The impact of this case on ATO policy is discussed in Decision Impact Statement: Commissioner of Taxation v Yalos Engineering Pty Ltd; Yalos Engineering Pty Ltd and Commissioner of Taxation (VID 479 of 2009 (FC); 2007/3018-3019 (AAT) ).
FC of T v YALOS ENGINEERING PTY LTDJudges:
Federal Court, Melbourne
MEDIA NEUTRAL CITATION:
 FCA 1569
1. This is an appeal on questions of law pursuant to s 44 of the Administrative Appeals Tribunal Act 1975 (Cth) ("the AAT Act") from a decision of the Administrative Appeals Tribunal ("the Tribunal") made on 29 May 2009. In that decision, the Tribunal set aside a decision of the applicant, the Commissioner of Taxation, made on 21 May 2007 to disallow an objection by the respondent, Yalos Engineering Pty Ltd, to a decision by the Commissioner made on 30 January 2007 to refuse to make a "personal services business determination" under s 87-65 of the Income Tax Assessment Act 1997 (Cth) ("the 1997 Act"). The Tribunal directed the Commissioner to make a personal services business determination relating to the personal services income of Mr L Koundouras included in the respondent's income for the years ended 30 June 2004 and 30 June 2005.
2. The presently relevant provisions of the 1997 Act are to be found in Part 2-42 thereof. They were introduced by the New Business Tax System (Alienation of Personal Services Income) Act 2000 (Cth). According to the Explanatory Memorandum accompanying the Bill for that Act -;
"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 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."
3. It is provided in s 85-10 of the 1997 Act that a tax deduction is not available with respect to income payable to the taxpayer otherwise than as an employee if the taxpayer would not be entitled to a deduction if the income in question were payable to him or her as an employee. There are several exceptions to this general rule, one of which (under s 85-30) is where the amount claimed as a deduction relates to income from the taxpayer conducting "a personal services business". Section 87-15 sets out what is a "personal services business" in the following terms:
- "(1) An individual or personal services entity conducts a personal services business if:
- (a) for an individual-a personal services business determination is in force relating to the individual's personal services income; or
- (b) for a personal services entity-a personal services business determination is in force relating to an individual whose personal services income is included in the entity's ordinary income or statutory income; or
- (c) in any case-the individual or entity meets at least one of the 4 personal services business tests in the income year for which the question whether the individual or entity is conducting a personal services business is in issue."
Paragraph (b) of this subsection is directly relevant to the facts of the present case, but the starting point is para (c).
4. As appears from the extract above, the effect of s 87-15(1)(c) is that, if an entity meets one of the "personal services business tests" in the relevant year, it will be treated as conducting a "personal services business" in that year. One of those tests is "the unrelated clients test under s 87-20". Section 87-20(1) provides as follows:
- "(1) An individual or a personal services entity meets the unrelated clients test in an income year if:
- (a) during the year, the individual or personal services entity gains or produces income from providing services to 2 or more entities that are not associates of each other, and are not associates of the individual or of the personal services entity; and
- (b) the services are provided as a direct result of the individual or personal services entity making offers or invitations (for example, by advertising), to the public at large or to a section of the public, to provide the services."
It will be noted that the test contains two parts, each of which must be met. The first relates to the number of unassociated customers that the entity had during the relevant year. The second relates to the means by which the entity obtained the business of those customers.
5. In the facts of the present case, the respondent did not meet any of the four tests referred to in s 87-15(1)(c). In those circumstances as noted above, it applied for the making of a "personal services business determination" so as to take advantage of para (b) of the subsection.
6. That application was to be decided by the Commissioner under s 87-65 of the 1997 Act. The Commissioner was empowered to make such a determination under that section, but subs (3) provided (for the 2004 year):
- "(3) The Commissioner must not make the determination unless satisfied that, in the income year during which the determination first has effect, or is taken to have first had effect, the conditions in one or more of subsections (3A), (3B) and (5) are met."
For the 2005 year, subs (6) was added to the list of subsections containing the conditions referred to.
7. For the 2004 income year, the condition which is, or ought to have been, relevant to the circumstances of the respondent was identified in s 87-65(3B) as follows:
- "(3B) The conditions in this subsection are that:
- (a) but for unusual circumstances applying to the entity in that year, the entity could reasonably have been expected to meet, or would have met, at least one of the 4 personal services business tests; and
- (b) the individual's personal services income included in the entity's ordinary income or statutory income could reasonably be expected to be, or was, from the entity conducting activities that met one or more of those tests."
For the 2005 income year, the presently relevant condition was that set out in s 87-65(6):
- "(6) The conditions in this subsection are that:
- (a) but for unusual circumstances applying to the entity in that year, the entity could reasonably have been expected to meet, or would have met, the unrelated clients test under section 87-20; and
- (b) if 80% or more of the individual's personal services income (not including income mentioned in subsection 87-15(4)) included in the entity's ordinary income or statutory income could reasonably have been expected to be, or would have been, income from the same entity (or one entity and its associates)-that is the case only because of unusual circumstances applying to the entity in the income year; and
- (c) the individual's personal services income included in the entity's ordinary income or statutory income could reasonably be expected to be, or was, from the entity conducting activities that met the unrelated clients test under section 87-20."
8. In each of the relevant years, it was para (a) of the provisions just referred to that was controversial in the proceeding before the Tribunal. The respondent submitted that, but for "unusual circumstances", it would have met, or could reasonably be expected to have met, the unrelated clients test. Under s 87-65(4) such circumstances include, without limitation -
"...providing services to an insufficient number of entities to meet the unrelated clients test under section 87-20 if:
- (a) the personal services entity starts a business during the income year, and can reasonably be expected to meet that test in subsequent income years; or
- (b) the personal services entity provides services to only one entity during the income year, but met the test in one or more preceding income years and can reasonably be expected to meet the test in subsequent income years."
It will be seen that this is a deeming provision of potential partial application under para (a) of subs (3B) or (in the later year) of subs (6). If it operated, it would assist the entity to meet part (a) of the unrelated clients test as defined in s 87-20(1), but it would still be necessary for the Commissioner to be satisfied that part (b) was met (ie that failure to comply with part (a) was the only reason "but for" which the entity did not meet the test) or that there were also unusual circumstances "but for" which the entity would have met, or could reasonably have been expected to meet, part (b) of the test. In this latter aspect, subs (4) would have no role.
9. The question which the Commissioner decided adversely to the respondent, and upon which the Tribunal upheld the respondent's administrative appeal, was whether, but for unusual circumstances applying to the respondent in each of the years 2004 and 2005, the respondent could reasonably have been expected to meet, or would have met, the unrelated clients test. It was common ground that the respondent did not in fact meet that test in either of those years.
10. The Tribunal summarised the state of the evidence before it in terms which effectively amounted to findings. In the years ended 30 June 2004 and 30 June 2005, Mr Koundouras was an employee of the respondent. In those years, the respondent received its sole income from Manpower Services Pty Ltd ("Manpower"), which in turn contracted with BHP Billiton Ltd ("BHPB") to provide Mr Koundouras's services as an offshore installation engineer for BHPB in relation to the Minerva gas field. He was responsible for the design and oversight of the fabrication and installation of the offshore pipe line as a representative of BHPB.
11. The respondent's contract with Manpower was made in October 2002 and was to have run until 31 December 2003. However, due to delays in the construction of the onshore gas plant, it was extended to April 2005. Mr Koundouras told the Tribunal that the normal duration of such contracts was 3-6 months, but his role on the Minerva project was larger than any previous role he had been given. He said it was unusual for offshore installation projects to be delayed to the extent that this one had been.
12. The Tribunal set out the consulting income received by the respondent, and the entities from which it received it, in each of the income years 2001, 2003, 2006, 2007 and 2008. Inserting the corresponding figures for 2004 and 2005, the position was as follows:
|Year ended 30 June 2001|
|Lawrence Allison Pty Ltd||37,193|
|Year ended 30 June 2003|
|BHP Billiton Ltd via Manpower||78,155||149,064|
|Year ended 30 June 2004|
|Manpower Services Pty Ltd||212,300||212,300|
|Year ended 30 June 2005|
|Manpower Services Pty Ltd||119,215||119,215|
|Year ended 30 June 2006|
|BHP Billiton Ltd||57,762|
|Alinta Network Services||18,480||76,242|
|Year ended 30 June 2007|
|BHP Billiton Ltd||45,188|
|Upstream Petroleum Pty Ltd||78,145||123,333|
|Year ended 30 June 2008|
|AGR Asia Pacific||284,589|
|AED Oil Ltd||64,600||349,189|
13. The Tribunal said:
"The remaining issues are whether Yalos, but for unusual circumstances in 2003 and 2004, could have been expected to meet the unrelated clients test and/or met the test in one or more preceding years and could reasonably have been expected to meet the test in subsequent years. In my view, the answer to both of these is yes. On the evidence of both Mr Koundouras and Mr Cini and having regard to the history of Yalos from 2001 to 2008, I am satisfied that the project involved and the services provided by Yalos were unusually large being expected to last some twelve months and the unexpected delays, out of control of either party, which extended the contract for more than one further year contributed unusual circumstances. Unusual, as defined in the Macquarie Dictionary, means not usual, common or ordinary. I would expect that many of these type of projects encounter these delays but would regard the extent of the delays in the Minerva Project as unusual. I further find that Yalos did meet the unrelated clients test in a preceding year; 2001 and 2003 and could reasonably have been expected to meet that test in subsequent years. It is appropriate to have regard to the industry in which Yalos operates and the limited number of players available within that industry. As seen by the three separate contracts with BHP Billiton it is likely that one party may appear as a customer in more than one year of income. Again, I am satisfied that the services provided is a direct result of offers or invitations to that limited market."
It followed from these conclusions, according to the Tribunal, that the respondent met the personal services business test in 2004 and 2005, and that the Commissioner should be directed to make personal services business determinations accordingly. (It was common ground that the references to 2003 and 2004 in the opening sentence of this passage was a typographical error, and that the Tribunal intended to refer, and should be taken to have been referring, to 2004 and 2005.)
14. The Commissioner advanced a number of criticisms of the Tribunal's reasons, but, rather than take them in the order in which they were advanced, it will be useful to turn first to the one which related to the way the Tribunal applied the "but for" criterion under subs (3B) (and (6)) and to the use it made of subs (4).
15. In the passage set out above, the Tribunal commenced by faithfully identifying the terms of the statutory provisions under which it was operating. However, after the words "and/or met the test", the Tribunal picked up the wording of subs (4). This is apparent from its reference to preceding years and subsequent years. Subsections (3B) and (6) are concerned not with those years but with the year of income itself. It was only to the extent that the respondent sought the assistance of para (b) of subs (4) to enable it to meet part (a) of the unrelated clients test that it was necessary to consider preceding years and subsequent years. The Tribunal is, in my view, to be regarded as addressing the subs (4)(b) point in the second half of the first sentence of the passage set out above. In the second sentence, an affirmative answer is given to the questions posed in the first. However, the Tribunal then seems to depart from the issues presented by subs (4)(b), and to deal with the general question of unusual circumstances unassisted by that provision. It expresses the view, in effect, that there were circumstances related to the Minerva project which were unusual for the respondent, and implies that, in more usual circumstances, projects would not last so long and that the respondent would have two or more customers per year. Although it is not altogether easy to discern, I think the Tribunal should be taken as here concluding that the circumstances which existed in 2004 and 2005 were unusual ones, and that but for those circumstances the respondent would have met part (a) of the unrelated clients test in 2004 and 2005. I read the Tribunal as having reached this conclusion without the assistance of subs (4).
16. However, in the sixth sentence of the passage - commencing "I further find" - the Tribunal returns to subs (4). It finds as a fact that the respondent did meet the unrelated clients test in "a preceding year" (but refers to two preceding years, 2001 and 2003) and could reasonably have been expected to meet the test in subsequent years. It is here that the reasoning of the Tribunal becomes, with respect, problematic. The sixth sentence is by way of a finding. One would normally expect that to be followed by a short statement of the reason justifying it. That is the way the Tribunal's reasons naturally read. That is to say, I read the last three sentences in the passage - commencing "It is appropriate" - as concerned to state why, for the purposes of para (b) of subs (4) of s 87-65, the respondent met the unrelated clients test in a preceding year and could reasonably be expected to meet the test in a subsequent year.
17. At this point I return to the Commissioner's ground of appeal which is relevant to the issues I have been discussing. The Commissioner contended that the Tribunal had overlooked the requirement that, even where unusual circumstances existed, it was necessary to consider whether the respondent would have met, or could reasonably have been expected to meet, the unrelated clients test "but for" those circumstances. I consider that there is substance in this ground. As I have attempted to explain earlier in these reasons, where one of the criteria in subs (4) is satisfied, the entity concerned is assisted in meeting part (a) of the unrelated clients test. That is to say, where subs (4) operates, the unusual circumstances are the provision of services to an insufficient number of entities to meet the unrelated clients test. Ex hypothesi, but for those unusual circumstances, the putative entity would have provided services to a sufficient number of entities to meet part (a) of the test.
18. As indicated above, I read the Tribunal as having had recourse to subs (4) in this way. However, I cannot find in the Tribunal's reasons any decision on part (b) of the unrelated clients test in its application directly to the years 2004 and 2005. I say this because I read the last three sentences of the passage as being concerned with the pattern by which the respondent secured work in the preceding and subsequent years. For a determination to be made within the constraints of subs (3), it was necessary for the Tribunal to have found, as a positive fact, either that the services provided to Manpower in 2004 and 2005 were so provided as a direct result of the respondent having made offers or invitations (for example, by advertising) to the public at large or to a section of the public, or that, but for unusual circumstances (unrelated to subs (4)) those services would have been so provided as a direct result of such offers or invitations. The Tribunal does not appear to have addressed these issues.
19. It is, of course, preferable for a court not to undertake a line-by-line dissection of the reasons of an administrative tribunal with a view to discovering some element of legal error. What should be examined is the substance of what was decided. Criticisms of a tribunal's manner of expressing itself are to be eschewed. However, the approach which I have taken has been made necessary by two factors. First, the Tribunal was concerned with the application of fairly precise provisions of a taxing statute which required separate attention to be given to identified criteria. Secondly, it has only been by a fairly meticulous examination of the Tribunal's reasons as expressed that it has been possible to identify how the Tribunal worked its way through the relevant provisions.
20. I appreciate in particular that, on one possible construction of the passage from the Tribunal's reasons set out above, the final sentence thereof might be understood as compendiously addressing the question mandated by part (b) of the unrelated clients test in its application to the years 2004 and 2005. However, I do not so understand it. Such an understanding would find no support in the facts of the case, so far as they are referred to in the Tribunal's reasons. As to how the respondent came to obtain the Manpower contract, the Tribunal said that Mr Koundouras had given evidence that he was "suggested for the project by a former colleague". The officer of BHPB to whom Mr Koundouras reported also gave evidence that he (the officer) "approached Mr Koundouras on the recommendation of a colleague". He was not aware of the existence of the respondent. The Tribunal referred to no other evidence about how the respondent came to be contracted to Manpower. In the light of the evidence to which it did refer, the proposition that the last sentence in the passage set out at para 13 above was an intended reference to the years 2004 and 2005 is, in my view, highly implausible as a matter of construction.
21. For the above reasons, I am of the view that the Tribunal reached the conclusion that a personal services business determination should be made without addressing one of the required statutory criteria, namely, that arising under part (b) of the unrelated clients test in its application under subs (3B) (for 2004) and (6) (for 2005) of s 87-65 of the 1997 Act. The application will be allowed, and the matter remitted to the Tribunal under s 44(5) of the AAT Act.
22. For the sake of completeness and in deference to the helpful submissions which the parties made on the subjects concerned, I shall refer briefly to the other grounds by reference to which the Commissioner attacked the Tribunal's reasons.
23. The first series of grounds related to a question of law expressed as follows:
- "(iii) Under what circumstances are services provided as a direct result of a 'personal services entity making offers or invitations (for example, by advertising), to the public at large or to a section of the public' for the purposes of s 87-20(1)(b) and whether such circumstances exist in the present case."
The Commissioner's principal attack upon this area of the Tribunal's decision was concerned with the connotation of the expression "to the public at large or to a section of the public" in para (b) of s 87-20(1) of the 1997 Act. The Commissioner's submissions were based upon an assumed factual scenario whereby the contracts engaged in by the respondent for the provision of the services to a third party, such as Manpower, arose from the "personal contacts" of Mr Koundouras himself. It was said that these personal contacts, or the businesses (such as, apparently, Manpower) which were put in touch with the respondent by reason of them, could not be regarded as "a section of the public" within the meaning of s 87-20(1)(b). It was submitted that the section should be construed as though "public" were the opposite of "private", and with a particular view to achieving the objectives referred to in s 87-10.
24. The reasons of the Tribunal do not disclose any specific attention being given to the construction of s 87-20(1)(b) of the 1997 Act. It is apparent that the Tribunal approached the provision as though "a section of the public" was apt to include, within the context of an industry which had a "limited number of players", those players. While recognising the objects of Div 87 of the 1997 Act set out in s 87-10, I think it unlikely that the legislature would have intended that s 87-20(1)(b) would be unavailable to an entity which had offered the services of its employee to the major corporations operating within the narrow area of industrial activity for which that employee's skills and experience were suited. In my opinion, this is amply within the connotation of "section of the public" in the provision. Such a view of the legal position appears to have been implicit in the reasoning of the Tribunal in the present case. For these reasons, I am not persuaded that the Tribunal erred in law in these respects
25. The other aspect of this series of grounds relates to the requirement of part (b) of the unrelated clients test that the services in question were provided as a direct result of the entity "making offers or invitations (for example, by advertising)". The Commissioner submitted that it was insufficient for the services to have been provided as a result of a person-to-person referral or of personal contacts within the industry concerned. Just how the Tribunal approached this aspect of the unrelated clients test is of itself problematic, for the reasons I have given above. It is not entirely clear whether the Tribunal was operating pursuant to what it perceived to be offers or invitations by the respondent. If not, it would have made an error of law. These are, however, matters to be considered by the Tribunal on remitter, and there would be little utility in my further dealing with them on a hypothetical basis at this stage.
26. The Commissioner's next series of grounds relates to the matter of "unusual circumstances", both as found as a matter of fact and as deemed by the operation of s 87-65(4). As to the latter, the Commissioner submitted that, as at 30 June 2004, the respondent's contract with Manpower had been extended to April 2005 and that it was, therefore, known that the respondent would fail to meet the unrelated clients test for that period at least. While the Tribunal did not advert to this aspect in terms, its failure to have done so is not, in my view, inconsistent with the conclusion which it drew that it could reasonably be expected that the respondent would meet the test in subsequent years. For all the court knows, the Tribunal might have taken the view that the respondent could, as a matter of reasonable expectation, have contracted with another entity during the brief period of the 2005 income year which followed the completion of its contract with Manpower.
27. The Commissioner also submitted that the words "subsequent income years" in s 87-65(4)(b) mean all subsequent income years, not merely subsequent income years generally. I cannot accept this submission. The expression "subsequent income years" is open-ended, and would be unworkable if construed as though imposing upon an entity the obligation to persuade the Commissioner that it might reasonably be expected to meet the test in every year in the future, however long the future existence of the entity may extend. This would be to impose upon the entity, and upon the Commissioner, an obligation to make a reasonable prediction about events extending many years into the future, the circumstances of which could not possibly then be known with any reliability. I consider that the construction of "subsequent income years" must be informed by the structure and purpose of s 87-65(4)(b) generally. Particularly having regard to the requirement to consider "one or more preceding income years" when looking to the past, I think that the expression "subsequent income years" refers to such years generally, not forever, and not necessarily without exception. I do not consider that the Tribunal fell into error by declining to read "subsequent income years" as a reference to every year into the unlimited future of the respondent.
28. As to the Tribunal's finding - to the extent that it made one - that there were "unusual circumstances" apart from the deeming effect of subs (4), the Commissioner submitted that there was nothing exceptional or "out of ordinary" about 2004 and 2005, and that the Tribunal had erred in the findings made in the third sentence in the passage set out in para 13 above. These challenges to the Tribunal's findings are, however, wholly on questions of fact. Neither the Tribunal's approach nor its reasons manifest, in my view, a misappreciation of the connotation of the word "unusual" in subs (3B) (for 2004) or (6) (for 2005).