Edited version of private advice

Authorisation Number: 1052124369542

Date of advice: 9 June 2023

Ruling

Subject: Personal services income

Question 1

Is the income from the medical practice of the taxpayer as it is currently conducted, personal services income within the meaning of the term as set out in section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the relevant income year?

Answer

Yes.

Question 2

If yes, would the Commissioner make a PSBD under section 87-60 ITAA 1997 in relation to the clinical practice conducted by the taxpayer?

Answer

Yes.

Question 3

Would the income of the proposed practice company to be incorporated be PSI of the taxpayer under sec 84-5 ITAA 1997?

Answer

Yes.

Question 4

If yes, would the Commissioner make PSBD under section 87-64 ITAA 1997 in relation to the practice conducted by the practice company?

Answer

Yes.

This ruling applies for the following periods:

30 June 2022

30 June 2023

30 June 2024

The scheme commences on:

1 July 2021

Relevant facts and circumstances

The taxpayer practises as a medical professional. The professional practice is not incorporated.

The taxpayer maintains a clinic at a hospital. Operations are performed at the same hospital. The clinic comprised of clinical rooms, a reception area/waiting room and tea room.

The taxpayer has staff members working at the clinical practice.

A table of the staff and their duties in the clinic has been provided.

The trust employs and pays the wages of the staff working at the clinic. The taxpayer pays a service fee to the trust.

The taxpayer supplies the equipment needed to perform the work.

The taxpayer has a professional indemnity insurance to cover any claim in relation to the work.

The taxpayer charges set fees for the procedures carried out and supplies all the equipment required to perform the tasks.

Although a set fee is charged for the procedures, part of the fee covers the work of the taxpayer's staff.

Patients are charged separately for other services, of which staff members perform their tasks.

A percentage of income derived from the practice was from services performed by staff members.

The taxpayer will transfer the clinical practice by incorporating it to a company that is wholly owned by the taxpayer. The taxpayer will apply the roll-over available under Subdivision 122-A of the ITAA 1997 and become an employee of the practice company and paid a salary.

The taxpayer will transfer all shares of the practice company to another company wholly owned by him (holding company). The roll-over will be applied under Subdivision 122-A of the ITAA 1997.

The proposed restructure

Upon incorporation, the service arrangement between the taxpayer and the trust will be terminated.

The practice company will employ all staff that are currently working in the clinic

The practice company will pay the staff salary. The salary for each staff member will be determined in accordance with the current market and award rates.

The taxpayer will be paid a salary by the practice company and that the salary would be benchmarked to the rate of pay of an employee in a practice of similar size and with the same abilities and skills as the taxpayer.

The practice company will engage clients through the taxpayer's client portfolio. Billings to patients will be issued in the name of the private company.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 84-5

Income Tax Assessment Act 1997 Section 87-18

Income Tax Assessment Act 1997 Section 87-60

Income Tax Assessment Act 1997 Section 87-65

Reasons for decision

Question 1

Is the income from the medical practice of the taxpayer as it is currently conducted, personal services income of the taxpayer within the meaning of the term as set out in section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The income received for medical services provided by the taxpayer as a sole trader is mainly a reward for his personal skills and expertise. The income so derived is the taxpayer's personal services income.

Detailed reasoning

Personal services income (PSI)

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.

The taxpayer performs medical services as a sole trader. The income for the services provided by the taxpayer as a sole trader is mainly a reward for the taxpayer's personal skills and expertise. The income so derived is the taxpayer's PSI.

Question 2

If yes, would the Commissioner make a personal services business determination (PSBD) under section 87-60 ITAA 1997 in relation to the practice conducted by the taxpayer?

Summary

All three conditions of the results test under section 87-18 of the ITAA 1997 are satisfied, hence the results test is met in relation to the personal services income derived by the taxpayer. Accordingly, the taxpayer is conducting a personal services business. The Commissioner can make a PSBD in relation to the taxpayer's current practice if a request is made under paragraph 87-70(1)(a) for the relevant income year.

Detailed reasoning

Personal services business (PSB)

A taxpayer conducts a personal services business (PSB), and the PSI rules will not apply, if one of the four personal services business tests is met in the income year.

If the PSI rules apply, the net PSI received by the PSE will be attributed to the individual who generated that income and available deductions are restricted.

Attribution does not apply to sole traders as they do not earn PSI through a PSE and the PSI is included in the individual's personal tax return.

There are four personal services business tests:

•         the results test[1]

•         the unrelated clients test[2]

•         the business premises test[3], and

•         the employment test.[4]

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

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 individual's 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.

The 80% rule itself is not a personal services business test but relates to whether self-assessment is available.

For the Commissioner to issue a PSBD one of the personal services business tests must be met. The Commissioner can only issue a PSBD in the following circumstances:

•         the results test, business premises test or employment test is met;

•         unusual circumstances prevented the results, employment or business premises test from being met;

•         the unrelated clients test was met but unusual circumstances prevented the 80% rule from being satisfied; or

•         unusual circumstances prevented the unrelated clients test and 80% rule from being met.

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 and

•         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.

To meet the test all three conditions must be satisfied in relation to 75% of the PSI received.

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.

The taxpayer's work involves medical services. On completion of the procedures, the taxpayer charges set fees. As the taxpayer is paid only upon completion of the services provided, the first condition of the results test is satisfied.

Required to supply the plant and equipment, or tools of trade, needed to perform the work

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

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.

In your case, you supply all the equipment necessary to perform the operations for your clients. Hence, the second condition of the results test is met.

Liable for the cost of rectifying any defect in the work performed

To satisfy the third condition, the individual or PSE must 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 pay for it.

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

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 individual or PSE is, or would be, liable for the relevant component of damages awarded for the faulty or defective work.

The existence of a term in an agreement that the individual or personal services entity is liable for the cost of rectifying any defect in the work performed would support the conclusion that liability to make good any faulty workmanship exists, particularly where the individual or PSE and the service acquirer are dealing with each other at arm's length. However, the term in the agreement should not be merely 'window dressing', and regard may be had to all the circumstances of the case in determining whether the relevant liability really exists. A requirement to have indemnity insurance is an indicator that an individual or PSE is liable for rectification where the indemnity insurance is part of the contractual arrangements between the parties.

The taxpayer holds a Practitioner Indemnity Insurance policy that covers any claim in relation to his practice.

As all three conditions of the results test are satisfied, the results test is met in relation to the personal services income derived by the taxpayer.

Question 3

Would the income of the proposed practice company to be incorporated be PSI under section 84-5 ITAA 1997?

Summary

As discussed in Question 1, the income received by the taxpayer as a sole trader is mainly a reward for his personal skills and expertise. The incorporation of a practice company as an interposed entity does not alter the fact that it is the taxpayer that is providing the personal services.

Detailed reasoning

The income of the proposed practice company for providing the taxpayer's medical services would be PSI by the same reasoning as explained in Question 1.

For completeness, we will consider whether the income from the taxpayer's practice is generated from a business structure.

Income which is generated from the business structure of an entity is not PSI[5]. Where income is derived by an entity which has substantial income-producing assets or a number of 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 following factors need to be considered in determining whether a taxpayer derives income from personal services:

•         the number of arm's length employees or others engaged by the sole trader or PSE to perform work

•         the existence of goodwill

•         the extent to which income-producing assets of the business 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 interposed 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 form a business structure.

Paragraph 10 of Taxation Ruling IT 2639 Income tax: personal services income (IT 2639) provides that 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 as 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".[6]

The information provided indicated that in the relevant income year, there are staffed members who performed particular tasks.

Based on the information provided, the staff members' contribution to the fee revenue of the taxpayer's clinical practice comprised of a percentage of the total revenue derived by the taxpayer's clinical practice. In this case, it is necessary to consider the following factors:

The number of arm's length employees or others engaged by the sole trader or PSE to perform work

There are staff working in the taxpayer's clinical practice. The staff members are provided by the trust who pays their salaries. The taxpayer pays the trust a service fee for the provision of staff.

The existence of goodwill

The taxpayer's professional services are also advertised in various platforms. The information provided indicated that for the relevant income year the taxpayer's practice had numerous patients. It can be said that the taxpayer's practice has generated goodwill considering the number of patients that he has seen.

The extent to which income-producing assets of the business are used to derive the income

Income producing assets include any investment of the practice in tangible business assets such as premises, fixtures and fittings, plant and equipment and industrial or intellectual property (whether owned or leased). However, the significance of these assets will have to be weighed against their relevance.

The taxpayer's practice comprised of clinic rooms, a reception/waiting area and tea room. Based on the information provided, substantial income producing equipment are employed within the practice.

The nature of the activities carried out

The taxpayer provides medical services. Other income producing activities are conducted at the clinic.

The size of the operation

The taxpayer provides medical services. Whilst the taxpayer has numerous patients during the relevant income year, the size of the clinical practice cannot be considered of a large scale as the services are only conducted at one practice.

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

The taxpayer provides medical services. The income derived from the taxpayer's practice is mainly from the services provided by the taxpayer. Whilst the staff perform other tasks independently of the taxpayer, the staff contribution to the professional fee revenue comprised only around a percentage of the total income derived from the practice. In regards of the work performed by the staff members, whilst they perform their tasks independently of the taxpayer, they are considered support roles, i.e. to assist the taxpayer in the primary work.

After weighing up the factors and objective facts surrounding this case based on the information and documentation provided, the Commissioner considers that the taxpayer's income is not generated from a business structure.

Question 4

If yes, would the Commissioner make PSBD under section 87-65 ITAA 1997 in relation to the practice conducted by the practice company?

Summary

The proposed practice company would meet the results test providing the taxpayer's medical services, hence the proposed practice company would conduct a PSB. The incorporation of a company as an interposed entity does not affect whether the results test is passed under section 87-18 of the ITAA 1997.

Detailed reasoning

We have established in our discussion in question 2 above that the taxpayer has passed the results test under subsection 87-18(1) of the ITAA 1997 in the relevant income years. The same outcome would apply (for the same reasons) to an entity that was interposed between the taxpayer and the service acquirers under subsection 87-18(3) of the ITAA 1997.

The incorporation of a company as an interposed entity between you and the services acquirer does not affect whether you passed the results test under section 87-18 of the ITAA 1997.

The results test is met if all conditions under section 87-18 are satisfied in respect of the individual providing the personal services, irrespective of whether you provide services as a sole trader or through a company.

[1] Section 87-18 of the ITAA 1997.

[2] Section 87-20 of the ITAA 1997.

[3] Section 87-25 of the ITAA 1997.

[4] Section 87-30 of the ITAA 1997.

[5] Subsection 84-5(1) ITAA 1997.

[6] IT 2639, paragraph 11.

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).