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Edited version of your private ruling
Authorisation Number: 1012519367181
Ruling
Subject: Part IVA - Personal Services Income
Question 1
Do the general anti-avoidance provisions apply as profits from PSI were retained by the personal services business (PSB)?
Answer
No.
This ruling applies for the following periods:
Year ended 30 June 2006
Year ended 30 June 2007
Year ended 30 June 2009
Year ended 30 June 2010
Year ended 30 June 2011.
The scheme commenced on:
1 July 2005
Relevant facts and circumstances
The Directors provide information technology (IT) services to clients of the PSB.
In the first half of 200X, the PSB consulted their accountant/tax consultant who advised them to change from operating as a partnership to a company structure.
The PSB incorporated in mm/yyyy.
Their accountant/tax consultant assisted in setting up the company and prepared the tax returns for the 200X income year for the PSB and the individuals.
The main reason the PSB changed from a partnership to a company was to limit liability and that it could make entering the Australian market easier.
The Directors previously worked for overseas companies before the PSB accepted a contract with an Australian company which advised the Directors that being a Pty Ltd company had certainly helped them win the contract.
In early 200Y, the PSB consulted a local tax agent to help with their business structure and tax matters. The local tax agent advised the PSB to pay the Directors a proper salary for their services provided. They explained that the PSB could pay out the company profits as franked dividends immediately or at a later stage, whenever it suited them.
The PSB earns PSI through the services of the Directors.
The PSB has always met the criteria for the results test, 80% rule or other personal services business tests.
All profits from PSI were retained in the PSB and no dividends have been paid.
The profits were retained as a reserve for future use due to uncertainty of maintaining a steady customer base. Some customers have been lost as a result of them moving their operations overseas.
The Directors decided to retain profits in the PSB because of vulnerability due to a limited customer base. The profits were retained to be used as a backup, to have money available to invest in other business opportunities, if the work in their industry decreased.
The PSB pays the Directors a monthly salary.
The Directors were paid an hourly rate that was initially decided by talking to people involved in similar business and has been increased over the period. The Directors believe the hourly rate they are paid is quite high compared to what is usually paid in Australia for similar work.
Relevant legislative provisions
Income Tax Assessment Act 1936 section 177C
Income Tax Assessment Act 1936 section 177D
Income Tax Assessment Act 1936 section 177F
Reasons for decision
As the PSB generates income from the personal efforts and skills of the Directors, the income is personal services income (PSI). The PSB has always met the criteria for the results test, 80% rule or other personal services business tests for the periods subject to this ruling. Therefore, the PSB is not affected by the alienation of PSI legislation. However, the general anti-avoidance provisions may apply if there is a scheme that is entered into or carried out for a dominant purpose of obtaining a tax benefit.
In your case, the scheme carried out was changing the business structure from a partnership to a company and profits were retained in that company. We have determined that the dominant purpose of carrying out the scheme was not to obtain a tax benefit. We formed our view based on the following:
· there were other commercial reasons for carrying out the scheme, such as:
o limited liability and that the Directors thought that it could make entering the Australian market easier
o the Directors thought being an incorporated entity may give the PSB a competitive advantage in the tender process
o Australian clients have advised the Directors they preferred to deal with a company rather than other business structures.
· profits were retained as a reserve for future use due to uncertainty of maintaining a steady customer base
· profits were retained to be used as a backup, to have money available to invest in other business opportunities, if the work in their industry decreased.
· the PSB pays the Directors a monthly salary that is commensurate with the value of their services
· no income splitting was involved.
Therefore, profits are able to be retained in the PSB for reinvestment into the growth of the business and business assets without the general anti-avoidance provisions applying.