Edited version of private advice

Authorisation Number: 1051973113386

Date of advice: 14 April 2022

Ruling

Subject: Personal services income

Question 1

Is the income made on behalf of the medical practice as it is currently conducted, personal services income (PSI) of the Doctor within the meaning of that term as set out in section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the income of the Clinic Company PSI of the Doctor within the meaning of that term as set out in section 84-5 of the ITAA 1997?

Answer

No.

Question 3

Would the Commissioner make a personal services business determination (PSBD) under section 87-60 of the ITAA 1997 in relation to the medical practice currently conducted by the Doctor?

Answer

No.

Question 4

If the Doctor were to incorporate his practice, would the Commissioner make a PSBD under section 87-65 of the ITAA 1997 for the practice company?

Answer

No.

Question 5

Would the Commissioner apply Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) if the Doctor were to incorporate his practice and accumulate some of the income in it after paying him a market salary?

Answer

No.

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Doctor practises medicine. His professional practice is not currently incorporated.

The Doctor maintains two clinics from where his work is based for four days per week. He typically works about 40 hours per week at the clinic over the four days earning fees for the practice. Operations are performed at various hospitals.

On average, about one day per week he works (as an employee) in the public hospital system and receives a salary for doing so.

The medical practice services are advertised to the public at large through various media including the practice's website and third-party websites.

The Doctor charges set fees (his clinic income) for the procedures carried out and is responsible to ensure they are carried out with the requisite professional skill and expertise. If something were to go wrong for a patient, the Doctor could be exposed to legal liability.

The Doctor provides all the various items needed to perform his work.

The Doctor engages the following staff:

•         one fulltime medical officer

•         two fulltime registered nurses

•         a practice manager undertaking administrative duties under direction.

•         secretarial/reception staff undertaking administrative duties under direction.

The Doctor employs a medical officer who works a total of 55 hours per week. The medical officer works 20 hours assisting the Doctor in theatre and 35 hours per week working independently doing medical consults which generate fees for the practice.

The two nurses employed by the Doctor typically work about 40 hours per week each. They assist patients with the likes of post-operative wound care, in a support role where there is no separate charge for the work. The nurses also perform work without direction, for which patients are charged. The two nurses work directly with patients earning fees for the practice, 25 hours per week (50 hours cumulatively).

It is proposed that the Doctor's clinical practice be incorporated by being transferred to a company in which the Doctor owns 100% of the shares (the Clinic Company). The Doctor will choose to apply the roll-over available under Subdivision 122-A of the ITAA 1997. The Doctor will become an employee of the Clinic Company and be paid a salary that is commensurate with the rate of pay of an employee employed by a practice of a similar size and who has the same abilities and skill as the Doctor.

The Clinic Company will remain wholly owned by the Doctor with the result that future dividends would be assessable to the Doctor in a personal capacity.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 84-5

Income Tax Assessment Act 1997 Section 87-60

Income Tax Assessment Act 1997 Section 87-65

Income Tax Assessment Act 1936 Part IVA

Reasons for decision

Question 1

Summary

The income generated from the medical practice as it is currently conducted does not constitute PSI within the meaning of section 84-5 of the ITAA 1997 as the income is derived from the business structure.

Detailed reasoning

Section 84-5 of the of the ITAA 1997 defines PSI as being income which is mainly a reward for an individual's personal efforts or skills.

Income which is generated from the business structure of an entity is not PSI (Subsection 84-5(1) of the ITAA 1997; paragraph 34 of Draft Taxation Ruling TR 2021/D2 Income tax: personal services income and personal services businesses (TR 2021/D2)).

Paragraph 35 of TR 2021/D2 provides that where income is derived by a practice with substantial income-producing assets or a number of employees or both, the income is more likely to be generated by the profit yielding structure of the business rather than the rendering of personal services.

Where a sole trader is not a practice company, TR 2021/D2 sets out at paragraph 36 the following factors for determining whether income is mainly a reward for the personal efforts or skills of an individual or is income generated from a business structure:

•         the number of arm's length employees or others engaged by the sole trader or PSE to perform work

•         the existence of goodwill

•         the extent to which income-producing assets of the business are used to derive the income

•         the nature of the activities carried out

•         the size of the operation, and

•         the extent to which the income is dependent upon a particular individual's own personal skills, efforts, or expertise.

Application to your circumstances

In this case, the Doctor operates a medical practice as a sole trader.

The activities of the practice are medical.

The business employs one other medical officer and two registered nurses that independently generate fees for the practice. The business also employs additional administrative and support staff who do not generate material fees for the practice. They are all arm's length employees.

Whilst the personal services of the Doctor greatly contribute to the income earnt by the business, the employee medical officer and nursing staff independently generate fees for the practice to the extent that the income produced for the medical practice is also dependent upon the services provided by these employees.

Specialised equipment is utilised within the business by the Doctor, the employee medical officer, and employee nurses to provide treatment to patients and thereby derive income on behalf of the business.

A machine is used within the medical practice to deliver treatment and generate material fees for the practice.

Taking into account these factors as a whole, the income derived by the practice is from a business structure and therefore the income is not PSI.

Question 2

Summary

The Clinic Company's income does not constitute PSI of the Doctor within the meaning of section 84-5 of the ITAA 1997 as the income is derived from the business structure.

Detailed reasoning

As outlined in question 1 above, income that is mainly generated from a business structure is not PSI (subsection 84-5(1) of the ITAA 1997; paragraph 34 of TR 2021/D2).

Paragraph 37 of TR 2021/D2 sets out the Commissioner's approach to determining whether the income of a practice company or trust is generated from the business structure, including that:

•         Where a practice company or trust has at least as many non-principal practitioners as principal practitioners, the income of the entity is considered to be derived from a business structure.

•         Where a practice company or trust has fewer non-principal practitioners than principal practitioners, then whether the income is considered to be from a business structure will need to be determined by considering the various factors discussed at paragraph 36 of this Ruling.

For the purposes of applying the guidelines at paragraph 37 of TR 2021/D2 paragraph 38 provides:

•         'Practitioners' include both full-time professional and non-professional staff who derive material fees for the practice. Part-time staff are counted proportionately.

•         'Practitioners' does not include administrative, clerical, or support staff. For example, a nurse under the direction of a doctor, or a legal secretary under the direction of a solicitor, are not practitioners unless they earn material fees in their own right.

•         'Principal practitioners' are those who own or share in the ownership of the practice, whether directly or indirectly.

•         'Non-principal practitioners' are those who are not principal practitioners; that is, who do not own or share in the ownership of the practice, whether directly or indirectly.

Application to your circumstances

Upon incorporation, the Clinic Company will employ the following staff:

•         Doctor

•         a full-time medical officer

•         two full-time qualified nurses

•         a practice manager

•         secretarial/reception staff.

There is one principal practitioner, the Doctor, who works full-time doing 40 hours a week over 4 days. The other full-time employed medical officer is a non-principal practitioner working 35 hours per week independently earning fees for the practice and has no ownership of the practice. In addition, the Clinic Company employs two full-time registered nurses who are both non-principal practitioners who together work 50 hours per week, also independently earning fees for the practice and with no ownership of the practice.

As the principal practitioner works 40 hours per week and the non-principal practitioners together work 85 hours per week there are as many non-principal practitioners as principal practitioners, therefore the income of the Clinic Company is considered to be derived from the business structure.

Question 3

Summary

The Commissioner would not make a PSBD under section 87-60 of the ITAA 1997 as the income is generated from a business structure and therefore is not PSI.

Detailed reasoning

The measures contained in Divisions 84 to 87 of the ITAA 1997 only apply if a taxpayer has income that is PSI.

A PSBD is a notice from the Commissioner of Taxation stating that one of the personal services business tests is met. The Commissioner can only make such a determination where there is PSI.

As concluded under question 1 and 2 above, the income is mainly generated from the business structure. Income that is mainly generated from a business structure is not PSI. As such, a PSBD under section 87-65 of the ITAA 1997 is neither relevant nor applicable.

Question 4

Summary

If the Clinic Company applied, using the approved form, the Commissioner would not make a PSBD under section 87-65 of the ITAA 1997 as the income is generated from a business structure and therefore is not PSI.

Detailed reasoning

As discussed above the measures contained in Divisions 84 to 87 of the ITAA 1997 only apply if a taxpayer has income that is PSI. Therefore, a PSBD under section 87-65 of the ITAA is not relevant or applicable where the income is not PSI as it is generated from a business structure.

Question 5

Summary

On the basis that the Doctor's practice would be incorporated and pay the Doctor a market rate salary the Commissioner would not seek to apply Part IVA to the arrangement.

Detailed reasoning

Part IVA of the ITAA 1936 may apply where there are factors indicating that the dominant purpose of the arrangement is to obtain a tax benefit by diverting or splitting an individual's income.

In deciding whether income splitting has occurred in order to gain a tax benefit, the following considerations may be relevant:

•         whether the salary or wages paid to the test individual is commensurate with the skills exercised or services provided and with the income received by the interposed entity for those services

•         whether the interposed entity distributes income to associates and does not distribute any income to the test individual (that is, the employee) who provided the actual services, and

•         whether the salary or wages paid to associates by the company is not commensurate with the skills exercised and services provided; and the income received by the company is for services performed by the test individual.

An example of a situation where there may be income splitting to which Part IVA could apply would be where an independent contractor, conducting business through an interposed entity, is paid substantially less than the market value for their work, and the profit made as a result of paying less than a market value salary is distributed to the contractor's relatives who are on a lower marginal tax rate, or accumulated in the interposed entity at a lower marginal rate of tax.

The considerations set out in the dot points above may be distinguished from those in the Doctor's proposed circumstances. Specifically:

•         It is proposed that the Doctor would be paid a salary by the Clinic Company and that that salary would be benchmarked to the rate of pay of an employee who has the same abilities and skill as the Doctor employed by a practice of a similar size.

•         The Doctor would be the sole shareholder of the Clinic Company, so there would be no scope for its income to be distributed to his associates - any dividends would go only to him personally; and

•         It is not proposed that associates of the Doctor be employed by the Clinic Company and paid at anything other than market rates (ie, rates which are commensurate with the skills exercised and services provided by the associate/s).

Further, the choice to apply the rollover in Subdivision 122-A of the ITAA 1997 in the circumstances described does not raise the issue of the application of Part IVA.

Based on the facts provided Part IVA will not be applied to the proposed arrangement.