Edited version of private advice

Authorisation Number: 1051931166541

Date of advice: 20 December 2021

Ruling

Subject: Personal services income, company distributions and foreign income tax offset.

Question 1

Is any of the income received in the 20XX-XX financial year, pursuant to the acting engagement contracts, personal services income (PSI) under section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Was the results test met as per section 87-18(3) of the ITAA 1997, in relation to the PSI of the taxpayer in the 20XX-XX financial year?

Answer

No

Question 3

Was the unrelated clients test under section 87-20 of the ITAA 1997 satisfied in relation to the PSI of the taxpayer in the 20XX-XX income year?

Answer

Yes

Question 4

Can the portion of Company A's profit derived from the taxpayer's personal exertion, be retained or distributed to associates?

Answer

Yes, in limited circumstances.

Question 5

Is the taxpayer entitled to a foreign income tax offset (FITO) under section 770-10 of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Financial year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The taxpayer is an actor who is an Australian resident in the 20XX-XX financial year.

The taxpayer's services were offered through professional agents who are frequently in talks with various directors and casting agents in order to secure roles.

The taxpayer was engaged and provided services through two interposed entities Company A and Company B during the 20XX-XX financial year.

Contract 1. Television series production

Following the taxpayer's agents having discussions with producers regarding the taxpayer's suitability for the role, the taxpayer was invited and successfully auditioned.

During the 20XX-XX financial year, Company A as lender of the taxpayer's services, entered a contract with the producers of the television series, for a total aggregate consideration of $XXX.

The consideration amount was made up of the following components:

•         An engagement fee.

•         Additional use pre-purchase payments.

•         Principal photography.

•         Prep time/pick up weeks.

The producer had the first call on the taxpayer's services for the periods totalling XX days during the relevant income year.

The payments for engagement fee, additional use payments, principal photography and prep time payments were guaranteed under the contract whether or not the taxpayer provided services.

The taxpayer was engaged to perform in the production and in the part specified in the contract during the engagement periods in the relevant year.

The total engagement fee was calculated with reference to engagement periods, the number of episodes produced, production day payments, the number of transmissions on Sky as well as non-theatric rights around the world.

Additional use payments provided for in the contract, were for the pre-purchase of additional uses being television, video and other media rights.

$XXX, being the total fixed compensation payment amount was received by Company A in the relevant year.

Contract 2. Film production

Following an approach made by the taxpayer's agents regarding the taxpayer's suitability, the producer offered the taxpayer the part in the film.

The engagement of the taxpayer's services in the film production was arranged via a contract between Company A and the producers.

The contract specified a fixed compensation amount of $XXX on a pay or play basis, meaning the Company A was to be paid the amount whether the production proceeded or not.

The taxpayer rendered services for the film production during the engagement periods in the relevant financial year

The fixed compensation amount was also described as an all-in buy-out fee, assigning the producer the exclusive right to the taxpayer's likeness in the film production.

Other obligations outlined in the contract:

•         Procurement of the taxpayer services for one week immediately preceding the start date for rehearsal and other pre-production services.

•         XX principal shooting days over the course of X consecutive weeks with twelve-hour workdays.

•         The taxpayer's travel and a reasonable amount of publicity and promotional services.

The contract also provided for contingent compensation payable in the event that the film is released equal to 20% of the net profit from the exploitation of the film, less bonuses.

Bonus payments are also outlined in the contract, with payment's calculated on the basis of domestic box office and video on demand milestones.

The fixed compensation amount $XXX, was received by Company A, however no contingent compensation or other payments were received under the contract during the relevant financial year.

Contract 3. Brand ambassador - Product A

Company A and Company B received payments under an agreement during the relevant year in relation to the taxpayer's engagement as a brand ambassador for a cosmetics brand.

Payment under the agreement are split into two original terms and two subsequent 'run off' terms, with payments due of $XXX for the original terms and $XX for the 'run-off' terms.

During the original terms the taxpayer was required to provide their services and image as a 'brand ambassador' in connection with an advertising campaign to advertise, promote and endorse products.

The sum of $XX was received in respect of the second run-off term was derived by the taxpayer's entities in the relevant financial year with some of this money received by Company B and the remainder by Company A.

The taxpayer was not required to provide any services during the relevant financial year, with payment related to the continuation of the advertising campaign.

Contract 4. Social Media Endorsement

The taxpayer was also engaged through Company A for social media endorsement services provided, with Company A receiving a payment of $XX during the relevant financial year.

The engagement was secured after the taxpayer was approached by a PR company.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 84-5

Income Tax Assessment Act 1997 Subsection 86-15(1)

Income Tax Assessment Act 1997 Subsection 87-18(3)

Income Tax Assessment Act 1997 Section 87-20

Income Tax Assessment Act 1997 Section 770-10

Income Tax Assessment Act 1997 Subsection 770-15(1)

Income Tax Assessment Act 1997 Section 770-130

Income Tax Assessment Act 1936 Part IVA

Reasons for decision

Question 1

Is the income received in the 20XX-XX financial year, pursuant to the acting engagement contracts, personal services income (PSI) under section 84-5 of the ITAA 1997?

Summary

The Commissioner considers the income derived in the 20XX-XX financial year from the engagement fees and prep time and pick up fee's portions of Contact 1 and all of the fixed compensation of Contract 2 is personal services income. The income earned under the social media endorsement engagement is also PSI. The PSI income earned under each contract was considered to be predominantly for the provision of the taxpayer's acting services and therefor a reward for personal efforts and skill.

Detailed reasoning

Ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

An entity derives an amount of ordinary income as soon as it is applied or dealt with in any way on the entity's behalf or as directed by it (subsection 6-5(4) of the ITAA 1997).

Ordinary income has generally been held to include three categories:

• income from rendering personal services
• income from property, and
• income from carrying on a business.

Personal Services Income

The PSI rules contained in Divisions 84 to 87 of the ITAA 1997 only apply if a taxpayer has income that is personal services income (of an individual). The definition of personal services income is contained in subsection 84-5(1) of the ITAA 1997 which states:

Your ordinary income or statutory income, or the ordinary income 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).

Income that is mainly generated from:

• the sale or supply of goods or the granting of a right to use property;
• 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).

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.

Taxation Ruling TR 2021/D2 Income tax: personal services income and personal services businesses provides at paragraphs 40 to 43 that it is the substance of the arrangement that is considered when determining if the income is mainly a reward for an individual's personal efforts and skills. Where there are different components integral to or common to each other that amount to one set of obligations they are looked at together. Where the substance of the arrangement deals with obligations that are separate and distinct, each obligation is the source of separate amounts of income.

Paragraph 20 of Taxation Ruling TR 2001/7 Income tax: the meaning of personal services income (TR 2001/7) explains that Part 2-42 of the ITAA 1997 requires each item of ordinary or statutory income derived to be analysed to determine whether or not it is personal services income. An entity may therefore have some income which is personal services income and some which is not.

Contract 1

In the private ruling application, it is contended that all payments under Contract 1, are not PSI but are payments for a contractual right, related to commercial and economic factors linked to screenings of the finished product. It is contended that there is no direct link to the taxpayer's personal services.

Additionally, it is contended that the agreed minimum total amount paid to Company A on a pay or play basis pursuant to the special stipulations component of the contract is not PSI as it is payable whether or not the taxpayer is called upon to provide acting services. The pay and play clause therefore creating a contractual right to the payment regardless of the service provision.

As the taxpayer actually provided services in this case, it is the Commissioner's view that the payment contingency for non-service provided by the pay or play clauses are rendered obsolete. Therefore, it remains that if the income received by Company A is considered mainly a reward for the personal efforts and skills of the taxpayer, it will be regarded as PSI.

Based on the information provided, the Commissioner considers the payments for engagement fees and production day payments, and prep time and pick up weeks to be personal services income. These payments being primarily for the taxpayer to provide acting services.

However, the payments for pre-purchase additional uses and the principal photography of the contract to be connected to the success of the overall production and other external factors outside of the control of the taxpayer. The Commissioner accepts that these payments are related to contractual rights and therefore are not PSI.

Contract 2

This contract is an agreement between Company A and the producer for the services of the taxpayer in the film production. The payment in the 20XX-XX financial year involved the fixed compensation amount of $XXX, with no income received contingent compensation component of the contract.

In the private ruling application, it is contended that the contingent amounts payable under the contract are driven by commercial and economic factors linked to screenings of a finished product.

The Commissioner agrees that the contingent compensation and bonuses of the contract are connected to the success of the overall production and other external factors outside of the control of the taxpayer. The Commissioner considers that had payments been received in relation to these clauses they would not have been PSI.

The private ruling application further contends that the fixed compensation amount was on a pay or play basis payable whether or not the taxpayer is called upon to provide acting services, providing a contractual right for Company A to receive payment.

As per Contract 1, the Commissioner considers the pay or play conditions in Contract 2 have been rendered obsolete in this case as the taxpayer actually provided acting services.

Based on the information provided, the Commissioner considers the fixed compensation all-in buy-out fee of $XXX is predominantly a reward for the provision of the taxpayer's personal efforts and skill related to the acting services provided and is therefore the taxpayer's PSI pursuant to subsection 84-5(1) of the ITAA 1997.

Contract 3

In the 20XX-XX financial year Company B and Company A received $XXX income for the second 'run-off' term of the cosmetic products endorsement contract, payments received as a result of the ongoing worldwide advertising campaign.

As the taxpayer was not required to provide services, the payment is not considered by the Commissioner to be mainly a reward for her effort and skill and is therefore not PSI.

Contract 4

Company A issued an invoice and received payment for an amount of $XX during 20XX-XX financial year being in relation to social media endorsement services provided by the taxpayer.

As the payment was received in relation to the provision of the taxpayer services the Commissioner considers it to be mainly a reward for her effort and skill. The $XX payment is therefore considered as the taxpayer's personal services income pursuant to subsection 84-5(1) of the ITAA 1997.

Question 2

Was the results test met as per section 87-18(3) of the ITAA 1997, in relation to the PSI of the taxpayer in the 20XX-XX financial year?

Summary

The results test was not met in the 20XX-XX financial year as, less than 75% of the income considered by the Commissioner to be PSI (as outlined in Question 1 of this ruling) met all three conditions of the results test.

Detailed reasoning

The results test as specified in subsection 87-18(3) of the ITAA 1997 provides:

A personal services entity meets the results test in an income year if in relation to at least 75% of the personal services income of one or more individuals that is included in the personal services entity's ordinary income or statutory income during the income year:

a)    the income is for producing a result; and

b)    the personal services entity is required to supply the plant and equipment, or tools of trade, needed to perform the work from which the personal services entity produces the result; and

c)    the personal services entity is, or would be, liable for the cost of rectifying any defect in the work performed.

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 that produces the result

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.

In the private ruling application, it is contended that in relation to Contracts 1 and 2, the agreed minimum amounts are payment for performing the role with the result being the film/show. Each scene the taxpayer is in, requires a successful 'take' for it to proceed to the production process. The company is ultimately being paid for each successful scene 'take' by the taxpayer and it is this identifiable task for which it is being remunerated.

Under Contract 1, the engagement fee payment is made on a weekly basis with no connection to the number of successful takes indicated. Similarly, the fixed payment component of Contract 2 specifies the time periods and number weeks that the acting services of the taxpayer will be required. Neither payment is considered by the Commissioner to be for producing a result. Instead, they are considered as payments for service work done during the engagements. Therefore, the first condition of the results test, producing a result will not be satisfied in relation to the PSI from these contracts.

It is unlikely that an actor is required to provide any plant and equipment or tools of trade to complete the work as acting is a performance using the actor's skills only. Having regard to the nature of the work, no plant and equipment or tools of trade are required to be provided. However, as the contract is not for 'producing a result' the second condition of the results test cannot be satisfied.

As rectification of work can be done during usual working times, in that a number of takes can be done to create the scene to the satisfaction of the director. Consequently, the third condition of the results test will not be met

As less than 75% of the PSI earned by Company A during the 20XX-XX financial year is not considered to be results based, when considered against the results test conditions, the results test is not passed.

Question 3

Was the unrelated clients test under section 87-20 of the ITAA 1997 satisfied, in relation to the PSI of the taxpayer in the 20XX-XX income year?

Summary

Company A satisfied the unrelated clients test during the 20XX-XX financial year as it was in receipt of income from at least two unrelated clients (Contract 1 and 2) as a direct result of the taxpayer (via her agent) making invitations to directors and producers, who are considered in this case to be a section of the public.

Detailed reasoning

The unrelated clients test as set out in section 87-20 of the ITAA 1997 provides:

1)    An individual or a personal services entity meets the unrelated clients test in an income year if:

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

2)    The individual or personal services entity is not treated, for the purposes of paragraph (1)(b), 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.

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.

An invitation is the mechanism by which an individual or personal services entity holds out to or informs the public or a section of the public the services that the individual or personal services entity is able to provide.

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, or a 'section of the public', where a select group is chosen to whom the invitation is made. 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.

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

• The number of persons or entities to which the offer or invitation is made.
• The nature and content of the offer or invitation.
• The nature of the particular relationship between the parties to the offer or invitation. Where the parties to the relationship deal with each other on an arm's length basis, the commercial character of the transaction is maintained.

Application to your situation

In the private ruling application, it is contended that the taxpayer has two or more unrelated clients, and the first condition of the unrelated clients test is met. Further the taxpayer's agent makes offers on behalf of the actor and general agency law applies so a thing done by the agent is a thing done by the taxpayer. Additionally, the agent makes offers to a section of the public as this includes various local and international film and television studios.

The Commissioner accepts that the taxpayers use of casting agents will not prevent the contracts obtained by this method from passing the unrelated client's test. The contracts in this case that were merely sourced by the agents. The contracts terms were then arranged between Company A and the third-party clients, rather than through the agency.

During the 20XX-XX financial year, Company A way was in receipt of income for services from three different clients in relation to Contracts, 1, 2 and 4. It is accepted by the Commissioner that the clients were not associates of each other or of the taxpayer or the taxpayer's associates, therefore, the fist limb of the unrelated clients test is met.

The acting engagements of the taxpayer (Contract 1 and Contract 2) for the 20XX-XX financial year were both obtained from the invitations made by the taxpayer's agents. The taxpayer's agents are frequently in talks with various directors and casting agents putting the actor forward for suitable roles. The Commissioner accepts these discussions as invitations made on the taxpayer's behalf.

It is clear from the information provided that Contracts 1 and 2 were not obtained from invitations to the public at large. However, it is accepted by the Commissioner that these invitations did constitute offers made to a section of the public, on the following basis:

• The agents would be in contact with (and therefor make invitations) to a reasonably large number of producers.
• The invitations would be made as part of a competitive commercial process. Generally, the taxpayer would be competing with all the other actors in the market.
• The parties to the invitation would be dealing with each other on an arm's length basis, with the commercial character of the subsequent transactions maintained.

The Commissioner considers that Company A satisfied the unrelated clients test in the 20XX-XX financial year and is therefore considered to be a personal services business under section 87-15 of the ITAA 1997.

Question 4

Can the portion of Company A's profit derived from the taxpayer's personal exertion, be retained or distributed to associates?

Summary

Profits derived by Company A from the taxpayer's exertion, that are retained by the company or distributed to associates, have the potential to attract the general anti-avoidance rules, if it is determined, that the dominant purpose of the arrangement was to obtain a tax advantage.

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.

The Commissioner released the ruling IT 2121 Income tax: family companies and trusts in relation to income from personal exertion (IT 2121), following the finding by the Federal Court in Tupicoff v FC of T 84 ATC 4851. The ruling addresses arrangements that are principally or predominantly entered to avoid liability for income tax by means of the splitting of income, rather than explicable as ordinary business or family dealings.

IT 2121 sets out that the tax benefit arising out of arrangements (for tax advantage) entered into on or after 28 May 1981 will be removed through the application of the general anti-avoidance rules Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936).

Paragraph 17 of IT 2121 provides that the view in the ruling can be applied to income derived by an entertainer from the exercise of their attributes or skills. However, it would not apply to income derived by entities that was not from the entertainer's personal exertion, such as from product endorsement where the entertainer's services were not involved.

In this case, if the amounts paid to the taxpayer are less than the market value of the services provided, and the dominant purpose of the arrangement was considered to be obtaining a tax advantage, the arrangement may attract the application of the general anti-avoidance rules.

Question 5

Is the taxpayer entitled to a foreign income tax offset (FITO) under section 770-10 of the ITAA 1997 for foreign tax paid by the taxpayer's entities on their income?

Summary

The taxpayer will not be entitled to a FITO under section 770-10(1) of the ITAA 1997 for salary and wages income paid by Company A or Company B. That is unless that salary and wage income was assessable in another country, and foreign tax had been paid on this income either by the taxpayer or by the companies on behalf of the taxpayer.

Detailed reasoning

Under section 770-10(1) of the ITAA 1997, for a taxpayer to be entitled to a FITO:

• the taxpayer must have actually paid, or be deemed to have paid, an amount of foreign income tax, and
• the income or gain on which the taxpayer paid foreign income tax must be included in the taxpayer's assessable income for the income year.

Section 770-15(1) of the ITAA 1997 provides that foreign income tax must be imposed under a law other than an Australian law and be:

• a tax on income
• a tax on profits or gains, whether of an income or capital nature, or
• any other tax that is subject to an agreement covered by the International Tax Agreements Act 1953.

The taxpayer is treated as having paid foreign income tax on their income where the tax has been paid in respect of that income by someone else on their behalf under an arrangement with the taxpayer or under the law relating to the foreign income tax (subsections 770-130(1) and (2) of the ITAA 1997).

For this to apply, the taxpayer must have derived an amount of foreign income and foreign tax must have been paid, in respect of that income.

The phrase 'in respect of' requires that the foreign tax paid, either by another party or by deduction, have some material connection with the taxpayer's foreign income. The relevant Explanatory Memorandum states (at para 1.101) that this nexus requires a material connection between the foreign tax and the amount included in assessable income.

In ATO ID 2008/135 Income Tax Foreign income tax offset: New Zealand National Provident Fund pension the Commissioner found that a taxpayer was not entitled to a FITO under s 770-10(1) of the ITAA 1997 in respect of a pension received from a New Zealand National Provident Fund on which the taxpayer was not assessable in New Zealand. The required nexus between the payment of the foreign income tax by the fund and the tax liability of the taxpayer was not present, i.e., the foreign tax paid by the fund did not relate to a tax liability of the taxpayer.

The Commissioner's view is that any foreign tax paid payable by Company A or Company B on their income does not have sufficient connection with the taxpayer's income to satisfy subsection 770-110(2) of the ITTA 1997 in this case. The foreign tax has not been paid on the taxpayer's behalf, rather it has been paid in order for Company A or Company B to meet their foreign income tax obligations.

Consequently, the taxpayer is not entitled to a FITO under section 770-10(1) of the ITAA 1997 on salary and wages income unless that income was assessable in another country and foreign tax was paid on the income either by the taxpayer or by the entities on behalf of the taxpayer.