Edited version of private ruling

Authorisation Number: 1011589601344

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Ruling

Subject: Income Derivation

1. Is the income from the foreign contract considered to be that of the Company although payments were received into your individual bank account?

Yes, the income is deemed to be derived by the Company as all contracts and invoices were addressed to the Company, although you used your individual personal account to facilitate the transactions.

2. Can you defer the net income received by the Company on XXXXX until the following 2008-09 income year in total or at least in part?

No. All transactions are accounted for using the receipts method.

3. Can you calculate the total profit from this payment and proportion it across the two financial years 2006-07 and 2007-08 on a profits emerging basis?

No. All transactions are accounted for using the receipts method.

This ruling applies for the following periods:

Year ended 30 June 2008

Year ended 30 June 2009

We considered these to be the relevant facts

You are an Australian resident for tax purposes.

You have degree qualifications relating to the Company's business activity.

You purchased a franchise which required you set up a private company, which was incorporated in 2005. This business was not successful and you sold back the franchise at a considerable loss, which left you the corporate shell. A corporate bank account exists.

You used the Company for your business activity which was already registered for Goods and Services Tax (GST), Income Tax Withholding (ITW) and (Income Tax Instalments (ITI) paid quarterly. You are the sole director and public officer of the Company.

The Company was awarded a large contract with a foreign organisation to furnish overseas offices. The contract and invoices were issued under the name of the Company. The Company does not provide a credit facility to the client, therefore the client paid in advance for the procurements of furniture etc based on your estimates. You operate the business on a receipts basis, consistent with the Company's GST reporting obligations.

The invoices clearly stated payments be made directly into your individual bank account held in Australia and overseas, as most of the project expenditure was made using your personal credit card.

You did not solely and exclusively provide your qualified services to your Company as you were also an employee of an Australian employer in a management role.

The Company did not rely wholly on your personal skills and expertise in providing your services. The Company procured items from independent manufacturers, and hired subcontractors as required.

You provided your own home office facilities such as computer terminals, design software, printers, phones and so on to undertake day to day business activities necessary to produce the desired results.

The Company is wholly liable for the cost of rectifying any defective work or unsatisfactory services.

The Company was engaged in contracts for more than one client, in addition to the foreign contract it had an Australian contract which commenced in 2007. These contracts were obtained via referrals from prior experience and similar projects undertaken when you were a foreign resident, and selection panels.

The Company's consultancy fees for these contracts excluded GST (not applicable) or similar taxes; travel, subsistence costs and disbursements which are in accordance with per diem expenses and travel regulations; and reimbursement costs for printing and document preparation.

For each client, the Company provided the services with assistance from subcontractors. You engaged independent consultants, numerous manufacturers and suppliers. All contractual arrangements were verbal. Consultants and subcontractors were paid on an hourly basis. You estimate about 25% of the work was undertaken by consultants and subcontractors. You provided copies of invoices you have received from consultants.

You conducted your business from your home office. As it is not used exclusively for business purposes you have no intention of claiming for mortgage interest or council rates and so on as tax deductions. You do not undertake work at the client's offices which are located in interstate and overseas. You travel extensively to the overseas sites to undertake supervision.

With reference to your foreign contract, you have provided income amounts including dates deposits were made into your account, and related project expenses paid from your account including the details of such payments. The consultancy fee was paid in a foreign currency into your Australian bank account.

Documents provided by you:

Copy of the foreign contract with fee proposal excluding local taxes for goods and services (not applicable), travel and subsistence costs and disbursements which are in accordance with per diem expenses and travel regulations. Reimbursable costs include printing and document preparation costs. Cost of site visits excluding per diem expenses.

Copy of your resume detailing your qualifications, experience and consultancy work on government and commercial projects.

Referral from a previous contract manager regarding your performance and successful completion of the project.

Tax Invoices from subcontractor A addressed to the Company regarding the foreign contract totalling AUD$ excluding GST.

Tax Invoices from the Company addressed to the foreign organisation to be paid into your individual bank account.

Transaction details of procurement expenses.

Copy of Australian contract with fee proposal excluding GST (not applicable), travel and subsistence, and document preparation and printing costs.

Tax Invoices from subcontractor B addressed to the Company regarding the foreign contract totalling AUD$ excluding GST.

Profit and Loss Statements for the 2006-07, 2007-08 and 2008-09 income years showing net profits respectively.

Balance sheets for the 2006-07, 2007-08 and 2008-09 income years showing net assets respectively.

A detailed General Ledger for the 2006-07, 2007-08 and 2008-09 income years showing dates and amounts of advance payments from the foreign organisation and the procurement fees associated with these payments.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 2-42 Section 84-5

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Subsection 995-1

Income Tax Assessment Act 1936 Subsection 262A(1)

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Issue 1

Question 1

Income from personal services is income that an individual taxpayer earns predominantly as a direct reward for his or her personal efforts by, for example, the provision of services, exercise of skills or the application of labour.

Whether a taxpayer derives income from rendering personal services is a question of fact and degree to be determined in the circumstances of each case. The crucial issue is the extent of the connection between the income concerned and the services rendered by the particular taxpayer involved.

Section 84-5 of Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997) states your ordinary or statutory income, or the ordinary 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). Only individuals can have personal services income. This applies whether the income is for doing work or is for producing a result. 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.

Taxation Ruling TR 2001/7 explains the meaning of personal services income contained in Division 84 of Part 2-42 of the ITAA 1997 (the alienation measure).

This ruling applies to:

· individuals whose ordinary income or statutory income includes income that is mainly a reward for their personal efforts or skills, and

· companies, partnerships or trusts whose ordinary or statutory income includes income that is mainly a reward for the personal efforts or skills of an individual (an individual's personal services income). Such entities are called personal service entities.

The alienation measure only applies to income earned mainly from the provision of an individual's labour or skills (personal services income) rather than being generated by the use of assets, the sale of goods, the granting of a right to use property or by a business structure.

By definition, income earned by an employee is personal services income. However, the measure does not apply to employees, except where an individual is an employee of an interposed entity.

The alienation measure will not apply where the income is earned in the course of conducting a personal services business. The meaning of personal services business is explained in Taxation Ruling TR 2001/8.

You will not be within the alienation measure and can self-assess accordingly if you come within one of the following four situations:

You satisfy the 'results test', that is:

(a) You work to produce a result(s); and

(b) You provide the tools and equipment necessary (if any) to produce the result(s); and

(c) You are liable for the cost of rectifying any defective work.

or

None of your clients pay you 80% or more of your personal services income in the year of income and you have two or more unrelated clients (who were obtained as a result of you making offers to the public at large or to a section of the public).

or

None of your clients pay you 80% or more of your personal services income in the year of income and

(d) You engage an individual(s) or an unrelated entity(ies) to perform 20% or more (by market value) of the principal work (ie the work that generates the personal services income) or

(e) You have an apprentice for at least half the year

or

None of your clients pay you 80% or more of your personal services income in the year of income, and you exclusively use business premises that are physically separate from your home, or from the premises of the person for whom you are working.

If the alienation measure applies to an individual or a personal services entity, the amount of the personal services income is included in the assessable income of the individual whose personal efforts or skills generate the income; the individual or personal services entity will not be able to claim certain deductions; and a personal services entity may also have additional withholding obligations in relation to personal services income that is attributed to an individual under the alienation measure.

Note that the general anti-avoidance provisions of Part IVA of the ITAA 1936 may still apply to cases of alienation of personal services income that fall outside the alienation measure.

Application to your circumstances

Individual

As an individual you are not considered to have derived personal services income from providing your qualified skills.

You satisfied the test where none of your clients paid you 80% or more of your personal services income. Your main source of income was derived as an employee of an Australian employer.

Accordingly, the alienation measure does not apply to you. The income derived by your Company under a contract with an independent party at arm's length is not assessable to you as an individual.

Company

A company can not have personal services income.

As the individual is deemed not to have derived personal services income, the alienation measure does not apply to the company. The income derived by the Company under a contract with an independent party at arm's length is assessable only to the Company under the self assessment provisions.

Questions 2 and 3

Under subsections 6-5(2) and (3) of the ITAA 1997 taxpayers must include in assessable income the gross income derived.

Two commonly used methods for determining when income is derived in a relevant year of income are the receipts methods and the earnings method. Taxation Ruling TR 98/1 discusses the factors that are relevant in determining when each method is the correct method to bring income to account for tax purposes. A method of accounting is appropriate if it gives a substantially correct reflex of income.

For many taxpayers the income they derive in a year is the income received in that year which is the receipts or cash accounting method. For other taxpayers the income they derive in a year is the income they earned in that year which is the earnings or accruals accounting method.

Paragraph 29 of TR 98/1 states the appropriateness of the accounting method used by a taxpayer is the sole test for determining which method of accounting should be used.

A taxpayer who accounts for items of income on a receipts basis should continue to adopt that method until it is no longer appropriate, for instance if the business expands or becomes involved in trading or manufacturing, then the earnings method of accounting is more appropriate.

Paragraph 39 of TR 98/1 states the factors that mitigate against the receipts method being appropriate for business income of a company include the commercial and accounting principles and practices governing accounts kept by companies generally require the accruals method of bookkeeping; and a company generally relies upon employees; it is not able to provide personal services.

Paragraph 52 of TR 98/1 further states that many taxpayers derive business income that is not clearly covered by the trading or non-trading distinction. It indicates the earnings method should be used, except in those circumstances where it is an '... artificial, unreal and unreasonably burdensome method of arriving at the income derived'.

Subsection 262A(1) of the ITAA 1936 does not prescribe the books of account that a taxpayer carrying on a business must keep. All that is required is that the records kept '... record and explain all transactions and other acts'.

Application to your circumstances

Individual

This question does not apply to you as you did not derive the income in question.

Company

It is accepted that you would find the earnings method an artificial, unreal and unreasonably burdensome method for arriving at the income derived. The particular circumstances that, on balance, would indicate this are:

You are the sole owner and employee of the Company, with subcontractors hired to perform work for the completion of projects.

No substantial credit is given or relied on by the Company.

You have kept accounts on a receipts basis for GST reporting purposes such as Business Activity Statements (BAS).

The Company has no trading stock nor substantial fixed and circulating capital.

The amount of AUD$ which was paid to the Company is income derived under the receipts accounting method, therefore it is assessable in the 2007-08 income year, and cannot be deferred to the 2008-09 income year in which it was expended. All expenses incurred in relation to the above-mentioned income are derived when it is paid, and is deductible in the income year that it is paid. Therefore, the net business profit or loss for the income year is determined on the basis that the derived income is assessable and the expenses are deductible for that income year.

Accordingly, the total profit resulting from this contract cannot be proportioned across the two financial years 2006-07 and 2007-08 on a profits emerging basis.

Further issues for you to consider

If further business expansion is expected with gaining substantial contracts in future, under TR 98/1 it is suggested that the receipts method will cease to be appropriate and consideration be made to transition to the accruals method of accounting.

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