Edited version of private advice

Authorisation Number: 1052203931406

Date of advice: 22 December 2023

Ruling

Subject: Personal services business determination

Question

Will the Commissioner issue a personal services business determination for Company A in accordance with section 87- 65 of the Income Tax Assessment Act 1997 for the income year ended 30 June 20XX?

Answer

No.

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commenced on:

In the income year ending 30 June 20XX

Relevant facts and circumstances

1.    Company A is an Australian private company.

2.    Individual A and Individual B are the directors of Company A (the directors).

3.    Company A was previously a professional consulting company until 20YY when the company ceased their consulting practice as the directors had moved overseas to pursue other business activities.

4.    Following inquiries from multiple international companies for Company A to provide consulting advice and services, the directors decided to commence business operations to provide the services requested at the end of the 20XY calendar year.

5.    Company A decided to operate under a corporate structure and take out professional indemnity insurance to assist with the logistics of working with international entities.

6.    Of the international companies that inquired with Company A:

6.a. One entity advised they would utilise the services on an ad hoc basis commencing in Company A's second year of operation.

6.b. Another entity (Company X) advised they wanted to proceed with consulting services.

7.    In the relevant income year Company A commenced their consulting work for Company X.

8.    Individual B provides the technology support to ensure the network and related hardware and software used to provide consulting advice and general management of the company are available and functioning.

9.    The market value of the work done by Individual B is estimated to be $X per annum.

10.  The gross amount of personal services income of Individual A is approximately $Y per annum.

11.  Company A's business premises are at a private residence with a dedicated office. The premises are jointly owned by the directors and are physically separate from Company A's clients (and client's associates') business addresses but are not physically separate from Individual A (or their associates') private residences.

The Contract

12.  Company A and Company X executed a Services Agreement during the relevant income year (the Contract).

13.  Company A have advised that the terms and conditions contained in the Contract are indicative of the terms and conditions that will be included in other contracts for this type of work.

14.  The services to be provided by Company A are set out in the Contract and include providing advice and guidance and training.

15.  In addition to the general services outlined in the Contract, there have been specific projects with deliverables that have been requested to date.

16.  Individual A has regular meetings with the Company X to discuss the assigned projects and their status.

17.  The remuneration policy for the services provided is set out in the Contract and states that the fees will be calculated at a set rate per day for a number of days per calendar month (between a set minimum and set maximum). A 'day' is defined to comprise a specific number of hours.

18.  Invoices provided by Company A to Company X calculate the amount invoiced by reference to hours worked per an attached timesheet with fees charged based on the hours/days worked.

19.  The Contact contains an indemnity clause.

20.  Company A provides all the tools and equipment required to do the work.

21.The application submitted to the Commissioner states that Company A expects to pass the personal services income unrelated clients test contained in section 87-20 of the Income Tax Assessment Act 1997 (ITAA 1997)in a year later than the second year of Company A's operation.

22.  The application also submits that unusual circumstances stopped Company A from passing the personal services income unrelated clients test and the business premises test as there are only a small number of potential clients in the relevant industry that may require Company A's services.

23.  Company A does not advertise for clients. Rather, referrals for consulting work are by word of mouth from a small network.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 84-5

Income Tax Assessment Act 1997 section 86-15

Income Tax Assessment Act 1997 section 87-15

Income Tax Assessment Act 1997 section 87-18

Income Tax Assessment Act 1997 section 87-20

Income Tax Assessment Act 1997 section 87-25

Income Tax Assessment Act 1997 section 87-30

Income Tax Assessment Act 1997 section 87-65

Reasons for decision

Issue 1

Question 1

24.  Will the Commissioner issue a personal services business determination for Company A in accordance with section 87- 65 of the Income Tax Assessment Act 1997 for the income year ended 30 June 20XX?

Summary

25.  The Commissioner is not satisfied that the conditions in one or more of subsections 87-65(3A), (3B), (5) and (6) of the ITAA 1997 are met, and as such, cannot issue a personal services business determination for Company A in accordance with section 87- 65 for the income year ended 30 June 20XX.

Detailed reasoning

Personal services income (PSI)

26.  Section 84-5 of the ITAA 1997 provides that the ordinary or statutory income of an individual or entity is an individual's personal services income (PSI) if the income is mainly a reward for the individuals personal efforts or skills. Only individuals can have PSI.

27.  Income that is mainly generated from the sale or supply of goods, the supply and use of income-producing assets or, from a business structure, is not PSI.

28.  The income derived by Company A is income derived mainly from the services provided by Individual A and are services that require their personal skills and expertise. Consequently, the income derived is PSI pursuant to section 84-5 of the ITAA 1997.

Personal services entity (PSE)

29.  As stated above, only individuals can have PSI. PSI can, however, be earned indirectly through an interposed personal services entity (PSE).

30.  Subsection 86-15(2) provides that 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.

31.  The PSI rules contained in section 86-15 of the ITAA 1997 ensure that the net PSI received by a PSE is attributed to the individual who performed the personal services.

Personal services business

32.  The PSI rules contained in subsection 86-15(1) of the ITAA 1997 do not apply if the PSE is conducting a personal services business (PSB). This exception is provided for by subsection 86-15(3) of the ITAA 1997.

33.  Division 87 of the ITAA 1997 provides the conditions to determine whether a sole trader or PSE is conducting a PSB in an income year. Section 87-15 states that a PSE is considered to conduct a PSB in an income year if the PSE has received a Personal Services Business Determination (PSBD) from the Commissioner or, if it meets at least one of the four PSB tests (in accordance with the eligibility rules relating to the use of the tests). The four PSB tests as set out in subsection 87-15(2) are:

•           the results test

•           the unrelated clients test

•           the employment test, and

•           the business premises test.

34.  Taxation Ruling TR 2022/3 Income Tax: personal services income and personal services businesses (TR 2022/3) discusses the operation of the PSB tests and when an entity is eligible to apply the different tests:

67. A PSE can self-assess that it conducts a PSB in relation to each test individual's PSI in an income year if:

•      it meets the results test in relation to at least 75% of the PSI of that test individual's PSI (see paragraphs 77 to 96 of this Ruling), or

•      less than 80% of the test individual's PSI is from the same entity and its associates and the test individual's PSI satisfies one or more of the other PSB tests (see paragraphs 97 to 148 of this Ruling).

35.  In summary:

•           Regardless of how much income comes from one source, a PSE can self-assess against the results test.

•           If less than 80% of the PSI is from one source, a PSE can self-assess against the unrelated clients test, employment test or business premises test.

•           In any event, the taxpayer can seek a PSBD from the Commissioner noting that in accordance with Note 2 to subsection 87-15(1) of the ITAA 1997 all the tests can be used by the Commissioner in deciding whether to make a PSBD, even where more than 80% of the PSE's PSI comes from one source.

36.  In the 2023 income year all of Company A's PSI was from the same source.

Personal services business determination

37.  Subsection 87-65(1) of the ITAA 1997 broadly provides that the Commissioner may, by written notice to a PSE, make a PSBD such that the individual's PSI is included in the PSE's ordinary or statutory income.

38.  Subsection 87-65(3) of the ITAA 1997 states that the Commissioner must not make a PSBD unless satisfied that, in the income year, one or more of the four alternatives in subsections 87-65(3A), (3B), (5) and (6) of the ITAA 1997 are met.

39.  The four alternatives referred to are:

•         First alternative - results, employment or business premises test met or reasonably expected to be met

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

•         Third alternative - unrelated clients test was met, or could reasonably be expected to be met, but 80% or more of the income was from the same source because of unusual circumstances

•         Fourth alternative - Unusual circumstances prevented the unrelated clients test and 80% rule from being met.

First alternative - Could be reasonably expected to meet, or met, the results, employment or business premises tests

40.  Subsection 87-65(3A) of the ITAA 1997 provides that the Commissioner may make a PSBD where the PSE could reasonably be expected to meet, or met, the results test under section 87-18, the employment test under section 87-25, the business premises test under section 87-30 or more than one of those tests.

The results test

41.  Subsection 87-18(3) of the ITAA 1997 provides that:

(3) 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.

The income is for producing a result

42.  The first condition that must be satisfied for the results test to be met is that the income is for producing a result. TR 2022/3 clarifies this requirement:

84. In contracts that are for producing a result, payment is usually made for a negotiated contract price to achieve a specified outcome. As opposed to an hourly or daily rate for doing work, payment is made when the contractually specified results have been fulfilled. A contract price for achieving a specified result may be calculated by reference to an estimated number of hours applied to an hourly rate. If that estimate changes, a new contract or a variation to the original contract may be agreed between parties, allowing for a change to the negotiated contract for producing the result. What needs to be considered is whether the contract price is for achieving a specified result and not merely payment for the hours worked.

85. The essence of the contract must be to achieve a result and not to do work. The fact that a sole trader or PSE is required to complete identifiable tasks is not the same as achieving a contractually specified result if those tasks merely form part of the work being paid for on an ongoing basis.

86. The condition will not be satisfied merely because the contract states that the contract is for producing a result. Consideration should be given to the substance of the arrangement between the sole trader or PSE and the service acquirer and what the sole trader or the PSE is actually being paid for.

43. Multiple examples are provided in paragraphs 195 to 209 of TR 2022/3 which demonstrate when income is or is not considered to be for producing a result and, consequently, when the results test will and will not be met.

44.  In example 17 at paragraphs 195 and 196 of TR 2022/3, a government department enters into a contract with a company for the provision of services by an individual. The contract provides that the individual is paid an hourly rate and works for a maximum number of hours per day. Department employees provide direction as to the required tasks and the manner in which they are to be performed. Example 17 concludes in relation to the first condition of the results test, that the income is paid for doing work and not for producing a result, as the PSE is entitled to payment for each hour the individual works with no risk of making a s loss as a result of undertaking the work. As the income is not for producing a result the results test is not met.

45.  In example 19 at paragraphs 200 to 204 of TR 2022/3, an engineer that operates through his own company entered into a contract for an 18 month period to carry out assigned planning projects. The fee specified in the contract is capped at a set amount which is calculated on a maximum time basis of 2,800 hours (40 hours per week × 70 weeks), at a fixed rate of $75 per hour. Payment is made upon submission of a fortnightly invoice which includes a time sheet. In considering the first condition of the results test, example 19 concludes that the payment of the amount is not contingent on a result being produced, even though the total contract amount is capped prior to the contract being undertaken. The company is paid fortnightly for hours worked and must work on projects that are assigned to the individual. He may cease working on a project before the project is completed to start work on another project.

46.  Conversely, in example 18 at paragraphs 198 to 199 of TR 2022/3, the income is considered to be for producing a result. In example 18 a government department enters into a contract with a company for the provision of services by a particular individual. The contract specifies that the individual is required to develop a product for use on the department's IT system in accordance with functional specifications provided by the department. The contract specifies a fixed amount to be paid to the company for the development of the product, which is required to be produced within 12 months of the commencement of the contract. Instalments of the contract price are payable upon achievement of specified milestones. The income in this example is for producing a result as the contract requires performance of a specific task that produces an outcome or result and payment is not made until the work is completed (even though instalments are payable upon the achievement of particular specified milestones or outcomes).

Application to Company A's circumstances

47.  The services required to be provided by Company A to Company X are set out in the Contract

48.  The Contract also sets out how Company A will be remunerated and states that the fees for the services provided are calculated at a set rate per day for a number of days per calendar month (between a set minimum and set maximum). A 'day' is defined to comprise a specific number of hours. An example invoice sets out the fees calculated in accordance with the Contract and refer to a timesheet for calculation.

49.  Considering the wording of the Contract in relation to the services to be provided and the remuneration policy, Company A's circumstances are analogous with examples 17 and 19 provided in TR 2022/3 where the income is not considered to be for producing a result. The Contract indicates that Company A will complete a variety of tasks at the direction of, or in consultation with, Company X. Company A is being paid an hourly rate for the time worked (for a period of time within a set range) as opposed to being paid a fixed amount for the performance and completion of a specific task regardless of how long it takes for the task to be completed. As such, we consider that the income received by Company A is not for producing a result.

50.  All three conditions must be satisfied for the results test in subsection 87-18(3) of the ITAA 1997 to be met. As the first requirement, that the income is for producing a result, is not met, the results test cannot be reasonably be expected to be met regardless of whether the remaining two conditions are met.

Employment test

51.  Subsection 87-25(2) of the ITAA 1997 sets out the employment test for a PSE as follows:

(2) A *personal services entity meets the employment test in an income year if:

(a) the entity engages one or more other entities to perform work, other than:

(i) individuals whose *personal services income is included in the entity's ordinary income or *statutory income; or

(ii) associates of the entity that are not individuals; and

(b) that other entity performs, or those other entities together perform, at least 20% (by market value) of the entity's principal work for that year.

52.  TR 2022/3 further explains:

112. The first requirement in order to meet the employment test is that there is the actual engagement of another entity by the sole trader or PSE. The reference to 'engages' in subsections 87-25(1) and (2) takes its ordinary meaning and is not limited to employment-type relationships. 'Engages' includes making a contractual arrangement or agreement for the services of another entity.

113. Any other individual who is not a test individual and who is engaged by the PSE to perform principal work counts towards the employment test even if the individual is an associate of the PSE. Entities, other than individuals, engaged to perform principal work only count towards the employment test if they are not associates of the PSE.

...

20% (by market value) - single contract in the income year

118. The Commissioner will accept the following formula for determining whether at least 20% (by market value) of the principal work is performed by another entity (or entities):

% = (market value amount ÷ contract price) × 100

119. The market value amount is what the sole trader or PSE charged the service acquirer on an arm's length basis for the principal work performed by the entity (or entities) engaged by the sole trader or PSE (the charge-out rate).

120. The contract price is the total amount paid under the agreement between the sole trader or PSE and the service acquirer.

121. The market value amount would normally exceed the amount that the sole trader or PSE pays to the entity they have engaged.

122. Where the parties performing the work are not dealing with each other at arm's length, the market value amount is the market rate that the sole trader or PSE would ordinarily charge a service acquirer on an arm's length basis for the services of the entity.

53.  Example 27 in TR 2022/3 describes a situation where the employment test is not met because the work performed by the other entity is not the principal work of the sole trader. The example discusses a house builder who provides building services and does the physical work and pays his wife to perform administrative tasks such as contract administration, keeping track of costs and recording times. The example concludes that these administrative activities are not integral to and part of the principal work of the house builder and as the wife is not engaged to perform any principal work, that element of the employment test is not met.

Application to Company A's circumstances

54.  Individual B provides information technology support for the systems and applications used to provide Company A's principal work, as well as general management of the company. Similar to example 27, these activities are not part of the principal work of the company and this element of the employment test is not met.

55.  For completeness we note that the information provided indicates that Individual B does not perform at least 20% by market value of Company A's work.

Business premises test

56.  The business premises test is contained in section 87-30 of the ITAA 1997 which states:

(1)     An individual or a *personal services entity meets the business premises test in an income year if, at all times during the income year, the individual or entity maintains and uses business premises:

(a) at which the individual or entity mainly conducts activities from which *personal services income is gained or produced; and

(b) of which the individual or entity has exclusive use; and

(c)  that are physically separate from any premises that the individual or entity, or any *associate of the individual or entity, uses for private purposes; and

(d) that are physically separate from the premises of the entity to which the individual or entity provides services and from the premises of any associate of the entity to which the individual or entity provides services.

(2)     The individual or entity need not maintain and use the same business premises throughout the income year.

Application to Company A's circumstances

57.  The business premises used by Company A are not physically separate from the private residence of Individual A but consist of a dedicated office space in their private residence and, as such, the business premises test in section 87-30 of the ITAA 1997 is not met.

Second alternative - Unusual circumstances prevented the results, employment or business premises test from being met

58.  Subsection 87-65(3B) of the ITAA 1997 provides that the Commissioner may make a PSBD where, but for unusual circumstances applying to the entity in the year, the entity could have been expected to meet, or would have met, the results test, the employment test, the business premises test, or more than one of those tests.

59.  TR 2022/3 provides further guidance as to what the Commissioner will consider to be unusual circumstances in this context:

Unusual circumstances

153. To issue a PSBD, the Commissioner must be satisfied that, if not for the unusual circumstances, the sole trader or PSE would have met, or could reasonably be expected to meet, the test or tests applied for in relation to the PSI of the test individual.

154. A reasonable expectation of an event requires more than a possibility, risk or chance of the event occurring.

155. Unusual circumstances are those circumstances that are not usual, not common and are out of the ordinary. For example, if a sole trader or test individual performing services on behalf of the PSE meets a PSB test in preceding years and expects to meet the test again in subsequent years but a one-off event has affected its ability to meet the test in the current income year, the one-off event may constitute unusual circumstances.

156. The unusual circumstances must apply to the sole trader or test individual performing services on behalf of the PSE that requests the PSBD. Industry-wide circumstances, such as economic downturn affecting a particular industry, cannot be relied on as an unusual circumstance.

157. Situations may arise where circumstances that might be considered unusual become usual or 'the norm'. For example, where a sole trader or PSE usually enters into monthly contracts with a client, then enters into a 12-month contract with the possibility of further rollovers. It is considered that, while the first 12-month contract may be unusual, the subsequent rollover may result in the circumstances ceasing to be unusual.

158. The unusual circumstances relevant to an income year must be temporary, rather than a new mode of operation. The more temporary the circumstances are and the greater the likelihood that normal conditions will resume, the easier it will be to satisfy the unusual circumstances requirement.

60.  Example 39 in TR 2022/3 discusses circumstances in which the Commissioner may accept that unusual circumstances have prevented one of the PSBD tests from being met. In that example, a partnership used a business premises for a number of years that satisfied the business premises test. The partnership expands and enters into a contract to purchase a larger premises. The new premises will also meet the business premises test. Prior to moving, the new premises suffers significant flood damage, and the partnership must relocate to a third premises. The third premises does not meet the businesses premises test. The partnership moves into the new premises as soon as the building can be reoccupied, which is four months after the flood. While the partnership does not pass the business premises test in respect of either of the partners because a business premises was not maintained at all times during the year, the circumstances that prevented the business premises from being met would be considered to be unusual circumstances because, had the flooding not happened, the partners would have moved straight into their new premises and the test would have been satisfied. The test was satisfied in prior years and is reasonably expected to be met in future years. In these circumstances the Commissioner could issue a PSBD in respect of the partnership that, but for unusual circumstances applying to the partnership entity in that year, the entity could reasonably have been expected to meet the business premises test.

Application to Company A's circumstances

61.  Company A commenced business operations approximately halfway though the relevant income year. The Contract is the first contract for the business and is expected to be indicative of the terms and conditions that will be included in future contracts. There are no unusual circumstances that prevented the results test from being met in the relevant year.

62.There are no circumstances that suggest that unusual circumstances prevented the employment test from being met in the relevant year and no facts that suggest it will be met in future income years.

63.At no time during the income year was the business premises test met. The business premises were located where they were intended to be located and no unusual circumstances affected their location. There is no indication that the business premises will change in future years and therefore we do not consider that unusual circumstances prevented the business premises test from being met in the relevant income year.

64.In summary, unusual circumstances did not prevent the results, employment or business premises tests from being met.

Third Alternative - Unrelated clients test was met, or could reasonably be expected to be met, but unusual circumstances prevented the 80% rule from being satisfied

65.  Subsection 87-65(5) of the ITAA 1997 provides that the Commissioner may make a PSBD where the Commissioner is satisfied that the unrelated clients test was met but 80% or more of the PSE's income was from the same source because of unusual circumstances.

66.  Subsection 87-65(5) states:

Third alternative - unrelated clients test was met but 80% or more of income from same source because of unusual circumstances

(5) The conditions in this subsection are that:

(a) the entity could reasonably be expected to meet, or met, the unrelated clients test under section 87-20; and

(b) because of unusual circumstances applying to the entity in the income year, 80% or more of the individual's *personal services income (not including income mentioned in subsection 87-15(4)) included in the entity's *ordinary income or *statutory income could reasonably have been expected to be, or would have been, income from the same entity (or one entity and its *associates); and

(c) the individual's personal services income included in the entity's ordinary income or statutory income could reasonably be expected to be, or was, from the entity conducting activities that me the unrelated clients test under section 87-20.

Unrelated clients test

67.  The unrelated clients test, set out in section 87-20, of the ITAA 1997 states:

(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 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.

68.  In the relevant income year, Company A provided services to only one entity and therefore subsection 87-20(a) of the ITAA 1997 was not met.

69.  The second element of the unrelated clients test at paragraph 87-20(1)(b) of the ITAA 1997 requires that:

•      the services are provided as a direct result of the PSE making offers or invitations to provide the services

•      those offers must be made to the public at large or a section of the public, and

•      the PSE must be the offeror.

Direct result of making offers or invitations

70.  TR 2022/3 discusses at paragraphs 99 to 102 that to meet this element of the unrelated clients test, the offer or invitation must be the reason that the sole trader or PSE obtained the work from the client and there must be a direct causal effect between the offer or invitation and obtaining the work. A wide variety of activities can constitute making offers or invitations, but they must involve making public announcements. TR 2022/3 gives the examples of print advertising, printing posters, radio and television broadcasting, public tender, having a website and posting internet advertisements as activities which constitute making offers or invitations.

The public or a section of the public

71.  Paragraph 103 to 105 of TR 2022/3 explains the meaning of an offer being made to the public or a section of the public:

103. An offer or invitation is made to 'the public at large' where any interested member of the public is capable of accepting it. 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.

104. A word-of-mouth referral is not generally considered to satisfy the requirements of the unrelated clients test. A word-of-mouth referral is when a sole trader or PSE is offered work because of a recommendation from a previous client or industry contact. However, offers made by word of mouth in a very specialised or niche industry where there are only a very small number of potential service acquirers may, in limited circumstances, meet this condition.

105. Where there is a prior or subsisting relationship between the parties to an offer or invitation, the following factors are relevant when determining whether the offer or invitation made by the sole trader or PSE is made to a section of the public:

•      The number of people or entities to which the offer or invitation is made. While not determinative, it is likely to be a public offer or invitation if more entities are involved.

•      The nature and content of the offer or invitation. Where the offer or invitation is made as part of a competitive commercial process, such as a public tender, a prior relationship may not detract from the offer being made to the public.

•      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. Accordingly, the fact that a sole trader or PSE may have worked for or provided services to an entity sometime in the past does not necessarily operate to exclude the sole trader or PSE from satisfying this test.

Who must make the 'offer'

72.  TR 2022/3 also confirms at paragraphs 106 to 108 that in order to satisfy the second element of the unrelated clients test, the offer must be made by the PSE. An offer made to a PSE by the service acquirer will not satisfy this element of the test, because it is the potential client (the service acquirer) making the offer rather than the sole trader.

Application to Company A's circumstances

73.  Company A have advised that the consulting work relevant to this application commenced in the 20XX income year following inquiries from multiple overseas companies and that referrals for the work are by word of mouth from a small network. Company A have advised that there are only a small number of potential clients in the specific field that may require the services provided by Company A and that they expect to gain more clients via networking within the industry and through references from existing clients/consultants.

74.  Company A does not advertise for clients and are not making offers or invitations to the public or a section of the public but rather referrals for consulting work are by word of mouth from a small network.

75.  The information provided indicates that that the services have not been provided due to Company A making an offer but by the service acquirers inquiring with Company A about their services.

76.  Paragraph 104 of TR 2022/3 does mention that offers made by word of mouth in a very specialised or niche industry where there are only a very small number of potential service acquirers may, in certain limited circumstances, be considered to be an offer made to the public or section of the public. Based on the information provided we do not consider that this has occurred in the 20XX year. Even if it is a specialised or niche industry, the offers were not made via word of mouth because of a specialisation. The acquisition of the services came about after a number of companies made inquiries into the services that Company A could provide, and Company A decided to commence business operations to provide the services requested.

77.  Considering the above factors, the second element of the unrelated clients test is not met.

78.  The conditions contained in both paragraph 87-20(1)(a) and 87-20(1)(b) must be met for the unrelated clients test to be met. Neither are met and as such the unrelated clients test is not met.

Fourth alternative - Unusual circumstances prevented the unrelated clients test and 80% rule from being met.

79.  Subsection 87-65(6) of the ITAA 1997 provides that the Commissioner may make a PSBD where the Commissioner is satisfied that unusual circumstances prevented the unrelated clients test and 80% rule from being met. Subsection 87-65(6) states:

Fourth alternative - unrelated clients test not met because of unusual circumstances

(6) The conditions in this subsection are that:

(a) but for unusual circumstances applying to the entity in that year, the entity could reasonably have been expected to meet, or would have met, the unrelated clients test under section 87-20; and

(b) if 80% or more of the individual's *personal services income (not including income mentioned in subsection 87-15(4)) included in the entity's *ordinary income or *statutory income could reasonably have been expected to be, or would have been, income from the same entity (or one entity and its *associates) - that is the case only because of unusual circumstances applying to the entity in the income year; and

(c) the individual's personal services income included in the entity's ordinary income or statutory income could reasonably be expected to be, or as, from the entity conducting activities that met the unrelated clients test under section 87-20.

80.  As discussed above in relation to the third alternative, the unrelated clients test was not met in the 20XX income year. The Commissioner may still make a PSBD if unusual circumstances prevented the unrelated clients test and 80% rule from being met.

Did unusual circumstances prevent the unrelated clients test and 80% rule from being met?

81.  As discussed above, subsection 87-65(6) of the ITAA 1997 provides that the Commissioner may make a PSBD where the Commissioner is satisfied that unusual circumstances prevented the unrelated clients test and 80% rule from being met.

82.  TR 2022/3 provides guidance as to when unusual circumstances may exist that prevent the unrelated client's test from being met and states:

159. 'Unusual circumstances' in relation to the unrelated clients test include providing services to an insufficient number of entities if the sole trader or PSE:

•           starts a business during the income year and can reasonably expect to meet the test in subsequent income years, or

•           provides services to only one entity during the income year, but met the test in one or more preceding income years and can reasonably be expected to meet the test in subsequent income years.

83.  The Explanatory Memorandum to New Business Tax System (Alienation of Personal Services Income) Act 2000 discusses what was intended to constitute unusual circumstances in this context and states:

1.122         ... Examples of unusual circumstances include where:

•         an entity who, for a number of years, has provided personal services to a range of different clients, decides to accept a one year full time contract with a single client;

84.  Example 38 in TR 2022/3 demonstrates when unusual circumstances in relation to the unrelated clients test may exist. In example 38, a company (SBC Pty Ltd) commenced business operations in May of the 2019 income year and entered into a three month contract to provide services. The company applied for a PSBD for the 2019 income year stating that it was their first year of operation and therefore they only had one client. The company had already entered into contract negotiations for two other unrelated clients in the following income year and was confident the unrelated clients test would be met in that second year of operation. The example concludes that although it was an unusual circumstance for the company to only have one client for the first income year, the unrelated clients test is not met because the two new clients were obtained by the consultant running the business approaching the clients after hearing about the availability of work from a friend. Example 38 concludes:

259. It would be considered that it was an unusual circumstance for SBC Pty Ltd to have only one client for the 2018-19 income year as 2 unrelated clients have been secured for the 2019-20 year. However, under the relevant provisions for unusual circumstances in the first year of operation, unusual circumstances is only accepted in relation to the number of clients obtained. For a PSBD to issue in this situation, SBC Pty Ltd also needs to evidence that there were unusual circumstances that prevented it from obtaining clients through making offers or invitations to the public in its first year of operation. Consequently, as this is not the case based on the facts that the only client obtained was by word of mouth, the Commissioner cannot issue a PSBD on the basis that unusual circumstances prevented the unrelated clients test from being met.

260. Although SBC Pty Ltd could evidence that it had 2 unrelated clients in the 2019-20 income year, those clients were not obtained as a result of making offers or invitations to the public or a section of the public as required by the unrelated clients test. While it was reasonable to expect SBC Pty Ltd would have 2 or more unrelated clients in the subsequent income year, it was usual for SBC Pty Ltd to obtain its clients through word of mouth. The Commissioner cannot issue a PSBD for these circumstances.

85.  Similarly, to example 38 in TR 2022/3 we do not consider that unusual circumstances prevented Company A from meeting the unrelated clients test in the 20XX income year. We do not have enough information to be satisfied about the number of clients Company A will have in subsequent income year and, as in example 28, we do not consider that unusual circumstances prevented Company A from obtaining their clients as a result of making offers or invitations to the public or a section of the pubic as required by the unrelated clients test.

Summary

86.  As the Commissioner is not satisfied that the conditions in one or more of subsections 87-65(3A), (3B), (5) and (6) of the ITAA 1997 are met, the Commissioner cannot issue a personal services business determination for Company A in accordance with section 87- 65 for the income year ended 30 June 2023.