Edited version of your written advice

Authorisation Number: 1012737297491

Ruling

Subject: Personal services income

Questions and answers

1. Is the income you received from Company Y assessable as salary and wage income?

Yes.

2. Is the income you received from Company Y assessable as personal services income?

No.

3. Do you meet the personal services income unrelated clients test?

Not applicable.

This ruling applies for the following period:

Year ended 30 June 2014.

The scheme commenced on:

1 July 2013.

Relevant facts and circumstances

You provide consulting services.

You were made a beneficiary of the Company Y trust. Up until the relevant income year, the amounts you received under the arrangement were returned as trust distributions.

You also claimed expenses related to the trust income; and claimed deductions for superannuation contributions.

During part of the relevant income year you participated in the arrangement with Company Y, in your capacity as an individual.

Under the Company Y arrangement, Company Y entered into contracts with various entities to provide your services.

You were required to submit weekly timesheets and Company Y invoiced each entity for the work that you performed.

You received trust distributions in respect of services that you provided.

In the relevant income year Company Y entered into 2 contracts to provide your services.

You contend that there was never an employment relationship between you and Company Y. Company Y had no say in the scope of the work, engagement, conditions or deliverable. A verbal contract already existed between you and the client prior to engaging Company Y. You state that you started the engagement without waiting for the written contract to be prepared or signed. To perform work for the clients you were required to have relevant insurances in place including, workers compensation. The arrangement with Company Y enabled you to meet these requirements. You maintain that you were an independent contractor who outsourced aspects of managing your affairs to Company Y as a contract management entity.

You also contend that the income in the 2013 income year is your PSI; that you were the one who required to satisfy any of the tests; and that the unrelated clients test is satisfied in both years (as per the decision in Yalos Engineering Pty Ltd v. Federal Commissioner of Taxation (2010) ATC 10-139) (Yalos) because the clients were sourced by word of mouth referrals. The fact that a labour hire firm was involved in the transaction did not prevent the individual who performed the services from satisfying section 87-20(2). The key determining factor was the manner in which the client was obtained by Yalos.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Part 2-42.

Income Tax Assessment Act 1997 Section 84-5.

Income Tax Assessment Act 1997 Section 87-20.

Reasons for decision

Under common law, you are considered to be an employee if the relationship between you and another party has the characteristics of an employer/employee relationship, whether or not there is a contract between you and the other party. Amounts paid for your personal services as an employee are salary or wages and are included in your income, pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

The principles in relation to whether an individual is an "employee" under common law is discussed in Taxation Ruling TR 2005/16 Income tax: Pay As You Go - withholding from payments to employees (TR 2005/16). Although TR 2005/16 discusses the employment relationship for the purpose of PAYG withholding, the Commissioner considers that the concepts in relation to the nature of the employment relationship can be equally applied to this case.

TR 2005/16 indicates that whether a person is a common law employee is a question of fact and is determined by evaluating certain factors within the context of the relationship, including contractual, between the parties. It is noted at paragraph 21 in TR 2005/16:

21. Contractual arrangements often contain a clause that purports to characterise the relationship between the parties as that of principal and independent contractor and not that of employer and employee. Such a clause cannot receive effect according to its terms if it contradicts the effect of the agreement as a whole - that is, the parties cannot deem the relationship between themselves to be something that is not. The parties to an agreement cannot alter the true substance of the relationship by simply giving it a different label. If the underlying reality of the relationship is one of employment the parties cannot alter that fact by merely having the contract state (or have the worker acknowledge) that the worker's status is that of an independent contractor.

As noted, you contend that there was never an employment relationship between yourself and Company Y. Company Y had no say in the scope of the work, engagement, conditions or deliverable. A verbal contract already existed between you and the client prior to engaging Company Y; and you started the engagement without waiting for the written contract to be prepared or signed.

It is the Commissioner's view that a contractual relationship existed between you and Company Y and that the relationship was a contract for the performance of work.

You performed the work under the agreements for services that had been entered into by Company Y, in return for which Company Y agreed to admit you as a beneficiary and to later pay amounts to you as consideration for the performance of work.

The classic 'test' for determining the nature of the relationship between a person who engages another to perform work and the person so engaged, is the degree of control which the former can exercise over the later. A common law employee is told not only what work is to be done but how and where it is to be done (TR 2005/16 paragraph 26).

In relation to the Company Y arrangements the Commissioner considers that it is the ultimate or legal control over the worker that is most relevant; not the day-to-day direction and control. The nature of the arrangement between you and Company Y was such that Company Y had ultimate control over you to require you to properly and effectively exercise your skill in the performance of the services provided

It is considered that Company Y directed you to perform the services, being the party to the contracts and naming you as either: the principal person; key personnel; or preferred operator. Company Y was the entity legally responsible for the services performed or not performed by you, and for any defects or loss caused. You were required to provide services through Company Y under their terms and conditions. Company Y would have had the ability to fire you. Company Y paid you for the services provided under the contract, thereby allowing Company Y the ability to refuse to pay you where reasonable.

It is the Commissioner's view that the relationship between Company Y and you constituted an employment relationship. You received remuneration for the provision of your services in the form of trust distributions. The remuneration is considered to be your salary and wages income, in accordance with the principles of TR 2005/16. Accordingly the amounts should have been returned as salary and wages income.

Personal services income

You consider that Part 2-42 of the ITAA 1997 is applicable to your circumstances and that the income from providing services under the arrangement with Company Y is his PSI. Notwithstanding the Commissioner's view that the relevant income is salary and wages, brief consideration is given to this alternative proposition.

The alienation measures contained in Part 2-42 of the ITAA 1997 apply to individuals or a personal services entity (company, partnership or trust) whose income is an individual's PSI. Section 84-5 of the ITAA 1997 defines personal services income as:

Your ordinary income or statutory income, or the ordinary or statutory income of any other entity, is your personal services income if the income is mainly a reward for your personal efforts or skills (or would mainly be such a reward if it was your income).

If an employment relationship was found not to exist between Company Y and you, Company Y's income from the contracts with the end users could be considered to be mainly a reward for your personal efforts or skills and would therefore be PSI within the definition of section 84-5 of the ITAA 1997. Accordingly, Company Y as the entity that was the party to the contracts with the end users, and which received the payments would be a PSE on the basis that it received the PSI of one or more individuals (subsection 86-15(2)).

The rules in Part 2-42 do not apply where a PSE is conducting a PSB. Section 87-15 provides that an entity conducts a PSB if it satisfies one of the four PSB tests or has a PSB determination in force relating to an individual whose PSI is included in the entity's income. There were no determinations in force for the relevant income year in respect of your PSI earned through Company Y.

It is noted that you contend that the income earned in the 2013 income year is your PSI and therefore you are the one who is required to satisfy any of the tests; and that the unrelated clients test is satisfied in both years. It is the Commissioner's view that the income from the contracts is paid to Company Y, and therefore as a PSE it is Company Y and not you who is required to satisfy one or more tests.

Does Company Y satisfy the unrelated clients test?

To satisfy the test in section 87-20 a PSE must have gained or produced income from providing services to two or more entities that are not associates of each other, and are not associates of the individual or of the PSE, and the services must have been provided 'as a direct result of the … PSE making offers or invitations … to the public at large or to a section of the public. This can include advertising or 'any form of solicitation to the public or a section of the public (TR 2001/8 at [50] - [51]), but excludes clients obtained through labour hire firms, employment agencies and the like s 87-20(2)

In the relevant income year Company Y entered into 2 contracts to provide your services:

Based on the above information, in the relevant income year Company Y gained or produced income from a couple clients, who do not appear to be related; accordingly in Company Y would satisfy the first limb in section 87-20(1).

The second limb of section 87-20(1) requires that the services are provided as a direct result of the PSE having made offers or invitations. The Commissioner accepts that offers or invitations can be made by word of mouth referrals however, in this case no offers or invitations were made by Company Y. In both income years all of the clients were sourced by you in your capacity as an individual, and not as a direct result of Company Y having made any offers or invitations to the public at large or to a section of the public via advertising or any form of solicitation. The Commissioner considers that the second limb in section 87-20(1) was not satisfied in the relevant year. Accordingly Company Y is not considered to have been a PSB in respect of the PSI of the taxpayer.

It is noted that you rely on the decision in Yalos to argue that the unrelated clients test is satisfied when clients are sourced by word of mouth referrals. You argue that the fact that a labour hire firm was involved in the transaction did not prevent the individual who performed the services from satisfying section 87-20(2). The key determining factor was the manner in which the client was obtained by Yalos.

The Commissioner considers that the decision in Yalos Engineering is not applicable in the current case. The Yalos case deals with the situation where the taxpayer's expertise was relevant to only a very small number of companies accordingly, it was determined that advertising in newspapers, brochures or other medium was inappropriate in the taxpayer's circumstances. In the current case, your expertise is not considered to be relevant to only a very small number of clients therefore word of mouth referrals alone would not be sufficient and offers or invitations through advertising would be required. Also in Yalos, it was not Mr Koundouras but the PSE Yalos Engineering Pty Ltd that was required to satisfy the test. In that case the PSE did satisfy the test by making offers and invitations. In contrast, in your case the PSE did not make any offers or invitations.