Edited version of private advice

Authorisation Number: 1052374635315

Date of advice: 19 March 2025

Ruling

Subject: Termination payment - personal services income

Question 1

Will the lump sum payment received constitute personal services income of the company's principal individual pursuant to subsection 84-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Person A commenced working as a full-time employee for Company M (located in country N) in January 200X as a XX.

About X years later Person A ceased working as an employee for Company M and established Company B through which to provide their consultant services to Company M.

Person A is the Director, and only employee of Company B although no salary, wages or director fees have been paid to them. Person A is referred to as the principal individual of Company B.

Company B entered a consultancy agreement with Company M on a specified date to provide Person A's services to Company M.

Under the agreement the following services are provided:

•                     List of services provided

•                     Such other services that may be agreed between Company M and Company B.

Person A was allowed X weeks leave a year, the same as their previous arrangement as an employee with Company M. Annual leave was logged in Company M's employee system and leave days were required to be pre-approved.

Various tasks could not occur in Person A's absence, so there are specific days that Person A was not allowed to have off.

At the time of Company B entering the consultancy agreement, the daily payment rate was XXX in country N's currency for each full day worked.

The daily payment rate increased, and in the 20XX income year the daily rate was YYY in country N's currency.

Based on the invoices provided for specific months, payments for Person A's consulting services were instructed to be made into a bank account held with a bank in country N in Person A's individual name.

Company B has not reported any income from Company M in their Company income tax returns for at least the last couple of years. The income from Company M has been classified as personal services income and has been reported by Person A in their individual tax return in the relevant years.

In 20XX, Company M was closing several tasks that Company B had provided consulting services to, and the services provided by Person A were no longer required.

As Person A was engaged as a contractor, not as an employee, they were not eligible to participate in Company M's employee redundancy scheme. However, Company M acknowledged Person A's years of service by providing the same package to Person A as the company was offering to equivalent employees under which an employee would be entitled to a lump sum payment which included a termination payment of one month of pay for every one year of employment, which was capped at 12 months, and a pro-rata bonus and a retention bonus.

Company M officially issued a letter on a specified date providing notice to terminate their consultancy agreement with Company B in accordance with clause X of the consultancy agreement. As stated in the letter:

•                     The termination date is XX XXX 20XX

•                     In recognition of Person A's years of service, Company M has agreed to make a goodwill payment of XXX,XXX in country N's currency. The payment is inclusive of Person A's remaining X months and X days' pay in lieu of notice.

On XX XXX 20XX, Company B issued an invoice to Company M with the invoice's description as 'Termination of Consultancy Agreement', for a total amount of XXX,XXX in country N's currency to be paid to Person A's bank account held in country N.

On XX XXX 20XX, Company M issued a remittance advice to Company B.

As advised, the lump sum payment of XXX,XXX of the following:

•                     Termination payment: XX,XXX

•                     Retention bonus: XXX,XXX (supposed to be due end of the 20XX calendar year originally)

•                     Bonus: XX,XXX (pro rata for period worked during the 20XX year)

•                     Notice in Lieu: XX,XXX (X months' notice, pro rata for time worked)

Consultancy Agreement between Company M (the Company) and Company B (the Supplier)

Clause X - Commencement and period of consultancy

The Supplier shall make the Services available to the Company on an ongoing basis with effect from X XXX 201X until terminated by either side giving to the other party X months' notice in writing at any time or in accordance with clause XX of this agreement. For the avoidance of doubt, the Company reserves the right (at its absolute discretion) to make a payment in lieu of notice, such payment to equate to fee for XX days at the daily rate as referred to in clause Y.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 84-5

Income Tax Assessment Act 1997 subsection 86-15(2)

Income Tax Assessment Act 1997 subsection 86-15(3)

Reasons for decision

Summary

The lump sum payment received is reward for Person A's personal efforts and skills and is their personal services income in accordance with subsection 84-5(1) of the ITAA 1997.

Detailed reasoning

Personal Services Income

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.

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.

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 company, partnership 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 in accordance with section 86-15 of the ITAA 1997.

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.

Whether a payment received by an individual or personal services entity is mainly a reward for personal efforts or skills is determined having regard to the substance of the arrangements between the parties. If the commercial substance of an arrangement is that there is one set of obligations (different components of which are integral or common to each other), they are looked at together. For example, the provision of plumbing services to replace a faulty tap would be looked at as one obligation, rather than separate sources of income, as the supply of the tap would be integral to the plumbing services. Where the income from the supply of the tap is less than 50% of the income received for the obligation overall, the whole amount is personal services income.

If, however, a contract deals with completely separate and distinct obligations, each is the source of separate amounts of income. This would be the case, for instance, if an individual derives income from plumbing activities and from the sale of household cleaning products, or if different individuals do the work.

In this case, Company B entered a contract to provide Person A's consulting services to Company M. The services provided include executing trades, monitoring overnight orders, notifying the CEO of any major market moves and checking and booking overnight trades.

Payments from Company M for these services were deposited into a bank account held in Person A's individual name. The income generated by Person A from the consultancy agreement between Company B and Company M has been reported in their individual tax returns as personal services income.

In 20XX Company M closed several investment funds, as a result, Person A's consulting services were no longer needed.

On a specified date, Company M officially provided Company B with a notice in writing that their consultancy agreement would be terminated in accordance with clause X of the agreement. Company M acknowledged Person A's years of service by providing the same package to them as the company was offering to equivalent employees.

Person A received a lump sum payment on XX XXX 20XX in a bank account held in their individual name. The payment comprised of the following components:

•                     Termination payment: XX,XXX

•                     Retention bonus: XXX,XXX

•                     Bonus: XX,XXX (pro rata for period worked during the 20XX year)

•                     Notice in Lieu: XX,XXX (X months' notice, pro rata for time worked)

Each component of the lump sum payment has been addressed below, to consider whether it amounts to personal services income.

Termination payment

This payment was offered in line with the employee redundancy scheme that employees of Company M were entitled to receive. This takes into consideration years of service, capped at 12 years. This payment was not expressly paid as compensation for termination of the service agreement, but rather, to recognise the years of service provided by Person A. Therefore, the termination payment of XX,XXX is personal services income, and is Person A's PSI.

Retention bonus payment

Generally, a retention bonus is paid by an employer to employees for working for a specific period of time. It is an incentive to attract or retain employees with valuable skills. Although Person A was engaged by Company M as a contractor, they were receiving the benefits of an equivalent employee, and one of these benefits was retention bonus. The retention bonus was additional reward payment for the consulting services provided by Person A. It was in recognition of securing the knowledge and skills of Person A and was a financial incentive to ensure that their services continued to be provided for a specific period. There is a direct correlation between the services Person A made available to Company M for a specific period, and the retention bonus payment received. Consequently, the XXX,XXX retention bonus payment is a reward for Person A's personal efforts or skills and is Person A's PSI.

Bonus Payment

The XX,XXX bonus payment was calculated pro rata for the period worked during the 20XX year. This directly correlates to the services provided by Person A during this specific period and is a reward for Person A's efforts, skills and knowledge and is therefore Person A's PSI.

Notice in Lieu

Clause X of the consultancy agreement between Company M and Company B (Agreement) provides that Person A's services can be terminated by either side giving to the other party X months' notice in writing at any time. It further states that Company M reserves the right (at its absolute discretion) to make a payment in lieu of notice, such payment to equate to fee for XX days at the daily rate that Company M would pay for Person A's full day work.

Company M officially provided a notice in writing on a specified date to terminate the Agreement with the termination date being XX XXX 20XX.

Under the Agreement Company M was under no obligation to make any further payment other than the amount accrued before the termination date. However, in recognition of Person A's service and at their discretion, Company M made a payment inclusive of the remaining X months XX days' pay in lieu of notice. This amount was calculated on the daily rate and was in acknowledgement of the services that had been provided and would have been provided by Person A for that remaining time. Therefore, the XX,XXX payment in lieu of notice represents a reward for Person A's skills and efforts, had they continued providing their services through the notice period, and is personal services income of Person A.

Conclusion

It is clear from the information provided that the lump sum payment received by Person A is a reward for their personal efforts and skills provided to Company M over a period of time. Consequently, the lump sum payment received by Person A as the principal individual of Company B is Person A's personal services income in accordance with subsection 84-5(1) of the ITAA 1997.