SKIBA v FC of T

Members:
A Sweidan SM

Tribunal:
Administrative Appeals Tribunal, Perth

MEDIA NEUTRAL CITATION: [2007] AATA 1705

Decision date: 27 August 2007

A Sweidan (Senior Member)

Background

1. The issue in these applications is whether the personal services income of Marketcroft Pty Ltd ( Marketcroft ), a personal services entity, was properly attributed to the applicant under section 86-15 of Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997) for the income years ended 30 June 2001 and 2002, as determined by the respondent.

2. A "personal services entity" is relevantly defined in section 86-15(2) as a company whose ordinary income includes the personal services income of one or more individuals. It is not contentious that the personal services income of Marketcroft was personal services income under section 84-5, received as reward for the personal efforts and skills of the applicant in performing work under engineering services contracts.

3. It is contended by the applicant that this income is not attributable to him as the exception in section 86-15(3) applies i.e. Marketcroft conducted a personal services business ( PSB ) within the meaning of section 87-15 because it meets the results test in section

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87-18(3) and the unrelated clients test in section 87-20 . The respondent contends that Marketcroft does not meet these tests and was not conducting a PSB and the personal services income of Marketcroft was properly attributed to the applicant under section 86-15.

4. In his statement of facts and contentions and his witness statement the applicant made various complaints regarding the Australian Taxation Office audit and objection processes. The applicant's allegations are denied by the respondent and are not dealt with here as they are not matters within the jurisdiction of the Tribunal nor are they relevant in this application, which is a review of the respondent's reviewable objection decisions put before the Tribunal by the applicant for review by operation of section 14ZZ of the Taxation Administration Act 1953 (TAA) . Under section 43 of the Administrative Appeals Tribunal Act 1975 as modified by section 14ZZJ of the TAA the Tribunal may affirm, vary or set aside the decisions under review. If it sets aside the decisions under review it may make a decision in substitution or remit the matter for reconsideration in accordance with any directions.

5. Under section 14ZZK of the TAA the applicant bears the onus to satisfy the Tribunal that the assessments the respondent issued to the applicant for the income years ended 30 June 2001 and 2002 are excessive and the taxable income assessed in each year should be reduced. The applicant is limited to the grounds stated in the notices of objection to which the respondent's reviewable objection decisions relate unless the Tribunal orders otherwise. The Tribunal allowed an amendment to include an additional ground of objection, to which further reference is made below. The Tribunal was assisted by detailed written submissions from Counsel for the respondent at the end of the hearing.

Assessments for the income years ended 30 June 2001 and 2002

6. Marketcroft paid the applicant a salary of $6,000 in the year ended 30 June 2001.

7. On 15 May 2002 the applicant lodged his income tax return for the year ended 30 June 2001, in which he declared:

7.1 Salary income from Marketcroft of $6,000;
7.2 Foreign source income of $26,480;
7.3 Foreign tax credit of $10,797;
7.4 Franked dividends of $5,520;
7.5 Imputation Credit of $2,760.

[T documents/55, 57 and 72]

8. On 22 May 2002 the respondent issued the applicant with a Notice of Assessment for the year ended 30 June 2001 on the taxable income returned by the applicant of $34,337 and allowed a foreign tax credit of $7,196.15. [T documents/95-96]

9. Marketcroft paid the applicant a salary of $20,000 in the year ended 30 June 2002.

10. On 4 June 2003 the applicant lodged his income tax return for the year ended 30 June 2002, in which he declared salary income from Marketcroft of $20,000. [T documents/126]

11. On 12 June 2003 the respondent issued the applicant with a Notice of Assessment for the year ended 30 June 2002 on the taxable income returned by the applicant of $28,033. [T documents/166]

12. On 21 November 2003 the respondent issued the applicant with:

12.1 Notices of Amended Assessment for the years ended 30 June 2001 and 30 June 2002 (amended assessments) attributing to the applicant personal services income of Marketcroft derived from providing engineering services by the applicant being $190,123 in the year ended 30 June 2001 and $140,831 in the year ended 30 June 2002 in accordance with section 86-15 of the ITAA 1997 and allowing a foreign tax credit of $10,797.00 in the year ended 30 June 2001;
12.2 Notice that penalties had been recorded on the applicant's account in the amount of $42,723.05 for the year ended 30 June 2001 and in the amount of $32,034.33 for the year ended 30 June 2002.

[T documents/234-243]

13. By letter dated 21 May 2004, the applicant objected to the amended assessments (objections) on grounds that:

13.1 Marketcroft was conducting a PSB in accordance with section 87-15 of the ITAA 1997 for the financial years ended 30 June 2001 and 30 June 2002 and no amounts should be attributed to the applicant under section 86-15 of the ITAA 1997;
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13.2 Alternatively that the amounts attributed to the applicant should be reduced under section 86-20 of the ITAA 1997 for deductions relating to personal services income;
13.3 The TOA Contract (defined paragraph 18.1 below) was governed by Canadian law, was performed in Canada and taxes were paid in Canada and section 23AG of the ITAA 1936 exempts the income from this source;
13.4 The personal service income attributed to the applicant was used by Marketcroft to meet the expenses of the restaurant (see paragraph 17.2 below) and were expenses incurred by the applicant in expectation of dividend income from Marketcroft. This ground was added by the applicant's email of 8 September 2004 [T documents 296-296].
13.5 A tax shortfall penalty should not have been imposed, alternatively should have been remitted by the respondent.

[T documents 244-275]

Further grounds of objection were subsequently added as to which see below.

14. On 29 October 2004 the respondent issued notices of decision disallowing the applicant's objections. The objections were partially allowed by:

14.1 Reducing the attributed personal services income for deductions relating to that income -
- 14.1.1 In the 2001 year to $190,123 − $32,593 = $157,530;
- 14.1.2 In the 2002 year to $140,831 − $29,844 = $110,987;
14.2 Excluding in the 2001 year the amount of $26,480 from the applicant's assessable income being foreign source income included twice as a result of the attribution to the applicant of the payments from TOEL (defined paragraph 18.3 below) to Marketcroft;
14.3 Increasing the foreign tax credit allowed in the 2001 year by $11,696 to allow the full amount of $22,493 withheld from the $144,873 paid by TOEL to Marketcroft In his oral evidence the applicant accepted that the $22,493 foreign tax credit had been allowed to him.

[T documents/302-328]

Relevant facts

The applicant and his tax agent, Ms Greenwell, both gave evidence and the Tribunal was provided with the "T" documents as well as a number of other documents. The Tribunal finds that the following facts are not in dispute:

15. The applicant is an electrical engineer: T documents/189 and Skiba witness statement 3.2.1. he gave oral evidence of the nature of his work as an electrical engineer.

16. During the period 1 July 2000 to 30 June 2002 (relevant period) the applicant was a director of Marketcroft, a company which was incorporated in Western Australia on 21 July 1992 and is now deregistered. The other director of Marketcroft during the relevant period was Panjai Skiba, the applicant's wife.

17. During the relevant period Marketcroft:-

17.1 Leased business premises at 189 Hay Street Subiaco from the partnership B & P Skiba (premises) ;
17.2 Operated a restaurant "The Golden Triangle" from the ground floor of the premises;
17.3 Provided electrical engineering services by the applicant. The first floor of the premises was used to house office equipment, furniture, files and records and from time to time was used in providing engineering services by the applicant.

[Skiba witness statement 3.2.3 and 3.2.4]

18. In the relevant period Marketcroft derived income from contracts to provide engineering services by the applicant as follows:-

	Contract	Income
18.1	A contract with Tri Ocean Australia Pty Ltd (TOA) for the provision of services to Atwood Oceanics during the period July 2000 to September 2000 (TOA Contract) .	$49,764
ATC 2471 18.2	A contract for the provision of services to Atwood Oceanics Australia Pty Ltd (Atwood) for services provided to it during September 2000 (Atwood Contract) .	$1,485
18.3	A contract with Tri Ocean Engineering Ltd (TOEL) for the provision of services to Sakhalin Energy Investment Corporation of Russia during the period January 2001 to June 2001 (TOEL Contract) .	$144,873
		$196,122
18.4	A contract with Caledonian Project Resources Pty Ltd (Caledonian) for the provision of services to Halliburton Australia Pty Ltd and Argo China Inc during the year ended 30 June 2002 (Caledonian Contract) .	$160,831

The TOA Contract [T documents/23-26]

19. The only written contract between Marketcroft and TOA that has been provided is for the period 16 November 1998 to 31 March 1999. However the applicant has indicated this contract continued until September 2000: [T documents/170, Skiba witness statement 12.2 and Skiba oral evidence].

20. By clause 2 of the TOA Contract entered into for the period 16 November 1998 to 31 March 1999, Marketcroft as "the Contractor" was to provide to TOA as "the Company" engineering services in accordance with the following work description:

"• Provision of services to the Company or their nominated Client or Clients.

• The Contractor shall have such functions as shall be notified by the Company or Client.

• The Contractor shall perform all Services assigned by the Company or Client together with all Services reasonably incidental and ancillary thereto.

• The Company or Client may give directions to the Contractor as to the tasks to be performed and the needs to be achieved in the Services. The Company or Client may at any time vary such Services and any variation shall be deemed part of these Services. The Contractor shall be fully qualified and sufficiently trained and experienced to fully perform the Services.

• Transport for travel to Clients offices and facilities within the Perth metropolitan area.

• Provision of all site personal safety apparel and work attire."

21. The TOA Contract entered into for the period 16 November 1998 to 31 March 1999 also provided, among other things:

21.1 The Company would pay the Contractor for all work at the rate of $65 per hour for all hours worked during the duration of the contract [clause 3.1];
21.2 Payment for hours worked would be due within 15 days of submitting an invoice, to be submitted on the first day of each month accompanied by a completed Company timesheet authorised by the Company Supervisor. Timesheets were to be submitted on a weekly basis. [clauses 3.4 and 6.3];
21.3 The Company would determine the hours and days that the Contractor worked and those hours and days could be modified and changed to suit the completion of the work as deemed necessary by the Company [clause 3.2];
21.4 The Company would reimburse the Contractor for all expenses incurred outside the scope of the contract during the performance of the work provided that prior written approval had been given by the Company's nominated Project Manager [clause 4];
21.5 Either party could terminate the contract by giving the other party one (1) week written notice [clause 5.1];
21.6 The Contractor agreed to be responsible to the Company's Engineering Manager or Client for work instructions, assignments, deadlines and quality and to abide by corporate and project procedures and all Company Procedures and Policies [clauses 6.4 and 6.7];
21.7 Where the work presented by the Contractor was unsatisfactory and unacceptable to the Company or their nominated Client it was to be "made good" and reworked at the Contractor's expense [clause 6.8].

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The Atwood Contract

22. The contract entered into between Atwood and Marketcroft was an oral contract, no details of which have been provided: [T documents/170 and 191 and Skiba witness statement 12.3]. In his oral evidence the applicant indicated this was a very short contract which he completed from home after some documents were sent to him for review. The contract fee of $1,485 also supports this statement.

The TOEL Contract [T documents/27-29]

23. The only written contract between Marketcroft and TOEL that has been provided is that described as a "Temporary Services Contract for an Incorporated Company" for the provision of the services of the applicant as a staff electrical engineer for the period 17 January 2001 to 31 January 2002, but the contract could be terminated sooner on 5 days notice. The Contractor is not identified in the contract but the applicant is named as the Staff Electrical Engineer whose services were to be provided and the applicant apparently signed the contract on 25 January [2001] on behalf of the Contractor. The applicant's oral evidence was that this contract only extended to 30 June 2001 and he returned to Australia.

24. The "Temporary Services Contract for an Incorporated Company" dated 25 January [2001] also provided, among other things:

24.1 The work would be carried out in the TOEL offices in Calgary, Canada [clause 2];
24.2 The hours and days worked would be determined by TOEL and could be changed or modified to suit the completion of the work as deemed necessary by TOEL [clause 3];
24.3 The Contractor agrees to meet the quality and schedule requirements of TOEL and TOEL reserved the right to assess and monitor quality, productivity and schedule issues to ensure they are in compliance with TOEL requirements and take appropriate action to correct non-compliances [clause 4];
24.4 TOEL would pay the Contractor for all hours worked at a standard hourly rate of US$53.00 [clause 5];
24.5 The Contractor was to submit a monthly invoice backed up with TOEL weekly timesheets duly completed and signed, which, upon approval, would form the basis for payments on a monthly basis based on a standard work period [clause 7].

The Caledonian Contract [T documents 31-34]

25. The only written contract between Marketcroft and Caledonian that has been provided is the agreement made on 5 July 2001 for Marketcroft to supply Caledonian's client, Halliburton Australia Pty Ltd - Granherne Perth Office, with a "Senior Technical Professional - Engineering" commencing "5 July 2001 8am". The duration of the agreement was specified as "Ongoing" but services under the agreement could be terminated on one month notice. The services to be provided were described as "Leading a Design Engineering team for Offshore Oil/Gas Projects".

26. The agreement made on 5 July 2001 with Caledonian also provided, among other things:

26.1 The Contractor would be directed and controlled in the performance of his work by Caledonian's client not Caledonian [clause 8];
26.2 The Contractor could not change the personnel working on the Client's project without prior approval from Caledonian and its Client [clause 9];
26.3 Caledonian would pay the Contractor $75 for all hours worked and that standard hours were 8 per day, 5 days a week [clause 2];
26.4 Payment would be made fortnightly to the Contractor by electronic transfer to a nominated account on receipt of signed timesheets and an appropriate invoice [clause 3];
26.5 The Contractor agreed to indemnify Caledonian against any liability, which Caledonian "may incur, arising out of or in connection with acts, defaults and lack of skill and qualifications of the Contractor" [clause 5(i)].

27. Descriptions of the work the applicant carried out under the TOA Contract, the Atwood Contract, the TOEL Contract and the

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Caledonian Contract (Contracts) are set out in his CV [T documents 191]. In each case the applicant worked on the design and procurement phases of major gas facilities.

28. At [16] on pages 13-15 of the applicant's Statement of Facts and Contentions the applicant discusses engineering industry practice and, among other things, refers to:-

28.1 Agencies for Engineering Services (AESs) which are normally appointed by Contract Engineering Service Providers (CESPs) or Energy and Resource Industry Clients (ERICs) on a project basis to locate suitable personnel to engage in projects. AESs act as a recruitment entity. The interposition of the agent [AES] in the arrangement has no bearing on the fact that the services are paid for by the CESP. The main purpose of this construct is to avoid payroll tax, and for the ERIC to be distanced from the service provider in case income and other tax controversies emerge. The contracting with a corporate entity such as [Marketcroft] also removes liability for payroll tax or did so in the past. This cost is then saved by all parties, AES, CESP and ERIC.
28.2 AESs usually have an agreement with CESPs and/or ERICs for provision of personnel. Companies such as Marketcroft approach agents [AESs] and advise them of availability to engage in projects. The agents [AESs] are agents of the CESPs and ERICs, not of service providers such as Marketcroft or the applicant. When a contract is finished with a particular CESP or ERIC, the service provider then usually contracts though another AES for other contracts. For smaller CESPs direct contracting between the CESP and the service provider is usually implemented because smaller CESPs are more cost sensitive than larger CESPs which overcomes the normal desire for legal separation between the CESP and the service provider.
28.3 CESPs are international corporations who engage in the design procurement and construction of engineering projects for energy and resource industry companies. CESPs engage the services of entities such as Marketcroft through agents [AESs].
28.4 ERICs are corporations such as Shell, Woodside, BHP and SANTOS who engage CESPs in the design procurement and construction of energy and resource industry facilities. It can also be mining, pipeline and other resource or energy industry producers. These entities sometimes engage personnel to provide services directly to them or through AESs.

29. It is not clear from the information in the applicant's Statement of Facts and Contentions and from the Contracts whether TOA, TOEL and Caledonian were AESs and/or CESPs. In his oral evidence the applicant described TOA as an AES and in respect of the TOA Contract, Atwood was the CESP and the ERIC was Woodside. He described TOEL as the CESP in relation to the TOEL Contract and the ERIC was Shell. In the Caledonian Contract, the CESP was Halliburton Australia and there were a number of ERICS including Woodside. The AES for this contract was Caledonian. In these reasons Atwood, TOEL and Halliburton Australia are collectively referred to as CESPs .

30. In his Statement of Facts and Contentions the applicant also discusses "deliverables" describing them as measures of engineering design performance and are outcomes of the provision of engineering services. Deliverables may be an activity or a document which may be produced by an individual or a team. The completion of those deliverables verifies the performance of the contract in accordance with the schedule. The project plan defines the expected start date and completion date of the deliverable. Personnel providing services are responsible for producing the deliverables or the management of a team producing deliverables. At [10.2.1.3] on page 34 of the applicant's Statement of Facts and Contentions (also at [16.2.1.3] on page 51 of version 1.00 of his witness statement) the applicant adds that "In engineering services, the client plans its work by units of measure called deliverables … which are a unit of measure of the works and which are measured in terms of manhours and schedule".

31. At [10.2.1.4] on page 35 of the applicant's Statement of Facts and Contentions in respect of tools of trade the applicant states that "It is common practice for CESPs and ERICs to provide services such as computers,

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computer networks and software … the reasons why clients provide computers and software and networks is for virus security, intellectual property security, software standardisation and software compatibility … no client readily permits engineering service providers to connect their own computers and software to client networks". The applicant also says he provided "application software to … determine loads and appropriate power generation capacity".

32. At [10.2.1.6] on page 36 of the applicant's Statement of Facts and Contentions in respect of liability for remedying defects in the work performed the applicant states "… Engineering industry practice whereby CESPs and ERICs obtain quality accreditation which requires them to implement quality processes and practices which facilitate a high level of independent checking of the work of engineers which then inculcates good practices and reduces the incidence of errors and eliminates large errors".

33. In his oral evidence the applicant stated that he relied upon his skills and reputation to get work and was listed with a number of engineering manpower agencies but also got work by personally making direct approaches to CESPs and clients. He was the only person associated with Marketcroft with the necessary skills to undertake engineering work. When engaged on a services contract he worked to the basis of design (BOD) and schedule produced by the CESPs and/or the clients and his work priorities varied with any scheduling changes. He received a copy of the Schedule. He worked as part of a team of multi discipline engineers where inter-discipline communication was essential to assist the CESPs to produce for the client the engineering project deliverables required by the client. He described the process by which datasheets for plant procurement were produced including the need for information from different engineering disciplines about technical matters from their areas of the project which would impact on the calculations for the datasheet. He described the revision and reissuing process for datasheets by which comments including any changes and errors were identified and corrected along the way as part of the work stream until finally a datasheet was produced that everyone was happy with. Finally he described the important quality assurance process by which work was checked, rechecked and approved, often by many depending upon the importance of the item of plant and its cost. This process ensured that the applicant rarely, if ever, signed off on his own work and approval usually came from the senior levels of the CESPs and/or the clients. These processes limited the risk of errors arising in the work.

34. He was paid by the AESs on the hours worked (usually 7.30am to 5pm) and booked on a timesheet which was approved by the engineering manager or supervisor. Payment did not depend on producing any deliverable. Payment was only ever made on the basis of verified hours worked. He received through the AESs reimbursement for expenses he incurred on behalf of the CESPs. The incurring of these expenses was approved by senior staff of the CESPs. The AES's administered the Contracts and the payments to the entities of the contracting engineers. The AESs had no input to the engineering work he carried out for the CESPs and their clients under the Contracts. The equipment and tools he needed to perform the engineering work were provided by the CESPs and/or their clients. He did use some software that he had developed himself to assist in datasheet calculations and he was permitted to load this software on to the CESPs' computers with approval from their IT departments.

History and ambit of the legislation

35. Fundamental to the question of the proper interpretation of legislation is the consideration of the objects, context and purpose of the statute:
CIC Insurance Ltd v Bankstown Football Club Limited (1997) 187 CLR 384;
Newcastle City Council v GIO General Ltd (1997) 191 CLR 85;
HP Mercantile Pty Ltd v FCT (2005) 143 FCR 553.

36. The use of interposed entities to alienate or split income from the personal exertions and skills of an individual were a subject for judicial consideration long before the introduction of Part 2-42 of the ITAA 1997: see for example
FCT v Gulland;
Watson v FCT;
FCT v Pincus (1985) 160 CLR 55;
Bunting v FCT (1989) 24 FCR 283; Cf
Rippon v Commissioner of Taxation (1992) 92 ATC 4186, on appeal
(1992) 92 ATC 4689, where the former section

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260 was invoked by the respondent to annihilate the interposed entity and attribute the income to the individual.

37. It is clear in the Tribunal's view that Part 2-42 was considered necessary because Part IVA was not an efficient way of dealing with the problem of alienation of personal exertion income. Part IVA was thought to be an ad hoc means of dealing with the problem because its provisions must be applied by the respondent on a case-by-case basis. By contrast, Part 2-42 (which gave effect to the Ralph Report Recommendation 7.2) deals systemically with alienation of personal services income, meaning there was no need for the respondent to have recourse to Part IVA in such cases.

38. Part 2-42 of the ITAA 1997 was enacted with effect from 1 July 2000. It is legislation that followed the Treasurer's Press Release 74 of 11 November 1999 announcing that the Government would introduce legislation implementing recommendations 7.2 to 7.4 of the "Review of Business Tax: A Tax System Redesigned" July 1999 (the Ralph Report).

39. The Ralph Report at pages 287, 289, 290 and 291 explains that Part 2-42 was only intended to apply to one category of taxpayers who alienate their personal services income, i.e. independent contractors whose working arrangements are closer to that of an employee than to an independent contractor. This category of taxpayers to which Part 2-42 was intended to apply are not employees or independent contractors in the strict sense, but fall into a third category, described as employee-like. (See page 291 and note also the bullet points at 291 identifying factors such as the manner in which services are being carried out, the level of control, the use by the interposed entity of substantial income producing assets and the degree of entrepreneurial risk).

40. Use may be made of the Ralph Report as extrinsic material in the interpretation of section 87-18(3): see section 15AB Acts Interpretation Act 1901 and Pearce & Geddes Statutory Interpretation in Australia 5^th edition at [3.9]ff. How the law has historically arrived at this position is of assistance to interpretation as it provides the setting or context.

41. The Explanatory Memorandum to the New Business Tax System (Alienation of Personal Services Income) Bill 2000 stated that Part 2-42 was to introduce new rules for the income tax treatment of certain personal services income. The general outline to the Bill states as follows:-

"… Personal services income is generally paid to an individual who provides the services or to a company, partnership or trust (interposed entity) through which the services are provided by an individual.

The measure will not:

• apply where an individual or interposed entity is conducting a personal services business; and

• affect the legal status of an interposed entity or deem an individual to be an employee for the purposes of an Australian law or instrument.

The rules are designed to improve the integrity of the tax system by addressing both the capacity of individuals and interposed entities providing the personal services of an individual to claim higher deductions than employees providing the same or similar services and the alienation of personal services income through an interposed entity.

These improvements will be achieved by:

• limiting and clarifying the deductions available against personal services income at both the individual and interposed entity level; and

• ensuring that, after allowing deductions to the interposed entity, any income remaining is attributed to the individual. Schedule 1 to the Taxation Administration Act 1953 is being amended to provide a collection mechanism for tax payable on any income so attributed."

42. Part 2-42 was amended by Taxation Laws Amendment Act (No 6) 2001 with effect from 1 July 2000. The general outline of the amendments in the Explanatory Memorandum to the Taxation Laws Amendment Bill (No 6) 2001 is in similar terms.

43. By these 2001 amendments section 87-18 was inserted into Division 87 in Part 2-42. Division 87 has provisions relating to "Personal services businesses" and section 87-18 contains the "results test" for taxpayers to self-assess whether they are conducting a

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personal services business or for the respondent to grant PSB determinations on application by individuals or personal service entities. With a PSB determination, personal services income alienated through an interposed entity is not attributed to the individual.

44. The guide to Part 2-42 states:-

"Guide to Part 2-42

SECTION 84-1 What this Part is about

This Part is about 2 issues relating to personal services income.

Division 85 limits the entitlements of individuals to deductions relating to their personal services income.

Division 86 sets out the tax consequences of individuals' personal services income being diverted to other entities (often called alienation of the income).

These Divisions do not affect individuals or other entities that conduct personal services businesses. Division 87 defines personal services businesses."

45. Personal services income is given meaning by section 84-5 which states:-

"Section 84-5. Meaning of personal services income

(1) Your *ordinary income or *statutory income, or the ordinary income or statutory income of any other entity, is your personal services income if the income is mainly a reward for your personal efforts or skills (or would mainly be such a reward if it was your income). …

(2) Only individuals can have personal services income.

(3) This section applies whether the income is for doing work or is for producing a result.

(4) The fact that the income is payable under a contract does not stop the income being mainly a reward for your personal efforts or skills."

46. Part 2-42 does not distinguish employees from independent contractors nor does it define persons either as employees or independent contractors. In the Tribunal's view it is clear that the provisions of Part 2-42 are intended to attribute an individual's personal services income derived by a personal services entity to the individual if none of the four PSB tests are satisfied, or the respondent has not determined that, but for unusual circumstances, one or more of the tests would have been satisfied. (The rules also limit entitlement to certain deductions.)

47. It is also clear that it is not intended that Part 2-42 apply to independent contractors carrying on genuine businesses where the income is generated from the carrying on of the enterprise: see section 87-1 which states:-

"Divisions 85 and 86 do not apply to personal services income that is income from conducting a personal services business.

It is not intended that the Divisions apply to independent contractors.

A personal services business exists if there is a personal services business determination or if one or more of 4 tests for what is a personal services business are met.

Regardless of how much of your personal services income is paid from one source, you can self-assess against the results test to determine whether you are an independent contractor. The results test is based on the traditional tests for determining independent contractors and it is intended that it apply accordingly.

However, you cannot "self-assess" whether you meet any of the other 3 tests if 80% or more of your personal services income is from one source. In these cases, you need a personal services business determination in order to be treated as conducting a personal services business.".

48. Section 87-1 is part of the Guide to Division 87. Subject to the requirements of section 2-40 and section 950-150 of the ITAA 1997, the guide to Division 87 may be considered for limited purposes in interpreting section 87-15 and particularly here for section 87-18(3) i.e. the "results test" for a personal services entity.

49. The 4 PSB tests referred to in section 87-1 are listed in section 87-15(2) as the results test under section 87-18, the unrelated clients test under section 87-20, the employment test under section 87-25 and the business premises test under section 87-30.

50. The PSB tests set out at section 87-15(2) are clearly designed to exclude from the

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operation of Part 2-42, an individual's personal services income (derived either by the individual or an entity) that is earned by the individual or the entity conducting a personal services business: see section 87-10 which states the object of Division 87 is to "define personal services in a way that ensures that it covers genuine businesses, but not situations that are merely arrangements for dealing with the personal services income of individuals". To be taken to be conducting a personal services business, one or more of the statutory tests must be satisfied, or would have been satisfied, but for unusual circumstances. Conducting a personal services business does not necessarily mean that a business is being conducted in the ordinary sense. Each PSB test is measuring whether a particular indicator which is usually present when an independent contractor is conducting his business, is actually present.

51. The results test in section 87-18(3) and the unrelated clients test in section 87-20 are the bases upon which the applicant contests the amended assessments.

The common law test of independent contractor

52. Whether an individual or an entity is an independent contractor is a mixed question of fact and law. The authorities show that the dividing line is often obscure particularly having regard to the complexity of arrangements between parties. The decided cases emphasise that in determining the question a wide survey of all relevant facts needs to be undertaken in order to ascertain the precise relationship between the parties. Although a number of relevant factors have been identified as bearing upon this issue, the distinction is not to be ascertained mechanically by checking a list of criteria which decided cases have identified as tending towards or against characterizing a person as either an employee or independent contractor. This is because the indicia do not always point in the same direction and may not always have the same significance:
Stevens v Brodribb Sawmilling Co Pty Limited (1986) 160 CLR 16. Rather the search is for the true relationship or nature of the relationship between the parties having regard to an overall consideration of all relevant factors. The totality of the relationship must be considered:
Stevens v Brodribb Sawmilling Co Pty Limited (1986) 160 CLR 16 at 29 per Mason J cited with approval in
Hollis v Vabu 2001 ATC 4508; (2001) 207 CLR 21 at 33[24].

53. Modern authorities allow a greater degree of flexibility in characterising such a relationship. Control is no longer recognised as the determining factor. However control remains relevant but is not the only relevant factor. In
Hollis v Vabu 2001 ATC 4508; (2001) 207 CLR 21 the joint judgment demonstrated that the characterisation involves inquiry whether the worker is a servant of another in that other's business or whether the worker carries on a trade or business on his or her own behalf. Considering the totality of the relationship the question is whether, viewed as a practical matter, the putative worker can be said to be conducting his or her own business.

54. McHugh J. in
Hollis v. Vabu at 48[68] goes some way to describing the sort of taxpayer intended to be covered by Part 2-42:

"I also agree with their Honours that the courier was not an independent contractor in the sense of someone who acts as an independent principal, exercising an independent discretion in carrying out a task for his own business interest and who is retained simply to produce a result. The couriers in this case were far removed from the paradigm case of an independent contractor - the person who has a business enterprise and deals with any member of the public or a section of it upon terms and conditions that the contractor sets or negotiates. Moreover, I agree that certain aspects of the work relationship between Vabu and the couriers suggest an employer/employee relationship, according to the classical tests. But while the couriers were subject to extensive direction and control by Vabu, were Vabu's representatives and worked for Vabu's business interests, there were features of the relationship which are not typical of a traditional employment relationship. They include the provision of their own equipment - in some cases, motor vehicles - the capacity to incorporate or form their own business structure, the tax and superannuation arrangements, and the lack of actual provision for annual leave and sick pay benefits."

ATC 2478

However, it should be noted that a PSB test may be passed by a taxpayer notwithstanding that his personal services income is not earned in the course of conducting his business or the personal service entity's business. For example, the couriers engaged by Vabu would in all likelihood have passed the results test.

55. While the labels used by the parties in any contract such as identifying the worker as an independent contractor are a relevant consideration they cannot operate to contradict the true nature of the relationship. Labels used by the parties to document their arrangements are not binding. The decided cases show that what is required is an examination of the substance of the relationship. In
Lopez v FCT (2005) 143 FCR 574 at 597 it was argued that a critical index is the identification of the party who is to produce the contemplated result. If the party supplying the labour is to produce the result, that supports the characterisation of that party as an independent contractor. On the other hand if the principal himself is to produce the result, the person supplying the labour who contributes to the achievement of that result is more likely to be an employee:
World Book (Aust) Pty Limited v FCT (1992) 92 ATC 4327 at 4344.

56. In
Queensland Stations Pty Limited v FCT [1945] 70 CLR 539 the drovers in question, in order to carry out the droving agreement required a substantial amount of equipment, the hiring of men and the provision of rations. They also assumed the business risk because of the risk of bad behaviour of cattle and because the contract price depended upon the number of cattle. Latham CJ at 545.5 considered that the payment made to the drover represented much more than the payment for his work. He drew the distinction between an independent contractor and an employee as being that an independent contractor "undertakes to produce a given result, but is not, in the actual execution of the work, under the order or control of the person for whom he does it". Rich J at 548.8-549 was influenced by the obligation under the agreement to find men and plant and horses and that the consideration for the performance of the contract was the payment of the price per head of cattle. This led to the conclusion that the drover was an independent contractor. The drover undertook to produce or bring about a specified result employing his own means to accomplish that result. The owner had no control over the particular details of the job as it went on. Dixon J was also influenced by the fact that the drovers were paid a rate per head of cattle and that the drover had to find all men and plant necessary, concluding at 551.4: "It appears rather to be a contract for the performance of a service for one party by another who is to employ men and plant for the purpose and to be paid according to the result."

The results test

57. A person within the employee-like category referred to in the Ralph Report, who is receiving reward for his personal efforts or skills (i.e. personal services income under section 84-5) will not meet all the criteria of independent contractor present in the Queensland Stations case because he is not venturing more than the provision of his labour and skills, he is subject to ultimate control in the manner in which the work is performed and he is not taking upon himself the commercial chance of profit and the risk of loss. Also see
Vabu Pty Ltd v FCT (1996) 96 ATC 4898 at 4900. Providing the plant and equipment and tools of trade needed and taking other steps at his discretion and at his risk to achieve the contracted for result, upon completion of which he will receive the contractual quid pro quo, are established important criteria of the independent contractor. They are embraced in the words of section 87-18(3).

58. Section 87-18(3) sets out the results test for a personal services business and states:-

"(3) A *personal services entity meets the results test in an income year if, in relation to at least 75% of the *personal services income of one or more individuals that is included in the personal services entity's *ordinary income or *statutory income during the income year:

(a) the income is for producing a result; and

(b) the personal services entity is required to supply the *plant and equipment, or tools of trade, needed to perform the work from which the personal services entity produces the result; and

ATC 2479
(c) the personal services entity is, or would be, liable for the cost of rectifying any defect in the work performed."

To satisfy the results test the applicant must satisfy each of the requirements in section 87-18(3)(a), (b) and (c).

59. In
Commissioner of Taxation v Metaskills Pty Ltd 2003 ATC 4644; (2003) 130 FCR 248, Lindgren J in the course of reaching his decision examined Part 2-42, particularly Division 87 and observed at [28]:

"Broadly speaking, an individual or entity, who or which is an "independent contractor" under traditional concepts should meet the results test. Indeed, the Revised Explanatory Memorandum to the Taxation Laws Amendment Bill (No 6) 2001 (Cth) stated (at para 7.6): "the results test … is based on the traditional tests for determining independent contractors".

60. While the "results test" is based on the common law criteria for distinguishing a independent contractor from an employee/employer relationship, the "results test" is satisfied by meeting 3 specified criteria (all being traditional indicia of a contract for service). Thus for the purposes of section 87-18(3) it is not necessary that all the recognised indicia of an independent contract are present. However, where many of the indicia of an independent contractor are present but any of the 3 "results test" criteria are absent the interposed entity or personal services entity is not conducting a PSB unless one of the other 4 PSB tests in section 87-15 is satisfied along with the 80% test in section 87-15(3) as set out below.

61. The respondent submits and the Tribunal agrees that the interpretation and application of section 87-18(3) cannot be resolved solely by reference to the terms of the relevant written agreements with Marketcroft for the following reasons:-

61.1 Properly construed the words of section 87-18(3) require a look through approach. Each of the requirements of the provision look to the performance of the work, the actuality of what occurs. This approach is also underlined by section 87-18(4) which directs attention to custom or practice for the purposes of section 87-18(3).
- 61.1.1 Section 87-18(3)(a) looks to the personal services income (of Mr Skiba) that is included in the personal services entity's (Marketcroft) income for the income year and asks whether that income "is for producing a result".
- 61.1.2 Section 87-18(3)(b) looks to the result produced and referred to in section 87-18(3)(a) and asks whether the personal services entity (Marketcroft) is required to supply the plant and equipment or tools of trade needed to perform the work (by Mr Skiba) from which the result is produced.
- 61.1.3 Section 87-18(3)(c) looks to the work performed (by Mr Skiba) and referred to in section 87-18(3)(b) and asks whether the personal services entity (Marketcroft) is or would be liable for the cost of rectifying any defect in the work performed (by Mr Skiba).
Thus clauses in a standard "boiler plate" contract requiring Marketcroft to provide services do not reveal the reality of what occurs in performing the work from which the result is produced and for which the personal services income of the applicant is received during the income year.
61.2 The guide in section 87-1 states that the existence or not of independent contractor status is relevant to the application of Divisions 85 and 86. In considering whether an individual is an independent contractor the established principle is that the terms of the written agreement are a relevant consideration but it is also important to consider the totality of the relationship. This includes the surrounding circumstances, the systems, processes and practices the parties operate under. It is clear from the case law that regard must be had to the practical reality of the relationship. The look through approach of section 87-18(3) is entirely consistent with that of the common law. See
Stevens v Brodribb Sawmilling (1986) 160 CLR 16 at 29.3;
Narich Pty Limited v Commissioner of Payroll Tax 84 ATC 4035; [1983] 2 NSWLR 597 at 601;
Hollis v Vabu 2001 ATC 4508; (2001) 207 CLR 21 at 33[24] and 41[47] where the High Court stated: "The concern here is with the bicycle couriers engaged on Vabu's business. A consideration of the nature of their engagement, as evidenced by the documents to which reference has been made and by the work practices imposed by Vabu, indicates that they were employees"; and
ACT Visiting Medical Officers Association v AIRC (2006) 232 ALR 69 at 76[25] where the Full Federal Court held:

"In determining whether the VMOs are providing their services in the hospital as part of the hospital's business or as part of their own businesses it is necessary to consider the particular terms and effect of the VMO contracts. However, the inquiry goes beyond the meaning of the individual terms and requires a decision as to the nature of the contract as a whole. Consideration of the surrounding circumstances, including the VMOs' own businesses and the contracts entered into as part of those businesses, is peculiarly important to such an inquiry. It is similarly important for the court to have regard to the practical reality of the relationship between the parties: see Hollis at [47].".

ATC 2480

For producing a result

62. The phrase "for producing a result" in section 87-18(3)(a) is not defined. However case law makes it clear that the essence of producing a result is performing a service that achieves a specified outcome and not doing work: "An independent contractor undertakes to produce a given result, but is not, in the actual execution of the work, under the order or control of the person for whom he does it.":
Queensland Stations Pty Ltd v FCT (1945) 70 CLR 539 at 545.5. What is involved in the concept is "the performance of a service by one party to another who is to employ men and plant for the purpose and is to be paid according to the result":
Queensland Stations Pty Ltd v FCT (1945) 70 CLR 539 at 551.4. Also see
World Book (Australia) Pty Ltd v FCT (1992) 92 ATC 4327 at 4331;
Zuijs v Wirth Brothers Pty Ltd (1955) 93 CLR 561 at 571.5-573 and
Neale v Atlas Products (Vic) Pty Ltd (1955) 94 CLR 419.

63. A result based contract usually has a negotiated contract price for the result achieved and not merely an hourly rate for hours worked: see
Hollis v Vabu 2001 ATC 4508; (2001) 207 CLR 21;
Vabu v FCT (1996) 96 ATC 4898 (courier paid on successful courier deliveries made);
Stevens v Brodribb Sawmilling (1986) 160 CLR 16 (trucker paid on volume of timber delivered);
Queensland Stations Pty Ltd v FCT (1945) 70 CLR 539 (drover paid per head of cattle delivered);
Humberstone v Northern Timber Mills (1949) 79 CLR 389 (carrier paid on weight mileage).

64. The words "producing a result" require something more than obtaining a payment reward for providing ongoing personal skills and efforts to enable another party (the CESPs) to produce a contracted for result to their clients. Consistent with the recognized indicia of the independent contractor, the words "for producing a result" require that the personal services income of the individual (Mr Skiba) was paid to him as the contract quid pro quo for producing a result and was not paid until and unless the result was produced.

65. Here, the evidence shows that the personal services income derived by the applicant was not paid upon producing a result but was a fortnightly or monthly payment based on the number of hours logged onto a weekly timesheet while working under the ultimate control of the CESPs and applying skill and effort to assist the CESPs complete the projects for their clients.

66. The ongoing skilled work provided by the applicant to the CESPs is not converted into "producing a result" within the meaning of section 87-18(3) by applying the label "deliverables" where the actuality of what occurred was the performance of ongoing work by the applicant (a skilled professional selected by the CESPs and/or their clients as suitable for their needs) under the ultimate control of the CESPs during the term of the Contracts.

67. The cases show that the terminology used by the parties is not and cannot be determinative. The words of the statute require one to look to the actuality of what occurred. Substance must be determined on the evidence of the whole of the relationship:
Lopez v FCT (2005) 143 FCR 574 at [80];
Roy Morgan Research Centre Pty Ltd v Commr of State Revenue (Vic) 97 ATC 5070; (1997) 37 ATR 528 at 537;
Stevens v Brodribb Sawmilling Co Pty Limited (1986) 160 CLR 16 at 29; and

ATC 2481
Hollis v Vabu 2001 ATC 4508; (2001) 207 CLR 21 at 33[24].

Supply of the plant and equipment or tools of trade needed

68. Generally the independent contractor supplies his own means to accomplish the contract result such as his own premises and staff, his own plant, equipment and vehicles and bears the cost of providing and maintaining the premises and equipment: see
Vabu v FCT (1996) 96 ATC 4898 (the courier supplied their own vehicles and met the cost of providing and maintaining the vehicles); and
Queensland Stations Pty Ltd v FCT (1945) 70 CLR 539 (the droving contractor paid for all the men, plant, horses and rations necessary).

69. "Plant" is a defined term in section 995-1 of the ITAA 1997 and has the meaning given by section 45-40. Equipment and tools of trade are not defined. The term "tools of trade" has generally been interpreted broadly when not limited by legislation and refers to implements used by a person to carry on that person's trade: see
Vaughan v Official Trustee in Bankruptcy (1996) 71 FCR 34. The Macquarie Dictionary refers to "equipment" as anything used in or provided for equipping, i.e. supplying what is needed for services.

70. Section 87-18(3)(b) stipulates that the personal services entity (Marketcroft) must be required to supply what is needed to perform the work which produces the result. In the present case, and without limiting the ambit of what might be needed, this would extend to the desk or workstation, storage unit, chair, computer, computer programs, the CESP and/or client intranet access, the CESP and/or client standards, procedures, templates and specifications, telephone, fax machine, printer, photocopy machine calculator and instruments needed by the applicant to perform his work. On the evidence, the practical reality was that Marketcroft was not required to supply these things. The CESP and/or client provided them for the applicant to perform his work.

Liable for the cost of rectifying any defect in the work performed

71. Section 87-18(3)(c) requires that the personal services entity (Marketcroft) is or would be liable for the cost of rectifying any defect in the work performed (by Mr Skiba). The key consideration is whether there is exposure to commercial risk by liability to meet the cost of rectifying defective work. This is consistent with the common law indicia of an independent contractor that in conducting his business there is the chance of profit and the risk of loss: see
Vabu v FCT (1996) 96 ATC 4898 at 4901.

72. The evidence is that the applicant did not sign off on his own work. The quality assurance/quality control process was a regime that ensured the final versions of the "milestone deliverables" must be approved at a senior level of the CESP and/or the client before they were issued. The liability for defective work rested with the CESP and/or the client and any defects in the preparation of the "milestone deliverables" was rectified during the iterative process by which datasheets and other deliverables were completed, checked and approved. The practical reality was that the personal service entity (Marketcroft) was not liable for the cost of rectifying any defect in the work performed.

Why the personal services income of Marketcroft is attributable to the applicant

Personal services income - section 84-5

73. As shown by the evidence, the applicant carried out the work that was assigned to him by the CESPs and/or their clients under the Contracts during the relevant period.

74. In the Tribunal's view it is clear that the fees received by Marketcroft under the Contracts for the services provided by the applicant were a reward for the personal efforts and skills of the applicant and they are therefore personal services income of the applicant under section 84-5.

Results test - section 87-18(3)

75. The Tribunal finds, for the reasons set out above, that Marketcroft fails to meet the requirements of section 87-18(3). The evidence is that the applicant was controlled in the work he performed for the CESPs and/or their clients. Neither Marketcroft nor the AESs were involved in the work the applicant did nor did they specify any requirements or expectations in regard to that work. The income received by Marketcroft under the Contracts was not for producing a result. The income was received for the ongoing performance by the applicant of work assigned to him by the CESPs and/or their clients. The evidence shows that this work was

ATC 2482

completed as part of a team environment because everything had to be checked and approved. The work was completed by teamwork and a process of iteration between the engineering disciplines. All documentation was produced on the computer systems of the CESPs and/or their clients. The applicant was not permitted to sign off on his own work. On the rare occasion that this happened it was due to urgent expediency and would not have occurred for deliverables involving the design and procurement of critical and expensive plant. His deliverables were approved at a senior level. The applicant was paid for the hours he worked each fortnight or month upon presentation of a timesheet authorised by his supervisor. He could only delegate his contract work with the approval of the CESPs and/or their clients and only to an appropriately skilled person they had first approved.

76. The role of the Contracts was to create a formal arrangement by which the AESs were the agent between the applicant, his interposed entity Marketcroft and the CESPs and/or clients. The applicant was selected by the CESPs and/or the clients to use his professional skills to carry out the ongoing work assigned to him for as long as his service was required by the CESPs and/or their clients.

77. On the evidence the nature of the work the applicant was undertaking and the payment arrangements he had with the AESs did not require any specified result to be produced prior to periodic payments being made to Marketcroft under the Contracts. Under the Contracts the AESs were required to pay Marketcroft for the applicant's time engaged in carrying out the activities specified by the CESPs and/or their clients during the period of the Contracts.

77.1 at an hourly rate for the hours worked which were not set on the basis of the extent and degree to which any predetermined result had been completed;
77.2 on submitting an invoice with a signed completed and authorised timesheet.

78. Clearly the payments made under the Contracts:

78.1 were not instalments of the total amount payable under a contract for producing a result;
78.2 were not conditional upon producing a contract result, indeed the Contracts stipulated that the CESPs and/or their clients would determine the hours the applicant worked and the work he would perform;
78.3 were in substance a regular payment for ongoing work performance during the previous fortnight or month;
78.4 included any reimbursement of expenses incurred.

79. Under the contracts, upon termination, Marketcroft was entitled to payment for work performed prior to termination, whether or not the service period under the Contracts had been completed. That is the applicant could walk away from the contract without the completion of any specified contractual result and still be paid.

80. With regard to section 87-18(3)(b) and whether Marketcroft was required to supply the plant and equipment or the tools of trade needed to perform the work from which the result was produced, the Tribunal finds that Marketcroft fails that test.

81. As previously noted all plant, equipment and tools that the applicant needed to do his work were made available to him by the CESPs and/or their clients. Marketcroft therefore fails to satisfy the requirement of supplying the equipment or tools needed to do the work from which the result was produced because:

81.1 the CESPs and/or their clients, not Marketcroft, supplied the plant and equipment and tools of trade to perform the work under the Contracts;
81.2 Marketcroft was not required to supply the plant and equipment and tools of trade needed for the applicant to perform the work.

82. As to whether Marketcroft was liable for the cost of rectifying any defective work as required by section 87-18(3)(c), the Tribunal finds that Marketcroft also failed to satisfy this requirement because the evidence shows that:

82.1 Marketcroft was not liable for the cost of rectifying any defect in the work performed. Any liability for defective work performed rested with the CESPs and/or their clients;
82.2 in fact, the applicant did not and was not permitted to sign off on his own work which was subject to a quality assurance/quality control and revision process. Under that process the applicant's deliverables were to be approved at a senior level of the CESPs and/or their clients. Any defects in the work he performed were detected as part of this process and remedied during the time the applicant was engaged in carrying out the work;
ATC 2483
82.3 the Contracts provided a fee for work performed by reference to a unit price for the cost of time engaged and did not exclude time spent on rectifying defects in the work performed.

Unrelated clients test - section 87-20

83. The Tribunal is of the view that the unrelated clients test in section 87-20 of the ITAA 1997 does not apply. There is an 80% test in section 87-15(3) which requires consideration of the immediate source of the applicant's personal services income, that is, who has made the payment/s. Where 80% or more of the applicant's personal services income for a year is from one entity (or from one entity and its associates) and Marketcroft does not meet the results test, the applicant's personal services income is not taken to be from conducting a personal services business and the unrelated clients test cannot therefore be considered.

84. The evidence is that in the year ended 30 June 2001 the applicant's personal service income was from three sources:

TOEL	74%
TOA	25%
Atwood Oceanics	1%

However on the evidence TOEL and TOA are associates and the combined personal services income from those entities is 99% of the total personal services income of the applicant for that year.

85. In section 995(1) of the ITAA 1997 "Associate" has the meaning given by section 318 of the Income Tax Assessment Act 1936 (ITAA 1936) and associates of a company are defined in subsection 318(2). It is not a requirement that companies are trading for them to be associates. Information obtained from the Australian Securities and Investments Commission shows that Tri Ocean Australia Pty Ltd and Tri Ocean Engineering Ltd were associates as defined throughout the year ended 30 June 2001: [T documents/207-215].

86. In the year ended 30 June 2002 the applicant's personal services income was from one source, Caledonian. Thus, Marketcroft does not pass the 80% test in both years.

87. Alternatively, even if the Tribunal's finding is wrong and the 80% test was satisfied and it was necessary to consider the unrelated clients test the evidence shows that in each year there were no services provided to clients that resulted from making offers or invitations to the public and the unrelated clients test would therefore not be satisfied. It is clear that the unrelated clients test is concerned with the identity of the client to whom services are provided rather than the identity of the payer. This is particularly relevant where the services are provided through an agency. For example, in the year ended 30 June 2002 the source of the applicant's personal services income was Caledonian but the services were provided to Halliburton and Argo China.

88. As well, in order to satisfy the unrelated clients test it is necessary under section 87-20(1)(a) that the personal services income is gained from providing services to two or more clients who are not associates of each other. Further, under section 87-20(1)(b) those services must be provided as a direct result of making offers or invitations to the public, or a section of the public, to provide the services. Section 87-20(2) provides that a person is not considered to have made offers or invitations to provide services merely by being available to perform services through an agency. All these requirements must be met to satisfy the unrelated clients test.

89. The evidence is that in the year ended 30 June 2001 services were provided to; Atwood (via TOA and directly) and Shakalin (via TOEL) and therefore section 87-20(1)(a) is satisfied. However the services were provided to Atwood as a result of being available to perform services through the AES, TOA. Similarly the services were provided to Shakalin as result of being available to perform services through the CESP, TOEL. In the year ended 30 June 2002 services were provided to two clients, Halliburton and Argo China (both via Caledonian) and section 87-20(1)(a) is satisfied. However the services were provided

ATC 2484

to Halliburton and Argo China as a result of being available to perform services through the AES, Caledonian.

90. It is clear from the evidence that the AESs were recruitment agencies and Marketcroft obtained clients as a result of registering with these and other AESs as being available to provide services. Under the Contracts, Marketcroft was not an agent within the meaning of section 87-40. Accordingly, the services were not provided as a result of offers or invitations by Marketcroft to the public or a section of the public to provide services and section 87-20(2) applies and section 87-20(1)(b) is not met.

Foreign earnings and foreign tax credit

91. The Tribunal fins that no part of the personal services income Marketcroft received pursuant to the TOEL Contract is exempt income under section 23AG of the ITAA 1936 because:

91.1 that provision only operates in respect of earnings of a natural person engaged in foreign service as the holder of an office or in the capacity of an employee and Marketcroft is a corporation; and
91.2 the term "foreign earnings" as defined in section 23AG clearly does not extend to attributed personal services income under Part 2-42 of the ITAA 1997.

92. However, whole of the foreign tax credit in respect of foreign tax withheld from the attributed personal services income that Marketcroft received from TOEL is allowable to the applicant under section 160AF(1) of the ITAA 1936 because:

92.1 The attributed personal services income Marketcroft received from TOEL is foreign income of the applicant for the purposes of section 6AB(1) of the ITAA 1936; and
92.2 Under section 6AB(3) the applicant is deemed to have been liable and to have paid the foreign tax withheld from the payments made to Marketcroft pursuant to the TOEL Contract.

The Tribunal notes that in the 2001 amended assessment the respondent has allowed the applicant a foreign tax credit of $22,493, that is the amount withheld from the payments made to Marketcroft under the TOEL Contract.

Deductions

93. The Tribunal finds that the reduction under section 86-20 of the ITAA 1997 of the personal services income attributed the applicant for certain deductions to which Marketcroft was entitled has been properly calculated by the respondent. The particulars of the respondent's calculation of the amount of the reduction are set out in the T documents pages 16 to 20. The applicant has provided no further evidence that warrants the allowance of further deductions.

94. There is no evidence before the Tribunal that the personal services income of Marketcroft attributed to the applicant was used by Marketcroft to meet the operating expenses of the restaurant business as the applicant has alleged. The Tribunal notes in this regard that:

94.1 Even if there was evidence to that effect, (which there is not), the use of the personal services income by Marketcroft does not constitute expenditure incurred by the applicant and is therefore not deductible under section 8-1 of the ITAA 1997;
94.2 Nor does the use of the personal services income by Marketcroft constitute a loan or injection of capital funds by the applicant to Marketcroft. In any event any injection of funds would be expenditure of a capital nature and not deductible under section 8-1. The decisions of the Federal Court in
FCT v Total Holdings (Aust) Pty Ltd 79 ATC 4279; (1979) 24 ALR 401 and
P & G Rocca Pty Ltd v FCT 2002 ATC 4543; (2002) 50 ATR 184 and of the Tribunal in
Economedes v FCT 2004 ATC 2353; (2004) 58 ATR 1046 are not relevant in this regard, each case dealing with the issue of the deductibility of interest payments made by a taxpayer in respect of money borrowed and on-lent to another entity in anticipation of an income flow;
94.3 In respect of the applicant's claim that a per diem amount of $14,700 should be allowed for the period he was living in Calgary Canada working the TOEL Contract, there is no evidence that any per diem allowance was paid by Marketcroft to the applicant for the cost of living away from home. There is also no evidence that TOEL paid the applicant or Marketcroft any per diem allowance for living away from home. The documentation that the applicant produces at T documents/287, 289 and 204 and Exhibit A2/11.5 does not establish the payment of a per diem allowance. The schedule at page 204 shows the expenses incurred by Marketcroft and the totals of the expense columns is the same as the total expenses shown in the income tax returns in T documents pages 41 and 109. There is no evidence to show that any per diem allowance was included in the amounts shown as "Professional fess" in the schedule. As there were no per diem expenses paid by Marketcroft no amount of this type can be taken into account in the process of attributing the personal services income to the applicant.
ATC 2485
94.4 Further the TOEL Contract was a contract to be performed on location in Canada, it was not a contract to be worked in Australia with periods living away from home and working in Canada with the expectation of a per diem overseas travel allowance. Any expenses incurred by the applicant in living in Canada are a private expense and are not deductible under section 8 of ITAA 1997 or any other provision.

Deduction variation certificate under PPS System

95. As noted earlier the Tribunal allowed the applicant to add an additional ground to his objections namely, that the amended assessments are excessive because Marketcroft held a Deduction Variation Certificate which exempted Prescribed Payment System (PPS) payers from Part 2-42 of the ITAA 1997 in the relevant period.

96. The note to section 84-1 in the Guide to Part 2-42 states "Note: This Part may not apply until the 2002-03 income year to participants in the prescribed payments system on 13 April 2000: see Item 26 of Schedule 1 to the New Business Tax System (Alienation of Personal Services Income) Act 2000".

97. Item 26 of Schedule 1 to the New Business Tax System (Alienation of Personal Services Income) Act 2000 states:

"26 Application

(1) The amendments made by this Part of this Schedule apply to assessments for the 2000-2001 income year and later income years.

(2) However, the Commissioner may, before 1 July 2000, declare in writing that the amendments made by this Part of this Schedule apply to an assessment that:

(a) is an assessment for the 2000-2001 income year or the 2001-2002 income year; and

(b) relates to a PPS entity that is included in a class of entities specified in the declaration;

as if the entity were conducting a personal services business and subsection 87-15(3) of the Income Tax Assessment Act 1997 did not apply. The declaration has effect accordingly.

(3) An entity is a PPS entity for the purposes of paragraph (2)(b) if:

(a) on or before 13 April 2000, the entity was entitled to make, and had made, a payee declaration to an eligible paying authority under section 221YHB of the Income Tax Assessment Act 1936; and

(b) the Commissioner had received the payee declaration for the entity from the eligible paying authority before the end of that day; and

(c) the declaration was in force at the end of that day.

(4) In subitem (3), eligible paying authority and payee declaration have the same meanings as in Division 3A of Part VI of the Income Tax Assessment Act 1936.".

98. The meanings given in Division 3A of Part VI of the ITAA 1936 are relevantly:

a. By section 221YHA(1) and (4) "eligible paying authority" has the meaning:
"For the purposes of this Division, a person who is a paying authority in relation to a prescribed payment is an eligible paying authority in relation to the prescribed payment if:
- (a) the person is not a natural person; or
- (b) …"

[box ] By section 221YHA(1) and section 221YHB(4) "payee declaration" has the meaning:

"If the payee gives the form to the eligible paying authority, the payee is said to make a "payee declaration" to the eligible paying authority"
ATC 2486
[box ] By section 221YHA(1) and section 221YHB(3) "a payee declaration form" has the meaning:
"A 'payee declaration form' is a document, in a form approved by the Commissioner for the purposes of this subsection, that (in addition to anything else that it requires or permits):
- (a) requires the payee completing the form:
  - (i) to state his or her tax file number; or
  - (ii) …
- (b) permits the payee completing the form:
  - (i) to state a declaration variation certificate number and deduction variation certificate percentage; or
  - (ii) to state a deduction exemption certificate number."
[box ] Section 221YHB(1) provides for when a payee may give a payee declaration form to an eligible paying authority:

"Subject to subsection (2), a payee who becomes entitled to receive a prescribed payment from an eligible paying authority may, for the purposes of this section, at any time before the payment is made give a payee declaration form, completed and signed by the payee, to the eligible paying authority."
[box ] By section 221YHA(1) "prescribed payment" means "a payment of the kind declared by the regulations to be a prescribed payment for the purposes of this Division". The relevant regulations are former regs 125A, 126 and 126A of the Income Tax Regulations 1936. These regulations were omitted by SR No 72 of 2000, effective 1 July 2000 and not applicable in relation to a payment made before 1 July 2000.

99. The respondent's declaration under Item 26 of Schedule 1 to the New Business Tax System (Alienation of Personal Services Income) Act 2000 was made by the respondent on 30 June 2000 and was published on 30 August 2000 in the Commonwealth of Australia Gazette No GN 34.

100. The evidence relevant to this matter is first a PPS Deduction Variation Certificate for Marketcroft, Certificate Number V V 386A, issued 14 September 1992 for a minimum deduction rate of 0% [Exhibit A4]. Applicant's evidence was that this certificate was produced to the AESs and CESPs and accordingly no deductions were made and remitted under the PPS scheme. Secondly, the income tax returns for Marketcroft for the income years ended 30 June 1997, 1998, 1999 and 2000 [Exhibit R2-R5]. Only the 1997 return for Marketcroft discloses PPS income.

101. Applicant contended that no PPS income was returned because the PPS Deduction Variation Certificate had been quoted. As the certificate was issued on 14 September 1992, this contention does not explain why PPS income was declared in the 1997 income year return. Importantly the certificate is presented for a deduction variation and does not excuse the proper disclosure in the income tax return of PPS income received during the income year. The question on the income tax returns was clear in requiring declaration of PPS income received during the income year

102. Under the regulations, a prescribed payment in respect of which a payee may give a payee declaration form to an eligible paying authority stating a declaration variation certificate number and deduction variation certificate percentage, must satisfy all the following conditions:

a. It must be made under a contract which involves the performance of work: reg 126(1);
b. The work performed must consist of an activity within an industry covered by the PPS: reg 126(2) and (3);
c. The activity must be carried out for a prescribed person under reg 126(4).

103. The activities in the engineering services industry that are covered by the PPS regime include soil testing, research and development, environmental testing, analysis and metallography, weld pre-heating and welding supervision etc in connection with any of the activities described for the building and construction industry such as the construction,

ATC 2487

erection, installation, alteration, modification, repair and improvement of any structure, road and thoroughfare. A prescribed person is any person carrying on a business that consists in whole or part in carrying out any of these engineering activities or that furnishes or arranges the services of another person to carry out those activities.

104. The Tribunal notes that the applicant's descriptions of his professional engineering assignments during the income years 1997 to 2000 appear in his CV at T documents 191-192. The descriptions evidence that during this time the applicant was engaged in engineering activities for the oil and gas industry and these are not activities within an industry covered by the PPS. Therefore, payments to Marketcroft for engineering services during those years would not attract the PPS provisions of the ITAA 1936. Consequently, it would not have been necessary for Marketcroft to give the AESs/CESPs a payee declaration form stating the deduction variation certificate number and percentage. This is consistent with the fact that no PPS income received is shown on the 1998, 1999 and 2000 income tax returns for Marketcroft.

105. In the Tribunal's opinion it also means that on 13 April 2000:

(a) Marketcroft was not entitled to make, and had not in fact made, a payee declaration to an eligible paying authority under section 221YHB of the ITAA 1936; and
(b) The respondent had not received a payee declaration for Marketcroft from a AES/CESP before the end of that day; and
(c) There was no payee declaration in force at the end of that day;

106. The Tribunal also notes that under section 221YHB(5)(a) and (b) of the ITAA 1936 a payee declaration made to an eligible paying authority is in force at all times after it is made until, inter alia:-

(a) one year passes after the eligible paying authority makes a prescribed payment to the payee (being a payment made when the declaration is in force) without the payee again becoming entitled to receive a prescribed payment from the eligible paying authority; or
(b) the payee makes another payee declaration to the eligible paying authority.

107. As noted above, only the 1997 return for Marketcroft discloses PPS income, and in the absence of evidence to the contrary the reasonable inference is that there was no payee declaration in force by operation of section 221YHB(5)(a).

108. Accordingly the Tribunal finds that Marketcroft was not a PPS entity for the purposes of the transitional period in Item 26 of Schedule 1 to the New Business Tax System (Alienation of Personal Services Income) Act 2000 and was subject to Part 2-42 in respect of it's personal services income in the 2001 and 2002 income years.

Penalties

109. The applicant omitted the personal services income of Marketcroft from his income tax returns for the years ended 30 June 2001 and 30 June 2002. There is a shortfall amount for each of the income years ended 30 June 2001 and 30 June 2002. The applicant is liable for an administrative penalty under section 284-75 of the TAA in respect of the shortfall amounts.

110. The Tribunal finds that, as contended by the respondent, the omission was reckless in circumstances where the evidence shows that the applicant's tax agent was aware of and informed the applicant of the provisions of Part 2-42 and the relevance of those provisions to the income of Marketcroft and asserted the provisions were initially difficult to apply, however:

110.1 No steps were taken by the tax agent to carefully ascertain the relevant facts from the applicant (for example, the Contracts were not called for and examined) and to analyse the requirements of Part 2-42 and assess whether the provisions did apply for each of the years ended 30 June 2001 and 2002 and if so how they applied and to comply with the requirements of those provisions;
110.2 No steps were taken by the applicant or his tax agent to carefully consider whether there was a reasonably arguable position having regard to the legislation and the relevant authorities that the provisions of Part 2-42 did not apply to Marketcroft and the applicant for each of the years ended 30 June 2001 and 2002;
ATC 2488
110.3 The tax agent evidently relied on the assertions of the applicant that there was no issue under Part 2-42 for him in the 2001 income year and then accepted the position as unchanged in the 2002 income year without further inquiry of the applicant: see the unfiled witness statement of Ms Greenwell, Exhibit A3;

111. The straightforward question in the 2001 and 2002 income tax returns of Marketcroft as to whether the income of Marketcroft for the year included personal services income was answered "no" in both years when clearly it was known to both the tax agent and to the applicant that the engineering income was a reward for the applicant's personal skills and efforts and had been paid to Marketcroft: [see T documents/48 and 117].

112. In the context of section 226H of the ITAA 1936 in
Hart v FCT (2002) 131 FCR 203, the Full Federal Court Hill and Hely JJ (Spender J in dissent) held at 214[44]-[45] that recklessness means something more than failure to exercise reasonable care but less than intentional disregard and is equivalent to a finding of gross negligence in propounding a claim. Their Honours cited the observations of Cooper J in
BRK (Bris) Pty Ltd v FCT 2001 ATC 4111; (2001) 46 ATR 347 at 364 in that regard.

113. In the circumstances the respondent determined that section 284-75 and section 284-90(1) Item 2 (shortfall amount resulting from recklessness) of the TAA applied and imposed a penalty on the applicant of 50% of the shortfall amount in the income years ended 30 June 2001 and 30 June 2002.

114. The Tribunal finds that no remission of that penalty under section 298-20 of Schedule 1 of the TAA is warranted.

115. The Tribunal finds that the applicant has not discharged the onus of showing that the amended assessments are excessive and the respondent's reviewable objection decisions should therefore in the Tribunal's view be affirmed.

Decision

116. The Tribunal accordingly affirms the decisions under review.

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