Edited version of private advice

Authorisation Number: 1051902423866

Date of advice: 29 September 2021

Ruling

Subject: Personal services income and trust distribution

Question 1

Is the income received by the trustee company for medical services provided by XXX their personal services income (PSI)?

Answer

Yes.

Question 2

Was the results test met in relation to the PSI of XXX in the 20XX income year?

Answer

Yes.

Question 3

Was the unrelated clients test met in relation to the PSI of XXX in the 20XX income year??

Answer

No.

Question 4

Did the trustee company conduct a personal services business in the 20XX income year?

Answer

Yes.

Question 5

Can the family trust distribute profits to its beneficiaries?

Answer

Yes, in limited circumstances.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

XXX is the sole Director of XXX which is the Trustee For XXX Trust.

The XXX is a family discretionary trust.

Private ruling applications were received in the name of XXX and XXX on XX XX 20XX. The private ruling information contended the unrelated clients test was met, the 80% rule was satisfied.

The private ruling application states that services were provided to patients who were unrelated.

In a conversation on XX XX 20XX the taxpayer's tax agent believed the results test would be met and this test was added to the ruling request.

XXX is a general practitioner who performed medical services on behalf of XXX (the trustee company) at three listed medical centres in the 20XX income year.

Copies of Service Agreements were provided for the listed medical centres.

The Services Agreements provide for administration and management services including use of a room, medical equipment (other than that normally found in a doctor's bag), collection of fees, and provision of support staff.

Medical Indemnity Insurance is required to be held and maintained by XXX.

Income received by the trustee company for medical services performed by XXX in the 20XX income year was provided.

Nine recipient created invoices were provided.

Tax Office records show that in the 20XX income year the Trustee for the XXX made a sole distribution to XXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 84-5

Income Tax Assessment Act 1997 Section 87-18

Income Tax Assessment Act 1997 Section 87-20

Income Tax Assessment Act 1936 Part IVA

Reasons for Decision

Question 1

Is the income received by the trustee company for medical services provided by XXX their personal services income (PSI)?

Summary

The income received for the provision of medical services is mainly a reward for XXX personal efforts and skills and is therefore their PSI.

Detailed reasoning

Personal services income (PSI)

PSI is income that is mainly a reward for an individual's personal efforts or skills (or would mainly be such a reward if it was the income of the individual).

By definition, income earned by an employee is PSI. However, the PSI rules do not apply to income received as an employee unless they are an employee of an interposed entity.

Income that is mainly generated from:

•         the sale or supply of goods;

•         the supply and use of income-producing assets; or

•         a business structure

is not PSI.

Only individuals can have PSI. PSI can be earned directly by an individual or indirectly through a company, partnership or trust (personal services entity).

A personal services entity (PSE) is a partnership, company or trust that receives the PSI of one or more individuals and is interposed between the individual(s) providing the work or services and the service acquirer.

The phrase 'or would mainly be such a reward if it was the income of the individual' applies to situations where the income is legally derived by a PSE and not the individual. If the PSE fails to meet a personal services business test in respect of a test individual, the PSI is deemed to be the income of the individual who earns the PSI and is attributed to that individual.

The use of the word 'mainly' means that the income referred to needs to be 'chiefly', 'principally' or 'primarily' a reward for the provision of the personal efforts of, or for the exercise of the skills of, an individual. That is, more than half (50%) of the ordinary or statutory income received is required to be a reward for the personal efforts and skills of an individual rather than being generated by the use of assets, the sale of goods or by a business structure.

XXX provides medical services as a general practitioner on behalf of the trustee company.

The income received by the trustee company for medical services is mainly a reward for XXX personal efforts and skills and is therefore their PSI.

Question 2

Was the results test met in relation to the PSI of XXX in the 20XX income year?

Summary

The results test was met in the 20XX income year, as at least 75% of the income received from XXX providing medical services met all three conditions of the results test.

Detailed reasoning

The results test

To meet the results test in an income year at least 75% of an individual's PSI in an income year must satisfy all three conditions below:

•         the income is for producing a result and

•         the individual or PSE is required to supply the plant and equipment and tools of trade needed to perform the work which produces the result and

•         the individual or PSE is liable for the cost of rectifying defects.

To meet the test all three conditions must be satisfied in relation to 75% of the PSI received.

Producing a result

In results-based contracts, payment is usually made for a negotiated contract price, as opposed to an hourly or daily rate, and is paid only when the contractual conditions have been fulfilled. Where remuneration is payable on the contractual conditions being fulfilled, the remuneration is for producing a result. The remuneration is often a fixed sum on completion of a particular job as opposed to an amount paid by reference to hours worked.

The essence of the contract must be to achieve a result and not to do work. The fact that an individual or PSE is required to complete identifiable tasks is not the same as achieving a result if those tasks merely form part of the work being paid for on an ongoing basis.

Required to supply the plant and equipment, or tools of trade, needed to perform the work

To satisfy the second condition, the individual or PSE must supply any plant and equipment or tools of trade needed to do the actual work which produces the result and which a service acquirer would expect the individual or PSE to provide or which the individual or PSE is contractually required to provide. There are situations where, having regard to the nature of the work, no plant or equipment or tools of trade are needed to perform the work. Where this is the case, this condition will be met.

Liable for the cost of rectifying any defect in the work performed

To satisfy the third condition, the individual or PSE must be liable for the cost of rectifying any defects in the work. There is no requirement that they actually perform the work which rectifies the defect so long as they pay for it.

The main consideration is whether they are exposed to commercial risk. Where physical rectification is not possible, the purpose of the provision would be satisfied where a right to claim for damages exists in respect of faulty or negligent performance of contractual obligations and the individual or PSE is, or would be, liable for the relevant component of damages awarded for the faulty or defective work.

The existence of a term in an agreement that the individual or personal services entity is liable for the cost of rectifying any defect in the work performed would support the conclusion that liability to make good any faulty workmanship exists, particularly where the individual or PSE and the service acquirer are dealing with each other at arm's length. However, the term in the agreement should not be merely 'window dressing', and regard may be had to all the circumstances of the case in determining whether the relevant liability really exists. A requirement to have indemnity insurance is an indicator that an individual or PSE is liable for rectification where the indemnity insurance is part of the contractual arrangements between the parties.

The three conditions of the results test are met. Payments received by the trustee company for medical services provided by XXX are for producing a result, that is payment is contingent on services being provided after consultation with each patient. Services are provided to the patient by XXX, Medicare is then billed by the medical centres and once payment is received from Medicare, 70% is paid to the trustee company and the remaining 30% is retained by the medical centres under the service agreements in payment for use of the rooms, computer equipment and other services provided by the medical centres such as administrative services.

The trustee company provides the tools and equipment required to do the actual work which produces the result including a doctors bag and stethoscope that are required to provide various medical services to the patients.

The appropriate medical indemnity insurance is required under the agreements and is maintained which evidences liability for rectification of defects in the services performed by XXX.

Question 3

Was the unrelated clients test met in relation to the PSI of XXX in the 20XX income year?

Summary

The unrelated clients test was not met in the 20XX income year, as it was not demonstrated the trustee company provided XXX medical services as a general practitioner as a direct result of making offers or invitations to the public at large or a section of the public.

Detailed reasoning

The unrelated clients test

To meet the unrelated clients test in an income year:

•         an individual or personal services entity (PSE) is required to gain or produce the PSI from providing services to two or more entities. Those entities cannot be associates of each other or associated to the individual or PSE and

•         the services must be provided as a direct result of making offers or invitations (for example, by advertising) and those offers must be made to the public at large or a section of the public.

If the services are provided by registering through a labour hire firm or similar arrangement, the test will not be met as the required offer or invitation has not been made to the public at large or a section of the public.

Direct result of making offers or invitations

To meet this condition, the offer or invitation must be the reason why the work was obtained and there must be a close and significant connection between the offer or invitation and obtaining the work.

A wide variety of activities can constitute making offers or invitations such as print advertising, printing posters, radio and television broadcasting, public tender, having a website and posting internet advertisements but all require the involvement of making public announcements.

Registering with labour hire firms, or similar, or responding to advertisements on web-based recruitment sites, will not meet this condition.

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 in certain circumstances for example in relation to competitive tenders.

An offer to the public at large or a section of the public is an indication of the PSE's willingness to perform services for anyone within a group or class of persons or to any member of the public. The intention in such activity is to attract or solicit members of the public to enter into agreements for their services.

A word of mouth referral is not generally considered to satisfy the requirements of the unrelated clients test.[1] A word of mouth referral is where work is offered because of a recommendation from a previous client or industry contact. However, offers made by word of mouth in a specialised or niche industry where there are only a very small number of potential clients may, in limited circumstances, meet this condition.[2]

Where a prior or subsisting relationship exists between the parties the following factors are relevant to determining whether the offer or invitation is made to 'a section of the public':

•         the number of persons or entities to which the offer is made

•         the nature and content of the offer eg competitive commercial process such as public tender

•         the nature of the relationship between the parties - where the parties deal with each other on an arm's length basis, the commercial character of the transaction is maintained so even if services had been provided sometime in the past, this element may still be satisfied.

Where a contractor has had previous contracts with a service acquirer the contractor will be considered to be genuinely independent of the service acquirer where a tendering process is competitive, other parties are invited to tender for the contracts, the service acquirer is not the only significant client of the contractor and the successful tenderer is chosen on commercial grounds.[3]

The private ruling application states that services were provided to patients who were unrelated. However, the unrelated clients test also requires that those patients were obtained as a direct result of the trustee company making offers or invitations to the public at large or a section of the public. No evidence has been provided that this is the case. Therefore, the Commissioner cannot be satisfied that the unrelated clients test was met in the 20XX income year.

Question 4

Did the trustee company conduct a personal services business in the 20XX income year?

Summary

The trustee company conducted a personal service business in the 20XX income year as the results test was met.

Detailed reasoning

The PSI rules will not apply and an individual or entity will be conducting a personal services business if one of the four personal services business tests is met in an income year. Because the results test was met, the PSI rules do not apply, as the personal services income of XXX is from the trustee company conducting a personal services business.

Question 5

Can the family trust distribute profits to its beneficiaries?

Summary

Yes, in limited circumstances.

Detailed reasoning

If an entity is conducting a personal services business, the PSI rules do not apply requiring the net PSI to be attributed to the individual who provided the services and the family trust may distribute profits to its beneficiaries in limited circumstances.

When a personal services business operates through a trust with a corporate trustee, amounts paid to XXX from the trust should be commensurate with the services provided by XXX, or they should be the sole beneficiary of the trust in relation to that income.

Tax Office records show that in the 20XX income year the Trustee for XXX made a sole distribution to XXX.

If the amounts paid to XXX are less than the market value for the services he provides, then the arrangement may attract application of the general anti-avoidance rules.

The general anti-avoidance rules are contained in Part IVA of the Income Tax Assessment Act 1936 (Part IVA). If the dominant purpose of the arrangement is to obtain a tax advantage, then Part IVA may apply.[4]

[1] Metaskills Pty Ltd and Commissioner of Taxation [2005] AATA 647 at [55]; Cameron v Commissioner of Taxation [2011] AATA 386 at [30]

[2] Yalos Engineering Pty Ltd v FC of T [2010] AATA 408; [2009] FCA 1569 at [24]

[3] Paragraph 173 of TR 2001/8

[4] Paragraph 14 of Taxation Ruling IT 2121