Edited version of private ruling

Authorisation Number: 1011511715228

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Ruling

Subject: Personal Services Income

Question 1

Is the income personal services income?

Answer

Yes

Question 2

Whether income generated under the proposed arrangement meets the requirements of the results test?

Answer

No.

Question 3

Whether the proposed arrangement meets the requirements of the business premises test?

Answer

No.

Question 4

Whether the proposed arrangement meets the requirements of the unrelated clients tests and 80% rule?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You have applied in relation to the services you propose to provide as a specialist through an interposed entity.

You are qualified in a profession.

You have an opportunity to contract your services to a professional firm.

The scheme or arrangement would be as follows:

- Your entity would be paid a share of commissions based upon the amount of revenue generated from the client base.

- No individual client would represent a substantial percentage of the total income.

- The income would be a share of commissions and service fees paid by clients who you would be providing services to.

- Your entity would rent an office, on an arms length basis, in the premises of the professional firm from where you would conduct your business activities.

- The clients to whom services would be provided are unrelated - they are individuals and businesses who have sought advice from the professional firm or you.

- The professional indemnity insurance for the professional firm's clients would be held by the professional firm and not you or your entity.

- You would provide the tools and equipment required; these are a laptop and a mobile phone.

- In addition to servicing the professional firm's clients you could have your own clients but you are aiming to be occupied full time with the professional firm's clients.

- You state that you expect that your proposed scheme of arrangement would satisfy the results test, the 80% rule as well as the unrelated clients and business premises test.

You advise that you would be

You will act with the authority of the professional firm.

Authorised to represent the professional firm and the services group

Payment would be dependant on commissions or fees based upon your performance.

You would canvas for clients on behalf of the professional firm

You would pay an arms length rate for the use of premises supplied by the professional firm.

Relevant legislative provisions

Income Tax Assessment Act 1997 84-5

Income Tax Assessment Act 1997 87-18(3)

Income Tax Assessment Act 1997 87-20

Income Tax Assessment Act 1997 87-30

Income Tax Assessment Act 1997 87-40

Reasons for decision

Personal Services Income

The measure contained in Divisions 84 to 87 of the Income Tax Assessment Act 1997 (ITAA 1997) only applies if a taxpayer has income that is personal services income (of an individual). The definition refers to income (including ordinary income or statutory income of any entity) that is mainly a reward for an individual's personal efforts or skills. Subsection 84-5(3) of the ITAA 1997 extends the definition of personal services income to income that is for doing work or for producing a result. The result must be produced from the individual's personal efforts or skills.

You stated that the personal services work undertaken by you is in a particular area.

Based on the information provided, the Commissioner is satisfied that your entities income from services is mainly a reward for your personal efforts or skills and is therefore personal services income.

Results Test

The results test as specified in subsection 87-18(3) of the ITAA 1997 provides:

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:

the income is for producing a result; and

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

the personal services entity is, or would be, liable for the cost of rectifying any defect in the work performed.

In considering the results test, regard must be had to the custom or practice as specified in subsection 87-18(4) of the ITAA 1997 which states:

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:

- for the personal services income from the work to be for producing a result; and

- for the entity to be required to supply the plant and equipment, or tools of trade, needed to perform the work; and

- for the entity to be liable for the cost of rectifying any defect in the work performed;

- as the case requires.

Requirement that 75% of the income meets the results test

You state that you expect more than 75% of your entities income to be from the arrangement with the professional firm. Consequently, an analysis of the arrangement with that will determine whether the results test is met.

Producing a result

To satisfy the first condition for the results test the personal services income must be for producing a result. The meaning of the phrase 'producing a result' means the performance of a service by one party for another where the first-mentioned party is free to employ his/her own means (ie., third party labour, plant and equipment etc) to achieve the contractually specified outcome. The essence of the contract has to be to achieve a result and not to do work.

The consideration often is a fixed sum on completion of the particular job as opposed to an amount paid by reference to hours worked.

The Explanatory Memorandum to the Alienation of Personal Services Income Act 2000 provides:

The individual must actually be paid on the basis of achieving a result, rather than for example, for hours worked. (paragraph 1.114)

If remuneration is payable when, and only when, the contractual conditions have been fulfilled, the remuneration is for producing a given result.

Where there is a contract, regard should be had to its true essence and the circumstances surrounding the formation of the contract may be of assistance to determine the true character of the contract. Having regard to the true essence of the contract, the manner in which payment is structured will not of itself exclude genuine result based contracts. For example, there are results based contracts where the contract price is based on an estimate of the time and labour cost that is necessary to complete the task, or may even be calculated on that basis, subject to reasonable completion times.

You stated that the outcome to be achieved by you is the production of specialist plans. Remuneration is by way of fees or commissions based on plans or funds invested by clients, these are dependent upon you producing plans and clients investing funds based upon your recommendations.

The information provided shows that you were paid for achieving a result.

Accordingly you satisfy the requirements of paragraph 87-18(3)(a) of the ITAA 1997.

Required to supply the plant and equipment, or tools of trade, needed to perform the work

The second condition for the results test is that the individual or the personal services entity is required to supply the plant and equipment or tools of trade, needed to perform the work that produces the result.

Having regard to the custom and practice in relation to particular work there may be an expectation that a genuine independent contractor would be required to supply the plant and equipment or tools of trade necessary to perform the work. Where such an expectation exists, or where the contractual arrangements require the supply of necessary equipment or tools, such equipment or tools have to be supplied in order to meet the 'results test'.

The plant and equipment or tools of trade that may be required to be provided are those that are necessary to do the actual work that the individual or the personal services entity is contractually required to perform. This is to be distinguished from those circumstances where a service acquirer provides plant and equipment that are not needed by the individual or the personal services entity to perform the work.

There are situations where, having regard to the custom and practice of the work, or the practical circumstances and nature of the work, no plant or equipment or tools of trade are necessary to perform the work from which the individual or personal services entity produces the result. If no equipment or tools are needed the provision will always be met in these circumstances.

You stated that the main tools and equipment used are a laptop and mobile phone which you will supply.

The information provided shows that you were required to supply the plant and equipment or tools of trade needed to perform the work which produces the result.

Accordingly paragraph 87-18(3)(b) of the ITAA 1997 is satisfied.

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

The third condition for the results test requires that the individual or the personal services entity is or would be liable for the cost of rectifying any defect in the work performed.

The emphasis here is on 'liability for the cost' of rectifying faulty work. That is, the key underlying consideration is whether the individual or entity is exposed to commercial risk in terms of a liability to cover the cost of rectifying defective work. This is consistent with the focus on 'the chance of profit and the risk of loss' as a traditional indicator that a taxpayer is an independent contractor conducting their own business.

It is only the cost of rectification of their defective work that must be met by the individual or entity. There is no requirement that the individual or entity actually perform the work which rectifies the defect so long as they pay for it. Nor does it matter whether the relevant exposure to a liability for the cost of defective work arises before or after payment by the service acquirer or delivery of the result.

The existence of a term in an agreement that the individual or personal services entity is liable for the cost of rectifying any defect in the work performed would support the conclusion that liability to make good any faulty workmanship exists, particularly where the individual or personal services entity and the service acquirer are dealing with each other at arm's length. However, the term in the agreement should not be merely 'window dressing', and regard may be had to all the circumstances of the case in determining whether the relevant liability really exists.

You stated that for your work under the arrangement with the professional firm would be covered by professional indemnity insurance that is held by the professional firm.

Information provided shows that you would not be liable for the costs of rectifying defects, as evidenced by the fact that the professional indemnity insurance would be held by the professional firm and not by you.

The information provided shows that you are not liable for the cost of rectifying any defects in the work performed under the professional firm arrangement.

The Commissioner is therefore not satisfied that you meet the requirements of paragraph 87-18(3)(c) of the ITAA 1997.

Summary

As all the conditions in paragraphs 87-18(3)(a)-(c) of the ITAA 1997 are not satisfied you are not eligible for a personal services business determination on the basis of the results test.

Further information on the results test can be found in Taxation Ruling 2001/8 Income tax: what is a personal services business and on our website at ato.gov.au.

Business Premises Test

The business premises test as set down in section 87-30 of the ITAA 1997 provides:

(1) An individual or a personal services entity meets the business premises test in an income year if, at all times during the income year, the individual or entity maintains and uses business premises:

(a) at which the individual or entity mainly conducts activities from which personal services income is gained or produced; and

(b) of which the individual or entity has exclusive use; and

(c) that are physically separate from any premises that the individual or entity, or any associate of the individual or entity, uses for private purposes; and

(d) that are physically separate from the premises of the entity to which the individual or entity provides services and from the premises of any associate of the entity to which the individual or entity provides services.

(2) The individual or entity need not maintain and use the same business premises throughout the income year.

All of the conditions must be met for the business premises test to be satisfied.

Business Premises

The requirement is that the individual or personal services entity has business premises at which the individual or entity conducts income earning activities.

The inclusion of paragraph 87-30(1)(a) of the ITAA 1997 suggests that the adjective business adds more to the word premises than just the notion of a place where business is carried on. Rather, to give it meaning in the context of section 87-30 of the ITAA 1997 which includes paragraph 87-30(1)(a) of the ITAA 1997, it is arguable that it describes premises which have the usual physical attributes and fixtures associated with commercial or business usage.

The Commissioner takes the view that the critical distinction between business premises and other premises is that, viewed from a business and commercial perspective, business premises must be apt for carrying on a business.

Physically separate

The business premises have to be physically separate from any premises used for private purposes of the individual, the personal services entity or an associate of the individual or entity.

The business premises also have to be physically separate from the premises of the any entity that you provide services too.

You provide services to the professional firm by servicing their clients at their premises.

As you operate at the premises of an entity to which you provide services you are not able to meet the requirements of the business premises test because of 87-30(1)(d) of the ITAA 1997. This is so regardless of whether you provide services to other clients at the premises.

Accordingly you do not meet the requirements of the business premises test.

Agents test and unrelated clients test

The unrelated clients test as set out in section 87-20 of the ITAA 1997 provides:

An individual or a personal services entity meets the unrelated clients test in an income year if:

- 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

- the services are provided as a direct result of the individual or the 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.

The individual or personal services entity is not treated, for the purposes of paragraph (1)(b), as having made offers or invitations to provide services merely by being available to provide the services through an entity that conducts a business of arranging for persons to provide services directly for clients of the entity.

You will meet the unrelated clients test in an income year if you have personal services income from two or more clients which are not associated with each other or with you, where those clients are obtained through offers to the public.

Agents test

Section 87-40 of the ITAA 1997 modifies the operation of the 80% rule and unrelated clients test for certain agents. The provisions of the section are:

The object of this section is to modify the operation of this Division for agents who bear entrepreneurial risk in the way they provide services.

Subsection 87-15(3) and section 87-20 apply, in the manner specified in this section, to an individual or personal services entity if:

- the individual or personal services entity is an agent of another entity (the principal) but not the principal's employee; and

- the agent receives income from the principal that is for services that the agent provides to other entities (customers) on the principal's behalf; and

- at least 75% of that income is commissions, or fees, based on the agent's performance in providing services to the customers on the principal's behalf; and

- the agent actively seeks other entities to whom the agent could provide services on the principal's behalf; and

- the agent does not provide any services to the customers, on the principal's behalf, using premises:

- that the principal or an associate of the principal owns; or

- in which the principal or an associate of the principal has a leasehold interest;

- unless the agent uses the premises under an arrangement entered into at arm's length.

If the agent is an individual, in applying subsection 87-15(3) to the personal services income of the agent during an income year, any part of the agent's personal services income from the principal that:

- the agent gains or produces during the income year; and

- is for services that the agent provided to a customer on the principal's behalf in the income year or an earlier income year;

- is treated as if it were personal services income from the customer, and not personal services income from the principal.

If the agent is a personal services entity, in applying subsection 87-15(3) to an individual's personal services income that is included in the entity's ordinary income or statutory income during an income year, any part of the individual's personal services income from the principal that:

- the agent gains or produces during the income year; and

- is for services that the individual or the agent provided to a customer on the principal's behalf in the income year or an earlier income year;

- is treated as if it were personal services income from the customer, and not personal services income from the principal.

In determining whether, during an income year, the agent meets the unrelated clients test under section 87-20, any services the agent provided in the income year or an earlier income year:

- for which the agent gains or produces, during the income year, personal services income from the principal; and

- that were provided to a customer on the principal's behalf;

- are treated for the purposes of paragraph 87-20(1)(a) as if the agent, and not the principal, provided them to the customer.

Agent has its ordinary meaning of acting for or representing another. A common law agent has an authority or capacity to create or affect legal relations between a principal and third parties. Generally speaking, what a person may do themself, the person may do by an agent.

The information provided shows that the arrangement will be that:

- You will act with the authority of the professional firm.

- You will receive income from the professional firm for plans and commissions on products sold by you to the principal's clients.

- At least 75% of your income will be fees or commissions based on providing services to the principal's clients.

- You will actively seek customers on behalf of the principal.

- You will use premises supplied by the principal under an arrangement entered into at arms length.

Therefore subsection 87-40(2) of the ITAA 1997 is satisfied and you will meet the unrelated clients test under section 87-20 of the ITAA 1997 and the 80% rule under subsection 87-15(3) of the ITAA 1997 on the basis of the agents test in the 2011 income year.

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