Metaskills Pty Ltd and Commissioner of Taxation

[2002] AATA 1204

DECISION AND REASONS FOR DECISION [2002] AATA 1204

ADMINISTRATIVE APPEALS TRIBUNAL      )

)          No NT2002/100

TAXATION APPEALS DIVISION )          
           Re      METASKILLS PTY LTD   
  Applicant
           And    COMMISSIONER OF TAXATION          
  Respondent

DECISION

Tribunal       Mr M D Allen, Senior Member      

Date22 November 2002

PlaceSydney

Decision      The decision under review is Set Aside, and this matter remitted to the Respondent with the direction that the Applicant has satisfied the provisions of subsection 87-65(3)(a)(ii) of the Income Tax Assessment Act 1997.       
  (Sgd)      M. D. ALLEN
  ........................................
  Senior Member

CATCHWORDS
INCOME TAX – Alienation of Personal Services Income – Declaration as to whether the Applicant a personal services business – Unable to meet the results test as contract not with the company but with a Director personally – Unable to show unusual circumstances regarding unrelated client for the same reason – Unusual circumstances test met regarding business premises.

Income Tax Assessment Act 1997 - Division 87
Taxation Administration Act 1953 - s14ZZK

re Creaton Pty Ltd and Commissioner of Taxation AATA [2002] (1 November 2002) 1121
Secretary, Department of Social Security v Ellis 24 AAR 535
Kirkbright v Secretary, Department of Family & Community Services 32 AAR 120

REASONS FOR DECISION

22 November 2002 Mr M D Allen, Senior Member                  

1. By application lodged 23 April 2002 the Applicant sought review of an objection decision made 22 February 2002 that disallowed an objection against the refusal of the Respondent to issue a Personal Services Business Determination in relation to the personal services income derived by Michael Strong in the tax year ended 30 June 2001.

2. The said application for review came on for hearing before me at Sydney on 6 November 2002, the Applicant being represented by Mr Strong.

3. Metaskills Pty Ltd is a proprietary company the directors of which are Mr Michael Strong and his wife Mrs Jann Strong. The company is the vehicle through which Mr Strong provides business and information technology consulting services.

4. On 14 June 2001 the Applicant applied for a Personal Services Business Determination, in respect of the personal services income of Mr Michael Strong in respect of the year of income ended 30 June 2001. That request followed the amendments to the Income Tax Assessment Act 1997 (the Act) by the grandiloquently entitled New Business Tax Systems (Alienation of Personal Services Income) Act 2000. The relevant part of that Act as amended by the Taxation Laws Amendment Act (No 6) 2001 are:

   (i) subsection 86-15(2) which reads:

   "A personal services entity is a company, partnership or trust whose ordinary income or statuary income includes the personal services income of one or more individuals."

   Personal services income is defined in s84-5 inter alia as being an individual's income or statuary income if the income is mainly a reward for personal efforts or skills.
   "Ordinary Income" is defined in s6-5 as income according to ordinary concepts whereas "Statuary Income" is defined as income not being ordinary income but included in assessable income by provisions about assessable income.

   (ii) subsection 86-15(1) provides that:

   "Your assessable income includes an amount of ordinary income or statuary income of a personal services entity that is your personal services income."

   Whereas ss86-15(3) states that section 86-15 does not apply if the income is from a personal services entity conducting a personal services business.

   (iii) the rationale of division 86 of the Act is set out in section 84-1 namely:

   "This part is about two issues relating to personal services income.
   Division 85 limits the entitlements of the individuals to deduction relating to their personal services income.
   Division 86 sets out the tax consequences of the individuals' personal services income being diverted to other entities (often called alienation of the income).
   These divisions do not affect the individuals or other entities that conduct personal services businesses. Division 87 defines personal services businesses."

   (iv) section 87-65 permits the Commissioner of Taxation to make a Personal Services Business Determination in respect of a Personal Services Entity whose ordinary or statuary income includes some or all of an individual's personal services income.

   (v) the Commissioner of Taxation can only make such a declaration if satisfied that in the income year during which the determination first has effect the entity:

   "(3)(a)(i) could reasonably be expected to meet, or met, the results test under section 87-18, the employment test under section 87-25, the business premises test under section 87-30 or more than one of those tests; or

   (ii) but for unusual circumstances applying to the entity in that year, could reasonably have been expected to meet, or would have met, at least one of the 4 personal services business tests;"

5. The rationale behind the scheme of the Act was stated in the second reading speech as follows:

   "This bill will prevent individuals reducing their tax by diverting the income generated by their personal services to a company, partnership or trust and limit work-related deductions available in those cases …
   The Commissioner's determination that a business is a personal services business may be given on one of four grounds:

• having two or more unrelated clients

• having one or more employees

• having a separate business premises

• that the individual or entity is producing a result, supplies their tools of trade and is liable for the cost of rectifying defective work."

1. The object of division 87 of the Act is spelt out in section 87-10 as follows:

   "The object of this Division is to define personal services businesses in a way that ensures that it covers genuine businesses but not situations that are merely arrangements for dealing with the personal services income of individuals."

1. Although the Applicant's objection to the Commissioner's decision to refuse to register it as a Personal Services Business referred to the tests in sections 87-20 (the unrelated client tests) and 87-30 (the business premises test) and claimed unusual circumstances pursuant to paragraph 87-65(3)(a)(ii) of the Act there being no objection by the Respondent, I gave leave to add at this hearing further grounds of objection namely that the Applicant met the results test pursuant to section 87-18 of the Act.

2. Subsection 87-18(3) reads:

   "A personal services entity meets the results test in an income year if, in relation to at least 75% of the personal services income of any or more individuals that is included in the personal services entity's ordinary income or statutory income during the income year:

   (a) the income is for producing a result; and
   (b) the personal services entity is required to supply the plant and equipment, or tools of trade, needed to perform the work from which the personal services entity produces the result; and
   (c) the personal services entity is, or would be, liable for the cost of rectifying any defect in the work performed."

3. At the outset a matter which Mr Strong who appeared for the Applicant company appeared not to fully appreciate, had a material effect upon these proceedings. The Applicant is Mr Strong's company, Metaskills Pty Ltd, and although Mr Strong is a director of that company with his wife and its only employee and is in effect the company, at law Mr Strong and the company are two entirely separate entities, see Salomon v A Salomon and Co Ltd [1897] AC 22, and re Eimberts and the Repatriation Commission 16 ALD 19 at 26.

4. The Applicant in its application for declaration that it was a Personal Services Business (see document T3-8 of the documents prepared for the Tribunal pursuant to section 37 of the Administrative Appeals Tribunal Act 1975) stated that the majority of revenue in the subject year came from the one client who required several large projects in a row. That client was IT Spark Pty Ltd (IT Spark) who acted as a head contractor and hired others to carry out the work.

5. I have used the term "head contractor" deliberately. The Respondent insisted on referring to IT Spark as a "labour hire firm" but to my mind this completely mistakes the position. The term "labour hire firm" may be appropriate to a firm that hires out tradesman for particular jobs, but the role of IT Spark was more that of the head contractor who then hired individual information technology (IT) professionals to carry out specific projects.

6. Documents T3-23 to 31 inclusive are copies of offers by IT Spark for the engagement of an IT consultant for a specific assignment (or task). It would seem that the contract was accepted by the performance of the task and the submitting of accounts for the work done to IT Spark. All of the said offers are addressed not to the Applicant company but to "Mike Strong".

7. The said offers also refer to the offer being "under the general terms of contract you have signed with IT Spark". A copy of that document became Exhibit A2 in these proceedings. That document is addressed to Mike Strong and the signature accepting the terms and conditions of the contract is that of Michael James Strong.

8. It is clear from the documents referred to above that although any accounts for work done may have been rendered to IT Spark in the name of the Applicant, the contractual arrangements were between Mr Strong and IT Spark.

9. Subsection 87-18(3) of the Act cannot therefore be applied to the Applicant as in the year of income the personal services entity could not meet the test in subparagraphs 87-18(3)(b) and (c).

10. Similar difficulties attended the Applicant's ability to meet the test in section 87-20, the unrelated clients test, in that the Applicant did not provide any services as opposed to the services provided by Mike Strong.

11. Notwithstanding that initial difficulty, the services that were provided were not provided to two or more entities. During the income year in question the services were provided to IT Spark who in effect subcontracted Mr Strong.

12. Paragraph 87-20(1)(b) reads:

    "An individual or a personal services entity meets the unrelated clients test in an income year if:

    (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."

Whereas subsection 87-20(2) states:

"The individual or personal services entity is not treated, for the purposes of paragraph (1)(b), as having made offers or invitations to provide services merely by being available to provide the services through an entity that conducts a business of arranging for persons to provide services directly for clients of the entity."

1. Although the Applicant may have advertised by having its name on the jerseys of a local football club, which could be characterised as an offer to the public at large and has sought work by word of mouth and by making enquires within the industry, the services in the income year were provided as a result of an ongoing relationship with the one head contractor.

2. Subsection 87-30(1) refers to a business premises test which is met if during the income year the entity maintains and uses business premises:

   "(a) at which the entity conducts activities from which personal services income is gained or produced; and

   (b) of which the entity has exclusive use; and
   (c) that are physically separate from any premises that the entity or any associate of the entity, uses for private purposes; and
   (d) that are physically separate from the premises of the entity to which the entity provides services and from the premises of any associate of the entity to which the entity provides services."

3. In the year of income the Applicant did obtain separate premises after having had its place of business for five years prior thereto at the residential premises of Mr Strong the move to separate premises took place late in the year of income.

4. The reasons advanced for the delay in moving to separate premises was stated in the Applicant's application as follows (T3-16):

   "FOR THE FIVE YEARS PRIOR TO THE commencement of FY00-01 I had operated my business from an office in my residential premises effectively and efficiently. The nature of the contracts I was executing and intensity of work required meant that there was no suitable time to take focus off the contract work for long enough to find and establish new premises until late in the year. The circumstances have ceased and I have found separate premises."

As an aside, it would be seem in the above passage that Mr Strong again makes the mistake, understandable in a layman, of failing to draw a distinction between himself and the Applicant company. I would have thought however that the Applicant's tax agent would have adverted to this distinction.

1. In evidence, Mr Strong referred in addition to the matters outlined above to complications arising from the introduction of the GST and that he was in negotiations with third parties which if completed would have obviated the need for separated premises.

2. Pages 169 to 171 inclusive of Exhibit A1 are letters from three companies which evidence that Mr Strong and those companies discussed a merging of business interests. The discussions appeared to have been initial negotiations rather than concrete proposals for any business relationship.

3. Subparagraph 87-65(3)(a)(ii) of the Act gives relief from strict compliances with the personal services business tests if "unusual circumstances" applied.

4. The term "unusual circumstances" is not defined in the Act, however I adopt the reasoning of Senior Member Sassella in re Creaton Pty Ltd and Commissioner of Taxation AATA 1121 that equated the term "unusual circumstances" with the phrase "special circumstances" as explained in re Beadle and Director General of Social Security 6 ALD 1 at 3.

5. The term "special circumstances" was further elucidated by Carr J in Secretary, Department of Social Security v Ellis 24 AAR 535 at 539 namely:

   "In Beadle v Director-General of Social Security (1985) 7 ALD 570, a Full Court of this court had to consider whether the Administrative Appeals Tribunal had erred in its interpretation of s102(1)(a) of the Act which provided for an extension of time in which to claim a family allowance '… in special circumstances…' At pp 673-674 the Full Court said:

   'Presumably in this context special circumstances must include events which would render the 6 month unfair or inappropriate … It would depend upon the circumstances of the particular case whether these constituted special circumstances. We do not think it is possible to lay down precise limits or precise rules. The matter is one for the Director-General bearing in mind the purpose for which the power is given. The phrase 'special circumstances', although lacking in precision, it is sufficiently understood in our view not to require judicial gloss.'

   In Groth v Secretary, Department of Social Security (1995) 40 ALD 541 at 545, Kiefel J, after referring to Beadle, said:

   '… For present purposes it is sufficient to observe that it would require something to distinguish Mr Groth's case from others, to take it out of the usual or ordinary case. That was, I consider, the only inquiry to be undertaken in this case. It would of course follow that if one were to conclude that something unfair, unintended or unjust had occurred that there must be some feature out of the ordinary. The inquiry I have referred to would involve considering what would be the effect, if the provision in question or the principle of liability it creates, is applied.'

   Later (on the same page) Kiefel J expressly approved the Tribunal's reasoning in holding that Mr Groth's circumstances were not out of ordinary when Pt 3.14 of the Act (in which ss1168 and 1184 are to be found) had the same effect on him as it did on other persons qualified to receive a disability support pension. Her Honour added:

   'It [the Tribunal] went on to find that his circumstances and those of his family although difficult, did not constitute hardship and they could not be said to be different from other pension recipients.'"

6. Although the remarks of Kiefel J as quoted above would seem to indicate that legislation which has a general application could not constitute special circumstances, that view of the law has been rejected. In Kirkbright v Secretary, Department of Family and CommunityServices 32 AAR 120 at 127, Mansfield J said:

   "… In Kertland v Secretary, Department of Family and Community Services (1999) 95 FCR 64; 30 AAR 411, Merkel J said at 71; 418:

   'In Smith to which I will later return, von Doussa J rejected a contention put on behalf of the Secretary that 'the circumstances of the case' should be confined to matters which are external to the operation of the statutory scheme. His Honour made the point, with which I respectfully agree, that a distinction cannot meaningfully be drawn between matters external to the operation of the scheme and matters which are the product of the strict application of the scheme.'

   His Honour expressly referred with approval to observation to von Doussa J in Smith to which I have already referred. I respectfully agree with and adopt their Honours' reasons for that conclusion. …"

7. As pointed out by Senior Member Sassella in re Creaton Pty Ltd supra, paragraph 87-65(4)(b) of the Act permits account to be taken of the Applicant meeting the test in one or more presiding income years even if not in the immediately presiding income year.

8. The Applicant stated in an annexure to its application (T3-32):

   "In the six (6) years that Metaskills Pty Ltd had been operating, it has executed approximately 18 major assignments / engagements (2-6 months duration) for 6 major clients (ISSC/Optus Vision, Vodac, Australian Federal Police, IBMGSA/Telstra, Compaq and One Tel). These major assignments were obtained through three separated organisations whose role was to find the work and establish the commercial relationship (Technology Solutions Pty Ltd, FMS International Inc., Technology Solutions and then IT-Spark Pty Ltd)."

Subsections 87-20(2) provides that although separate individual entities may be the recipient of the services there are not unrelated clients if the services were provided through an entity that "conducts a business of arranging for persons to provide services directly for clients of the entity". In this case IT Spark is a classic case of such an entity.

1. The Applicant further stated:

   "In summary, there have been a wide range of customers and assignments over the Company's years of operation. It is an unfortunate co-incidence of timing that, in the year that the PSI legislation was introduced, there was a (good) client who required several large projects in a row and represented the vast majority of the Company's revenue in the one financial year. It is an unusual circumstance and is unlikely to happen again."

2. Cross-examined Mr Strong gave details of work carried out for other services suppliers. Although a criticism was made by the Respondent that these contracts were sequential, I do not understand that criticism. There is nothing in the legislation to state that work for two or more entities must be carried out at the same time.

3. Section 14ZZK of the Taxation Administration Act 1953 provides inter alia that on an application for review of a reviewable objection decision, the Applicant has the burden of proving that the Taxation decision concern should not have been made or should have been made differently.

4. In this matter whereas I am satisfied that in the year in question, Mr Strong had an unusual circumstance in that he was engaged by one head contractor only (for example compare a barrister who is engaged for a long trial or Royal Commission). I am also satisfied that with the Act now in force the Applicant can reasonably be expected to meet the test in subsequent income years.

1. What I am not satisfied of is that the Applicant in a preceding year met the test as opposed to Mr Strong personally.

2. I have referred above to the contracts in the evidence as being between IT Spark and Mr Strong. There is no evidence before me as to the parties to the contracts in the preceding years. As the onus pursuant to section 14ZZK of the Taxation Administration Act is upon the Applicant then the ground for the declaration pursuant to paragraph 87-65(3)(a)(ii) and subsection 87-65(4) fails.

3. The circumstances regarding the maintenance of the business premises for part of the year only is, in my opinion, unusual when taken in their entirety.

4. As pointed out in Kirkbright supra changes affected by legislation may be considered in ascertaining whether special circumstances exist. To this must be added a doubt in the mind of the directors and sole shareholders in the Applicant company as to whether the premises would in fact be required. I accept that any merger negotiations were at an explanatory stage at best, but prudence would indicate that possible unnecessary property arrangements should not be entered into. So far as other external matters such as pressure of work and the introduction of the GST at the same time are concerned, I do not accept that these individually would amount to unusual circumstances but in combination I do accept that the circumstances were in the particular year out of the ordinary (to adopt the words used by Kieful J).

5. I accept that the Applicant company had for five years previously been conducted out of the residential premises of its directors and shareholders, Mr and Mrs Strong. I am also satisfied that were it not for the legislation any search for separate premises would not have taken place when it did but would have awaited the natural evolution of the business. However, as alluded to above, changes in an entity's operation brought about by changes in legislation are matters which can be taken into account. The directors of the company were aware of the change in legislation, consequently I am satisfied and so find that but for the unusual circumstances identified above, the Applicant could reasonably have been expected to have met the business premises test under section 87-30 of the Act.

6. As pointed out by Senior Member Sassella in re Creaton Pty Ltd supra, the ultimate decision is for the Commissioner of Taxation, therefore my decision is that the decision under review is Set Aside, and this matter remitted to the Respondent with the direction that the Applicant has satisfied the provisions of subsection 87-65(3)(a)(ii) of the Income Tax Assessment Act 1997.

   I certify that the 40 preceding paragraphs are a true copy of the reasons for the decision herein of Mr M D Allen, Senior Member.

   Signed:         .....................................................................................
     Associate

   Date of Hearing  6 November 2002
   Date of Decision  22 November 2002
   Representative for the Applicant    Mr M Strong
   Counsel for the Respondent          Mr R Quinn
   Solicitor for the Respondent          Australian Tax Office Legal Practice