Douglass and Commissioner of Taxation (Taxation)

[2018] AATA 3729

Douglass and Commissioner of Taxation (Taxation) [2018] AATA 3729 (3 October 2018)

Division:Taxation and Commercial Division

File Number(s):2016/4403; 2017/1355; 2017/1356      

Re:Roderick DOUGLASS  

APPLICANT

Commissioner of TaxationAnd  

RESPONDENT

Decision

Tribunal:Mr P W Taylor SC, Senior Member

Date:3 October 2018  

Place:Sydney

The objection decisions of 23 June 2016 and 7 March 2017, relating to assessments for the 2013 and 2014 tax years, are each affirmed.

...........................[sgd].............................................

Mr P W Taylor SC, Senior Member

Catchwords

TAXATION – review of objection decisions – whether Applicant engaged by employer to produce a result – whether the Applicant’s partnership business satisfied the “results test” and was therefore a personal services business – relevance of “custom or practice” to “results test” criteria – criterion for producing a result not statutorily defined – concept of “working for a result” distinguished from “income for producing a result” – Applicant’s conduct with respect to reporting income satisfies criterion of recklessness – decisions under review affirmed.

Legislation

Explanatory Memorandum to the New Business Tax System (Alienation of Personal Services Income) Act 2000 - Paragraphs 1.115, 1.116, 1.117

Income Tax Assessment Act 1936 s 170(1)
Income Tax Assessment Act 1997 - Part 2-42, ss 84-5, 84-10, 86-15, 87-1, 87-10, 87-14, 87-15, 87-18, 87-20, 87-25, 87-30, 87-60, 87-65
New Business Tax System (Alienation of Personal Services Income) Act 2000
Revised Explanatory Memorandum to the Taxation Laws Amendment Bill (No 6) 2001 - paragraphs 2.8, 7.6
Tax Administration Act 1953 – ss 298-20, 284-75, 284-90

Taxation Laws Amendment Act (No 6) 2001

Cases

BP Refinery (Westernport) Pty Ltd v Hastings Shire Council (1977) 180 CLR 266; (1977) 16 ALR 363

BRMJCQ Pty Ltd v Federal Commissioner of Taxation, Re [2010] AATA 311; (2010) 79 ATR 220
Commissioner of Taxation v Metaskills Pty Ltd (2003) 130 FCR 248
Commissioner of Taxation v Traviati [2012] FCA 546
Con-Stan Industries v Norwich Winterthur Insurance (Aust) Ltd (1986) 160 CLR 226
Cooper v Federal Commissioner of Taxation, Re (2010) 78 ATR 669; (2010) ATC 10-130
Electricity Generation Corporation v Woodside Energy Ltd  [2014] HCA 7; (2014) 251 CLR 640
Federal Commissioner of Taxation v Hart [2004] HCA 26; 217 CLR 216; 206 ALR 207; 2004 ATC 4599; 55 ATR 712
Federal Commissioner of Taxation v R & D Holdings Pty Ltd [2007] FCAFC 107; (2007) 160 FCR 248
Hart v FC of T [2003] FCAFC 105; (2003) 131 FCR 2003
Imperial Group plc v Philip Morris Ltd [1984] RPC 293
Interlego AG v Croner Trading Pty Ltd (1991) 102 ALR 379
IRG Technical Services Pty Ltd v DCT [2007] FCA 1867; 165 FCR 57
Mainteck Services Pty Ltd v Stein Heurtey SA [2014] NSWCA 184; (2014) 89 NSWLR 633
Masterton Homes Pty Ltd v Palm Assets Pty Ltd (2009) 261 ALR 382; [2009] NSWCA 234
Norwest Beef v Peninsular and Oriental (1987) 8 NSWLR 568
Park v Commissioner of Taxation [2011] AATA 567
Pridecraft Pty Ltd v FCT (2004) 213 ALR 450; [2004] FCAFC 339
Ritz Hotel Ltd v Charles of the Ritz Ltd (1988) 15 NSWLR 158
Ryan v Federal Commissioner of Taxation [2004] AATA 753; [2004] ATC 2181
Skiba v FC of T [2007] AATA 1705; (2007) 67 ATR 682; [2007] ATC 2647
Taneja v Federal Commissioner of Taxation [2009] AATA 87
Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165

Walstern v FCT (2003) 138 FCR 1; [2003] FCA 1428

Secondary Materials

Taxation Ruling [2001/8] Income tax: what is a personal services business, Australian Taxation Office

Taxation Ruling TR 2005/16, Income tax: Pay As You Go – withholding from payments to employees, Australian Taxation Office

REASONS FOR DECISION

Mr P W Taylor SC, Senior Member

1. Mr Douglass is an electronics engineer.  Prior to December 2015 he had worked for many years on large infrastructure projects, mainly in Western Australia.  He did so as the principal, and the sole service provider, of a “control systems engineering” business.  The business typically operated by contracting with a labour hire firm to provide Mr Douglass’ services to one of the firm’s clients.  The business did not have its own premises.  Mr Douglass’ practice was to work either at the client’s premises, by remote connection to the client’s office, or from his own home.

2. Between 2000 and 2014 the formal entities that operated Mr Douglass’ engineering business were as follows:-

   (a)2000 to 2007 tax years:-  the “RGD & SED” partnership, between Mr Douglass and his then spouse.

   (b)2008 to 2010 tax years:-  Douglass Engineering Services Pty Ltd,  a company Mr Douglass operated after divorcing from his first wife, and of which he was the sole director and shareholder.

   (c)2011 to 2014 tax years:-  the “RGD & MLG” partnership, between Mr Douglass and his new spouse.

3. In 2000 the New Business Tax System (Alienation of Personal Services Income) Act 2000 amended the Income Tax Assessment Act 1997 (“ITAA 97”) and inserted the Part 2-42 provisions dealing with “personal services income”:- see paragraph 11 below.  The amendments followed concerns and recommendations expressed in the July 1999 Report by the Commonwealth Treasurer’s Committee (“Review of Business Taxation: A Tax System Redesigned - the “Ralph Report”) about the erosion of the tax revenue base by the increasing use of personal and corporate service contractors where the legal structure of the relationships did not really change the “fundamental employer-employee relationship”:- see Ralph Report paragraph 202-203 & recommendation 7.2.  The Committee’s view was that “transactions having the same economic substance” should be similarly taxed, irrespective of their respective legal forms:-  see Report page 288.[1]

   [1]The Ralph Report is a permissibly relevant consideration in construction of the “personal services income” provisions:-  see IRG Technical Services Pty Ltd v DCT [2007] FCA 1867; 165 FCR 57 at [28].

4. Following the legislative change in 2000 (and complementary amendments made by the Taxation Laws Amendment Act (No 6) 2001[2]) Mr Douglass had a general understanding of the effect of the ITAA 97 “personal services income” provisions. Accordingly, prior to the 2006 tax year (and in the 2008 to 2010 tax years) he included all of the business income in his individual tax returns. But in the 2006 and 2007 tax years, and after his remarriage, in each of the tax years from 2011 to 2014, he and his then spouse’s tax returns split the business income equally between them.

   [2]The October 2001 amendments were taken to have applied to the 2000/2001 tax year:-  see Schedule 6 Item 19.

5. In late January 2015 the Commissioner began an income tax audit relating to Mr Douglass’ 2011 to 2014 tax returns.  A little later, the Commissioner expanded the audit to include the 2006 and 2007 tax years.  Following completion of the audit process, on 3 November 2015 the Commissioner issued Mr Douglass with amended primary tax assessments, and with penalty assessments.  They were for each of the 2006 and 2007 tax years, and for all of the tax years from 2011 to 2014.  The effect of the Commissioner’s assessment decisions is summarised in the following Table:

6. Despite Mr Douglass’ 8 December 2015 objection, the Commissioner upheld the primary tax assessments in a 23 June 2016 objection decision. In the course of both the audit and the objection process, Mr Douglass’ main claim seems to have been that the 2006 change in his tax treatment of the business income was based on an understanding that income splitting between partner spouses was then permissible, irrespective of the ITAA 97 “personal services income” provisions. He said that his understanding had been derived from

   (a)a Commissioner’s 13 December 2005 media release “Refocus of the Income-Splitting Test Case Program

   (b)a High Court decision he had seen publicised on the ATO website some time in about 2006

   (c)ATO Practice Statement PS LA 2005/24:  Application of general anti-avoidance rules

   (d)ATO Guide “Part IVA: The General Anti-Avoidance Rule For Income Tax” (NAT 14331-12.2005)

   (e)(perhaps) a February 2006 publication by the Independent Contractors Association.

7. That main claim developed, in the course of the objection process, into a contention by Mr Douglass that the ITAA 97 “personal services income” provisions did not apply to the partnership. The proposition advanced was that the partnership business passed “the results test” in ITAA 1997 s 87-18: - see paragraph 13 below.

   Challenge and change of position – 2013 & 2014 assessments

8. The Commissioner’s 23 June 2016 objection decision, in so far as it relates to the amended primary tax assessment for the 2013 and 2014 tax years, is one of the matters Mr Douglass seeks to have reviewed in the present proceedings.  The other matter is the Commissioner’s 7 March 2017 objection decision.  That decision affirmed the penalty assessments for the 2013 and 2014 tax years.

9. The limitation of the review applications to the primary tax and penalty assessments for the 2013 and 2014 tax years requires an explanation.  The explanation begins with the consideration that the Commissioner’s ability to have issued amended assessments for the pre 2013 tax years depended on an opinion of fraud and evasion in relation to the original assessments:-  see Income Tax Assessment Act 1936 s 170(1) Table Items 1 & 5.  The Commissioner’s assessments, and the June 2016 objection decision, recorded such an opinion.  The Commissioner had come to that opinion despite Mr Douglass’ contrary assertions, his claimed reliance on the information referred to in paragraph 6 above, and the contents of the various partnership tax returns.  (Each of the June 2011, 2012, 2013 and 2014 partnership tax returns disclosed that (i) the partnership income included “personal services income” attributable to Mr Douglass, (ii) none of that income had been paid to him as wages or salary and, (iii) the partnership neither satisfied the “results test” nor held a “personal services business determination” in the tax year:-  see paragraphs 13 & 57 below.)

10. Perhaps unsurprisingly (in view of his professed understanding of the 2006 ATO website information, and the contents of the 2011 to 2014 partnership tax returns) Mr Douglass challenged the Commissioner’s fraud and evasion opinion in Federal Court proceedings.  In November 2016 those proceedings were resolved in Mr Douglass’ favour, after the Commissioner indicated he would resile from his fraud or evasion opinion, and would issue further amendments for the pre-2013 tax years.  Those amendments reversed the effect of the primary (and penalty) assessments of November 2015, in relation to those tax years.  It follows that only the 2013 and 2014 tax year assessments remain in contention.  The primary tax and penalty amounts those assessments involved are apparent from the Table in paragraph 5 above.  (I note that in each of the 2013 and 2014 tax years the partnership tax returns disclosed, but Mr Douglass’ personal tax returns denied, the receipt of personal services income.)

    Personal Services income – ITAA 1997 provisions

11. Where income is derived by an entity and is “mainly a reward for” an individual taxpayer’s “personal efforts or skills” it is that taxpayers “personal services income”.  As such, it is part of their ordinary income:-  Income Tax Assessment Act 1997 (“ITAA 1997”) s 84-5(1)&(2).

12. Subject to two main qualifications, a taxpayer’s assessable income includes the income of a “personal services entity” that is the taxpayer’s “personal services income”:  ITAA 1997  s 86-15(1).  Those two qualifications are that the “personal services entity” (ie., an entity whose income includes an individual’s “personal services income”)

    (a)has not paid the “personal services income” to the taxpayer, as wages or salary:-  ITAA 1997 s 86-15(4), or

    (b)was not conducting a “personal services business”:-  ITAA 1997 s 86-15(2)&(3).

13. A “personal service entity” conducts a “personal services business” if they either (i) have a relevant “personal services business determination” (made by the Commissioner under ITAA 97 s 87-65) or, (ii) meet at least one of four “personal services business tests” in the income year:- ITAA 1997 s 87-15(1)&(2).  Those four tests are:-

    (a)the “results” test (ie., principally that at least 75% of the income is for “producing a result”):- see ITAA 1997 s 87-18

    (b)the “unrelated clients” test (ie., principally that the entity publicly solicits, and provides services to multiple, clients):-  see ITAA 1997 s 87-20

    (c)the “employment” test (ie., principally that at least 20% of the entity’s work is done by persons whose “personal services income” is not part of the entity’s income):-  see ITAA 1997 s 87-25

    (d)the “business premises” test (ie., principally that the entity’s income is derived from activities mainly conducted at discretely used business premises):-  see ITAA 1997 s 87-30.

14. The only one of those tests relevant to Mr Douglass’ circumstances in the 2013 and 2014 tax years is the “results” test.  This is so because Mr Douglass was the partnership’s only service provider, its payments to him were his only income and the only payments the partnership received were from the same labour hire firm (and related to work he did for the same client of the labour hire firm).  Consequently, more than 80% of his “personal services income” came from the partnership and unless the partnership satisfied the “results” test, its income could only be characterised as income from a “personal services business” if it held an applicable “personal services business determination”:- see ITAA 1997 s 87-15(3).  The partnership never held any such determination.

15. A “personal services business” meets the ITAA 1997 s 87-18(3) “results test” where

    (a)at least 75% of the business’ “personal services income” is for “producing a result”, and

    (a)the personal services entity is required to provide the plant or tools needed for the work performed, and

    (b)the entity is liable for the cost of remedying any defective work.

16. In determining whether any of the “results test” criteria have been met in any particular case, regard must be had to any “custom or practice” (when work is performed by persons who are not employees) in relation to the matters to which the particular criterion relates:-  see ITAA 1997 s 87-18(4).

17. The criterion relating to the provision of plant or tools is expressed as cumulative.  But it is unclear whether it is intended to require the contractor to provide “all” equipment necessary to perform the work, or only that which would ordinarily be provided by a genuinely independent contractor:- see IRG Technical Services Pty Ltd v DCT [2007] FCA 1867; 165 FCR 57 at [113]. Paragraphs 1.115 & 1.117 of the Explanatory Memorandum to the New Business Tax System (Alienation of Personal Services Income) Act 2000 had stated explicitly that the criterion would not be satisfied where either no equipment or tools of trade were needed to perform the work, or the custom was not to require the contractor to provide them. However Taxation Ruling [2001/8] conjectured (in paragraphs [126] to [130]) that it was “arguable” the criterion would be satisfied if no equipment was necessary to perform the work, and explicitly adopted that view.

18. The third of the results test criteria refers only to liability for the cost of defective work remediation. But it is likely that it is intended to refer to the substance of the arrangement rather than to a merely formal contractual obligation. Such an interpretation is consistent with the Ralph Committee’s emphasis on the substance of the transaction, and also with the explicit statement to that effect in paragraph 1.116 of the Explanatory Memorandum to the New Business Tax System (Alienation of Personal Services Income) Act 2000. Taxation Ruling [2001/8] (at paragraphs [131] to [139] accepts that a contractual liability to meet the cost of defective work may suffice, but emphasises that it will do so only if the liability “really exists” and is not “merely window dressing”.

19. The Ralph Report’s allusion to the “fundamental employer-employee relationship”, and its recommendations about the economic substance of transactions, might be thought to suggest that the “personal services income” provisions operate by reference to the conventional distinction between employment and independent contractor relationships. That possibility is given some credence by a part of the Guide in ITAA 97 s 87-1 that was inserted with the 2001 amendments. The suggestion is also apparently consistent with paragraph 7.6 of the Revised Explanatory Memorandum to the Taxation Laws Amendment Bill (No 6) 2001. Both declared that the “results test is based on the traditional tests for determining independent contractors and it is intended to apply accordingly”:- see Commissioner of Taxation v Metaskills Pty Ltd (2003) 130 FCR 248 at 28. However, in IRG Technical Services Pty Ltd v DCT (2007) 165 FCR 57 at [12] & [35]-[37] Allsop J pointed to the limited use that could be made of the Guide provision in construing the specific legislative provisions, and rejected the suggestion that the “traditional” independent contractor tests could control the construction of the ITAA 97 s 87-18(1)(a) “results test” criterion. The criterion is part of statutory provisions that have two significant features. The first is their objective of defining the concept of “personal services businesses” to cover “genuine businesses” and to exclude formal structures that are “merely arrangements for dealing with” an individual’s personal services income:- see ITAA 97 s 87-10.  The second is their explicit intention to apply to “non-employment arrangements”, and their disavowal of any implication that the individual service provider operates as an employee:-  see ITAA 97 ss 84-10, 86-15(4)(a) & paragraph 2.8 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No 6) 2001. (Consistent with those features, the latter Explanatory Memorandum summarised (on page 8) the broad effect of the Bill as including ensuring that “genuine independent contractors” were not affected by the personal services income provisions.) Having regard to those provisions, and the exclusive “personal services business” criteria in ITAA 97 s 87-15 (see paragraph 13 above), there is no justification for attempting to limit the operation of the “personal services income” provisions to a binary formal distinction between employment and independent contracting:-  Skiba v FC of T [2007] AATA 1705; (2007) 67 ATR 682; [2007] ATC 2647 at [39], [46] & [60].

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. Explaining that requirement, in IRG Allsop J said this (at 165 FCR 57 [50])

    [50] …  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 question whether the income was for producing a result directs attention to how the services were provided and what they brought about when they were deployed ….. This may be assisted, but is not governed, by the terms of the contract with (the labour hire company).

1. The last part of this passage (the statement that the characterisation question is “assisted”, but not “governed”, by the terms of the contract between the personal services entity and the labour hire company) indicates that characterisation of the nature of the contentious income involves an impressionistic assessment.  The matters likely to inform that assessment are discussed in the immediately following sections of these reasons.

   The “producing a result” concept

2. The concept of an engagement to produce a “result”, as distinct from one to do work, has been the subject of considerable comment – in the Explanatory Memoranda for the relevant ITAA 1997 amendments, in Taxation Rulings, and in previously decided cases.

3. At the time of the initial amending legislation the “result” criterion was part of the considerations relevant to the grant of a “personal services business determination” where the entity derived no less than 80% of its income from the same entity:- see (the then version of) ITAA ss 87-60(5)(a) & 87-65(5)(a).  The Explanatory Memorandum discussed the provision dealing with personal services business determinations):- 

   [1.114] An individual will not satisfy the test … merely because the contract states that the personal services income is for producing a result.  The individual must actually be paid on the basis of achieving a result, rather than for example, for hours worked.  For example, if a management consultant’s contract requires the consultant to produce a report but he or she is paid according to the hours worked, not a price for the report, the consultant will not satisfy this condition.

4. Taxation Ruling TR 2001/8 picked up that paragraph of the Explanatory Memorandum and emphasised that the totality of the arrangement between the individual and the contracting entities was relevant to the characterisation of the nature of the income.  It suggested (in paragraph 110) that there were at least 11 relevant considerations – including (i) the contractual obligations, and particularly the specificity of the task, (ii) the individual’s discretion about the hours, place and method of work, and about the identity of the actual work performer, and (iii) the mode of payment and, in particular, the nature of any performance contingency affecting the payment entitlement.  Later parts of Taxation Ruling TR 2001/8 discussed (in paragraphs [259] & [288] to [314]) specific examples of the situations in which an information technology personal services provider, and a civil engineer, would likely either fail, or satisfy the results test.  The thrust of the examples was that the personal services provider was likely to pass the results test where (i) the contract required delivery of a specified work product, (ii) the service provider typically worked at times and places of their own choice, (iii) payment entitlement was not (or not primarily) time based and, (iv) the work performance task was time limited.  Conversely, the personal services provider was likely to fail the results test where (i) the contract did not specify any work product requirement, (ii) payment entitlement was time based (even if subject to an overall limit), (iii) performance was within the principal’s work times and places, and liable to periodic change or direction, (iv) remedial work was performed as an ordinary part of work task and the time spent was chargeable at the contract rate, and (v) the contract was terminable for unsatisfactory performance.

5. Taxation Ruling TR 2005/16 addressed what it described as “key indicators” of the employee / independent contractor distinction.  These included (i) the degree of control exercised, or capable of being exercised, by the putative employer, (ii) the extent to which the individual worker operated “on their own account” or in the business of the putative employer, and (iii) whether the worker had been engaged to undertake “the production of a given result”:- see paragraphs [28] to [35].  In relation to that latter expression the Ruling then continued with the following passage:-

   [36] The phrase “the production of a given result” means the performance of a service by one party for another where the first-mentioned party is free to employ their own means (such as third-party labour, plant and equipment) to achieve the contractually specified outcome.  Satisfactory completion of the specified services is the “result” for which the parties have bargained.  The consideration is often a fixed sum on completion of the particular job as opposed to an amount paid by reference to hours worked.  If remuneration is payable when, and only when, the contractual conditions have been fulfilled, the remuneration is usually made for producing a given result

   …

   [38] Having regard to the true essence of the contract, the manner in which the payment is structured will not of itself exclude genuine result based contracts.  For example, there are results based contracts where the contract price is based on an estimate of the time and labour cost that is necessary to complete the task, or may even be calculated on that basis, subject to reasonable completion times.

   …

   40. Accordingly, the contractual relationship as a whole must still be considered in order to determine the true character of the relationship between the parties.

6. The first of the relevant decisions that addressed the “results test” criterion for the purposes of the “personal services income” legislation was that in Skiba v FC of T [2007] AATA 1705; (2007) 67 ATR 682; [2007] ATC 2647. It involved an electrical engineer whose contracting entity was a corporation of which he and his wife were directors. That corporation had entered into various contracts with labour hire firms relating to the engineer’s engagement to work on the design and procurement stages of major gas facility construction projects. Those contracts necessarily pre-supposed the existence of complementary contracts between the labour hire firm and a construction project owner or principal contractor.

7. The terms of the contracts between the engineer’s corporation and the labour hire firms typically required the contractor to provide “services” to the firm’s client, transport to the client’s premises and compliance with the client directions, “project procedures” and quality requirements.  They typically contemplated payment, at a specified hourly rate, “for hours worked”.  Sometimes the contract was expressed to specify a requirement for the personal services of the engineer).  But the existence of such an express requirement was a mere formality, because the engineer was the only person ever really contemplated as the performer of the work.

8. The reasons for decision in Skiba suggest that there was no evidence about the nature and content of the contractual relationship between the labour hire firm and the various construction project owners or principals.  However it is apparent that the engineer’s contentions and evidence sought to establish the practicalities of that relationship, and of his own involvement with the owner / principal.  This is evident from the passages of the reasons I set out below.  (I have added or substituted various [interpolations] to enhance the readability of the passages in the present context.):-

   [30] In his Statement of Facts and Contentions the applicant also discusses “deliverables” describing them as measures of engineering design performance and are outcomes of the provision of engineering services.  Deliverables may be an activity or a document which may be produced by an individual or a team. The completion of those deliverables verifies the performance of the contract in accordance with the schedule.  The project plan defines the expected start date and completion date of the deliverable.  Personnel providing services are responsible for producing the deliverables or the management of a team producing deliverables. …  the applicant adds that “In engineering services, the client plans its work by units of measure called deliverables … which are a unit of measure of the works and which are measured in terms of manhours and schedule”.

   [33] In his oral evidence the applicant stated that he relied upon his skills and reputation to get work and was listed with a number of engineering manpower agencies but also got work by personally making direct approaches to [project principals and their agents].  He was the only person associated with [the company] with the necessary skills to undertake engineering work.  When engaged on a services contract he worked to the basis of design (BOD) and schedule produced by the [project principals or their agents] and his work priorities varied with any scheduling changes.  He received a copy of the Schedule.  He worked as part of a team of multi discipline engineers where inter-discipline communication was essential to … produce for the client the engineering project deliverables required ….  He described the process by which datasheets for plant procurement were produced including the need for information from different engineering disciplines about technical matters from their areas of the project which would impact on the calculations for the datasheet.  He described the revision and reissuing process for datasheets by which comments including any changes and errors were identified and corrected along the way as part of the work stream until finally a datasheet was produced that everyone was happy with.  Finally he described the important quality assurance process by which work was checked, rechecked and approved, often by many depending upon the importance of the item of plant and its cost.  This process ensured that the applicant rarely, if ever, signed off on his own work and approval usually came from the senior levels of the [project principals or their agents].  These processes limited the risk of errors arising in the work.

9. In relation to the proper interpretation of the ITAA 97 s 87-18(3)(a) “for producing a result” criterion, the Tribunal noted that it was not statutorily defined. But the Tribunal considered that its meaning was well enough apparent from the statutory context (see paragraphs 3, 18 & 20 above) and from its consideration in the relevant case law. That meaning was summarised in the following paragraphs of the Tribunal’s reasons. (In the paragraphs set out below I have omitted some caselaw citations included in the original, and provided some necessary [interpolations].)

   [62] …  case law makes it clear that the essence of producing a result is performing a service that achieves a specified outcome and not doing work: “An independent contractor undertakes to produce a given result, but is not, in the actual execution of the work, under the order or control of the person for whom he does it.”:  Queensland Stations Pty Ltd v FCT (1945) 70 CLR 539 at 545.5.  What is involved in the concept is “the performance of a service by one party to another who is to employ men and plant for the purpose and is to be paid according to the result”: Queensland Stations Pty Ltd v FCT (1945) 70 CLR 539 at 551.4.   ….

   [63] A result based contract usually has a negotiated contract price for the result achieved and not merely an hourly rate for hours worked …

   [64] The words “producing a result” require something more than obtaining a payment reward for providing ongoing personal skills and efforts to enable another party … to produce a contracted for result to their clients.  Consistent with the recognized indicia of the independent contractor, the words “for producing a result” require that the personal services income of the individual … was paid to him as the contract quid pro quo for producing a result and was not paid until and unless the result was produced.

   [65] Here, the evidence shows that the personal services income derived by the applicant was not paid upon producing a result but was a fortnightly or monthly payment based on the number of hours logged onto a weekly timesheet while working under the ultimate control of the [project principal] and applying skill and effort to assist the [project principal]  complete the projects for … clients.

   [66] The ongoing skilled work provided by the applicant to the [project principal] is not converted into “producing a result” within the meaning of s 87–18(3) by applying the label “deliverables” where the actuality of what occurred was the performance of ongoing work by the applicant … under the ultimate control of the [project principal] during the term of the Contracts.

10. In the light of that interpretation of the “results” criterion, and an understanding of the engineer’s work role as part of a “team of multi discipline engineers”, the Tribunal concluded in Skiba that the engineer’s income could not properly be characterised as “income … for producing a result”.  Both the factual basis for that conclusion, and the logical force of the Tribunal’s reasoning, are readily apparent in the following passage of the reasons.  (I have again added [interpolations] to enhance its readability in the present context.)-

    [75] … The evidence is that the applicant was controlled in the work he performed  ….  Neither [his corporate entity nor the labour hire firms] were involved in the work the applicant did nor did they specify any requirements or expectations in regard to that work.  The income received by [the corporate entity] under the Contracts was not for producing a result.  The income was received for the ongoing performance by the applicant of work assigned to him by the [the project principals].  The evidence shows that this work was completed as part of a team environment because everything had to be checked and approved.  The work was completed by teamwork and a process of iteration between the engineering disciplines.  All documentation was produced on the computer systems of [the project principals].  The applicant was not permitted to sign off on his own work.  On the rare occasion that this happened it was due to urgent expediency and would not have occurred for deliverables involving the design and procurement of critical and expensive plant.  His deliverables were approved at a senior level.  The applicant was paid for the hours he worked each fortnight or month upon presentation of a timesheet authorised by his supervisor.  He could only delegate his contract work with the approval of [the project principals] and only to an appropriately skilled person they had first approved.

11. The decision in IRG Technical Services Pty Ltd v DCT [2007] FCA 1867; 165 FCR 57; 69 ATR 433 was addressed as a “test case” for the application of the “results” test. It involved individual taxpayers who were instrumentation engineers with substantial experience in working on oil and gas resources projects. Both had been engaged to work as senior engineers at an early stage of one of Woodside Petroleum’s liquified natural gas plant construction projects. The project plant principal contracted with labour hire firms. Those firms had then engaged each of the engineers (or their contracting entity).

12. Under the former category of contract the labour hire firm undertook to “provide qualified and experienced engineering and technical services” to the project principal.  The contract contemplated that the project principal would issue a “service order … for every individual … to be provided”.  Consistent with that contemplation the principal provided the labour hire firm with “requisitions or job specifications”.  Those documents included specific duties and responsibilities, declared that the individual would be “responsible for the production of project deliverables” and stated they would also be required to “work closely with … other teams … to ensure the … deliverables are consistent and complete within the required project schedule”.  Following the delivery of such a specification the labour hire firm would locate a suitable contractor for the particular job.  Once a suitable contractor had been located the labour hire firm provided their resume to the project principal.  The principal would select the approved contractor (often after conducting a personal interview) and issue a “service order” to the labour hire firm.  The typical such order identified the contractor, the title of the position they were to occupy, their supervisor and the applicable rates of pay.  After all of that had been done, the labour hire firm would contract with the approved person (or their trading entity).

13. In the particular case there were two sequential contracts between the labour hire firms and each of the engineers.  The first of those contracts specifically referred to the engineer’s engagement as one of “contract hire” to the project principal.  It stipulated that the engineer was an independent contractor, but it described the contractual obligation as that of providing the services of a “senior instrumentation engineer”.  The payment entitlement was at an hourly rate for a 9 hour day. 

14. The second contract was with a different labour hire firm, and replaced the first contract. It was intended to “maximise the legitimate characterisation of their position” in relation to the personal services income provisions of ITAA 97. Evidencing that intention, each contract attempted to describe the engineer’s role by reference to specific functions (instrument design, liaison, tender evaluation and reporting) and to identify required “deliverables” (specifications, tenders, datasheets, trenching and cable layouts and technical reports). It also attempted to characterise the required work as involving discrete “assignments”, and to make the engineer’s payment entitlement contingent on satisfactory completion of each assignment “or part of an assignment”. Payment was, however, at an hourly rate, subject to a maximum fortnightly amount.

15. The principal argument in IRG was that each of the engineers had been engaged to provide results, and that they were paid according to their performance in so doing.  This argument was based on the content of their (second) contract with the labour hire firm.  That contract had an evident emphasis on “deliverables” and purported description of the contractor’s contingent payment entitlement.

16. Allsop J rejected the proposition that the content of the contract between the labour hire firm and the engineer’s contracting entities was determinative. At 165 FCR 57 [50] His Honour said

    [50] That, in my view, is too limited an approach. It can be accepted that neither …  was an employee of [the labour hire firm].  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.  Here … [the labour hire firm] is a labour procurement agency. (Nothing turns on the particular choice of words to describe its function.)  [The engineers] were passed on to the [project principal] as skilled engineers, for which [the labour hire firm] received a commission.  [The engineers] did not provide their services to [the labour hire firm], but to the [project principal].  The personal service entities … contracted with [the labour hire firm] to bring about the provision of the services of the individuals to the [project principal].  The question whether the income was for producing a result directs attention to how the services were provided and what they brought about when they were deployed at the [project principal]. This may be assisted, but is not governed, by the terms of the contract with [the labour hire firm].

1. Allsop J also rejected the proposition that the contractual payment entitlement was probative of payment for results.  After noting that time based rates were not necessarily inconsistent with an entitlement contingent on “results”, and examining the actual terms of the contract between the labour hire firm and the engineer’s contracting entity, Allsop J made the following finding:- 

   [75] … the provisions were worded to reflect a notion of payment for results.  Once again, however, in the light of what the definition of assignment was, they provided, in substance, for nothing other than an hourly rate, up to a sum per fortnight, for performing the work of a lead instrument engineer ….  The choice of language of the parties can be respected.  What is plain, however, is that an hourly rate was payable, and the definition of assignment was comprised of the broad integers of the position undertaken by [the engineer] …..

2. Later in the reasons for judgment Allsop J made a factual finding that there was no correlation between the payments each engineer received and the completion of any particular task.  He then went further, and declared it impossible to identify any particular payment entitlement for any such task.

3. In relation to the concept of “deliverables” Allsop J was sympathetic to the vernacular use of that word to describe the required outcome of the various project tasks or stages.  But His Honour rejected the further proposition that such a legitimate description determined the proper characterisation of either the engineer’s activity or their payment entitlement.  That rejection was expressed in the following paragraphs of the judgment reasons:-

   [90] … [the engineer]  was responsible for managing the instrument design  …. He was involved in the whole design process, the QA/QC procedures and ultimately was responsible for the delivery of the instrument design …  by the required date.  He was situated on a floor with other engineers ….  Theoretically, he could have worked from home at times.  However, it was quite plain on the whole of the evidence that for him … this would have been inconvenient, and in all likelihood, unsatisfactory, if done other than occasionally.   [The engineer] said that he spoke with [his supervisor] on a daily basis, going up to his office for these conversations.  The work done by [the engineer], which I will describe below, required the production of individual schedules and documents in a staged process, so that ultimately the tender documents and specifications and drawings could be prepared on time for the prospective vendors of the goods to tender and thereafter, if accepted, to produce the goods.  It can be accepted that it is a legitimate use of the English language to describe these as the production of “deliverables”.  However, in reality, what [the engineer] was doing was working as a skilled engineer for the [the project principal] in the [principal’s] professional business on a particular project in careful consultation with his peers and with his supervisors to create all necessary documents for the satisfactory design and construction of a complex engineering plant.

   [100] Looking at all the evidence, in my view, [the engineer] was performing work as an engineer which can be described as the production of deliverables, but, in substance, was the performance of services of a skilled engineer in exchange for an hourly contractual rate for a given number of hours in the week which was flexible upwards if, in all the circumstances, it was reasonable for a professional of his calibre to spend more than 45 hours per week on the job.

   [110] For the above reasons, in my view, the income of [the engineer] (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 [the project principal] as part of a co-ordinated team of engineers and remunerated on an hourly rate for such work.  This work involved [the engineer] 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.

   [157] … the income of [the engineer] was not for producing a result.   [the engineer] worked in the business of the [project principal], …, being paid by the hour for doing the skilled and specialised work of an instrument engineer.  … it would be a misuse of language to say that he was paid for producing a result or results.  He was paid to work as a skilled engineer and expected in that work to produce data sheets.  That is not being paid for results. The work was completed in an iterative fashion, through teamwork and co-ordinated skill and experience of a group of engineers working in the [the project principal’s] business designing the plant.  All the documentation was produced in the business of the [project principal], on the [principal’s] computer system.  [The engineer] did not produce his own documents.  He participated in the production of documents which were the product of coordination, co-operation and supervision in which not only he, but others, signed off.  The deliverables were the product of the work of [the two engineers] and their colleagues.

4. It is necessary to recognise the distinction between (i) Allsop J’s factual findings about the contractual arrangements and the engineer’s actual work in IRG and, (ii) the relevant characterisation of the income related to that work.  The factual findings depend on the extent and quality of the evidence in the particular case.  On the other hand, His Honour’s rejection of the idea that work activity (and payment entitlement) of the kind described in paragraphs [90] and [110] of the IRG reasons for judgment applies the statutory criterion to those matters, and involves a finding of principle about the meaning of that criterion.  As such it reflects a construction of the criterion that the Tribunal must apply.  Even if that proposition were to be regarded as overstating the position, Allsop J’s reasoning is in any event logically compelling, and informs the proper construction of the statutory criterion.

5. The Tribunal decision in Taneja v Federal Commissioner of Taxation [2009] AATA 87 was based on reasons that partly addressed the idea of custom or practice and, to that extent, was relied on by Mr Douglass to support his objection. In Taneja the taxpayer was a computer systems analyst who provided his services to third party clients.  He did so as an officer / director of a corporation he controlled.  The company’s client contracts variously required performance of (i) services “as agreed”, (ii) “services in consultation with the Client”, (iii) a computer programming assignment and, (iv) a personal consulting role to be performed by Mr Taneja personally.  In each instance the company charged the clients at an hourly rate for the actual time Mr Taneja worked.  It was uncontentious that the company provided Mr Taneja’s work equipment, and was liable for the cost of rectifying any defects in his work. 

6. Mr Taneja argued that hourly rate payment was “custom or practice” for the purposes of ITAA 97 s 87-18(4). That was said to provide a basis for satisfaction that the income was “for producing a result” and satisfied the ITAA 97 s 87-18(3)(a) criterion. The logic of the argument is not readily apparent. It was rejected – in the following paragraphs of the Tribunal’s reasoning:-

   [22]  We agree with the Commissioner that the main purpose of s 87-18(4) is to act as a safety net for those individuals or entities who cannot point to a written agreement to establish that they have been paid “for producing a result”: if the industry custom or practice is that people are engaged to produce a result, then that fact may support a conclusion that the particular individual or entity was paid for producing a result.

   [23]. On the other hand, industry custom or practice (where, for example, it is uncommon for people’s income to be for producing a result) cannot come to a person’s aid where there is a written agreement specifying that the person is entitled to payment for doing something that does not amount to producing a result. To hold otherwise would remove, for an entire industry, the criterion in s 87-18(3)(a) as a necessary step in meeting the results test. That cannot have been the intention of the legislature.

7. Context suggests that within the parenthesis in the first sentence in the paragraph [23] passage the intended reference is to a custom where it is “common” for income to be for producing a result.  In addition, the last two sentences in the same paragraph are perhaps a little cryptic.  What they were meant to convey was that the mandatory obligation (in ITAA 1997 s 87-14) to have regard to a relevant industry practice was not a direction to disregard, and to refrain from characterisation of, the actual contractual arrangements under which the taxpayer performed their work.

8. The thrust of the Tribunal’s reasoning in Taneja was that a practice of hourly rate payment was not itself probative that the payment satisfied the “result” criterion.  Conversely, the Tribunal also accepted that hourly rate payment might nevertheless be consistent with a “for a result” engagement.  The Tribunal’s reasons included the following paragraphs:-

   [24]. We also note that in the context of s 87-18(3)(a) it is not how your fee is calculated, but what you are paid for, that is important.  It is possible for a person who is contracted to produce a result to choose to charge hourly rates as the means of remuneration, without altering the fact that payment is made for producing a result.  In saying this, we are mindful of the comment of Allsop J in IRG at [43] that the method of payment may be important – but there is nothing in what his Honour said to suggest that a fee based on time spent will necessarily exclude the possibility of being paid “for producing a result”.

   [25]. In the language of s 87-18(3)(a), the question is: What is the income for?  And the answer to that question will depend on the income-earner’s responsibilities to its clients; or, put another way, what does he have to do to satisfy the obligations he has under the agreement with the client, and to justify payment?  …

9. The Tribunal’s reasoning in Taneja was followed in Park v Commissioner of Taxation [2011] AATA 567. That was another case involving a taxpayer with information technology expertise who provided his services under contracting arrangements with a labour hire firm and a corporate entity he controlled. The contracts variously required his services as (i) a “mainframe developer” and, (ii) a “senior analyst programmer. In each instance the relevant invoices claimed payment for “consultancy services” at a daily rate. Notwithstanding those contract details, Mr Park contended that his work engagement was to produce an outcome / output / result for the ultimate client. In rejecting that contention the Tribunal said (at [15]) “no amount of emphasis can overcome the fundamental shortcoming in the factual landscape: namely that the income derived … was not for producing a result.”

10. The circumstances involved in Cooper v FCT (2010) ATC 10-130; 78 ATR 669 provide another example of a situation where a consultant operated, through arrangements with a labour hire company, as the service provider for his family company.  In the contentious tax years the contracts with the labour hire company obliged the family company to provide the consultant’s “professional business services” in relation to any “assignment briefs” issued by the firm.  He was to be paid a daily rate, in response to fortnightly invoices and completed timesheets, and without reference to any expressed “result” obligation.  The contract was terminable for unsatisfactory performance or at the unilateral discretion of the firm’s client, but without prejudice to payment entitlement for time already worked.

11. In the contentious tax years the consultant had worked for (and typically at the premises of) the same client of the labour hire firm, but on a number of different tasks / assignment briefs.  Each of these was the subject of a “purchase order” issued by the client to the labour hire firm.  The purchase orders typically set out a specific job description, guidelines, duration and monetary value (although one apparently expressed as a “budgeting costing” rather than a fixed contract price).  As between the client and the labour hire firm (but not between the firm and the family company) each purchase order task included milestone and progress payment provisions.

12. The consultant’s argument in Cooper was that the fortnightly payments he received were “progress payments” as part of a “results” production income entitlement.  The focus of the argument was on the substance of the client’s “purchase order” task, and the details of the client’s arrangement with the labour hire firm.  In that respect the argument reflected the converse of the taxpayer’s unsuccessful argument in IRG.  In that case the taxpayer had contended that the arguably specific provisions of their agreement with the labour hire firm was determinative.  Allsop J had rejected that contention, and had emphasised the necessity of a “look through” approach that addressed the substance of the combined transactions and the circumstances in which the work was performed for the ultimate client recipient: -  see paragraph 20 above.

13. In Cooper the Tribunal, applying the reasoning in Skiba (see the extracts cited in paragraph 29 above) rejected that argument.  It did so essentially for the following reasons:-

    (a)The labour hire / family company agreement was explicitly for a time limited period of service, not for any stated outcome or result

    (b)The family company was both contractually entitled to payment, and in fact paid, for the time the consultant worked

    (c)The family company was not privy to the values and milestone provisions that apparently applied to the arrangements between the labour hire firm and its client.

14. In BRMJCQ Pty Ltd v Federal Commissioner of Taxation [2010] AATA 311; [2010] 79 ATR 220 the income characterisation question again arose in the context of an information technology consultant who provided his services under hourly payment contracting arrangements between his company, a labour hire firm and the latter’s clients. One of the principal issues was whether the consultant’s company was entitled to a “personal services business determination”, on the basis that it satisfied the ITAA 97 s 87-13(3)(a) results criterion. Under the relevant contracts between the labour hire firm and the company, the performance obligation was to provide “consulting services”. Under one of the contracts between the labour hire firm and its client, the obligation was to provide “a metaframe deployment manager oversighting the work of the transition project”. That obligation was expanded upon by the detailing of a number of “deliverables”. Those “deliverables” were stated to include the following activities (i) leading a team of IT professionals to develop management plans for the transition project, (ii) workload and progress management and reporting, (iii) carrying out technical investigations and providing advice, (iv) providing programming assistance and guidance and (v) providing desktop support to system users. Under another contract the company had been engaged to “rectify the primary defect” in another project. Under other contracts the company was required to deliver “key infrastructure initiatives” or “consulting services” to plan “an end of life migration path for aged infrastructure”.

15. The Tribunal concluded in BRMJCQ Pty Ltd that the company taxpayer did not satisfy the “results” criterion – for the following reasons:- (see 79 ATR 220 at [79])

    (a)none of the company’s contracts with the labour hire firms specified any result, they simply required the provision of “consultancy services”.

    (b)the “deliverables” identified in the agreements between the labour hire firm and its clients simply required similar services, rather than identifiable results

    (c)all the relevant contracts specifically provided for remuneration for time spent.

    (d)the payment entitlement was not contingent on achieving any particular result, and survived termination, irrespective of the stage of completion of any underlying work or project.

    Informed, but not governed, by the terms of the labour hire firm contract

16. In IRG Allsop J recognised the distinction between the engineer’s contracts with the labour hire company and the labour hire company’s contract with the project principal.  But His Honour regarded the statutory provisions as permitting, and indeed requiring, regard to the latter contractual arrangements in order “to understand the structure of the interlocking relationships” between all the entities involved:-  see IRG at [80]. On the other hand, parts of the reasoning in Taneja and Cooper appear to place primary emphasis on the content of the former type of contract and, in so doing, suggest that whilst the “look through” approach could operate to justify disregard of (arguably) specific “results” provisions in the taxpayer’s labour hire firm agreement, it could not overcome the significance of time payment provisions in such an agreement.  Such a proposition acknowledges the general significance of the contractual payment provisions, and reflects the likelihood that a time related payment entitlement will determine the characterisation of the income as not being “for producing a result”:-  Re Cooper v Federal Commissioner of Taxation (2010) 78 ATR 669 at [39] & [72]; Re BRMJCQ v Federal Commissioner of Taxation (2010) 79 ATR 220 at [66], [72] & [74]; 77]-[83]; IRG Technical Services Pty Ltd v DCT [2007] FCA 1867 at [43].

17. That likelihood does not detract from the need to pay regard to “the true essence of the contract”:- see TR 2005 / 16 and paragraph 24 above.  It does, however, raise questions about the completeness of the express written contractual arrangements and the extent to which the personal services contractor is privy to the arrangements between the labour hire firm and the project principal.  In that context, it accords with conventional legal principle that written agreements may (i) comprise multiple documents, (ii) be complemented by other written agreements, (iii) be subject to implied terms, including terms implied by “business necessity” and custom or business practice, (iv) be complemented by oral terms and (v) be construed with regard to commercial context and purpose:-  see Masterton Homes Pty Ltd v Palm Assets Pty Ltd (2009) 261 ALR 382 ; [2009] NSWCA 234 at [90] (on the completeness of a written contract); Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7; (2014) 251 CLR 640 at [35] (on construction); Mainteck Services Pty Ltd v Stein Heurtey SA [2014] NSWCA 184; (2014) 89 NSWLR 633 at [69]-[85] (on construction). Where the written contractual terms apparently conflict, the contractual interpretation task is to attempt to reconcile them to give the contract the meaning the parties should objectively be taken to have intended:- see Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165 at [40]. Where no such meaning can be discerned, the terms (and perhaps the contract as a whole) may be void for uncertainty. Where assertedly oral or implied terms conflict with the written contractual terms, they cannot take effect:- BP Refinery (Westernport) Pty Ltd v Hastings Shire Council (1977) 180 CLR 266; (1977) 16 ALR 363 at 376 (business efficacy implication); Norwest Beef v Peninsular and Oriental (1987) 8 NSWLR 568 (oral term).

1. That approach to the “reasonably arguable” criterion is consistent with what was said in Pridecraft Pty Ltd v FCT (2004) 213 ALR 450 ; [2004] FCAFC 339 at [108]. There the Full Court of the Federal Court agreed with the exegesis provided by Hill J in Walstern v FCT (2003) 138 FCR 1 ; [2003] FCA 1428 at [108]:- (i) the criterion is one requiring an objective assessment of the merits of the argument (see also Commissioner of Taxation v Traviati [2012] FCA 546 at [36]-[37]), (ii) it must have resulted from the exercise of reasonable care, and (iii) the taxpayer’s argument must be one that, whilst determined to have been wrong, was one that could rationally be advanced as likely to be correct. That possibility of rational advancement of an arguably correct proposition does not require any positive satisfaction that the taxpayer’s argument was actually likely to be correct.

2. Earlier in these reasons I have examined both the relevant legislative provisions, and the most significant of the decisions dealing with their application.  I have also outlined Mr Douglass’ apparent original argument about the general permissibility of splitting partnership income, and his later advanced, principal argument about “results” and about “custom or practice.”  The difficulty with Mr Douglass’ arguments were (i) the inability to draw attention to any specific basis for his original argument, (ii) his inability to identify any contractual obligation to produce “results”, (iii) the inherent conflation of the distinction between employees and “genuine independent contractors” – involved in the assertion that “all” engineers worked or were engaged for “results”, and (iv) the failure to appreciate the extent to which the decided cases, involving factual scenarios essentially similar to Mr Douglass’ own circumstances, were quite inconsistent with his principal argument.  That difficulty was compounded by the patent inconsistency between the partnership tax returns and the personal tax returns in the 2013 and 2014 tax years:-  see paragraph 10 above.

3. The written reply submissions advanced on Mr Douglass’ behalf sought to sustain the proposition that his tax return treatment involved a “reasonably arguable” position for three reasons.  These were that IRG had recognised the potential relevance of “custom or practice” to the “results” test.  The second was that the decision in Taneja had failed to acknowledge the potential relevance of “custom or practice” to the results test.  The third was that Taneja had imposed an unjustified restriction on resort to “custom or practice” in considering the application of the “results” test.  None of these propositions has a reasonable foundation. 

4. In relation to the first point, it is true that whilst IRG did recognise the general potential relevance of “custom or practice”, it only specifically addressed its application to the “equipment” criterion.  But IRG also specifically rejected the notion that the existence of project or task “deliverables” relevantly constituted the provision of services for “results” and justified the characterisation of income as “for producing a result”.  In essence IRG accepted that there was an express (ie., not merely a custom or practice) obligation to produce “deliverables”, but nevertheless rejected such an obligation as meriting the income characterisation as being “for producing a result”.  When the circumstances involved in IRG, and Allsop J’s reasoning, are properly understood, the decision is quite inconsistent with the argument sought to be advanced on Mr Douglass’ behalf.

5. In relation to the second point, as I have pointed out earlier, the decision and reasoning in Taneja involves the conventional proposition that custom or practice cannot be accorded a contractual effect that is inconsistent with express contractual terms.  In particular cases., the circumstances may show that the written contract is not complete.  In other cases the apparent inconsistency may be capable of resolution by the application of ordinary principles of contractual interpretation.  Those possibilities may permit a conclusion in such a case that a written contractual term is not determinative.  The reasons in Taneja explicitly recognised that possibility.  The decision did not involve any erroneous application of principle, nor any misapplication of the reasoning in IRG.

6. In relation to the third point, it is simply wrong to contend (as the argument advanced on Mr Douglass’ behalf appeared to do) that the effect of the reasoning in Taneja was to require a specific written contract entitlement before their income could be characterised as being “for producing a result”.  Taneja expressly accepted the conditional proposition that custom or practice could satisfy the “results test”.  The qualifying condition was that it could not contradict express contrary contractual provisions:-  see paragraph 42 above. 

7. I turn now to deal with the criterion of recklessness as it applies to Mr Douglass’ circumstances.  In doing so I proceed on the basis, favourable to him, that the understatement of assessable income in his 2013 and 2014 tax returns was, as a matter of fact, the result of his view about the underlying permissibility of partnership income splitting, rather than a positive view, at the time of submitting his returns, that his income did not include “personal services income”.  Such an approach, whilst recognising the inconsistency between the partnership and individual tax returns in the responses to the “personal services income” question, starts with a willingness to accept at face value Mr Douglass’ originally advanced argument – that he thought partnership income splitting was permissible, and had come to that view following the release of an ATO statement in about 2006:-  see 6 paragraph above.  It treats his subsequent reliance on the “results” test issues as, in essence, a retrospectively adopted argument that did not in fact influence  the actual content of his tax returns in the 2013 and 2014 tax years.

8. The Commissioner’s 13 December 2015 media release, when read superficially, does appear to provide some support for Mr Douglass’ original argument.  The emphasis of the media release was on the distinction between “contrived” partnership arrangements and those with a legitimate commercial purpose.  The statement acknowledged the principle that a partnership (particularly a husband and wife partnership) could have a legitimate commercial purpose even if the majority of the income was principally generated by one of the partners.  But the media statement had (and has) to be read as a whole.  Its emphasis was not on “personal services income”.  Indeed, in at least two places it contained explicit reservations about the permissibility of income splitting in the context of arrangements that reflected a “disguised employment relationship” or where the individual taxpayer was “in substance an employee of an entity” with which the partnership contracted, or to which the individual provided their services. 

9. The December 2005 media statement referred to the 19 July 2004 Tribunal decision in Ryan v Federal Commissioner of Taxation [2004] AATA 753; [2004] ATC 2181. That was a case in which an information analyst conducted his business under a corporate structure and employed his wife to perform secretarial services. The case involved tax years prior to the introduction of the personal services income provisions in 2000 and 2001. The particular question in issue was whether the company structure had been adopted merely for the purpose of obtaining a tax benefit. Properly understood, the case has no application to the application of the personal services income legislative provisions, and certainly not to their application in the 2013 and 2014 tax years. Apart from this decision Mr Douglass could not point to any decision to support his contention that there had been a significant change of stance by the ATO in the 2005 and 2006 period in relation to the treatment of personal services income derived by a spousal partnership.

10. Another document Mr Douglass claimed to have relied on to support his original argument was Practice Statement Law Administration PS LA 2005/24. This Practice Statement appears also to have been first published in December 2005, and also deals with general anti avoidance provisions in ITAA 36 – rather than the personal services income provisions in ITAA 97. It is a large (193 paragraph) document with 9 attachments. Attachment 4 is an ATO paper released in March 2005 commenting on the operation of the anti avoidance provisions and including specific discussion of the High Court’s 27 May 2004 decision in Federal Commissioner of Taxation v. Hart [2004] HCA 26; 217 CLR 216; 206 ALR 207; 2004 ATC 4599; 55 ATR 712. It seems likely that this is the decision to which Mr Douglass was referring in his initial explanations to the ATO in the initial stages of the 2015 audit process. That proposition, the substantial irrelevance of the Hart decision to the present matter, and the selective reliance Mr Douglass placed on the Practice Statement is reasonably apparent from the following extract.  In his July 2015 letter to the ATO Mr Douglass had included this extract – but without the text I have underlined:-

    But the fact that there are different ways of doing a transaction or organizing your business affairs does not mean that Part IVA applies if you choose the one that produces less tax. This is where the s.177D factors operate. The choice of the most tax efficient structure might, as a matter of subjective intention, have been chosen solely for tax reasons. (Of course, it might not.) But it is a mistake to say well of course they chose this one for tax, so Part IVA applies.

    This point may be illustrated by the use of a partnership, recalling the statement of the then Treasurer when Part IVA was introduced that a taxpayer who carried on business in partnership with his spouse need have no fear of Part IVA applying to his affairs. Suppose the Smiths want to start a small grocery business. The Smiths could organize their affairs in several ways. Mr Smith might employ Mrs Smith and pay her a wage, or vice a versa. They would get an allowable deduction for it, to the extent it was reasonable in amount, and the employee would be assessable on it. Alternatively, they could incorporate, or Mr and Mrs Smith might carry on business in partnership. If they chose the latter and they had no specific agreement to the contrary, under the Partnership Act they would share in profit and loss in equal shares. They would then be assessable in equal shares on the profit, or have equal shares in any tax loss. From the point of view of income tax this division of profit might seem more attractive than the employment or, incorporation option. On the other hand, there are other, very real non-tax consequences that follow: for example, Mrs Smith becomes fully liable for the debts of the partnership. Now even though there might be a tax advantage, in this hypothetical example, the formation (which may have involved contributions to partnership capital) and conduct of a partnership in the ordinary way would not of itself show that the tax advantage was the dominant purpose of the arrangement.

    That purpose has to show up, as it did in Hart , in a way that is relevant to s.177D. Look at how the court approached it in Hart . In that case there was a very artificial division of the loan in question into two parts, with deductible interest being incurred but not paid on the deductible part, and then compounded, in a way that … made interest in substance on a home loan tax deductible. This artifice was essential to the outcome.

11. When the entirety of the passage is read as a whole, and in the context of the subject matter of the Practice Statement, it is readily apparent that the criterion being addressed is whether or not the “dominant purpose” of the arrangement is to derive a tax advantage. That is not a relevant criterion for the personal services income provisions of ITAA 97. Nothing in the Practice Statement could have been read by a reasonable person as justifying the approach Mr Douglass took in his 2013 and 2014 tax returns.

12. A further document on which Mr Douglass claimed to have relied on to support his original argument was an eight page guide issued by the ATO in December 2005 and entitled “Part IVA: The General Anti-Avoidance Rule For Income Tax” (NAT 14331-12.2005). The Guide starts with the general proposition that Part IVA of ITAA 1936 will only apply where the sole or dominant purpose of an arrangement was to obtain a tax benefit. The Guide also summarised the circumstances in Hart’s case.  The summary indicated that it was concerned with a “split” loan in which the interest obligation on the investment purpose component had been increased to compensate for the favourable interest treatment of the personal component of the loan.  So explained, it demonstrated that the Hart decision had no relevance to Mr Douglass’ circumstances. 

13. Furthermore, Mr Douglass’ selective use of the contents of the Guide are readily apparent from a comparison of what he set out in, and what he omitted from, the extract he submitted to the ATO in his 9 July 2015 audit submission.  The full extract from the Guide is set out below.  The underlined section indicates what Mr Douglass omitted from his submission letter:-

    Part IVA would not apply to a typical husband and wife partnership arrangement where there are no unusual features.

    Under such an arrangement, a husband and wife conduct a business in partnership and, as the relevant Partnership Act provides, share equally in profits and losses, notwithstanding that only one party performs the main bulk of the work. This arrangement has the effect of dividing income equally notwithstanding that only one of the partners is the main generator of the income of the partnership. However, the arrangement also has the very real financial consequence of exposing each partner to full liability for the debts of the partnership.

    When regard is had to the eight matters in Part IVA, it would not be objectively concluded that the dominant purpose of the partnership arrangement was to obtain a tax benefit through the equal division of profits and losses.

    Entering into a partnership is an ordinary means for a husband and wife to conduct a business together. There is nothing contrived about the manner of sharing profits and losses because that is what the Partnership Act prescribes as the normal consequence of forming a partnership.

    The arrangement is a partnership in form and in substance and it is a way of the husband and wife conducting business over the longer term.

    In the absence of unusual features, therefore, Part IVA would not apply to such husband and wife partnerships. The sort of unusual features that could see Part IVA apply include where the:

    income generating activity was in reality a disguised employment arrangement, or          use of the partnership is prohibited by regulatory or other laws.

    In employee like arrangements, provisions in the income tax law which specifically deal with the alienation of personal services income may apply in any event. This would mean that the partner performing the main bulk of the work is taxed on all of the partnership income. In such cases, Part IVA would have no application.

14. The final document on which Mr Douglass perhaps claimed to have relied to support his original argument was a short summary that the Independent Contractors Association published in February 2006. It was, however, no more than a summary of the position the ATO had adopted (in its December 2005 publications) about the “ordinary case” of income splitting by a “genuine partnership” conducted by spouses. In his July 2015 submission Mr Douglass highlighted a single sentence in the document that “This can apply for IT professionals, engineers, consultants and so on.” Mr Douglass appears to have ignored a more pertinent statement, later on the same page of the document. It was to the effect that the ATO’s new approach only applied to independent contractors who were classified as a “Personal Services Business”. In its context (having regard to the ITAA 97 legislative provisions summarised earlier in these reasons;- see paragraph 13 above) that effectively meant that unless the partnership satisfied the “results” test, the “new” ATO approach had no application.

15. In the light of the matters Mr Douglass advanced to support his original argument, and my scrutiny of them, I have significant reservations about the credibility of the proposition that, at the time he submitted the 2013 and 2014 tax returns, he genuinely believed that splitting the partnership income was in any sense justified.  But it is unnecessary to reach a concluded view about his contemporaneous subjective state of mind.  The matters I have set out above in reviewing Mr Douglass’ professed reliance eloquently highlight the caution and reservation that a reasonable person in Mr Douglass’ circumstances could and should be expected to have shown before departing from (and subsequently persisting in his departure from) his previous practice of observing the provisions requiring him to include the partnership income as part of his assessable income.  Mr Douglass’ conduct at least merits characterisation as gross carelessness, and satisfies the criterion of relevant recklessness.

16. The conclusion I have expressed in the previous paragraph would apply even more strongly if I had been of the view that Mr Douglass’s income splitting, and erroneous personal tax returns, in the 2013 and 2014 tax years had been subjectively motivated by the view that the partnership satisfied the “results” test.  As it seems to me, having regard to Mr Douglass’s professed past understanding of the personal services income provisions, he could only have come to such a subjective view as a result of a grossly careless and self interested misunderstanding of the legislative provisions, and grossly careless disregard of the cautions and warnings contained in the ATO’s various 2005 publications.

    Remission issues

17. The Commissioner has a general discretion to remit all or part of a shortfall penalty:-  see TAA Schedule s 298-20.  The essential criterion for the exercise of the discretion is that of fairness and reasonableness – having regard to the basic taxable criteria, and the objectives of the penalty regime.  In essence, the discretion calls for an impressionistic decision about the quality and culpability of the conduct involved in the shortfall occurrence.  In the light of the findings I have made above, Mr Douglass’ conduct amply justifies characterisation as involving recklessness.  There is no occasion to remit, to any extent, the penalty assessments.

    Conclusion

18. In so far as they remained contentious (see paragraphs 8 to 10 above) the decisions under review are affirmed.

I certify that the preceding 129 (one hundred and twenty-nine) paragraphs are a true copy of the reasons for the decision herein of Mr P W Taylor SC, Senior Member

............................[sgd]............................................

Associate

Dated: 3 October 2018

Dates of hearing:	3 April 2018 and 17 July 2018
Counsel for the Applicant:	Mr R Niemann, Douglas Menzies Chambers
Solicitor for the Applicant:	Mr J Findley, Christopher Levingston and Associates
Counsel for the Respondent:	Mr M O'Meara, Sixth Floor Selborne Wentworth Chambers
Solicitors for the Respondent:	Ms R Sayed and Mr W Vuong, Australian Government Solicitor