Edited version of private ruling

Authorisation Number: 1011748979307

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Ruling

Subject: Business Structure or Personal Services Income

Question

Whether the income produced is income from a business structure?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 2009

Income year ending 30 June 2010

Income year ending 30 June 2011

The scheme commences on:

1 July 2008

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.

An entity (you) have applied for a ruling about the income generated from a professional practice that you conduct.

You charge clients for professional services that you provide.

As part of your practice you also provide other services through the skills and qualifications of the principal. Those services comprise attending to more complex matters.

The services of the principal are obtained under contract.

You wish to know whether the income generated from your professional practice is from a business structure or whether some part of the income represents the personal services income of the principal.

You advise that your practice is conducted as a normal professional practice and that it has;

· business premises

· substantial work in progress

· a large number of clients

· the normal assets of a professional practice

You state that in addition to the principal you have one other (non principal) practitioner who performs charge out work and two support staff.

Relevant legislative provisions

Income Tax Assessment Act 1997 84-5.

Reasons for decision

You are seeking a ruling on whether income generated from your professional practice is income from a business structure.

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 of personal services income is contained in subsection 84-5(1) of the ITAA 1997 which states:

Your ordinary income or statutory income, or the ordinary income or statutory income of any other entity, is your personal services income if the income is mainly a reward for your personal efforts or skills (or would mainly be such a reward if it was your income).

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 ITTA 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 service providers personal effort or skills.

The fact that income is payable under a contract does not stop the income being mainly a reward for a service providers personal efforts or skills (subsection 84-5(4) of the ITAA 1997).

The reference to the income that is mainly a reward for the personal efforts or skills of a service provider requires a conclusion as to the substance of contractual arrangements between the relevant parties to those contracts. The Macquarie Dictionary (Second Revision) defines "mainly" as:

· chiefly; principally; for the most part

Whether the provision of the personal efforts or skills of a service provider to a service acquirer is the chief or the principal component of a contract will depend on the terms and conditions of that contract.

Income from personal services is to be distinguished from income that is mainly:

· for the supply of goods;

· for the granting of a right to use property

· for the use of assets in the income producing activities and where those assets generate the income for the entity.

Income from a business structure is not personal services income

The alienation measure does not apply to businesses that have a substantial profit-yielding structure. The distinction between income that is mainly a reward for personal efforts or skills and income from a business structure will need to be made having regard to factors such as the number of arms length employees or others engaged to perform work, the presence of goodwill, the extent to which income-producing assets 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 individuals own personal skills, efforts or expertise.

Taxation Ruling TR 2001/7 Income tax: the meaning of personal services income provides examples of the distinction between income derived from personal services and income derived from the supply and sale of goods, use of income-producing assets, and business structure.

Income Taxation Ruling IT 2639 Income Tax: Personal Services Income expands upon the factors that are considered for whether income is from a business structure. Income derived by a firm or practice which has substantial income producing assets, or many employees, or both, is more likely to be generated from the income yielding structure of the business rather than from the rendering of personal services.

Paragraph 8 of IT 2639 states that the extent of the connection between the income concerned and the services rendered by the particular taxpayer involved is crucial in determining whether or not the income is the personal services of the individual or whether it is from a business structure. The paragraph identifies factors that need to be considered in determining whether a taxpayer derives income from personal services, although no one factor is determinative. The factors identified are the nature of the taxpayers activities, the extent to which the income depends upon the taxpayers own skill and judgement, the extent of the income producing assets used to derive the income and the number of employees and others engaged. These factors are discussed below.

Paragraph 10 of IT 2639 states that, as a general rule of thumb, if there are as many non-principal practitioners as there are principal practitioners, then this may indicate that the income is from the business structure rather than from the personal services of an individual. However, all the factors in paragraph 8 of IT 2639 need to be considered.

Paragraph 11 of IT 2639 defines a practitioner as professional and non professional staff whose function is to derive material fees for the practice. The term practitioner does not include clerical or support staff.

The nature of the taxpayer's activities

The activities of salary and wage earners and professionals practising on their own account clearly generate personal services income. Radiologists or pathologists who operate on their own account, however, often employ many technical staff and operate an array of technical equipment. Their income is generated from the business structure rather than from their rendering of personal services. The activities of consultants, salespersons, journalists, life insurance agents and tradespersons are also likely to give rise to income from personal services. These examples are far from being exhaustive.

The arrangements are those common to professional practices and involve the provision of services to your clients. The services are provided by two practitioners, assisted by support staff.

The extent to which the income depends upon the taxpayer's own skill and judgment

The more the income producing activities involve the exercise of the taxpayer's own skill and judgment the more probable it is that the income will be derived from personal services rather than from the business structure.

The principal and one other non principal practitioner would be providing professional services assisted by two support staff.

The income from professional services would be derived from the efforts of the practice as a whole rather than being dependent upon the services of any particular individual.

The extent of the income producing assets used to derive the income

The more substantial the income producing assets employed within a practice the more likely it is that the income of the practice will be derived from the business structure rather than from the rendering of personal services. For example, the array of equipment used by radiologists and pathologists may often suggest that their income is being derived from the business structure. However, minor equipment such as the drawing board of an architect or the heart monitor/blood pressure machine of a medical practitioner would not suffice to change what would otherwise be personal service income into income from the business structure. The expression "income producing assets" is used in this context to include any investment of the practice in tangible business assets such as premises, fixtures and fittings, plant, equipment and industrial or intellectual property (whether owned or leased). However, the significance of these assets would have to be weighed against their relevance to the derivation of income - given the other factors mentioned in this paragraph.

TR 2001/7, at paragraph 31, states that the determination of whether income is mainly a reward for the personal efforts or skills of an individual or whether it is generated by the sale of goods, granting of a right to use property, supply and use of assets or business structure, requires practical judgement as to whether the value contributed by the efforts or skills of the individual exceeds the value of other inputs such as plant and equipment, intellectual or other property or goodwill.

You state that you have the use of premises; whether these are owned or leased these constitute a substantial asset. In addition there would be the goodwill and work in progress associated with a substantial practice with a large number of clients.

The substantial assets used by the practice indicate the existence of a business structure.

The number of employees and others engaged

The more substantial the number of employees, practitioners or technicians used in a practice the more probable it is that the income is derived from the business structure rather than from the rendering of personal services (see Henderson v. F.C. of T. 70 ATC 4016; (1970) 1 ATR 596). For example, large accounting and legal firms with tens, or even hundreds, of practitioners but without extensive or substantial equipment would also be considered to be generating their income from their business structure.

In addition to the fees generated by the principal practitioner the practice would have one other non principal practitioner who performs charge out work. A further two staff would provide clerical support.

Summary

It is considered that the income from the professional practice is income from a business structure.

We have reached this conclusion based on the fact that there are as many non principal practitioners as principal practitioners, the use of business premises and substantial assets used in the conduct of the practice.

Consequently, the Commissioner considers that the income of the practice from providing professional services would be income from a business structure.