Edited version of your written advice

Authorisation Number: 1013114173966

Date of advice: 27 October 2016

Ruling

Subject: Personal Services Income

Question 1

Does the Company A earn income from mainly for providing services?

Answer

Yes

Question 2

Is the income of Company A generated from a business structure?

Answer

No

Question 3

Is Company A an agent of Company R?

Answer

Yes

Question 4

Is the income personal services income of you?

Answer

Yes

Question 5

Is Company A a personal services entity?

Answer

Yes

Question 6

Will Company A meet the results test in respect of you?

Answer

Yes

Question 7

Will Company A be considered to be a personal services business?

Answer

Yes

This ruling applies for the following periods:

1 January 20YY to 30 June 20YY

The scheme commences on:

1 January 20YY

Relevant facts and circumstances

You are a salesperson.

You are currently employed by Company R on a commission only basis.

You will set up Company A. As a shareholder you will be the principal of Company A.

Due to State Government regulations (the regulations) the income of Company A needs to be channelled through Company R who will be the Principal agency for the purposes of the regulations.

You have made enquiries under the relevant state (State) legislation and it is possible for you to operate through a company, if the company fulfils certain conditions.

You will enter into a co-agency agreement with Company R where they will “conjunct” with you on sales. A “conjunct” agreement is entered into for each sale and is initiated by the vendor when signing up for the sale. Under the “conjunct” agreement the commission income received on these sales will be split x% to Company A and x% to Company R.

Under State industry rules only one Licensee is to be listed. All payments need to go into and out of the Licensee's trust account. As a result Company A will need to bill the Company R for its share of the Commission.

In the future Company A will employ sales and administration staff in its own right under the Independent Contractors agreement. However, initially you will be the only employee of Company A.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 2-42

Income Tax Assessment Act 1997 Section 84-5

Income Tax Assessment Act 1997 Subsection 86-15(1)

Income Tax Assessment Act 1997 Subsection 84-5(1)

Income Tax Assessment Act 1997 Subsection 86-15(2)

Income Tax Assessment Act 1997 Division 87

Income Tax Assessment Act 1997 Subsection 87-18(3)

Income Tax Assessment Act 1997 Subsection 87-18(4)

Income Tax Assessment Act 1997 Section 87-15

Income Tax Assessment Act 1997 Subsection 87-15(2)

Income Tax Assessment Act 1997 Section 87-18

Income Tax Assessment Act 1997 Section 87-40

Income Tax Assessment Act 1997 Paragraph 87-40(2)(a)

Reasons for decision

Summary

You will pass the results test, therefore the personal services income rules will not apply to you.

The Personal services income law in Part 2-42 of the ITAA 1997 will not apply to attribute Company A's income to you.

Detailed reasoning

Does Company A earn income from mainly for providing services?

Company A will earn its income from mainly providing services.

Company A will provide employees who use their knowledge and skills to perform the required duties. Initially, you will be the only employee.

Is the income from the Company A generated from a business structure?

Section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997) defines the personal services income of an individual as being income which is mainly a reward for that person's personal efforts or skills; or would mainly be such a reward if it was their income.

Only individuals can have personal services income.

A personal services entity is a company, partnership or trust whose ordinary or statutory income includes the personal services income of one or more individuals (subsection 86-15(2) of the ITAA 1997).

If income is classified as personal services income, the individual or personal services entity will be subject to the personal services income alienation rules unless a personal services business determination is in force or the individual or entity meets at least one of the four personal services business tests (Division 87 of the ITAA 1997).

Where the personal services income rules apply 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 (subsection 86-15(1) of the ITAA 1997).

Personal services income is to be distinguished from income that is mainly from any of the following:

● the use of assets (for example, a semi-trailer or bulldozer)

● the sale of assets (for example, trading stock)

● a business structure.

The Commissioner's view on what constitutes personal services income is contained in Taxation Ruling TR 2001/7 Income tax: the meaning of personal services income (TR 2001/7).

Where income is derived by a firm or practice which has substantial income producing assets, or many employees or both, the income is more likely to be generated by the profit-yielding structure of the business rather than from the rendering of personal services.

The distinction between income that is mainly a reward for personal efforts or skills of individuals and income from a business structure will need to be made having regard to factors such as:

● the number of arm's length employees or others engaged to perform work

● the existence of goodwill

● the extent to which income-producing assets are used to derive the income

● the nature of the activities carried out

● the size of the operation and

● The extent to which the income is dependent upon a particular individual's own personal skills, efforts or expertise.

The fact that services are performed through an entity does not automatically mean there is a business structure for the purposes of the PSI legislation. The factors listed above must be applied to each test person's particular circumstances to assess whether the income is generated from a business structure.

General rule of thumb for a practice company or trust

In determining whether the income of a practice company or trust is from a business structure and not from personal services income, the Commissioner will apply the following guidelines in Taxation Ruling IT 2639 Income tax: personal services income as a general rule of thumb:

● Where a practice company or trust has at least as many non-principal practitioners as principal practitioners, the income of the entity is considered to be derived from a business structure.

● Where a practice company or trust has fewer non-principal practitioners than principal practitioners, then whether the income is considered to be from a business structure will need to be determined by considering the various factors above.

For the purposes of applying this general rule:

● “Practitioners” include both full-time professional and non-professional staff who derives material fees for the practice. Part-time staff are counted proportionately. The term “practitioners” does not include administrative, clerical or support staff. For example, a nurse under the direction of a doctor, or a legal secretary under the direction of a solicitor, are not “practitioners” unless they earn material fees in their own right.

● “Principal practitioners” are those who own or share in the ownership of the practice, whether directly or indirectly.

● “Non-principal practitioners” are those who are not “principal practitioners”; that is, who do not own or share in the ownership of the practice, whether directly or indirectly.

Your circumstances

Currently,

● there no arm's length employees or others engaged to perform work for Company A

● there is no goodwill

● Company A has no or few income-producing assets used to derive the income

● the activities to be carried out is the sale of properties

● the operation of Company A is currently on relatively small scale, and

● the income is dependent upon your own personal skills, efforts or expertise as a sales agent.

The income of Company A is not generated from a business structure as you will be the sole shareholder therefore you will be the principal and the requirements in IT 2639 are not met.

Is Company A an agent of Company R?

The operation of the personal services income provisions is modified for agents who bear entrepreneurial risk in the way they provide services. One of the modifications relates to where 80% of an entity's income is from one entity only. Under the provision the income received by the entity will be treated on a 'look through' basis, that is, as though it is earned directly from the customers of the principal.

An agent is not defined for the purposes of the ITAA 1997. However, the Explanatory Memorandum accompanying the Taxation Laws Amendment Bill (No 6) 2001 states that “agent” takes its ordinary meaning of acting for or representing another. Paragraph 87-40(2)(a) of the ITAA 1997 specifically excludes employees from the category of service providers affected by section 87-40 of the ITAA 1997.

GSTR 2000/37: Goods and services tax: agency relationships and the application of the law gives the following clarification of the meaning of agency.

10. An entity may be authorised by another party to do something on that party's behalf. Generally, the authorised entity is called an agent. The party who authorises the agent to act on their behalf is called the principal. For an insurance policy, the authorised entity is often called an insurance broker. The party who authorises an insurance broker to act on their behalf is called the insured (the recipient of the supply). Also, if appropriately authorised, an insurance broker could act as an agent on behalf of the insurer.

11. For commercial law purposes, an agent is a person who is authorised, either expressly or impliedly, by a principal to act for that principal so as to create or affect legal relations between the principal and third parties.

12. The principal is bound by the acts of an agent as a result of the authority given to the agent. In cases of actual authority, the relationship between a principal and an agent is a consensual one so that no party can claim to be a principal's agent unless both parties consent to the creation of the agency.

13. Further, a principal may be bound by the acts of another person if the principal acts in a way that a third party believes that the other person is authorised to act as the principal's agent when this previously has not been the case. The authority for the agent to act for the principal in this circumstance is termed 'ostensible authority'. The principal will be liable for acts of the agent within the scope of the authority that the principal gives to the agent by virtue of his or her conduct and actions.

14. The characteristics of actual authority and ostensible authority were summarised in Equiticorp Finance Ltd ( in liquidation ) v . Bank of New Zealand (1993) 32 NSWLR 50. As Clarke JA and Cripps JA stated at 132:

An agent may have actual authority to bind a principal which is quite distinct from, but may overlap, ostensible authority. Actual authority may be express or implied. There is no evidence that Hawkins had express authority to commit the use of the liquidity reserve and the only question is whether implied actual authority or ostensible authority was established.

Actual authority arises where a principal grants, and an agent accepts, authority for the agent to perform specific tasks on behalf of the principal - in short there must be a consensual agreement between the principal and agent. Notwithstanding the absence of an express agreement, the parties, that is, the principal and agent, may conduct themselves in such a way that it is proper to infer that the relevant authority has been conferred on the agent.

Accordingly, where the question is whether the agent has implied authority to act in a particular way the court directs its attention to the conduct of the parties in order to decide whether the inference of authority should be drawn. Ostensible authority is quite different. The question then is whether the principal has held out the agent as having authority to act on its behalf. Obviously a principal may expressly hold out a person as its agent to act on his or her behalf in a specific transaction but usually where this occurs there will have been a grant of actual authority. On the other hand there may be no evidence of a grant of actual authority and yet the principal may have so acted as to hold out the agent as having the requisite authority. In many instances the circumstances which gave rise to ostensible authority may also provide a basis for inferring an actual grant of authority.

15. When an agent uses his or her authority to act for a principal, then any act done on behalf of that principal is an act of the principal. Also, a principal is not bound by acts that are not within the expressed, implied or ostensible authority conferred on the agent. However, the principal may ratify or confirm an unauthorised dealing.

16. Particular statutes may govern the creation of an agency relationship for different transactions. For example, the appointment of an agent by a deed is required where the agent must execute an instrument under seal on behalf of the principal. Also, the appointment of an agent is required in writing where the agency is to last for a period exceeding one year.

The conditions that must be met for “agents” to be included in subsection 87-40(2) of the ITAA 1997 are:

● The individual or personal services entity is an agent of another entity (the principal) but is not the principal's employee. "Agent" has its ordinary meaning of acting for or representing another.

● The agent receives income from the principal for services that the agent provides to other entities (customers) on the principal's behalf.

● At least 75% of the agent's personal services income from the principal is income based on the agent's performance in providing services to customers on the principal's behalf, such as a percentage of income generated or fees for service. The object of this condition is that most of the agent's income must be at risk - so that if, for example, the agent does not perform well enough or bring in enough customers they will not receive the income.

● The agent actively seeks other entities to which the agent could provide services on the principal's behalf. However, the agent must be able to demonstrate that they themselves are making an active effort (eg by advertising) to obtain customers, and that they are not merely receiving referrals from their principal or other parties, or allowing the principal to take all the responsibility for obtaining customers.

● The agent does not provide any services to the customers, on the principal's behalf, using premises that the principal, or an associate of the principal, owns or has a leasehold interest in, unless the agent uses the premises under an arrangement entered into at arm's length. An arm's length agreement is one entered into on terms, and for a consideration, that could be expected if the agent entered the agreement with a completely independent third party on a commercial basis.

The look through test in subsection 87-40(3) of the ITAA 1997 applies to treat the personal services income as if it was received directly from the customer rather than personal services income from the principal.

Your circumstances

The agency provisions will apply as:

● Company A is not Company R's employee

● Company A receives income from the Company R for the services Company A provides to customers

● at least 75% of the income is from Commissions, or fees based on the Company A's performance

● Company A will actively seek customers for Company R and

● a percentage of Company A's commission will be retained by Company R to pay for expenses, for example rental of office space.

Company R is acting as agent for Company A. When Company R receive the seller's payment they are acting on Company A's behalf.

Company A and Company R contract directly with the sellers. Company A and Company R only receive payment on the successful completion of the sale; that is Company R and Company A only receives payment for producing a result. The final payment for the property is made to the Company R as they are the Licensee named in appointment forms. Company A will invoice Company R for Company A's share of the commission on sale. Company R are acting as agent for Company A.

Is the income of Company A personal services income of you?

Subsection 84-5(1) states that personal services income is income which is mainly a reward for an individual's efforts or skills (or would mainly be such a reward if it had been derived by the individual).

Your circumstances

Under the contract the Company A will provide sales staff to Company R as an agent. Company A will receive a fixed percentage of the sales commission for each sale.

The income is considered to be mainly a reward for the personal efforts or skills of the individual.

Is the Company A a personal services entity?

Subsection 86-15(2) of the ITAA 1997 defines a personal services entity as a company, partnership or trust whose ordinary income or statutory income includes the personal services income of one or more individuals.

Your circumstances

The Company A is a personal services entity because its ordinary and statutory income includes PSI from an individual.

Will Company A meet the results test in respect of you?

Subsection 87-18(3) of the ITAA 1997 provides that a personal services entity meets the results test in the relevant income year if, in relation to at least 75% of the personal services income of one or more individuals that is included in the entity's income for the year:

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

(b) the personal services entity is required to provide the equipment or tools necessary to do the work; and

(c) the personal services entity is, or would be, liable for the cost of rectifying any defects in the work performed.

Paragraph 34 of Taxation Ruling TR 2001/8 Income tax: what is a personal services business explains that 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 (that is, for producing the outcome or result);
(b)   the individual or personal services entity provides the equipment and tools, if any, necessary for doing the work; and
(c)  the individual or personal services entity bears the commercial risks, including liability for defective work.

TR 2001/8 indicates that where no plant and equipment or tools of trade are necessary to perform the work, this condition would be satisfied.

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 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.

Where there is a liability for the cost of rectifying any defect in the relevant work performed, including situations where action is taken to rectify the error at the individual's or personal services entity's own cost prior to completion of the task or prior to the taking of legal action. This sort of voluntary action reflects the custom and practice in some industries, and is indicative of the entrepreneurial risk of an independent contractor in contrast to the "employee-like" contractor.

Additionally, being liable for the cost of rectifying any defect is inclusive of rectification achieved by the service acquirer pursuing a legal remedy for damages, in circumstances where the defect is incapable of physical repair.

Requirement that 75% of the income meets the results test

It is evident that in relation to at least 75% of the personal services income you will derive:

(a) the income will be for producing a result; and

(b) Company A is required to provide the equipment or tools necessary to do the work; and

(c) Company A is liable for the cost of rectifying any defects in the work performed.

Your circumstances

Company A is paid a fixed percentage of the sale commission regardless of the time taken to make the sale. You will initially be the sole proprietor of company A.

The Company A will be paid the agreed amount irrespective on how long the job takes.

You are not paid a daily or hourly amount for your efforts.

It is considered that you will be paid for producing a result.

It is expected that the other requirements of the results test would also be met.

Will Company A be considered to be a personal services business?

An individual or personal services entity that satisfies the results test will be taken to be conducting a personal services business (section 87-15 of the Income Tax Assessment Act 1997). The income from that business will therefore be exempt from the personal services income alienation measures.

Your circumstances

Your personal services income will be for producing a result. It is considered that the other requirements of the results test would be met. Therefore, the Company A will pass the results test and will be conducting a personal services business. The income will not be subject to the personal services income alienation rules in the year ended 30 June 20YY.

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