Edited version of private ruling

Authorisation Number: 1011740181081

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Ruling

Subject: Personal Services Income

Question 1

Is the income personal services income?

Answer

Yes

Question 2

Does the arrangement with a client meet the requirements of the results test?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 January 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

A company (you) have applied for private binding ruling for the 2011 and 2012 income years. You are seeking a ruling on whether income produced under a contract with a client, would be income paid for the production of a result.

You utilise the services of an individual with professional qualifications to provide services to a client.

The client will send you requests for specific products from time to time. At the end of the month you will send an invoice charging for the products that you have sent them (and they have accepted) during that month. Any unfinished product would have to wait until it is finished, sent and accepted before you could charge for it.

You have supplied an invoice showing that you have charged for individual products that have been finished and accepted in a month.

You stated that you are required to provide all tools necessary to complete the work.

Your application states that you will be fully liable for public liability or professional indemnity.

Relevant terms of the agreement between you and the client are as follows;

· Products Supplied - the products to be supplied by you as requested by the client from time to time are identified, the products are a result of professional services performed by the individual.

· Supply - provides that you provide the products to the client within the time and in a form mutually agreed between the client and you.

· Payment - provides that you will receive payment for products supplied once the products have been accepted by the client in accordance with mutually agreed payment terms and methods. Payment is calculated on an hourly rate.

· Warranty - provides a warranty of the quality of the products supplied. That clause also provides that where a product does not meet the accepted standards applicable to the type of product supplied, the client has the right to demand and you have an obligation to perform rectification of identified deficiencies at your own expense.

· Equipment - provides that you are responsible for the provision of all facilities, equipment, supplies, registration and insurances necessary for the satisfactory production of the products.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 84-5(3)

Income Tax Assessment Act 1997 section 84-10

Income Tax Assessment Act 1997 subsection 87-18(3)

Income Tax Assessment Act 1997 subsection 87-18(4)

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 individuals 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.

Mainly

The reference to mainly requires more than half of the relevant amount or item of the ordinary income or statutory income be a reward for the personal efforts or skills of an individual. Where the income is derived under a contract and that contract is for the rendering of personal efforts or the provision of the skills or expertise of a particular individual, the income derived under that contract would mainly be a reward for that individuals personal efforts or skills.

Whether the provision of the personal efforts or skills of an individual to a service acquirer is the chief or the principal component of a contract will depend on the substance of the agreement or contract under which services are provided. Whilst the terms and conditions of a contract will be important, regard will be had to all the circumstances to determine the true nature of the contractual obligations of one party to another.

The use of the word mainly in this context does not preclude the use of some materials, tools or plant and equipment in the rendering or provision of personal services.

Conversely, situations will arise where the rendering or provision of personal efforts or skills is incidental or secondary to the sale or supply of goods, or to the granting of a right to use property, or to the supply and use of income-producing assets. Income in these situations will not be mainly a reward for personal efforts or skills and will not be personal services income under section 84-5 of the ITAA 97.

Personal Services Income

The services provided by the individual are professional services.

Based on the information provided, the Commissioner is satisfied that your income from professional services represented in the products, is mainly a reward for the individuals 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 entities 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 trade, needed to perform the work from which the personal services entity produces the result; and

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

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: 

(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 requires.

However, section 84-10 of the ITAA 1997 provides the application of Divisions 84 to 87 does not imply that the individual concerned is an employee.

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 (that is, 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 consideration often is a fixed sum on completion of the particular job as opposed to an amount paid by reference to hours worked. However, the Commissioner recognises that there may be situations where the amount payable by a service acquirer for the result contracted for is not determined until after the work had been completed, for example. do and charge contracts.

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.

An independent contractor enters into a contract for a specific task or series of tasks often based upon performance of the contract rather than being paid an hourly rate, piece rates or award rates.

You stated that you believe the contract with the client meets the requirements of the results test. Only the identified contract is considered in this ruling.

You perform the professional services in an industry; particularly you produce products that encompass the professional expertise of the individual. At the end of the month you will send an invoice charging for the products that you have sent the client (and they have accepted) during that month. Any unfinished product would have to wait until it is finished, sent and accepted before you could charge for it

The contractual obligations are for the provision of products, a specific result, even though it is calculated at an hourly rate on a do and charge basis. That is you are contracting for a specific result, the production of the identified product. Further, payment is contingent upon that result, the production of completed product.

The information provided shows you are paid for achieving a result being the completed product, the payment being calculated on a do and charge basis.

From the information provided the Commissioner is satisfied that the contract with the client meets the requirements of paragraph 87-18(3)(a) of the ITAA 1997.

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 the individual or the personal services entity is 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 the individual or the personal services entity is contractually required to perform. This is to be distinguished from those circumstances where a service acquirer provides plant and equipment that are not needed by the individual or the personal services entity 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 the individual or personal services entity produces the result. If no equipment or tools are needed the provision will always be met in these circumstances.

You stated that you are required to provide all tools necessary to complete the work.

The particular clause of the agreement provided shows that you are required to supply the equipment or tools of trade needed to perform the work.

Accordingly paragraph 87-18(3)(b) of the ITAA 1997 is satisfied, in respect of the contract with the client.

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.

Paragraphs 87-18(1)(c) and 87-18(3)(c) of the ITAA 1997 make it a requirement of the results test that the individual or entity must meet the costs associated with rectifying the defect. It is only the cost of rectification of their defective work that must be met by the individual or entity. 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 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 personal services entity 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 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.

Your application states that you will be fully liable for public liability or professional indemnity.

Further another clause of the agreement provided states that you warrant the quality of the products supplied. That clause also provides that where a product does not meet the accepted standards the client has the right to demand and you have an obligation to perform rectification of identified deficiencies at your own expense. Another particular clause of the contract requires you to provide all necessary insurances.

The information provided shows that you would be liable for the cost of rectifying defects in the work performed.

From the information provided the Commissioner is satisfied that the contract with the client meets the requirements of paragraph 87-18(3)(c) of the ITAA 1997.

Summary

As all of the conditions in paragraphs 87-18(3)(a)-(c) of the ITAA 1997 are satisfied the Commissioner is satisfied that the income produced under the contract with the client is paid for the production of a result and thus meets the requirements of the results test.