Summary: Where a contractor is classed as an employee, and they are working as an individual, they cannot salary sacrifice or make self-employed super contributions … unless their employment income is less than 10 per cent of the total assessable income.
Key take-out: The topic of tax-deductible self-employed superannuation contributions is complicated and anyone considering making such a contribution, but unsure of their eligibility, should seek professional advice.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.
In one of my recent articles I set out the facts about being able to claim self-employed super contributions (see Tax with Max: Making self-employed super contributions, October 14). Because this topic is incredibly complicated I have received a number of questions since the article was published.
These questions include:
- Am I correct that a contractor who is classed as an employee cannot salary sacrifice as they do not earn salary or wages and they cannot make self-employed contributions if they are classed as an employee?
- If a self-employed person earns 11 per cent of their income as an employee, even though they are working as a contractor, can they only make the compulsory employer super contributions?
- The two tests that you quoted in your article seem to contradict each other in relation to employer contributions, are you saying that the two tests must be passed or that one of the two tests must be passed?
The problem with there being the two tests is that someone can think that they are an independent contractor, but if the Australian Taxation Office audits their business or the one they contract to, and decides that a business is not really being operated, the income received will be classed as salaries and wages and application of the two tests becomes important.
Where someone is only receiving investment income, not receiving any income from an employer, and they are under 65, it is clear they can make a tax-deductible self-employed super contribution.
The only time that someone who has worked as an employee during a financial year will be eligible to make a self-employed tax-deductible super contribution, is when their employment income is substantially less than their other income.
This situation can arise when someone has ceased employment during a financial year and they earn significant investment income, including capital gains on the sale of investments, which results in their employment income being less than 10 per cent of their total assessable income.
The main problems for people who make self-employed tax-deductible super contributions arise when they have considered themselves to be running a business, possibly as an independent contractor, and the ATO classes them as an employee.
The six tests used by the ATO to determine whether someone is operating a business and is not an employee are as follows:
- This test requires a contractor to have the ability to appoint or subcontract someone else to do the work on their behalf rather than being required to do the work. This ability to appoint someone else to complete or do the work on behalf of the contractor must be in writing.
- An independent contractor must be paid to produce a result, preferably based on a quote, rather than just being paid on an hourly basis. This means that where someone only works for an hourly rate rather than to complete a project, such as doing the framing for a house or producing a website, they will be classed as an employee.
- The tools, equipment and other assets used to perform the work must all be supplied by the independent contractor and they cannot receive an allowance or reimbursement for the cost of the tools or equipment.
- Where there is a mistake made by an independent contractor they must be liable to fix any defects and mistakes at their own cost and they are therefore legally responsible for the quality of their work.
- An independent contractor has full control over how they perform the work and effectively do not have someone directing them how to perform their duties.
- The final test requires the independent contractor to have the ability to refuse work and also work for other people rather than only working for the one business.
The main problems for an independent contractor, with regard to making self-employed super contributions, are created when they work as an individual rather than through a company, partnership, or a trust. This is because when working in these other entities, an individual can receive a salary and therefore make tax-deductible employer and salary sacrifice contributions.
If someone works as an individual independent contractor, and is then classed as an employee of the business that they are working for, and doesn’t have significant other business or investment income, this person will have their self-employed super contribution disallowed. In addition, the business they have been working for will be liable for make compulsory employer super contributions on their behalf.
The statement made in question 1 is correct: Where a contractor is classed as an employee, and they are working as an individual, they cannot salary sacrifice or make self-employed super contributions … unless they pass the second test related to their employment income being less than 10 per cent of the total assessable income.
When a self-employed individual working as a contractor is classed as an employee, because an individual cannot employ themselves, they would not be eligible to make compulsory employer super contributions or salary sacrifice contributions. If the contractor was however working through one of the three entities previously mentioned (company, partnership or trust) they could be paying themselves a salary and therefore could make employer and salary sacrifice contributions on their own behalf.
The way in which the two tests relating to self-employed super contributions for whether an individual is eligible to make a self-employed super contribution work, and the order they are applied, is as follows:
- a) When someone is working as an employee and they are receiving compulsory employer super contributions they cannot make self-employed super contributions,
b) If someone is working as a contractor, but they are subsequently classified as an employee by the ATO and therefore the business they had been contracting to must make compulsory employer super contributions on their behalf, they will not be eligible to make tax-deductible self-employed super contributions unless they pass the second test,
- An individual that is held to be an employee, and therefore either has received or is eligible to receive compulsory employer super contributions, will only be able to make tax-deductible self-employed super contributions if their employment income is less than 10 per cent of their total income.
Employment income includes not only amounts classed as salaries and wages but also includes salary sacrifice super contributions that are reportable employer super contributions and reportable fringe benefits.
As can be seen from the questions received in relation to the subject of making self-employed super contributions, this is a complicated area of income tax. Therefore anyone who is thinking about making tax-deductible self-employed super contributions, and is unsure whether they will pass the tests, should seek professional advice from an accountant who specialises in this area.
Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.
Do you have a question for Max? Send an email to firstname.lastname@example.org.