Edited version of private advice

Authorisation Number: 1052209308650

Date of advice: 19 January 2024

Ruling

Subject: Personal service income - business premises test

Question

Does the Company meet the business premises test under subsection 87-30(1) of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the IT consulting services provided?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2022

Year ended 30 June 2023

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

The Company operates a legal practice and is also engaged IT business consulting activity. The Company has employees working for its legal practice business.

The Company holds a License to occupy and use a dedicated space within the commercial premises. There are a variety of other businesses utilising other areas of the premises, some of which are on a long-term permanent basis or others that may use a space on an infrequent or sporadic schedule. The Company conducts its business activities at the allocated space.

During the relevant income years, the Company has entered into agreements with two entities for the provision of IT consulting services.

The individual who provides his personal services on behalf of the Company undertakes his personal services work at the Company's business premises. He attends the clients' premises only when requested for ad-hoc meetings.

The Company has been using the business premises for their legal practice work years before the Company entered into the two contracts for the provision of personal services.

The business premises

The allocated space within the commercial premises includes a signage including the Company logo, making it distinct from other entities leasing sections of the shared office environment. Chairs and desks are provided to the Company. The Company has its own lockable storage at the allocated space in the premises.

The space is used by the Company solely for business purposes comprising the legal practice (not subject to PSI rules) and IT consulting activity.

The Company has the director and a number of employees working in the legal practice. One individual provides personal services (IT consulting) on behalf of the Company.

The License Agreement

The Company has a License Agreement for the use of one of the spaces allocated to the Company within the commercial premises.

The License extends to access and use of all of the available facilities in the commercial premises (e.g., kitchen, café, meeting spaces, printing facilities etc). The License also grants access to the Company's team members.

The License Agreement defines License as the non-exclusive license granted by the owner of the premises for the Licensee and its team members to access and use the space.

The salient features of the agreement include:

•         The License does not grant the Company exclusive right to any part of the building premises and no relationship of landlord and tenant is created between the parties. The agreement is not a lease or commercial tenancy agreement and does not confer any interest in the premises on the Company or grant the Company any rights except as expressly set out in the Agreement.

•         The owner of the premises retains control, possession and management of the commercial premises.

•         The Company must not assign, license, part with, share the possession of (other than their team members), grant any mortgage, charge or otherwise deal with the allocated space, memberships, License or the agreement.

•         The owner of the premises reserves the right to require the Company to relocate to an alternative office during the License Period (either in the same building premises or in an alternative premises operated by the owner), by providing the Company with at least three months' written notice.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 84-5

Income Tax Assessment Act 1997 section 87-30

Reasons for decision

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.

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 employment test[3], and

•         the business premises test[4].

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

Your question is about whether the Company meets the business premises test in relation to the personal services provided by the test individual.

The business premises test

The business premises test requires that, at all times during the income year, the sole trader or PSE maintains and uses business premises:

•         where the main activities conducted there gain or produce PSI; and

•         of which they have exclusive use; and

•         that are physically separate from any premises that they (or any associate) use for private purposes; and

•         that are physically separate from the premises of the service acquirer (or any associate of the service acquirer).

Business premises

'Business premises' are premises that have the usual physical attributes and fixtures associated with commercial or business usage and, from a business and commercial perspective, are apt for the purpose of carrying on a business.

Maintains and uses

It is a requirement that the sole trader or PSE maintains and uses the business premises at all times in the income year. This means that the sole trader or PSE must do more than merely have leased premises in its name to pass the test. The premises should actually be used to produce the PSI.

Business premises are maintained when they are kept in existence or retained

Business premises may be maintained by ownership or by way of occupancy under a lease, sublease, License or possession. However, not all of these occupancy arrangements satisfy the 'exclusive use' requirement of the test.

There is no requirement for running costs associated with the premises, such as cleaning or utility costs, to be borne by the sole trader or PSE.

At all times in the income year

The sole trader or PSE must have business premises for the whole period during which activities are conducted for the purpose of generating PSI.

Where a sole trader or PSE commences or ceases activities during the income year, it is sufficient that the business premises are maintained and used for that part of the income year in which the activities are conducted.

Changing business premises

A sole trader or PSE is not required to maintain and use the same business premises throughout the whole year.

Main activities generate PSI

The generation of PSI must be the primary usage to which the business premises are put. Where more than one activity is conducted at the premises it is necessary to determine which activities generate PSI and which activities generate non-PSI. If more than 50% of the activities conducted at the premises are directed at producing PSI, this requirement will be met.

Exclusive use

A sole trader or PSE is required to have exclusive use of the business premises. This will be satisfied where premises are occupied under ownership or lease as the legal nature of the proprietary interest allows the holder to determine who may or may not enter the premises and therefore, they have exclusive use for the purposes of the test.

A sole trader or PSE cannot have exclusive use of the premises if they do not have exclusive possession. If the owner grants permission for the occupation of premises amounting to a License and not a lease, the individual sole trader or PSE does not have exclusive use of the premises.

A sole trader or PSE cannot lease premises together with another individual or entity on the basis that they share the premises to meet this requirement. As joint lessees, neither lessee has exclusive use of the premises.

Shared areas

Shared areas such as reception and waiting rooms are considered ancillary to the business premises and are not included for the purposes of the business premises test.

Physically separate

Business premises must be physically separate from premises that the sole trader or PSE (or their associates) use for private purposes.

For example, a PSE may lease a shed in an associate's back yard as its business premises. As the shed is part of the premises used by the associate for private purposes, the shed is not physically separate. The visual impression of the premises is that the entirety of the dwelling and surrounds (curtilage) is for private purposes.

On the other hand, if the PSE leased a shed in an associate's backyard that had its own entry from the road and was blocked off from the associate's private residence by a fence with no access to the private residence then the shed may be considered as physically separate. The visual impression in this case is that the business premises are physically separate to the associate's private premises.

The business premises must also be physically separate from the premises of the service acquirer or an associate of the service acquirer. For example, where a sole trader or PSE leases a room within the premises of the service acquirer for its business premises, the room is not considered to be physically separate from the premises of the service acquirer and would not meet what is required for the business premises test.

On the other hand, where a sole trader or PSE leases a discrete floor or part of a floor from the service acquirer for its business premises, such premises may be physically separate from the premises of the service acquirer depending on such factors as:

•         the extent to which the floors or parts of floors are functionally and physically integrated with each other

•         entry and exit facilities

•         signage

•         security arrangements, and

•         occupancy rights.

Application to the taxpayer's circumstances

The Company states that the allocated space is being used for legal practice (not subject to PSI rules) and for IT consulting services. The Company has the director and a number of employees to perform the work in relation to the legal practice. The Company has one individual providing IT consulting services on its behalf.

To determine whether the business premises test has been met in relation to the PSI generated from the IT consulting services, we examined the conditions under subsection 87-30(1) of the ITAA 1997.

Were the main activities conducted at the premises generate the PSI?

The Company conducts two activities i.e., legal practice and IT consulting and the latter generates PSI. The legal practice has the director and a number of employees working on the premises. Hence, the main activities conducted at the premises in the relevant years relate to the legal practice. Further, a higher percentage of the total income has been generated from the legal practice in the relevant years.

Accordingly, this condition of the business premises test has not been satisfied.

Did the Company have exclusive use of the business premises?

A sole trader or PSE cannot have exclusive use of the premises if they do not have exclusive possession.

Although the Company has an allocated space to conduct its business activities, the terms of the License Agreement do not confer exclusive possession of the space to the Company. The License Agreement provides:

•         The Agreement does not give the Company an exclusive right to any part of the premises.

•         The owner of the commercial premises retains control, possession and management of the premises and the Company has no right to exclude the owner from any part of it, including the allocated space.

•         The owner of the commercial premises has the right to require the Company, at any time on giving reasonable notice, to transfer to a comparable area elsewhere within the premises and the Company must comply with such requirement.

In Radaich v Smith, (1959) 101 CLR 209, the High Court held that in determining whether an instrument creates a lease or a License, the decisive factor in favour of a lease was whether the instrument conferred a right to exclusive possession. In this case, the appellants and the respondent became the parties to a deed dated 29th May 1954 which witnessed that the respondents, as licensors, thereby granted to the appellant, as licensee, for a term of five years from the date of the deed, "the sole and exclusive license and privilege to supply refreshments to the public admitted to premises. McTiernan J, stated:

It is the substance of the deed that matters. As Denning L.J. said in Facchini v. Bryson (1952) 1 TLR 1386 "... the parties cannot by the mere words of their contract turn it into something else. Their relationship is determined by the law and not by the label they choose to put on it" (1952) 1 TLR, at pp 1389, 1390. The true test of a supposed lease is whether exclusive possession is conferred upon the putative lessee. The validity of this test is confirmed by the judgment of the Court of Appeal in Addiscombe Garden Estates Ltd. v. Crabbe (1958) 1 QB 513 where Jenkins L.J. states: - "We were also referred by Mr. Blundell to Errington v. Errington and Woods (1952) 1 KB 290. In that case it was held that in very unusual circumstances a lady was a licensee, and entitled to remain in occupation of premises so long as she paid the instalments on a certain mortgage; and in the course of his judgment, Denning L.J. said: 'The test of exclusive possession is by no means decisive'. (1952) 1 KB, at p 297. I think that wide statement must be treated as qualified by his observations in Facchini v. Bryson (1952) 1 TLR 1386, at p 1389; and it seems to me that, save in exceptional cases of the kind mentioned by Denning L.J. in that case, the law remains that the fact of exclusive possession, if not decisive against the view that there is a mere License, as distinct from a tenancy, is at all events a consideration of the first importance." (1958) 1 QB, at p 528. (at p214).

Therefore, this condition of the business premises test is not satisfied.

Are the business premises physically separate from any premises that the Company (or their associates) use for private purposes?

Based on the information, the allocated space within the commercial premises is used by the Company solely for business purposes. Hence, this condition of the business premises test has been satisfied.

Conclusion

The License Agreement does not grant the Company exclusive use of the premises. Further, the main activities conducted at the premises relate to the legal practice and the activities generating PSI from the IT consulting services represent a smaller proportion of the activities conducted at the premises during the relevant years. Accordingly, the Commissioner is not satisfied that the business premises test under subsection 87-30(1) of the ITAA 1997 has been met in relation to the IT consulting services in the 2022 and 2023 income years.

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

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

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

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