Edited version of your written advice

Authorisation Number: 1012691294361

Ruling

Subject: Personal services income - unrelated clients test

Question and answer

For the purposes of the personal services income provisions of the Income Tax Assessment Act 1997, do you meet the unrelated clients test?

No.

This ruling applies for the following period:

30 June 2014

The scheme commenced on:

1 July 2013

Relevant facts and circumstances

You provide services in the industry X.

You have one director and sole owner who is also the individual who performs the services provided.

In the relevant income year, you had three clients, Client A, Client B and Client C. There is no relationship between these three clients.

You have not advertised your services to the public directly other than your website. To date, your website has not provided you with any clients.

Client A

You provided various services from 1 July 20XX to 3 June 20YY for Client A. You received $X for these services.

You did not have a current contract with Client A in the 20YY year. You received payment for services based on invoices issued by you.

You obtained Client A as a client as your director had previously been an employee with them.

Client B

You provided various services from 31 March 20XX to 30 June 20XX for Client B. You received $X for these services. You did have a formal written contract with Client B in the 20XX year.

Your director approached their friend and former colleague, now an employee of Client B, to enquire as to whether Client B had any work that you could do for them. This person then arranged a meeting in between your director and Client B and Client B offered you work on a project which you accepted.

Client C

You provided various services for Client C from 31 March 20XX to 30 June 20XX. You received $X for these services. You did not have a formal written contract with Client C in the 20XX year. You received payment for services based on invoices issued by you.

When you started providing your services, you sought out a business partner. As the relationship was beneficial to both parties, Client C decided to engage you in providing services.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 87-20.

Income Tax Assessment Act 1936 Section 318.

Reasons for decision

Unrelated clients test

The unrelated clients test as set out in section 87-20 of the Income Tax Assessment Act 1997 (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.

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.

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 arm's 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 individual or personal services entity from satisfying this test.

Application to your circumstances

In your case, you obtained Client A as a client due to the previous employment relationship between Client A and your director. You therefore did not obtain this client through making any offer to the public or section of the public.

You obtained Client B as a client due to your director's personal friendship with an employee of Client B. You therefore did not obtain this client through making any offer to the public or section of the public.

You obtained Client C as a client when seeking to enter into a partnership arrangement with Client C, where they then offered to contract your services. You therefore did not obtain this client through making any offer to the public or section of the public.

There is little evidence that you have advertised your services to the public or a section of the public. Your only form of public advertising, being your website, has to date not resulted in any work.

Recent court cases have considered 'word of mouth referrals' and accept that in niche industries where the potential client base is very small, maintaining contracts with major players in the industry would constitute offers to a section of the public. This is in contrast to your situation where you are in industry X, which is very large and therefore simply maintaining contact with your existing network is not considered sufficient to constitute making offers to the public or a section of the public.

You therefore do not meet the unrelated clients test.