Edited version of private advice

Authorisation Number: 1052165115962

Date of advice: 5 September 2023

Ruling

Subject: Personal services income

Question

Is the income derived by Company A Pty Ltd, in respect of providing services using radiation oncology equipment, personal services income of Dr X under section 84-5 of the Income Tax Assessment Act 1997?

Answer

No. The income received by Company A Pty Ltd from the provision of services related to the use of equipment and facilities owned by B Group is mainly generated from the supply and use of income-producing assets and is not PSI.

However, the general anti-avoidance provisions may apply where there are factors indicating that the dominant purpose of the arrangement is to obtain a tax benefit by diverting, alienating or splitting what is properly Dr X's ordinary income, or retaining profits in Dr X's lower-taxed company such that Dr X's ordinary income is reduced.

This ruling applies for the following periods

year ended 30 June 202X

year ended 30 June 202Y

The scheme commenced on:

24 March 202X

Relevant facts and circumstances

Dr X is a medical practitioner. He practices in a specialisation.

Dr X provides his services to patients through Company A Pty Ltd (A Co). Dr X is a director of A Co.

A Co also provides patients with access to specialised equipment and facilities, and to medical professionals trained to operate that equipment. A Co does not own this specialised equipment or the facilities; or employ the medical professionals who operate the equipment.

A Co has entered into an agreement, dated March 202X, with B Group for these services and for medical practice management services (the Agreement).

Under the Agreement, A Co can access the equipment and facilities owned and operated by B Group. Principally, A Co relies on B Group to provide a range of specific services to its patients. (i.e. the patients of Dr X).

Under the Agreement, A Co also acquires from B Group practice management services, including the provision of consulting rooms and billing and administrative services. B Group, in its provision of practice management services, prepares and manages the invoicing processes on behalf of A Co.

The Agreement provides for A Co. to pay B Group two types of fees. Practice Management Fees are what A Co pays B Group its practice management services. Facility Fees are what A Co pays B Group for its services. These fees are calculated on a monthly basis.

The Practice Management Fee is calculated as X% of the total amount of funds collected on behalf of A Co and reconciled to patient and other invoices during the month.

The Facility Fee is charged for all fee classes dealing with the provision of services related to the use of equipment and facilities owned by B Group. It is calculated as a percentage of the funds collected on behalf of A Co and reconciled to patient invoices during the month. The percentage used to calculate the Facility Fee depends on what percentage of the Medicare Benefits Schedule fee the patient is charged.

1.    When the patient is charged less than or equal to 99% of the Medicare Benefits Schedule fee, the patient incurs no out of pocket costs, and B Group uses 90% to calculate the Facility Fee.

2.    When the patient is charged between 100% and 149% of the Medicare Benefits Schedule fee, the patient incurs out of pocket costs, and B Group uses 75% to calculate the Facility Fee.

3.    When the patient is charged at or above 150% of the Medicare Benefits Schedule fee, the patient incurs higher out of pocket costs and B Group uses 65% to calculate the Facility Fee.

Fees characterised as patient consultations fees relate to professional advice and consultations provided by Dr X (through A Co) to patients. A Co retains X% of the amount billed for this fee class after B Group charges a practice management fee of Y%.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 84-5

Income Tax Assessment Act 1997 section 87-10

Income Tax Assessment Act 1997 section 87-15

Income Tax Assessment Act 1997 section 87-18

Does Part IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidancerule for income tax'.

Reasons for decision

This is to explain how we reached our decision. This is not part of the private ruling.

Provisions and ruling relating to Personal services income (PSI)

Section 84-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the ordinary or statutory income of an individual or entity is an individual's personal services income if the income is mainly a reward for the individuals personal efforts or skills.

Section 84-5 ITAA 1997:

Meaning of personal services income

(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).

(2) Only individuals can have personal services income.

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

(4) 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.

Taxation Ruling TR 2022/3 Income Tax: personal services income and personal services businesses (TR 2022/3) provides further guidance:

5. 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; that is, the personal services entity (PSE).

6. The PSI rules ensure that the net 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 (referred to as 'sole traders' in this Ruling).

Meaning of personal services income

34. PSI is defined as 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).

35. Only individuals can have PSI. It can be earned directly by a sole trader or indirectly through an interposed entity (PSE).

36. The reference to '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 net PSI is deemed to be the income of the test individual and is attributed to that individual.

Meaning of 'mainly'

37. 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 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.

TR 2022/3 also provides guidance on what is not personal services income

Supply or sale of goods

38. Income that is mainly generated from the supply and sale of goods is not PSI.

39. Although personal efforts and skills may be required to make or produce an item for sale, the contract for the sale of the item would be considered to be a contract for the sale or supply of goods. The contract payment is to acquire ownership of the item and therefore, the payment is not considered to be PSI.

Supply and use of income-producing assets

40. Income that is mainly generated from the supply and use of income-producing assets is not PSI.

41. The following factors are relevant in determining whether an amount is mainly for the use or supply of assets or the provision of personal efforts or skills:

•         the market value of the supply and use of the asset, compared with the market value of the personal services

•         the basis on which the contract price has been calculated and whether the contract price includes costs borne by the sole trader or PSE for the supply and use of the asset in the income-producing activity

•         the significance or uniqueness of the assets

•         the gross value of the asset compared to the income of the sole trader or PSE from the particular activity, and

•         the role the asset plays in generating the income.

Business structure

42. Income which is generated from the business structure of an entity is not PSI.

43. Where income is derived by an entity which has 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 from the rendering of personal services.

44. Entities may have regard to the following factors to determine whether their income is mainly a reward for the personal efforts or skills of individuals or is derived from a business structure:

•         the number of arm's length employees or others engaged by the entity to perform work and their relative contribution to the income earning activities

•         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.

45. The fact that services are performed through an entity that is not an individual does not automatically mean that income received by the entity in respect of those services is generated from a business structure. The factors listed in paragraphs 43 to 44 of this Ruling must be applied to each test individual's particular circumstances to assess whether the income is generated from a business structure or whether it is generated from the test individual's own personal skills, efforts or expertise.

Considering the substance of contractual arrangements

46. Whether an amount received by a sole trader or PSE is mainly a reward for the personal efforts or skills of the test individual depends on the substance of the arrangement between the parties.

47. Where the substance of the arrangement is that there is one set of obligations (different components that are integral or common to each other), they are looked at together. For example, where a sole trader or PSE provides plumbing services to replace a faulty tap, all the activities associated with those services would be looked at as one source of income rather than separate sources of income for labour and replacement parts. The supply of the tap in this case is integral to the plumbing services. If the income from the supply of the tap is less than 50% of the income received for the service overall, the whole amount is PSI.

Personal Service Entities (PSE)

A 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.

Section 86-15(2) provides:

(1) Your assessable income includes and amount of ordinary income or statutory income of a personal services entity that is your personal services income.

(2) A personal services entity is a company, partnership or trust whose ordinary income or statutory income includes the personal services income of one or more individuals.

Exception: personal services businesses

(3) This section does not apply if that amount is income from the personal services entity conducting a *personal services business.

Note: Even if the entity is conducting a personal services business, it is possible that some of its income is not income from conducting that business.

TR 2022/3 discusses the effect of the personal services income rules on personal services entities:

61. In the case of a PSE, the PSI rules:

•         restrict the types of deductions that can be claimed against the PSI of the test individual39

•         attribute the net PSI received by the PSE to the test individual that mainly generated the PSI (after deductions that are incurred in deriving that PSI)40, and

•         will generally give rise to pay as you go withholding obligations whether or not a test individual is an employee of the PSE.

62. Where a sole trader or PSE qualifies as a PSB in an income year in relation to a test individual, the PSI rules do not apply to that test individual's PSI in that income year.42 As such, the ordinary tax rules apply for that income year and the income retains its character as PSI of the sole trader or PSE.

63. Individuals do not become employees of service acquirers as a consequence of the PSI rules applying to them.

Personal Services Business (PSB)

The PSI rules do not apply if the PSE or sole trader conducts a PSB. A PSE or sole trader conducts a PSB if it meets at least one of 4 PSB tests or if they have received a Personal Services Business Determination (PSBD) from the Commissioner.

The following 4 PSB tests can be applied to the PSI of each test individual:

•         results test

•         unrelated clients test

•         employment test, and

•         business premises test.

Incorporation of Medical Practices

The ATO has provided guidance on the incorporation of medical and other professional practices in IT 2503: Income Tax: Incorporation of Medical and Other Professional Practices. IT 2503 provides:

5. As already indicated, the incorporation of professional practices is accepted for income tax purposes where, inter alia, incorporation does nothing more in relation to income tax than reduce a professional's income by the amount of an appropriate superannuation cover. This position was confirmed by Dawson J. in FCT v Gulland 85 ATC 4765 at page 4797:

"Of itself and without more, the establishment and operation of a superannuation fund, notwithstanding the opportunity it offers to deduct from assessable income contributions to the fund on behalf of an employee, will not attract s.260." (emphasis added)

6. Generally, this would mean that a practice company should have no taxable income. The total income for a year, after expenses, should have been fully paid out to the professional person by way of a salary.

10. The retention of profits in the practice company is generally not acceptable. Where profits are retained, salary payments and, therefore, superannuation contributions will be reduced accordingly. Although at times the tax rates on the salary in the hands of the professional and the profits in the company may be the same, the purported main object of the incorporation, obtaining superannuation, will be frustrated. In effect, any arrangements have been put forward and accepted, viz., the provision of superannuation benefits.

12. On the other hand, a practice company that makes little or no attempt to distribute the whole of its income to the professional person by way of salary prior to the end of its financial year, or retains income in the company, will not be taken to have made a bona fide attempt to comply with the guidelines. Cases have arisen where the salary paid by the practice company to the professional practitioner is far below that contemplated in the guidelines and the overall result is that the total tax payable by the professional practitioner and the company is significantly less than that which would otherwise be payable. The prima facie conclusion that emerges is that incorporation has been undertaken for the purpose of minimising income tax. In cases of this sort the income from the practice should be treated as that of the professional practitioner involved and reliance placed on Part IVA.

Broadly, a medical practitioner is required to include in their personal tax return ordinary income for professional services consistent with the services provided and the value of the professional services regardless of whether the services are provided through a PSE, a PSB or an interposed entity.

Part IVA may be relevant to personal services income arrangements

TR 2022/3 provides guidance on the application of the general anti-avoidance provisions:

A PSE or sole trader that conducts a PSB may still be subject to the anti-avoidance provisions contained in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936). Part IVA gives the Commissioner the power to cancel a 'tax benefit' that has, or would but for section 177F of the ITAA 1936, be obtained by a taxpayer in connection with a scheme to which Part IVA applies. This power is found in subsection 177F(1) of the ITAA 1936. Regard must be had to the individual circumstances of each case in making a determination under section 177F of the ITAA 1936 to cancel a tax benefit. Part IVA of the ITAA 1936 may apply to the sole trader or PSE that conducts a PSB involving an income-splitting arrangement where the dominant purpose is to obtain a tax benefit resulting from the alienation or the splitting of the PSI of the sole trader or the individual undertaking the work for, or on behalf of, the PSE.17

The ATO may seek to apply the general anti-avoidance provisions in Part IVA where there are factors indicating that the dominant purpose of the arrangement is to obtain a tax benefit by diverting, alienating or splitting an individual's income or retaining the rewards for that person's personal efforts or skills in the lower taxed PSB, PSE or interposed entity.

In deciding whether income has been split or alienated to gain a tax benefit, the following considerations may be relevant:

•         Whether the remuneration paid to you is commensurate with:

o   the skills you exercised or services you provided, and

o   the income your services generated.

•         Where the income ends up, and whether this results in less tax being paid than if it were paid to you.

•         Whether the salary or wages paid to associates by the entity is not commensurate with

o   the skills exercised and services provided by the associate, and

o   the income received by the sole trader or PSB is for services performed by the individual (which is different to income being generated by assets of an interposed entity).

Analysis and conclusion

Dr C, through A Co, provides services to patients. In addition, as part of the medical services it provides, A Co contracts B Group to provide treatment services and facilities to patients using B Group equipment.

A Co charges patients directly for the total medical advice and services it provides, including access to the B Group facilities and services. Patients are billed by B Group on behalf of A Co. The fees consist of:

•         Medical services and advice of Dr X (Consulting Fees)

•         All other fee classes relating to the work performed by B Group on behalf of A Co.

B Group invoices A Co for the services performed by B Group using B Group's equipment and personnel (Services and Facility Fee).

Based on the information provided, the majority of the fees charged to Dr X's patients by A Co relate to the percentage A Co receives in respect of the services B Group is subcontracted to provide to the patients i.e. services performed by B Group on behalf of A Co. A Co has characterised the Consulting Fees, which make up a much smaller part of the Patient Treatment Fee as the PSI of Dr X.

On the facts and circumstances in this case the income earned by A Co that relates to the component of the Patient Treatment fees that are not consulting fees would not be PSI of Dr X. The supply of B Group services (both facilities and personnel) by A Co would be income that is mainly generated from the supply and use of income-producing assets and is not PSI.

The factors relevant in this analysis includes:

•         The significance and uniqueness of the assets.

•         The role the assets play in generating the income.

In this case our view is the fees derived by A Co in respect of using B Group services are not PSI of Dr X. It is not necessary to consider the treatment of the consulting services for the purpose of this ruling.

However, we would be concerned with any arrangement that caused a medical services provider's ordinary income to be less than they might usually expect to receive, and especially so where other fees, not characterised as the service provider's ordinary income, are intended to make up that shortfall. In this case there is the potential for a large amount of the income to be retained by A Co or paid out to shareholders. We have a concern that this may amount to a redirection of the income properly attributable to the value of professional services provided by Dr X. Also of relevance is the fact that A Co employs no personnel and has no assets or equipment of its own.