Law Administration Practice Statement PS LA 2003/6
Alienated personal services payments - calculating withholding amounts
Date of issue: 1 July 2003
Date of effect: 1 July 2003
Draft: False
Withdrawn: False

1. What this Practice Statement is about: From 1 July 2003, taxpayers can use an administrative method to calculate the withholding amounts on their alienated personal services payments to comply with Division 13 of Schedule 1 to the Taxation Administration Act 1953. When a personal services entity (PSE) follows this arrangement, we will remit any failure to withhold penalty that might otherwise arise under the law. This Practice Statement discusses the arrangement in detail. It sets out the calculations, the circumstances in which they can be used and provides worked examples. All further legislative references in this Practice Statement are to Schedule 1 to the Taxation Administration Act 1953, unless otherwise indicated. | 2. Why there are administrative arrangements: Administrative arrangements relieve an unintended difficulty for taxpayers arising from the law. Division 13 deals with collecting income tax and other liabilities included in an individual's assessable income under the Alienation of personal services income measures in Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997). PSEs use the method statement in subsection 13-5(2) to work out their liability. At Step 2(a) of the method statement, the PSE must identify amounts that are included in the individual's assessable income under section 86-15 of the ITAA 1997 that relate to alienated personal services payments the entity received during the pay as you go (PAYG) payment period. However, the method statement creates a timing mismatch if the entity is eligible for deductions under section 86-20 of the ITAA 1997. These deductions must be worked out at the end of the income year, yet the method statement requires an amount to be included at Step 2(a) during the year. If the PSE cannot quantify the amount to be paid under Division 13 and this results in a shortfall, a failure to withhold penalty will apply under section 16-30. The administrative arrangements address this problem. | 3. What the administrative arrangements are: The administrative arrangement corrects the difficulty for PSEs by allowing them to fulfil their obligations by applying the correct withholding rate to a minimum personal services income (PSI) payout measure and: • pay amounts as salary or wages to the service provider and withhold under Division 12, or • choose not to pay the amounts as salary or wages to the service provider but pay them to us under Division 13. • pay amounts as salary or wages to the service provider and withhold under Division 12, or • choose not to pay the amounts as salary or wages to the service provider but pay them to us under Division 13. If a PSE does this using the calculations set out in this Practice Statement, we will remit to nil the failure to withhold penalty on any shortfall that arises from the entity's being unable to follow the method statement in subsection 13-5(2). The withholding rate is the rate listed in the relevant PAYG withholding tax tables (or a relevant variation granted to the individual service provider). The minimum PSI payout measure will be an amount that is either equal to or greater than: • 70% of the gross PSI (goods and services tax-exclusive (GST-exclusive)) received by the PSE during the current PAYG payment period, or • a net PSI percentage applied to the gross PSI (GST-exclusive) received by the PSE during the current PAYG payment period. • 70% of the gross PSI (goods and services tax-exclusive (GST-exclusive)) received by the PSE during the current PAYG payment period, or • a net PSI percentage applied to the gross PSI (GST-exclusive) received by the PSE during the current PAYG payment period. To work out the net PSI percentage: • subtract the amount worked out under the method statement in section 86-20 of the ITAA 1997 for the individual's previous income year from the individual's gross PSI (GST-exclusive) for the previous income year • divide the result by the PSE's gross PSI (GST-exclusive) for the previous income year, and • multiply by 100 to give a percentage. • subtract the amount worked out under the method statement in section 86-20 of the ITAA 1997 for the individual's previous income year from the individual's gross PSI (GST-exclusive) for the previous income year • divide the result by the PSE's gross PSI (GST-exclusive) for the previous income year, and • multiply by 100 to give a percentage. Apply this percentage to the gross PSI (GST-exclusive) for each PAYG payment period in the current year. The formula is: Failure to comply If the PSE does not follow the administrative arrangement or meet its conditions, the usual guidelines on remission of failure to withhold penalty apply. | 4. Worked examples: In the 3 worked examples in this Practice Statement, assume that the PSEs: • are subject to the Alienation of personal services income measures under Part 2-42 of the ITAA 1997, and • have withholding obligations under Division 13. • are subject to the Alienation of personal services income measures under Part 2-42 of the ITAA 1997, and • have withholding obligations under Division 13. Note: the withholding amounts calculated in the following examples are based on the PAYG Withholding Tax Tables (Quarterly) that were current at 1 July 2003. Always refer to the current Tax tables when working out withholding amounts. Example 1 - company In this example, a company uses the net PSI percentage option to calculate salary to pay to an individual service provider. [1] The example concludes with an analysis of the application of this Practice Statement to the shortfall in amounts that should have been paid under Division 13. InfotechBiz Co. (InfotechBiz) provides Peter's services as an IT consultant. InfotechBiz has only one worker (Peter) and is registered as a small withholder. InfotechBiz chooses to pay amounts out as salary to Peter within 14 days of the end of the quarter, calculated using the net PSI percentage. During the current income year The net PSI percentage is the same for each quarter in the income year, as it is worked out using amounts from the previous income year. For the previous income year, InfotechBiz: • received total payments of $100,000 (GST-exclusive) for Peter's services • received other income of $2,000 • incurred expenses (other than promptly paid salary or wages and entity maintenance expenses) of $30,000 to generate the income for Peter's services, and • incurred entity maintenance expenses of $5,000. • received total payments of $100,000 (GST-exclusive) for Peter's services • received other income of $2,000 • incurred expenses (other than promptly paid salary or wages and entity maintenance expenses) of $30,000 to generate the income for Peter's services, and • incurred entity maintenance expenses of $5,000. This worked example utilises the net PSI percentage formula from Section 3 of this Practice Statement to provide how to calculate the salary to pay to the service provider. Peter's gross PSI (GST-exclusive) for the previous income year was $100,000. As InfotechBiz had no other service providers, its gross PSI (GST-exclusive) for the previous income year was also $100,000. The amount worked out under the method statement in section 86-20 of the ITAA 1997 is $33,000. The steps in subsection 86-20(2) (and resulting calculations for InfotechBiz) are set out below: Step 1 : Work out, for the income year, the amount of any deductions (other than entity maintenance deductions or deductions for amounts of salary or wages paid to you) to which the PSE is entitled that are deductions relating to your PSI. The outcome of Step 1 for InfotechBiz is $30,000. Step 2 : Work out, for the income year, the amount of any entity maintenance deductions to which the PSE is entitled. The outcome of Step 2, for Peter as PSE, is $5,000. Step 3 : Work out the PSE's assessable income for that income year, disregarding any income it receives that is your PSI or the PSI of anyone else. The outcome of Step 3, for Peter as PSE, is $2,000. Step 4 : Subtract the amount under Step 3 from the amount under Step 2, noting that: (a) Step 4 ensures that, before entity maintenance deductions can contribute to the reduction, they are first exhausted against any income of the entity that is not PSI (b) if the PSE received another individual's PSI, see section 86-25 of the ITAA 1997. (a) Step 4 ensures that, before entity maintenance deductions can contribute to the reduction, they are first exhausted against any income of the entity that is not PSI (b) if the PSE received another individual's PSI, see section 86-25 of the ITAA 1997. The calculation for Step 4 is $5,000 - $2,000 = $3,000. Step 5 : If the amount under Step 4 is greater than zero, the amount of the reduction under subsection 86-20(1) of the ITAA 1997 is the sum of the amounts under Steps 1 and 4. The calculation for Step 5 is therefore $30,000 + $3,000 = $33,000. Step 6 : If the amount under Step 4 is not greater than zero, the amount of the reduction under subsection 86-20(1) of the ITAA 1997 is the amount under Step 1. Step 6 is not applicable. The net PSI percentage is worked out as follows: The net PSI percentage equals 67%. To work out the amount of salary to pay to Peter, Infotechbiz multiplies the net PSI percentage by the gross PSI (GST-exclusive) of InfotechBiz for the current PAYG payment period. During quarter 1, InfotechBiz received gross PSI (GST-exclusive) of $28,000: 67% × $28,000 = $18,760 InfotechBiz pays out $18,760 as salary to Peter within 14 days of the end of quarter 1. InfotechBiz works out the amount to withhold from the payment by referring to the PAYG Withholding Tax Tables (Quarterly) and withholds $5,811 from the payment of $18,760. InfotechBiz has not made any other withholding payments during that quarter, so the amount of $18,760 is reported at W1 and the amount of $5,811 is reported on InfotechBiz's quarterly business activity statement (BAS) at W2, as Peter is an Australian resident for tax purposes. InfotechBiz then lodges the BAS together with $5,811 (assume InfotechBiz has no other activity statement obligations). Assume the gross PSI (GST-exclusive) received by InfotechBiz is the same for each quarter (that is, $28,000). By the end of the income year, InfotechBiz has withheld the amounts shown in Table 1 of this Practice Statement during the year from payments of salary to Peter. Table 1: Example 1 - applying net PSI percentage to current income year Quarter Promptly paid salary Amount withheld under Division 12 1 $28,000 × 67% = $18,760 $5,811 2 $28,000 × 67% = $18,760 $5,811 3 $28,000 × 67% = $18,760 $5,811 4 $28,000 × 67% = $18,760 $5,811 Note: the total promptly paid salary is $75,040 and the total amount withheld under Division 12 is $23,244. InfotechBiz fills out the BAS correctly and pays the withheld amounts to us. After the end of the income year By 14 July, InfotechBiz prepares a payment summary for Peter. InfotechBiz also prepares an annual report and submits it to us. To complete their tax returns, Peter and InfotechBiz need to work out the amount of PSI that is attributed to Peter under Part 2-42 of the ITAA 1997. Assume that during the income year, InfotechBiz: • receives $112,000 (GST-exclusive) as a payment for Peter's services • receives investment income of $4,000 • incurs other expenses of $32,000 to generate the income for Peter's services, and • incurs entity maintenance expenses of $6,000. • receives $112,000 (GST-exclusive) as a payment for Peter's services • receives investment income of $4,000 • incurs other expenses of $32,000 to generate the income for Peter's services, and • incurs entity maintenance expenses of $6,000. The amount attributed to Peter at the end of the income year is Peter's PSI less deductions worked out under sections 86-15 and 86-20 of the ITAA 1997. The amount of Peter's PSI is $112,000. This amount is reduced by amounts promptly paid to Peter as salary (that is, $75,040). Peter's PSI under section 86-15 of the ITAA 1997 (before the application of section 86-20 of that Act) is therefore $36,960. This amount is then reduced by $34,000, the amount worked out using the method statement in subsection 86-20(2) of the ITAA 1997. The steps (and resulting calculations) in section 86-20 of that Act are set out below: Step 1 : Work out, for the income year, the amount of any deductions (other than entity maintenance deductions or deductions for amounts of salary or wages paid to you) to which the PSE is entitled that are deductions relating to your PSI. The outcome of Step 1, for Peter, is $32,000. Step 2 : Work out, for the income year, the amount of any entity maintenance deductions to which the PSE is entitled. The outcome of Step 2, for Peter as PSE, is $6,000. Step 3 : Work out the PSE's assessable income for that income year, disregarding any income it receives that is your PSI or the PSI of anyone else. The outcome of Step 3, for Peter, is $4,000. Step 4 : Subtract the amount under Step 3 from the amount under Step 2, noting that: (a) Step 4 ensures that, before entity maintenance deductions can contribute to the reduction, they are first exhausted against any income of the entity that is not PSI (b) if the PSE received another individual's PSI, see section 86-25 of the ITAA 1997. (a) Step 4 ensures that, before entity maintenance deductions can contribute to the reduction, they are first exhausted against any income of the entity that is not PSI (b) if the PSE received another individual's PSI, see section 86-25 of the ITAA 1997. The outcome of Step 4 is $2,000. Step 5 : If the amount under Step 4 is greater than zero, the amount of the reduction under subsection 86-20(1) of the ITAA 1997 is the sum of the amounts under Steps 1 and 4. The outcome of Step 5 is $34,000. Step 6 : If the amount under Step 4 is not greater than zero, the amount of the reduction under subsection 86-20(1) of the ITAA 1997 is the amount under Step 1. The amount therefore attributable to Peter under section 86-15 of the ITAA 1997 is $2,960 (that is, $36,960 less $34,000). Peter includes the amounts of $2,960 (attributed PSI) and $75,040 (salary) in his assessable income. Analysis After the end of the income year, we are in a position to accurately review the amounts that should have been paid under Division 13, had InfotechBiz been in a position to know the amount to include at Step 2(a) in the method statement in subsection 13-5(2). This potentially exposes InfotechBiz to a penalty for failure to withhold if there is a shortfall in the amounts that should have been paid under Division 13. The amounts which should have been paid under Division 13 in quarter 1 are set out in the steps from subsection 13-5(2) below: Step 1 : Identify the payments that the PSE makes to the individual during the period mentioned in paragraph 13(1)(b) that are withholding payments covered by section 12-35. The outcome of Step 1 is $18,760. Step 2 : Identify the amounts that: (a) are included in the individual's assessable income under section 86-15 of the ITAA 1997, and (b) relate to alienated personal services payments the entity receives during that period. (a) are included in the individual's assessable income under section 86-15 of the ITAA 1997, and (b) relate to alienated personal services payments the entity receives during that period. The outcome of Step 2 is $740, using the formula $2,960 × ($28,000 ÷ $112,000). Step 3 : Work out the sum of all the amounts that Division 12 would require the entity to withhold in respect of that period if both of these were taken into account, noting that: (a) the payments identified in Step 1, and (b) the amounts identified in Step 2, as if they were payments of salary covered by section 12-35. (a) the payments identified in Step 1, and (b) the amounts identified in Step 2, as if they were payments of salary covered by section 12-35. The outcome of Step 3 is $6,169, which is the amount to withhold on a quarterly basis from $19,500. Step 4 : Work out the sum of all the amounts withheld under section 12-35 from the payments identified in Step 1. The outcome of Step 4 is $5,811. Step 5 : Subtract the sum under Step 4 from the sum under Step 3. The outcome of Step 5 is $6,169 - $5,811 = $358. In addition to the amounts withheld under Division 12 throughout the year, InfotechBiz should have paid $358 per quarter under Division 13. There is, therefore, a shortfall in the amounts that InfotechBiz was required to pay under Division 13 and a failure to withhold penalty of $358 applies to InfotechBiz for quarter 1. Similarly, a failure to withhold penalty of $358 will apply for quarters 2, 3 and 4. However, the penalties are remitted to nil, because InfotechBiz complied with the administrative arrangements by: • paying salary within 14 days after the end of the PAYG payment period that was equal to the net PSI percentage applied to the gross PSI received by InfotechBiz during the quarter, and • withholding from that salary at the applicable withholding rate. • paying salary within 14 days after the end of the PAYG payment period that was equal to the net PSI percentage applied to the gross PSI received by InfotechBiz during the quarter, and • withholding from that salary at the applicable withholding rate. Example 2 - partnership Example 2 illustrates the application of the administrative options for partnerships. As partnerships cannot pay amounts to partners as salary or wages, they can only pay amounts under Division 13 rather than Division 12. In this example, the partnership has chosen to work out Division 13 amounts based on the flat rate of 70% of the gross PSI of the partnership during the PAYG payment period. Carrie and Jamie are partners in a partnership trading as 'Chic Deco', which provides Carrie's services as an interior designer. Chic Deco does not have any employees but registers as a small withholder. Jamie provides assistance in the administration of the partnership. Chic Deco chooses to work out its Division 13 obligations using 70% of the partnership's gross PSI (GST-exclusive) per quarter. During quarter 1, Chic Deco receives gross PSI (GST-exclusive) of $28,000. Chic Deco attributes $19,600 (70% of $28,000) to Carrie. Chic Deco then works out the amount to pay to us under Division 13 by referring to the PAYG Withholding Tax Tables (Quarterly). The amount Chic Deco is required to pay is $6,218. They have not made any other withholding payments during that quarter, so the amount of $19,600 is reported on their quarterly BAS at W1 and the amount of $6,218 is reported at W2, as Carrie is an Australian resident for tax purposes. Chic Deco then lodges the BAS and pays the $6,218 (assume Chic Deco has no other activity statement obligations). Assume for each quarter that the gross PSI (GST-exclusive) received by Chic Deco is the same as for quarter 1 (that is, $28,000). By the end of the income year, Chic Deco has paid the amounts shown in Table 2 of this Practice Statement to us under Division 13. Table 2: Example 2 - flat rate applied to current income year Quarter Attributed income Amount paid under Division 13 1 $28,000 × 70% = $19,600 $6,218 2 $28,000 × 70% = $19,600 $6,218 3 $28,000 × 70% = $19,600 $6,218 4 $28,000 × 70% = $19,600 $6,218 Note: the total attributed income is $78,400 and the total amount paid under Division 13 is $24,872. All amounts are correctly reported on the BAS and Division 13 amounts have been paid to us. After the end of the income year By 14 July, Chic Deco prepares a payment summary for Carrie. They also prepare an annual report and submit it to us. To complete their tax returns, Carrie and Chic Deco need to work out the amount of PSI attributed to Carrie under Part 2-42 of the ITAA 1997. Assume that during the year, Chic Deco: • receives $112,000 (GST-exclusive) as payment for Carrie's services • receives investment income of $4,000 • incurs other expenses of $32,000 to generate the income from Carrie's services, and • incurs entity maintenance expenses of $6,000. • receives $112,000 (GST-exclusive) as payment for Carrie's services • receives investment income of $4,000 • incurs other expenses of $32,000 to generate the income from Carrie's services, and • incurs entity maintenance expenses of $6,000. The amount attributed to Carrie at the end of the income year is Carrie's PSI less deductions worked out under sections 86-15 and 86-20 of the ITAA 1997. The amount of Carrie's PSI under section 86-15 of the ITAA 1997 (before the application of section 86-20 of that Act) is $112,000. This amount is then reduced by the amount worked out in accordance with the method statement in subsection 86-20(2) of the ITAA 1997 of $34,000 (calculations are the same as in Example 1 of this Practice Statement). The amount therefore attributable to Carrie under section 86-15 of the ITAA 1997 is $78,000 (that is, $112,000 less $34,000). Carrie includes the amount of $78,000 (attributed PSI) in her assessable income. Analysis After the end of the income year, we are in a position to accurately review the amounts that should have been paid under Division 13 had Chic Deco been in a position to know the amount to include at Step 2(a) in the method statement in subsection 13-5(2). This potentially exposes Chic Deco to a penalty for failure to withhold if there is a shortfall in the amounts that should have been paid under Division 13. The amounts which should have been paid under Division 13 in quarter 1 are set out in the steps from subsection 13-5(2) below: Step 1 : Identify the payments that the PSE makes to the individual during the period mentioned in paragraph (1)(b) that are withholding payments covered by section 12-35. The outcome of Step 1 is nil. Step 2 : Identify the amounts that: (a) are included in the individual's assessable income under section 86-15 of the ITAA 1997, and (b) relate to alienated personal services payments the entity receives during that period. (a) are included in the individual's assessable income under section 86-15 of the ITAA 1997, and (b) relate to alienated personal services payments the entity receives during that period. The outcome of Step 2 is $19,500, using the formula $78,000 × ($28,000 ÷ $112,000). Step 3 : Work out the sum of all the amounts that Division 12 would require the entity to withhold in respect of that period if both of these were taken into account: (a) the payments identified in Step 1, and (b) the amounts identified in Step 2, as if they were payments of salary covered by section 12-35. (a) the payments identified in Step 1, and (b) the amounts identified in Step 2, as if they were payments of salary covered by section 12-35. The outcome of Step 3 is $6,169, which is the amount to withhold on quarterly basis from $19,500. Step 4 : Work out the sum of all the amounts withheld under section 12-35 from the payments identified in Step 1. The outcome of Step 4 is nil. Step 5 : Subtract the sum under Step 4 from the sum under Step 3. The outcome of Step 5 is $6,169 - $0 = $6,169. Had Chic Deco been in a position to accurately calculate Step 2(a) of the method statement in subsection 13-5(2), they would have known that their Division 13 liability was $6,169. Instead, they paid $6,218 under Division 13 for quarter 1. There is, therefore, a small 'over-withholding' of $49 per quarter. There was no shortfall under Division 13 for quarter 1, so no penalty applies. Example 3 - applying the ordinary rules to a company that pays a flat rate In this example, we consider remission of the failure to withhold penalty under the general remission policy, rather than the specific guidelines. In this case, the company is not applying the administrative arrangement. Instead, they pay a set amount of salary not calculated from the gross PSI the company receives. Peppe Co. (Peppe) provides Jack's services as an engineer. Peppe is aware that it had Division 13 obligations for the personal services provided by Jack. Peppe is registered as a small withholder. In quarter 1, Peppe receives $60,000 in gross PSI (GST-exclusive). Peppe pays $20,000 as salary to Jack. Peppe works out the amount to withhold by referring to the PAYG Withholding Tax Tables (Quarterly) and withholds $6,412 from the payment of $20,000. Peppe has not made any other withholding payments during that quarter so, on Peppe's BAS, the amount of $20,000 is reported at W1 and the amount of $6,412 is reported at W2, as Jack is an Australian resident for tax purposes. Peppe lodges the BAS and pays $6,412 to us (assume Peppe has no other activity statement obligations). Assume the gross PSI (GST-exclusive) received by Peppe is the same for each quarter (that is, $60,000). By the end of the income year, Peppe has withheld the amounts shown in Table 3 of this Practice Statement from salary paid to Jack. Table 3: Example 3 - amounts withheld without administrative arrangements Quarter Promptly paid salary Amount withheld under Division 12 1 $20,000 $6,412 2 $20,000 $6,412 3 $20,000 $6,412 4 $20,000 $6,412 Note: the promptly paid salary total is $80,000 and the amount withheld under Division 12 total is $25,648. These amounts are correctly reported on the BAS and the withheld amounts paid to us. After the end of the income year By 14 July, Peppe prepares the payment summary for Jack. Peppe also prepares an annual report and submits it to us. To complete their tax returns, Jack and Peppe need to work out the amount of PSI that is attributed to Peppe under Part 2-42 of the ITAA 1997. Assume that during the income year, Peppe: • receives $240,000 (GST-exclusive) as a payment for Jack's services • receives investment income of $5,000 • incurs other expenses of $65,000 to generate the income for Jack's services, and • incurs entity maintenance expenses of $5,000. • receives $240,000 (GST-exclusive) as a payment for Jack's services • receives investment income of $5,000 • incurs other expenses of $65,000 to generate the income for Jack's services, and • incurs entity maintenance expenses of $5,000. The amount attributed to Jack at the end of the income year is Jack's PSI less deductions worked out under sections 86-15 and 86-20 of the ITAA 1997. The amount of Jack's PSI is $240,000. This amount is reduced by amounts promptly paid to Jack as salary or wages (that is, $80,000). Jack's PSI under section 86-15 of the ITAA 1997 is therefore $160,000. This amount is reduced by $65,000, the amount worked out using the method statement in subsection 86-20(2) of the ITAA 1997. The steps (and resulting calculations) in subsection 86-20(2) of that Act are set out below: Step 1 : Work out, for the income year, the amount of any deductions (other than entity maintenance deductions or deductions for amounts of salary or wages paid to you) to which the PSE is entitled that are deductions relating to your PSI. The outcome of Step 1, for Peppe, is $65,000. Step 2 : Work out, for the income year, the amount of any entity maintenance deductions to which the PSE is entitled. The outcome of Step 2, for Jack, is $5,000. Step 3 : Work out the PSE's assessable income for that income year, disregarding any income it receives that is your PSI or the PSI of anyone else. The outcome of Step 3, for Jack, is $5,000. Step 4 : Subtract the amount under Step 3 from the amount under Step 2, noting that: (a) Step 4 ensures that, before entity maintenance deductions can contribute to the reduction, they are first exhausted against any income of the entity that is not PSI (b) if the PSE received another individual's PSI, see section 86-25 of the ITAA 1997. (a) Step 4 ensures that, before entity maintenance deductions can contribute to the reduction, they are first exhausted against any income of the entity that is not PSI (b) if the PSE received another individual's PSI, see section 86-25 of the ITAA 1997. The outcome of Step 4 is nil ($5,000 - $5,000). Step 5 : If the amount under Step 4 is greater than zero, the amount of the reduction under subsection 86-20(1) of the ITAA 1997 is the sum of the amounts under Steps 1 and 4. Step 5 is not applicable. Step 6 : If the amount under Step 4 is not greater than zero, the amount of the reduction under subsection 86-20(1) of the ITAA 1997 is the amount under Step 1. The outcome of Step 6 is $65,000, the amount under Step 1. The amount therefore attributable to Jack under section 86-15 of the ITAA 1997 is $95,000 (that is, $160,000 - $65,000). Jack includes the amounts of $95,000 (attributed PSI) and $80,000 (salary or wages) in his assessable income. Analysis After the end of the income year, we are in a position to accurately review the amounts that should have been paid under Division 13 had Peppe been in a position to know the amount to include at Step 2(a) in the method statement in subsection 13-5(2). This potentially exposes Peppe to a penalty for failure to withhold if there is a shortfall in the amounts that should have been paid under Division 13. The amounts which should have been paid under Division 13 in quarter 1 are set out in the steps from subsection 13-5(2) below: Step 1 : Identify the payments that the PSE makes to the individual during the period mentioned in paragraph (1)(b) that are withholding payments covered by section 12-35. The outcome of Step 1 is $20,000. Step 2 : Identify the amounts that: (a) are included in the individual's assessable income under section 86-15 of the ITAA 1997, and (b) relate to alienated personal services payments the entity receives during that period. (a) are included in the individual's assessable income under section 86-15 of the ITAA 1997, and (b) relate to alienated personal services payments the entity receives during that period. The outcome of Step 2 is $23,750, using the formula $95,000 × (60,000 ÷ 240,000). Step 3 : Work out the sum of all the amounts that Division 12 would require the entity to withhold in respect of that period if both of these were taken into account: (a) the payments identified in Step 1, and (b) the amounts identified in Step 2, as if they were payments of salary covered by section 12-35. (a) the payments identified in Step 1, and (b) the amounts identified in Step 2, as if they were payments of salary covered by section 12-35. The outcome of Step 3 is $17,931, which is the amount to withhold on quarterly basis from $43,750. Step 4 : Work out the sum of all the amount withheld under section 12-35 from the payments identified in Step 1. The outcome of Step 4 is $6,412. Step 5 : Subtract the sum under Step 4 from the sum under Step 3. The outcome of Step 5 is $17,931 - $6,412 = $11,519. In addition to the amounts withheld under Division 12 for quarter 1, Peppe should have also paid $11,519 under Division 13. There is, therefore, a shortfall, and a failure to withhold penalty of $11,519 applies to Peppe for quarter 1. Similarly, a penalty of $11,519 will apply to Peppe for quarters 2, 3 and 4. Even though Peppe did not make a conscious choice to adopt the administrative options, we will remit the failure to withhold penalty to nil if the amounts that Peppe withheld during each quarter of the year are equal to or greater than the amounts that would have been withheld if the relevant withholding rate had been applied to: • 70% of the gross PSI (GST-exclusive) received by Peppe during the quarter, or • the net PSI percentage applied to the gross PSI (GST-exclusive) received by Peppe during the quarter. • 70% of the gross PSI (GST-exclusive) received by Peppe during the quarter, or • the net PSI percentage applied to the gross PSI (GST-exclusive) received by Peppe during the quarter. Otherwise, if the amounts that Peppe withheld during each quarter of the year are not equal to or greater than the amounts that would have been withheld if the relevant withholding rate had been applied we will apply the general guidelines on remission of failure to withhold penalty for Division 13. The amount actually withheld during quarter 1 was $6,412. Under the 70% of the gross PSI option, 70% of $60,000 (Peppe's gross PSI for quarter 1) is $42,000. The amount to withhold from $42,000, according to the PAYG Withholding Tax Tables (Quarterly) is $17,082. Under the net PSI percentage option, the calculation relies on the previous year's figures. Assume for the previous income year, Peppe: • received total payments of $200,000 (GST-exclusive) for Jack's services • received other income of $4,000 • incurred expenses (other than promptly paid salary or wages and entity maintenance expenses) of $60,000 to generate the income for the Jack's services, and • incurred entity maintenance expenses of $5,000. • received total payments of $200,000 (GST-exclusive) for Jack's services • received other income of $4,000 • incurred expenses (other than promptly paid salary or wages and entity maintenance expenses) of $60,000 to generate the income for the Jack's services, and • incurred entity maintenance expenses of $5,000. This worked example utilises the net PSI percentage formula from Section 3 of this Practice Statement to provide how to calculate the salary to pay to an individual service provider. Jack's gross PSI (GST-exclusive) for the previous income year was $200,000. As Peppe has no other service providers, his gross PSI (GST-exclusive) for the previous income year is also $200,000. The amount worked out under the method statement in section 86-20 of the ITAA 1997 is $61,000. The steps in subsection 86-20(2) of that Act (and resulting calculations) are set out below: Step 1 : Work out, for the income year, the amount of any deductions (other than entity maintenance deductions or deductions for amounts of salary or wages paid to you) to which the PSE is entitled that are deductions relating to your PSI. The outcome of the Step 1, for Peppe, is $60,000. Step 2 : Work out, for the income year, the amount of any entity maintenance deductions to which the PSE is entitled. The outcome of Step 2, for Jack as PSE, is $5,000. Step 3 : Work out the PSE's assessable income for that income year, disregarding any income it receives that is your PSI or the PSI of anyone else. The outcome of Step 3, for Jack, is $4,000. Step 4 : Subtract the amount under Step 3 from the amount under Step 2, noting that: (a) Step 4 ensures that, before entity maintenance deductions can contribute to the reduction, they are first exhausted against any income of the entity that is not PSI (b) if the PSE received another individual's PSI, see section 86-25 of the ITAA 1997. (a) Step 4 ensures that, before entity maintenance deductions can contribute to the reduction, they are first exhausted against any income of the entity that is not PSI (b) if the PSE received another individual's PSI, see section 86-25 of the ITAA 1997. The outcome of Step 4 is $5,000 - $4,000 = $1,000) Step 5 : If the amount under Step 4 is greater than zero, the amount of the reduction under subsection 86-20(1) of the ITAA 1997 is the sum of the amounts under Steps 1 and 4. The outcome of Step 5 is $60,000 + $1,000 = $61,000. Step 6 : If the amount under Step 4 is not greater than zero, the amount of the reduction under subsection 86-20(1) of the ITAA 1997 is the amount under Step 1. Step 6 is not applicable. The net PSI percentage is worked out as follows: The net PSI percentage equals 69.5%. 69.5% of $60,000 (Peppe's gross PSI for quarter 1) is $41,700. The amount to withhold from $41,700 according to the PAYG Withholding Tax Tables (Quarterly) is $16,936. The amount that Peppe actually withheld in quarter 1 (that is, $6,412) is neither equal to nor greater than the amount that would have been withheld using one of the administrative options (that is, $17,082 or $16,936). We, therefore, will not remit the failure to withhold penalty of $11,519 for quarter 1 (or the other 3 quarters) to nil under the guidelines in this Practice Statement. We would consider remission of the failure to withhold penalties under the general failure to withhold remission guidelines for Division 13. | 5. More information: For more information, refer to the Tax tables .

Legislative references: ITAA 1997 Pt 2-42 | ITAA 1997 86-15 | ITAA 1997 86-20 | ITAA 1997 86-20(1) | ITAA 1997 86-20(2) | ITAA 1997 86-25 | TAA 1953 Sch 1 Div 12 | TAA 1953 Sch 1 12-35 | TAA 1953 Sch 1 Div 13 | TAA 1953 Sch 1 13-5(2) | TAA 1953 Sch 1 16-30
Other references: Tax tables

Additional content:
Updated in line with current ATO style and accessibility requirements. | Attachment A (Transitional arrangements for 2001-02 and 2002-03) removed due to passage of time. | Updated to new LAPS format and style. | [1] This example would apply in the same way if the PSE were a trust. | File 2003/007197; 1-17K3HMW0