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Ruling

Subject: Medical practice and Part IVA

Questions and Answers

1. Will the income derived from the provision of a specialist's services be income from a personal services business and thus not be required to be attributed to the specialist by the personal services provisions in the Income Tax Assessment Act 1997?

Yes

2. Will the Commissioner apply the provisions contained in Part IVA of the Income Tax Assessment Act 1936 to the distribution to the specialist's spouse?

Part IVA is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with a scheme and it can be concluded that the scheme, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled.

No.

This ruling applies for the following periods:

Year ending 30 June 2010

The scheme commences on:

31 December 2009

Relevant facts and circumstances

1. A specialist is a beneficiary of The Specialist Family Trust (the trust). Other beneficiaries include the specialist's spouse.

2. The trust was established by a deed. The deed is a discretionary trust deed in a conventional form. Schedule 1 to the trust deed identifies the named beneficiaries as being the specialist, the specialist's spouse and other immediate family. Eligible beneficiaries are identified as being

· Relatives of the named beneficiaries,

· Schools, universities, colleges and other educational bodies of any kind either within or outside Australia,

· Companies of which any of the beneficiaries otherwise mentioned in the schedule is a shareholder or director, or in which at least one share is owned by one of the beneficiaries otherwise mentioned in the schedule,

· Charities the trustee nominates for this purpose or other legal entities the trustee nominates for this purpose.

3. The trust conducts a specialist medical practice.

4. The income of the trust includes the personal services income of the specialist.

5. In the private ruling application for the 2009-10 financial year the agent advised that the trust is carrying on a business and in a phone call stated that the trust satisfies the results test in respect of the personal services of specialist and is therefore conducting a personal services business.

6. In respect of the results test the following information was provided:

· payment is paid by Medicare, health funds or the patients for a result in the form of an operation or treatment,

· the trust provides the tools and equipment needed to produce the result (in line with the usual custom of the profession operating theatre tools are the hospitals).

· the trust is liable for the cost of rectifying defects.

7. The spouse of the specialist, assists in the conduct of the specialist practice by providing administrative services, including managing phone calls and appointments as well as invoicing and accounting functions. Further information provided states that the services include:

· scheduling appointments with GPs/GP practices and other medical professionals for the expansion of the practice.

· collection of fees from patients and hospitals.

· payments of practice bills and arranging for appropriate medical insurances, subscriptions and conferences for the specialist.

· provide medical advice as required in relation to emergency cases, including discussion of suitable medical drug treatments.

· typing of medical letters and record keeping.

8. The spouse is an experienced medical practitioner. The spouse does not specialise in the field that the specialist practices in.

9. The trustee has resolved to distribute an amount of the income for the 2009-10 financial year to the spouse and the balance to the specialist. The amount distributed to the spouse is to recompense the spouse for the spouse's efforts in producing the trust's income. The tax agent for the trust states that if the spouse was not remunerated by receiving a distribution then the spouse would have been remunerated by the payment of a wage of a similar quantum.

10. Information provided states that the amount of the distribution to the spouse was determined on the basis of an hourly rate, which annualised resulted in a figure. As the trust only commenced operations from 31 December 2009, the distribution for the 2009-10 financial year was half the annualised figure.

11. Information provided states that it is anticipated that the distribution pattern in future years will remain the same, albeit that the spouse will receive a distribution of the annualised figure, which may be increased in line with the CPI, but no more.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 84-5(1),

Income Tax Assessment Act 1997 Subsection 84-5(3),

Income Tax Assessment Act 1997 Subsection 84-5(4),

Income Tax Assessment Act 1997 Division 85,

Income Tax Assessment Act 1997 Division 86,

Income Tax Assessment Act 1997 Division 87,

Income Tax Assessment Act 1936 Part IVA,

Income Tax Assessment Act 1936 Section 177A,

Income Tax Assessment Act 1936 Section 177C and

Income Tax Assessment Act 1936 Section 177D.

Reasons for decision

Question 1

Will the income derived from the provision of a specialist's services be income from a personal services business and thus not be required to be attributed to the specialist by the personal services provisions in the Income Tax Assessment Act 1997?

Detailed reasoning

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 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 application for a ruling states that the personal services work undertaken by the specialist is the provision of specialist medical services.

Based on the information provided, the Commissioner is satisfied that the income of the trust from the provision of the specialist's services is mainly a reward for the specialist's 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. The trust contends that it passes the results test in respect of the specialist's services.

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;

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.

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 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.

The specialist provides medical services to patients through the trust. Remuneration from Medicare, heath funds or the patients is based on identified services supplied and is dependent upon the services being supplied

Payment is made for medical services and is dependent upon the completion of a particular task or the achievement of a particular result.

In a contract for a result payment must be contingent upon the achievement of a contractually specified result. Payment on the basis of medical treatment provided is consistent with a results based contract.

Based on the information provided remuneration is payable when specific contractual results have been met.

Therefore the requirements of paragraph 87-18(3)(a) of the ITAA 1997 are 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 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 trust supplies the tools and equipment that are needed for the specialist to produce the result, having regard to the usual practice in the profession and the nature of the work.

Information provided shows that the trust is required to provide the plant and equipment needed to perform the services.

As the trust provides the tools and equipment needed to produce the result the requirements of paragraph 87-18(3)(b) of the ITAA 1997 are 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 contractual arrangements are such that the trust would be liable for the costs of rectifying any defects in the work of the specialist.

The trust is therefore liable for the cost of rectifying any defects for which the specialist was responsible.

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

Summary

As all the conditions in paragraphs 87-18(3)(a), (b) and (c) of the ITAA 1997 are satisfied the trust meets the requirements of the results test.

As the requirements of the results test are met the income would not be required to be attributed to the specialist by the personal services provisions of the ITAA 1997.

Question 2

Will the Commissioner apply the provisions contained in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) to the distribution to the specialist's spouse?

Detailed reasoning

The general anti-avoidance provisions

Part IVA applies to a scheme in connection with which a taxpayer has obtained a tax benefit if, having regard to the eight factors specified in section 177D of the ITAA 1936, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the taxpayer to obtain the tax benefit.

Part IVA does not prevent the interposition of entities per se. But where the interposition of an entity is part of a scheme to split income which would have been (or might reasonably have been expected to have been) derived by the principal and having regard to the section 177D factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the taxpayer to obtain the tax benefit, it will attract the application of Part IVA.

Dominant purpose

Where it can be concluded that there are two or more purposes for entering into a scheme, the purpose of obtaining a tax benefit must be the dominant purpose: subsection 177A(5) of the ITAA 1936.

The dominant of two or more purposes is the ruling, prevailing or most influential purpose.

It is possible for Part IVA to apply notwithstanding that the dominant purpose of obtaining the tax benefit was consistent with the pursuit of commercial gain. Furthermore, the fact that a particular course of action is both 'tax driven' and bears the character of a rational commercial decision does not determine whether a person has entered into or carried out a scheme for the dominant purpose of enabling the taxpayer to obtain a tax benefit. This is made clear in Federal Commissioner of Taxation v. Hart at {16} per Gleeson CJ and McHugh J:

Even so, the transaction may take such a form that there is a particular scheme in respect of which a conclusion of the kind described in s 177D is required, even though the particular scheme also advances a wider commercial objective.

And at [64] per Gummow and Hayne JJ:

But so too, as was held in Spotless, there is a false dichotomy between a "rational commercial decision" and the "obtaining of a tax benefit as 'the dominant purpose of the taxpayers in making the investment'". Pointing to the "commercial end" of the scheme reveals the adoption of the same, or at least a substantially similar, false dichotomy. The presence of a discernible commercial end does not determine the answer to the question posed by s177D.

Interposing an entity will commonly achieve one or more commercial purposes. For example, interposition of a corporation may effect asset protection and limit personal liability of the principal. The fact that such a commercial objective is achieved does not of itself mean that Part IVA will not apply. For one thing, the manner in which a commercial end is achieved may reveal a dominant purpose of enabling the taxpayer to obtain a tax benefit. For another, although achieving a commercial end may be one purpose, nevertheless it may be concluded that the dominant purpose is to obtain a tax benefit.

The mere assertion of a commercial purpose will not prevent Part IVA from applying where having regard to the 177D factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling the taxpayer to obtain the tax benefit. Therefore, if adoption of a particular entity structure is said to have taken place to achieve a particular (commercial) end, but other facts are inconsistent with this, it may be doubted that the entity structure was adopted to achieve the commercial end.

Is there a scheme?

For Part IVA to apply there must be a scheme within section 177A of the ITAA 1936, by which a taxpayer obtains a tax benefit. Under section 177A, a scheme is defined to include any agreement, understanding, promise or undertaking and whether or not enforceable and any scheme, plan, proposal, action, course of action or course of conduct.

Under the arrangement the specialist will provide his services through the trust and will receive a distribution of the net income of the trust remaining after his spouse receives a distribution of an amount representing the market value of the spouse's services. Services provided by the spouse are administrative services, including managing phone calls and appointments as well as invoicing and accounting functions. Further information provided more details of the services, which include:

o scheduling appointments with GPs/GP practices and other medical professionals for the expansion of the practice.

o collection of fees from patients and hospitals.

o payments of practice bills and arranging for appropriate medical insurances, subscriptions and conferences for the specialist.

o provide medical advice as required in relation to emergency cases, including discussion of suitable medical drug treatments.

o typing of medical letters and record keeping.

The spouse is an experienced medical practitioner who does not specialise in the field that the specialist practices in.

This ruling is based on the distribution of trust income being only to the specialist and the specialist's spouse and on the basis that the distribution to the spouse will be limited to an amount that is equivalent to the wages that would otherwise be paid.

The Commissioner is of the opinion that the arrangement, which includes the formation of the trust and the use of a trust distribution to recompense the spouse for the spouse's services, constitutes a scheme.

Is there a tax benefit?

The anti-avoidance provisions only apply where there is a tax benefit from the scheme. Under section 177C of the ITAA 1936 a tax benefit received in relation to a scheme is any of the following four amounts:

An amount that was not included in the assessable income of the taxpayer, where that amount would have been included, or might reasonably be expected to be included, in the assessable income of the taxpayer if the scheme had not been entered into.

An amount for a deduction being allowable to the taxpayer, where that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into.

An amount of a capital loss being incurred by the taxpayer, where that amount would not have been, or might reasonably be expected not to have been, incurred by the taxpayer if the scheme had not been entered into.

An amount of a foreign tax credit being allowable to the taxpayer, where that foreign tax credit would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into.

The net income from the specialist practice is paid to the specialist aside from an amount distributed to the spouse that equates to wages that would otherwise be payable for the spouse's services. It is considered that an alternative arrangement would have been for the trust to employ the spouse on wages and then distribute the net income of the practice to the specialist. On this basis there would not be a tax benefit as the amount of income derived by the specialist would be the same either under the current arrangement or under the alternative of the trust employing the spouse.

The amount of income derived and tax payable by the specialist is the same under the current arrangement as under a counterfactual where the spouse is remunerated for the spouse's services by the payment of wages. Accordingly there is no tax benefit.

As no tax benefit arises within the meaning of section 177C of the ITAA 1936 there is no need to consider the eight factors that are specified in section 177D of the ITAA 1936.

Conclusion

It is the view of the Commissioner that the conduct of the specialist practice through the trust is for the conduct of the practice and the remuneration of those whose efforts generate the income. Given there is no tax benefit identifiable it is concluded that it is not the dominant purpose of the scheme to achieve a tax benefit for the purposes of Part IVA.