Ariss and Commissioner of Taxation (Taxation)
[2019] AATA 2958
•23 August 2019
Ariss and Commissioner of Taxation (Taxation) [2019] AATA 2958 (23 August 2019)
Division:TAXATION AND COMMERCIAL DIVISION
File Numbers: 2017/5383
2017/5384
2017/5385
Re:Terence Ariss
APPLICANT
AndCommissioner of Taxation
RESPONDENT
DECISION
Tribunal:Senior Member Dr M Evans
Date:23 August 2019
Place:Perth
The Reviewable Decision of 9 August 2017 is affirmed.
..............[sgd]..........................................................
Senior Member Dr M Evans
CATCHWORDS
TAXATION – income tax – whether trust distributions ordinary income and/or personal services income – whether Part IVA applies – entitlement to income tax deductions – whether Applicant entitled to clerical deductions for income attributed to spouse – whether deductions unreasonable amount paid to a related person – whether Applicant entitled to deduction for payments made to an associate – whether Applicant entitled to deductions for personal superannuation contributions – entitlement to income tax deduction for travel expenses where reimbursement already made – whether Respondent out of time to amend assessments – limited amendment period – whether Applicant beneficiary under a trust – whether any person entered into or carried out a scheme for the sole or dominant purpose of the individual obtaining a scheme benefit – decision under review affirmed
LEGISLATION
Income Tax Assessment Act 1936 (Cth) – ss 170, 170(1), 170(1) (Table, Item 1, Qualification (d)), 170(1) (Table, Item 1, Qualification (e)), 170(14), 177D, 318(1)(c)
Income Tax Assessment Act 1997 (Cth) – ss 4-1, 4-10(1) and (2), 4-15, 6-1(1), 6-5,
6-5(1), 6-5(4), 8-1, 8-1(1)(a), 26-35, 84-5, 85-20, 86-15, 87-15, 87-15(3), 87-18(1), 87-18(3), 87-20, 87-30(1), 290-160 as repealed by Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 (Cth), 290-170(1), Pt IVA, 318(1)(c), 995-1(1)Superannuation Guarantee (Administration) Act 1992 (Cth) – s 12(3)
Taxation Administration Act 1953 (Cth) – s 284-150 of Schedule 1, 14ZZK, 14ZZK(b)(i)
CASES
Federal Commissioner of Taxation v Dixon Consulting Pty Limited [2006] FCA 1748; (2006) 65 ATR 290
Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404
Douglass and Commissioner of Taxation [2018] AATA 3729
Douglass v Commissioner of Taxation [2019] FCA 1246
IRG Technical Services Pty Ltd and Another v Federal Commissioner of Taxation [2007] FCA 1867, 165 FCR 57
Kocharyan v Commissioner of Taxation [2015] FCAFC 196
Skiba v Commissioner of Taxation [2007] AATA 1705; 67 ATR 682REASONS FOR DECISION
Senior Member Dr M Evans
23 August 2019
BACKGROUND TO THE APPLICATION
By an application filed with the Tribunal on 8 September 2017 (T1, page 1), the Applicant is seeking a review of a decision of the Deputy Commissioner of the Respondent dated
9 August 2017 (the Reviewable Decision) (T29, page 252). The Reviewable Decision disallowed objections to amended assessments issued for the income years ending:(a)30 June 2010 (T19, page 161);
(b)30 June 2012 (T24, page 190); and
(c)30 June 2013 (T25, page 194).
These income years will be collectively referred to as the relevant income years.
In each of the relevant income years, the Applicant (T3, page 26; T4, page 32; T5, page 39) and his wife, Mrs Ariss (T194, page 831; T202, page 861; T204, page 869) lodged income taxation returns declaring distributions from the Agency Resource Management Services (Global) Trust (ARMS) as trust income.
The Applicant is an information technology specialist in software systems designed by Oracle Corporation (Oracle), and provides professional services to large corporations to assist them to manage their supply chains.
In the relevant income years, the Applicant provided these professional services to the following clients: Wesfarmers Coal Limited; Fusion Applications Pty Ltd; Wesfarmers Resources Limited; and Premier Coal Ltd (the Clients).
The distributions in the income taxation returns for the relevant income years were the amounts invoiced by ARMS to the Clients for work undertaken by the Applicant, stated as “[f]or professional services rendered by Terence Ariss” (see invoices at T30 to T155; and distribution statements at T12 and T13).
The income was attributed by ARMS in the ratio of 70% to the Applicant and 30% to
Mrs Ariss (the 70% to 30% ratio). Mrs Ariss did not received any payments by way of distributions. Instead, payments were received into the bank account of the Applicant’s business.
Assessments were issued to the Applicant in accordance with the tax returns lodged by the Applicant for the 2010, 2012 and 2013 income years for the following amounts:
(a)$163,910.00 in 2010;
(b)$189,950.00 in 2012; and
(c)$298,150.00 in 2013.
The Applicant lodged an amended return on 3 October 2013 (T6, page 42) for the income year ended 30 June 2013, and as a result, on 11 October 2013, an amended assessment was issued which reduced the Applicant’s taxable income to $297,189.00 (Exhibit R3, paragraph [22], see also T25, page 194).
The Respondent conducted an audit of the remuneration received by Mr Ariss for the provision of his services for the 2010, 2012, and 2013 income years (T18, page 137; T23, page 171). Following this audit, the Respondent issued amended assessments based on the trust distributions being solely attributed to the Applicant as salary and wage income.
Specifically, on 16 February 2015 the Respondent issued an amended income taxation assessment to the Applicant for the income year ended 30 June 2010. The amount of the distribution attributed to Mrs Ariss was included in the Applicant’s assessable income. This resulted in an increase in the Applicant’s taxable income from $163,910.00 to $262,645.00 (T19, page 161).
Further, on 6 January 2017, the Respondent issued amended income taxation assessments to the Applicant for the income years ended 30 June 2012 and
30 June 2013. Again, the amounts of the distributions attributed to Mrs Ariss were included in the Applicant’s assessable income for each of those income years. Additionally, the amended assessments disallowed deductions for superannuation contributions. This resulted in an increase in the Applicant’s taxable income from $189,950.00 to $314,899.00 for the 2012 income year (T24, page 190); and from $297,189.00 to $445,813.00 for the 2013 income year (T25, page 194).
In a letter dated 21 July 2017 the Applicant’s legal representative, Ms Velevski, objected to the amended assessments for the 2010, 2012, and 2013 (T26, page 198) on the Applicant’s behalf.
In a letter dated 2 June 2017, the Deputy Commissioner of the Respondent advised that the objection to the amended assessment for the income year ending 30 June 2010 was not valid because it was made outside the applicable time limit (T27, page 215). In a letter from Ms Velevski dated 21 July 2017, an extension of time due to late lodgement was sought with respect to the 2010 amended assessment (T28, page 226, paragraph [15]).
On 9 August 2017 the Deputy Commissioner of the Respondent made the Reviewable Decision (T29, page 252) which granted the extension of time, and disallowed the objections for each of the relevant income years in full.
ISSUES
The substance of the parties’ submissions about the issues requiring determination by the Tribunal, as set out in their Statements of Facts, Issues and Contentions (SFICs) were similar (see Exhibit A1, paragraphs [24]-[31]; and Exhibit R3, paragraphs [28]-[36]).
It is the Tribunal’s opinion that the issues were more succinctly and accurately stated by the Respondent in its Amended SFIC:
28. Whether the amounts paid by the Clients to ARMS in respect of the Applicant in the relevant income years were ordinary income of the Applicant in those relevant income years (ordinary income issue).
29. Alternatively, whether the amounts paid to ARMS by the Clients were assessable to the Applicant under section 86-15 (personal services income issue), in particular:
29.1. whether the amounts were “personal services income”; and
29.2. whether ARMS or the Applicant was conducting a “personal services business”.
30. Alternatively, in the event that the answer to both the ordinary income issue and the personal services income issue is ‘no’, whether Pt IVA applies to include all or part of the amounts paid by the Clients to ARMS in the assessable income of the Applicant (Part IVA issue).
31. In the event that the answer to the ordinary income issue or the personal services income issue is ‘yes’, whether the Applicant is entitled to deductions under section 8-1 for amounts disclosed by Mrs Ariss in her income tax returns for the relevant income years (clerical deductions issue).
32. In the event that the answer to the clerical deductions issue is issue ‘yes’, whether any part of that deduction is not allowable by reason of it being an unreasonable amount pursuant to section 26-35 (unreasonable deduction issue).
33. In the event that the answer to the personal services income issue is ‘yes’, whether section 85-20 applies to deny any deductions claimed by the Applicant for payments or amounts incurred to an associate (PSI associate deductions issue).
34. Whether the Applicant is entitled to income tax deductions for personal superannuation contributions that he made in the relevant income years (superannuation issue).
35. Whether the Applicant is entitled to an income tax deduction in relation to the year ended 30 June 2010 for the items described in correspondence received from his tax agent as “Travel - $3,750.00”- in particular whether the Applicant was reimbursed for those expenses (travel expense issue).
36. Whether the Respondent amended the Applicants’ amended assessments for the relevant income years within the period provided for in s 170 of the ITAA 1936, in particular whether the amendments were within time because the amendment period was 4 years by reason that:
36.1. the Applicant was a beneficiary of a trust estate referred to in s 170(1) (Table, Item 1, Qualification (d); or
36.2. it is reasonable to conclude that any person entered into or carried out a scheme for the sole or dominant purpose of the individual obtaining a scheme benefit referred to in s 170(1) (Table, item 1, Qualification (e)).
(Original emphasis.)
The Tribunal agrees with the formulation of the issues in this manner.
MATERIAL BEFORE THE TRIBUNAL
The hearing took place on 25 and 26 March 2019.
The Applicant appeared in person and was represented by Ms Velevski.
Mr Peadon appeared as counsel for the Respondent, assisted by his instructing solicitor Mr McGrade.
The Applicant gave oral evidence, and was cross-examined. He also called Mrs Ariss, as a witness, who gave evidence and was cross-examined.
The Tribunal admitted the following documents into evidence at the hearing:
(a)Applicant’s amended SFIC, filed with the Tribunal on 14 September 2018 (Exhibit A1);
(b)Applicant’s SFIC filed with the Tribunal on 2 March 2018 (Exhibit A2);
(c)
undated witness statement of the Applicant, filed with the Tribunal on
2 March 2018 (Exhibit A3);
(d)undated witness statement of Mrs Ariss, filed with the Tribunal on 2 March 2018 (Exhibit A4);
(e)email from the Applicant dated 20 March 2006 (Exhibit A5);
(f)s 37 documents (T Documents) numbered T1 to T29 comprising 252 pages (Exhibit R1);
(g)supplementary T Documents numbered T30 to T205 comprising pages 253 to 872 (Exhibit R2); and
(h)Respondent’s amended SFIC dated 6 March 2019 (Exhibit R3).
The Tribunal also had before it the following written closing submissions filed by the parties subsequent to the hearing:
(a)undated Applicant’s outline of closing submissions, filed with the Tribunal on 29 March 2019;
(b)Respondent’s Consolidated Outline of Closing Submissions dated 4 April 2019; and
(c)undated Applicant’s amended outline of closing submissions, filed with the Tribunal on 5 April 2019.
EVIDENCE BEFORE THE TRIBUNAL
Although there are, broadly speaking, numerous issues that require determination by the Tribunal, the determination of these issues will be informed by the Tribunal determining how the Applicant’s income is to be characterised. This involves the Tribunal making findings of fact concerning the nature of the Applicant’s business; the proper legal characterisation of the relationship between the Applicant and ARMS; and the characterisation of the role undertaken by Mrs Ariss in the Applicant’s business.
The Tribunal will first examine the evidence of the Applicant and Mrs Ariss. In the Tribunal’s opinion, both were honest and credible witnesses who gave evidence to the best of their recollections.
The Applicant
The Applicant is a highly skilled information technology specialist. He has a unique set of skills with respect to Oracle, particularly in the enterprise management area (day 1 transcript, page 47).
The Applicant has never been issued with an Australian Business Number, nor has he been registered for GST (transcript, pages 63-64). There is no allegation before the Tribunal of any underpayment of GST.
The Applicant stated that he had worked for Oracle since 2000, where he was very successful and won several high achiever awards and incentives. In the third quarter of 2005 he decided to leave Oracle to “work as an independent consultant” (Exhibit A3, paragraph [2]).
The Applicant first came into contact with ARMS in approximately late 2005 during his first contract (of 3-4 months duration) with St John of God Hospital working through a recruitment agency called RDBMS (Exhibit A3, paragraph [3]).
In early 2006, the Applicant ceased working with RDBMS and ARMS when he accepted a contract position working in the Adelaide office of Santos Oil and Gas (Santos). The Applicant stated that “distributions were dealt with by an agency mandated by Santos” (Exhibit A3, paragraph [4]).
The Applicant stated that his contract expired with Santos in approximately the third quarter of 2007, and he was then approached by Wesfarmers Energy in Perth regarding a three month contract to review the configuration of their maintenance module (Exhibit A3, paragraph [5]).
He then contacted ARMS to “manage [his] invoicing and distributions” and made arrangements with them to charge him 3% (which included insurance) to do so (Exhibit A2, paragraph [6]). In his evidence at the Tribunal hearing, the Applicant expanded on his arrangement with ARMS (transcript, page 38):
MS VELEVSKI: Thank you, Dr Evans. So, I wish to continue with that paragraph, Mr Ariss, where you had contacted Arms Global. So, we clarified how you contacted them?
APPLICANT: Yes.
MS VELEVSKI: And you asked them how much they would charge to manage the invoicing and - - -? Yes, that’s right. So, they were going to charge me a fee for - for basically my interpretation was to administer my business.
APPLICANT: Yes.
SENIOR MEMBER: And what do you mean by administer your business? What was your understanding about what they would do?
APPLICANT: Well, effectively - I think I have another email somewhere that I might be able to dig up. I’ve been desperately looking through my whole - the old email accounts but, effectively, the way I articulated it to - I said it’s very, very simple. I said I’ll tell you how much I’ve worked, you invoice the client. When you get the money take 3 per cent and split the - the income up between me and my wife and that was it in a nutshell and, obviously, they would do other things such as - if I wanted to send some of my distributions as - to the superannuation, I’d ask them to - to salary - I think they term it’s salary sacrifice but it was just part of what I - the revenue that I’d raised and that - that really was the extent of the - my association with them. I think, on occasions - one year, maybe, we didn’t pay as you go and another - I didn’t like that because I used to get big bills at the end of it, so I said no, next year we’ll go and - you just take it out as we go. I don’t want to be in a position of just forward payments and - so, a few of those sort of scenarios going on but fundamentally that’s what happened, yes.
SENIOR MEMBER: So, is it fair to say that like you could direct the extent of what they would do and actually what they would do. So, you would tell exactly what you wanted?
APPLICANT: That’s it. That’s it, and they didn’t dictate anything to me, and nor should they, and certainly as far as, you know, anything - you know, they didn’t find work for you or anything like that. All they did was - was do the administration as I’ve just described it.
(Emphasis added.)
The Applicant gave evidence at the hearing that “there was no formal contract in place between Wesfarmers and myself or ARMS and myself” (transcript, page 62).
The Applicant further stated that he personally knew many of the Wesfarmers Energy staff from his time working at Oracle because Wesfarmers Energy had been a client of Oracle. Regarding his relationship with Wesfarmers Energy and ARMS, the Applicant further stated (Exhibit A3, paragraph [6]):
… At the time I do recall I wasn’t concerned with formal contracts I advised ARMS that as far as I was concerned ‘I knew them and they knew me’. I knew they would pay on time and was comfortable with ARMS processing the distribution of monies received. There was no formal contract in place between Wesfarmers and myself or ARMS and myself.
According to the Applicant, other opportunities within the Wesfarmers Energy organisation presented themselves and he was offered more work from managers within different departments. The initial project he was working on went for much longer than expected, and he also obtained work from other Wesfarmers Energy businesses (Exhibit A3, paragraph [7]).
The Applicant’s evidence was that in 2009, Wesfarmers Energy split into two separate entities, Wesfarmers Energy and Wesfarmers Resources. The Applicant contracted to these entities because he was familiar with the issues surrounding the system configuration issues experienced by the two mining operations. The Applicant stated that he “continued to work with both mining operations on specific projects together with system maintenance and troubleshooting” (Exhibit A3, paragraph [9]).
The Applicant stated that when Wesfarmers Resources decided to sell Premier Coal to the company Yancoal, a major system separation was conducted. Premier Coal approached the Applicant and asked if the Applicant could assist them in the maintenance and support of their system while they transitioned away from the Oracle system (Exhibit A3, paragraphs [10]–[12]). The Applicant described that he would (Exhibit A3, paragraph [12]):
…capture issues and requests via their internal IT Support system, each evening (after working for Wesfarmers Resources) I would access their system and resolve the problems reported and develop and test any required system configurations changes. I supported Premier for approximately one year.
The Applicant described working on “numerous discrete projects” during his time with Wesfarmers including systems upgrades, the implementation of an Oracle repository contracts module, and the implementation of an Oracle Internet expenses module. These projects lasted from between four months to one year (Exhibit A3, paragraph [13]). In his evidence at the hearing however, the Applicant clarified that his work was completed at a daily rate and was not dependent on the completion of any project. This is indicated by the following exchange under cross-examination (transcript, pages 68 - 69):
MR PEADON: The discussion was not, "We have a project and you need to complete it within this 12 months". Is that correct?
APPLICANT: No.
…
MR PEADON: Were any of your payments of your invoices ever delayed by reason the project, so called, had not finished? Failed?
APPLICANT: No.
MR PEADON: So no matter where the project was up to, if you issued an invoice you got paid. Is that correct?
APPLICANT: Yes.
Whilst working for Wesfarmers Energy and Premier Coal, the Applicant stated that he also undertook contract work with a company called Fusion Applications. The Applicant stated that (Exhibit A2, paragraph [14]):
Again I know the owners of Fusion Applications personally having worked with them on previous projects both as an Oracle employee and as a sole trader. Projects I worked on for Fusion included Oracle implementation/ upgrades…
The Applicant also stated (Exhibit A3, paragraph [15]) “I was also engaged from time to time by Fusion to conduct presentations and to respond to tender documentation to potential clients…”
The Applicant’s work was undertaken at home in a dedicated home office that was not used for any other purpose (in her evidence, Mrs Ariss referred to the room being a dedicated room in the family home – transcript, page 85). A laptop belonging to each Client would be used to access the Client’s respective network (for security purposes), and the research tasks, for example, would be undertaken on laptops belonging to the Applicant (transcript, pages 71-72).
With respect to the work undertaken by Mrs Ariss, the Applicant stated in his witness statement that (Exhibit A3, paragraph [8]):
I can’t remember when I asked [Mrs Ariss] to assist in the administration of my business but it was certainly early in the piece… I continued basically as a one-man operation with [Mrs Ariss] assisting when required.
At the hearing the Applicant clarified the nature of the work undertaken by Mrs Ariss as follows (transcript, page 42):
…all client facing work was done by myself and my wife’s work was at my direction basically so - and I’d, sort of, advise her what to do and she’d come back and - and come back with the results for me…
Further, under cross-examination Mr Ariss clarified the importance of Mrs Ariss’ work and the effect of the 70% to 30% ratio (transcript, page 49-50):
APPLICANT: The bottom line is particularly 2012-2013, when I was running three clients at the same time, I can't be in three places at one time. We had three laptops in the office at that time. If I was travelling to Queensland for a week, which I did quite regularly, then the - well not so much Fusion but certainly Premier Coal would need to understand that we can react quickly still so my wife would spend time there just monitoring that laptop and if there were service requests that came in and they appeared to be urgent, then she would contact me and I would walk through what we would need to do but I fully agree I was the major part in all this and Lesley did a support role but as I said, sort of don't underestimate support, that's my view, and I thought that what she did, I would not have been able to run those three clients had - because how can I? So - but I managed to run those three clients, run them successfully, and for that she got what she got and I think it's just fair and, yes, her importance can't be underestimated for me because I would not have been able to do the amount of revenue that I did, and that's good for the ATO as well, and I wouldn't have got the length of tenure for the contract that I got at Coronado which has been the main one, so I hear where you're going but I'm not enjoying what you're trying to get at.
MR PEADON: Be that as it may, the way you work this out, you went and told Arms Global that you thought that all the money that was paid for your services should be split 70 per cent to you and 30 per cent to Mrs Ariss?---
APPLICANT: That's it, yes.
MR PEADON: As you said, you might be servicing multiple clients in a week?---
APPLICANT: Yes.
MR PEADON: And let’s say you had a good week and earned $5000?---
APPLICANT: Yes.
MR PEADON: That would mean - I am using broad maths here, Senior Member - that would mean Arms, in accordance with the direction you had given them, would pay $3500 to you and $1500 to Mrs Ariss?---
APPLICANT: Yes.
MR PEADON: Anybody feel free to correct my maths as we do this. If you had, you know, you might have gone on a holiday. The kids might have been sick. You might have just had a down week. So if you had earned $100 in a week, Mrs Ariss has still done her normal amount of work. You get $70 and she gets $30, is that correct?---
APPLICANT: Well, I would say so, yes.
MR PEADON: If you had just a mammoth week, huge week, $10,000?---
APPLICANT: Yes.
MR PEADON: For the same amount of work, instead of getting $30, she gets $3000 if you earn ten?---
APPLICANT: M’mm.
The Applicant agreed, under cross examination, that it was his work personally that the Clients were paying for (transcript, page 70):
MR PEADON: And you would agree with me that the principal work for which you were paid was what you did?---
APPLICANT: The majority of the work is what I did, yes. I - I can't argue with that but as I mentioned previously, particularly 2012/2013, there's no way I could have survived without my wife because I simply didn't have the heads to do it, and - and that's it.
The Applicant’s evidence as to how he arrived at the 70% to 30% ratio was as follows (transcript, page 66):
MR PEADON: And you were also told by somebody at Arms Global or by somebody at RDBMS - - -?---
APPLICANT: Yes.
MR PEADON: - - - that you were able to split your income with your wife?---
APPLICANT: No.
MR PEADON: At 70/30 per cent?---
APPLICANT: No.
MR PEADON: Who told you you could do that then?---
APPLICANT: Well, I knew there was - you could, husband and wife teams could do things, and at the time when I was unemployed, way back when, we had thought, well, maybe we could get a consultancy going together because a mate of mine had done it. In fact, it was now Fusion obligations. So we, at that point we started to collate - even though neither one of us was getting paid, but the - the concept of paying her was purely based on her worth to the - the organisation. Organisation, well, sole trader, and I did - I don't know who told me that bit of it, to be honest with you, but I did - somebody did tell me that and it was probably, I've got lots of, well, bricklaying companies.
…
SENIOR MEMBER: Sorry, which company?---
APPLICANT: Friends of mine who own bricklaying companies and they said it's perfectly legit. Their accountant says you can give a little bit for doing administration and so I may have got it from the pub, to be honest with you, to be brutally honest, so I don't think it was - I don't think it was Arms Global or RDBMS. Like I said, that is a long time ago.
The Applicant directed ARMS to split the income in these percentages, and to withhold money for tax to be remitted to the ATO on his behalf (transcript, pages 65-66).
The Applicant agreed that he was essentially a “sole trader” (transcript, page 53).
He further stated (transcript, page 55):
… there’s no formal partnerships, no. There’s no formal – and there’s no formal contractors, there’s no formal sub-contractors. There’s only my wife.
Ms Velevski also submitted to the Tribunal that her client, the Applicant, was a sole trader (transcript, page 29).
However, the Applicant stated that Mrs Ariss was “an essential part of the business and I wouldn’t have been able to do what I did without her” (transcript, page 55). He further described the work undertaken by Mrs Ariss (transcript, page 77) as having “a high level of instruction and a high level of interaction”.
The Applicant’s evidence was that he did not deliberately seek to avoid tax, and that he has always been responsible with his tax and has sought to pay his fair share (see Exhibit A3, paragraph [16]; and the following from transcript, page 54):
… Senior Member, if you come to that conclusion [that the Applicant had not paid enough tax], I may not agree with it, but I would accept it, but I’m not going to accept being sort of pointed out that I deliberately went to evade tax. It’s just not the case. And I won’t have that. I will never accept that. And that’s my position, but that’s the way it seems to be going here.
He also expressed frustration with the process, as well as with the Respondent (see Exhibit A3, paragraphs [17]-[18] and the following from transcript, page 61):
Over the last 12 years, we've probably contributed 1.4 to the ATO coffers and yet we're still getting chased for 33 grand or whatever it is you decide that you're going to try and attack me for. I mean, it's just not right and that's why I'm getting quite emotive about it all. We were just trying to do the right thing and I was lazy, I should have done my own invoicing. I should have done - I should have set it up like I've got it right - set (indistinct). It wasn't that hard to do that component of it. I just thought it was an easy way out and it's got me in all this sort of rubbish and it's very, very frustrating and, yes, I just want it to go away. I just want a conclusion, yes.
The Applicant also gave evidence at the hearing that he had not seen the following documentation from ARMS that was contained in the T Documents (transcript, page 40-41):
MS VELEVSKI: …If I could please refer you to T156 on page 380?
APPLICANT: Yes.
MS VELEVSKI: So, this is the deed of trust of Arms Global. Did you ever see a copy of that?
APPLICANT: Never, not - but we are talking a long time ago but I - no, I don’t think so, no.
MS VELEVSKI: And then following on T157 on page 394, the consultancy agreement?
APPLICANT: No, I can’t remember. Well, I say I can’t remember but I don’t recall seeing anything like that.
MS VELEVSKI: And have you seen a copy of that T160, the Arms Global position paper on page 412?
APPLICANT: No, no, sorry.
MS VELEVSKI: So, I’ll just go into that T160, just bear with me. The reference to the brochures, which was on page 430?
APPLICANT: Yes.
MS VELEVSKI: Did you ever see any brochures from Arms?
APPLICANT: No, no.
MS VELEVSKI: Did you see the services agreement referred to at paragraph 18 on page 427?
APPLICANT: 427? No.
MS VELEVSKI: And then at 216 - T161, sorry, page 478, did you ever see a response on the position paper prior to the two documents submitted?
SENIOR MEMBER: Sorry, what page was that?
MS VELEVSKI: 478?
APPLICANT: No, definitely not.
These documents will be discussed in detail below.
Mrs Ariss
The evidence of Mrs Ariss was substantially consistent with that of her husband, the Applicant, in terms of the nature of the work she undertook for him.
In her witness statement (Exhibit A4, paragraph [8]) Mrs Ariss stated:
The work that I did included:
a.Conducting research for example if there was a new functionality for the Oracle software, I would do research to see what the reviews were for the new application, whether there were any bugs or issues and so forth. I would then explain this to [the Applicant] and provided the paperwork to support the research;
b. I would prepare documents such as training manuals, for example, [the Applicant] would sometimes draft handwritten notes and I would type it up into a Word documents [sic]. I would also assist in putting together PowerPoint presentations for his work;
c.General administration such as paying bills, filing, backing up computer files, checking Internet and papers for potential business etc.
d.Office maintenance - everything from cleaning, picking up stationery and other supplies, through to ensuring the printer had ink and paper loaded.
The following exchange during cross-examination is relevant to the nature of the business carried out by the Applicant (transcript, page 83):
MR PEADON: Do you have any training in the information technology field?
MRS ARISS: No.
MR PEADON: You agree with me that your husband is a highly qualified, highly experienced information technology specialist in the field of Oracle software?
MRS ARISS:Yes.
MR PEADON: The business that he carries on is one he does by himself; do you agree with that?
MRS ARISS: With my help, yes.
MR PEADON: Do you agree that he’s the one who interacts with the clients, not you?
MRS ARISS: Absolutely.
MR PEADON: Do you agree that it is he who attracts the work and it’s for his services, so far as the clients are concerned, that the payments are made?
MRS ARISS: Yes.
Mrs Ariss stated (Exhibit A4, paragraph [9]) that “…the time spent per week could vary dependent on [the Applicant’s] workload e.g. if a new project such as a system upgrade came up then the workload would increase.” The following exchange under cross examination is relevant to the time that Mrs Ariss spent working for her husband (transcript, pages 83-84):
MR PEADON: In terms of what - your evidence in the witness statement is you said you thought you did about 15 hours per week during the relevant years; is that correct?
MRS ARISS:Around about that but it could be longer and it could be shorter, depending how - how busy we were at the time and what [the Applicant] wanted me to investigate or look into, or things like that, so it could be seven one week, could be 20 another week, so it wasn’t an exact date or time.
MR PEADON: No?
MRS ARISS: Yes, I should imagine so.
MR PEADON: I’m just making sure we understand, on average, call it 15 hours per week?
MRS ARISS: Yes.
MR PEADON: And just picking up what you were saying about the work you were doing, you were doing work at the direction, and under the instruction, of Mr Ariss?
MRS ARISS:Yes.
In terms of whether there was any formal employment relationship, Mrs Ariss stated during cross-examination (transcript, page 85):
MR PEADON: Do you agree with me that there was no formal contractual business partnership between you and your husband during these years of income?
MRS ARISS: Yes.
MR PEADON: Do you agree that you had no contract of employment with your husband?
MRS ARISS: Yes.
MR PEADON: Do you agree that you were not a contractor or a subcontractor - I might be asking the same question in a different way, but there is just no contract between you and your husband to be paid?
MRS ARISS: No, we were just a partnership.
MR PEADON: In a family law sense, if I can put it like that?
MRS ARISS: Yes.
Mrs Ariss also gave evidence that the money she earned was not paid to her, but rather into her husband’s business bank account (transcript, page 86):
MR PEADON: When money was deposited into your bank account, who did it come from?
MRS ARISS:Well, I don’t know because it was - [the Applicant] did that kind of thing.
MR PEADON: It was part of [the Applicant’s] - - -?
MRS ARISS: It wasn’t paid to me.
MR PEADON: …So, your evidence is the cash payments all went to [the Applicant]?
MRS ARISS: Yes. Well, they went to TLC Consultants. I’m not really - - -
The following exchange during cross-examination suggests that Mrs Ariss was attributed 30% of the Applicant’s income, regardless of the total hours of work undertaken during each payment period, although in busy periods she would likely work more hours per week than in quieter periods (transcript, pages 87-88):
MR PEADON: Did you understand that for tax purposes 70 per cent of the income was being attributed to Mr Ariss and 30 per cent of the income was being attributed to you?
MRS ARISS: Yes, yes.
MR PEADON: And you understood that that occurred no matter how much, or how little, was charged each time; do you agree?
MRS ARISS: Yes.
MR PEADON: So, if Mr Ariss - let’s just say the bottom fell out of the economy and he had a bad week and you worked 15 hours, that he would get $70 and you would get $30 for tax purposes?
MRS ARISS: Yes.
MR PEADON: And if you had a fantastic week and he earned $10,000, he would get $7000 and you would get $3000 and you’d still just done 15 hours work?
MRS ARISS:But if he earned $10,000, I wouldn’t have been working 15 hours a week, would I? I’d be working 40, 60 hours a week because - - -
MR PEADON: Let me bring the numbers back then, I was using it as an illustrative purposes. Let me bring the numbers back to 6000, brings it 1200 a day, that’s quite feasible. …. It’s $6000 in a week, he would be paid $4200 and you would be paid $1800…Do you agree that that’s what would happen in a good week?
MRS ARISS: In a good week, yes.
MR PEADON: Yes. And it didn’t matter how much work you had done, what you got paid depended on the split and how much Mr Ariss had earned?
MRS ARISS:Yes, to a certain degree but I think that’s just simplifying it too much because some weeks, yes, I might have only worked 15 hours and got 80 but that - the week after, when he still only worked six - when he got 6000, I might have worked 24, 25, 30 hours, so it’s a broad basis. It’s like you’re taking it out of context and it’s - it’s - we worked - it wasn’t - it wasn’t a nine to five job, it was a 24/7 job, so, you know, I’d be working Sunday morning so he’d pay me double-time. You know, it’s not like that, it’s - it’s a family business and so I don’t think it’s as simplistic as - as you’re saying here, like you work 15 hours and you only - and you’re getting this. Well, maybe I’m worth that, you know.
ARMS
ARMS was established on approximately 6 July 2005 (T156, page 379-390). ARMS (Global) Pty Ltd was the Trustee and the beneficiaries were Jeffrey Killeen and Monika Kloszynski (T156, page 389).
The ATO prepared a Position Paper which reported “on the compliance risks that have been identified or examined during the audit of ARMS (Global) Pty Ltd (ARMS) as Trustee for the ARMS Trust (ARMS Trust)” and which “details the application of the tax law to the identified non compliance” (T160, page 414). The evidence referred to in the Position Paper was obtained from “informal interviews conducted with certain service providers during December 2011 and February 2012”, as well as a “formal interview of Mr Jeffrey Killeen, the sole director of ARMS on 26 March 2012”, and documents obtained from ARMS (T160, page 423).
The Position Paper refers to an ARMS Brochure which listed the advantages of joining ARMS as follows (T160, page 430):
· Full compliance with the 80/20 rule of the Australian Taxation Office (ARMS complies with the unrelated clients test, separate business premises test and the employment test);
· Spouses may join ARMS and receive distributions;
· Being an associate of ARMS defines you as a “self employed individual” for taxation purposes, thereby providing greater avenues for tax planning and tax minimisation.
With respect to spouses receiving contributions, the Position Paper states under the heading “Interviews with Service Providers” that (T160, page 425):
Certain trust distributions by the ARMS Trust were split between the service provider and their spouse, by way of two separate fund transfers. The splitting of income was agreed between ARMS and the service provider and ranged between 25/75 or 50/50. The spouse appears to have been appointed as an ‘associate’ of the ARMS Trust.
The Position Paper then refers to the following frequently asked questions from the ARMS Brochure (T160, page 430):
Q1 How does ARMS satisfy the 80/20 rule?
Arms is an “Organisation” of professionals who are engaged in common to derive income from various sources (similar to a partnership of Accountants, Lawyers etc)… You work on behalf of ARMS (Global). The ‘time’ that you import in performing your duties for ARMS becomes the basis of your distribution, which is paid into your nominated bank account.
Q4 What deductions can I claim?
By being defined a self-employed individual for taxation purposes you can claim the following deductions, which relate to your business related expenses:
(1)Telephone…
(2)Computer…
(3)Home Office expenses…
(4)Motor vehicle expenses…
(5) Other expenses…
The Position Paper refers to a further information brochure titled, “What is ARMS?” which outlines the services ARMS could provide (T160, page 430):
ARMS possess the necessary skills and expertise that is required to perform administrative functions, which enables you to outsource your regular administrative hassles through ARMS… Functions include:
(a)invoicing and debt collection
(b)payments to contractors suppliers and associates
(c)employee payroll
(d)GST collection payments and business activity statements
(e)PAYG and FBT administration
(f)Bookkeeping
(g)contract advice
(h)Superannuation
(i)income protection insurance
(j)work care cover
(k)negative gearing proposal, and
(l)investment property proposals
ARMS will invoice the Client for services rendered and manage all issues relating to the tax system and other business returns… Upon receipt of payments from the Client, a statement of distribution will be prepared to which the Associates are immediately entitled’
The Position Paper further states that the application form to become an “associate” of ARMS stated (T160, pages 431-432):
I wish to become a member of ARMS Global. I have read the documentation and understand that signing this document does not bind me to any contract or financial obligation. I further understand that I will need to become an associate to obtain any income from ARMS Global.
In the Tribunal’s view, the following paragraph from the Respondent’s amended SFIC (Exhibit R3, paragraph [10]) accurately summarises paragraphs 27 to 31 of the Position Paper, which sets out how a person would enter into an arrangement with ARMS:
The arrangements involving the individual professional, the professional’s clients, and ARMS included the following: (a) the professional and the professional’s spouse applied to become “associates” or beneficiaries of the ARMS Trust; (b) the professional negotiated fees for work with a client and directed the client to pay the fees to ARMS; (c) the professional directed ARMS to pay the fees (less a commission of 3% and any agreed withholding) to the bank accounts of the professional and the spouse respectively in specified proportions; (d) ARMS issued tax invoices to the professional’s clients for work performed by the professional, collected the fees, and paid the fees as directed; (e) ARMS issued “Distribution Statements” to the professional and spouse, and advised of the amounts that should be declared as trust distributions in tax returns.
The income taxation returns of the Applicant and Mrs Ariss for the income years ending 30 June 2006 through to 30 June 2013 in which they declared receipt of trust distributions, indicate that some time prior to the financial year ending 30 June 2006, they became associates of ARMS (T3, page 26, T4, page 32, T5, page 39, T182, page 693, T185, page 698, T187, page 757).
The Tribunal has before it a Consultancy Agreement between Wesfarmers Energy (as the Principal) and ARMS Pty Ltd (as the Consultant) which was signed sometime in 2006, but otherwise undated (T157, pages 393-408). This is the only Consultancy Agreement before the Tribunal.
The Consultancy Agreement appears to the Tribunal to be a standard form agreement. Relevant provisions of this Consultancy Agreement are as follows (T157, page 397-407):
2 Commencement
This agreement commences on 1 May 2006 and, subject to clause 17, will terminate on 31 October 2006 (“Term”). The Term may be extended by mutual agreement of the Parties to that effect in writing.
3.1 Provision of Services
The Consultant will provide the Principle with the Services set out in Item 1 of the Schedule (“Services”), and must comply with the Principal’s reasonable requirements in respect of the provision of the Services.
…
4.2 Performance of services
The Services will be performed by the following person or persons (“the Delegate”):
(a)Terry Ariss; or
(b) Any person who the Principal has agreed in writing may replace Terry Ariss; and
(c)Any person who the Principal has agreed in writing may assist Terry Ariss or his replacement.
…
12.1 Principal/contractor relationship
The Consultant is engaged as an independent contractor and nothing in this agreement will be construed so as to constitute, as between the Principal and the Consultant, or as between the Principal and any Personnel, a relationship of partnership, principal and agent, employer and employee, or joint venture. It is the express intention of the parties that any such relationships are expressly denied.
13.1 Fees
In consideration of the Consultant providing the Services, the Principal shall pay the Consultant the fees as set out in the Schedule (“Fees”).
…
Item 1: Services (clause 3.1)
Such professional services as required by the Principal in relation to the implementation of the Oracle EAM module for the Principle including but not limited to:
· Review of Systems as currently implemented by the Principal
· Detailed needs analysis
· Specification of Oracle system to meet needs
· Implementation Planning
· Documentation
· Training…
(Original emphasis.)
The fee payable under clause 13.1 was $1,100.00 per day, exclusive of GST (T157, page 407, Item 2).
On approximately 1 November 2008, ARMS entered into a Consultancy Agreement with Wesfarmers Resources to provide services to be performed solely by the Applicant in relation to Oracle software. The term of the agreement was a period of one year, being
1 November 2008 to 31 October 2009; which was subsequently extended for a further period of one year, until to 31 October 2010 (T158, page 409; T159, page 410).
The Tribunal only has before it one page of the agreement which terminated on
31 October 2009 (T158, page 409). This page does not have a copy of any written agreement concerning the extension, which is only referred to in a series of emails (T159, pages 410-411).
A response to the Position Paper from Mr Jeffrey Killeen, the Director of ARMS (Global) Pty Ltd, states that in summary “The paperwork does not correspond to the reality of the situation nor the intention of all parties, particularly that of ARMS and requires rectification.” (T161, page 479). Part of Mr Killeen’s response states (T161, pages 478-480):
All of the service providers who come to the ARMS Trust have already entered into an agreement whether in writing (letter of offer) or orally with the client or a recruitment agency.
ARMS is not a party to this agreement. A legal contract exists between the service provider and the client and whatever ARMS does or does not do both the service provider and the client can enforce that contract.
ARMS does not agree that it “interposes” on that contract which already exists. A further contract is entered into between ARMS and the service provider whereby ARMS agrees to perform administrative services for the service provider who agrees to pay a fee to ARMS for those services…
It is not the reality nor indeed the intention that ARMS supplies the service provider to the client and the paperwork obtained when the ARMS business was acquired does not correctly reflect the reality nor intention of the parties.
… A legally enforceable contract exists between the service provider and the recruitment agency and ARMS is not a party to this agreement. Whatever ARMS does or does not do both the service provider and the recruitment agency can enforce that contract.
A further contract is entered into between ARMS and the service provider whereby Arms agrees to perform administrative services for the service provider who agrees to pay a fee to ARMS for those services.
The paperwork does not correspond to the reality of the situation nor the intention of all parties, particularly that of ARMS, and requires rectification.
ARMS does not supply service providers to the recruitment agency.
ARMS does not administer the work of the service provider. It provides administrative services to the service provider.
…
Clients do not make payments to ARMS. ARMS Trust receives money on behalf of service providers in the course of its administrative duties. The full amount of which is accounted to the service provider and to the ATO in the trust tax returns.
Further statements made by Mr Killeen in his response to the Position Paper included (T161, page 481 and 482):
… The service provider was not an employee of ARMS and the payments made by the ARMS Trust where distributions under a bare trust.
…
…the amount received by ARMS was for services rendered by ARMS to the service provider. The ARMS Trust distributed the full amount of the service provider who then paid ARMS a fee for services rendered. This distribution was reported annually to the ATO. Further the service provider reported receipt of the full amount in its tax return.
Further, with respect to ARMS being a bare trustee, Mr Killeen stated in his response (T161, page 487):
As previously stated ARMS documentation is inadequate and it is accepted by ARMS that it does not reflect the intention. What remains due to the improper documentation, including the defective Trust Deed is ARMS as a trustee holding a bare trust. ARMS holds any moneys of the service providers in equity as a bare trustee. ARMS, in any event, as a Trustee of the ARMS Trust duly reported distributions to the ATO thereby discharging its real and actual obligations as a bare trustee.
The following statements are relevant to the amounts withheld by ARMS (T161, page 486):
In invoicing all GST was claimed, recorded and remitted to the ATO as part of the administrative duties of ARMS.
…
Except in circumstances where the service provider requested ARMS to withhold and report to the ATO the full amount was distributed to the service provider as a distribution and ARMS reported that to the ATO in its Schedule of Trust Distributions.
Mr Killeen provided the following explanation for the failure of the consultancy and trust documentation to accurately reflect the nature of the agreement (T161, pages 484 and 485):
At a. above the service provider confirms that it first entered into an agreement with the client or a recruitment agency. At c. they agree that they then approached ARMS and consequently there was a second agreement between arms and the service provider for ARMS to provide administrative services. However this audit has revealed that arms commercial structure and documents do not properly reflect the reality and what is intended. ARMS accepts with hindsight that it should have had the documents checked by a lawyer. ARMS used the set up documents created by Paul Ingle & Associates from whom the business was acquired in 2002.
…
ARMS purchased the Trust Deed from a legal stationer who advised that a lawyer had drafted the Deed. The stationer was told of ARMS requirements and as a substantial amount of money was paid for the deed ARMS believed that the Deed enabled the ARMS Trust to take associates and distribute to those associates. The Trust deed requires rectification. In any event ARMS held the monies received on bare trust for the service providers.
ARMS issued tax invoices to the Clients of the Applicant. The Clients paid a daily rate for the services provided by the Applicant (see T30-T155; T178). As noted above, this was initially $1,100 but after 2010 was increased to $1,200 (transcript, page 78).
Additionally, ARMS issued Distribution Statements to the Applicant and Mrs Ariss, in which the amounts paid by ARMS to them were stated as “Salary” (T179, pages 665-679). These Distribution Statements also showed the withholding of a 3% management fee and amounts for PAYG.
ARMS also issued an Annual Distribution Statement (see for example for the year ended 30 June 2011, T179) in which the Applicant’s “income” was listed as a “Taxed Trust Distribution (Item 13U)”.
As mentioned above, the Applicant and Mrs Ariss then declared these distributions as trust income in their annual income tax returns.
Findings of fact based on the above evidence
Based on the evidence outlined above, the Tribunal makes the following findings of fact:
(a)The Applicant is a highly skilled information technology specialist. He has a unique set of skills with respect to Oracle software, particularly in the enterprise management area, which put him in demand with the Clients. The Applicant attracted the work, was the main point of contact with the Clients, and the payment he received from the Clients was due to the professional services he provided.
(b)The Applicant was not an employee of ARMS, but rather a “sole trader”. He was assisted by Mrs Ariss, who worked under his supervision and instruction. There was a tenuous correlation between her hours of work and the 30% of the Applicant’s income that she was allocated. However, the Tribunal accepts that in busy periods when Mr Ariss was paid more, she was likely to have undertaken more work. There was no formal employment relationship, or partnership between the Applicant and Mrs Ariss. She was not an independent contractor.
(c)The Applicant was paid a daily rate and although he described working on “projects” his work was not dependent on project completion. The Applicant was paid regardless of where any “project” was up to, a payment was never delayed if a project was not completed, and he did not have to remedy any defaults at his expense.
(d)The Applicant undertook his work from a dedicated home office using laptops belonging to the Clients to access their networks, in addition to using his own laptops to complete tasks.
(e)The evidence tends to suggest that
some time prior to the financial year ending
30 June 2006, the Applicant and Mrs Ariss became associates of ARMS.
(f)The Tribunal accepts the Applicant’s evidence that there was no formal written contract in place between the Clients and the Applicant directly, due to the Applicant already having established relationships with the Clients.
(g)The evidence does however tend to suggest that there were standard form Consultancy Agreements in place between ARMS and the Clients. The Consultancy Agreements did not reflect the reality of the relationship between ARMS and the Clients. The Applicant was not a party to these Consultancy Agreements (but was named as a “Delegate”), and the Tribunal accepts his evidence that he did not see copies of this documentation.
(h)The Tribunal accepts that the Applicant entered into an arrangement with ARMS to reduce the administrative burden of running a business and to simplify his business administration. The extent of the Applicant’s arrangement with ARMS was that the Applicant advised ARMS of the number of hours that he had worked for each client; at which point ARMS invoiced the Clients, withheld PAYG and superannuation contributions, and allocated an income split of the 70% to 30% ratio between the Applicant and Mrs Ariss. ARMS only acted as directed by the Applicant, which is indicative that ARMS was a bare trust.
(i)There was no deliberate intention on the part of the Applicant to unlawfully avoid his taxation liabilities. He did not realise that he was doing anything wrong. Indeed, the Tribunal notes that the income splitting arrangement with Mrs Ariss was not based upon proper accounting advice. It was based on a suggestion from friends of the Applicant, whom the Tribunal notes operate a bricklaying business and who to the knowledge of the Tribunal have no formal qualifications in the field of taxation. However, Mrs Ariss did not directly receive any of the money apportioned to her. The amounts apportioned to her went into the business account of the Applicant. Thus, the Applicant did receive a benefit from the 70% to 30% ratio arrangement, which was to lower his taxable income, and thereby pay less income tax.
(j)The Tribunal notes that ARMS misrepresented that certain deductions and income splitting arrangements complied with taxation laws in its brochures. The Tribunal accepts that the Applicant had not seen these brochures or the other documentation from ARMS discussed in the Position Papers.
ORDINARY INCOME ISSUE
Section 4-1 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) provides that “Income tax is payable by each individual and company, and by some other entities”.
A person or entity must pay income tax on their taxable income in each financial year
(s 4-10(1) and (2) ITAA 1997).
“Taxable income” is the sum of “assessable income”, less the sum of “deductions”
(s 4-15(1) ITAA 1997).
Section 6-1(1) of the ITAA 1997 provides, that “assessable income consists of ordinary income and statutory income”.
In relation to ordinary income, s 6-5(1) of the ITAA 1997 provides that: “Your assessable income includes income according to ordinary concepts, which is called ordinary income.” (Original emphasis.)
In summary, ordinary income is “income according to ordinary concepts” (s 6-5(1) ITAA 1997) which means that it has been defined by the courts at common law. It has been recognised to include income from employment, income from carrying on a business, and income from property including rent, interest and dividends.
Further, s 6-5(4) of the ITAA 1997 concerns when a person is deemed to have derived the ordinary income. It provides:
(4) In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.
(Original emphasis.)
The evidence of the Applicant and Mrs Ariss indicated that the amounts attributed by ARMS to them were not in reality trust distributions, despite being listed as such in their tax returns for the relevant years. Their evidence was that ARMS assisted with some of the administration of the Applicant’s business in that it invoiced the Clients at a daily rate, withheld PAYG and attributed the income of Mr Ariss at a 70% to 30% ratio for a 3% administration fee (which included insurance). The evidence of the Applicant was that ARMS was acting in accordance with his directions. The income was derived from
Mr Ariss carrying on a business as a “sole trader” in which he used his own intellect, skills and specialist expert knowledge in aspects of Oracle.Consequently, the Tribunal finds that the distributions from ARMS were the ordinary income of the Applicant at the time the amounts were paid to ARMS by the Clients. This finding is relevant to whether the Applicant can claim the clerical deductions and whether the clerical deductions are unreasonable.
PERSONAL SERVICES INCOME ISSUE
The Respondent submitted that as well as being ordinary income, the payments made by the Clients to the Applicant, through ARMS, were also personal services income (PSI). However, the Applicant argues that even if the income was PSI, the PSI rules do not apply because the results test is satisfied.
Section 84-5 of the ITAA 1997 sets out the 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).
…
(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.
(Emphasis added.)
Applying s 84-5 of the ITAA 1997, the Tribunal finds that the amounts paid by the Clients to ARMS for the professional services provided by the Applicant were “personal services income”. This is because the amounts were remuneration for the personal efforts and skills of the Applicant in providing specialist IT services with respect to Oracle.
Subsection 87-15(1) of the ITAA 1997 provides that:
(1) An individual or personal services entity conducts a personal services business if:
(a) for an individual - a personal services business determination is in force relating to the individual's personal services income; or
(b)for a personal services entity - a personal services business determination is in force relating to an individual whose personal services income is included in the entity's ordinary income or statutory income; or
(c)in any case - the individual or entity meets at least one of the 4 personal services business tests in the income year for which the question whether the individual or entity is conducting a personal services business is in issue.
…
Note 2: Under subsection (3), the personal services business tests, apart from the results test under section 87-18, do not apply if 80% or more of your personal services income is from one source (but they can still be used in deciding whether to make a personal services business determination).
(Original emphasis.)
ARMS did not have a personal services business determination in force relating to the Applicant. Therefore, ARMS was not conducting a personal services business. The Applicant did not have a personal services business determination in force either, and so the Tribunal must consider whether the Applicant meets the four personal services business tests. Subsection 87-15 of the ITAA 1997 provides:
(2)The 4 personal services business tests are:
(a)the results test under section 87-18; and
(b)the unrelated clients test under section 87-20; and
(c)the employment test under section 87- 25; and
(d)the business premises test under section 87-30.
(Original emphasis.)
The PSI rules, which limit certain deductions and attribute income to an individual from an interposed entity (in this case ARMS), will not apply if the Applicant satisfies all of the conditions in the results test. The results test is set out in s 87-18 of the ITAA 1997 which provides, in part:
The results test for a personal services business
(1)An individual meets the results test in an income year if, in relation to at least 75% of the individual’s personal services income (not including income referred to in subsection (2)) during the income year:
(a)the income is for producing a result; and
(b)the individual is required to supply the plant and equipment, or tools of trade, needed to perform the work from which the individual produces the result; and
(c)the individual is, or would be, liable for the cost of rectifying any defect in the work performed.
…
(4) For the purposes of paragraph (1)(a), (b) or (c) or (3)(a), (b) or (c), regard is to be had to whether it is the custom or practice, when work of the kind in question is performed by an entity other than an employee:
(a)for the personal services income from the work to be for producing a result; and
(b)for the entity to be required to supply the plant and equipment, or tools of trade, needed to perform the work; and
(c)for the entity to be liable for the cost of rectifying any defect in the work performed;
as the case requires.
Although the Applicant referred to working on “projects” for the Clients, whether an Applicant was paid to produce a result is a matter of substance over form. As stated by Senior Member Sweidan in Re Skiba and Federal Commissioner of Taxation [2007] AATA 1705; 67 ATR 682 at [67]:
The cases show that the terminology use by the parties is not and cannot be determinative. The words of the statute require one to look to the actuality of what occurred. Substance must be determined on the evidence of the whole of the relationship…
In IRG Technical vFederal Commissioner of Taxation (2007) FCA 1867, 165 FCR 57 (IRG) at 72 [50], Allsop J made the following comments regarding s 87-18(3) (whether a personal services entity meets the results test), which in the Tribunal’s opinion, are equally applicable to s 87-18(1) (whether the individual meets the results test):
The whole purpose of s 87-18(3), as is plain from the secondary material, is to bring an eye guided by substance, not form, to the circumstances of the provision of the personal services to the party who acquires or receives them. The central relationship for examination (irrespective of the nature and number of interposed entities) is between the individual whose exertions produce the personal service income and the requirer or acquirer of those exertions or services. Thus, in assessing what the income is "for" and whether the income is "for producing a result" (in s 87-18(3)(a)), one directs attention to all the circumstances of the individual, and in particular, what the individual does at, and with, the ultimate acquirer or requirer of the services.
The above passage from IRG was cited by Senior Member Taylor in Douglass and Commissioner of Taxation [2018] AATA 3729 at [20]:
Consistent with the statutory objective of applying to mere “arrangements”, but not to “genuine businesses”, in IRG Technical Services Pty Ltd Allsop J made the further point that characterisation of the nature of the taxpayer’s “personal services income” depended on the circumstances of the entity that actually received the benefit of the taxpayer’s work. This involved rejection of the idea that the terms of the contract between the individual engineer (or their corporate entity) and the labour hire company were conclusive: - see also Skiba at [61]. Instead the required approach is one of “looking through” that contract and having regard to the totality of the circumstances in which the services were provided.
The Federal Court recently dismissed an appeal by the Applicant, Mr Douglass (Douglass v Commissioner of Taxation [2019] FCA 1246).
In the relevant income years, the Applicant was paid for performing work and providing services, rather than producing a result. Specifically, as noted above, the Applicant charged a daily rate regardless of where any “project” was up to. The Applicant worked on his own laptops, and laptops were also provided by the Clients for the purpose of accessing the Client’s systems for security reasons. The Applicant’s evidence was that payment was never delayed if a project was not completed, and he did not have to remedy any defaults at his expense. There is no evidence before the Tribunal of any custom or practice. Consequently, the Tribunal finds that the Applicant did not meet the results test pursuant to s 87-18(1) of the ITAA 1997 in the 2010, 2012 and 2013 income years.
The situation of the Applicant is not dissimilar to one the Applicants in IRG, a skilled Engineer, who was found not to be producing a result. At 83 [110], Allsop J stated:
For the above reasons, in my view, the income of Mr Green (the personal services income of the relevant individual included in IRG’s income) was not for producing a result. Without restricting what I have already said, it was for the performance of work as a skilled engineer in the business of the KJV as part of a co-ordinated team of engineers and remunerated on an hourly rate for such work. This work involved Mr Green producing, from time to time, documents, schedules and data sheets, and involved him in identifiable tasks and responsibilities. It would not be a reflection of substantial reality, however, to say that his income was for the results he produced. It was for his work as a skilled engineer, which work produced those results or outcomes, as a necessary professional consequence of the work of a skilled lead instrument engineer on such a project.
(Emphasis added.)
Further, s 87-15(3) of the ITAA 1997 provides, in part, that:
(3)However, if 80% or more of an individual's personal services income (not including income referred to in subsection (4)) during an income year is income from the same entity (or one entity and its associates), and:
(a)the individual's personal services income is not included in a *personal services entity's ordinary income or statutory income during an income year, and the individual does not meet the results test under section 87-18 in that income year; or
(b)the individual's personal services income is included in a personal services entity's ordinary income or statutory income during an income year, and the entity does not, in relation to the individual, meet the results test under section 87-18 in that income year;
the individual's personal services income is not taken to be from conducting a personal services business unless:
(c)when the personal services income is gained or produced, a personal services business determination is in force relating to the individual's personal services income; and
(d)if the determination was made on the application of a personal services entity - the individual's personal services income is income from the entity conducting the personal services business.
Applying s 87-15(3) of the ITAA 1997, although in 2010 and 2012 the Applicant received more than 80% of his work from a single client, as noted above, he did not pass the results test because he was paid for performing work and providing services rather than producing a result.
In 2013, the Applicant did not receive at least 80% of his work from a single client, but for the reasons stated above, he did not satisfy the results test, and as set out below, he did not satisfy any of the other personal services business tests, being the unrelated clients test, employment test, or the business premises test.
The unrelated clients test is set out in s 87-20 of the ITAA 1997, which in part, provides:
(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.
…
This test is not satisfied because there is no evidence that the Applicant made direct offers or invitations to the public, for example by advertising to provide services. Rather, it appears that the Applicant obtained work through his existing business relationships and contacts. He was in demand from people who knew him and did not need to advertise.
The employment test is set out in s 87-25 of the ITAA 1997 which provides in part:
(1) An individual meets the employment test in an income year if:
(a)the individual engages one or more entities (other than associates of the individual that are not individuals) to perform work; and
(b)that entity performs, or those entities together perform, at least 20% (by market value) of the individual's principal work for that year.
…
This test also is not satisfied as the Applicant did not have any employees. The evidence of the Applicant and his wife was that there was no formal employment relationship, or partnership between the Applicant and Mrs Ariss, nor was she an independent contractor. Additionally, Mrs Ariss is an “associate” because she is a relative (that is the spouse) of the Applicant (see s 318(1)(c) Income Tax Assessment Act 1936 (Cth) (ITAA 1936).
Further, s 87-30(1) of the ITAA 1997 sets out when an individual will meet the business premises test as follows:
(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.
The definition of “premises” was discussed by Emmett J in Federal Commissioner of Taxation v Dixon Consulting Pty Limited [2006] FCA 1748; (2006) 65 ATR 290 at [48]:
There is no reason why the word ‘premises’ should not be understood according to its ordinary English usage. Premises means a house or building with the grounds, etc. belonging to it (Macquarie Dictionary, 4th ed, The Macquarie Library Pty Ltd, Macquarie, 2005); it also means a house or building, together with its land and outbuildings occupied by a business or considered in an official context (Shorter Oxford English Dictionary, 5th ed, Oxford University Press, Oxford, 2002).
In summary, a “premises” is a house or building together with the land. The Applicant does not satisfy this test because he worked from a single room (a dedicated home office) in his private residence.
PART IVA ISSUE
As the Tribunal has found that the payments made by the Clients to the Applicant (through ARMS) were ordinary income, as well as PSI, it is unnecessary for the Tribunal to consider the Part IVA issue. However, some of the submissions made by the parties in relation to the Part IVA issue are relevant to the limited amendment period issue below.
CLERICAL DEDUCTIONS ISSUE
Section 8-1 of the ITAA 1997 provides that:
(1)You can deduct from your assessable income any loss or outgoing to the extent that:
(a)it is incurred in gaining or producing your assessable income; or
(b)it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
Note:Division 35 prevents losses from non‑commercial business activities that may contribute to a tax loss being offset against other assessable income.
…
(Emphasis added.)
There was no legal relationship between the Applicant and Mrs Ariss. To clarify, both the Applicant and Mrs Ariss gave evidence that she was not an employee, a business partner or an independent contractor. The Tribunal has found that the Applicant was essentially a sole trader who was paid for his time, based on his expert skill and experience in aspects of the Oracle software. Consequently, there was no legal obligation for the Applicant to pay Mrs Ariss. Further, practically speaking, she was not paid at all, with the monies apportioned to her being paid by ARMS into the Applicant’s business bank account. Consequently, the 30% apportioned to Mrs Ariss was not incurred in gaining or producing the Applicant’s assessable income.
UNREASONABLE DEDUCTION ISSUE
Section 26-35 of the ITAA 1997 provides the following:
Reducing deductions for amounts paid to related entities
You can only deduct reasonable amounts paid to related entities
(1)If, under another provision of this Act, you can deduct an amount for a payment you make, or for a liability you incur, to a related entity, then you can only deduct so much of the amount as the Commissioner considers reasonable.
Note: This section has a special operation if the payment is made, or the liability is incurred, by a partnership in which a private company is a partner: see section 65 (Payments to associated persons and relatives) of the Income Tax Assessment Act 1936.
Meaning of related entity
(2)A related entity is any of the following:
(a)your relative; or
(b)a partnership in which your relative is a partner.
(3)In the case of a partnership, a related entity is any of the following:
(a)a relative of a partner in the partnership;
(b)an individual who is or has been a director of a company that is a partner in the partnership and is a private company for the income year;
(c)an entity that is or has been a shareholder in a company of that kind;
(d)a relative of an individual who is or has been a director or shareholder of a company of that kind;
(e)a beneficiary of a trust if the trustee is a partner in the partnership;
(f)a relative of a beneficiary of a trust if the trustee is a partner in the partnership;
(g)another partnership, if a partner in the other partnership is a relative of a partner in the first partnership.
However, a partner in a partnership is not a related entity of the partnership.
If you can’t deduct, then related entity doesn’t include amount as income
(4)To the extent that subsection (1) stops you deducting an amount, the amount is neither assessable income, nor exempt income, of the related entity.
(Original emphasis.)
Subsection 995-1(1) of the ITAA 1997 defines “relative” as including “the person’s spouse”.
The issue for the Tribunal is whether the Applicant’s claim of the 30% income nominally attributed to Mrs Ariss was unreasonable. Although Mrs Ariss estimated that during the relevant income years she worked approximately 15 hours per week, regardless of how many hours Mrs Arris worked she would be attributed 30% of the Applicant’s income.
The Respondent contends that the amounts earned by Mrs Ariss were unreasonable for the nature and type of work she performed, which was largely administrative in nature. Specifically, she was apportioned $94,980.00 in 2010, $90,900.00 in 2012 and $123,624.00 in 2013. The Tribunal accepts the Applicant’s evidence that Mrs Ariss’ work was invaluable to him and that he could not have managed the work without her. However, the evidence before the Tribunal suggests that given the time worked by Mrs Ariss, and the administrative nature of the tasks undertaken, that the flat amount of 30% was unreasonable in the circumstances. Additionally, the fact that the income attributable to Mrs Ariss was not received directly by her, but rather was paid into the Applicant’s business account also tends to indicate that the deduction was unreasonable.
PSI ASSOCIATE DEDUCTIONS ISSUE
Section 85-20 of the ITAA 1997 provides that:
(1)You cannot deduct under this Act:
(a)any payment you make to your associate; or
(b)any amount you incur arising from an obligation you have to your associate;
to the extent that the payment or amount relates to gaining or producing your personal services income.
(2)Subsection (1) does not stop you deducting a payment or amount to the extent that it relates to engaging your associate to perform work that forms part of the principal work for which you gain or produce your personal services income.
(3)An amount or payment that you cannot deduct because of this section is neither assessable income nor exempt income of your associate.
A “spouse” is an “associate” (s 318(1)(c) ITAA 1936). On the basis of the Tribunal’s finding that the Applicant’s income was PSI, the amounts paid to Mrs Ariss are not deductable because Mrs Ariss is an associate of the Applicant.
SUPERANNUATION ISSUE
Former s 290-160 of the ITAA 1997 which is applicable to the relevant income years provides the following:
(1)This section applies if:
(a)in the income year in which you make the contribution, you engage in any of these activities:
(i) holding an office or appointment;
(ii) performing functions or duties;
(iii) engaging in work;
(iv) doing acts or things; and
(b)the activities result in you being treated as an employee for the purposes of the Superannuation Guarantee (Administration) Act 1992 (assuming that subsection 12(11) of that Act had not been enacted).
(2) To deduct the contribution, less than 10% of the total of the following must be attributable to the activities:
(a)your assessable income for the income year;
(b)your reportable fringe benefits total for the income year.
Subsection 12(3) of the Superannuation Guarantee (Administration) Act 1992 (Cth) (SGAA) provides that:
(3)If a person works under a contract that is wholly or principally for the labour of the person, the person is an employee of the other party to the contract.
The Applicant meets the extended definition of an “employee” in s 12(3) of the SGAA because he had a contractual relationship with the Clients, in which he provided specialist professional services in Oracle. That is, his contractual relationships with the clients were wholly or principally for his labour. In the 2012 and 2013 income years, more than 10% of his assessable income was attributable to the work the Applicant engaged in as an employee within the meaning of this extended definition.
Section 290-60 of the ITAA 1997 provides that:
(1)You can deduct a contribution you make to a superannuation fund, or an RSA, for the purpose of providing superannuation benefits for yourself (regardless whether the benefits are payable to your SIS dependants if you die before or after becoming entitled to receive the benefits).
Note:Other provisions of this Act and the Income Tax Assessment Act 1936 may reduce, increase or deny the deduction in certain circumstances. For example, see section 26‑55 of this Act.
(2)However, the conditions in sections 290‑155, 290‑165, 290‑167, 290‑168 and 290‑170 must also be satisfied for you to deduct the contribution.
…
Section 290-170(1) of the ITAA 1997 provides the following:
Deductibility of contributions
(1)To deduct the contribution, or a part of the contribution:
(a)you must give to the trustee of the fund or the RSA provider a valid notice, in the approved form, of your intention to claim the deduction; and
(b)the notice must be given before:
(i) if you have lodged your income tax return for the income year in which the contribution was made on a day before the end of the next income year—the end of that day; or
(ii) otherwise—the end of the next income year; and
(c)the trustee or provider must have given you an acknowledgment of receipt of the notice.
…
The Tribunal agrees with the Respondent’s submission that s 290-170 of the ITAA 1997 also operates to deny the Applicant a deduction for his personal contributions to superannuation in the 2012 and 2013 income years. There is no evidence before the Tribunal that the Applicant gave notice to the Trustee of his superannuation fund within the time specified in s 290-170(1) of the ITAA 1997. Consequently, the Applicant has failed to meet the burden under s 14ZZK of the Taxation Administration Act 1953 (Cth) (TAA) of establishing the assessments are excessive with respect to disallowing this deduction.
TRAVEL EXPENSE ISSUE
Subsection s 8-1(1)(a) of the ITAA 1997 allows a person to deduct from their assessable income any loss or outgoing incurred in gaining or producing their assessable income. In the 2010 income year, the Applicant claimed expenses for travel and parking to the sum of $3,750.00.
In a letter from the Applicant’s accountant to the Respondent dated 30 September 2014, the Applicant’s accountant responded to the Respondent’s intention to amend the Applicant’s 2010 income taxation return (see T7, page 49), stating that “Mr Ariss was reimbursed for any expenses incurred travelling to Wesfarmers” (T8, page 54). The Applicant has not adduced any evidence to indicate that he was not reimbursed. Consequently, the Tribunal finds that there was no loss or outgoing that could be deducted.
WERE THE AMENDMENTS WITHIN TIME?
The final issue is whether the Respondent was within time to amend the assessments.
Subsection 170(1) (Table, Item 1, Time of Amendment) of the ITAA 1936 provides that:
The Commissioner may amend an assessment of an individual for a year of income within 2 years after the day on which the Commissioner gives notice of the assessment to the individual.
However, Qualification (d) and (e) states that:
This item does not apply…:
(d) if the individual is a beneficiary of a trust estate at any time in that year unless the trust is a small business entity for that year or the trustee of the trust (in that capacity) is a full self‑assessment taxpayer for that year; or
(e) if it is reasonable to conclude that any person entered into or carried out a scheme (either alone or with others) for the sole or dominant purpose of the individual obtaining a scheme benefit in relation to income tax from the scheme for that year;…
Item 4 of s 170(1) provides that:
If item 1, 2 or 3 does not apply, the Commissioner may amend an assessment within 4 years after the day on which he or she gives notice of the assessment to the taxpayer.
Subsection 995-1(1) of ITAA 1997 defines a scheme (see s 170(14) of ITAA 1936) as follows:
"scheme" means:
(a)any arrangement; or
(b)any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.
A “scheme benefit” is defined by s 284-150 in Schedule 1 to the TAA (see s 170(14) of ITAA 1936) as:
(1) An entity gets a scheme benefit from a scheme if:
(a)a tax-related liability of the entity for an accounting period is, or could reasonably be expected to be, less than it would be apart from the scheme or a part of the scheme; or
(b)an amount that the Commissioner must pay or credit to the entity under a taxation law for an accounting period is, or could reasonably be expected to be, more than it would be apart from the scheme or a part of the scheme.
ARMS held monies on trust for its associates (also referred to as members). The Applicant and Mrs Ariss were associates (beneficiaries) of ARMS. Consequently, the Respondent was within time to amend the assessments pursuant to Qualification (d) of
s 170(1) of the ITAA 1936 because the Applicant was a beneficiary of a trust estate.
Although not necessary to consider because the Tribunal has already determined that the Respondent could amend the assessments under Qualification (d) of s 170(1) of the ITAA 1936 (Table, Item 1), for the avoidance of any doubt, the Tribunal will briefly consider whether any person entered into or carried out a scheme for the sole or dominant purpose of the individual obtaining a scheme benefit (Qualification (e) of s 170(1) of the ITAA 1936 (Table, Item 1)).
In Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 (Spotless) at 423, the High Court described the “dominant purpose” as the “most influential and prevailing or ruling purpose”.
There is no requirement that the benefit was obtained or obtainable. As noted by the Full Court of the Federal Court in Kocharyan v Commissioner of Taxation [2015] FCAFC 196 at [66]-[67], “The language of s 170 is clear and unambiguous. It is concerned with the taxpayer’s sole or dominant purpose, not whether that purpose was achieved or was achievable”.
The test is an objective one. As noted by the High Court in the context of s 177D of Part IVA in Spotless at 422:
…the question is whether, having regard, as objective facts, to the matters answering the description in par (b), a reasonable person would conclude that the taxpayers entered into or carried out the scheme for the dominant purpose of enabling the taxpayers to obtain a tax benefit in connection with the scheme.
As noted above, the Tribunal is not of the opinion that the Applicant deliberately set out to avoid his taxation obligations. The Tribunal accepts that the Applicant thought the income splitting arrangement with ARMS was a legitimate arrangement that was compliant with tax laws.
However, when the Tribunal views the evidence from the perspective of a reasonable person, the evidence tends to indicate the existence of such a scheme and a scheme benefit. Whilst the arrangement with ARMS made the administration of the Applicant’s business easier (for example, ARMS would issue invoices to the Clients on the Applicant’s behalf, withhold PAYG tax and the like), the 70% to 30% ratio arrangement had the additional benefit of reducing the Applicant’s tax liability by the Applicant being able to direct that the monies received from the Clients be split in that ratio. The Applicant and Mrs Ariss then declared these as trust distributions in their personal tax returns for the relevant income years which had the effect of reducing the Applicant’s taxable income. Further, the Applicant had no legal obligation to pay Mrs Ariss, and she did not receive any of the money (which was paid by ARMS into the Applicant’s business account). But for the scheme, 100% of the income would have been paid to the Applicant by the Clients directly, or by ARMS to the Applicant (less the 3% management fee) and would likely have been included as part of his assessable income in his income tax returns for the relevant years.
Consequently, the Tribunal finds that a reasonable person would conclude that the Applicant entered into a scheme, which had the dominant purpose of obtaining a scheme benefit; therefore, the Respondent was within time to amend the assessments pursuant to Qualification (e) of s 170(1) of the ITAA 1936.
CONCLUSION
For the reasons outlined above, the Tribunal finds that, for the relevant income years:
(a)The amounts paid by the Clients to ARMS for professional services provided by the Applicant were ordinary income, as well as personal services income;
(b)It was unnecessary to decide the Part IVA issue;
(c)The Applicant is not entitled to deductions for amounts disclosed by Mrs Ariss in her income tax returns, nor is he entitled to deductions for the superannuation and travel expenses; and
(d)The Respondent was within time to amend the assessments.
The Applicant has been unable to meet the burden of establishing that the amended assessments were excessive or otherwise incorrect (s 14ZZK(b)(i) of the TAA).
DECISION
Accordingly, the correct or preferable decision is to affirm the Reviewable Decision of
9 August 2017.
I certify that the preceding one hundred and forty-four (144) paragraphs are a true copy of the reasons for the decision herein of Senior Member Dr M Evans
......[sgd]..................................................................
Associate
Dated: 23 August 2019
Dates of hearing:
25 and 26 March 2019
Representative for the Applicant:
Solicitors for the Applicant:
Ms D Velevski
Diana Velevski Tax Lawyers
Counsel for the Respondent:
Mr C J Peadon
Solicitors for the Respondent:
The Australian Government Solicitor
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