Edited version of private ruling

Authorisation Number: 1011511962741

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Ruling

Subject: Personal Services Income

Question 1

Whether the income is personal services income?

Answer

Yes.

Question 2

Whether the results test is met or could reasonably be expected to be met?

Answer

Yes.

Question 3

Whether the income is required to be included in your personal return as a result of the personal services income attribution rules?

Answer

No.

This ruling applies for the following period<s>:

Year ending 30 June 2008

Year ending 30 June 2009

The scheme commences on:

1 July 2007

Relevant facts

You seek a ruling on whether the commission income received by an entity from the successful sales as a result of your efforts meets the requirements of the results test and therefore is not required to be included in your personal income by the attribution rules in the personal services income provisions.

You state that payment by way of commission is made only once a sale is concluded, no other payment is received and no payment is received for unsuccessful sales.

You state that no tools and equipment are required to perform the contractual requirements.

You state that the entity is responsible for fixing any problems.

You have supplied a copy of the contract under which the income is generated.

Relevant clauses in the contract provide as follows.

An indemnity is given by the entity covering breaches of requirements of authorities resulting from undertaking the agreement.

Remuneration is payable on a commission basis and only paid for successful sales.

The entity is responsible for providing all equipment and materials required to undertake the agreement.

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 individuals 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.

The services provided are marketing services.

Based on the information provided, the Commissioner is satisfied that the income of the entity from the marketing activities undertaken by you is mainly a reward for your personal efforts or skills and is therefore personal services income.

You seek a ruling on whether the income you generate for the entity meets the requirements of the results test and therefore would not be required to be included in your personal income by the attribution rules in the personal services income provisions.

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.

The results test is based on the traditional criteria for distinguishing independent contractors from employees. Accordingly, there is significant overlap and the totality of the relationship between the parties will be relevant as to whether the contract is properly to be construed as one for the production of a result.

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.

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

In a contract for a result payment must be contingent upon the achievement of a contractually required outcome. Payment to an independent contractor is often based upon performance of the contract rather than being paid an hourly rate, piece rates or award rates.

Information supplied shows that the entity is paid a commission dependent upon successful sales, no other payment is received and no payment is received for unsuccessful sales. The entity is contractually entitled to payment only upon the achievement of a result, in the form of sales made.

Payment on a commission only basis is consistent with a results based contract.

Based on the information provided remuneration is only payable when the result contracted for has been achieved.

Therefore the requirements of paragraph 87-18(3)(a) of the ITAA 1997 are met.

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 you are 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 you are contractually required to perform. This is to be distinguished from those circumstances where a service acquirer provides plant and equipment that are not needed to perform the work. For example, the construction, by a builder, of scaffolding at a large, commercial building site does not result in carpenters, who use that scaffolding in getting to that part of the site where they do their work, failing the second condition. Whilst the scaffolding permits them to have access to the particular part of the site where they do their work, it would not constitute plant and equipment needed by them to do their particular 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 you produce the result. If no equipment or tools are needed the provision will always be met in these circumstances.

You state that no tools and equipment are required to perform the contractual requirements; the contract provided states that if tools or equipment were needed that the entity would be required to provide them.

As outlined above where no tools and equipment are required that this provision will always be met.

It is considered that you as there are no tools and equipment needed to perform the contract that the requirements of paragraph 87-18(3)(b) of the ITAA 1997 are met.

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.

Paragraph 87-18(3)(c) of the ITAA 1997 make it a requirement of the results test that you must meet the costs associated with rectifying the defect. It is only the cost of rectification of their defective work that must be met by you. There is no requirement that you 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 you are 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 you and the service acquirer are dealing with each other at arms 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.

The phrase rectifying any defect literally means to put right any fault or imperfection. Clearly, not all work is capable of rectification if that phrase is given its narrow literal meaning. It is arguable on this narrow view that if the work is not capable of rectification then the results test cannot be passed.

The Macquarie Dictionary definition of rectify includes to remedy which can mean legal redress or the legal means of enforcing a right or redressing a wrong. Consequently, being liable to rectify the cost of any defect could be inclusive of a rectification achieved by the acquirer of the services pursuing a legal remedy for damages, in circumstances where the defect is incapable of physical repair.

You state that the entity is responsible for fixing any problems. An indemnity is given by the entity covering breaches of requirements of authorities resulting from undertaking the agreement.

The Commissioner is therefore satisfied that you are or would be liable for the cost of rectifying any defect in the work performed.

Accordingly the requirements of paragraph 87-18(3)(c) of the ITAA 1997 are met.

Summary

As all the conditions in paragraphs 87-18(3)(a)-(c) of the ITAA 1997 are satisfied the personal services income of the entity generated by your efforts meets the requirements of the results test and would not be required to be attributed under the personal services income provisions.

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