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Ruling

Subject: Personal Services Income & Interest on Money Borrowed to pay Income Tax

Question:

Whether the amounts received from a State Government entity through a partnership arrangement are personal services income?

Answer:

Yes

Whether the requirements of the unrelated clients test and 80% rule were met?

Answer:

Yes

For the 2010-11 financial year can you claim a deduction for the interest expenses on your loan to pay your income tax liabilities?

Answer:

Yes

For the 2010-11 financial year can you claim a deduction for the interest expenses on your loan to pay your income tax liabilities?

Answer:

Yes

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You are a medical specialist. You have been employed/contracted by an arm of a State Government for many years. You, along with other specialists, entered into successive partnership contracts (the contract) with a State Government entity. A copy of the current contract has been supplied; the previous contract has the same terms. The partnership contract is in line with industrial relations policies of the State Government entity.

Under the contract the State Government entity agreed to grant the specialists the right to engage in limited private practice on the terms set out in the contract. The specialists pay fees under the contract which cover administration, debt collection and the use of facilities.

Under the contract you treat your own private patients and receive remuneration which is paid to you less the contracted fees.

The following information was provided with respect to the partnership contract between you, the other specialists and the State Government entity:

· There is no partnership agreement.

· There is no partnership capital.

· There are no partnership accounts.

· There is no partnership bank account.

· There are no employees of the partnership.

Fees are collected and disbursed through a State Government entity trust account.

An uncollected fee, that is bad debts in respect of a patient, reduce the income of the individual specialist who treated the particular patient.

The partnership has no tax file number or Australian Business Number, nor does the partnership lodge Business Activity Statements (BAS).

Each specialist receives a net amount being the gross income they have generated by their efforts less fees charged by the State Government entity. Specialists are paid over the entire net fee i.e. if Good and Services Tax (GST) has been charged, the specialist is given an amount including the GST and accounts for any GST liability themself on their individual quarterly BAS.

Equipment used is the State Government entity's and is provided under the arrangement

Patients are patients of the specialist

You state that the partnership is not a business structure nor is the partnership a partnership under taxation law, as amongst other things income is received individually by the respective persons identified as partners. The partnership is constituted by contract in line with industrial relations policies of the State Government entity.

A substantial income is generated from the provision of medical services.

You are holding out your availability to the general public in line with usual practice of medical specialists and have a large number of patients.

You borrowed money to pay the tax liability resulting from your practice for the 2009-10 financial year in the 2010-11 financial year. You wish to know if you can claim the interest on the money you borrowed to pay your tax liability.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 84-5

Income Tax Assessment Act 1997 section 87-20

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

You seek a ruling on whether the requirements of unrelated clients test in the personal services income legislation are met.

Unrelated clients test

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

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

a) 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

b) 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.

2) 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.

Associates

Whether two entities or individuals are associated within the meaning of section 318 of the Income Tax Assessment Act 1936 (ITAA 1936) is a matter of fact. However, where the fact of that association is not known or could not reasonably be expected to be known to a contractor, the clients will be treated as unrelated.

Direct result

The term direct result requires a traceable and substantive connection between the offer to the public (or a section of the public) and the engagement for the work.

What is meant by making offers or invitations?

Making an offer or invitation to the public in general or to a section of the public is an indication by the individual or personal services entity of their willingness to perform services for anyone within a group or class of persons or to any member of the public. The intention of the individual or personal services entity in such activity is to attract or solicit members of the public to enter into agreements for their services. Relevant activities, such as advertising, points to the commerciality and independence of the enterprise conducted by the individual or the personal services entity. Advertising and similar activities are factors that point to the existence of a genuine business.

An invitation is the mechanism by which an individual or personal services entity holds out to or informs the public or a section of the public the services that the individual or personal services entity is able to provide. An invitation may be made in written or spoken form.

Advertising is an example of making an offer or invitation to the public given in the legislation. Other types of activities or actions that are considered to be making offers or invitations in this context include:

· public tender;

· maintaining an Internet web site on which the availability of services are advertised; and

· word of mouth offers.

What is meant by to the public or a section of the public?

An offer or invitation is made to the public at large where any interested member of the public is capable of accepting it. An offer or invitation to a section of the public is made in situations where only a select group is chosen to whom the invitation is made. Making an offer or invitation to a section of the public could include offering to provide services to one entity for example in relation to competitive tenders.

For the purpose of the unrelated clients test, where there is a prior or subsisting relationship between the parties to an offer or invitation, the following factors are relevant when determining whether the offer or invitation is made to a section of the public:

The number of persons or entities to which the offer or invitation is made. While not determinative, it is likely to be a public offer or invitation if more entities are involved;

The nature and content of the offer or invitation. Where the offer or invitation is made as part of a competitive commercial process, such as a public tender, a prior relationship may not detract from the offer being made to the public;

The nature of the particular relationship between the parties to the offer or invitation. Where the parties to the relationship deal with each other on an arm's length basis, the commercial character of the transaction is maintained. Accordingly, the fact that an individual or personal services entity may have worked for/provided services to an entity sometime in the past does not necessarily operate to exclude the individual or personal services entity from satisfying this test.

Your case

In the 2009-10 and 2010-11 financial years you had many clients none of whom represented more than 80% of your personal services income. Your services are available to the general public in line with the normal practice of medical specialists.

Summary

You meet the unrelated clients test the 2009-10 and 2010-11 financial years as you have two or more clients that were obtained by making offers or invitations to the public or section of the public.

Interest on Borrowings to pay Income Tax

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or necessarily incurred in carrying on a business to gain or produce assessable income except where the outgoings are of a capital, private or domestic nature.

Taxation Ruling IT 2582 Deductibility of interest incurred on moneys borrowed to pay income tax states that the interest incurred on moneys borrowed to pay income tax will be deductible provided that the taxpayer is carrying on a business for the purpose of gaining or producing assessable income and, in connection with the carrying on of that business, the taxpayer borrows money to pay income tax.

While IT 2582 has a reference to companies carrying on a business, the same approach is applicable to an individual carrying on a business as a sole trader. The fact that the same approach is applicable is outlined in ATO ID 2006/269. Deductions and Expenses: interest incurred on moneys borrowed by a sole trader to pay income tax

Your circumstances

You are in receipt of a substantial income from a specialist medical practice under a partnership contract. The facts show that the partnership is not a partnership under taxation law, as amongst other things income is received individually by the respective persons identified as partners. The partnership is constituted by contract in line with industrial relations policies of the State Government entity.

As you are not a partner under tax legislation, the income is received as an individual conducting a professional practice as a sole trader. Equipment, facilities and administration services are obtained under the partnership contract.

You wish to claim a deduction for interest incurred to pay the tax on the income generated by the professional practice.

You a have incurred an interest expense in the 2010-11 financial year to pay a tax liability arising from the profession that you carry on as a sole trader. In your circumstances you are entitled to a deduction under section 8-1 of the ITAA 1997 for the interest incurred on moneys borrowed to pay your income tax.

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