SCIMITAR SYSTEMS PTY LTD v DFC of T

Members:
GA Barton M

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [2004] AATA 720

Decision date: 6 July 2004

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Associate Professor GA Barton (Member)

This is an application for review of the respondent's decision of 16 April 2003 to refuse the applicant a personal services business determination (``PSBD'') for the year ending 30 June 2003 (``the year of income''). The respondent may make PSBD's pursuant to the provisions of subdivision 87-B of Division 87 of the Income Tax Assessment Act 1997 (``the Act''). The respondent, who was represented by Ms Lorraine Price of counsel, lodged documents T1 to T12 under section 37 of the Administrative Appeals Tribunal Act 1975 and tendered documentary exhibits R1 to R10. Mr Paul Jakins and Mr Gary William Shier testified for the applicant. The applicant lodged a written statement for each of its witnesses and tendered documentary exhibits A1 to A9. Both parties lodged a statement of facts and contentions and the respondent lodged an outline of submissions.

2. Scimitar Systems Pty Ltd (``the applicant'') was incorporated in August 1999. The shareholders and directors are Mr Paul Jakins and his wife. The applicant's place of business is the Jakins' family home. It has no employees and it has movable assets, consisting of office furniture and computer equipment, to the approximate value of $10,000. It has no other assets.

3. Mr Paul Jakins graduated as a Bachelor of Business and Information Processing in 1982. From 1982 to 2000 he held a number of positions as an employee except for one occasion when his services were provided to a government department through a third party that paid him on an hourly basis. His last position was as a systems analyst in the area of information technology. Since August 2000 the applicant has provided Mr Jakin's services as a systems analyst exclusively to People in Computers Pty Ltd (``PIC'') on a contract by contract basis to fulfil PIC's corresponding contractual obligations to provide his services to the West Australian government successively in the Department of Training and Employment, the Department of Training and, currently, the Department of Education and Training (``WAD'') (T11). The issues to be decided by the Tribunal are whether the payments from PIC to the applicant under these contracts were the personal services income of Mr Jakins in the year of income and, if so, whether the respondent correctly refused the applicant a PSBD in respect of them. The personal services income provisions are in Divisions 84, 85, 86 and 87 in Part 2-42 of the Act. These Divisions do not affect individuals or other entities that conduct personal services businesses.

4. It was not contested, and the Tribunal finds, that the WAD tender requirements for the work done by Mr Jakins have remained materially the same for each successive request to tender. The WAD requires the services of a Systems Analyst to analyse, review and redesign the business rules, functionality and design of its College Management Information System (``CMIS''). The systems analyst is required to prepare relevant documents such as functional specifications, detailed design, development and implementation plans that will enable the development of the CMIS Model (R1). The following key tasks are specified: to carry out the CMIS development analysis and

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design tasks in accordance with WAD standards; to liaise with WAD, college and support groups in regard to business rules issues and the potential impact of changes; to liaise with the CMIS support manager to ensure the correct and timely design and implementation of new developments; and to provide support to CMIS analysts and programmers (R1). PIC as tenderer was required to include Mr Jakins' curriculum vitae in its submission and to highlight particular skills relating to the key tasks specified. It was also required to provide the details of two referees who could be contacted to discuss claims relating to Mr Jakins made in the submission. Proposals were required to provide an hourly rate for the service (R1).

5. The contracts concluded between the applicant and PIC in respect of Mr Jakins' work mirror the principal requirements of the WAD. This is exemplified by the contract of 28 November 2002 to provide the services of a systems analyst to the WAD to analyse, review and redesign the business rules, functionality and design of its CMIS (T3). The period of the contract was from 2 December 2002 to 30 May 2003 at an hourly rate of $58. The preferred operator was Mr Paul Jakins who signed the contract in that capacity and for and on behalf of the applicant. PIC tendered for and was awarded its corresponding contract with the WAD on the basis of Mr Jakins' qualifications and experience. The applicant was paid fortnightly by PIC against invoices specifying the number of hours Mr Jakins had worked (T5) based on timesheets it kept for PIC. The WAD kept its own timesheets on the hours worked by Mr Jakins for the purpose of its payments to PIC (R6).

6. As a systems analyst working in the WAD, Mr Jakins prepares project proposals in response to its CMIS needs, identified and particularised in his correspondence and discussions with its managers. He is responsible for the practical implementation of the proposals that are accepted. This involves further discussions with stakeholders to document their specific requirements in a manner understandable to them and to the developers of the software to meet those requirements. Exhibits A 1 to A9 are examples of the documents he is required to produce for approval by the stakeholders in progressing from a functional requirement specification to the design of the appropriate software. The purpose of this process is to ensure that the interested parties have approved of, and so will be satisfied with, the result. In his evidence Mr Jakins described this process as ``self rectifying''. He is principally responsible for system design rather than its maintenance. He testified that he spends between 5% and 10% of his time on maintenance.

7. Mr Jakins works in a WAD building on a daily basis where he is provided with desk space. The WAD provides the computing infrastructure, both hardware and its standard software. The applicant is under no contractual obligation to supply any tools or equipment. It is a WAD requirement that Mr Jakins work an average of 40 hours per working week (based on an 8 hour day). Mr Gary Shier, the Manager ICT Governance in the WAD, testified that contractors such as Mr Jakins, were expected to keep the ``core hours'' from 9.30am to 3.30pm on business days in the sense that they are physically present at the relevant WAD premises during those times. The order in which Mr Jakins deals with specific tasks or projects is determined by WAD management.

8. The WAD has a policy of conducting a contract initiation meeting with the operator or consultant to outline the key tasks to be performed during the contract period. In the case of the contract commencing on 2 December 2002 referred to above, this meeting was held some 2 months after the contract commenced because Mr Jakins continued working on the projects he had been involved in during the preceding contract (T4). In fact his duties hadn't changed since he commenced providing services to the WAD in August 2000. At the end of a contract period Mr Jakins' performance is reviewed and any extension of the contract between WAD and PIC depends on the outcome of the review.

9. Mr Jakins is one of a team of 5 to 6 analyst/programmers attached to the CMIS working under the direction of a project manager who is responsible for monitoring the progress of approved projects and departmental resources and reporting to the senior management of the WAD.

10. The applicant has a website at which it is described as providing information technology consulting services (R7). The purpose of the website is to advertise the applicant's business activities other than consulting services, given

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its present consulting commitments to the WAD.

11. The conditions of the agreement concluded between the applicant and PIC on 28 November 2002 were before the Tribunal (T3). It was agreed between the parties, and the Tribunal finds, that all the contracts between the applicant and PIC for the services of Mr Jakins were subject to the same conditions. It was not a condition of these contracts that the applicant or Mr Jakins as the preferred operator, be liable for the cost of rectifying any defects in the work performed by Mr Jakins for the WAD.

12. The Tribunal finds that the payments from PIC to the applicant in the year of income in respect of the work performed by Mr Jakins in the WAD constituted the personal services income of Mr Jakins (``the PSI'') pursuant to s 84-5 of the Act. It was not disputed that the payments were ordinary income of the applicant and the facts, as found by the Tribunal, show conclusively that if it had been the income of Mr Jakins it would have been mainly a reward for his personal efforts and skills. Although the applicant also derived some sales income in the year of income there was no, or very little, evidence that it has a business structure or operation. It has no substantial income producing assets and it has no rental, salary or other expenses that would indicate a business operation. It does not provide its consulting services to the public at large because Mr Jakins is fully occupied in the WAD.

13. Division 86 of the Act attributes the PSI to Mr Jakins for income tax purposes, to the extent that he has not derived it promptly as salary from the applicant, unless the applicant derived it from a personal services business. The provisions that determine whether the applicant was conducting a personal services business at that time are contained in Division 87 of the Act. The applicant is a personal services entity (``PSE'') for these purposes because its ordinary income included the PSI; s 86-15(2) of the Act.

14. A PSE conducts a personal services business during a year of income if 80% or more of the relevant personal services income does not come from the same entity and it meets at least one of the 4 personal services business tests in that year or a PSBD is in force relating to the relevant personal services income individual; s 87-15(b)(1)(c) of the Act. The 4 personal services business tests are the results test; the unrelated clients test; the employment test and the business premises test; s 87-15(2) of the Act. The position is different if 80% or more of the relevant personal services income does come from the same entity. In this event the PSE conducts a personal services business if it meets the results test in relation to the personal services income individual in that year or a PSBD is in force relating to the individual's personal services income or a PSBD is in force relating to the PSE and the relevant personal services income is from the personal services business; s 87-15(3) of the Act. The applicant clearly falls into the latter category because all of the PSI comes from PIC.

15. In the year of income no PSBD was made in relation to Mr Jakins and the applicant was not prepared to rely on its own judgment that it met the results test in relation to Mr Jakins, choosing instead to make the PSBD application under review.

16. The respondent may make a PSBD in relation to the applicant's PSI in a written notice to the applicant that may specify the day on which the determination takes effect, the period for which the determination has effect and any conditions that attach to the determination; s 87-65(1), (2) of the Act. The respondent however must not make a PSBD unless satisfied in one of two alternative ways set out in s 87-65(3) of the Act.

17. The first is where the respondent is satisfied that in the year of income the applicant could reasonably be expected to meet, or met, one or more of the results test, the employment test and the business premises test and the PSI could reasonably be expected to be, or was, from the applicant's activities that met one or more of those tests. It is noteworthy that s 87-65(3)(a)(i) of the Act does not refer to the unrelated clients test under s 87-20. The significance of this omission is not relevant to these reasons as it was undisputed that the applicant did not meet the unrelated clients test in the year of income.

18. The applicant meets the results test in the year of income if, in relation to at least 75% of the PSI, the income was for producing a result; and the applicant was required to supply the plant and equipment, or tools of trade, needed to perform the work that produced the result; and the applicant was, or would be, liable for the cost of rectifying any defect in the work

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performed; s 87-18(3) of the Act. The Tribunal finds that, at the time the PSBD application was made, the applicant did not meet and could not reasonably be expected to meet, any of the requirements of the results test. The contracts between the applicant and PIC were for the ongoing efforts and skills of Mr Jakins and not for a result and they did not impose any obligation on the applicant to supply plant and equipment or to bear the cost of rectifying any defect in the work performed by Mr Jakins. In deciding whether the results test is satisfied regard must also be had to the custom or practice in the relevant industry when work is performed by an entity other than an employee; s 87-18(4) of the Act. There was no evidence before the Tribunal that it is customary for entities providing the services of a systems analyst to be paid for a result and to assume the obligations set out in the results test.

19. As agreed between the parties, the respondent tendered a copy of the Government Information Technology and Communications terms and conditions (GITC 3-Western Australia) (``GITC 3'') that governed contracts between PIC and WAD in the year of income. Clause 21 of GITC 3 refers to the obligation of a contractor to indemnify the customer for certain loss, injury or damage flowing from its wilful, unlawful or negligent acts, defaults or omissions. The Tribunal finds that PIC's obligation in this regard is irrelevant to the question of whether the applicant met the results test in the year of income.

20. The applicant meets the employment test in the year of income if it employed other unassociated entities that performed at least 20% by market value of its principal work for that year: s 87-25(2) of the Act. It was not contended, and the Tribunal finds, that, at the time the PSBD application was made, the applicant did not meet and would not reasonably be expected to meet, the employment test.

21. The applicant meets the business premises test in the year of income if it maintained and used business premises at which it mainly conducted the activities from which it gained or produced the PSI, that it used exclusively and that were physically separate from the private residence of Mr Jakins and the premises of the WAD; s 87-30 of the Act. The applicant's place of business has always been the Jakins' family home so the Tribunal finds that at the time the PSBD application was made, the applicant did not meet and could not reasonably be expected to meet, the business premises test.

22. The respondent is also empowered by s 87-65(3)(ii) of the Act to make a PSBD if satisfied that in the year of income, but for unusual circumstances applying to the applicant in that year, the applicant could reasonably have been expected to meet, or would have met, at least one of the 4 personal services business tests and the PSI could reasonably be expected to be, or was, from the applicant's activities that met at least one of those tests.

23. The applicant contended that but for unusual circumstances applying to it in the year of income it could reasonably have been expected to meet, or would have met, the unrelated clients test for a personal services business contained in s 87-20 of the Act.

24. The applicant meets the unrelated clients test in the year of income if it gained or produced income from providing services to 2 or more unassociated entities as a direct result of advertising to the public at large or to a section of the public. The applicant is not treated as having made offers or invitations to the public merely by being available to provide the services through an entity (such as PIC) that conducts a business of arranging for persons to provide services directly for clients of the entity; s 87-20(2) of the Act.

25. Section 87-65(4) of the Act provides that unusual circumstances include providing services to an insufficient number of entities to meet the unrelated clients test if the PSE starts a business during the income year and can reasonably be expected to meet that test in subsequent income years or provides services to only one entity during the income year but met the test in one or more preceding years, and can reasonably be expected to meet the test in subsequent income years.

26. In relation to unusual circumstances, Mr Jakins testified that the Information Technology (``IT'') industry in Perth had experienced an economic downturn in the year of income attributable to the completion of major projects such as the introduction of the Goods and Services Tax and the year 2000 (Y2K) problem. These had depleted IT budgets to the point where there was a fall in demand for computer analysts. He also referred to the fact that the

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applicant was developing software products and its website.

27. The respondent is empowered by s 87-65(ii) of the Act to make a PSBD if he is satisfied that the circumstances described by Mr Jakins are unusual circumstances applying to the applicant in the year of income and that but for them, the applicant could reasonably have been expected to meet, or would have met, the unrelated clients test for a personal services business.

28. The circumstance that the applicant was developing software products in the year of income is irrelevant to the making of a PSBD as that activity related to the applicant's sales income and not the PSI. The Tribunal has reached the same conclusion in relation to the development of the website which was used principally to promote sales.

29. Section 87-65(3)(ii) of the Act refers to ``unusual circumstances applying to the entity''. The Tribunal has construed this requirement to refer to circumstances other than those that affected the IT industry generally and which were not regular or recurring incidents of the applicant's activities that produced the PSI. In the context of the unrelated clients test this construction is exemplified by the special provisions of s 87-65(4) of the Act referred to in paragraph 25 above. So the Tribunal finds that the prevailing economic circumstances pertaining to the IT industry in the year of income, as described by Mr Jakins, do not constitute unusual circumstances applying to the applicant in that year for the purposes of s 87-65(3)(ii) of the Act. It is therefore unnecessary for the Tribunal to consider whether but for those circumstances, the respondent ought to have been satisfied that the applicant could reasonably have been expected to meet, or would have met, the unrelated clients test in the year of income.

30. The Tribunal affirms the respondent's decision of 16 April 2003 to refuse the applicant a PSBD in respect of the PSI for the year of income.