Edited version of private advice

Authorisation Number: 1051653305277

Date of advice: 6 April 2020

Ruling

Subject: PSI, PSB, franked dividends

Question

Is Company A able to declare franked dividend and pay it to its shareholders?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2020

The scheme commences on:

1 January 2020

Relevant facts and circumstances

Company A was established over a year ago and began trading few months later. It is carrying on a business of providing services through the services of only one of its staff (staff A).

Company A is owned by shareholders in equal shares.

There is no contract between Company A and staff A.

Company has a licencing agreement with other companies.

Under the licencing agreements Company A receive an income for staff A services and pay a fee to use the premises and existing staff.

No premises are maintained by Company A for the exclusive use of the business.

All the income received by Company A has been paid to staff A less expenses.

Company has paid its tax and would now like to declare a fully franked dividend and pay it to its shareholders.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 84

Income Tax Assessment Act 1997 section 84-5

Income Tax Assessment Act 1997 Division 86

Income Tax Assessment Act 1997 subsection 86-15

Income Tax Assessment Act 1997 Division 87

Income Tax Assessment Act 1997 subsection 87-15(2)

Income Tax Assessment Act 1997 section 87-18

Income Tax Assessment Act 1997 section 87-20

Income Tax Assessment Act 1997 section 87-25

Income Tax Assessment Act 1997 section 87-30

Reasons for decision

Personal services income (PSI)

Section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997) defines PSI as 'income that is mainly a reward' for the personal efforts or skills of an individual.

Paragraph 4 of Taxation Ruling TR 2001/7 Income Tax: The meaning of personal services income goes on to say that PSI income does not include income that is 'generated by the use of assets, the sale of goods, the granting of a right to use property or by a business structure'.

The services provided by you, either directly as a sole trader or via an interposed entity, are services that require your skill and expertise. The income so derived will be PSI.

Personal services entity (PSE)

Subsection 86-15(2) of the ITAA 1997 defines a personal services entity as 'a company, partnership or trust whose ordinary income or statutory income includes the personal services income of one or more individuals'.

Personal services business (PSB)

Division 87 of the ITAA 1997 provides guidance on what a personal services business is and how to determine if an individual or PSE is conducting a personal services business. The object of Division 87 of the ITAA 1997 is to define personal services businesses in a way that ensures that it covers genuine businesses but not situations that are merely arrangements for dealing with the personal services income of individuals.

Subsection 87-15(2) of the ITAA 1997 provides four personal services business tests and only one test needs to be met for the PSI rules not to apply, namely:

● the results test

● the unrelated clients test

● the employment test

● the business premises test.

We look to Taxation Ruling TR 2001/8 Income tax: what is a personal services business? for further information and the Commissioners view of the tests.

Results Test

The results test has three limbs and is set out in section 87-18 of the ITAA 1997:

● 'the income is for producing a result'; and

● they are 'required to supply the plant and equipment, or tools of trade, needed to perform the work from which they produce the result; and'

● they are, 'or would be, liable for the cost of rectifying any defect in the work performed'.

An individual or entity will meet the results test where at least 75% of their personal services income during the income year passes all three limbs. The results test will not be satisfied merely because the contract states that the personal services income is for producing a result.

TR 2001/8 discusses the meaning of the phrase 'producing a result'. It says that the essence of the contract has to be to achieve a contractually specified outcome and not to do work. This is shown as a fixed sum on the completion of a job, rather than an amount paid by reference to the hours worked.

Payment for time spent at work indicates that the contract is not for a result. Where there are additional clauses for allowances, for example for leave or travel, are indicators that the contract is not for a result.

Further results-based contracts tend to embrace the defining characteristics of an independent contractor. Payment is often made for a negotiated contract price, or a volume or quantity based approach as opposed to an hourly rate. For example, couriers may be 'paid a prescribed rate for the number of successful deliveries' they made (Vabu Pty Ltd v FCT 96 ATC 4898) and not per time period engaged, or determined by the volume of an item delivered (Stevens v Brodribb Sawmilling Co Pty Ltd 160 CLR 16; 63 ALR 513), or a fixed sum per item.

A results-based contract generally has a specified end date or a deliverable on completion. Where contracts are ongoing or provide a clause for termination, this is an indicator that the contract is simply remuneration for the provision of services and not result-based (Cooper v FC of T [2010] AATA 215).

A results-based contract leaves the personal services entity responsible for the management of the risks and rewards and ultimately accountable where outcomes are not achieved.

Where there is a results-based contract, the contract is based on certain deliverables, which are to be achieved as a precondition for payment. A deliverable is a quantifiable good or service produced or a specified function or characteristic. It may be broken down into specific milestones to mark critical decision points. Further, the contract is not to be paid, until and unless, the deliverable is produced or specific milestones are completed.

Another strong indicator that the contract is for a result is when remuneration is payable when, and only when, the contractual conditions have been fulfilled. The contract needs to say that your business must produce an outcome before being paid. This may include progressive payments paid on achieving specified milestones or outcomes.

Unrelated Clients Test

Section 87-20 of the ITAA 1997 states:

An individual or an unrelated PSE entity meets the unrelated clients test in an income year if:

a)    during the year, the individual or PSE 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 PSE making offers or invitations (for example, by advertising), to the public at large or to a section of the public, to provide the services.

The individual or personal services entity is not treated, for the purposes of paragraph (b) above, 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.

Here the Commissioner is looking for an indication that the individual or personal services entity is willing to perform services for anyone within a group or class of persons, or to any member of the public.

Activities that are considered to be making offers or invitations in this context include advertising, public tender, maintaining an internet website on which the availability of services is advertised, and (in a limited number of cases) word-of-mouth referrals.

Word-of-mouth referrals will only meet this condition of the test where there are a small number of potential clients such as where specialised services are provided. Where a large client base exists, a word-of-mouth offer cannot be said to be made to the public at large or a section of the public. (Yalos Engineering Pty Ltd v FC of T [2010] AATA 408; 2010 ATC 10-139 at paragraph 19).

Responding to advertised vacancies is also not considered to be making offers or invitations to the public at large or a section of the public.

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.

Employment test

The employment test is set out in section 87-25 of the ITAA 1997 and provides:

An individual or PSE meets the employment test where:-

· at least 20% (by market value) of the entities principal work for the year is performed by an entity or entities engaged by the individual or PSE, and

· and the entity or entities engaged are neither individuals whose PSI is included in the PSE's or individual's income, nor non-individuals that are associates of the individual or PSE, or the entity has one or more apprentices for at least half the income year.

TR 2001/8 says that 'principal work' does not include incidental clerical or administrative work.

Business premises test

Section 87-30 of the ITAA 1997 provides that an individual or PSE meets the business premises test in an income year if they maintain and use business premises:

· at which they mainly conduct activities from which PSI is gained

· of which they have exclusive use (this would typically require ownership or a lease)

· that are physically separate from any premises that the service provider or service provider's associate uses for private purposes, and

· that are physically separate from the premises of the service provider's client or client's associate.

Application to your situation

Staff A receives income from provision of services which is mainly a reward for personal efforts and skills and is therefore PSI.

However, from the information provided, the Commissioner considers that the PSB result test is satisfied for the following reasons.

The income is for producing a result

Under the agreement Company A receives 100% of its income once staff A has provided services to its clients. If staff A does not provide its services no income is received.

They are required to supply the plant and equipment, or tools of trade, needed to perform the work from which they produce the result

From the agreements, company A is charged a services fee which covers the costs for providing staff, equipment and using premises. As there is a cost to Company A (the service/licensing fee) for the plant and equipment or tools of trade needed to do the work, the Commissioner considers that these items are being provided by Company A and this element of the test is met.

They are, or would be, liable for the cost of rectifying any defect in the work performed

Under the agreements Company A is required to hold relevant insurances, including professional indemnity insurance for the work staff A performs. Consequently, this element of the test is satisfied.

As all conditions of the results test are satisfied, the results test is met and Company A is considered to be a personal service business. Consequently, the PSI rules will not apply.

As the PSI rules do not apply, franking dividends from PSI can be distributed to both shareholders.