Edited version of private ruling

Authorisation Number: 1011493324481

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Ruling

Subject: Personal Services Income, Small Business Tax Break and IT 2503

Issue 1

Question 1

Are you conducting a personal services business under Division 87 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Issue 2

Question 1

Are you eligible for the small business tax break under Division 41 of the ITAA 1997?

Answer

Yes, providing that you satisfy all of the other eligibility requirements. The fact that you are a personal services entity and do not meet any of the personal services business tests nor have a personal services determination will not in itself prevent you from claiming the small business tax break.

Issue 3

Question 1

Does the ruling IT 2503 apply to dentists?

Answer

Yes.

Question 2

Can the income be retained in the company and not paid to the individual practitioner?

Answer

No. As you are not considered to be carrying on a personal services business the PSI rules will apply. The personal services income should be promptly paid as salary or wages or the amount must be attributed to the individual performing the personal services.

Relevant facts and circumstances

You are a company that provides dental services. You have one shareholder and sole director who is a dentist and is your sole employee. The work is performed for you by this individual.

You have one client.

You have provided a copy of the contract between you and your client.

The preamble to the contract provides that your client operates a dental practice and has engaged you to provide services of a registered dentist at the premises of your client.

You are contracted to perform the services of a registered dentist who will perform the services normally provided by a dentist registered to practice in private practice in Australia.

The contract provides that you will ensure that all patients treated by the individual remain patients of your client and not, you or the individual.

The contract provides that the fees you received are based on a percentage of the net receipts paid by the patients for the month.

The patients pay the fees to your client.

You bill your client on a monthly basis in arrears.

Your client provides the all the plant and equipment needed to perform the work. Such items of plant and equipment include chair, computer dental equipment and materials. You only are required to pay for bleach.

The contract states that you are required to pay all incidental costs to the individual including wages, salaries, allowances, superannuation, payroll tax, long service leave

You are required to rectify all defective work and you are liable for the cost of rectifying defects. The time taken to fix defects is not liable to be charged to the client. You are required to hold your own professional indemnity and public liability insurance. The contract states that the you/contractor are required to indemnify and keep indemnified the client I respect of all claims, demands, action, proceedings, costs, losses, expenses and damages whatsoever which are made or brought against the contractor or incurred or suffered by the contractor which arises either directly or indirectly out of provision of the services, whether or not the contractor has performed its services under the contract.

You are required to hold your own workers compensation insurance policy.

You provide you services at the time stated in the contract. There is provision to amend these times.

The client doe not provide specific instructions to the contractor on how a particular service is to be provided. The contract does provide for certain professional standards to be adhered to. The contractor is able to delegate work to other dentists within the surgery if required.

Issue 1 Question 1

Summary

Your income is from dental professional services that is mainly a reward for an individual's personal efforts or skills and is therefore personal services income

The personal services tests, apart from the results test under section 87-18 of the ITAA 1997, do not apply if 80% or more of your personal services income is from one source.

As 80% or more of your personal services income is from one source, the other 3 personal services business tests will not be examined.

All the conditions in paragraphs 87-18(3)(a)-(c) of the ITAA 1997 are not met, accordingly you do not meet the requirements of the results test.

As the results test is not met and 80% or more of your personal services income is from one source the PSI alienation measures apply. Accordingly the personal services income is included in the assessable income of the individual whose personal efforts generate the income and the provisions limiting deductions apply.

Detailed reasoning

Personal Services Income

The measure contained in Divisions 84 to 87 of the Income Tax Assessment Act 1997 (ITAA 1997) only applies if a taxpayer has income that is personal services income (of an individual). The definition refers to income (including ordinary income or statutory income of any entity) that is mainly a reward for an individual's personal efforts or skills. Subsection 84-5(3) of the ITAA 1997 extends the definition of personal services income to income that is for doing work or for producing a result. The result must be produced from the individual's personal efforts or skills.

The services provided by you are dental professional services which are services of a registered dentist who performs services normally provided by a dentist registered to practice in private practice in Australia.

Based on the information provided, the Commissioner is satisfied that your income is from dental professional services that is mainly a reward for an individual's personal efforts or skills and is therefore personal services income.

Results test

The results test as specified in subsection 87-18(3) of the ITAA 1997 provides: 

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:

· the income is for producing a result; and

· the personal services entity is required to supply the plant and

· equipment, or tools of trade, needed to perform the work from which the personal services entity produces the result; and

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

Each of the three limbs of subsection 87-18(3) must be met to pass the results test.

In considering the results test, regard must be had to the custom or practice as specified in subsection 87-18(4) of the ITAA 1997 which states:

For the purposes of paragraph (1)(a), (b) or (c) or (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:

· for the personal services income from the work to be for producing a result; and

· for the entity to be required to supply the plant and equipment, or tools of trade, needed to perform the work; and

· for the entity to be liable for the cost of rectifying any defect in the work performed;

· as the case requires.

The results test is based on the traditional criteria for distinguishing independent contractors from employees.

Accordingly, there is significant overlap and the totality of the relationship between the parties will be relevant as to whether the contract is properly to be construed as one for the production of a result.

Producing a result

To satisfy the first condition for the results test the personal services income must be for producing a result. The meaning of the phrase producing a result means the performance of a service by one party for another where the first-mentioned party is free to employ his/her own means (i.e., third party labour, plant and equipment etc) to achieve the contractually specified outcome. The essence of the contract has to be to achieve a result and not to do work.

The Explanatory Memorandum to the Alienation of Personal Services Income Act 2000 provides:

The individual must actually be paid on the basis of achieving a result, rather than for example, for hours worked. (paragraph 1.114)

If remuneration is payable when, and only when, the contractual conditions have been fulfilled, the remuneration is for producing a given result.

Where there is a contract, regard should be had to its true essence and the circumstances surrounding the formation of the contract may be of assistance to determine the true character of the contract. Having regard to the true essence of the contract, the manner in which payment is structured will not of itself exclude genuine result based contracts. For example, there are results based contracts where the contract price is based on an estimate of the time and labour cost that is necessary to complete the task, or may even be calculated on that basis, subject to reasonable completion times.

The totality of the relationship is looked at in determining whether the results test is met for the purposes of subsection 87-18(3) of the ITAA 1997.

In a contract for a result payment must be contingent upon the achievement of a contractually required outcome. Payment is based upon performance of the contract rather than being paid an hourly rate, piece rates or award rates.

Based on your statements and the contract, the fees you received are based on a percentage of the net receipts paid by the patients for the month. You bill the client on a monthly basis in arrears.

You provide you services at the time stated in the contract. There is provision to amend these times.

The contract provides that you will ensure that all patients treated by the individual remain patients of your client and not, you or the individual.

The contractor is able to delegate work to other dentists within the surgery if required.

In weighing the evidence provided, the essence of the contract is payment to perform work as opposed to producing a result. Even though the receipts are based on a percentage of the net receipts paid by the patients for the month, the days and hours are set for you, which indicate that the contract is based on daily performance. The contract indicates that payments were made based on days worked regardless of whether a result was produced. This is inconsistent with a results based contract; rather it indicates a contract for work.

The information provided shows that you were not paid for achieving a result.

Accordingly you do not satisfy paragraph 87-18(3)(a) of the ITAA 1997.

Summary producing a result

Considering the material above, it is considered that remuneration is not payable when the contractual conditions have been met, but for work done. It is not enough that you are required to produce results from your work; payment must be contingent on the achievement of contractually specified results.

The evidence indicates that the proposed arrangement is for work done and not for achieving a result and therefore the requirements of paragraph 87-18(3)(a) of the ITAA 1997 are not met.

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

The second condition for the results test is that you are required to supply the plant and equipment or tools of trade, needed to perform the work that produces the result.

Having regard to the custom and practice in relation to particular work there may be an expectation that a genuine independent contractor would be required to supply the plant and equipment or tools of trade necessary to perform the work. Where such an expectation exists, or where the contractual arrangements require the supply of necessary equipment or tools, such equipment or tools have to be supplied in order to meet the results test.

The plant and equipment or tools of trade that may be required to be provided are those that are necessary to do the actual work that you are contractually required to perform. This is to be distinguished from those circumstances where a service acquirer provides plant and equipment that are not needed to perform the work.

For example, the construction, by a builder, of scaffolding at a large, commercial building site does not result in carpenters, who use that scaffolding in getting to that part of the site where they do their work, failing the second condition. Whilst the scaffolding permits them to have access to the particular part of the site where they do their work, it would not constitute plant and equipment needed by them to do their particular work.

This condition is to be considered on a substantive basis and minimal usage of the tools or equipment of others will not of itself disqualify the taxpayer. For example, the use of the service acquirers pen or telephone by an electrician or even the temporary use of tools (where it is more convenient to do so because, for example, the electricians tool kit is not readily available at a particular time) would not cause this condition to be failed. In relation to the work more generally, the common practice and requirement in such a case may be that the electrician would be expected to supply and would be required, as a practical matter, to supply the necessary tools for the job.

There are situations where, having regard to the custom and practice of the work, or the practical circumstances and nature of the work, no plant or equipment or tools of trade are necessary to perform the work from which you produce the result. If no equipment or tools are needed the provision will always be met in these circumstances.

You advised that your client provides the all the plant and equipment needed to perform the work. Such items of plant and equipment include chair, computer dental equipment and materials. You only are required to pay for bleach. It would be custom or practice for dentists to supply the necessary equipment or tools.

The information provided shows that you were not required to supply the plant and equipment or tools of trade needed to perform the work.

Accordingly paragraph 87-18(3)(b) of the ITAA 1997 is not satisfied.

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

The third condition for the results test requires that the individual or the personal services entity is or would be liable for the cost of rectifying any defect in the work performed.

The emphasis here is on liability for the cost of rectifying faulty work. That is, the key underlying consideration is whether the individual or entity is exposed to commercial risk in terms of a liability to cover the cost of rectifying defective work. This is consistent with the focus on the chance of profit and the risk of loss as a traditional indicator that a taxpayer is an independent contractor conducting their own business.

It is only the cost of rectification of their defective work that must be met by you. There is no requirement that the individual or entity actually perform the work which rectifies the defect so long as they pay for it. Nor does it matter whether the relevant exposure to a liability for the cost of defective work arises before or after payment by the service acquirer or delivery of the result.

The existence of a term in an agreement that you are 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 you and the service acquirer are dealing with each other at arms 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.

The phrase rectifying any defect literally means to put right any fault or imperfection. Clearly, not all work is capable of rectification if that phrase is given its narrow literal meaning. It is arguable on this narrow view that if the work is not capable of rectification then the results test cannot be passed.

The Macquarie Dictionary definition of rectify includes to remedy which can mean legal redress or the legal means of enforcing a right or redressing a wrong. Consequently, being liable to rectify the cost of any defect could be inclusive of a rectification achieved by the acquirer of the services pursuing a legal remedy for damages, in circumstances where the defect is incapable of physical repair.

You state that you are required to rectify all defective work and you are liable for the cost of rectifying defects. The time taken to fix defects is not liable to be charged to the client. You are required to hold your own professional indemnity and public liability insurance. The contract states that the you/contractor are required to indemnify and keep indemnified the client I respect of all claims, demands, action, proceedings, costs, losses, expenses and damages whatsoever which are made or brought against the contractor or incurred or suffered by the contractor which arises either directly or indirectly out of provision of the services, whether or not the contractor has performed its services under the contract.

The Commissioner is satisfied that you are or would be liable for the cost of rectifying any defect in the work that you performed.

Accordingly the requirements of paragraph 87-18(3)(c) of the ITAA1997 are met.

Summary

As all the conditions in paragraphs 87-18(3)(a)-(c) of the ITAA 1997 are not met you do not meet the requirements of the results test.

As the results test is not met and 80% or more of your personal services income is from one source the PSI alienation measures apply.

Issue 2 Question 1

Summary

You are eligible for the small business tax break under Division 41 of the ITAA 1997 provided that you satisfy all of the other eligibility requirements. The fact that you are a personal services entity and do not meet any of the personal services business tests nor have a personal services determination will not in itself prevent you from claiming the small business tax break.

Detailed reasoning

The Tax Laws Amendment (Small Business and General Business Tax Break) Act 2009 received Royal Assent on 22 May 2009. This has been inserted into the ITAA 1997 as Division 41.

Small business entities are able to claim a bonus tax deduction of 50% for eligible assets costing $1,000 or more (exclusive of GST) that they:

· commit to investing in between 13 December 2008 and 31 December 2009, and

· start to use or have installed ready for use by 31 December 2010.

To qualify for the 50% rate you need to meet the definition of a small business entity in section 328-110. This generally means that the taxpayer is carrying on a business and has an annual turnover of $2 million or less.

Businesses can commit to investing in an asset by:

· entering into a contract under which they will hold the asset, or

· starting to construct the asset.

Eligible assets

The Tax Break is available for new tangible, depreciating assets for which a deduction is available under Subdivision 40-B and new investment in existing eligible assets.

Capital works expenditure for which a deduction is available under Division 43 is not eligible for the Tax Break.

When a taxpayer first starts to use an eligible asset it must be reasonable to conclude that the asset will be used principally in Australia for the principal purpose of carrying on a business.

Decline in value deduction

Section 40-25 allows you to deduct from your assessable income an amount equal to the decline in value of a depreciating asset to the extent to which it is used to produce assessable income.

Under section 40-30, a depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. There are exceptions to that rule such as land, an item of trading stock and some intangible assets.

Personal services entity

If you are a personal services entity (for example, a company) carrying on a business and in receipt of personal services income, but do not meet any of the four personal services business tests and have not received a personal services determination, you will be entitled to a deduction for the tax break if you meet all the other eligibility requirements.

A personal services entity is defined by subsection 86-15(2) to be a company, partnership or trust whose ordinary or statutory income includes the personal services income of one or more individuals.

Section 86-60 contains the general rules concerning deduction entitlements of personal services entities. This section does not apply to deny a deduction for the tax break to a personal services entity that is conducting a business.

Conclusion

As long as you satisfy all the other requirements, you eligible for the small business tax break. The fact that you do not satisfy any of the personal services business tests nor have personal services determination does not in itself prevent you from claiming the tax break.

Issue 3 Question 1

Summary

IT 2503 will apply to dentists that incorporate their professional practices.

Detailed reasoning

Income Tax Ruling IT 2503 is concerned with the tax consequences of the incorporation of medical and other professional practices. The ruling states that it covers companies (or trusts) formed by professional persons such as doctors, lawyers, accountants, engineers and architects to take over and conduct their professional activities. The sole practitioner or partners are then employed by the practice entity. Dentists are a class of professional practices, similar to doctors, envisaged by the ruling. Therefore the ruling will apply to dentists.

Issue 3 Question 2

Summary

As you are not considered to be carrying on a personal services business the PSI rules will apply. The personal services income should be promptly paid as salary or wages or the amount must be attributed to the individual performing the personal services.

Detailed reasoning

The Commissioners opinion as stated in IT 2503 that an incorporated professional practice which earns its income from the provision of personal services should have no taxable income. This would be achieved by paying the income, after expenses, to the practitioners by way of salary.

The Commissioner accepts that, where a bona fide attempt has been made has been made to break even but the practice company has returned a relatively small taxable income the company should distribute all of the taxable income to the practitioners by way of a franked dividend in the following year.

As you are not considered to be carrying on a personal services business the PSI rules will apply. The personal services income should be promptly paid as salary or wages or the amount must be attributed to the individual performing the personal services.