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Ruling

Subject: PAYG Withholding

Question 1

Does A Ltd have an obligation to withhold and remit PAYG withholding in respect of payments described as "management services" provided by B Pty Ltd to A Ltd, under subdivision 12-B of the Taxation Administration Act 1953 (TAA 1953)?

Summary

Yes. A Ltd is required to withhold pay as you go tax to the extent the payment to B Pty Ltd relates to management services provided by X and Y.

This ruling applies for the following periods:

· Year ending 30 June 2010

· Year ending 30 June 2011

The scheme commenced on

1/09/2009

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.

Relevant facts

· B Pty Ltd entered into a loan agreement and management services agreement with A Ltd. The agreement was made orally between X as a Director of B Pty Ltd and a director of A Ltd.

· X was one of a number of directors of A Ltd and was also a full time senior executive of A Ltd for the entire duration that he was paid the management fee pursuant to the management services agreement.

· For the duration of the management services agreement of approximately 3 years, X was not paid salary or wages for his/her services as a senior executive of A Ltd other than for a small, insignificant amount for one of the financial years. Y was engaged as bookkeeper for the duration of the management services agreement and was not paid salary or wages by A Ltd during this period.

· The management services agreement was entered into to provide management services to A Ltd and it was agreed that A Ltd would pay the cost of management services so provided on a running account and on terms that would include:

· that the rent of premises would be paid for by A Ltd;

· no management fee would be payable for a period of approximately 1 year;

· the agreement included amounts payable for both X and Y per annum including GST; and

· the management fees would be payable on demand.

· B Pty Ltd and A Holdings Pty Ltd as vendor and C Ltd purchaser entered into a Share Purchase Deed for the acquisition of 100% of share capital of A Ltd. This resulted in the sale of A Ltd.

· Just prior to the takeover, X and Y were engaged by A Ltd under an employment contract basis and paid salary and wages to perform the same roles as they were engaged under the management services agreement.

· A Deed of Termination and Release was entered into between A Ltd, B Pty Ltd, X and Y agreeing to terminate the management services agreement. In addition it was agreed that Y's employment contract recognise all leave and other entitlements accrued during his/her employment with B Pty Ltd.

· The management services agreement also required that A Ltd pay all moneys owing to B Pty Ltd and that such payments be made in the ordinary course of business.

· As at the time of the Private Ruling application and further information request, A Ltd had not paid B Pty Ltd any of the above loan or management service fee amounts.

Assumptions

· The services provided by X under the management services agreement were the same services as were provided by X in his/her role as a senior executive of A Ltd.

· The services provided by Y under the management services agreement were also the same services that were required to be fulfilled in the role of bookkeeper of A Ltd as described in the employment contract.

Relevant legislative provisions

Subdivision 12-B of the Taxation Administration Act 1953 (TAA 1953)

Section 12-35 of the ITAA 1953

Section 12-1 of the ITAA 1953

Reasons for decision

Subdivision 12-B of the Taxation Administration Act 1953 (TAA 1953) provides for various sections which require that an entity withhold an amount from certain payments as outlined.

Relevantly in this situation, section 12-35, Payment to employees, states:

"An entity must withhold an amount from salary, wages, commission, bonuses or allowances it pays to an individual as an employee (whether of that entity or another entity)."

The exceptions are provided for in section 12-1, however none of these apply to the payments in this situation.

The TAA 1953 does not define the term "employee" for the purposes of section 12-35 and therefore it takes its ordinary meaning: paragraph 6 of Taxation Ruling TR 2005/16 - Income tax: Pay As You Go - withholding from payments to employees (TR 2005/16).

TR 2005/16 provides in paragraphs 57 to 61 that whilst section 12-35 of the TAA 1953 relates to payments to individuals, section 12-35 can also apply where a payment is made to a company, which then makes payment to an employee. Paragraph 57 to 61 states:

Payments made to persons other than individuals

57. Section 12-35 of Schedule 1 to the TAA 1953 applies to payments made to individuals in their capacity as employees. It does not apply to payments made to other entities - provided the arrangement is not a sham or a mere redirection of an employee's salary or wages.

58. A sham is an arrangement that creates the appearance of rights and obligations different from those actual rights and obligations that the parties intend to create. The parties must have a common intention that the arrangement is a mere facade, disguise or false front for a sham arrangement to exist.

59. A redirection occurs where for example a payment is made to a third party in discharge of the obligation to pay an amount of salary or wages to an employee. For example, where the payer pays an employee's salary into a bank account at the direction of the employee.

60. Also, a payment to a third party is treated as a redirection of an employee's salary or wages (and hence a constructive payment of salary or wages to the employee) in circumstances where the payment to the third party is attributable to salary, wages etc for services rendered by the employee in the course of that employment.

61. In Southern Group Ltd v. Smith the Full Court of the Western Australian Supreme Court considered an arrangement whereby an individual's remuneration as managing director of a public company was paid to the individual's private company. Making payments to the individual's private company was a continuation of the practice required under an earlier short term consultancy contract between the two companies. The Full Court found that the individual's appointment as managing director was as an employee, and the payments to the individual's private company were made under an administrative practice. In circumstances such as this, there would be a constructive payment of salary or wages to the employee.

The terms of the management services agreement according to the Statement of Claim by X provided that both X and Y would provide management services on behalf of B Pty Ltd to A Ltd.

Employee

Broadly, whether a person is an employee of another person or an entity is a question of fact to be determined by examining the terms and circumstances of the contractual arrangement between the parties. This, in turn, involves the examination of a range of common law indicators as expressed in relevant case law. Of these indicators, there is no one indicator of itself that is determinative of that relationship. The totality of the relationship between the parties must be considered.

Paragraph 17 of the TR 2005/16 states:

The relationship between an employer and employee is a contractual one. It is often referred to as a contract of service. Such a relationship is typically contrasted with the principal/independent contractor relationship that is referred to as a contract for services. An independent contractor typically contracts to achieve a result whereas an employee contracts to provide their labour (typically to enable the employer to achieve a result).

Terms and circumstances of the formation of the contract

While it is important to consider all the terms and conditions of the contract between the parties to determine the nature of contractual relationship, the true substance of the relationship, i.e., the underlying reality of the relationship must be considered.

In the present case, there is little information known about the management services agreement due to the fact that the agreement was made orally and that the A Ltd representatives that entered into the contract are no longer available to provide further information as to the nature of the contract. That said, the key features of the agreement were:

· that X was engaged to provide management services akin to such services that would be provided by a senior executive and Y was engaged to provide administrative and bookkeeping services;

· the rent of premises would be payable by A Ltd under the agreement; and

· in addition to the supply of management services, the agreement provided A Ltd with a credit arrangement for the payment of the management services fees for a period of at least 1 year.

The above terms including the fact that the services provided would be akin to such services provided by employees and also the fact that A Ltd was to provide Mr X and Ms Y with premises in which to carry out their work indicate that the terms were more akin to the provision of services to A Ltd.

Control

Paragraph 26 of the TR 2005/16 states:

The classic 'test' for determining the nature of the relationship between a person who engages another to perform work and the person so engaged is the degree of control which the former can exercise over the latter. A common law employee is told not only what work is to be done, but how and where it is to be done.

However, in paragraph 28 of the TR 2005/16:

The mere fact that a contract may specify in details how the contracted services are to be performed does not necessarily imply an employment relationship. In fact, a high degree of direction and control is not uncommon in contracts for services. The payer has a right to specify how the contracted services are to be performed, but such control must be expressed in the terms of the contract; otherwise the contractor is free to exercise their discretion (subject to any terms implied by law). This is because the contractor is working for themselves.

In the current circumstances, X could not exercise control over the work he did due to the fact that X as one of a number of directors was accountable to the other directors and shareholders and therefore could not exercise complete control over the work that was carried out under the management services agreement.

Does the worker operate on their own account or in the business of the payer?

In Marshall v Whittaker's Building Supply Co (1963) 109 CLR 210, Windeyer J stated:

… the distinction between an employee and independent contractor is rooted fundamentally in the difference between a person who serves his employer in his, the employer's business, and a person who carries on a trade or business of his own.

Similarly in respect of control, X could not have operated on his own account, rather he operated as a representative of the A Ltd business.

Results contracts

Where the substance of a contract is to achieve a specified result, there is a strong, but not conclusive, indication that the contract is one for service: paragraph 35 of TR 2005/16. The TR 2005/16 cites the case World Book (Australia) Pty Ltd v FC of T, 92 ATC 4327, where Sheller JA held that:

Undertaking the production of a given result has been considered to be a mark, if not the mark, of an independent contractor.

Whilst it is not known whether X was contracted under the management services agreement to provide a result, based on the fact that he/she carried out work consistent with a senior executive and his/her remuneration was fixed and not determinative based on a certain result, it is can be concluded that A Ltd and X did not enter the management services agreement to provide a result, rather the agreement was one of service.

Furthermore the remuneration payable under the management services agreement for X's services was based on a per annum pro rata rate, which whilst not determinative, indicates that the contract was not entered into to provide a result. Likewise this was the case with Y as well.

Whether the work can be delegated or subcontracted

The power to delegate or subcontract is a significant factor in deciding whether a worker is an employee or independent contractor: paragraph 41 of TR 2005/16. If an individual has unlimited power to delegate the work to others, it is a strong indication that the person is engaged as an independent contractor: paragraph 2005/16.

In the current scenario, there is no evidence that the work completed under the management services agreement could be delegated or subcontracted or in fact was delegated or subcontracted.

Risk

Paragraph 44 of TR 2005/16 states:

Where the worker bears little or no risk of the costs arising out of injury or defect in carrying out their work, he or she is more likely to be an employee. On the other hand, an independent contractor bears the commercial risk and responsibility for any poor workmanship or injury sustained in the performance of work. An independent contractor often carries their own insurance and indemnity policies.

There is no evidence to suggest that X and Y took responsibility for any risk arising from injury or defect in carrying out their work. This is also consistent with the fact that they were not paid for a result, but rather paid on a per year pro rata basis, regardless of injury or defective work.

Provision of tools and equipment and payment of business expenses

The provision of assets, equipment and tools by an individual and the incurring of expenses and other overheads is an indicator that the individual is an independent contractor: paragraph 45 of TR 2005/16.

However, provision of necessary tools and equipment is not necessarily inconsistent with an employment relationship. It will depend on the particular circumstances and the context and nature of the contractual work: paragraphs 48-49 of TR 2005/16.

As outlined above, the rent for the premises was provided by A Ltd which is an indicator that the management services agreement was more akin to an employment arrangement.

There is no evidence of whether any other assets, equipment or tools were used or provided by X and Y in carrying out their work, however it is reasonable that in their role as a senior executive and book keeper, that they may have utilised equipment such as computers etc. Even if such equipment was provided by X or Y, this would not be determinative of whether there was an employee/employer relationship or not based on the fact that any contributions of such equipment would have been more incidental to the provision of the individuals labour.

Conclusion

The payment of management fees by A Ltd to B Pty Ltd is considered a redirection of payments of salary and wages to X and Y, in accordance with paragraph 59 and 60 of TR 2005/16. In other words, the management fees payable to B Pty Ltd are attributable to salary and wages for services provided by X and Y.

When considering the above common law tests including the terms and circumstances of the formation of the contract, control, whether the person operates on their own account, whether they are required to fulfil a result, whether the work can be subcontracted, who bears the risk and who provides the tools and equipment, it can be concluded that the relationship between both X and Y and A Ltd is one of employee/employer.

Therefore pursuant to section 12-35 of the TAA 1953, A Ltd must withhold an amount from the payment of management fees that relate to management services provided by X and Y.

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