Edited version of your private ruling

Authorisation Number: 1012601073556

Ruling

Subject: Personal Services Income

Question 1

Is the income derived by the trust in an income year the personal services income of the taxpayer within the meaning of section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is the income derived by the trust in an income year the personal services income of the taxpayer within the meaning of section 84-5 of the ITAA 1997?

Answer

No, however if the taxpayer has entered into an arrangement where the main purpose is to obtain a tax benefit, the anti-avoidance rules under Part IVA of ITAA 1936 may apply.

Relevant facts and circumstances

The taxpayer operates a business in the mining industry through a trust structure.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 Division 84

Income Tax Assessment Act 1997 Division 85

Income Tax Assessment Act 1997 Division 86

Income Tax Assessment Act 1997 Division 87

Reasons for decision

Part 2-42 of the ITAA 1997 (the alienation measures in divisions 84 to 87) contains a special tax regime for personal services income. Personal services income is defined in subsection 84-5(1) of the ITAA 1997 and it states that:

'Your ordinary or statutory income, or the ordinary or statutory income of another entity, is PSI if the income is mainly a reward for their personal efforts or skill (or would mainly be such a reward if it was their income.'

The alienation measures only apply 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. Examples of personal services income include income payable under a contract which is wholly or principally for the labour or services of a person and income derived by a consultant from the exercise of his professional expertise.

Only an individual can have personal services income (subsection 84-5(2) of the ITAA 1997). An interposed entity such as a trust cannot have personal services income, even though it might contractually be entitled to receive the relevant payments. Subsection 84-5(3) of the ITAA 1997 extends the definition of personal services income to income that is for doing work or producing a result. The result must be produced from the individual's personal efforts or skills. The fact that income is payable under a contract does not prevent the income being mainly a reward for an individual's personal efforts or skills (subsection 84-5(4) of the ITAA 1997).

An individual or personal services entity that is conducting a personal services business falls outside the alienation services income rules in Division 85 and 86 of the ITAA 1997. A personal services business exists if there is a personal services business determination in place or one of the four personal service business tests are met (section 87-15 of the ITAA 1997).

You will not be within the alienation measures if you come within one of the following:

• 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 (subsection 87-18(1) of the ITAA 1997)

Or

• None of your clients pay you 80% or more of your personal services income in the year 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) (section 87-20 of the ITAA 1997).

Or

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

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

b) You have an apprentice for at least half the year (section 87-25 of the ITAA 1997)

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 (section 87-30 of the ITAA 1997).

Personal services business tests

Part 2-42 of the ITAA 1997 does not apply to individuals or entities conducting a personal services business (PSB). Subsection 87-15(2) of the ITAA 1997 specify that:

The four personal services business tests are:

a) The results test under section 87-18;

b) The unrelated clients test under section 87-20;

c) The employment test under section 87-25; ad

d) The business premises test under section 87-30.

However under subsection 87-15(3) of the ITAA 1997, if:

• 80% or more of an individual's personal services income is income from the same entity, and

• That income is not included in the income of a personal services entity, and

• The individual does not meet the results test; or

• That income is included in the income of a personal services entity but the individual does not meet the results tests;

then that income is not taken to be conducting a personal services business unless a personal services business determination is in place.

Under subsection 87-15(3) of the ITAA 1997, the personal services business tests, apart from the results test under section 87-18 of the ITAA 1997, do not apply if 80% or more of your personal services income is from source.

The Results Test

The results test in subsection 87-18(1) of the ITAA 1997 contains three conditions that must be met by the individual. These conditions must be met in relation to at least 75% of the personal services income earned during the income year. Similarly subsection 87-18(3) contains the same three conditions that must be met by the personal services entity in relation to at least 75% of the personal services income personal services income that is included in the entity's ordinary or statutory income during the income year.

The results test therefore must be met by this personal services entity in the relevant income years in relation to your personal services income. The results test as specified in subsection 87-18(3) of the ITAA 1997 contains three conditions that must be met. These conditions must be met in relation to at least 75% of your personal services income earned during the income year.

The 'results test' will be met where:

a) The contract is to produce a specified outcome or result and payment is based on performance of the contract (i.e for producing the outcome or result); and

b) The personal services entity provides the equipment and tools, if any, necessary for doing work; and

c) The personal services entity bears the commercial risks, including liability for defective work.

Working to produce a result entails having a contract to produce a specified outcome or result and payment being based on performance of that specified outcome. The Explanatory Memorandum¹ states at paragraph 1.114:

'An individual will not satisfy the test… merely because the contract states that the personal services income is for producing a result. The individual must actually be paid on the basis of achieving a result, rather than, for example, for hours worked. For example, a management consultant's contract requires the consultant to produce a report but he or she is paid according to the hours worked, not as a result of a price agreed to be paid for the report. The consultant will not satisfy this condition.'

Taxation Ruling TR 2001/8² at paragraph 110 states that the 'results test' is based on the traditional criteria for distinguishing independent contractors from employees. Taxation Ruling TR 2005/16³ provides guidance on the distinction between an individual as an employee and individual as a contractor. Paragraph 36 states:

'The phrase 'the production of a given result' means the performance of a service by one party for another where the first-mentioned party is free to employ their own means (such as third party labour, plant and equipment) to achieve the contractually specified outcome. Satisfactory completion of the specified services is the 'result' for which the parties have bargained. The consideration is often 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 usually made for producing a given result.⁴ '

Further at paragraph 39:

'While the notion of 'payment for a result' is expected in a contract for services, it is not necessarily inconsistent with a contract of service. The High Court in FC of T v. Barrett & Ors⁵ found that land salesmen who were engaged by a firm of land agents to find purchasers for land entrusted to the firm for sale and who were remunerated by commission only were employees and not independent contractors. Likewise the High Court in Hollis v. Vabu⁶ considered that payment to the bicycle couriers per delivery, rather than per time period engaged, was a natural means to remunerate employees whose sole purpose is to perform deliveries. Further, the Full Court of the Supreme Court of South Australia in Roy Morgan⁷ found that interviewers who were only paid on the completion of each assignment, not on an hourly basis, were employees and not independent contractors.'

In IRG Technical Services Pty Ltd and Another v DC of T⁸ the entities involved were a company and a family trust, each of which was controlled by a (different) qualified engineer. The income of each entity included the personal services income of the engineer who controlled it. The entities separately contracted with a labour hire firm to provide engineering services to a joint venture of construction companies involved in a construction project. The labour hire firm contracted with the joint venture to provide engineering and other services. The joint venture paid the labour hire firm for the services of the engineers and the labour hire firm then paid the entities in accordance with their contracts with the labour hire firm. The use of a labour hire firm was standard practice for the relevant industry in WA.

The entities' contracts with the labour firm provided that payment for work done by the engineers was calculated at a 'unit price' up to a maximum sum per fortnight which appeared to reflect a payment for results. The joint venture made fortnightly payments to the labour hire firm based on timesheets of the engineers and a standard 45 hour working week. The engineers worked as part of an integrated team with other staff and contract engineers to produce documents which were necessary for construction of the relevant infrastructure. The contracts with the labour hire firm purported to require the entities to provide laptops for the engineers. However the joint venture provided all equipment, office space, computers and software and essential templates for the work of the engineers. The work of the engineers was performed for and overseen by the joint venture. The work was done in consultation with peers and supervisors.

In assessing each of the three results tests the Federal Court concluded:

• It is the substance and not the form of the circumstances surrounding the relationship of the individual whose exertions produce the personal services income and the party who acquires or receives the services which is of primary importance. The contracts between the engineers and the labour hire firm assisted in but were not determinative in assessing the three tests;

• The reformulation of the relevant contracts in terms of deliverables did not change the substance of the work required into the production of results;

• The income of the engineers was not for producing a result but to work as part of a team and to provide their services as skilled engineers;

• The engagements were for the performance of work as skilled engineers in the business of the joint venture for which they were remunerated at an hourly rate.

In Cooper v. FC of T the taxpayer was an IT consultant and project manager. He and his wife were directors of a company which entered into agreements with a labour hire firm. The agreements provided that the company would engage the taxpayer to provide professional services to the labour hire firm and its clients. The agreements set out terms including the remuneration rate to be paid, that the taxpayer must attend the labour hire clients' premises and how the labour hire firm should be invoiced and how the agreement should be terminated. No specific tasks were identified in the agreements. For the relevant years the company provided the taxpayer's services to only one client of the labour hire firm. The issue before the AAT was whether the company was a conducting a personal services business or whether the taxpayer was properly assessable on the income earned by the company in the relevant income years.

The AAT held that the remuneration the company received from the labour hire firm was not for producing a result. Factors relevant to this conclusion included:

• Relevant agreements did not identify any result;

• The company was not remunerated for producing any result;

• The remuneration the company received under the terms of the relevant agreement was not in any way dependent on producing a result;

The relevant agreement did not confer any freedom on the company to delegate or subcontract the professional business services

Based on the information provided by the taxpayer, it is apparent that the income received is for the performance of work/services rather than for producing a result. Therefore, the trust does not meet the first condition of the results test in relation to all of the taxpayer's personal services income. As a result the trust fails to meet the results test.

If the taxpayer does not pass the results test, they need to apply an additional rule, called the 80% rule, to work out if 80% or more of their income comes from one client. If 80% or more of their personal services income is from one source then the personal services income rules will apply to their personal services income.

Question 1

Answer

After following the relevant tests, the personal services income is to be attributed to the taxpayer after reducing it by any deductions that are allowable and not specifically denied or limited under subdivision 86-B of the ITAA 1997.

Question 2

Answer

After following the relevant tests, the personal services income of the taxpayer does not need to be attributed wholly to the taxpayer, however if they have entered into an arrangement where the main purpose is to obtain a tax benefit, the anti-avoidance provisions of Part IVA of the ITAA 1936 may apply.

¹ The Explanatory Memorandum to the New Business Tax System (Alienation of Personal Services Income) Bill 2000

² Taxation Ruling TR 2001/8 Income tax: what is a personal services business

³ Taxation ruling TR 2005/16 Income tax: pay As You Go - withholding from payment to employees

⁴ Neal (Deputy Commissioner of Taxation) v. Atlas Products (Vic) Proprietary Limited (1955) 94 CLR 419 at 424-425.2er

⁵ 73 ATC 4147 at 4153

⁶ (2001) 207 CLR 21 at 44.

⁷ [2004] SASC 288.

⁸ [2007] FCA 1867

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