Edited version of private ruling

Authorisation Number: 1011824650807

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Ruling

Subject: Personal Services Income

Question

Are you required to include attributed personal services income from a trust in your return?

Answer

Are you required to include attributed personal services income from a trust in your return?

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

1 July 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.

1) You have applied for a Private Binding Ruling for the 2011-12, 2012-13 and 2013-14 financial years.

2) You have applied in relation to the personal services income that a trust will generate through the provision of your professional services.

3) The scheme or arrangement is as follows:

· You will provide professional services through the trust using your professional expertise.

· The trust will provide your services to an associated entity in return for fees paid under a contract. These fees will equate to what would otherwise be the net income of the associated entity. Fees will flow in a timely manner to trust.

· The entity would pass the results test under the personal services legislation.

· The trust would not supply the tools and equipment needed for the entity to produce the result contracted for by that entity's clients.

· The trust would not be responsible for the cost of rectifying defects in the work you perform on the entity. The entity would be liable for the cost of rectifying defects.

· All of the trust income would be from one source, the entity.

· You state that there is not a Personal Services Business Determination in force and that the trust will not be applying for one

· The trust does not expect to have any other person contracting to perform your work.

· The trust will not have business premises.

Relevant legislative provisions

Income Tax Assessment Act 1997 84-5,
Income Tax Assessment Act 1997 87-18(3),
Income Tax Assessment Act 1997 87-20,
Income Tax Assessment Act 1997 87-25 and
Income Tax Assessment Act 1997 87-30.

Reasons for Decision

Detailed reasoning

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 are professional services.

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

You seek a ruling on whether the income generated by the trust as a result of the provision of your services is required to be included in your return by the attribution provisions of the personal services income provisions.

Income is required to be attributed unless it is from a personal services entity conducting a personal services business (subsection 86-15(3) of the ITAA 1997). A personal services business is conducted when the entity has a Personal Services Business Determination in force or passes one of the four personal services tests (Subdivision 87-A of the ITAA 1997).

You state that there is not a Personal Services Business Determination in force and that you will not be applying for one. The four tests that determine whether the trust is conducting a Personal Services Business will now be considered.

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:

(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;

(d) 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 (ie. 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.

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

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

Information supplied shows that the trust is paid an amount of income for providing professional services that will amount to the net income of the entity under a contractual arrangement. Payment to the trust is not made on the basis of completed work but is based on the net income of the entity. The trust is contractually entitled to payment of what is effectively the net income of the entity rather than an amount paid for the production of a result.

Payment on the basis of the net income of another entity, being a contractual entitlement for your services, is not payment for a result.

Based on the information provided the remuneration is not paid for the production of a result.

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.

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 state that the trust would not provide the tools and equipment needed to perform the contracted work.

Information provided shows that the trust would not be contractually required to provide the tools and equipment required to perform the work that produces the result.

It is considered that the requirements of paragraph 87-18(3)(b) of the ITAA 1997 are not met.

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.

Paragraph 87-18(3)(c) of the ITAA 1997 makes it a requirement of the results test that you must meet the costs associated with rectifying the defect. It is only the cost of rectification of the defective work that must be met by you. There is no requirement that you actually perform the work which rectifies the defect so long as you 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 the trust would not be financially liable for the costs of rectifying defects as the entity would be financially liable for the cost of rectifying defects in the work performed.

The Commissioner is therefore satisfied that the trust would not be contractually liable for the cost of rectifying any defect in the work performed.

Accordingly the requirements of paragraph 87-18(3)(c) of the ITAA 1997 are not met.

Summary

As none of the conditions in paragraphs 87-18(3)(a), (b) and (c) of the ITAA 1997 is satisfied, the income of the trust generated by your efforts does not meet the requirements of the results test.

Employment, Business Premises and Unrelated Clients Test

The employment, business premises and unrelated clients test will now be discussed.

To pass the employment test another entity must perform more than 20% of the market value of your work in a year of income.

The business premises test requires there to be business premises that are not at the residence of the individual or at the client's premises

The unrelated clients test requires that there be two or more clients that are obtained by making offers or invitations to the public or a section of the public. For this test to be used to avoid attributing the personal services income to the individual, less than 80% of the income (the 80% rule) must be from one source or there must be unusual circumstances preventing the test, the 80% rule or both the test and the 80% rule being met.

In the case of the trust no entity has been identified that performs more than 20% of the market value of your work and there are no business premises. In considering the unrelated clients test the trust will have only one client the entity in the years of income under consideration and as result all of the income from your personal services will be from one source.

Accordingly none of the employment, business premises and unrelated clients tests will be passed by the trust.

Summary

As none of the four personal services business tests are passed and there is not and will not be a Personal Services Business Determination in force, your income from the provision of personal services through the trust would be subject to attribution under the personal services provisions, particularly section 86-15 of the ITAA 1997, and thus, would be required to be included in your personal income tax return. The amount to be included under section 86-15 of the ITAA 1997 would reflect whether the entity is using the receipts (cash) or earnings method of returning income.