The impact of this case on ATO policy is discussed in Decision Impact Statement: Commissioner of Taxation v Yalos Engineering Pty Ltd; Yalos Engineering Pty Ltd and Commissioner of Taxation (VID 479 of 2009 (FC); 2007/3018-3019 (AAT) ).
YALOS ENGINEERING PTY LTD v FC of TMembers:
BH Pascoe SM
Administrative Appeals Tribunal, Melbourne
MEDIA NEUTRAL CITATION:
 AATA 408
Mr B H Pascoe, Senior Member
1. This application was the subject of a decision of this Tribunal of 29 May 2009. Following an appeal from this decision to the Federal Court of Australia, Jessup J on 23 December 2009, set aside the decision and remitted it to the Tribunal for hearing and determination consistently with the reason of the court given on that day.
2. At the hearing on remittal, the applicant, Yalos Engineering Pty Ltd (Yalos) was represented by Mr A Sandbach of counsel and the respondent, Commissioner of Taxation was represented by Ms M Schilling of counsel.
3. The application was for the review of a decision of the respondent to disallow an objection against the refusal of the respondent to make a personal services business determination under section 87-65 of the Income Tax Assessment Act 1997 (the Act). In the Tribunal decision of 29 May 2009, the respondent was directed to make such a determination relating to the personal services income included in the income of Yalos in the years ended 30 June 2004 and 30 June 2005.
4. Part 2-42 of the Act provided that a taxpayer can only claim deductions for personal service income if they are conducting a personal service business.
5. Subsection 87-65(3) provided that the Commissioner may make a personal business services determination in relation to a business for an income year. The conditions for making a determination were in subsections 87-65 (3B) (for 2004) and 87-65(6) (for 2005). Relevantly, the Commissioner must not make the determination unless satisfied that, but for unusual circumstances applying to an entity in that year, the entity could reasonably have been expected to meet the unrelated clients test in s 87-20.
6. Subsection 87-20(1) set out the unrelated clients test. It had two parts. First, income must be gained from providing services to two or more associated customers: s 87-20(1)(a). Second, the services must be provided as a direct result of the individual or entity making offers or invitations to the public to provide those services: s 87-20(1)(b).
7. Subsection 87-65(4) defined what unusual circumstances might prevent part (a) of the unrelated clients test from being met. Unusual circumstances included providing services to an insufficient number of entities if:
- - the entity started business during an income year, and could reasonably be expected to meet the test in subsequent income years; or
- - the entity provided services to only one entity during the income year but met the test in one or more preceding income years and could reasonably be expected to meet the test in subsequent income years.
8. The Commissioner appealed to the Federal Court, arguing that the Tribunal had erred in directing the Commissioner to make a personal services business determination. The Commissioner submitted that the Tribunal had misapplied the but for criterion in subsections 87-65 (3B) and (6). The Commissioner further submitted that the Tribunal had not correctly applied the unrelated clients test in s 87-20(1).
9. The Court rejected the Commissioner' submission that the Tribunal had not correctly applied s 87-20(1)(a). The Court observed that, where there are unusual circumstances, the entity was assisted in meeting subsection (a) by subsection 87-65(4).
10. However the Court held that the Tribunal had overlooked the requirement in s 87-20(1)(b), which required services to be provided as a direct result of the individual or entity making offers or invitations to the public to provide those services. The Court found that, even where unusual circumstances existed, it was necessary to consider whether Yalos would have met, or could reasonably have been expected to meet, the unrelated clients test but for those unusual circumstances.
11. At paragraphs 17 and 18 of Reasons for Judgment, Jessup J said:
".... The Commissioner contended that the Tribunal had overlooked the requirement that, even where unusual circumstances existed, it was necessary to consider whether the respondent would have met, or could reasonably have been expected to meet, the unrelated clients test 'but for' those circumstances. I consider that there is substance in this ground. As I have attempted to explain earlier in these reasons, where one of the criteria in subs (4) is satisfied, the entity concerned is assisted in meeting part (a) of the unrelated clients test. That is to say, where subs (4) operates, the unusual circumstances are the provision of services to an insufficient number of entities to meet the unrelated clients test. Ex hypothesi, but for those unusual circumstances, the putative entity would have provided services to a sufficient number of entities to meet part (a) of the test.
As indicated above, I read the Tribunal as having had recourse to subs (4) in this way. However, I cannot find in the Tribunal's reasons any decision on part (b) of the unrelated clients test in its application directly to the years 2004 and 2005. I say this because I read the last three sentences of the passage as being concerned with the pattern by which the respondent secured work in the preceding and subsequent years. For a determination to be made within the constraints of subs (3), it was necessary for the Tribunal to have found, as a positive fact, either that the services provided to Manpower in 2004 and 2005 were so provided as a direct result of the respondent having made offers or invitations (for example, by advertising) to the public at large or to a section of the public, or that, but for unusual circumstances (unrelated to subs (4)) those services would have been so provided as a direct result of such offers or invitations. The Tribunal does not appear to have addressed these issues."
12. At paragraph 21 it was said:
"For the above reasons, I am of the view that the Tribunal reached the conclusion that a personal services business determination should be made without addressing one of the required statutory criteria, namely, that arising under part (b) of the unrelated clients test in its application under subs (3B) (for 2004) and (6) (for 2005) of s 87-65 of the 1997 Act. The application will be allowed, and the matter remitted to the Tribunal under s 44(5) of the AAT Act."
13. It is quite clear from the words and from the decision as a whole that the sole issue for consideration by the Tribunal on remittal from the Court is to address the question of whether Yalos satisfied part (b) of the unrelated clients test in its application directly to the years 2004 and 2005.
14. Section 87-20(1) relevantly provides that:
- "(1) An individual or a *personal services entity meets the unrelated clients test in an income year if:
- (a) ...
- (b) the services are provided as a direct result of the individual or personal services entity making offers or invitations (for example, by advertising), to the public at large or to a section of the public, to provide the services. ..."
15. In paragraph 24 of Jessup J's judgment it was said:
"The reasons of the Tribunal do not disclose any specific attention being given to the construction of s 87-20(1)(b) of the 1997 Act. It is apparent that the Tribunal approached the provision as though 'a section of the public' was apt to include, within the context of an industry which had a 'limited number of players', those players. While recognising the objects of Div 87 of the 1997 Act set out in s 87-10, I think it unlikely that the legislature would have intended that s 87-20(1)(b) would be unavailable to an entity which had offered the services of its employee to the major corporations operating within the narrow area of industrial activity for which that employee's skills and experience were suited. In my opinion, this is amply within the connotation of 'section of the public' in the provision. Such a view of the legal position appears to have been implicit in the reasoning of the Tribunal in the present case. For these reasons, I am not persuaded that the Tribunal erred in law in these respects"
16. From the recommendation of the Ralph Report and the Explanatory Memorandum to the Bill which introduced this legislation it is clear that it is to ensure that genuine business situations whose services are available to the public at large in the year of income are differentiated from an employee-like situation.
17. As stated in paragraph 8 of the original decision of this Tribunal:
"The sole income of Yalos in both the 2004 and 2005 years was from Manpower Services Pty Ltd and amounted to $212,300 in 2004 and $119,215 in 2005. Mr Koundouras said that this contract entered into in October 2002 was a contract to perform services as an offshore installation engineer for BHP Billiton in relation to the Minvera gas field. He said that he was suggested for the project by a former colleague and dealt direct with Mr Cini. He was advised that BHP Billiton at that time insisted that all such contracts were to be with a labour hire firm, Manpower, for convenience of paperwork etc, but no fee would be deducted from the contract payment. The contract provided for a daily rate plus expenses and the location was at BHP Billiton offices or other locations as agreed. This arrangement was confirmed by Mr Cini. The original contract was to 31 December 2003. It was extended to April 2005 as a result of delays in the construction of the onshore gas plant. Mr Koundouras described his role as being responsible for the design and oversight of the fabrication and installation of the offshore pipe line as a representative of BHP Billiton. He said that, at all times, the rate of pay was negotiated by himself and generally, resulted from agreement of the rate sought by him. Mr Koundouras maintained that the normal duration of contracts was three to six months. However, the Minerva Project role for BHP Billiton was larger than any prior role, including both design and installation which involved the full range of his knowledge. He stated, also, that it was unusual for such offshore installations to be delayed to the extent that this project was delayed."
18. The Tribunal went on to find that Yalos did not satisfy the unrelated clients test under s 87-20(1)(a) in either of the years ended 30 June 2003 or 2004 in that 100% of the income was from one client but that, but for the unusual circumstances relating to that contract it could reasonably have been expected to meet that test. However, the issue to be now considered is whether but for unusual circumstances it could reasonably have been expected to meet the test contained in s 87-20(1)(b).
19. The evidence of Mr Koundouras and Mr Cini at the original hearing was that the contract was entered into as a result of the personal recommendation of a former colleague of Mr Koundouras. It was the further evidence of Mr Koundouras that his expertise is relevant to a very small number of companies engaged in offshore petroleum exploration and mining. As a consequence advertising in a general sense of advertising in newspapers, brochures or other medium is clearly inappropriate in this context. I am satisfied that those companies constitute a section of the public. Further, I am satisfied that a regular personal contact with those companies within the industry to assess their needs and the opportunity to provide specialised services via word of mouth and personal recommendations from others in the industry constitute making offers or invitations to provide services.
20. In his evidence at the first hearing, Mr Koundouras said that clients were acquired primarily through word of mouth and by referrals or phone calls by him to the various companies in the industry. He said that it was a continuous thing, it doesn't stop whether he was in Australia or overseas. I am satisfied on his evidence that this was a continuous process which satisfied the requirement of s 87-20(1)(b). I am further satisfied that the services to BHP Billiton through Manpower were provided as a result of this form of marketing. I am satisfied, also, that, if it were not for the unusual circumstances of the extension of his contract he would have satisfied the unrelated clients test of s 87-20(1)(a) and those services would have been provided pursuant to s 87-20(1)(b).
21. For completeness it is appropriate to state that, on the evidence, I am satisfied that all approaches and contact with existing or prospective clients was made by Mr Koundouras in his capacity as director/employee of Yalos, so that it can be said that the offer to provide services were made by Yalos.
22. It follows from the foregoing that the original decision of this Tribunal should be affirmed.
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