Edited version of your written advice

Authorisation Number: 1051332532258

Date of advice: 16 February 2018

Ruling

Subject: Capital loss on shares and personal services income rules

Question 1

In calculating its net capital gain for the particular income year under section 102-5 of the Income Tax Assessment Act 1997 (ITAA 1997), can Company X reduce any capital gains made during the year by the amount that was paid to purchase additional shares in Company Y?

Answer

No

Question 2

Is the consulting income received by Company X subject to the personal services income rules in Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company X is a private Australian Company.

D and BD are the registered directors and equal shareholders of Company X.

Company Y is a private Australian Company. The shareholders of Company Y are:

● Company X

● D

● E

● F

During the particular income year, Company X agreed to purchase all Company Y shares held by E and F for a specified total consideration. Payment was to be completed in a specified number of instalments.

Company X had paid some of the monthly instalments when members decided that Company Y would cease trading. No liquidator or administrator was appointed.

Company Y lodged an Application for voluntary deregistration of a Company, Form 6010, with ASIC.

Following lodgement of the form 6010 the Australian Taxation Office (ATO) requested ASIC defer the deregistration action. ASIC granted the ATO’s deferral request.

Company Z is a private Australian Company owned by:

● Company X

● F

● F.

The company directors of Company Z are D and BD and E and F.

The directors of Company Z made a corporate resolution regarding services to be delivered by Company X which included the following resolutions:

● Company Z shall engage consulting services from Company X on a fixed price basis.

● Company X will provide services equal to one full time equivalent employee. Services to be delivered encompass, but are not limited to, operational management and information technology services. These services may also be provided to Company Y rather than to Company Z, at no charge to Company Y.

● Company X will be remunerated a specified amount per calendar month for services provided, payable in arrears, before the end of each calendar month. No remuneration for office maintenance shall be payable as services will be delivered from existing premises either rented or owned by Company Z.

● This agreement will by default continue indefinitely should no subsequent corporate resolution modifying or cancelling it be made.

It was intended that both directors of Company X were to be paid equally.

D and BD were subsequently paid by Company X and these amounts had no relationship to the amount of work performed.

During the particular income year, both directors of Company X provided services to Company Z in accordance with the agreement in the corporate resolution.

There were no specific roles, performance criteria, or minimum hours of work specified.

The work performed was inequitable at times. D performed more day to day functions than the other director, shouldering over X% of the workload.

D was the primary client facing director of the two directors of Company X although most client interactions were undertaken by a small number of staff employed in sales and distribution.

The staff were not employees of Company X. They were all paid by Company Z; they had contracts with Company Z which were taken over by the purchaser of the business.

Consultancy services provided by Company X include:

● managing employees and managing the retail store 9.00am to 5.00pm five days a week

● setting up infrastructure – workplace environment, security

● training staff in customer service

● ensuring stock-takes were completed correctly

● auditing

● guidance and strategic direction of Company Z

● customer interaction

● opening and closing the store (staff did not have keys or alarm codes)

● covering for absent staff

Activities mostly involved responding to unplanned issues that were raised by the employees in their day to day duties.

The employees were not skilled in troubleshooting the IT systems and it was up to the directors to make sure the system worked for the employees.

Weekend working was expected. There was some overseas travel required annually.

The directors of Company X were not paid for producing a result.

No director’s fees were paid; directorial duties were provided as part of the consultancy service.

D performed the bulk of their duties from the Company Z office (the retail store) from 9.00am to 5.00pm.

BD would open and close the retail store when D was unavailable. BD performed directorial and other duties, mostly at Company X’s business premises, which is D and BD’s residential address. BD also shouldered considerable parental responsibility.

Company X’s previous business address was Company Z’s business premises.

Company X’s current address was not mainly used (that is, more than 50%) for work that generated the individual’s income as most of the work was done at Company Z’s premises.

Company Z was the only client Company X received consulting income from.

The majority of the time D spent at the business and during the last year was devoted to Company Y specific activities or activities related to selling Company Z, including ensuring the employees were able to run and manage the business alone, independent of the directors of Company X and Company Z.

Company Z sold its business operations as a going concern during the particular income year.

Company X’s company tax return for the particular income year included an amount identified as Personal Services Income (PSI). This is the amount of consultancy income received from Company Z.

Company X does not hold a personal services business determination (PSBD) in respect of any individual and consultancy income.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 47

Income Tax Assessment Act 1997 Part 2-42

Income Tax Assessment Act 1997 Section 84-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subsection 104-25(2)

Income Tax Assessment Act 1997 Subsection 104-135(1)

Income Tax Assessment Act 1997 Subsection 104-135(3)

Corporations Act 2001 Section 601AA

Reasons for decision

Capital gains and losses

Summary

As there has been no CGT event in relation to the Company Y shares in the particular income year:

● a capital loss has not been realised in that year, and

● Company X cannot reduce any capital gains in that year by the amount paid for additional shares in that year.

A taxpayer disposes of a CGT asset if a change of ownership occurs from the taxpayer to another entity whether because of some act or event or by operation of law.

CGT event A1 will not happen in this case as there has been no change of ownership of the shares in Company Y from Company X to another entity.

Company Y ceased trading but is not yet deregistered.

Taxation Determination TD 2000/7 (TD 2000/7) discusses the capital gains tax implications of deregistration of a Company under the Corporations Law (C Law) and the CGT events which can happen to shares in a company.

CGT event G3 may happen in respect of shares declared worthless by a liquidator or administrator. This CGT event is not relevant in your case as no liquidator or administrator was appointed.

CGT event C2 happens if your ownership of an intangible CGT asset, including shares, ends by the asset being redeemed or cancelled.

The timing of CGT event C2 is:

a. when you enter into the contract that results in the asset ending; or

b. if there is no contract – when the asset ends.

A company may be deregistered under subsection 601AA(4) of the C Law (where the Australian Securities and Investments Commission (ASIC) deregisters a company on application by the company or by a director, a member or a liquidator of the company).

Deregistration amounts to the cancellation of shares in the company.

CGT event C2 therefore happens in respect of a member's shares when the company is deregistered in accordance with subsection 601AA(4) of the C Law.

The shares end on their cancellation.

In this case, Company X purchased additional shares in Company Y for a specified amount in the particular income year. Company Y ceased trading and lodged an Application for voluntary deregistration of a Company (Form 6010) with the ASIC shortly after.

Following Company Y’s lodgement of the form 6010 the Australian Taxation Office (ATO) requested ASIC defer their deregistration action. ASIC granted the ATO’s deferral request.

All members agreeing to deregister a company is a requirement of the C Law to have the company voluntarily deregistered. A written or verbal agreement to deregister the company is not considered to be a contract for CGT purposes.

The Form 6010 lodged with the ASIC is not considered a contract.

By completing and lodging the application form Company Y is simply complying with the requirement of the C Law to apply to have the company deregistered.

The ASIC is not obliged to decide the application in favour of deregistering Company Y.

No contract between Company Y and the ASIC has been entered into. No contract between Company X, as a member of Company Y, and the ASIC has been entered into.

As there is no contract, the timing of CGT event C2 will be when Company Y is voluntarily deregistered in accordance with the C Law, and Company X’s shares in Company Y end by being cancelled.

TD 2000/7, at paragraph 5, Deregistration that is voluntary, states ‘If the ASIC decides on an application being made in accordance with subsection 601AA(1) of the C Law to deregister a Company and publishes a notice to this effect in the Commonwealth of Australia Gazette (‘Gazette’), it may deregister the Company when 2 months have passed since the Gazette notice. We take the view that a CGT event (usually CGT event C2 in section 104-25 of the 1997 Act) happens in respect of a member's shares, for the purposes of Parts 3-1 and 3-3 of the 1997 Act, when the Company is deregistered in accordance with subsection 601AA(4) of the C Law.’

Consequently, we consider that the CGT event does not happen until 2 months after the Gazette notice of deregistration.

Deregistration of Company Y has not yet happened and Company X remains a shareholder of a number of the issued shares.

Conclusion

CGT event C2 did not happen in the particular income year. This means that in calculating its net capital gain for the income year for the ruling, Company X cannot reduce any capital gains made during the year by the amount paid to purchase additional shares in Company Y.

Other comments

Subdivision 165-CA of the ITAA 1997 must be considered in relation to the application of carry forward loss rules where there has been a change in company ownership.

Personal services income rules

Summary

The consulting income received by Company X is subject to the personal services income rules in Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997)

Detailed reasoning

Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997) provides for the alienation of personal services income (PSI), imposing similar tax treatment on income for work or services, regardless of whether the income is received directly by the individual who performs the work or services, or is received indirectly through an interposed entity such as a company.

The first thing you need to do is work out if any of your income is classified as PSI. If it is, you need to work out if the PSI rules apply to that income. There is a series of steps to follow to do this. If more than one individual is generating PSI for your company, you need to work through the steps separately for each individual.

Step 1: Has Company X received PSI?

PSI is income that is mainly a reward for an individual's personal efforts or skills (or would be mainly such a reward if it was income of the individual as opposed to a Company, partnership or trust).

When working out if the PSI rules apply, a taxpayer needs to look at each contract or job to determine if the income generated from the contract or job is PSI of one or more individuals.

The terms and conditions of contracts with clients, as well as invoices and written agreements (which show the arrangements for the work) are important in working out if the income is PSI.

A taxpayer needs to calculate what percentage of income from each contract was:

● for labour, skills knowledge, expertise or efforts of each individual

● for anything else, such as materials supplied and/or tools and equipment used to complete the work.

If more than 50% of the income received for a contract was for labour, skills or expertise of individuals, then all income for that contract is PSI. If 50% or less of the income received for a contract was for labour, skills or expertise of individuals, then none of the income for that contract is PSI (Taxation Ruling TR 2001/7 Income tax: the meaning of personal services income, paragraph 25).

In the particular income year Company X received income from Company Z as payment for operational management and information technology services Company X provided to Company Z. Based on the information provided (as detailed in the facts), the services were mainly for the labour, skills or expertise of D (over 70%) and the balance for BD.

As such, all of the consulting income is PSI of D.

To work out if the PSI rules apply, move on to Step 2.

Step 2: Results test

To pass the results test in an income year, a taxpayer needs to meet the following three conditions for at least 75% of each individual’s PSI for the income year:

● the income is for producing a result

● the individual is required to supply the equipment or tools to complete the service; and

● the individual is required to fix any mistakes or faults at their own cost or to pay someone else to fix them, at any time during or after the contract.

If the PSI of the individual passes the results test, the taxpayer’s business is a personal services business (PSB) for that income year and the PSI rules don't apply.

In this case, Company X advised that the payments were not paid to produce a specific result. As such, the results test is not passed and Company X must consider Step 3.

Step 3: The 80% rule

At this step a taxpayer looks at the amount of PSI that they receive for each individual and how much of that amount comes from one client.

If 80% or more of the PSI of an individual comes from one client (including their associates) the taxpayer is not taken to be conducting a PSB unless a PSB determination (PSBD), relating to the individual, is in force when the income is earned.

A taxpayer can apply for a PSBD if they believe they will pass the ‘employment test’ or ‘business premises test’ or if ‘unusual circumstances’ stopped them from passing at least one of the four personal services business tests.

In this case, Company X did not have a PSBD from the Commissioner that was in force for the period the individual/s earned the PSI.

Before concluding that Company X was not conducting a PSB, we looked at whether the tests would be passed:

The employment test

To pass the employment test in an income year, a taxpayer’s business must employ or contract others to help complete the work that generates the individual’s PSI - other employees or contractors that the taxpayer engages must perform at least 20% of the principal work or the taxpayer must employ one or more apprentices for at least six months of the income year.

In this case, Company X did not employ others. The four staff were employees of Company Z. Company X therefore does not pass the employment test.

Accordingly, the Commissioner would not issue a PSBD on the basis of the employment test.

Business premises test

To pass the business premises test in an income year, a taxpayer’s business premises must satisfy all of the following:

● the taxpayer must use the business premises mainly (that is, more than 50%) for work that generates the individual’s PSI

● the taxpayer’s business must have exclusive use of the premises

● the business premises must be separate from any premises which the taxpayer or their associates use for private purposes; and

● the premises must be physically separate from the premises of the taxpayer’s clients (or their associates).

In this case, Company X would not pass the business premises test because:

● when Company X’s business premises address was Company Z’s business premises, Company X did not have exclusive use of the premises

● Company X’s current business premises was not mainly used (that is, more than 50%) for work that generated the individual’s PSI as most of the work was done at Company Z’s premises; and

● Company X’s current registered business premises was the private residence of the individual earning the PSI.

Accordingly, the Commissioner would not issue a PSBD on the basis of the business premises test.

Unusual circumstances

Taxation Ruling TR 2001/8 states at paragraph 96:

The term 'unusual circumstances' used in sub paragraphs 87-60(3)(a)(ii) and 87-65(3)(a)(ii) refers to exceptional circumstances that are temporary, with the likelihood that the usual circumstances will resume in the short term.

In this case, no unusual circumstances appear to have prevented Company X meeting at least one of the PSI business tests. Therefore, the Commissioner would not issue a PSBD to Company X on the basis of unusual circumstances.

Was Company X conducting a Personal Services Business?

Company X received consulting income from only one client, Company Z.

Company X did not pass the results test and the Commissioner would not have granted a PSBD to Company X for the period the income was earned because it did not pass either the employment test or business premises test and no unusual circumstances stopped Company X from passing at least one of the PSI business tests.

As 80% or more of the PSI came from one client and a PSBD was not in force, Company X is not conducting a PSB.

Conclusion

The consulting income received by Company X from Company Z is therefore subject to the PSI rules in Part 2-42 of the ITAA 1997.

Other comments

Refer to Taxation Ruling TR 2003/6 which explains how the attribution of PSI rules apply.