Edited version of private advice

Authorisation Number: 1051792665369

Date of advice: 22 December 2020

Ruling

Subject: Part IVA and personal services business

Question

Does Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to any residual taxable income retained in the company and taxed at company tax rates?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2020

The scheme commences on:

1 July 2019

Relevant facts and circumstances

The company was established to provide technical support and a consultancy service within the IT industry, with Taxpayer A as sole director and who has 100% shareholding.

The Company has self-assessed as a Personal Services Business (PSB) as it meets the requirements of section 87-20 of the Income Tax Assessment Act 1997 (ITAA 1997) (the unrelated clients test).

The Company was established for the following reasons:

•   Taxpayer A wanted to expand their business and serve more clients

•   To be able to work with a variety of clients on a variety of projects

•   To have flexible working arrangements and an improved quality of life by employing others in the business so as to be able to share the workload.

•   Tender for contracts, the entity form being a necessity given the requirements of the industry in respect of contractors.

•   Allow enhanced asset protection.

•   To allow the option at the later date of taking on of partners in the business.

Taxpayer A is employed by the Company and is commercially remunerated. Taxpayer A's salary is dependent upon how much profit the business makes and how much working capital is needed for the company for the following year's product research.

The intention to retain the profit in the company is to be able fund the development and research of additional products for the business.

Relevant legislative provisions

ITAA 1936 Part IVA

All legislative references are to the ITAA 1936 unless otherwise stated.

Reasons for decision

Question

Summary

Part IVA will not apply to any residual taxable income retained in the company and taxed at company tax rates.

Detailed reasoning

The general anti-avoidance provisions

Part IVA applies to a scheme in connection with which a taxpayer has obtained a tax benefit if, having regard to the eight factors specified in section 177D, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the taxpayer to obtain the tax benefit.

Generally, the tax benefit obtained by the taxpayer will be that an amount is not included in the assessable income of the taxpayer in a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income absent the scheme.

Is there a scheme?

For Part IVA to apply there must be a scheme within the meaning of section 177A, by which a taxpayer obtains a tax benefit. Under section 177A, a scheme is defined to include any agreement, understanding, promise or undertaking and whether or not enforceable and any scheme, plan, proposal, action, course of action or course of conduct.

In the current case, there is a scheme, as described in the 'relevant facts' outlined above, being the establishment of the Company to provide a consultancy service within the IT industry, with Taxpayer A as the sole director.

Is there a tax benefit?

The anti-avoidance provisions only apply where there is a tax benefit from the scheme. Under section 177C of the ITAA 1936 a tax benefit received in relation to a scheme is any of the following four amounts:

•                     An amount that was not included in the assessable income of the taxpayer, where that amount would have been included, or might reasonably be expected to be included, in the assessable income of the taxpayer if the scheme had not been entered into.

•                     An amount for a deduction being allowable to the taxpayer, where that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into.

•                     An amount of a capital loss being incurred by the taxpayer, where that amount would not have been, or might reasonably be expected not to have been, incurred by the taxpayer if the scheme had not been entered into.

•                     An amount of a foreign tax credit being allowable to the taxpayer, where that foreign tax credit would not have been allowable or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into.

In the current case a tax benefit may arise where the net taxable income of the Company exceeds the commercial salary paid to Taxpayer A. The tax benefit will be the difference between the company tax rate and the marginal tax rate of Taxpayer A.

Part IVA factors

Under subsection 177D(2) the Commissioner must have regard to:

a.    the manner in which the scheme was entered into or carried out;

b.    the form and substance of the scheme;

c.     the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

d.    the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

e.    any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

f.      any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

g.    any other consequences for the relevant taxpayer, or for any person referred to in subparagraph (f), of the scheme having been entered into or carried out; and

h.    the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (f)

Applying these factors to your circumstances:

•                     There were clearly identifiable commercial reasons for the establishment of the Company. Namely, to enhance asset protection, to expand the business and allow for the tendering for contracts.

•                     The Company pays a commercial salary to Taxpayer A in relation to the work they perform for the Company.

•                     The Company will derive a taxable income in those years where the total income received is in excess of the commercial remuneration paid to Taxpayer A and other operating costs. The Company will be taxable on this excess and it will be retained by the company to fund working and capital requirements.

Conclusion

After considering all the relevant facts and evidence the Commissioner is of the opinion that a scheme has not been entered into or carried out for the dominant purpose of enabling a relevant taxpayer a tax benefit. Accordingly, Part IVA will not apply to any income that is retained in the Company and on which the Company is taxed at the company tax rate.