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Ruling

Subject: Personal Services Income

Questions

1. Whether the income is personal services income?

2. Whether the results test is met or could reasonably be expected to be met in respect of the individual's services for the 2007-08, 2008-09 and 2009-10 financial years?

3. Whether the requirements of the unrelated clients test is met or could reasonably be expected to be met in respect of the individual's services for the 2007-08, 2008-09 and 2009-10 financial years?

Answers

1. Whether the income is personal services income?

Yes

2. Whether the results test is met or could reasonably be expected to be met in respect of the individual's services for the 2007-08, 2008-09 and 2009-10 financial years?

No

3. Whether the requirements of the unrelated clients test is met or could reasonably be expected to be met in respect of the individual's services for the 2007-08, 2008-09 and 2009-10 financial years?

No

This ruling applies for the following periods:

2007-08 financial year

2008-09 financial year

2009-10 financial year

The scheme commences on:

1 July 2007

Relevant facts and circumstances

As per answers to Commissioners questionnaire, further information provided, attachments and contracts -

1. The Trust (the trust/you) has applied for a Private Binding Ruling for the 2007-08, 2008-09 and 2009-10 financial years in respect of the personal services income an individual generates for the trust. A ruling is requested on whether the requirements of the results test and the unrelated clients test were met.

2. The individual provides their services in a medical field.

3. The application identifies the result the trust, through the individual, is required to produce as being the performance of tasks and the production of a report for each task.

4. The application states that it is the normal industry practice that the clients provide the tools and equipment necessary to produce the result.

5. The trust is liable for any errors that the individual may make in medical reports and professional liability insurance is held.

6. You advised that you had four clients in the three year period for which a ruling is sought. The details of the clients and the way in which work was obtained with them is as follows;

· Client A - work was obtained with this client as the individual was an employee of this client in previous years.

· Client B - the individual was performing tasks at a private clinic for patients of client B. Client B offered the individual work as a contractor performing tasks for the client directly.

· Client C - the individual approached client C after finding out through word of mouth that the company needed medical services work conducted. Client C offered the individual a position.

· Client D - the individual approached client D after finding out through word of mouth that the company needed medical services work conducted. Client D offered the individual a position.

7. Income details show that the trust was paid for the provision of the individual's services on two bases, an hourly rate basis and a per test basis. The client, basis on which payment is made and the percentages that each payment basis represents are as follows.

2007-08 financial year

Client A - payment was made on an hourly rate basis

Client B - payment was made on a per task basis

Less than 75% of the income was paid on a per task basis

2008-09 financial year

Client A - payment was made on an hourly rate basis

Client B - payment was made on a per task basis

Client C - payment was made on an hourly rate basis

Less than 75% of the income was paid on a per task basis

2009-10 financial year

Client B - payment was made on a per task basis

Client C - payment was made on an hourly rate basis

Client D - payment was made on a per task basis

Less than 75% of the income was paid on a per task basis

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 84-5,

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

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

Income Tax Assessment Act 1997 section 87-20 and

Income Tax Assessment Act 1936 section 318.

Reasons for decision

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 trust's application states that the personal services work undertaken is the provision of medical services, which are performed by an individual.

Based on the information provided, the Commissioner is satisfied that the trust's income from the provision of the individual's medical services, is mainly a reward for their personal efforts or skills and is therefore personal services income.

Income from personal services is attributed to the individual under the personal services income legislation unless one or more of the four personal services income tests are passed. You are seeking a ruling on whether the requirements of the results and unrelated clients test are met in respect of the individual's services provided in the 2007-08, 2008-09 and 2009-10 financial years. These two tests 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:

· 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.

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 totality of the relationship between the parties will be relevant to whether the contract is properly to be construed as one for the production of a result.

Requirement that 75% of the income meets the results test

For the trust to meet the requirements of the results test in respect of the individual's services at least 75% of her personal services income must be for the production of a result. In determining whether the trust meets the requirements of the results test all the personal services income of the individual in a given year is aggregated and the percentage calculated. Information provided shows that in all of the years under consideration, the income of the individual comprised amounts paid both on an hourly rate and on the basis of tasks performed. Information provided shows that less than 75% of the income was paid on the basis of tasks performed in the 2007-08, 2008-09 and 2009-10 financial years.

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 consideration often is a fixed sum on completion of the particular job as opposed to an amount paid by reference to hours worked.

The Explanatory Memorandum to the New Business Tax System (Alienation of Personal Services Income) Bill 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 results 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.

Based on the information provided remuneration is payable both on an hourly rate basis and per task performed basis in the 2007-08, 2008-09 and 2009-10 financial years. Payment on an hourly rate is payment for hours worked rather than payment for a specific result. Payment on the basis of tasks performed is payment based on the production of a result, being the performance of a task. To satisfy the requirements of the results test at least 75% of the income in aggregate must be paid for the production of a result. As outlined above less than 75% of the income was paid on the basis of tasks performed in the 2007-08, 2008-09 and 2009-10 financial years.

In the 2007-08, 2008-09, 2009-10 financial years less than 75% of the income produced by the individual was paid for a result.

Therefore the requirements of paragraph 87-18(3)(a) of the ITAA 1997 are not met for any of the 2007-08, 2008-09, 2009-10 financial years. An insufficient percentage of the income is paid for a result in the 2007-08, 2008-09, 2009-10 financial years.

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.

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.

The application states that it is the usual custom of the profession that clients provide the tools and equipment needed to produce the result.

Given the custom or practice of the profession, it is accepted that there is not a requirement or expectation that the trust supply the tools and equipment. Accordingly the trust would meet the requirements of this limb of the results test, in respect of the individual.

Accordingly paragraph 87-18(3)(b) of the ITAA 1997 is 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 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 arm's 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 application stated that the trust is liable for the cost of rectifying any defects and that appropriate insurance cover is held to cover any liability for faulty work performed by the individual.

The trust's contractual arrangements with your clients in respect of your client's patients would make the trust liable for the cost of rectifying any defects in the work. This is reflected in the information provided and the holding of professional indemnity insurances.

The trust's contractual arrangements are such that the trust would be liable for the cost of rectifying defects for which the individual is responsible.

The Commissioner is therefore satisfied that the trust meets the requirements of paragraph 87-18(3)(c) of the ITAA 1997.

Summary

As not all the conditions in paragraphs 87-18(3)(a)-(c) of the ITAA 1997 are met for the 2007-08, 2008-09 and 2009-10 financial years the personal services income of the trust generated by the individual efforts does not meet the requirements of the results test.

The unrelated clients test is the other test that you have sought a ruling on, that test will now be considered.

Unrelated clients test

The unrelated clients test as set out in section 87-20 of the ITAA 1997 provides:

(1) An individual or a personal services entity meets the unrelated clients test in an income year if:

a) during the year, the individual or personal services entity gains or produces income from providing services to 2 or more entities that are not associates of each other, and are not associates of the individual or of the personal services entity; and

b) the services are provided as a direct result of the individual or the 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.

(2) The individual or personal services entity is not treated, for the purposes of paragraph (1)(b), as having made offers or invitations to provide services merely by being available to provide the services through an entity that conducts a business of arranging for persons to provide services directly for clients of the entity.

Associates

Whether two entities or individuals are associated within the meaning of section 318 of the Income Tax Assessment Act 1936 (ITAA 1936) is a matter of fact. However, where the fact of that association is not known or could not reasonably be expected to be known to a contractor, the clients will be treated as unrelated.

Direct result

The term direct result requires a traceable and substantive connection between the offer to the public (or a section of the public) and the engagement for the work.

What is meant by making offers or invitations?

Making an offer or invitation to the public in general or to a section of the public is an indication by the individual or personal services entity of their willingness to perform services for anyone within a group or class of persons or to any member of the public. The intention of the individual or personal services entity in such activity is to attract or solicit members of the public to enter into agreements for their services. Relevant activities, such as advertising, points to the commerciality and independence of the enterprise conducted by the individual or the personal services entity. Advertising and similar activities are factors that point to the existence of a genuine business.

As the phrase 'making offers or invitations' is not given in the ITAA 1997, for the purposes of the unrelated clients test the meaning is based on the ordinary usage of the terms and may include a wide variety of activities, including word of mouth attempts to attract general business.

An invitation is the mechanism by which an individual or personal services entity holds out to or informs the public or a section of the public the services that the individual or personal services entity is able to provide. An invitation may be made in written or spoken form.

Advertising is an example of making an offer or invitation to the public given in the legislation. Other types of activities or actions that are considered to be making offers or invitations in this context include:

· public tender;

· maintaining an Internet web site on which the availability of services are advertised; and

· word of mouth offers.

What is meant by to the public or a section of the public?

An offer or invitation is made to the public at large where any interested member of the public is capable of accepting it. An offer or invitation to a section of the public is made in situations where only a select group is chosen to whom the invitation is made. Making an offer or invitation to a section of the public could include offering to provide services to one entity for example in relation to competitive tenders.

For the purpose of the unrelated clients test, where there is a prior or subsisting relationship between the parties to an offer or invitation, the following factors are relevant when determining whether the offer or invitation is made to a section of the public:

· The number of persons or entities to which the offer or invitation is made. While not determinative, it is likely to be a public offer or invitation if more entities are involved;

· The nature and content of the offer or invitation. Where the offer or invitation is made as part of a competitive commercial process, such as a public tender, a prior relationship may not detract from the offer being made to the public;

· The nature of the particular relationship between the parties to the offer or invitation. Where the parties to the relationship deal with each other on an arms length basis, the commercial character of the transaction is maintained. Accordingly, the fact that an individual or personal services entity may have worked for/provided services to an entity sometime in the past does not necessarily operate to exclude the individuals or personal services entity from satisfying this test.

What is a business of arranging for persons to provide services?

An offer or invitation is not made by an individual or personal services entity who is merely available to provide services through an entity that conducts a business of arranging for persons to provide services to its clients. Individuals or personal services entities who obtain clients merely through registration with employment agencies, labour hire firms, personnel agencies or any arrangement involving an entity hiring the services of a individual or personal services entity in a manner similar to that of a labour hire firm, are taken not to have made an offer or invitation to provide services to the public at large or to a section of the public.

This is to be contrasted with the situation where an individual or personal services entity makes offers or invitations to the public at large (e.g. by newspaper advertisement) as well as registering with a labour hire firm. The test would be met in this case if two or more unrelated clients engaged the individual or personal services entity as a result of the advertisement.

Your case

You have stated that the individual's work with the four clients was obtained in the following way

· Client A - work was obtained with this client as the individual was an employee of this client in previous years.

· Client B - the individual was performing tasks at a private clinic for patients of client B. Client B offered the individual work as a contractor performing tasks directly.

· Client C - the individual approached client C after finding out through word of mouth that the company needed medical work performed. Client C offered the individual a position.

· Client D - the individual approached client D after finding out through word of mouth that the company needed medical work performed. Client D offered the individual a position.

In the 2007-08 financial year you had two clients who utilised the individual's services, client A and client B. In the 2008-09 financial year you had three clients who utilised the individual's services, client A, client B and client C. In the 2009-10 financial year you had three clients who utilised the individual's services client B, client C and client D. In all years under consideration, less than 80% of the personal services income came from any one client and their associates.

The trust meets the first limb of the unrelated clients test in the 2007-08, 2008-09 and 2009-10 financial years as it provided the individual's services to two or more clients who were not associated.

To meet the requirements of the unrelated clients test, in addition to providing your services to two or more clients, the clients must have been obtained as a direct result of making offers or invitations to the public at large or a section of the public

Your application indicates that you obtained the work at client A as a result of a prior employment relationship. The work at client B was obtained as the client had become aware of the individual's work through a referral relationship and offered the individual work directly. The individual made a successful direct approach seeking work to both client C and client D after finding out that the companies needed medical services performed.

Information provided shows that you obtained the clients as a result of a prior employment relationship, an existing relationship performing tasks for a client's patients and by making direct approaches to companies that needed medical work performed. Approaches made as a result of a prior employment relationship or as a result of performing tasks for a client's patients do not amount to making offers or invitations to the public. Similarly the making of targeted approaches to potential clients who have been identified as needing medical services does not amount to making offers or invitations to the public generally or a section of the public.

Summary

The trust does not meet the unrelated clients test in respect of the individual's services in the 2007-08, 2008-09 and 2009-10 financial years as the trust did not have two or more clients, in respect of the individual's services, that were obtained by making offers or invitations to the public or a section of the public.

As the trust has not met the requirements of the results test or unrelated clients test in respect of the individual's services for the 2007-08, 2008-09 and 2009-10 financial years, the income generated by the provision of the individual's personal services is required to be attributed to the individual.