• The impact of this case on ATO policy is discussed in Decision Impact Statement: Horner v Commissioner of Taxation (Published 4 December 2009).

HORNER v FC of T

Members:
GL McDonald DP

Tribunal:
Administrative Appeals Tribunal, Melbourne

MEDIA NEUTRAL CITATION: [2009] AATA 537

Decision date: 20 July 2009

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GL McDonald (Deputy President)

1. The applicant seeks a review of the decision of the respondent to attribute Torville Pty Ltd's (Torville) income to the applicant for the years ended 30 June 2004 and 30 June 2005 (the relevant years) pursuant to Division 86 of the Income Tax Assessment Act 1997 (the Act).

2. The applicant did not file an objection with the Australian Tax Office (ATO) against the penalty assessment. The applicant has not sought a review in this Tribunal of the assessment of penalty.^[1] The applicant, in his final submissions filed on 12 December 2008, at pages 9 to 10, stated that although he did not object to the notice of penalty, it could not be separated from the objection to which the decision relates. He asked the Tribunal to exercise discretion under s 14ZZK(a) of the Tax Administration Act 1953 . The applicant is mistaken in his view that that section contains a discretion to review a part of a decision that has not been appealed against. The applicant needs to apply for a review of the penalty decision separately. Therefore, that part of the decision cannot be reviewed by this Tribunal.

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The hearing

3. At the hearing, Mr Horner represented himself and Ms Moutafis appeared on behalf of the respondent. The Tribunal had before it the documents filed for the purposes of satisfying s 37 of the Administrative Appeals Tribunal Act 1975 (T documents).

Background

4. The applicant was the sole director, shareholder and employee of Torville during the relevant years. Torville provided the following services during the relevant years:

• (a) enterprise architecture;
• (b) web software design and development;
• (c) technical audits and reviews; and
• (d) computer book technical reviews and authoring.

During the relevant years, Torville derived all of its income as a result of the services provided by the applicant.

5. For the relevant years, the applicant lodged tax returns for himself and Torville at the same time. The applicant's tax return stated his occupation as an "architect". However, the applicant's records showed he performed the work of a computer consultant. The applicant, in response to a review by the respondent, advised that he provided the following services:

• (a) consultant in relation to Microsoft Legacy and NET technology;
• (b) technical reviewer in the computer field; and
• (c) author/co-author of computer books.

^[2] Respondent’s Statement of Facts and Contentions, filed on 5 December 2008, paragraph 7.

6. The applicant explained that he had defined his occupation as an "architect" because an "architect" is "a type of Computer Consultant" and denied he had misrepresented his occupation.^[3] Applicant’s submissions, filed at the hearing on 12 December 2008, page 9.

7. The applicant provided the following income details in his income tax return for the 2004 tax year:

• (a) $1,387.00 - salary and wages;
• (b) $7,000.00 - director's fees;
• (c) $897.00 - interest;
• (d) $11,142.00 - other income; and
• (e) $31,714.00 - franked dividend (franking credit of $9,514.00).

^[4] Respondent’s submissions, filed at the hearing on 12 December 2008, paragraph 8.

8. On 10 September 2004 the ATO issued a Notice of Assessment to the applicant for the tax year ending in 2004 imposing a tax liability of $6,779.50.^[5] T documents, T4. The applicant lodged an amended return excising the salary and wages and reducing the franked dividend from $31,714.00 to $22,20.00.^[6] T documents, T5. A Notice of Amended Assessment was issued on 18 November 2004 to give effect to the applicant's amendment and a tax liability of $2,609.77 was imposed.^[7] T documents, T6.

9. The applicant provided the following income details in his income tax return for the 2005 tax year:

• (a) $7,000.00 - director's fees;
• (b) $1,682.00 - interest;
• (c) $3,714.00 - other income; and
• (d) $22,750.00 - franked dividend (franking credit of $9,750.00).

^[8] Respondent’s Statement of Facts and Contentions, paragraph 15.

10. The ATO issued the applicant a Notice of Assessment on 4 November 2005 for a tax refund of $2,280.98.^[9] T documents, T8.

11. In both of the relevant years, a dividend was paid out of Torville's profits to the applicant.

12. The respondent subsequently reviewed the tax returns of Torville for the relevant years. Torville consequently made a voluntary disclosure and provided updated Revenue Statements with improved profits but did not submit a Personal Services Business Determination application and accepted that Personal Services Income (PSI) would be attributed to the applicant. Torville's tax returns for the relevant years were consequently amended to disallow claims for motor vehicle expenses and increase taxable income in accordance with the updated Revenue Statements provided.

13. On 1 August 2007, the ATO issued notices of amended assessments to the applicant for the relevant years.^[10] T documents, T13 and T14. The applicant's assessments were amended to:

• (a) remove the dividends and franking credits:
  • (i) $22,200.00 dividend and a $9,514.00 franking credit for the 2004 tax year; and
  • (ii) $22,750.00 dividend and a $9,750.00 franking credit for the 2005 income year;
• (b) attribute additional income to the applicant by application of the PSI provisions:
  • (i) $52,950.00 for the 2004 tax year; and
  • (ii) $84,498.00 for the 2005 tax year.^[11] Respondent’s Statement of Facts and Contentions, paragraph 23.

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ATC 2981

Notices of Amended Assessment have not been issued to Torville for the relevant years.

14. Also on 1 August 2007, the ATO issued a Notice of Assessment for penalty.^[12] T documents, T15. The respondent applied a base penalty rate of 25% for each tax year for lack of reasonable care. The base penalty was then reduced by 80% in accordance with s 298 20 of the Tax Administration Act 1953 (TAA 1953) for voluntary disclosure.^[13] Respondent’s Statement of Facts and Contentions, paragraphs 24 to 25.

15. On 18 October 2007, the applicant lodged a notice of objection against the amended assessments. The respondent subsequently partially allowed the objections. The General Interest Charge and Shortfall Interest Charge were remitted.^[14] T documents, T17.

16. In September 2006, Torville lodged objections to the Notices of Assessment for the relevant years.^[15] Applicant’s Statement of Facts and Contentions, filed on 11 October 2008, paragraph 5.

17. Prior to the hearing, the respondent, in its Statement of Facts and Contentions prepared for the purposes of the hearing, reconsidered its position in relation to the motor vehicle expenses that were previously disallowed to Torville during the relevant years. Those expenses will now be allowed. Taking into account the respondent's concessions, the positions of Torville and the applicant before and after the application of the PSI provisions are summarised as follows:^[16] Taken from Respondent’s Statement of Facts and Contentions, paragraph 33, Table C.

	2004	2005
Original Tax Liability	Applicant	$2,609.77	−$2,280.98
	Torville	$12,960.90	$19,391.40
	Total	$15,570.67	$17,110.42
Tax Liability with PSI	Applicant	$21,344.80	$29,136.42
	Torville	$0.00	$0.00
	Total	$21,344.80	$29,136.42
Variation	$5,774.13	$12,026.00

Relevant legislation

18. The rules governing PSI are set out in the Act. Division 86 operates to attribute certain income that is derived by a "personal services entity" to the individual who carries out the services that give rise to the entity deriving that income: s 86-15(1).

19. Section 84-5 relevantly defines PSI as:

• "(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."

20. The effect of obtaining PSI through a personal services entity is governed by s 86-15, which is relevantly as follows:

"Amounts included in your assessable income

• (1) Your assessable income includes an amount of ordinary income or statutory income of a personal services entity that is your personal services income.
• (2) A personal services entity is a company, partnership or trust whose ordinary income or statutory income includes the personal services income of one or more individuals.

Exception: personal services businesses

• (3) This section does not apply if that amount is income from the personal services entity conducting a personal services business.

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  ATC 2982

  Note: Even if the entity is conducting a personal services business, it is possible that some of its income is not income from conducting that business.

Exception: amounts promptly paid to you as salary or wages

• (4) This section does not apply to the extent that:
  • (a) the personal services entity pays that amount to you, as an employee, as salary or wages; and
  • (b) the payment is made before the end of the 14th day after the PAYG payment period during which the amount became ordinary income or statutory income of the entity.

Exception: exempt income etc.

• (5) This section only applies to the extent that that amount would be assessable income of the personal services entity if this Division did not apply."

21. In order for the entity to be considered an entity that is carrying on a personal services business, the entity must satisfy one of the four tests set out in Division 87. Those tests are the results test, the employment test, the business premises test, and the unrelated clients test. If 80% or more of the person's PSI is from once source and the results test under s 87-18 is not satisfied, then the entity will not be deemed to be conducting a personal services business.^[17] Unless there is a personal services business determination in force in relation to the individual’s PSI.

22. Section 87-5 sets out the following diagram which shows how Division 87 operates to ascertain whether PSI is income from conducting a personal services business:

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Contentions

23. The applicant asserted that the issue before the Tribunal was whether there was a reduction of income tax (and other liabilities) by attributing PSI to Torville in the relevant years, and that it did not extend to deferral of income tax (and other liabilities) by attributing PSI to Torville (because there was no deferral).^[18] Applicant’s Statement of Facts and Contentions, page 1.

24. The applicant contended that s 86-10 imposed a threshold test (to determine whether the object of Division 86 is met) and that he is not caught by that threshold (because the object of Division 86 cannot be met). The applicant phrased the test as follows:

"Test the fact situation to see whether there is a threat to the revenue base or equity. But a threat is only a threat when there is a reduction in the revenue base and to equity. Thus, it would follow that there is an implied obligation on the Respondent to apply a threshold test to see whether the fact situation contains the threat to the revenue base and to equity …^[19] Applicant’s submissions, filed on 12 December 2008, page 4. "

The applicant argued that Division 86 could only be "put to work" if the object can be met.^[20] Applicant’s submissions, filed on 12 December 2008, pages 3-4. As a consequence, it was argued, Division 86 does not apply, nor does the penalty.^[21] Applicant’s Statement of Facts and Contentions, page 4.

25. The applicant further claimed the respondent misinterpreted s 86-10. The applicant states that s 86-10 requires the Tribunal to determine whether there has been a reduction of income (and other liabilities), and the respondent has been misguided in its interpretation requiring a determination on whether there has been a reduction of tax payable. The applicant argues that an amount of tax payable is not the same as an amount of income tax (and other liabilities).^[22] Applicant’s Statement of Facts and Contentions, page 3. The applicant reasons that the respondent, when calculating tax payable, includes the following elements:

• (a) tax on taxable income;
• (b) Medicare levy;
• (c) Medicare levy surcharge;
• (d) collection credits;
• (e) rebates - foreign tax credits; and
• (f) rebates - franking credits.^[23] Applicant’s Statement of Facts and Contentions, page 4.

The applicant contends that the calculation of income tax (and other liabilities) requires only (a), (b) and (c). Collection credits are neither income tax or other liabilities because that tax has already been paid. Foreign tax credits should be excluded because it is a rebate which prevents double taxation of income. Franking credits should also be excluded for the same reason.^[24] Applicant’s Statement of Facts and Contentions, page 4.

26. The respondent contended that the income derived by Torville during the relevant years was a direct result of the applicant's skills and personal effort and therefore clearly falls within the definition of PSI under Division 84 of the Act. Torville was not a personal services entity during the relevant years as it did not pass any of the tests set out in Division 87. The respondent therefore contended that the income derived by Torville was subject to the PSI income provisions and attributable to the applicant in accordance with the attribution rules contained in Division 86 of the Act.

27. The respondent disputes the applicant's contention that s 86-10 of the Act contains a threshold test. The respondent argues the object of Division 86 is to prevent alienation by employees of PSI by contracting through a separate entity. The respondent claims the object of the Division has clearly been met. The respondent points to the fact that the applicant had reduced his income tax and other liabilities by providing services through the interposed entity (refer to the Table above).

28. In regard to the franking tax offset, the respondent contends s 86 35(1) of the Act provides that where part of the PSI is distributed as a dividend, it will not be assessable to the recipient. Therefore, the respondent has removed the dividend and corresponding franking credit from the applicant's assessments for the relevant years. The respondent submits that the term "payment" used by s 86-35 is broad enough to catch a dividend payment.

29. The respondent continues that once PSI is to be attributed to the applicant under s 86-15 of the Act, the Tribunal must then turn to the method statement in s 86-20(2) to allow for deductions to the extent prescribed by Division 86.

30.

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The applicant contended that the Superannuation Guarantee Levy must be taken into account. Section 86-75 of the Act provides that in some circumstances an income tax deduction to the company for superannuation contribution despite the attribution of PSI to an individual. The respondent could not find evidence if any superannuation contributions made by Torville. The respondent also asserted that the attribution of PSI to an individual does not create superannuation guarantee obligations for the relevant personal services entity. Income which has been attributed to a person in accordance with s 86-15 has not been received by the person and in the absence of receipt, the attributed income does not comprise "earnings" to which superannuation guarantee obligations attach.^[25] Respondent’s final submissions, filed on 13 February 2009, paragraph 32.

Submissions after the hearing

31. Both parties were asked to provide written submissions after the hearing.

32. The applicant, in his final submissions filed on 19 January 2009, maintained that s 86-10 contained a threshold test which works to assess whether Division 86 needs to be applied and thus whether PSI needs to be attributed. The applicant maintained Division 86 should only be applied when "mischief" is present, that if alienation has been used that does not result in mischief, then the operation of Division 86 does not arise.^[26] Applicant’s final submissions, filed on 19 January 2009, paragraph 2.

33. The applicant was also adamant that there was not a reduction of income tax (and other liabilities) and that the respondent made a series of calculation errors in determining that there was a reduction.^[27] Applicant’s final submissions, filed on 19 January 2009, paragraphs 2-8.

34. The respondent, in its final submissions filed on 13 February 2009, conceded the following in regard to the tax year ending in 2004:

• (a) Torville did not derive 80% or more of its PSI from one source;
• (b) Torville provided services to two or more entities that were not an associate of any party; and
• (c) Torville made efforts and invitations to the public at large that gave rise to those services.

The respondent is apparently satisfied that for that year, Torville satisfies the unrelated clients test under s 87-20 of the Act and is therefore a personal services business for the purposes of s 87-15. Consequently, no PSI of Torville is to be attributed to the applicant in that year.^[28] Respondent’s final submissions, filed on 13 February 2009, page 1.

35. Despite the above concession, the respondent maintained that the attribution of income to the applicant in the tax year ending in 2005 is correct.

36. Additionally, the respondent acknowledged that it omitted to account for the Medicare levy surcharge for the 2005 year.^[29] Respondent’s final submissions, filed on 13 February 2009, paragraph 17.

Tribunal's deliberation

37. The evidence leaves the Tribunal satisfied that the income derived by Torville arose through the applicant's skills and personal effort. Accordingly, it meets the definition of personal services contained in s 84-5 of the Act. Section 86 of the Act results in the applicant's PSI being alienated from the income of Torville and applied to his income as he was the person providing the services which generated the income. Alienation of PSI does not occur when the entity providing the services is a personal services business or the income is promptly paid to the individual as salary or wages or the income is non assessable income of the entity.

38. It is not disputed by the applicant that 80% or more of his PSI comes from the one source.^[30] Applicant’s submissions, filed on 19 January 2009, paragraph 9.

39. The next issue to determine is whether Torville is conducting a "personal services business." The applicant has not applied to the Commissioner to have a determination that Torville be determined to be a personal services business and there is no evidence which establishes Torville meets any of the following tests set out in s 87 to enable it to be classified as a personal services business:

• • "the results test"(s 87-18);
• • "the unrelated clients test" (s 87-20);
• • "the employment tests" (s 87-25); and
• • "the business premises test" (s 87-30).

No such application was made by the applicant and therefore the Tribunal is satisfied that Torville does not meet any of the tests. It then follows that s 86 applies.

40. Section 86-10 sets out the object of the section (division). Section 86-10 has no operative role. It cannot therefore have the role that the applicant seeks to attribute to it. It

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contains no "threshold" test which must be met before the balance of the section becomes effective. In particular, it is not a requirement of the section that the respondent demonstrate that there has been a deferral or reduction of income tax as the result of the operation of the section, before the section can otherwise have effect. Once it has been determined that the applicant was providing personal services then s 86-15 applies, and subject to any offset claimable under s 86-20, the amount is alienated to the applicant's individual income.

41. The respondent has made adjustments to the 2005 assessment. The applicant submitted that the Medicare levy surcharge was omitted in the 2005 return, the respondent agrees that his was omitted.^[31] Respondent’s submissions, filed on 13 February 2009, paragraph 17. The Tribunal determines that an adjustment for that amount should be taken into account.

42. Additionally, the applicant submitted that the respondent erred by removing the dividend paid by Torville to him from his assessable income (being $22,750 in the 2005 income year). To do this the respondent relied on s 86-35(1) of the Act. The applicant claims support for contending that s 86-35(1) has no application to his circumstances by referring to the heading contained in the section. As a matter of ordinary statutory interpretation the heading cannot be utilised to determine the content of the section (s 13 of the Acts Interpretation Act 1901). The answer to the applicant's submission is found in the opening words of s 86-35 where the section refers to a payment "by the personal services entity … to you …" The section relieves the applicant of paying tax on the amount distributed or claiming a deduction of the payment where the amount is characterised as PSI and alienated. As paragraph 32 of TR 2003/6 makes apparent the subsection only comes into effect if there is non PSI contained in the company (entity) accounts. The section has no application in the present case.

43. Finally, the applicant claims that adjustments should be made to account for the payment of the superannuation guarantee levy. There is no evidence that Torville made any such payments on behalf of the applicant so no question for determination arises under s 86-75 of the Act. The income attributed to the applicant is not made to him in his capacity as an employee and therefore no superannuation guarantee levy arises. Since the Tribunal has ruled against the applicant's interpretation of s 86-10 there is no call to take into account any superannuation guarantee levy otherwise payable in calculating the PSI attributed to him.

Tribunal's decision

44. The Tribunal varies the assessment for the 2005 taxation year for the applicant by directing that an adjustment be made with respect to his Medicare levy but otherwise affirms the decision under review. For the 2004 taxation year the respondent concedes no PSI of Torville is to be attributed to the applicant.