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Ruling

Subject: Personal services income and foreign income tax offset

Question 1

Does the income of the company, a personal services entity, constitute personal services income of an individual?

Answer

No.

Question 2

Is the company entitled to a foreign income tax offset for the foreign tax paid on its taxable income?

Answer

No.

Question 3

Is the individual entitled to a foreign income tax offset for the foreign tax?

Answer

No.

Question 4

Could the individual's wages income be treated as attributed income instead of salary or wages?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

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.

The company is an Australian resident for tax purposes.

The individual is an Australian resident and is the director/shareholder and the sole employee of the company.

The company derives income from the provision of consultancy service.

The individual worked as an employee and he conducts his activities through the company.

Some of the work is Australian sourced but the bulk was foreign earnings.

The company does not have a permanent establishment in the foreign country. There is no regular fixed base to perform activities in the foreign country.

The individual was not present in the foreign country for a period exceeding 120 days in any period of 12 months in the foreign country.

The individual was not present in the foreign country for a period exceeding in the aggregate 183 days in the year of income of the foreign country.

The company invoices are determined by number of days worked times the individual's day rate. Once income was received by the company it was paid out to the individual by way of wages and had the relevant amount of PAYG withholding taken out of it.

The company is not a personal services business as it does not meet the results test. The individual conducting the work is paid on a daily rate and is not liable to rectify any defects in the work.

The company has paid a salary to the individual within a reasonable time.

Our records show that the company has lodged a PAYG summary statement for the relevant year shows the salary and wages have been paid and the amounts of tax were withheld.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 86-15

Income Tax Assessment Act 1997 Subsection 86-15(4)

Income Tax Assessment Act 1997 Section 86-20

Income Tax Assessment Act 1997 Section 86-30

Income Tax Assessment Act 1997 Section 770-10

Income Tax Assessment Act 1997 Subsection 770-130(2)

Income Tax Assessment Act 1936 Subsection 6AB(3)

Reasons for decision

Question 1

Summary

The income of the company, a personal services entity, did not constitute personal services income of an individual.

Detailed reasoning

Paragraph 28 of Taxation Ruling TR 2003/6 provides that if an entity ('the personal services entity') has income that constitutes personal services income of an individual, the amount of the income after certain reductions is included in the assessable income of the individual by sections 86-15 and 86-20 of the Income Tax Assessment Act 1997 (ITAA 1997). This amount is referred to as the net personal services income. The net personal services income is also excluded from the assessable and exempt income of the personal services entity by section 86-30.

The inclusion of the net personal services income in the assessable income of the individual and its exclusion from the assessable or exempt income of the personal services entity is called attribution.

Attribution will not occur where the personal services entity pays the personal services income promptly to the individual employee (that is, within 14 days) as salary or wages (subsection 86-15(4) of the ITAA 1997). Attribution will also not occur where the personal services entity is conducting a personal services business.

In your case, the company was not conducting a personal services business. The personal services income was paid promptly to the individual by the company as a salary during the year ended 30 June 2010.

Therefore, the attribution did not occur and the personal services income was assessable to the company. The individual had no personal services income that must be included in the individual's assessable income.

Questions 2 and 3

Summary

The company is not entitled to a foreign income tax offset for the foreign tax paid on its taxable income as its net foreign income is nil.

The individual is not entitled to a foreign income tax offset for the foreign tax paid as there is no personal services income which is foreign income in the individual's assessable income.

Reasoning

Under section 770-10 of the ITAA 1997, to be entitled to a foreign income tax offset, you must have actually paid, or be deemed to have paid, the foreign income tax and the income on which you paid foreign income tax must be included in your assessable income in Australia.

Subsection 770-130(2) of the ITAA 1997 provides that the individual could claim a foreign income tax offset if the personal services income is included in the individual's assessable income in respect of foreign tax paid by the personal services entity. A personal services entity may derive foreign sourced income on which it directly pays foreign income tax where an individual provides personal services in a foreign country.

In your case, the company had no taxable income for the year ended 30 June 2010 after allowing a deduction for the salary paid to the individual. Therefore, the company is not entitled to a foreign income tax offset for the foreign tax paid on its taxable income.

Under the former foreign tax credit (FTC) system, if the company has no taxable income, the foreign tax credits can be carried forward until they can be offset against taxable foreign income. However, under the new foreign income tax rules that apply to the year ended 30 June 2009 and following income years, foreign income tax offsets cannot be carried forward.

The issue of whether an individual is required to include personal services income in his assessable income and if the individual is entitled to claim a foreign income tax offset is addressed in the context of the former FTC system in Taxation Ruling TR 2005/3.

The ruling states that former subsection 6AB(3) of the ITAA 1936 would apply to deem the individual to have paid the foreign tax that had been paid by the personal services entity. As there would be a material connection between the assessable personal services income of the individual and the foreign tax, the individual could therefore claim an FTC for the foreign tax.

A personal services entity may pay personal services income to the individual as salary or wages, which will be included in the individual's assessable income. The Commissioner states in TR 2005/3 that an FTC cannot be claimed for foreign tax paid by a personal services entity in respect of amounts included in an individual's assessable income as salary or wages. The Commissioner considered that there will not be a material connection between the assessable income and the foreign tax paid in these circumstances and so the former subsection 6AB(3) of the ITAA 1936 deeming provisions would not apply. The same result would arise under the foreign income tax offset rules in subsection 770-130(2) of the ITAA 1997.

As stated above, for the year ended 30 June 2010, the personal services income was assessable to the company and not to the individual. The foreign income tax offset is not allowed in relation to salary and wages income that the individual has received from the company. The individual did not receive attributed personal services income from the company. Therefore, the individual is not entitled to a foreign income tax offset for the foreign tax paid.

Question 4

Summary

The wages income could not be treated as attributed income instead of salary or wages as the nature of the payment cannot be changed after the company made a salary payment to the individual.

Reasoning

You have asked if the company could restructure their affairs for the year ended 30 June 2010 (for example, changing from personal services income to attributed income to the individual, attributing all profits to the individual instead of making salary payment to the individual) in order that the individual can claim a foreign income tax offset.

As evidenced on the PAYG payment summary for that income year, the company had paid out to the individual by way of salary or wages.

In Case (1999) AATA 822 it was held that the nature of the payment cannot be changed after it is made. The fact that the drawer of the cheque was not the proposed actual employer does not change the character of the receipt in the hands of the recipient. This is despite the fact that the money was paid as a reward for services to be provided in the future, and the fact that the contract under which it was paid was subsequently re-negotiated. Case G43 75 ATC 268 also applied.

In your case, the company cannot change the nature of the payment after it made a salary payment to the individual and had the relevant amount of PAYG withholding taken out of it during the year ended 30 June 2010

Therefore, the wages income could not be treated as attributed income instead of salary or wages for that income year.