Edited version of private advice

Authorisation Number: 1052351121003

Date of advice: 28 February 2025

Ruling

Subject: Deductions - overseas contractors

Question 1

Are you entitled to a deduction for engaging overseas contractors under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in the course of your employment?

Answer 1

No. As an employee, you are required to perform the work personally and are not able to delegate or subcontract your work to third parties. Engaging research consultants to perform part of or assist with your duties under your employment contract is not an expense which is incurred in gaining or producing your employment income and are considered of a private or domestic nature. Therefore, the expenditure is not deductible under section 8-1 of the ITAA.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Background

You registered for ABN as a sole trader on XX March 20XX. You registered your business, on X April 20XX.

You operate as a Research Specialist and Service Designer. Your work involves complex tasks such as research design, synthesis of research insights, strategic report generation and stakeholder engagement.

In the 20XX income year you have been engaged by various companies to provide your services. Due to the nature of the work and its financial benefits, an employment arrangement was preferred over a contractor arrangement.

Employment contracts

Employer A

You were employed by Employer A in the relevant year. You received a salary and are required to perform your duties under the direction of a designated officer. You worked the prescribed hours at the employer's business office.

Employer B

You were employed by Employer B for a fixed term employment contract which has been extended in the relevant year. You received salary and all other terms and conditions of your employment remained the same.

Employer C

You were employed by Employer C in the relevant year. You received a fixed salary and were required to work 5 days a week at the employer's business office, however you were allowed to work from home. You were entitled to leave and superannuation.

Employer D

You were employed by Employer D in the relevant year and receive a fixed annual salary. You work from the employer's business office and reports to a designated officer. You are entitled to leave and superannuation.

Business activities

In the relevant income year, you provided your personal services as a sole trader to Company E, a research company for their projects. You derived income for the provision of your services.

Engaging research consultants (subcontractors)

Your workload was beyond what you could manage while ensuring high-quality outputs and meeting deadlines. Hence, you engaged qualified research consultants that were based overseas to help manage the depth of quantitative and qualitative research needed, ensuring that projects continued to meet the required standards without compromising timelines.

The decision to engage contractors from overseas was driven by:

•                     Specialised Expertise: the unique skills required for your projects are scarce in the Australian market.

•                     Volume and Quality Control: the high volume of simultaneous projects made it essential to outsource specific tasks to maintain quality and meet project deadlines.

•                     Operational Efficiency: overseas contractors enabled you to handle extensive data collection and analysis, which are integral to our research and directly impact the quality of the insights provided to clients.

The research consultants invoiced you for their work in the relevant year as follows:

•                     Subcontractor company F

­        First invoice - billed to you for providing you with research assistants, 95% of the tasks conducted by the research assistants was to assist you with your tasks under your employment contract with Employer A whilst 5% was research for your consultancy business.

­        Second invoice - billed to you for providing you with research assistants, 90% of the tasks conducted by the research assistants was to assist you with your tasks under your employment contract with Employer A, 5% was for assisting you with your tasks under your employment contract with Employer B and 5% was research for your consultancy business projects.

•                     Subcontractor company G

­        First invoice - billed to you for providing you with research assistants, 90% of the tasks conducted by the research assistants was to assist you with your tasks under your employment contract with Employer C and 10% was for your business consultancy work with Company E for their project.

­        Second invoice - billed to you for providing you with research assistants, 90% of the work across all items in the invoice related to assisting with your tasks under your employment contract with Employer C, 10% supported your consultancy work with Company E for their project.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable Income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

•                     it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478, (Lunney's case)),

•                     there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

•                     it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

It is a long-standing principle that a taxpayer does not satisfy section 8-1 of the ITAA 1997 merely by demonstrating some casual connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection. The expenditure must be incurred in gaining or producing assessable income (Lunney's case). These principles have been affirmed by the High Court in Commissioner of Taxation v Payne [2001] HCA 3.

Taxation Ruling TR 2020/1 Income tax: employees: deductions for work expenses under section 8-1 of the Income Tax Assessment Act 1997 (TR 2020/1) provides guidance on the work-related expenses that an employee is allowed to claim as deductions. Relevantly, TR 202/1 explains the phrase 'in relation to gaining or producing assessable income' at paragraphs 13 to 15:

In gaining or producing assessable income

13.          The pivotal element of section 8-1 for work expenses is the requirement that expenses be incurred 'in gaining or producing assessable income'. The High Court majority in Payne said it is well established that these words are to be understood as meaning incurred 'in the course of' gaining or producing assessable income, and do not convey the meaning of outgoings incurred 'in connection with' or 'for the purpose' of deriving assessable income.

14.          The majority further stated that the meaning of 'in the course of' gaining or producing income was amplified in Ronpibon Tin NL where it was held that:

... to come within the initial part of [section 8-1] it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income, or if none be produced, would be expected to produce assessable income...

15.          While the High Court authority indicates the nature of the connection that needs to be found between outgoings and assessable income, the sufficiency of the connection in a given case cannot simply be determined by reference to a precise formula. Section 8-1 is expressed in such terms that it is intended to cover any number of legal and factual situations. In many cases, only a proper consideration of all the relevant facts and circumstances will reveal whether the occasion of a particular outgoing is to be found in what produces assessable income.

The requirement that expenses be incurred in the course of producing assessable income means that it is not enough to show only that there is some general link or causal connection between expenditure and the production of income. The expenditure must have a sufficiently close connection to the activities through which the taxpayer earns income.

In Case M55 80 ATC 366; (1980) 24 CTBR (NS) Case 30, the Board of Review considered the deductibility of wages paid by an employee. In that case an employee pathologist was denied a deduction for wages paid to his wife to take messages for him when he was on call. The Board considered that the expenditure was not incurred in gaining or producing the assessable income and was of a private or domestic nature. Dr Beck stated at ATC page 368, CTBR (NS) page 242:

If an employee pays another party to render some of the services for which the employee is paid this expenditure is not a cost of deriving the income. It can be regarded as a cost of lightening the workload, of gaining time off, of filling a gap in the employees competence, or, perhaps of rendering service beyond that which he is being paid for, and all expenditure of this kind is private and hence specifically excluded...[from being deductible]

Where a taxpayer pays another to perform part of or assist with the duties of their employment it is not an expense which is incurred by the taxpayer in gaining or producing their employment income. In addition, the wages paid would be an outgoing of a private or domestic nature.

In Frisch v Federal Commissioner of Taxation [2008] AATA 462; 2008 ATC 10-031; (2008) 72 ATR 551 (Frisch), the Tribunal found that wages paid to the taxpayer who was disabled to an assistant, who provided certain services, to work as law clerk, were deductible. The non-personal services were an expense incurred to enable the taxpayer to carry out her duties and incurred in the derivation of the relevant income. The assistant's services (except in relation to personal care) were required and provided only at and for work. These are services without which the taxpayer could not fulfil her work obligations. The essential character of the expenditure was to enable the taxpayer to derive income. The taxpayer did not delegate her legal tasks to her assistant, but rather, obtained the assistance needed by her to fulfil her obligations and functions as a law clerk.

Taxation Ruling TR 2023/4 Income tax and superannuation guarantee: who is an employee? (TR 2023/4) explains when an individual is an 'employee' of an entity for the purposes of section 12-35 of Schedule 1 of to the Taxation Administration Act 1953 (TAA). TR 2023/4 outlines various indicia to determine whether the relationship between the contracting parties is one of employment.

Relevantly, TR 2023/4 states at paragraph 54 that a critical feature of an employment relationship is the personal service of the employee; the worker themselves should be serving in the engaging entity's business. As such, the existence of a right which allows a worker to delegate, subcontract or assign their work to another, qualified or otherwise, is generally to be viewed as inherently inconsistent with an employee relationship.

Application to your circumstances

In your case you contracted research consultants from overseas to complete your work as an employee as it became too time consuming for you to complete all the required research tasks. The engagement of the research consultants enabled you to increase your workload and deliver the required tasks under your employment contracts and secure multiple jobs simultaneously.

Your circumstances are different to the case of Frisch where it was held that the taxpayer did not delegate her tasks to her assistance. In your case, you have delegated your tasks for which you are paid salary as an employee by engaging research consultants.

As an employee, you serve in the business of your employers to perform the work as a part of that business and paid salary for the tasks you are required to do. To the extent the expenses were incurred in outsourcing your tasks as an employee to overseas subcontractors, they were not considered a cost of deriving the income. The expenses were not incurred in gaining or producing your employment income and are considered private and domestic in nature. Therefore, the deduction is not allowable under section 8-1 of the ITAA 1997.