Edited version of private advice

Authorisation Number: 4120085851675

Date of advice: 29 January 2021

Ruling

Subject: Income tax - personal services income

Question 1

Will any of the income of Trust Y be classified as your 'personal services income' (PSI) pursuant to Division 84 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will Division 85 of the ITAA apply to deny you any deductions in relation to deriving PSI?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

During the year ended 30 June 20XX

Relevant facts and circumstances

You are in a senior management position at Company X.

Company X is a parent entity to numerous businesses.

Company X has manages certain services for the businesses.

Company X was originally intended to be an investment entity.

As the group grew it was appropriate and efficient to keep certain functions within Company X however this operating structure has become outdated and cumbersome.

Company X intends to segregate some of its functions and return to its intended purpose of an investment entity.

It is intended that certain functions will be managed by a new entity, Trust Y.

Trust Y will operate in its existing premises (i.e. at the Company X current office), however it will incur rent expense on a square meterage basis, as well as other expenses (e.g. printing and stationary, motor vehicle expenses, travel expenses, etc.).

There will be an overarching agreement using a fixed percentage calculation between Trust Y and Company X for the services provided

The fixed percentage is an amount that falls between the cost of the function of Trust Y and the tangible benefits received by the businesses for the services provided.

The percentage amount has remained consistent for many years and any increase would be based on an assessment of the cost of the service versus the benefit provided.

Trust Y will employ more general employees than senior management. You will work in a similar role for Trust Y as you currently perform at Company X.

You are currently paid a salary that is commercial and in line with the market rate for your role and you will continue to receive the same salary from Trust Y following restructure.

There will be no cross over of staff employed by the Trust Y to Company X or any of the businesses in the group and there will be a separate area in the office for the Trust Y staff.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 84-5

Income Tax Assessment Act 1997 section 85-5

Reasons for decision

Question 1

Summary

The income of Trust Y is not your personal services income.

Detailed reasoning

Meaning of personal services income

Divisions 84 to 87 of the Income Tax Assessment Act 1997 (ITAA 1997) set out the personal services income (PSI) measures which apply where a taxpayer has income that is PSI.

Section 84-5 of the ITAA 1997 defines PSI as:

Section 84-5

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).

...

Example 3: Jim works as an accountant for a large accounting firm that employs many accountants. None of the firm's ordinary income or statutory income is Jim's personal services income because it is produced mainly by the firm's business structure, and not mainly as a reward for Jim's personal efforts or skills.

(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 2001/7 Income Tax: the meaning of personal services income (TR 2001/7) summaries the definition of PSI as follows:

4. The alienation measure only applies to income earned mainly from the provision of an individual's labour or skills (personal services income) rather than being generated by the use of assets, the sale of goods, the granting of a right to use property or by a business structure.

Income earned mainly from the provision of an individual's labour or skill

In reference to the use of the word 'mainly' in the context of the section 84-5 ITAA 1997 definition of PSI, TR 2001/7 states:

24. The use of 'mainly' in the definition 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. Therefore, the use of tools of trade or plant and equipment does not of itself preclude the income from being personal services income, if they are ancillary to the generation of the income.

25. Implicit in the word 'mainly' is that more than half of the relevant amount of the ordinary or statutory income is a reward for the personal efforts or skills of an individual.

26. In interpreting Division 84 it is relevant to ask whether the income is mainly a reward for an individual's personal efforts or skills. If it is, then it is personal services income. If it is not, then that particular amount of income is not personal services income, and not within the alienation measure.

That is, if the income is mainly a reward for an individual's personal efforts or skills (approximately more than half of the income) then it is personal services income.

Income that is not PSI

TR 2001/7 provides that there are specific types on income which will not possess the characteristics of PSI:

29. The meaning of personal services income is wider than that which might otherwise be the case under the common law, but does not include income that is mainly:

- from an entity supplying goods or granting a right to use property;

- generated by assets an entity holds; or

- generated by the business structure.

30. Where personal services are provided that are ancillary to:

(a) the sale or supply of goods;

(b) the granting of a right to use property;

(c) the supply and use of assets that have a significant role in the generation of the income; or

(d) the generation of the income by the business structure,

the income so generated is not personal services income.

Business structure

Whether the income is derived from the business structure rather than your individual efforts or skills is the most relevant factor in considering whether the income is your PSI.

Guidance in classifying income as being generated by a business structure is provided by Taxation Ruling TR 2001/7 which states:

31. The determination of whether income is mainly a reward for the personal efforts of an individual or is income generated from the circumstances outlined in paragraph 30(2) to (d) above, requires the exercise of practical judgement as to whether the value contributed by the efforts or skills of the individual exceeds the value of the other inputs, such as the efforts of other workers, and the use of plant and equipment or machinery, or intellectual or other property or goodwill. In making that judgement, regard may be had to factors including:

•         the nature of the activities being conducted that generate the income;

•         the extent to which the amounts paid or payable or particular amounts paid or payable by a service acquirer to an individual or a personal services entity under an agreement is primarily for the personal efforts or skills of a particular individual;

•         the extent to which the contract price has been calculated having regard to the costs to be borne by an individual or a personal services entity in providing and using assets or plant and equipment in the performance of the obligations of the individual or the personal services entity to the service acquirer;

•         the market price of using any equipment, plant or tools in comparison with the market price of hiring the relevant labour or skills for the same period;

•         the nature, size and significance of the plant and equipment or other assets that are used by the individual or the personal services entity in relation to the income-producing activity;

•         the value of the asset in relation to the total income generated in the performance of obligations under an agreement;

•         the uniqueness and degree to which an asset is specialised in the performance of a particular function;

•         the uniqueness, level of skill or degree of specialisation of an individual to provide the particular services contracted for by the service acquirer;

•         whether the contractual payments made to an individual or a personal services entity is for the transfer of the ownership or a right in respect of an item that is produced by the individual or personal services entity;

•         the existence of goodwill;

•         the existence of substantial income-producing assets;

•         the size of the business operation; and

•         the contribution of other workers to the income-earning activities.

32. Whilst the above is a list of factors that are relevant, no one factor may be decisive, nor is the list exhaustive. Their individual weighting will depend on the circumstances of each case.

...

Income from a business structure is not personal services income

69. The alienation measure does not apply to businesses that have a profit-yielding structure. The distinction between income that is mainly a reward for personal efforts or skills and income from a business structure will need to be made having regard to factors such as the number of arm's length employees or others engaged to perform work, the presence of goodwill, the extent to which income-producing assets 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 individuals own personal skills, efforts or expertise.

Nature of the activities

Trust Y will provide services to Company X. Although you and the other employees will use your own skill and expertise to perform your roles, with consideration of other factors, this does not stop the income from being produced by a business structure.

Number of arm's length employees or others engaged to perform work

You will not be carrying out the duties of Trust Y alone. Trust Y will have fewer principal workers than employees. The majority of the day to day work will be done by the employees.

The presence of goodwill

Given the structure of Company X's business and that Company X has a majority stake in the businesses to which the fee will be charged it cannot be easily determined whether goodwill exists. If goodwill does exist it is difficult to assign a value to the goodwill.

The extent to which income-producing assets are used to derive the income

Trust Y will operate in its existing premises (at Company X current office), however it will incur rent expense on a square meterage basis, as well as other expenses. These assets and expenses will help generate the income of the operation however the majority of the of the income of Trust Y will be generated through the provision of services.

The size of the operation

The service charge charged by Trust Y is in line with a market rate and on commercial terms. The fee has been determined as an amount that falls between the cost of the corporate function and the tangible benefits received by the businesses. The percentage service charge has remained consistent for many years and there are no plans to change the rate in the near future.

The salaries of the employees are similarly on commercial terms and in line with market norms.

The income generated by the operation will be proportionate to the size of the operation.

The extent to which the income is dependent upon a particular individual's own personal skill, efforts or expertise

The substantial work of Trust Y will be performed by the employees. This is routine within the industry with principals operating at a senior management and key oversight level. You will not be performing a significant aspect of the operation yourself. The income generated will not be dependent on a particular individual's skills or expertise but will be generated in combination with other employees.

Conclusion

As discussed in paragraph 32 of TR 2001/7, the list of factors provided by paragraph 31 of 201/7 is not exhaustive in determining whether the income is mainly a reward for the personal efforts of an individual or, as considered in your circumstances, is income generated from a business structure. Further, the individual weighting of the factors will depend on the circumstances of the case.

It is considered that in weighing the factors listed, on balance, the income of Trust Y is from a business structure. Therefore, the income of Trust Y is not your personal services income.

Question 2

Summary

Division 85 of the ITAA will not apply to deny you any deductions in relation to deriving PSI.

Detailed reasoning

Division 85 of the ITAA denies certain deductions in relation to deriving PSI where the business is not conducted through a personal services business. The object of Division 85 is provided as:

Section 85-5

The object of this Division is to ensure that individuals who are not conducting personal services business cannot deduct certain amounts (such as amounts that employees cannot deduct).

As concluded in question one above, the income of Trust Y is generated by the business structure of Trust Y. Division 85 of the ITAA 1997 will not apply to deny deductions (if any) for you.