Edited version of private advice

Authorisation Number: 1052044895321

Date of advice: 12 October 2022

Ruling

Subject: Assessable income - personal services income

Question

Is all of the income to be received by Aus Co from Foreign LLP, pursuant to the services agreement for the provision of legal services by Aus Co to Foreign LLP (Services Agreement), Personal Services Income (PSI) pursuant to Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Foreign LLP

1.         Foreign LLP is an international law firm with its head offices located in XYZ Country. Foreign LLP carries on a business of providing legal services with a view to deriving profits for partners of the firm.

2.         Foreign LLP is a limited liability partnership registered in XYZ Country.

3.         Foreign LLP is a Corporate Limited Partnership (CLP) for Australian taxation purposes pursuant to section 94D of the ITAA 1936.

4.         Mr ABC is a limited liability partner of LLP.

5.         All partners worldwide are limited liability partners of Foreign LLP. As at 31 January 20XX, Foreign LLP had XX partners, over XX other lawyers and over XX legal assistants and administrative staff.

6.         Foreign LLP's primary operations are in XYZ Country, but it also has offices in other foreign countries.

7.         Prior to the establishment of Aus Co, Foreign LLP had no related entities or branches in Australia.

8.         Foreign LLP is not focused on the Australian market. Where advice has been provided to Australian clients in the past, it has been through one of Foreign LLP's offices. Foreign LLP is not registered to practice Australian law.

9.         Foreign LLP's partners are taxed on their share of Foreign LLP's profits. The taxation of these partners depends on the tax profile of the individual partners (e.g., their tax residency etc).

Mr ABC

10.       Mr ABC is an Australian citizen and an equity partner of Foreign LLP.

11.       Mr ABC moved to DEF Country with his family in 20XX, from which time he was a non-resident of Australia for taxation purposes and was taxable in DEF Country on his partnership earnings from Foreign LLP.

12.       During his time in DEF Country, Mr ABC held XYZ Country practising certificates and only advised clients on XYZ Country law. Mr ABC did not practice Australian law and has not provided Australian legal advice to any clients (Australian or otherwise) during the years he has worked with Foreign LLP.

13.       Mr ABC is a member of the Global Finance team at Foreign LLP and focuses on advising clients on XXX projects in the HIJ region.

14.       Mr ABC's duties include collaborating with other lawyers on client matters to deliver legal advice and assist clients in closing transactions.

15.       Mr ABC's role also includes other standard partnership duties such as:

•                assisting with the recruitment of lawyers and support staff in the DEF Country office

•                undertaking and contributing to continuing legal education sessions in DEF Country

•                reviewing and settling legal advice and legal documentation in connection with client matters, and

•                generally supporting and servicing firm clients.

16.       Mr ABC does not hold any formal management positions within Foreign LLP.

Change of personal circumstances

17.       Last year, Mr ABC relocated to Australia and re-established his Australian taxation residency on 1 July 20XX (the date he returned from DEF Country). Mr ABC and his family now reside in Australia.

18.       Mr ABC continues to work for Foreign LLP from their offices in DEF Country and has an apartment in DEF Country.

19.       Mr ABC has a home in both DEF Country and Australia and intends to divide his time between the two locations to enable him to see his family regularly and intends to work while he is in Australia.

20.       Foreign LLP wants to ensure it can meet the personal circumstances and needs of partners. To facilitate Mr ABC's request, Foreign LLP has established a local subsidiary company, Aus Co, which will employ Mr ABC when he works from Australia. Details of the arrangements between Foreign LLP, Aus Co and Mr ABC are set out below from Fact 24.

Aus Co

21.       Aus Co was incorporated and registered with ASIC on XX date. Aus Co is 100% owned by Foreign LLP and Mr ABC is the sole Director, Public Officer and Secretary.

22.       Australian law requires Mr ABC to have an Australian Practising Certificate as a Principal of Aus Co even though Mr ABC does not intend, and is not authorised by Foreign LLP, to provide Australian legal advice to clients.

23.       To satisfy this regulatory requirement in Australia, Mr ABC received his Australian Practising Certificate and professional indemnity insurance was paid by Aus Co.

Legal and financial relationships

24.       The following legal and financial relationships exist between Foreign LLP, Aus Co and Mr ABC.

Sub-contract arrangement

25.       Foreign LLP and Aus Co will enter into the Services Agreement for the provision of legal services by Aus Co. With regards to specific client engagements involving Mr ABC while he is in Australia, Aus Co will be engaged by Foreign LLP via a sub-contract arrangement through which AUs Co will provide legal services to Foreign LLP rather than direct to the client.

26.       Aus Co will charge Foreign LLP for services rendered by Mr ABC while Mr ABC is in Australia, calculated by reference to hours charged in respect of client engagements (as recorded in Foreign LLP's Daynotes System using unique client matter numbers) at a specified hourly billing rate.

27.       The hourly billing rate will be determined each calendar year by taking Mr ABC's standard hourly rate as a partner at Foreign LLP and then applying the average discounting provided by Foreign LLP to its clients with respect to work undertaken by Mr ABC during the prior calendar year. This is intended to be a reasonable estimate of the realisable value of the work undertaken by Mr ABC.

28.       Aus Co will also charge Foreign LLP for expenses incurred by Aus Co, including:

•                accounting, tax and audit fees (as applicable)

•                professional indemnity insurance, and

•                Payroll Tax (if any).

29.       Clients will continue to engage Foreign LLP directly, and where necessary, Aus CO will be engaged via Foreign LLP under the sub-contract arrangement provided for in the Services Agreement. Aus Co will not contract with any clients. Aus Co's sole client will be Foreign LLP.

Employer / Employee

30.       Mr ABC will act as Principal and Director of Aus Co and will work from his Australian residence. Mr ABC will be employed by Aus Co.

31.       Mr ABC will be paid a salary and bonus by Aus Co (inclusive of Superannuation) funded by the payments received by Aus Co from Foreign LLP. Essentially, the salary will be calculated by reference to hours charged to client engagements (in Foreign LLP's systems) at the stipulated hourly billing rate referred to above while Mr ABC is in Australia.

32.       An employment contract (Employment Contract) has been provided and the key terms are detailed below.

33.       Clause 1 of the Employment Contract states Mr ABC will employed on a full-time basis in the position of Director and Company Secretary, and that the role will be primarily based in Australia.

34.       Clause 5 of the Employment Contract provides that Mr ABC will be paid a base salary of AUD$X.XX (paid on a monthly basis) and will be paid a quarterly bonus worked out using the following formula:

Bonus = (Hours Worked x Hourly Rate) - base salary for the quarter

Services performed

DEF Country

35.       Mr ABC will remain a Partner of Foreign LLP and when in DEF Country, will represent himself as a Partner of Foreign LLP and not as Principal of Aus Co.

36.       While in DEF Country, Mr ABC will undertake routine responsibilities as a Partner of Foreign LLP which includes engaging with and providing advice to clients on behalf of Foreign LLP.

37.       Mr ABC intends to be in DEF Country throughout the year on a very regular basis as many of his partnership duties will be carried out there.

38.       While Mr ABC is in DEF Country, he typically works from Foreign LLP's office.

Australia

39.       While Mr ABC is in Australia, all work that he undertakes will be in his capacity as an employee of Aus Co.

40.       Mr ABC will represent himself as Principal of Aus Co and perform work in accordance with the Services Agreement and Employment Contract, and all formal advice will be provided through Foreign LLP to its clients.

41.       Where Mr ABC communicates with and advises clients by email, this will be in his capacity as a principal of Aus Co performed under the authorisation of Foreign LLP in accordance with the engagement agreement (contract) between Foreign LLP and the client, in conjunction with the Services Agreement between Foreign LLP and Aus Co.

42.       Generally, all legal work undertaken by Mr ABC as an employee of Aus Co will be provided directly to clients without modification or review. The delivery of this advice is predominantly done over email and (while he is physically located in Australia) Mr ABC will indicate in the signature block of his email that he is providing advice on behalf of Aus Co. Accordingly, Mr ABC will use two different signature blocks depending on whether he is inside or outside of Australia.

43.       As is standard for law firms, all of Mr ABC's time working on client matters is recorded in a Daynotes System and this requires that Mr ABC specify his physical location when entering time. This feature enables Mr ABC's time to be easily and accurately allocated between the two respective roles / capacities.

44.       Although Aus Co's registered office is in Australia, Mr ABC does not work from there and there is no physical Aus Co office at that location. While Mr ABC is in Australia, he typically works from his separate home study which includes standard office equipment.

Other relevant facts

45.       Foreign LLP operates on a December year-end. Individual partnership earnings are determined by the Committee on an annual basis having regard to client billings, seniority and overall contribution to the partnership.

46.       To maintain a fair and equitable outcome among the partners of Foreign LLP, Mr ABC's partnership distribution from Foreign LLP for a given year will equal his individual partnership earnings, as determined by the Committee, less the payments made by Foreign LLP to Aus Co in that given year. As such, Mr ABC's total Foreign LLP-related earnings will comprise his:

a.         Foreign LLP partnership distribution, and

b.         AUs Co salary and bonus.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 2-42

Reasons for decision

Part 2-42 of the ITAA 1997 contains the provisions governing the tax treatment of PSI and Division 86 of the ITAA 1997 sets out the rules for how individuals' PSI is treated when received by other entities (called attribution). These provisions are referred to as the PSI Rules.

Section 86-1 of the ITAA 1997 states:

Income from the rendering of your personal services is treated as your assessable income if it is the income of another entity and is not promptly paid to you as a salary.

However, this does not apply if the other entity is conducting a personal services business.

There are limits to the other entity's entitlement to deductions to offset against the amount treated as your income.

Taxation Ruling TR 2001/7 Income tax: the meaning of personal services income (TR 2001/7) provides the Commissioner's views on the PSI rules and how they apply to an individual or entity.

The PSI rules are aimed at improving the integrity of, and equity in, the tax system by ensuring that individuals cannot reduce or defer their income tax by alienating or splitting their PSI through the use of interposed companies, partnerships or trusts.

Section 86-15 of the ITAA 1997 provides that a company, partnership or trust whose ordinary income includes the PSI of an individual is referred to as a Personal Services Entity (PSE).

The PSI rules ensure that PSI received by a PSE is attributed to the individual who performed the personal services. They also limit the deductions available to PSEs and to individuals who provide personal services but not through a PSE.

In accordance with sections 85-10 and 86-1 of the ITAA 1997, in assessing whether the PSI rules apply to an individual, it is necessary to establish whether the individual is an employee or independent contractor, as the PSI rules do not apply if an individual provides their personal services to a service acquirer as an employee. If an individual is an employee, any income derived in that capacity will be the ordinary assessable income of the individual.

In assessing whether the PSI rules apply to an entity (being the PSE), it is necessary to consider whether the PSE conducts a personal services business (PSB). If the PSE conducts a PSB, then the PSI rules do not apply.

Therefore, the PSI rules generally apply if the following conditions are met:

•                the income is PSI, and

•                the income is not derived as an employee or office holder, or

•                the income is not derived as part of a personal services business.

Aus Co is not an employee or officeholder so it is not necessary to consider that condition. The other conditions are considered below.

The income is PSI

Section 84-15 of the ITAA 1997 contains the meaning of 'personal services income' and states:

84-15(1) 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).

...

84-5(2) Only individuals can have personal services income.

84-5(3) This section applies whether the income is for doing work or is for producing a result.

84-5(3) The fact that the income is payable under a contract does not stop the income being mainly a reward for your personal efforts or skills.

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 a PSE fails to meet a PSB test in respect of a test individual, the PSI is deemed to be the income of the test individual and is attributed to that individual.

TR 2001/7 states at paragraphs 24 and 25:

24. The use of 'mainly' in the definition 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....

25. Implicit in the word 'mainly' is that more than half of the relevant amount of the ordinary or statutory income is a reward for the personal efforts or skills of an individual.

As outlined above, Aus Co receives income from Foreign LLP that is derived under the Services Agreement, which, except as it relates to the compensation for company expenses, is entirely as a result of the labour performed by Mr ABC.

Specifically, the terms of the Services Agreement confirm that the Service Charge payments from Foreign LLP to Aus Co is based on the hours of work performed by Mr ABC multiplied by Mr ABC's hourly rate.

Foreign LLP is Aus Co's sole client and all of Aus Co's income (except for nominal other amounts) is therefore received from Foreign LLP under the Service Agreement.

Therefore, the income of Aus Co is mainly a reward for the personal efforts and skills of Mr ABC such that all of the income derived by AUs Co under the Services Agreement is PSI and Aus Co is a PSE pursuant to section 86-15 of the ITAA 1997.

Therefore this requirement is satisfied.

Not derived as part of a PSB

Section 85-30 of the ITAA 1997 states:

This Division does not apply to an amount, payment or contribution to the extent that the amount, payment or contribution relates to income from you conducting a personal services business.

Subsection 87-15(1) of the ITAA 1997 states:

An individual or personal services entity conducts a personal services business if:

...

(b) for a personal services entity - a personal services business determination is in force relating to an individual whose personal services income is included in the entity's ordinary income is included in the entity's ordinary income or statutory income; or

(c) in any case - the individual or entity meets at least one of the 4 personal services business tests in the income year for which the question whether the individual or entity is conducting a personal services business is in issue.

Aus Co does not have a personal services business determination and it is therefore necessary to consider whether any of the four PSB tests apply. Subsection 87-15(2) of the ITAA 1997 states:

The 4 personal services business tests are:

(a)        the results test under section 87-18; and

(b)        the unrelated clients test under section 87-20; and

(c)         the employment test under section 87-25; and

(d)        the business premises test under section 87-30.

If one of the tests is met in an income year, the PSI rules will not apply to the PSI of the test individual in that income year.

The unrelated clients test, employment test and business premises test can only apply if less than 80% of the test individual's income is from the same entity and its associates. Mr ABC is the test individual in this instance and more than 80% of Mr ABC's income is from Aus Co and its associates, which includes Foreign LLP. Therefore, only the results test can be self-assessed by Aus Co.

Subsection 87-18(3) of the ITAA 1997 provides that a PSE meets the results test in an income year if, in relation to at least 75% of the PSI that is included in the PSE's ordinary or statutory income for the year, the:

•                income is for producing a result; and

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

•                the PSE is, or would be, liable for the cost of rectifying any defect in the work performed.

The results test is based on the common law indicia for distinguishing an independent contractor from an employee.

In order to satisfy the results test, all three conditions must be met. Therefore, if any of the three conditions are not satisfied, Aus Co will not satisfy the results test.

To satisfy the first condition, the income must be for producing a result.

The phrase 'for producing a result' is not defined, however TR 2001/7 provides at paragraphs 114 to 117 that the essence of the contract must be to achieve a result and not to do work. In results-based contracts, payment is usually made for a negotiated contract price, as opposed to an hourly or daily rate, and is only paid when the contractual conditions have been fulfilled.

Taxation Ruling TR 2001/8 Income tax: what is a personal services business (TR 2001/8) contains further guidance on the results test and provides at paragraph 115 that the consideration for producing a result is often a fixed sum payable on completion of the particular job as opposed to an amount paid by reference to hours worked.

Further, TR 2001/8 provides at paragraph 120 that if remuneration is payable when, and only when, the contractual conditions have been fulfilled, the remuneration is for producing a given result.

Under the Services Agreement, Aus Co will charge Foreign LLP for services rendered calculated by reference to hours charged in respect of client engagements at a specified hourly billing rate. Specifically the Service Charge is calculated by the number of hours worked by Mr ABC multiplied by Mr ABC's discounted hourly rate.

The Services Agreement does not stipulate that payment by Foreign LLP to Aus Co is contingent on a result being achieved, rather, it is solely based on hours worked by Mr ABC. It is therefore reasonable to conclude that the income received by Aus Co from Foreign LLP is the PSI of Mr ABC and is not for producing a result.

The first condition of the results test has therefore not been satisfied.

Given that the results test requires all three conditions to be met in order for the results test to be satisfied, it is not necessary to consider the remaining conditions as the test cannot be satisfied by virtue of the first condition not being met.

Therefore, PSI derived by Aus Co is not derived as part of a PSB.

Conclusion

The income of Aus Co from Foreign LLP that is derived under the Services Agreement is the PSI of Mr ABC, pursuant to PSI rules in Part 2-42 of the ITAA 1997.

Therefore, in accordance with section 86-1 of the ITAA 1997, any PSI received by Aus Co that is not promptly paid to Mr ABC as a salary will be attributed to Mr ABC.