Edited version of private ruling

Authorisation Number: 1011824284936

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Ruling

Subject: Personal Services Income

Questions

Is the income personal services income?

Are you conducting a personal services business on the basis that the results test is passed?

Under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) should you be assessed for tax purposes on a receipts (cash) basis for the years ended 30 June 2012, 30 June 2013 and 30 June 2014.

Answers

Is the income personal services income?

Yes.

Are you conducting a personal services business on the basis that the results test is passed?

Yes.

Under subsection 6-5(2) of the ITAA 1997 should you be assessed for tax purposes on a receipts (cash) basis for the years ended 30 June 2012, 30 June 2013 and 30 June 2014.

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

1 July 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

A company (you) has applied for a Private Binding Ruling for the 2011-12, 2012-13 and 2013-14 financial years.

You have applied in relation to the personal services income an individual generates through you by the provision of the individual's professional services.

The scheme or arrangement is as follows:

You will provide the professional services using the individual's professional expertise.

You will charge out for the provision of the individual's services on a fixed price basis, having provided a quote to a prospective client previously. Clients of yours who accept the quote will contract for the quoted services to be provided for a fixed price. The services quoted for would be an identified outcome rather than time based charging.

You will provide the tools and equipment needed to produce the work contracted for.

You will be liable for the costs of rectifying defects in the work performed. You state that the potential liability for faulty work is very high.

You will derive income from a number of clients and it is expected that no client will represent more than 80% of the personal services income generated.

The individual will be the only person engaged by the company.

Consumables used in providing the professional services will be a small percentage of the amount of income generated.

You will have a modest turnover from the provision of the professional services and have a small amount of circulating capital.

Relevant legislative provisions

Income Tax Assessment Act 1997 6-5(2),
Income Tax Assessment Act 1997 84-5,
Income Tax Assessment Act 1997 86-15(3) and
Income Tax Assessment Act 1997 86-18(3).

Reasons for decision

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.

The services provided are professional services.

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

You seek a ruling on whether the income generated meets the requirements of the results test and is therefore income from conducting a Personal Services Business.

Income is required to be attributed to an individual unless it is from a personal services entity conducting a personal services business (subsection 86-15(3) of the ITAA 1997). A personal services business is conducted when the entity has a Personal Services Business Determination in force or passes one of the four personal services tests (Subdivision 87-A of the ITAA 1997).

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:

(a) the income is for producing a result; and

(b) 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

(c) 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:

(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.

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 you are paid a fixed amount for providing professional services that are contracted for on the basis of accepted quotes. Payment is only made based on completed work, no other payment is payable under the contract. You are contractually entitled to payment only upon the achievement of a result, in the form of the completed professional services.

Payment on the basis of completed work 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 you provide the tools and equipment needed to perform the contracted work.

Information provided shows that you are contractually required to provide the tools and equipment required to perform the work that produces the result.

It is considered 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 makes 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 the 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 you 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 you are financially liable for the cost of rectifying defects in the work performed and that the liability is potentially very large.

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),(b) and (c) of the ITAA 1997 are satisfied your income generated by the efforts of the individual meets the requirements of the results test and would not be required to be attributed under the personal services income provisions.

As the requirements of the results test are met you are taken to be conducting a personal services business.

Method of Returning Income

You seek a ruling on whether you should return the ordinary income you derive on a receipts (cash) basis or on an earnings basis.

Sub-section 6-5(2) of the ITAA 1997 requires Australian resident taxpayers to include in their assessable income ordinary income derived directly or indirectly from all sources, whether in or out of Australia.

Taxpayers must adopt the method of accounting which provides the 'substantially correct reflex' of income. Taxpayers cannot elect to adopt whichever method that they prefer.

Taxation Ruling TR 98/1 Income Tax: determination of income; receipts versus earnings (TR 98/1) lists a number of factors that are useful in determining whether the receipts (cash) basis method or the earnings (accruals) method is the appropriate method. The factors include whether the entity is a corporate entity, whether the income is trading income, the size of the business, whether the entity relies on circulating capital or consumables to produce income, whether the entity relies on capital items such as plant and machinery to produce income, whether the entity readily gives credit and what method was used in the books of account.

TR 98/1 at paragraph 39 says that usually the earnings method is normally appropriate for companies, except where it would be artificial, unreal and unreasonably burdensome.

In the present case, you are a corporate entity with a modest turnover from providing personal services, have no employees, provide the services of one associated person and make a limited number of sales in a year of income. Your application states that you have a limited amount of circulating capital employed, reflecting that the level of consumables and debtors is small.

In these circumstances, in particular, having regard to the modest turnover, the limited circulating capital employed and the fact that the business conducted involves one person's professional services being provided, it is considered that the 'substantially correct reflex' of income is derived by adopting the receipts (cash) method of accounting. These factors outweigh the consideration that companies would be expected to use the earnings method to bring income to account.

Accordingly, you must adopt the receipts (cash) method.

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