Edited version of private advice

Authorisation Number: 1051543563745

Date of advice: 1 August 2019

Ruling

Subject: Personal services business

Question 1

Is the entity a PSB?

Answer

No

Question 2

Will incorporation affect whether the PSI rules apply?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2018

Year ending 30 June 2019

The scheme commences on:

1 July 2017

Relevant facts and circumstances

You are a contractor.

Your income is Personal Services Income.

You provide understanding, interpretation of exploration data, training and organisation of staff, preparation of annual programmes and budgets and preparation of reports and documents for Entity A.

You earn income from four or five unrelated clients in a given financial year. The largest income is produced from Company A which equates to 60 - 75% of total income.

You are remunerated on an hourly or daily basis however Company B pays a monthly retainer based on 80 hours of work and expenses.

You do not hire any employees or rent separate business premises.

You do not have a website.

You do not advertise.

You do not receive more than 80% of income from one source.

Your clients are unrelated and are generally sourced from word of mouth due to having a good name in a unique industry.

You wish to incorporate a company (X-co) and interpose it between you and your clients.

When you incorporate X-co and interpose it between you and your clients

·  You will provide the services through X-co.

·  The contracts with your clients will have the same terms and conditions as you currently do.

·  You will not hire any employees or rent separate business premises.

·  You will not have a website.

·  You will not advertise.

·  You will not receive more than 80% of income from one source.

·  Your clients will be unrelated and are generally sourced from word of mouth due to having a good name in a unique industry.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 Division 84

Income Tax Assessment Act 1997 Section 84-5

Income Tax Assessment Act 1997 Division 86

Income Tax Assessment Act 1997 Subsection 86-15

Income Tax Assessment Act 1997 Division 87

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

Income Tax Assessment Act 1997 Subsection 87-15(3)

Income Tax Assessment Act 1997 Section 87-18

Income Tax Assessment Act 1997 Section 87-20

Income Tax Assessment Act 1997 Section 87-25

Income Tax Assessment Act 1997 Section 87-30

Reasons for decision

Question 1

Is the entity a Personal Service Business (PSB)?

Answer

No

Detailed reasoning

Personal services income (PSI)

Section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997) defines PSI as income that is mainly a reward for the personal efforts or skills of an individual. Taxation Ruling TR 2001/7 Income Tax: The meaning of personal services income goes on to say that PSI income does not include income that is generated by the use of assets, the sale of goods, the granting of a right to use property or a business structure.

Only individuals can have personal services income.

The services provided by you, either directly through you as a sole trader or via an interposed entity on are services that require your skill and expertise. The income so derived will be PSI.

Personal services entity (PSE)

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

Personal services business (PSB)

Division 87 of the ITAA 1997 provides guidance on what a personal services business is and how to determine if an individual or PSE is conducting a personal services business.

The object of Division 87 of the ITAA 1997 is to define personal services businesses in a way that ensures that it covers genuine businesses but not situations that are merely arrangements for dealing with the personal services income of individuals.

Subsection 87-15(2) of the ITAA 1997 provides four personal services business tests, namely:

● The results test

● The unrelated clients test

● The employment test

● The business premises test

We look to Taxation Ruling TR 2001/8 Income tax: what is a personal services business? for further information and the Commissioners view of the tests.

Results Test

The results test has three limbs and is set out in section 87-18 of the ITAA 1997.

● the income is for producing a results; and

● they are required to supply the plant and equipment, or tools of trade, needed to perform the work from which they produce the result; and

● they are, or would be, liable for the cost of rectifying any defect in the work performed.

An individual or entity will meet the results test where at least 75% of their personal services income during the income year passes all three limbs.

The results test will not be satisfied merely because the contract states that the personal services income is for producing a result.

Paid for a result and not to do work

TR 2001/8discusses the meaning of the phrase 'producing a result'. It says that the essence of the contract has to be to achieve a contractually specified outcome and not to do work. This is shown as a fixed sum on the completion of a job, rather than an amount paid by reference to the hours worked.

Payment for time spent at work indicates that the contract is not for a result. Where there are additional clauses for allowances, for example for leave or travel, are indicators that the contract is not for a result.

Further results-based contracts tend to embrace the defining characteristics of an independent contractor. Payment is often made for a negotiated contract price, or a volume or quantity based approach as opposed to an hourly rate. For example, couriers may be "paid a prescribed rate for the number of successful deliveries" they made (Vabu Pty Ltd v FCT ) and not per time period engaged, or determined by the volume of an item delivered (Stevens v Brodribb Sawmilling Co Pty Ltd), or a fixed sum per item.

A results-based contract generally has a specified end date or a deliverable on completion. Where contracts are ongoing or provide a clause for termination, this is an indicator that the contract is simply remuneration for the provision of services and not result-based (Cooper and Commissioner of Taxation).

A results-based contract leaves the personal services entity responsible for the management of the risks and rewards and ultimately accountable where outcomes are not achieved.

Deliverables

Where there is a results-based contract, the contract is based on certain deliverables, which are to be achieved as a precondition for payment. A deliverable is a quantifiable good or service produced or a specified function or characteristic. It may be broken down into specific milestones to mark critical decision points. Further, the contract is not to be paid, until and unless, the deliverable is produced or specific milestones are completed.

Timing of payment

Another strong indicator that the contract is for a result is when remuneration is payable when, and only when, the contractual conditions have been fulfilled. The contract needs to say that your business must produce an outcome before being paid. This may include progressive payments paid on achieving specified milestones or outcomes.

Application to your situation

You are paid regularly on an hourly or daily basis. You receive a retainer and are paid expenses. These are clear indicators that the income is not based on a result.

To pass the results test you must pass all three limbs. Your income is not for producing a result; you do not pass the first limb.

You therefore do not pass the results test.

Unrelated Clients Test

An individual or an unrelated PSE entity meets the unrelated clients test in an income year if:

a) during the year, the individual or PSE 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 PSE making offers or invitations (for example, by advertising), to the public at large or to a section of the public, to provide the services.

The individual or personal services entity is not treated, for the purposes of paragraph (b) above, 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.

Here the Commissioner is looking for an indication that the individual or personal services entity is willing to perform services for anyone within a group or class of persons, or to any member of the public.

Activities that are considered to be making offers or invitations in this context include advertising, public tender, maintaining an internet website on which the availability of services is advertised, and (in a limited number of cases) word-of-mouth referrals.

Word-of-mouth referrals will only meet this condition of the test where there are a small number of potential clients such as where specialised services are provided. Where a large client base exists, a word-of-mouth offer cannot be said to be made to the public at large or a section of the public. (Yalos Engineering Pty Ltd v FC of T [2010] AATA 408; 2010 ATC 10-139 at paragraph 19) (Yalos Engineering)

Responding to advertised vacancies is also not considered to be making offers or invitations to the public at large or a section of the public.

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.

Application to your situation

You do not have a website or advertise to obtain contracts to provide your services.

On a general application of the second limb of the unrelated clients test, you do not make offers and invitations to the public at large or to a section of the public as set out in the legislation and as explained by the courts. This is because you obtain contracts via word of mouth rather than by actively promoting your business to the public by advertising your services.

On this general application of the law relating to offers and invitations, you do not satisfy the second limb of the unrelated clients test.

However, you have referred to your working in a 'unique' industry, and we take this to be a reference to the narrow exception for 'niche' industries (although those two words are quite different) that arose in the case of Yalos Engineering.

In the Yalos Engineering case the taxpayer provided services involving design and oversight of the fabrication and installation of offshore undersea gas pipelines. On remittance to the Administrative Appeals Tribunal from the Federal Court, Senior Member Pascoe considered this to be specialised work in a small and specialised market and that the taxpayer's expertise was relevant to a very small number of companies engaged in offshore petroleum exploration and mining. Therefore advertising in a general sense was not appropriate.

The Commissioner's view is that you have not established any basis for viewing your profession or the field of your work as 'niche' in a way that would be required for the narrow exception of the 'offers and invitations' limb of this test to apply. Word-of-mouth referrals are unlikely to be sufficient in the general operation of your industry or profession to meet the second part of the provision.

We therefore consider that you could complete activities that are considered to be making offers or invitations to the public at large, and so you do not satisfy the second limb of the unrelated clients test.

As you need to satisfy both limbs to meet the unrelated clients test, you do not pass this test.

Employment test

The employment test is set out in section 87-25 of the ITAA 1997 and provides:

An individual or PSE meets the employment test where:-

·         at least 20% (by market value) of the entities principal work for the year is performed by an entity or entities engaged by the individual or PSE, and

·         and the entity or entities engaged are neither individuals whose PSI is included in the PSE's or individual's income, nor non-individuals that are associates of the individual or PSE.

Or the entity has one or more apprentices for at least half the income year.

TR 2001/8 says that "principal work" does not include incidental clerical or administrative work.

Application to your situation

You have said that you do not have any employees and therefore will not meet the test.

Business premises test

Section 87-30 of the ITAA 1997 provides that an individual or PSE meets the business premises test in an income year if they maintain and use business premises:

·         at which they mainly conduct activities from which PSI is gained

·         of which they have exclusive use (this would typically require ownership or a lease)

·         that are physically separate from any premises that the service provider or service provider's associate uses for private purposes, and

·         that are physically separate from the premises of the service provider's client or client's associate

Application to your situation

You have advised that you do not rent business premises. Our assumption is that you do not otherwise maintain and use business premises that meet the four criteria above. Therefore you will not meet the business premises test.

Conclusion

You do not meet the results test, the unrelated clients test, the business premises' test or the employment test. You are not a personal services business.

Question 2

Will incorporation affect whether the Personal Services Income (PSI) rules apply?

Answer

No

Detailed reasoning

Provisions relating to the alienation of personal services income (PSI) are contained in Division 86 of the ITAA 1997.

Section 86-15(1) states that your assessable income includes an amount of ordinary income or statutory income of a personal services entity that is your personal services income.

Section 86-15(2) defines a personal services entity as a company, partnership or trust whose ordinary or statutory income includes the personal services income of one or more of its workers.

Divisions 84 and 86 of the ITAA 1997 provide the following example:

NewIT Pty. Ltd. provides computer programming services, but Ron does all the work involved in providing those services. Ron uses the clients' equipment and software to do the work. NewIT's ordinary income from providing the services is Ron's personal services income because it is a reward for his personal efforts or skills. Assume that NewIT only provides services to one client. Ron's assessable income includes ordinary income of NewIT from providing the computer programming services, because the income is Ron's personal services income.

An exception to the above arises under section 86-15(3) of the ITAA 1997 where the income is from a PSE that is conducting a personal services business. In those circumstances, section 86-15(1) does not apply.

For further information, also see Taxation Ruling IT 2121 (Family companies and trusts in relation to income from personal exertion) which deals with income splitting arrangements by which individuals try to split their personal services income among family members by diverting it to a family company or trust. It regards these arrangements as ineffective for income tax purposes under section 260 or Part IVA of the Income Tax Assessment Act 1936 ("the Act").

Application of the law to your circumstances

Where you provide personal services as an individual, the personal services income derived from the provision of these services is attributed to you as assessable income.

In circumstances where a personal services entity (e.g. a company) is interposed between you and the services acquirer, section 86-15(1) of the ITAA 1997 comes into operation, effectively ensuring that the income so derived through that entity remains your assessable income.

Therefore, the answer to Question 2 above, is 'no'. Incorporation of a company between you and the services acquirer does not affect whether the PSI rules apply, as the result is the same in either case.

Regarding the exception that arises pursuant to section 86-15(3) of the ITAA 1997, we have established in our analysis of Question 1, above, that you are not a personal services business. The same outcome would apply (for the same reasons) to an entity that was interposed between you and service acquirers.

Consequently, the exception in section 86-15(3) is not applicable in your circumstances.

Conclusion

Incorporation of a company between you and the services acquirer does not affect whether the PSI rules apply.

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