The Engineering Company and Commissioner of Taxation
[2008] AATA 934
•21 October 2008
Administrative Appeals Tribunal
DECISION AND REASONS FOR DECISION [2008] AATA 934
ADMINISTRATIVE APPEALS TRIBUNAL )
) No 2007/3360
Sitting as Small Taxation Claims Tribunal ) Re THE ENGINEERING COMPANY Applicant
And
COMMISSIONER OF TAXATION
Respondent
DECISION
Tribunal Mr S E Frost, Member Date 21 October 2008
PlaceSydney
Decision The objection decision is affirmed. ...............[sgd]...............................
Mr S E Frost
Member
CATCHWORDS
TAXATION – income tax – personal services business determination – Applicant does not meet any of four personal service business tests in income year – whether unusual circumstances prevent Applicant meeting tests – determination of personal services income – ordinary income and statutory income – “amounts” of income – interpretation of “mainly” – employment test – interpretation of “principal work” – unusual circumstances – unrelated clients test – offer or invitation to the public at large or a section of the public – objection decision affirmed
Income Tax Assessment Act 1997 – s 6-15(1), 84-5(1), 84-5(2), 85-10, 85-10(2)(e), 85-20(2), 85-25(2), 86-15(1), 86-15(2), 86-15(4), 86-25(b), 86-60, 86-75(2), 87-15, 87-18, 87-20(1)(a), 87-20(1)(b), 87-25, 87-25(1)(b), 87-25(2)(a)(i), 87-25(2)(b), 87-30, 87-65(3), 87-65(3B), 87-65(6)
Taxation Ruling TR 2001/8 – paragraph 58
Explanatory Memorandum to the New Business Tax System (Alienation of Personal Services Income) Bill 2000 – paragraphs 1.53, 1.54
REASONS FOR DECISION
21 October 2008 Mr S E Frost, Member Introduction
1. The tax law was changed in 2000 in response to what was described as a “significant and accelerating trend” for employees to alienate their personal services income (Review of Business Taxation: A Tax System Redesigned, July 1999, Overview, paragraph 202). The Review stated that the alienation of personal services income:
… moves the income received by the unincorporated contractor or the interposed entity out of the PAYE tax system. The arrangements have had the practical effect of these taxpayers claiming deductions not available to ordinary employees and, if there is an interposed entity, allows scope for income splitting. As the economic reality of the earning of their income is unchanged, their income should be taxed on the same basis as other PAYE income. This is consistent with the principle adopted by the Review that tax be levied on the basis of economic substance rather than legal form.
2. One of the desired outcomes of the changes to the law, contained in a new Part 2-42 of the Income Tax Assessment Act 1997 (“the Act”), was to tax, in the hands of an individual, income that had been earned from the rendering of personal services, even if the income was contractually earned by a company rather than the individual.
3. The Applicant in this matter is described by the pseudonym “The Engineering Company” to preserve its anonymity. It is a company that provides engineering and related services to clients. Its director, referred to in these reasons as “Mr Engineer”, is one of the individuals who actually provide those services to the Applicant’s clients.
4. In relation to the 2006 income year, the Applicant asked the Commissioner to make a “personal services business determination” under Part 2-42 of the Act, which would have had the effect of not attributing certain of the Applicant’s income to Mr Engineer personally. The Commissioner declined to make the determination, and the Applicant objected against that decision. When the Commissioner disallowed the objection, the Applicant applied to the Tribunal for review.
Issues
5. The question in this case is whether the Applicant is entitled to the benefit of a personal services business determination for the 2006 income year.
6. The Applicant’s case is that it is entitled to a determination because, but for unusual circumstances in the 2006 income year, it would have satisfied the “employment test” in s 87-25 of the Act or the “unrelated clients test” in s 87-20. In summary, the Applicant says that it satisfies either the so-called “second alternative” in s 87-65(3B) or the so-called “fourth alternative” in s 87-65(6) of the Act. If either one of those provisions applies, then a personal services business determination can be made: s 87-65(3) of the Act.
7. The relevant provisions in Part 2-42 of the Act are set out in the Annexure to these reasons.
8. The issues that arise in this matter are:
(i)How Mr Engineer’s “personal services income” (s 84-5(1)) should be determined;
(ii)What is the meaning of the expression “principal work” in paragraph (b) of the employment test in s 87-25(2);
(iii)Whether, taking into account the answers to (i) and (ii), the Applicant met the employment test in any or all of the 2003, 2004 and 2005 income years;
(iv)If the answer to (iii) is yes – Whether, but for unusual circumstances, the Applicant could have been expected to meet the employment test in the 2006 income year;
(v)If the answer to (iv) is yes – Whether the test in s 87-65(3B)(b) has been met;
(vi)Whether the Applicant gained or produced income from two or more entities in any or all of the 2003, 2004 and 2005 income years;
(vii)Whether, taking into account the answer to (vi), the Applicant met the unrelated clients test in any or all of the 2003, 2004 and 2005 income years;
(viii)If the answer to (vii) is yes – Whether, but for unusual circumstances, the Applicant could have been expected to meet the unrelated clients test in the 2006 income year;
(ix)If the answer to (viii) is yes – Whether the test in s 87-65(6)(b) has been met; and
(x)If the answer to (ix) is yes – Whether the test in s 87-65(6)(c) has been met.
9. Unless either (v) or (x) is answered “Yes”, the Applicant will not be entitled to a personal services business determination for the 2006 income year.
10. The reason for the examination of the 2003, 2004 and 2005 income years in (iii) and (vii) is that, if a regular pattern had been established in those years that led to the meeting of one of the primary tests (the “employment test” or the “unrelated clients” test), there might be a foundation for an argument that “unusual circumstances” prevented the meeting of the test in the relevant income year of 2006.
11. Before discussing the various issues, I should note the elements of the case that are not controversial. They are that:
· The Applicant, The Engineering Company, is a personal services entity: s 86-15(2);
· At least some of the Applicant’s ordinary income or statutory income is Mr Engineer’s personal services income: s 84-5(1);
· Mr Engineer has always been an employee of the Applicant;
· Over the years, the Applicant has had other employees in addition to Mr Engineer – Mr O, who was an employee from 1997 until May 2005; and Mr D, who was an employee during the 2004 income year.
Issue 1 – How should “personal services income” be determined?
12. For the purpose of considering both alternatives it is necessary to calculate Mr Engineer’s “personal services income” which is defined in s 84-5 of the Act. There are several different ways of approaching the interpretation of “personal services income”. The differences between the competing interpretations reflect the alternative ways of identifying the “ordinary income” and the “statutory income” of an entity, the personal services entity, for the purpose of determining whether that “income is mainly a reward for [the individual’s] efforts or skills” (and therefore, the individual’s personal service income).
13. Both the expressions “ordinary income” and “statutory income” are dealt with in Division 6 of the Act. While there is no need to undertake a detailed examination of the concepts here, it is appropriate to note that there is an expectation – see for example s 6-15(1) – that the terms “ordinary income” and “statutory income” apply to “amounts” of income. Therefore, when s 84-5(1) talks of “the ordinary income or statutory income of [a personal services entity]”, it is talking of an amount that is ordinary income of the entity, and of an amount that is statutory income of the entity. The subsection then poses the question whether the amount is “mainly” a reward for a particular person’s personal efforts or skills.
14. The Commissioner submitted that “mainly” means “chiefly”, “principally”, “for the most part” or, in practical terms, “more than 50%”. If an amount of income is “mainly” a reward for a particular person’s personal efforts or skills, then the Commissioner says that all of that amount is “personal services income” of that person. It is an all-or-nothing test. It is different from a “to the extent” test, which suggests an apportionment, where some of the amount can be “personal services income” and some of it not.
15. So much can be accepted. But it still leaves open the question: what is the amount to be examined? Is it all of the income of the entity? Or is each amount of income derived from each client to be examined separately? Or does one examine each amount of income that is attributable to the different categories of work undertaken by the entity? Or is it to be an examination of each discrete amount of income derived from the entity’s clients?
16. In my view, the first alternative – the “global income” alternative – does not examine the entity’s income in sufficient detail. It would also make it impossible for the circumstances envisaged by paragraph (b) in s 86-25 to exist. In a case such as this one, where there are multiple clients and different mixes of work contribution by the employees of the Applicant, a high-level enquiry directed at the entity’s “global income” could not be expected to produce the correct identification of the income that is mainly a reward for Mr Engineer’s personal efforts or skills. For practical purposes the test would be whether most of the Applicant’s income was attributable to the personal efforts or skills of Mr Engineer, and if that were the test it could have been much more easily expressed than by the terms used in s 84-5(1).
17. Under the second alternative – that is, the separate examination of each amount of income (in total) derived from each client – it would follow that no part of the income derived by the Applicant from Client A would be included in Mr Engineer’s personal services income, since Mr Engineer’s portion of the total does not satisfy the “mainly”, or 50 per cent, test. That does not seem a logical outcome, since all of the income attributable to Mr Engineer’s contribution (where that contribution can be identified) is a reward for his personal efforts or skills.
18. I have come to the view that, where it is possible to do so, each discrete amount of income that has been received from the entity’s clients are the amounts of income that should be examined for the purposes of s 84-5(1). These amounts will generally be reflected in the invoices issued to the clients. Where the amount shown on a particular invoice is itself a total amount, and not capable of dissection into distinct components, the question that should be asked is whether the total amount is “mainly” a reward for an individual’s personal efforts or skills. Where, on the other hand, the amount is capable of dissection, the question should be asked in relation to each distinct component of it. In summary, the “amounts” of income that are to be analysed in terms of s 84-5(1) are the amounts that have been identified by the personal services entity as the various amounts of ordinary income and statutory income that go to make up the entity’s total income.
19. In the case of The Engineering Company, amounts invoiced to Client A that relate solely to work carried out by Mr Engineer form part of his personal services income. Amounts that are not capable of dissection, but that relate to work carried out by both Mr Engineer and Mr O, form part of Mr Engineer’s personal services income only if the work invoiced is “mainly” – that is, to the extent of more than 50 per cent – a reward for his personal efforts or skills. Amounts that relate solely to Mr O’s activities, of course, would not form part of Mr Engineer’s personal services income.
20. Taking this approach, and by reference to Annexure D to the Applicant’s Extra Supplementary Submissions dated 26 June 2008 and paragraph 9 of the Respondent’s Submissions in Response to Applicant’s Further Submissions and Evidence dated 1 August 2008, I conclude as follows in relation to the 2003, 2004 and 2005 income years (“Mr E’s PSI” signifies Mr Engineer’s personal services income; the clients can be identified by reference to T8-91 and T8-92):
2003
2004
2005
Client
Total
Mr E’s PSI
Total
Mr E’s PSI
Total
Mr E’s PSI
A
121,979
33,930
187,759
68,620
143,682
44,010
B
109,890
109,890
C
26,367
26,367
D
19,668
19,668
E
660
660
F
2,513
0
G
3,289
0
H
75,110
75,110
Total
231,869
143,820
236,967
115,315
222,081
119,120
Issue 2 – What does “principal work” mean in the context of the employment test: s 87-25(2)(b)?
21. A personal services entity will meet the employment test if it engages one or more other entities (excluding individuals whose personal services income is included in the entity’s ordinary income or statutory income and associates of the entity that are not individuals) that contribute at least 20 per cent to the entity’s “principal work”. The Commissioner submitted that “principal work” means “work done on behalf of an entity that generates income that is personal services income of the relevant individual” (Respondent’s Submissions dated 7 April 2008, paragraph 28). Reliance was placed on paragraph 58 of Taxation Ruling TR 2001/8 which says:
The term “principal work” in paragraphs 87-25(1)(b) and (2)(b) can be described as that work which fulfils the obligations under the agreement with the service acquirer. It is the work that generates the personal services income of the test individual or personal services entity under the contract.
22. That closing reference to “the personal services income of the … personal services entity” is a confusing one. As is made plain by s 84-5(2), only individuals can have personal services income; personal services entities cannot. Perhaps the Commissioner’s statement says more than intended about how difficult it is both to understand these provisions, and to express concepts that are central to them.
23. The Commissioner also referred me to certain paragraphs in the Explanatory Memorandum to the New Business Tax System (Alienation of Personal Services Income) Bill 2000 (“the Explanatory Memorandum”) which introduced Part 2-42. In particular, paragraphs 1.53 and 1.54 of the Explanatory Memorandum (although discussing the expression “principal work” appearing in s 85-10(2)(e), rather than in s 87-25(2)(b)) say this:
1.53 The term “principal work” will not be defined for the purposes of the new rules and so takes on its ordinary meaning. This is because whether an associate is performing work which forms part of the principal work of the individual is a question of fact that must be decided on a case by case basis.
1.54 As a general guide, the principal work of an individual can be described as that work that is central to meeting the individual’s obligations under agreements between himself or herself, or a personal services entity, and the acquirer of the personal services. It is work that is essential to the generation of income of the relevant individual or entity from the personal services of an individual.
24. It should be noted that paragraph 1.53 refers to “principal work of the individual” because s 85-10 is directed towards the restricted deductions that are available to an individual who operates on his or her own account, as a sole trader. However, those same restrictions apply to a personal services entity (such as a company, partnership or trust – see s 86-15(2)) through the operation of s 86-60. Therefore, it seems to me, the expression “principal work of a personal services entity” is just as much “a question of fact that must be decided on a case by case basis” as is the corresponding expression “principal work of an individual” referred to in paragraph 1.53.
25. Paragraph 1.54 is of limited assistance. First, it explicitly describes itself as a “general guide”. Then it appears to lapse into the same confusion of concepts as is evident in paragraph 58 of TR 2001/8. Although it refers to “work that is central to meeting the individual’s obligations under agreements between … a personal services entity and the acquirer of the personal services”, it should be remembered that it is only actually speaking about the circumstance where the individual – a sole trader – is the ultimate service provider. The reference to “a personal services entity” must have come as an afterthought – but, unfortunately, after not much thought. This is because, when the agreement under consideration has been entered into by a personal services entity, one would expect the focus to be on that entity’s obligations, rather than on “the individual’s obligations”.
26. In the end, I find the structure of Part 2-42, and the context in which its provisions appear, to be more reliable indicators of the meaning of “principal work” than the Explanatory Memorandum or the Taxation Ruling.
27. The expression “principal work” appears six times in Part 2-42. On three occasions it forms part of a larger expression “principal work for which you gain or produce your personal services income”: s 85-10(2)(e), 85-20(2) and 85-25(2). On the remaining three occasions the expression “principal work” stands by itself, without further qualification: s 86-75(2), 87-25(1)(b) and 87-25(2)(b). It is the meaning of the expression on that last occasion, in s 87-25(2)(b), that I have to determine.
28. The Commissioner says that the expression should be read as if it has the qualification that was used on the first three occasions (Respondent’s Submissions dated 7 April 2008, paragraph 29):
If “principal work” was interpreted more generally to include work that did not generate personal services income of the relevant individual (the “test individual”), Part 2-42 would be easily avoided by individuals grouping together and each operating their own personal services businesses through a shared entity. Each individual would be entitled to argue that the entity complies with the employment test, provided one or more of the other individuals with whom the first individual has grouped together will have performed at least 20% of all of the principal work (broadly defined) of the entity. Division 87 is not intended to allow this outcome. …
29. But surely the answer to that perceived problem is that if two individuals grouped together, both of them having the purpose of alienating his or her income, then the entity would not be able to satisfy the employment test because each of the individuals would be within the exclusion in s 87-25(2)(a)(i).
30. In my view, the Commissioner’s argument cannot be sustained.
31. When the Parliament demonstrates an ability to express a concept – as it did with the words “principal work for which you gain or produce your personal services income” – it can be assumed that it will use the same expression every time it wishes to express the same concept. The use of a similar, but truncated, expression can indicate either that the Parliament is using shorthand, or that it is seeking to refer to a different concept. Common experience tells us that the Parliament rarely uses shorthand unless it specifically identifies a concept which it will refer to by the use of a label, in the guise of a statutory definition. That is not the case here.
32. My conclusion is that, by the use of the alternative, unqualified expression “principal work”, the Parliament intended to identify a different concept from the one represented by the longer, qualified expression. In my view, “the entity’s principal work” in s 87-25(2)(b) is the principal activity undertaken by the entity – in the Applicant’s case, that is the provision of engineering services to its clients.
Issue 3 – Did the Applicant meet the employment test in the 2003, 2004 or 2005 income years?
33. Yes, in every one of those years. It engaged “one or more other entities to perform work” – namely, Mr O in all of those years, and in addition Mr D in 2004. Furthermore, those employees were not “individuals whose personal services income is included in the entity’s ordinary income or statutory income”. (Counsel for the Commissioner accepted this last point, after taking instructions, during oral submissions towards the end of the second hearing day (Transcript, P-38, line 20), and properly so, in my opinion, in light of the combined effect of s 84-5(1) and s 86-15(1) and (4).) In addition, it is clear from the table in paragraph [20] that Mr O, or Mr O and Mr D together, performed at least 20% (by market value) of the Applicant’s principal work for each of those years.
Issue 4 – Would the Applicant have met the employment test in the 2006 income year, but for unusual circumstances?
34. On the question of “unusual circumstances”, the Commissioner said (paragraph 31 of the Respondent’s Submissions dated 7 April 2008):
Even if the Applicant had satisfied the employment test in 2003, 2004 and 2005, it cannot be said that there were unusual circumstances in the 2006 year that caused the failure of the employment test. Rather, 2006 marked a year in which a fundamental change occurred in the way the Applicant generated income: the Applicant’s long term employee, Mr O, terminated his employment in 2005, there is no evidence that a replacement was sought, and it is clear that a further employee will only be hired in the future if the Applicant manages to secure a contract that warrants another employee’s services: T3-30. There is no documentary evidence that suggests that the Applicant has been seeking such a contract. It is the Respondent’s contention that the change that occurred was in the nature of a permanent change in the Applicant’s business and is thus incapable of constituting an unusual circumstance in that year.
35. The circumstances as outlined by the Applicant were these:
· In March 2005 a long-term client, Client A, indicated that it had no plans to engage the Applicant’s services for the foreseeable future;
· In May 2005 Mr O resigned; and
· Mr O took another client, Client G, with him when he left.
36. It was unusual that Client A did not roll forward its work into the 2006 year as it had done for so many years prior to that. It was unusual that Mr O, an employee of eight years’ standing, resigned from the Applicant. It was unusual that Client G, which had been serviced on behalf of the Applicant by Mr O personally, chose to transfer its work away from the Applicant, and to give it instead to Mr O. Although each of those unusual events occurred in the 2005 income year, the circumstances that arose from them, which were themselves unusual, were still “applying” to the Applicant in the 2006 income year. But for those circumstances, and in particular the circumstances arising from the first two events, it is the case that the Applicant could reasonably have been expected to meet the employment test in the 2006 income year. The Applicant thus satisfies the first condition required to satisfy the second alternative.
Issue 5 – Has the test in s 87-65(3B)(b) been met?
37. There is a degree of uncertainty around the expression “activities that met one or more of those tests” contained in the second condition that must be satisfied in the second alternative: s 87-65(3B)(b). There are two reasons for the uncertainty. First, the three tests that are referred to are constructed by reference to whether entities, not activities, meet them. Second, the very premise on which s 87-65(3B) is based is that the tests will not have been met.
38. Curiously, this particular provision, despite its problematic nature, is not dealt with at all in the Explanatory Memorandum or in Taxation Ruling TR 2001/8. (When those documents were written, this provision was numbered s 87-65(3)(b)(ii).)
39. To make sense of s 87-65(3B)(b), it is necessary to understand how the three tests referred to in s 87-65(3B) are constructed.
40. The first one is the results test, in s 87-18. In simplified form, it requires that:
· the entity’s income be for “producing a result”;
· the entity supply the plant and equipment, or tools of trade; and
· the entity be liable for the cost of rectifying any defects in the work performed,
in relation to at least 75% of the personal services income of an individual or individuals included in the entity’s income.
41. The second test is the employment test, in s 87-25. Put simply, it requires that:
· the entity engage one or more entities to perform work, other than individuals who derive personal services income, or associates who are not individuals,
who perform at least 20% of the principal work of the entity.
42. The third test is the business premises test, in s 87-30. That test requires the entity to maintain and use business premises:
· where personal services income is gained;
· that are for the entity’s exclusive use;
· that are physically separate from premises used for private purposes; and
· that are physically separate from premises used by the entity’s clients,
at all times during the income year.
43. In my view, the test in s 87-65(3B)(b) will be met if, but only if, the bullet-pointed requirements in any of paragraphs [40] to [42] are satisfied. In other words, if a primary test (results test, or employment test, or business premises test) is not met, it must be through failure to satisfy the final qualifier in those paragraphs – the “75% of the personal services income” qualifier; or the “20% of the principal work” qualifier; or the “whole of the income year” qualifier respectively. Only then can it be the case that the individual’s personal services income “could reasonably be expected to be, or was, from the entity conducting activities that met one or more of those tests” – and the reason for the failure is that the activities were not conducted to the required extent.
44. Why did the Parliament use the language “could reasonably be expected to be, or was”? The answer is that a personal services business determination might be requested, for a particular income year, at different times in relation to that income year. For example, it might be requested before the income year starts, or during the income year, and in either of those cases the test is whether the income “could reasonably be expected to be” from the conduct of relevant activities. Alternatively, the determination might be requested after the end of the income year, and then it is appropriate to ask whether the income “was” from the conduct of the relevant activities.
45. The Applicant’s case is not put by reference to either the results test or the business premises test. Relevantly, for the purposes of s 87-65(3B)(b), it is founded on the employment test. The determination was requested on 30 May 2006 (T3) – that is, during the 2006 income year. At the time it was requested, the relevant factual claim, made on behalf of the Applicant by Mr Engineer, was this (T3-30):
In the year ending 30/6/2007 and subsequent years I expect [the Applicant] to satisfy the 80/20 rule and unrelated clients test with a return to shorter duration projects for multiple clients. As [the Applicant] is not adverse (sic) to employing workers, if the projects warrant it, [the Applicant] would pass the employment test.
46. When that statement was made there was only one month to go before the end of the 2006 income year. I do not accept that, at that time, any part of the entity’s income “could reasonably be expected to be” from the conduct of the relevant activity (that is, of engaging one or more other entities to perform work). Eleven months of the income year had gone by without the engaging of additional employees, and nothing in that statement at T3-30 suggests a quick turnaround of that position. Furthermore, with the benefit of hindsight, it is not the case that any part of the entity’s income “was” from the conduct of the relevant activity, because in fact no additional employees were engaged during the 2006 income year.
47. My conclusion, therefore, is that the test in s 87-65(3B)(b) is not met. As a result, it is not possible to make a personal services business determination under s 87-65(3B) (the second alternative).
Issue 6 – Did the Applicant gain or produce income from two or more entities in the 2003, 2004 or 2005 income years?
48. The fourth alternative concerns the unrelated clients test. A preliminary consideration is whether the Applicant gained or produced income from providing services to two or more entities in the 2003, 2004 or 2005 income years. This is part of the enquiry specified in s 87-20(1)(a). There is a further requirement that the “2 or more entities” not be associates of each other, of Mr Engineer or of the Applicant.
49. The Commissioner says that the “income” that is to be tested is income of the Applicant that is personal services income of Mr Engineer. The Applicant, on the other hand, says that the “income” is any income of the Applicant. The table in paragraph [20] shows that the Applicant gained or produced income from two or more entities in each of the 2003, 2004 and 2005 income years. As the table also shows, in each of those years two or more entities have contributed to the personal services income of Mr Engineer. The entities are not associates of each other, and they are not associates of Mr Engineer or of the Applicant. As a result, s 87-20(1)(a) is satisfied no matter which view I take of the meaning of the word “income” in that paragraph.
Issue 7 – Did the Applicant meet the unrelated clients test in the 2003, 2004 or 2005 income years?
50. The answer to the question of whether the Applicant met the unrelated clients test in the 2003, 2004 or 2005 income years depends on whether paragraph (b) of s 87-20(1) is satisfied. That, in turn, depends on whether the services provided in those years were provided as a direct result of the Applicant’s “making offers or invitations (for example, by advertising), to the public at large or to a section of the public, to provide the services”.
51. The Applicant presented the following information about its initial engagement by Client A (Applicant’s Extra Supplementary Submissions dated 26 June 2008, paragraph 1):
[Client A] was [the Applicant’s] first client obtained shortly after [the Applicant] was registered. [Mr Engineer] met with the Engineering Manager and Principal Electrical Engineer at [Client A] in February 1996. At that meeting, an offer was made to supply services to [Client A] at an hourly rate of […]. A fixed price quotation for [training] was provided on 28/2/1996 to [a Client A engineer]. Both the hourly rate and quotation were accepted and [Client A] issued purchase orders for initial work on 4/3/1996. …
52. As to “subsequent renewals or re-engagements”, the Applicant, through Mr Engineer, stated at paragraph 2:
There has never been any formal contract for supply of services between [the Applicant] and [Client A]. [Client A] provides “purchase order” documents for services to be supplied by [the Applicant]. While many of the projects undertaken by [the Applicant] for [Client A] have been on a fixed price quoted basis, services have also been supplied on an hourly rate basis. [The Applicant] has made verbal offers and invitations to various managers at [Client A] on many occasions, and these offers have been revised from time to time as hourly rates are adjusted. [The Applicant] has also made numerous written offers in the form of written quotations. …
53. One single company does not constitute “the public at large” or “a section of the public”. The services provided to Client A have not been provided as a direct result of the Applicant’s offers or invitations to the public at large or to a section of the public, but as a result of the Applicant’s offers to Client A alone.
54. The Applicant claims to have made, over a period of time, offers or invitations to supply services to a range of targets, 33 of which (including Clients A to H) have been named (Applicant’s Extra Supplementary Submissions dated 26 June 2008, paragraph 4). There is some documentary evidence that offers have been made (pages 61 to 67 of the Applicant’s Extra Supplementary Submissions) but any that have been made to Clients A to H are not included.
55. Of the seven examples that have been provided, four of them (pages 62, 65, 66 and 67) are direct responses to advertised positions or advertised requirements of the targets. I conclude from this evidence that the Applicant had two broad approaches to obtaining work – one was to respond to advertisements; and the other was to make “direct approaches” – also referred to as “cold calling” (Transcript P-22, 9 April 2008) – to companies that the Applicant thought might be able to use Mr Engineer’s or Mr O’s skills. Neither kind of approach amounts to making offers or invitations to the public at large or to a section of the public.
56. Therefore, the Applicant fails s 87-20(1)(b) and, as a consequence, also fails the unrelated clients test for the 2003, 2004 and 2005 income years.
Issues 8, 9 and 10
57. Given my conclusion in relation to Issue 7, these issues do not arise – see also paragraph [10] of these reasons.
Conclusion
58. It is not possible to make a personal services business determination under s 87-65(3B) or 87-65(6). The objection decision is therefore affirmed.
I certify that the 58 preceding paragraphs are a true copy of the reasons for the decision herein of Mr S E Frost, Member
Signed: ...........[sgd].....................................................................
AssociateDates of Hearing 9 April 2008, 10 June 2008
Date of final submissions 1 August 2008
Date of Decision 21 October 2008
Representative for the Applicant Its director, “Mr Engineer”
Counsel for the Respondent Ms K Deards
Solicitor for the Respondent Ms V Hammond, ATO Legal Services
Annexure
84‑5Meaning of personal services income
(1)Your *ordinary income or *statutory income, or the ordinary income or statutory income of any other entity, is your personal services income if the income is mainly a reward for your personal efforts or skills (or would mainly be such a reward if it was your income).
Example 1:NewIT Pty. Ltd. provides computer programming services, but Ron does all the work involved in providing those services. Ron uses the clients’ equipment and software to do the work. NewIT’s ordinary income from providing the services is Ron’s personal services income because it is a reward for his personal efforts or skills.
Example 2:Trux Pty. Ltd. owns one semi‑trailer, and Tom is the only person who drives it. Trux’s ordinary income from transporting goods is not Tom’s personal services income because it is produced mainly by use of the semi‑trailer, and not mainly as a reward for Tom’s personal efforts or skills.
Example 3:Jim works as an accountant for a large accounting firm that employs many accountants. None of the firm’s ordinary income or statutory income is Jim’s personal services income because it is produced mainly by the firm’s business structure, and not mainly as a reward for Jim’s personal efforts or skills.
(2)Only individuals can have personal services income.
(3)This section applies whether the income is for doing work or is for producing a result.
(4)The fact that the income is payable under a contract does not stop the income being mainly a reward for your personal efforts or skills.
85‑10Deductions for non‑employees relating to personal services income
(1)You cannot deduct under this Act an amount to the extent that it relates to gaining or producing that part of your *ordinary income or *statutory income that is your *personal services income if:
(a)the income is not payable to you as an employee; and
(b)you would not be able to deduct the amount under this Act if the income were payable to you as an employee.
Example:Ruth is an architect who works as an independent contractor for one firm. She is not conducting a personal services business. On most days she travels from her home to the business premises of the firm, where she does her work. She also has a home office, where she does some of her work.
This section confirms that Ruth cannot deduct her expenses of travelling between her home and the firm’s premises because she could not deduct them if she were an employee.
(2)Subsection (1) does not stop you deducting an amount to the extent that it relates to:
(a)gaining work; or
Examples:Advertising, tendering and quoting for work.
(b)insuring against loss of your income or your income earning capacity; or
Examples:Sickness, accident and disability insurance.
(c)insuring against liability arising from your acts or omissions in the course of earning income; or
Examples:Public liability insurance and professional indemnity insurance.
(d)engaging an entity that is not your *associate to perform work; or
(e)engaging your *associate to perform work that forms part of the principal work for which you gain or produce your *personal services income; or
(f)contributing to a fund in order to obtain superannuation benefits for yourself or for your dependants in the event of your death; or
Note:For deductions for superannuation contributions: see Subdivision AB of Division 3 of Part III of the Income Tax Assessment Act 1936.
(g)meeting your obligations under a *workers’ compensation law to pay premiums, contributions or similar payments or to make payments to an employee in respect of *compensable work‑related trauma; or
(h)meeting your obligations, or exercising your rights, under the *GST law.
85‑20Deductions for payments to associates etc.
(1)You cannot deduct under this Act:
(a)any payment you make to your *associate; or
(b)any amount you incur arising from an obligation you have to your associate;
to the extent that the payment or amount relates to gaining or producing your *personal services income.
(2)Subsection (1) does not stop you deducting a payment or amount to the extent that it relates to engaging your *associate to perform work that forms part of the principal work for which you gain or produce your *personal services income.
(3)An amount or payment that you cannot deduct because of this section is neither assessable income nor *exempt income of your *associate.
85‑25Deductions for superannuation for associates
(1)You cannot deduct under this Act a contribution you make to a fund or an *RSA to provide for superannuation benefits payable for your *associate, to the extent that the associate’s work for you relates to gaining or producing your *personal services income.
(2)Subsection (1) does not stop you deducting a contribution to the extent that your *associate’s performance of work forms part of the principal work for which you gain or produce your *personal services income.
(3)…
(4)…
86‑15 Effect of obtaining personal services income through a personal services entity
Amounts included in your assessable income
(1)Your assessable income includes an amount of *ordinary income or *statutory income of a *personal services entity that is your *personal services income.
Example:Continuing example 1 in section 84‑5: Assume that NewIT only provides services to one client. Ron’s assessable income includes ordinary income of NewIT from providing the computer programming services, because the income is Ron’s personal services income.
Note:The amount included in your assessable income can be reduced by certain deductions to which the personal services entity is entitled: see section 86‑20.
(2)A personal services entity is a company, partnership or trust whose *ordinary income or *statutory income includes the *personal services income of one or more individuals.
Exception: personal services businesses
(3)This section does not apply if that amount is income from the *personal services entity conducting a *personal services business.
Note:Even if the entity is conducting a personal services business, it is possible that some of its income is not income from conducting that business.
Exception: amounts promptly paid to you as salary or wages
(4)This section does not apply to the extent that:
(a)the *personal services entity pays that amount to you, as an employee, as salary or wages; and
(b)the payment is made before the end of the 14th day after the *PAYG payment period during which the amount became *ordinary income or *statutory income of the entity.
Note:The entity is obliged to withhold amounts from salary or wages paid before the end of that day: see section 12‑35 in Schedule 1 to the Taxation Administration Act 1953.
Exception: exempt income etc.
(5)This section only applies to the extent that that amount would be assessable income of the personal services entity if this Division did not apply.
Example:If the entity’s income includes an amount that is your personal services income for a service on which GST is payable, the amount included in your assessable income will not include the GST, because the GST is neither assessable income nor exempt income of the entity: see section 17‑5.
86‑25 Apportionment of entity maintenance deductions among several individuals
If, in the income year:
(a)the amount worked out under step 4 of the method statement in section 86‑20 is greater than zero; and
Note:This happens if the entity has entity maintenance deductions that form some or all of the reduction under section 86‑20.
(b)the *ordinary income or *statutory income of the *personal services entity includes another individual’s *personal services income (as well as your personal services income); and
(c)the other individual’s personal services income is included in the other individual’s assessable income under section 86‑15;
the amount worked out under step 4 is taken to be:
where:
original step 4 amount is the amount that would be the amount worked out under step 4 if this section did not apply.
total personal services income is the sum of all the amounts of personal services income (whether your personal services income or someone else’s) that are included in the personal services entity’s ordinary income or statutory income for the income year.
your personal services income is the sum of all the amounts of your personal services income that are included in the personal services entity’s ordinary income or statutory income for the income year.
Example:Continuing example 2 in section 86‑20: Assume that Robyn, another computer consultant, joined NewIT, and NewIT’s ordinary income from providing the services also includes Robyn’s personal services income of $168,000.
Because NewIT now receives the personal services income of someone else, Ron’s step 4 amount is reduced as follows:
Under step 5 of the method statement in section 86‑20, the amount of the reduction under that section is therefore $52,500, and the amount included in Ron’s assessable income is $67,500.
86‑60 General rule for deduction entitlements of personal services entities
A *personal services entity cannot deduct under this Act an amount to the extent that it relates to gaining or producing an individual’s *personal services income, unless:
(a)the individual could have deducted the amount under this Act if the circumstances giving rise to the entity’s entitlement to deduct the amount had applied instead to the individual; or
Note:In particular, Division 85 specifies limits on an individual’s entitlements to deductions relating to the individual’s personal services income.
(b)the entity receives the individual’s *personal services income in the course of conducting a *personal services business.
86‑75Superannuation
(1)Section 86‑60 does not stop a *personal services entity deducting a contribution the entity makes to a fund or an *RSA for the purpose of making provision for superannuation benefits payable for an individual whose *personal services income is included in the entity’s *ordinary income or *statutory income.
For deductions for superannuation contributions: see Subdivision AA of Division 3 of Part III of the Income Tax Assessment Act 1936.
(2)However, if:
(a)the individual performs less than 20% (by *market value) of the entity’s principal work; and
(b)the individual is an *associate of another individual whose *personal services income is included in the entity’s *ordinary income or *statutory income;
the entity’s deduction cannot exceed the amount it would have to contribute, for the benefit of the individual, to a *complying superannuation fund or an *RSA in order to ensure that it did not have any *individual superannuation guarantee shortfalls in respect of the individual for any of the *quarters in the income year.
(3)…
87‑15What is a personal services business?
(1)An individual or *personal services entity conducts a personal services business if:
(a)for an individual—a *personal services business determination is in force relating to the individual’s *personal services income; or
(b)for a personal services entity—a personal services business determination is in force relating to an individual whose personal services income is included in the entity’s *ordinary income or *statutory income; or
(c)in any case—the individual or entity meets at least one of the 4 *personal services business tests in the income year for which the question whether the individual or entity is conducting a personal services business is in issue.
Note 1:For personal services business determinations, see Subdivision 87‑B.
Note 2:Under subsection (3), the personal services business tests, apart from the results test under section 87‑18, do not apply if 80% or more of your personal services income is from one source (but they can still be used in deciding whether to make a personal services business determination).
(2)The 4 personal services business tests are:
(a)the results test under section 87‑18; and
(b)the unrelated clients test under section 87‑20; and
(c)the employment test under section 87‑25; and
(d)the business premises test under section 87‑30.
(3)However, if 80% or more of an individual’s *personal services income (not including income referred to in subsection (4)) during an income year is income from the same entity (or one entity and its *associates), and:
(a)the individual’s personal services income is not included in a *personal services entity’s *ordinary income or *statutory income during an income year, and the individual does not meet the results test under section 87‑18 in that income year; or
(b)the individual’s personal services income is included in a personal services entity’s ordinary income or statutory income during an income year, and the entity does not, in relation to the individual, meet the results test under section 87‑18 in that income year;
the individual’s personal services income is not taken to be from conducting a *personal services business unless:
(c)when the personal services income is gained or produced, a *personal services business determination is in force relating to the individual’s personal services income; and
(d)if the determination was made on the application of a personal services entity—the individual’s personal services income is income from the entity conducting the personal services business.
Note:Sections 87‑35 and 87‑40 affect the operation of subsection (3) in relation to Australian government agencies and certain agents.
(4)Subsection (3) does not apply to income:
(a)that the individual receives as an employee; or
(b)that the individual receives as an individual referred to in paragraph 12‑45(1)(a), (b), (c), (d) or (e) (payments to office holders) in Schedule 1 to the Taxation Administration Act 1953; or
(c)to the extent that it is a payment referred to in section 12‑47 (payments to *religious practitioners) in that Schedule.
87‑18The results test for a personal services business
(1)…
(2)…
(3)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 one 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.
(4)For the purposes of paragraph (1)(a), (b) or (c) or (3)(a), (b) or (c), regard is to be had to whether it is the custom or practice, when work of the kind in question is performed by an entity other than an employee:
(a)for the *personal services income from the work to be for producing a result; and
(b)for the entity to be required to supply the *plant and equipment, or tools of trade, needed to perform the work; and
(c)for the entity to be liable for the cost of rectifying any defect in the work performed;
as the case requires.
87‑20 The unrelated clients test for a personal services business
(1)An individual or a *personal services entity meets the unrelated clients test in an income year if:
(a)during the year, the individual or personal services entity gains or produces income from providing services to 2 or more entities that are not *associates of each other, and are not associates of the individual or of the personal services entity; and
(b)the services are provided as a direct result of the individual or personal services entity making offers or invitations (for example, by advertising), to the public at large or to a section of the public, to provide the services.
Note:Sections 87‑35 and 87‑40 affect the operation of paragraph (1)(a) in relation to Australian government agencies and certain agents.
(2)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.
87‑25The employment test for a personal services business
(1)An individual meets the employment test in an income year if:
(a)the individual engages one or more entities (other than *associates of the individual that are not individuals) to perform work; and
(b)that entity performs, or those entities together perform, at least 20% (by *market value) of the individual’s principal work for that year.
(2)A *personal services entity meets the employment test in an income year if:
(a)the entity engages one or more other entities to perform work, other than:
(i)individuals whose *personal services income is included in the entity’s *ordinary income or *statutory income; or
(ii)*associates of the entity that are not individuals; and
(b)that other entity performs, or those other entities together perform, at least 20% (by *market value) of the entity’s principal work for that year.
(2A)...
(3)...
87‑30 The business premises test for a personal services business
(1)An individual or a *personal services entity meets the business premises test in an income year if, at all times during the income year, the individual or entity maintains and uses business premises:
(a)at which the individual or entity mainly conducts activities from which *personal services income is gained or produced; and
(b)of which the individual or entity has exclusive use; and
(c)that are physically separate from any premises that the individual or entity, or any *associate of the individual or entity, uses for private purposes; and
(d)that are physically separate from the premises of the entity to which the individual or entity provides services and from the premises of any associate of the entity to which the individual or entity provides services.
(2)The individual or entity need not maintain and use the same business premises throughout the income year.
87‑65Personal services business determinations for personal services entities
Making etc. personal services business determinations
(1)The Commissioner may, by giving written notice to a *personal services entity whose *ordinary income or *statutory income includes some or all of an individual’s *personal services income:
(a)make a personal services business determination relating to the individual’s personal services income included in the entity’s ordinary income or statutory income; or
(b)vary such a determination.
(2)The Commissioner may, in the notice, specify:
(a)the day on which the determination or variation takes effect, or took effect;
(b)the period for which the determination has effect;
(c)conditions to which the determination is subject.
Matters about which the Commissioner must be satisfied
(3)The Commissioner must not make the determination unless satisfied that, in the income year during which the determination first has effect, or is taken to have first had effect, the conditions in one or more of subsections (3A), (3B), (5) and (6) are met.
(3A)…
Second alternative—unusual circumstances prevented the results, employment or business premises test from being met
(3B)The conditions in this subsection are that:
(a)but for unusual circumstances applying to the entity in that year, the entity could reasonably have been expected to meet, or would have 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; and
(b)the individual’s *personal services income included in the entity’s *ordinary income or *statutory income could reasonably be expected to be, or was, from the entity conducting activities that met one or more of those tests.
(4)For the purposes of paragraph (3B)(a) but without limiting the scope of that paragraph, unusual circumstances include providing services to an insufficient number of entities to meet the unrelated clients test under section 87‑20 if:
(a)the*personal services entity starts a *business during the income year, and can reasonably be expected to meet that test in subsequent income years; or
(b)the personal services entity provides services to only one entity during the income year, but met the test in one or more preceding income years and can reasonably be expected to meet the test in subsequent income years.
(5)…
Fourth alternative—unrelated clients test not met because of unusual circumstances
(6)The conditions in this subsection are that:
(a)but for unusual circumstances applying to the entity in that year, the entity could reasonably have been expected to meet, or would have met, the unrelated clients test under section 87‑20; and
(b)if 80% or more of the individual’s *personal services income (not including income mentioned in subsection 87‑15(4)) included in the entity’s *ordinary income or *statutory income could reasonably have been expected to be, or would have been, income from the same entity (or one entity and its *associates)—that is the case only because of unusual circumstances applying to the entity in the income year; and
(c)the individual’s personal services income included in the entity’s ordinary income or statutory income could reasonably be expected to be, or was, from the entity conducting activities that met the unrelated clients test under section 87‑20.
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