Edited version of private advice

Authorisation Number: 1052069130043

Date of advice: 7 March 2023

Ruling

Subject: Personal services income

Question 1

Is the income received by the taxpayer considered personal services income (PSI)?

Answer

Yes.

Question 2

Was the results test met in the XXXX and XXXX income year?

Answer

No.

Question 3

If the taxpayer provides his medical services through a company structure, will this affect his personal services income and can the company employ his family and pay them wages?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June XXXX

Year ended 30 June XXXX

The scheme commences on:

1 July XXXX

Relevant facts and circumstances

The taxpayer applied for a private ruling for the relevant income years. The taxpayer derives income as a doctor/general practitioner.

The taxpayer works as a contractor at a government hospital and in a medical centre clinic.

The taxpayer is paid a daily rate at the hospital and the hospital provides most equipment and tools during working hours.

For the medical services provided by the taxpayer in the medical centre, the medical centre pays a percentage of patient billings.

The taxpayer has indemnity insurance for the hospital and medical centre.

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 87-60

Income Tax Assessment Act 1997 Section 87-65

Reasons for decision

Question 1

Is the income received by the taxpayer considered personal services income (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.

The taxpayer provides services as a medical practitioner at a medical centre and hospital. The income received by the taxpayer is mainly a reward for his personal effort and skills and is therefore PSI.

Question 2

Was the results test met in the XXXX and XXXX income year?

Detailed reasoning

Personal services business (PSB)

A taxpayer conducts a personal services business (PSB), and the PSI rules will not apply, if one of the four personal services business tests is met in the income year.

If the PSI rules apply, the net PSI received by the PSE will be attributed to the individual who generated that income and available deductions are restricted.

Attribution does not apply to sole traders as they do not earn PSI through a PSE and the PSI is included in the individual's personal tax return.

There are four personal services business tests:

•         the results test[1]

•         the unrelated clients test[2]

•         the business premises test[3], and

•         the employment test[4]

Only one test is required to be met for the PSI rules not to apply.

The 80% rule

Individuals/PSEs can self-assess against the results test irrespective of how much income comes from one source. If less than 80% of the PSI is from one source, an individual/PSE can self-assess against the other tests. However, if more than 80% of the individual's PSI is from one source, the individual/PSE must hold a Personal Services Business Determination (PSBD) from the Commissioner for the PSI rules not to apply to that income.

The 80% rule itself is not a personal services business test but relates to whether self-assessment is available. For the Commissioner to issue a PSBD one of the personal services business tests must be met. The Commissioner can only issue a PSBD in the following circumstances:

•         the results test, business premises test or employment test is met

•         unusual circumstances prevented the results, employment or business premises test from being met

•         the unrelated clients test was met but unusual circumstances prevented the 80% rule from being satisfied

•         unusual circumstances prevented the unrelated clients test and 80% rule from being met.

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.

Hospital

The taxpayer is a contractor at the hospital and produces a full consulting day rate inclusive of all other allowances and payments for actual hours worked. The hospital pays the taxpayer within 20 days of receipt of a tax invoice.

Based on the information provided, the taxpayer is paid a daily rate for his work and not paid to produce a contractually specified result. This condition of the results test is not met.

Medical Centre

The taxpayer works as a contractor at the medical centre. The contractor is paid every fortnight on the basis that work is done at sites and will be paid a percentage of billings on receipts.

The medical centre conducts the billings for every patient seen the taxpayer and the medical centre provides a percentage of total earnings every fortnight. Therefore, payments received by the taxpayer for medical services are for producing a result.

However, to pass this condition of the results test, the PSI generated by the taxpayer for producing a result needs to be at least 75% of his PSI derived during the income year.

For the XXXX income year

The total PSI income generated by the taxpayer from the medical centre represents approximately 38.06% of the taxpayer's total PSI income in the XXXX income year.

For the XXXX income year

The PSI income generated by the taxpayer from the medical centre represents around 73.89% of the total PSI income for the XXXX income year.

The PSI generated by the taxpayer for producing a result during the relevant years is below the minimum 75% required to satisfy the results test. Consequently, the first condition of the results test is not satisfied for the relevant income years.

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.

Medical Centre

The taxpayer is not required to provide any equipment. This condition of the results test is met.

Hospital

The hospital provides most equipment and tools during working hours.

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 taxpayer has professional indemnity insurance for both the medical centre and hospital. This condition of the results test is met for both the hospital and medical centre.

Conclusion

Hospital

The income received from the hospital does not pass the results test as only one condition of the results test is satisfied.

Medical Centre

The taxpayer's PSI income from the medical centre satisfies all three conditions of the results test. However, the PSI from the medical centre represents less than 75% of the total PSI received in each of the relevant income years.

As the taxpayer does not meet all three conditions of the results test in relation to 75% of the PSI received in an income year, the taxpayer does not pass the results test in the relevant income years.

Question 3

If the taxpayer receives personal services income through a company structure, will this affect his personal services income and can the company employ his family and pay them wages?

Summary

The incorporation of a company does not affect whether there is a personal services business. An arrangement to split a taxpayer's personal services income among family members by diverting it to a family company or trust is regarded as in as ineffective for income tax purposes under Taxation Ruling IT 2121.

Detailed Reasoning

Where personal services are provided as an individual, the PSI derived from the provision of these services is attributed to the individual as assessable income.

If an entity such as a company or trust derives income that is the PSI of an individual, the PSI is attributed to the individual unless the entity is carrying on a personal services business or the PSI was promptly paid to the individual as salary and wages

Section 87-15 of the Income Tax Assessment Act 1997 states that:

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

a)    for an individual, a personal services determination is in force relating to the individual's personal services income; or

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 or statutory income; or

c)    in any case, the individual or entity meets one of the 4 personal services business test in the income year for which the question whether the individual or entity is conducting a personal services business is in issue.

Incorporation of a company does not affect whether there is a personal services business.

As we have established in Question 2 that the taxpayer is not personal services business the same outcome would apply if you change to a company structure.

Employing family members and paying them wages in a company structure

Taxation Ruling No IT 2121 Income tax: family companies and trusts in relation to income from personal exertion deals with the use of family trusts and companies as a means by which individuals try to split their personal services income among family members by diverting it to a family company or trust. It regards these arrangements as ineffective for income tax purposes under section 260 or Part IVA of the Income Tax Assessment Act 1936.

[1] Section 87-18 of the ITAA 1997.

[2] Section 87-20 of the ITAA 1997.

[3] Section 87-30 of the ITAA 1997.

[4] Section 87-25 of the ITAA 1997.