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The impact of this case on ATO policy is discussed in Decision Impact Statement: Park and Commissioner of Taxation (Published 9 December 2012).
PARK v FC of T
Members:SE Frost SM
Tribunal:
Administrative Appeals Tribunal, Sydney
MEDIA NEUTRAL CITATION:
[2011] AATA 567
SE Frost (Senior Member)
Introduction
1. Jooheon (John) Park is an information technology (IT) specialist, and a director of a company named Photocom Pty Ltd.
2. During the 2006 and 2007 tax years Photocom earned income through the provision of Mr Park's personal efforts or skills to third party clients. For taxation purposes, because of various provisions in Part 2-42 of the Income Tax Assessment Act 1997 (the Act), that income of Photocom is the "personal services income" of Mr Park. As a result, unless Photocom conducted a "personal services business" during the relevant income years:
- • the income will be attributed to Mr Park as his assessable income rather than that of Photocom; and
- • certain deductions that might otherwise have been available to Photocom will not be allowable.
3. Mr Park contends that Photocom was conducting a personal services business during the relevant income years, but the Commissioner disagrees. The Commissioner made tax assessments for the relevant years which included an attribution to Mr Park of income earned by Photocom. Mr Park, dissatisfied with the assessments, objected against them but the objections were disallowed. He has applied to the Tribunal for review of the objection decisions.
The Issues
4. The main issue for determination by the Tribunal is whether Photocom conducted a personal services business during the relevant years. That question turns on whether Photocom meets the "results test" in s 87-18 of the Act.
5. If it did not conduct a personal services business, then the following additional issues arise:
- • Whether the amount of personal services income attributed to Mr Park may be reduced by amounts of rental expenses incurred by Photocom in both of the relevant years, or by a living away from home allowance (LAFHA) for the 2007 year;
- • Whether administrative penalty was properly imposed, and if it was, whether it should be remitted to any extent;
- • Whether shortfall interest charge should be remitted to any extent.
6. It was not necessary for the Tribunal to give consideration to some additional matters that were the subject of the objection decision as the Respondent conceded:
- a) That general expenses of $5,484 incurred by Photocom in the 2006 year in furnishing Mr Park's temporary residence in Perth may be deducted from the personal services income of Photocom that is attributable to Mr Park;
- b) That an amount of $1,200 paid to Ms Wong in the 2006 year was not personal services income attributable to Mr Park and his assessment for the 2006 year should be reduced by this amount; and
- c) That the proceeds from the sale of a computer of $3,688 was not personal services income and the amount assessed as attributable to Mr Park in the 2007 year should be reduced by $3,688. The cost of the computer may not be deducted from the personal services income attributable to Mr Park under s 86-20(2) as it relates to the sale and not the personal services income.
Does Photocom Meet The "Results Test"?
7. The results test for a personal services entity such as Photocom is set out in s 87-18(3) of the Act. The first requirement of the test, in para (a), is that at least 75% of the personal services income of Mr Park that is included in Photocom's income is "for producing a result".
8. All, or virtually all, of Mr Park's personal services income - 100% in 2006, and 99.3% in 2007 - was earned during the relevant years by Photocom under one of several contracts that it had over a period of time with a labour hire firm, Candle Australia Ltd.
9. The earliest relevant contract with Candle[1]
10. The contract includes the following at clause 10:
- "
10. PAYMENT FOR SERVICES
- 10.1 In consideration of the Contractor performing the Services and completing the assignment, Candle shall pay the Contractor the Fees as detailed in part 15 - Variable Conditions.
- 10.2 The Fees shall be paid by Candle provided that:
- (a) The Contractor keeps time sheets on a daily basis and submits these to the Client weekly for approval.
- (b) In respect of each two week period during the Assignment, the Contractor renders timesheets maintained by the Contractor and in a form approved by the Client; and
- (c) Such timesheets are to be received in Candle's office by the Monday of the week after the end of each fortnightly period. Timesheets received after this time will be processed and paid in the fortnightly payment cycle following their receipt.
- 10.3 Candle shall pay the Fees via Direct Deposit into the account nominated by the Contractor and set out in part 15 - Variable Conditions.
…
"
11. Once that particular engagement came to an end on 22 July 2005, Photocom continued to provide services, through Candle to the ultimate client, BankWest, for successive 13-week (or, on one occasion, 15-week) periods until 4 August 2006. Each of those periods ended on a Friday, with the next one starting on the following Monday. In this way, Photocom, and Mr Park, eventually provided services to Candle, and BankWest, for an uninterrupted period (with the exception of the four weekends just described) of 67 weeks, apparently on the same broad contractual terms as described in [9] above.
12. Then came a further engagement, once again through Candle, although this time the ultimate client was IBM in Sydney. This engagement was initially for 14 weeks, from 7 August 2006 to 10 November 2006, but again it was extended (with the customary interruption of a weekend), this time for two further periods of 17 weeks each, until 6 July 2007.
13. For the initial IBM engagement there is a second contract with Candle[2]
14. Throughout all these periods (in respect of both the BankWest work and the IBM work) Photocom and Candle had in place a "Recipient Created Tax Invoice (RCTI) Agreement", under which Candle, rather than Photocom, would generate the tax invoices for the services Photocom provided to Candle. Several examples of these RCTIs are before the Tribunal[3]
15. Mr Park sought to emphasise in his affidavit, and also in his oral evidence, that the purpose of his engagement by Candle was to produce a result for the client, namely BankWest or IBM. He repeatedly referred to the "output" of his work, to the "deliverables" that were specified by the client, and to the "outcome" sought by the client. But no amount of emphasis can overcome the fundamental shortcoming in the factual landscape: namely, that the income derived by Photocom was not "for producing a result".
16. The Tribunal said in
Re Taneja and Commissioner of Taxation [2009] AATA 87; (2009) 75 ATR 111 at 116 ([24]-[25]):
"… [I]n the context of s 87-18(3)(a) it is not how your fee is calculated, but what you are paid for, that is important. It is possible for a person who is contracted to produce a result to choose to charge hourly rates as the means of remuneration, without altering the fact that payment is made for producing a result. In saying this, we are mindful of the comment of Allsop J in IRG[4]
at [43] that the method of payment may be important - but there is nothing in what his Honour said to suggest that a fee based on time spent will necessarily exclude the possibility of being paid "for producing a result". IRG Technical Services Pty Ltd vDCT 2007 ATC 5326 ;(2007) 165 FCR 57 ;69 ATR 433 In the language of s 87-18(3)(a), the question is: What is the income for? And the answer to that question will depend on the income-earner's responsibilities to its clients; or, put another way, what does he have to do to satisfy the obligations he has under the agreement with the client, and to justify payment? …"
17. Here, as in Taneja, and as is confirmed by clause 10 of the Candle agreements and the RCTIs, the income was not for producing a result. It was for making Mr Park available to perform the role of a "Mainframe Developer" at BankWest and, later at IBM, a "Senior Analyst Programmer/MVS Developer". There is no evidence that any result was ever produced, or even that Photocom was required to produce one.
18. In his affidavit Mr Park also said:
- "24. I must emphasize that the method of hourly rate is based on the common practice of IT market and it is not negotiable factor on the engagement stage of contract agreement to revise it to a lump sum payment method. (Please refer the common practice of hourly rate or daily rate for IT market).
- 25. I, as the director of a sub-contracting company, had no authority or power to make any revision of payment method or timesheet recording based on the hourly rate against the standard of client's requirements in IT industry as a common practice and regulation of relevant parties."
19. Those statements appear to be directed towards s 87-18(4) of the Act, which provides:
"For the purposes of paragraph (1)(a), (b) or (c) or (3)(a), (b) or (c), regard is to be had to whether it is the custom or practice, when work of the kind in question is performed by an entity other than an employee:
- (a) for the *personal services income from the work to be for producing a result; and
- (b) for the entity to be required to supply the *plant and equipment, or tools of trade, needed to perform the work; and
- (c) for the entity to be liable for the cost of rectifying any defect in the work performed;
as the case requires."
20. However, as the Tribunal explained in Taneja at 116 ([22]-[23]):
"We agree with the Commissioner that the main purpose of s 87-18(4) is to act as a safety net for those individuals or entities who cannot point to a written agreement to establish that they have been paid "for producing a result": if the industry custom or practice is that people are engaged to produce a result, then that fact may support a conclusion that the particular individual or entity was paid for producing a result.
On the other hand, industry custom and practice (where, for example, it is uncommon for people's income to be for producing a result) cannot come to a person's aid where there is a written agreement specifying that the person is entitled to payment for doing something that does not amount to producing a result. To hold otherwise would remove, for an entire industry, the criterion in s 87-18(3)(a) as a necessary step in meeting the results test. That cannot have been the intention of the legislature."
21. I am satisfied that Photocom did not meet the results test in either of the relevant years. It follows, since that is the only personal services business test that the taxpayer relied on, that Photocom did not conduct a personal services business.
Can the amount of income attributed to Mr Park be reduced by certain rental expenses incurred?
22. While Photocom and Mr Park were engaged in the Candle/BankWest contract, Mr Park found accommodation in Perth. For an initial brief period he was in shared accommodation but then he decided to rent an apartment reasonably close to the BankWest premises. He was unable, he said, to lease an apartment for only three months and had to settle for a six-month commitment even though the BankWest contract originally covered only a three-month period. His family of a wife and two children remained in the family home in suburban Sydney. Mr Park travelled back and forth between Perth and Sydney "many times", he said, during the 15-month BankWest engagement.
23. The immediate question is whether Mr Park's personal services income can be reduced by the rental expense incurred in relation to the Perth apartment. Section 86-20(1) provides that the answer to that question depends on whether the rental expense is a deduction to which Photocom is entitled. That question, in turn, is affected by s 86-60 which provides relevantly as follows (notes omitted):
"A *personal services entity cannot deduct under this Act an amount to the extent that it relates to gaining or producing an individual's *personal services income, unless:
- (a) the individual could have deducted the amount under this Act if the circumstances giving rise to the entity's entitlement to deduct the amount had applied instead to the individual; or
- (b) the entity receives the individual's *personal services income in the course of conducting a *personal services business."
24. The final piece of the puzzle is s 85-15, which provides:
"You cannot deduct under this Act an amount of rent, mortgage interest, rates or land tax:
- (a) for some or all of your residence; or
- (b) for some or all of your *associate's residence;
to the extent that the amount relates to gaining or producing your *personal services income."
25. The question therefore becomes this: Would Mr Park have been entitled to a deduction if he himself had derived the income from Candle, and incurred the rent expense? The parties agree that this depends on the application of s 8-1, the general deduction provision, to those hypothetical circumstances.
26. Section 8-1 provides, as far as relevant (original emphasis, notes omitted):
- "(1) You can deduct from your assessable income any loss or outgoing to the extent that:
- (a) it is incurred in gaining or producing your assessable income; or
- (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
- (2) However, you cannot deduct a loss or outgoing under this section to the extent that:
…
- (b) it is a loss or outgoing of a private or domestic nature
…"
27. My initial impression, expressed to the parties during the hearing, was that only paragraph (a) of subsection (1) could be relevant to Mr Park's circumstances. I have given further consideration to the question and I still hold that view. It would be a curious outcome if Part 2-42 of the Act, designed as it is to attack practices by which income might be alienated and tax liabilities reduced through the use of entities that resemble businesses, nevertheless allowed the benefit of "business" deductions to individuals who are, and whose entities are, caught by the provisions in the first place.
28. In relation to s 8-1(1)(a), there is a useful brief summary of principles and reference to applicable authorities in the Commissioner's public ruling TR 98/9 (although the ruling is entitled "deductibility of self-education expenses" the following excerpts deal with general principles):
- 33. The High Court of Australia has indicated that the expenditure must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (
Lunney v. FC of T;
Hayley v. FC of T (1958) 100 CLR 478 at 497 498; (1958) 11 ATD 404 at 412). There must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of the assessable income (
Ronpibon Tin NL v. FC of T (1949) 78 CLR 47 at 56; (1949) 8 ATD 431 at 435).- 34. Consequently, it is necessary to determine the connection between the particular outgoing and the operations by which the taxpayer more directly gains or produces his or her assessable income (
Charles Moore & Co (WA) Pty Ltd v. FC of T (1956) 95 CLR 344 at 349-350; (1956) 11 ATD 147 at 148; (1956) 6 AITR 379 at 384;
FC of T v. Cooper 91 ATC 4396 at 4403; (1991) 21 ATR 1616 at 1624;
Roads and Traffic Authority of NSW v. FC of T 93 ATC 4508 at 4521; (1993) 26 ATR 76 at 91). Whether such a connection exists is a question of fact to be determined by reference to all the facts of the particular case.
29. More recently, a majority of the High Court (Gummow, Hayne, Heydon and Kiefel JJ) in
Commissioner of Taxation v Day [2008] HCA 53; (2008) 236 CLR 163 provided the following caution (at [29], 179):
"Reference in some cases to the expenditure having an "essential characteristic" must likewise be treated with some care. As Gaudron and Gummow JJ observed in [
Commissioner of Taxation v Payne 2001 ATC 4027; [2001] HCA 3; (2001) 202 CLR 93], the use of the term may avoid the evaluation which the section requires. It is perhaps better understood as a statement of conclusion than of reasoning."
30. Their Honours went on to explain (at [30], 179) that the question posed by s 8-1(1)(a) is: "is the occasion of the outgoing found in whatever is productive of actual or expected income?" That inquiry, their Honours said:
"will provide a surer guide to ascertaining whether a loss or expenditure has been 'incurred in [the course of] gaining or producing … assessable income'."
31. TR 98/9 specifically discusses accommodation and meal expenses, in the context of the exclusion in s 8-1(2)(b) for expenditure of a private or domestic nature. Although [89] is expressed to refer to self-education activity, the explanation clearly has broader application than that:
- 88. Expenditure on accommodation and meals ordinarily has the character of a private or domestic expense. However, the occasion of the outgoing may operate to give the expenditure the essential character of an income-producing expense. An example is where the expenditure is incurred while away from home overnight on a work-related activity (
Case E34 5 TBRD (NS) 205 at 211; 4 CTBR (NS)
Case 99 at 587;
FC of T v. Cooper 91 ATC 4396 at 4415; (1991) 21 ATR 1616 at 1638;
Roads and Traffic Authority of NSW v. FC of T 93 ATC 4508 at 4521; (1993) 26 ATR 76 at 92).- 89. Where a taxpayer is away from home overnight in connection with a self-education activity, accommodation and meals expenses incurred are deductible under section 8-1. (Examples include an overseas study tour or sabbatical, a work-related conference or seminar or attending an educational institution.) They are part of the necessary cost of participating in the tour or attending the conference, the seminar or the educational institution. We do not consider such expenditure to be of a private nature because its occasion is the taxpayer's travel away from home on income-producing activities.
- 90. However, we believe that comments by Hill J in the Roads and Traffic Authority of NSW support our view that there may be exceptions to the general rule outlined in the previous paragraph. The case raised issues concerning the application of fringe benefits tax where workers required to camp at the work site, were paid a camping allowance. It was necessary for his Honour to consider whether expenditure on meals in the circumstances would have been deductible under section 8-1. In considering the question he stated (
93 ATC at 4523; 26 ATD at 94 and 95) that:'An employee who had no private home and was employed indefinitely to work at a particular site and did in fact work for the whole of his employment at that site, might be said to have chosen to live at the site so that the cost of his accommodation there would be private.'
- 91. In our opinion, the same principle applies when a taxpayer establishes a new home. In these circumstances, expenditure on meals and accommodation is private or domestic in nature and therefore not allowable under section 8-1.
- 92. Generally, it is obvious where a taxpayer's home is located. For example, if a taxpayer lives with her spouse and children in Sydney and travels to Melbourne for a 10-day seminar, her home remains in Sydney. Alternatively, if she sold the family home in Sydney and moved with the family to Harvard (USA) to do a two-year business course, her home would now be in Harvard.
When is a new home established?
- 93. The key factors to be taken into account in determining whether a new home has been established include:
- • the total duration of the travel;
- • whether the taxpayer stays in one place or moves frequently from place to place;
- • the nature of the accommodation, e.g., hotel, motel, long term accommodation;
- • whether the taxpayer is accompanied by his or her family;
- • whether the taxpayer is maintaining a home at the previous location while away. The fact that the taxpayer did not maintain a home while away for an extended period was the decisive factor in characterising expenditure on accommodation and meals as private 'living expenses' in a series of Board of Review decisions: Case N13 13 TBRD (NS) 45; 10 CTBR (NS) Case 98; Case N16 13 TBRD (NS) 65; 10 CTBR (NS) Case 99; Case N19 13 TBRD (NS) 76; Case N20 13 TBRD (NS) 79; and
- • the frequency and duration of return trips to the previous location.
32. I am satisfied on the basis of the authorities referred to in [28]-[30] above and the factors mentioned in [88]-[93] of TR 98/9 (see [31] above) that Mr Park would be entitled to a deduction in respect of the rent expenses paid for the Perth apartment. This is on the basis that the "occasion" of the expenditure is found in the income-producing activities conducted under the contractual arrangement with Candle, and it is not expenditure of a private or domestic nature. It is significant that Mr Park's family did not move to Perth with him, and it is also significant that (as I infer from the evidence) the home in Sydney was being maintained throughout his period in Perth. Against him, perhaps, is the length of his stay in Perth, but that needs to be viewed in light of his initial commitment to provide services for only 13 weeks, and the fact that, although he could not have known this at the time, the period was subsequently extended on several occasions.
33. The remaining question is whether the Perth apartment was his "residence" during the relevant period, because if it was, then s 85-15 will operate to reverse the s 8-1 outcome, with the result that Mr Park cannot reduce his personal services income by the rent amount.
34. The Commissioner points me to the Macquarie Dictionary definition of "residence", as follows:
- "1. the place, especially the house, in which one resides; dwelling place; dwelling.
- 2. a large house.
- 3. the act or fact of residing.
- 4. the time during which one resides in a place."
35. Definitions 2, 3 and 4 are not relevant here, but nor, in my opinion, are the second or third elements in definition 1. We are not concerned here with the question whether the Perth apartment is a residence, but whether it was Mr Park's residence. Only the first element of definition 1 can be relevant to that question.
36. The question whether the Perth apartment was Mr Park's residence is closely linked to the question whether his rent expense was of a private or domestic nature. To that extent the factors set out in [93] of TR 98/9 are relevant here as well.
37. The Commissioner submits that Mr Park "resided" in the Perth apartment throughout the period, but in my view the better way to characterise the arrangement is that he "stayed" there. Mr Park regarded his residence as the family home in Sydney, and on balance I agree with him. I am satisfied that the Perth apartment was not Mr Park's residence, and there should be a consequent reduction in the amount of income attributed to him.
What about the living away from home allowance?
38. Mr Park contends that Photocom paid him a living away from home allowance (LAFHA) while he was in Perth. However, the evidence does not support that contention.
39. Exhibit A5 of a bundle of documents filed by Mr Park shows various "ledger entries" labelled "Paid by Photocom" in a spreadsheet headed "Account - LAFHA" for the period 1 July 2005 to 2 August 2006. For the most part those entries correspond to debit entries in Photocom's business bank account statements. But they are irregular, and they are not for consistent amounts. Mr Park was not able, in his oral evidence, to displace the impression that those amounts are simply withdrawals that he made from Photocom's account when he needed money. In fact he agreed with Mr Miller's characterisation of the arrangement as one in which Mr Park simply took money out of the company account and used it to live on.
40. I am not satisfied that Photocom paid Mr Park a living away from home allowance while he was in Perth and so his contention that his income should be reduced on this basis must be rejected.
Administrative Penalty
41. Administrative penalty was imposed under Division 284 in Schedule 1 to the Taxation Administration Act 1953 (TAA), at the rate of 25% of the shortfall amount. That 25% rate applies in circumstances where a taxpayer or his or her agent fails to take reasonable care to comply with a taxation law. The penalty may be remitted wholly or in part under s 298-20 in Schedule 1.
42. I find that the failure to include Mr Park's personal services income in his tax returns was a consequence of the failure of Mr Park himself, or his tax agent, to take reasonable care to comply with a taxation law. I am not satisfied on the material before me that there are grounds to remit that penalty to any extent. Of course, notwithstanding that finding, the quantum of administrative penalty will be reduced as a consequence of the conclusion I have reached in relation to the rent expense in Perth and the concessions made by the Commissioner.
Shortfall Interest Charge
43. This charge is imposed under Division 280 in Schedule 1 to the TAA, essentially in recognition of the fact that tax payable to the Commissioner as a result of an amendment to an assessment has not been paid. It may be remitted under s 280-160 "if the Commissioner considers it fair and reasonable to do so", and under s 280-170 a taxpayer may object in the manner set out in Part IVC of the TAA against an adverse remission decision, but only if the amount not remitted is more than 20% of the additional amount of tax payable.
44. In respect of the 2007 year Mr Miller informed the Tribunal that the amount not remitted is less than 20% of the additional amount of tax payable, and on that basis the Tribunal has no jurisdiction to review the remission decision.
45. In respect of the 2006 year there should be no further remission of the charge since Mr Park has not satisfied me that there are grounds on which further remission would be "fair and reasonable".
Decision
46. The objection decision in respect of each year is set aside and instead the Tribunal decides:
- 1. The Applicant's objection is to be allowed in part to take into account the Tribunal's conclusion in relation to the rent paid on the Perth apartment and those matters the subject of the Respondent's concession referred to in [6] of the Tribunal's reasons for decision, but is otherwise affirmed.
- 2. The quantum, but not the rate, of administrative penalty is reduced as a consequence of 1.
- 3. There is to be no remission of the resulting administrative penalty amount.
- 4. There is to be no further remission of shortfall interest charge in relation to the 2006 year.
47. The Tribunal has no jurisdiction to consider whether the shortfall interest charge in relation to the 2007 year should be remitted.
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