Edited version of private advice

Authorisation Number: 1052120177111

Date of advice: 19 May 2023

Ruling

Subject: Personal services business

Question

Does XXXX satisfy the tests to be a personal services business pursuant to section 87-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

DDMMYYYY

Relevant facts and circumstances

1. Person A works as a dentist as an employee of Company A.
2. Person A is the sole director and shareholder of Company A.
3. There is a service agreement (the Contract) between Company A and Company B to outsource the management of its dental practice.
4. The Contract states that Company A engages Company B to provide services, facilities and premises to Company A.
5. Under the agreement Company B makes bookings with patients for dental services and invoices and collects dental fees on behalf of the Company.
6. The Contract provides for administration and management services including the use of treatment rooms, provision of equipment, stock, disposables, supplies and support staff and the collection of fees.
7. Under the contract, Company A authorises Company B to collect and retain all of the fees rendered and received for dental services provided from the premises by the dentist, Person A, as a representative of Company A.
8. Company B collects and retains the fees on behalf of Company A and forwards the payments to Company each month.
9. Both Company B and Company A set some of the fees charged for the work performed by Person A. Certain fees set by health fund providers cannot be altered by Person A to increase the amount charged.
10. There are fees that Company B sets for clients that do not have private health cover and Person A has the authority to change the amounts that are charged.
11. A sample invoice shows the fee charged is calculated by the particular type of service being provided
12. Company A receives income for dental services provided by Person A to customers.
13. If any work needs to be rectified, Company A rectifies it and covers all costs.
14. Company A is responsible for all necessary insurance for their dental practice.
15. Most of the materials and items are charged as a set fee by Company B and some products and materials are itemised and charged individually.
16. All of the income of Company A is the income generated by Person A's work at Company B.
17. There are no other employees of Company A, and it has no other business operations.
18. Company B provides the following equipment for Person A to use in the course of performing his work for a service fee:

•         chair

•         drills

•         scalers

•         extraction forceps

•         materials for fillings and root canals

19. Under the Contract, Company A provides the following specialised tools:

•         an implant drill for dental implant placement

•         all dental implants and abutments

•         a dental implant restorative kit

•         a high-powered curing light to set all restorations.

20. Company A withholds PAYGW for the wages paid to Person A.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 84-5

Income Tax Assessment Act 1997 section 87-10

Income Tax Assessment Act 1997 section 87-15

Income Tax Assessment Act 1997 section 87-18

Reasons for decision

Personal services income (PSI)

Section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the ordinary or statutory income of an individual or entity is an individual's personal services income if the income is mainly a reward for the individuals personal efforts or skills.

Subsections 84-5(2) to 84-5(4) of the ITAA 1997 confirm that only individuals can have personal services income. Section 84-5 applies whether the income is for doing the work or is for producing a result and, the fact that the income is payable under a contract does not stop the income being mainly a reward for an individual's personal efforts or skills.

Section 84-5 of the ITAA 1997 states:

Section 84-5

Meaning of personal services income

(1)  Your ordinary income or statutory income, or the ordinary income or statutory income of any other entity, is your personal services income if the income is mainly a reward for your personal efforts or skills (or would mainly be such a reward if it was your income).

...

Example 3: Jim works as an accountant for a large accounting firm that employs many accountants. None of the firm's ordinary income or statutory income is Jim's personal services income because it is produced mainly by the firm's business structure, and not mainly as a reward for Jim's personal efforts or skills.

(2)  Only individuals can have personal services income.

(3)  This section applies whether the income is for doing work or is for producing a result.

(4)  The fact that the income is payable under a contract does not stop the income being mainly a reward for your personal efforts or skills.

Taxation Ruling TR 2022/3 Income Tax: personal services income and personal services businesses (TR 2022/3) clarifies:

Meaning of personal services income

34. PSI is defined as 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).

35. Only individuals can have PSI. It can be earned directly by a sole trader or indirectly through an interposed entity (PSE).

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.

The services provided by Person A are services that require their personal skills and expertise and therefore the income derived will be PSI.

Personal services business (PSB)

Personal services entity (PSE)

As stated above, only individuals can have PSI. However, PSI can be earned indirectly through an interposed personal services entity.

A 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.

Specifically, section 86-15(2) states:

Effect of obtaining personal services income through a personal services entity

Amounts included in your assessable income

...

(2) A personal services entity is a company, partnership or trust whose *ordinary income or *statutory income includes the *personal services income of one or more individuals.

Exception: personal services businesses

(3) This section does not apply if that amount is income from the *personal services entity conducting a *personal services business.

Note: Even if the entity is conducting a personal services business, it is possible that some of its income is not income from conducting that business.

TR 2022/3 discusses the effect of the personal services income rules on personal services entities:

Effect of the personal services income rules

...

Personal services entity

61. In the case of a PSE, the PSI rules:

•         restrict the types of deductions that can be claimed against the PSI of the test individual

•         attribute the net PSI received by the PSE to the test individual that mainly generated the PSI (after deductions that are incurred in deriving that PSI), and

•         will generally give rise to pay as you go withholding obligations whether or not a test individual is an employee of the PSE.

62. Where a sole trader or PSE qualifies as a PSB in an income year in relation to a test individual, the PSI rules do not apply to that test individual's PSI in that income year. As such, the ordinary tax rules apply for that income year and the income retains its character as PSI of the sole trader or PSE.

PSE conducting PSB

Division 87 of the ITAA 1997 provides guidance on how to determine whether a sole trader or PSE is conducting a PSB in an income year.

Section 87-10 of the ITAA 1997 states that the object of Division 87 is to define personal services businesses in a way that ensures genuine businesses are covered but situations that are merely arrangements for dealing with the PSI of individuals are not.

Section 87-15 of the ITAA 1997 sets out how to determine whether a sole trader or PSE is conducting a PSB and states:

(1)  An individual or *personal services entity conducts a personal services business if:

(a)  for an individual - a *personal services business determination is in force relating to the individual's *personal services income; or

(b)  for a personal services entity - a personal services business determination is in force relating to an individual whose personal services income is included in the entity's *ordinary income or *statutory income; or

(c)   in any case - the individual or entity meets at least one of the 4 *personal services business test in the income year for which the question whether the individual or entity is conducting a personal services business is in issue.

(2)  The four PSB tests are set out in subsection 87-15(2) of the ITAA 1997 as follows:

(a)  the results test under section 87-18; and

(b)  the unrelated clients test under section 87-20; and

(c)   the employment test under 87-25; and

(d)  the business premises test under section 87-30.

If more than one test individual provides their services through a PSE, the tests must be applied to each individual. As Person A is the only individual providing their services through Company A, the relevant test(s) must only be applied to them.

In accordance with section 87-15 of the ITAA 1997, a PSE is considered to conduct a PSB in relation to each individual's PSI in an income year if:

• there is a personal services business determination; or
• it meets the results test in relation to at least 75% of the PSI of the test individual's PSI; or
• less than 80% of the PSI comes from the same source, one or more of the other three PSB tests are satisfied (the unrelated clients test, the employment test, the business premises test).

The results test

Subsections 87-18(3) to 87-18(4) of the ITAA 1997 sets out the criteria that must be met for a PSE to meet the results tests and states:

(3)  A *personal services entity meets the results test in an income year if, in relation to at least 75% of the *personal services income of one or more individuals that is included in the personal services entity's *ordinary income or *statutory income during the income year:

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

(b)  the personal services entity is required to supply the *plant and equipment, or tools of the trade, needed to perform the work from which the personal services entity produced the result; and

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

(4)  For the purposes of paragraph ... (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 required.

Subsection 87-18(4) discusses industry custom or practice in relation to determining whether the conditions of results test have been met. TR 2022/3 confirms that reference is a safety net and is not intended to override the conditions set out in subsection 87-18(3):

80. When working out if a sole trader or PSE (in relation to a particular test individual) meets the 3 conditions of the results test, the custom or practice in the particular industry is a relevant consideration.

81. The reference to custom or practice in the PSI rules is to act as a safety net for a sole trader or PSE who works in an industry where participants would generally meet the test but whose contract mat not clearly indicate that a particular condition is met. In such a case, the sole trader or PSE can rely on custom and practice to support a conclusion that they meet the particular condition.

82. However, custom or practice is not intended to override the 3 conditions required to meet the results test. For example, the fact that participants in a particular industry are generally paid for their time will not result in the first condition being met where their agreement clearly indicates that they are not being paid for producing a result.

In summary, the results test will be satisfied in your circumstances if at least 75% of Person A's PSI in an income year meets all the following conditions:

• the income is for producing a result
• Company A is required to supply the plant, equipment and tools of the trade needed to do the work that produces the result
• Company A is, or would be, liable for the cost of rectifying defects.

Income for producing a result

Paragraphs 83 to 86 of TR 2022/3 set out when income is considered to be for producing a result and states:

The income is for producing a result

83. To satisfy the first condition, the income must be for producing a result.

84. In contracts that are for producing a result, payment is usually made for a negotiated contract price to achieve a specified outcome. As opposed to an hourly or daily rate for doing work, payment is made when the contractually specified results have been fulfilled. A contract price for achieving a specified result may be calculated by reference to an estimated number of hours applied to an hourly rate. If that estimate changes, a new contract or a variation to the original contract may be agreed between parties, allowing for a change to the negotiated contract for producing the result. What needs to be considered is whether the contract price is for achieving a specified result and not merely payment for the hours worked.

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

86. The condition will not be satisfied merely because the contract states that the contract is for producing a result. Consideration should be given to the substance of the arrangement between the sole trader or PSE and the service acquirer and what the sole trader or the PSE is actually being paid for.

Person A works as a dentist as an employee of Company A. All of the income of Company A is the income generated by Person A by their work at Company B.

Person A, as a dentist, contracts with each client. The contract price is for achieving a specified result and not merely for the hours worked by the test individual.

Under the contract Person A provides dental services to patients who are booked by Company B. Sample invoices provided indicate the fee charged to those patients is calculated by reference to the type of service the dentist is performing for example clean and scale, filling, etc.

The fee is payable by the patient upon the dentist rendering those specific services (that is, producing a result) as evidenced by the sample invoice provided. Person A does not invoice a flat fee for hours worked regardless of what they do for the patient rather it is specific to the result the patient wants achieved and not simply to do the work.

Payments received by Company A for the dental services provided by Person A are for producing a result. That is the payment is contingent on services being provided after consultation with each patient. Under the service agreement dental services are provided to the patient by Person A and the client is billed for the services. Company B retain a percentage as a service fee for the provision of facilities, tools and equipment along with support staff and associated services. The remaining percentage of billings is paid to Company A.

We are satisfied that Company A's income received for the dental services provided by Person A is for producing a result and as such the first condition of the results test is satisfied.

Supply of plant, equipment and tools of trade needed to perform the work

In relation to the second condition of the results test, TR 2022/3 provides the following guidance:

Supply of plant, equipment and tools of trade needed to perform the work

87. To satisfy the second condition, the sole trader or PSE must supply any plant and equipment or tools of trade needed to do the work that produces the result and which a service acquirer would expect the sole trader or PSE to provide or which the sole trader or PSE is contractually required to provide.

88. There are situations where, having regard to the nature of the work, no plant or equipment or tools of trade are needed to perform the work. Where this is the case, this condition will be met.

89. Minimal usage of the tools or equipment of others will not of itself disqualify the taxpayer from meeting this condition.

Company A provides the tools and equipment required to do the actual work which produces the result. It is not uncommon practice in the health industry to outsource the management side of a health practice. Under the Contract Company B provides, for a service fee, the chair, drills, scalers, extraction forceps and material for fillings and root canals for Person A to use in the course of performing their work. Company A provides the other specialised tools of an implant drill for dental implant placement, all dental implants and abutments, a dental implant restorative kit and a high-powered curing light to set all his restorations. This is customary in the industry.

We are satisfied that Company A provides the tools and equipment required for Person A to do the actual work which produces the result and as such the second condition of the results test is satisfied.

Liable for the cost of rectifying defects

Paragraphs 90 to 96 of TR 2022/3 provide the following guidance regarding the third requirement of the results test, that the PSE is, or would be, liable for the cost of rectifying any defect in the work performed:

Liability for the cost of rectifying defects

90. To satisfy the third condition, the sole trader or PSE is, or would be, liable for the cost of rectifying any defects in the work. There is no requirement that they actually perform the work which rectifies the defect, so long as they are liable for the cost of rectifying any defect in the work performed.

91. The main consideration is whether they are exposed to commercial risk.

92. Where physical rectification is not possible, the purpose of the provision would be satisfied where a right to claim for damages exists in respect of faulty or negligent performance of contractual obligations and the sole trader or PSE is, or would be, liable for the relevant component of damages awarded for the faulty or defective work.

93. A requirement to have professional indemnity insurance is an indicator that the sole trader or PSE is liable for rectification where the indemnity insurance is part of the contractual arrangements between the parties. However, the fact that a person may be subject to disciplinary action by a professional body for misconduct is not sufficient to satisfy the rectification element of the test.

94. This condition will not be satisfied where rectification occurs in circumstances where the sole trader or PSE has not been liable for the cost of rectification.

95. A contractual term stating the sole trader or PSE has the liability for the cost of rectification of defects would support the conclusion that this condition could be satisfied if the term creates an actual liability.

96. Having a client refuse to pay for work done if they are unhappy with the service provided is considered a different risk to having the liability to pay for the rectification of defects and will not satisfy this condition.

Under the terms of the Contract, Company A is required to maintain all necessary insurances relating to:

• carrying out a dental practice
• the employment or engagement of Person A, including worker's compensation insurance
• Personal A's own sickness and accident insurance
• a professional indemnity insurance policy in joint names with Company B for cover of at least ten million dollars.

The Contract also specifies that Company A shall indemnify and keep Company B indemnified from and against all Losses and Claims arising out of a number of situations.

We are satisfied that Company A is liable for the cost of rectifying any defects in the work performed by Person A and as such the third condition of the results test is satisfied.

Summary

We are satisfied the results test was met in relation to the PSI derived from the arrangement with Company B. As all of the PSI received by Company A is derived from the arrangement with Company B, it follows that the results test is met in relation to at least 75% of their PSI. Therefore, Company A can self-assess that it conducts a PSB in relation to the PSI of the test individual. As Company A is conducting a PSB pursuant to section 87-15 of the ITAA 1997 in relation to the PSI of Person A, the PSI rules will not apply.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).