-employed and in business for yourself. The ‘three-point test’ to decide whether you’re an employee or a self-employed contractor is as follows:

Contract Test: Whether your employer can control your activities while the work is being done.
Risk Test: Whether you own your equipment and are paid only if the work is done (unlike an employee, who is paid even if it isn’t, although he may subsequently be fired!).
Labour Versus Completion of the Job Test: Whether you’re paid for hours worked, like an employee, or for completing a job, like a contractor.

If the ATO agrees that you’re self-employed, you should get them to confirm their decision in writing.