Edited version of private advice

Authorisation Number: 1051750029472

Date of advice: 18 February 2021

Ruling

Subject: Personal services business

Question

Is Company A a personal services business?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company A was incorporated on XX/XX/XXXX.

From XX/XX/XXXX, Person B started providing consulting services through the Company A.

The primary business activity of Company A is providing professional consulting services as they relate to commercialisation of technology.

Company A only employs Person B and operates from Person B's place of residence.

Company A makes offers to the public consisting of the following:

    word of mouth referrals;

    sales calls based on networking; and

    Person B's personal LinkedIn profile.

In the 20XX income year, Company A provided services to four unrelated entities.

The most income from one client was less than 80% of the total income for the year.

For the clients obtained in the 20XX year,

    Person B was known as an expert to Entity A;

    Person B was sought out upon word of mouth by Entity B;

    Person B had prior experience working with Entity C; and

    Person B obtained a position with Entity D through a competitive interview.

Invoices and contracts were provided for the various entities. The income received from Entity A and B is for producing a result and the income received from Entity C and D is for work done and tasks to be completed on an ongoing basis.

Relevant legislative provisions

Income Tax Assessment Act Division 84

Income Tax Assessment Act Division 86

Income Tax Assessment Act Division 87

Reasons for decision

Personal services income

Taxation ruling TR 2001/7 explains the meaning of personal services income (PSI) contained in Division 84 of Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997) (the alienation measure).

PSI is income that is mainly a reward for an individual's personal efforts or skills (or would mainly be such a reward if it was the income of the individual).

By definition, income earned by an employee is PSI. However, the PSI rules do not apply to income received as an employee unless they are an employee of an interposed entity.

Income that is mainly generated from the sale or supply of goods, the supply and use of income-producing assets, or a business structure is not PSI.

Only individuals can have PSI. PSI can be earned directly by an individual or indirectly through a company, partnership or trust (personal services entity).

A personal services entity (PSE) is a partnership, company or trust that receives the PSI of one or more individuals and is interposed between the individual(s) providing the work or services and the service acquirer.

The phrase 'or would mainly be such a reward if it was the income of the individual' applies to situations where the income is legally derived by a PSE and not the individual. If the PSE fails to meet a personal services business test in respect of a test individual, the PSI is deemed to be the income of the individual who earns the PSI and is attributed to that individual.

The use of the word 'mainly' means that the income referred to needs to be 'chiefly', 'principally' or 'primarily' a reward for the provision of the personal efforts of, or for the exercise of the skills of, an individual. That is, more than half (50%) of the ordinary or statutory income received is required to be a reward for the personal efforts and skills of an individual rather than being generated by the use of assets, the sale of goods or by a business structure.

Person B provides professional consulting services through Company A. The income generated is mainly a reward for Person B's personal efforts and skills and is therefore personal services income.

Personal services business

Taxation Ruling TR 2001/8 (TR 2001/8) explains what is a personal services business (PSB). You conduct a PSB and the PSI rules will not apply, if you meet one of the four PSB tests in the income year. If the PSI rules apply then the net PSI received by the PSE will be attributed to the individual who generated that income and available deductions are restricted.

There are four PSB tests:

    the results test;

    the unrelated clients test;

    the business premises test; and

    the employment test.

Only one test is required to be met for the PSI rules not to apply.

Company A advises that it had only one employee in the 20XX income year, Person B. Consequently, the employment test will not be met.

Company A also advises that it operates from Person B's place of residence. Consequently, the business premises test will not be met.

This leaves only the results test and unrelated clients test available for consideration of whether Company A is conducting a PSB.

The 80% rule

Individuals/PSEs can self-assess against the results test irrespective of how much income comes from one source. If less than 80% of the PSI is from one source, an individual/PSE can self-assess against the other tests. However, if more than 80% of the PSI is from one source, the individual/PSE must hold a Personal Services Business Determination (PSBD) from the Commissioner for the PSI rules not to apply to that income.

Company A advises that in the 20XX income year no more than 80% of the PSI was from one source.

The results test

To meet the results test in an income year at least 75% of an individual's PSI in an income year must satisfy all three conditions below:

    the income is for producing a result;

    the individual or PSE is required to supply the plant and equipment and tools of trade needed to perform the work which produces the result; and

    the individual or PSE is liable for the cost of rectifying defects.

All three conditions must be satisfied in relation to 75% of the PSI received in the income year.

Producing a result

In results-based contracts, payment is usually made for a negotiated contract price, as opposed to an hourly or daily rate, and is paid only when the contractual conditions have been fulfilled. Where remuneration is payable on the contractual conditions being fulfilled, the remuneration is for producing a result. The remuneration is often a fixed sum on completion of a particular job as opposed to an amount paid by reference to hours worked.

The essence of the contract must be to achieve a result and not to do work. The fact that an individual or PSE is required to complete identifiable tasks is not the same as achieving a result if those tasks merely form part of the work being paid for on an ongoing basis.

A contract to 'produce a result' is one to produce a specified outcome or result and payment is based on performance of the contract (ie for producing the outcome or result).

To meet the results test 75% of the PSI received in the income year must meet all three conditions of that test.

The income received from Entity A and B is for producing a result and the income received from Entity C and D is for work done and tasks to be completed on an ongoing basis. The PSI from Entity A and Entity B is below the 75% of the total PSI earned to satisfy the results test. Consequently, the first condition of the results test is not satisfied.

As the first condition of the results test has not been met, it is not necessary to consider the other two conditions.

The unrelated clients test

To meet the unrelated clients test in an income year:

    an individual or PSE is required to gain or produce the PSI from providing services to two or more entities. Those entities cannot be associates of each other or associated to the individual or PSE; and

    the services must be provided as a direct result of making offers or invitations (for example, by advertising) and those offers must be made to the public at large or a section of the public.

If the services are provided by registering through a labour hire firm or similar arrangement, the test will not be met as the required offer or invitation has not been made to the public at large or a section of the public.

Direct result of making offers or invitations

To meet this condition, the offer or invitation must be the reason why the work was obtained and there must be a close and significant connection between the offer or invitation and obtaining the work.

The offer must be made by the individual sole trader or PSE. Where the offer is made by the individual and it is clear that the offer is made by the individual as a representative of the PSE, then the offer is considered to have been made by the PSE and this element of the test will be met. [5]

A wide variety of activities can constitute making offers or invitations such as print advertising, printing posters, radio and television broadcasting, public tender, having a website and posting internet advertisements but all require the involvement of making public announcements.

Registering with labour hire firms, or similar, or responding to advertisements on web-based recruitment sites, will not meet this condition.

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 in certain circumstances for example in relation to competitive tenders.

A word of mouth referral is not generally considered to satisfy the requirements of the unrelated clients test (Metaskills Pty Ltd and Commissioner of Taxation [2005] AATA 647 at [55]; Cameron v Commissioner of Taxation [2011] AATA 386 at [30]). A word of mouth referral is where work is offered because of a recommendation from a previous client or industry contact. However, offers made by word of mouth in a specialised or niche industry where there are only a very small number of potential clients may, in limited circumstances, meet this condition (Yalos Engineering Pty Ltd v FC of T [2010] AATA 408; [2009] FCA 1569 at [24]).

Where a prior or subsisting relationship exists between the parties the following factors are relevant to determining whether the offer or invitation is made to 'a section of the public':

    the number of persons or entities to which the offer is made;

    the nature and content of the offer eg. Competitive commercial process such as public tender; and

    the nature of the relationship between the parties - where the parties deal with each other on an arm's length basis, the commercial character of the transaction is maintained so even if services had been provided sometime in the past, this element may still be satisfied.

Where a contractor has had previous contracts with a service acquirer the contractor will be considered to be genuinely independent where a tendering process is competitive, other parties are invited to tender for the contracts, the service acquirer is not the only significant client of the contractor and the successful tenderer is chosen on commercial grounds.[6]

In the 20XX income year, Company A provided services to four unrelated entities.

Company A's offers to the public at large or a section of the public consist of word of mouth referrals, sales calls based on networking and a personal LinkedIn profile. All four clients in the 20XX income year were either obtained through word of mouth or prior working relationships with key personnel. It was for these reasons that contracts were obtained and not as a direct result of making offers or invitations to the public at large or a section of the public.

Word of mouth referrals may meet the requirements of the unrelated clients test in very limited circumstances.

Consulting services provided by Person B relate to commercialisation of technology.

Whilst some of the professional services Person B provides may be considered specialised, the information provided shows that the taxpayer does not have a very small potential pool of clients as was the situation in the Yalos case.

Based on the information provided, the Commissioner considers:

    Company A provided the services of Person B to four unrelated clients; and

    the services provided to Company A's clients are not as a direct result of Company A making offers or invitations to the public at large or a section of the public.

Consequently, the Commissioner does not consider Company A has satisfied all the conditions of the unrelated clients test in the 20XX income year.

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