Private ruling: Personal services income and deduction of trust losses
Date of advice: 3 June 2016
Published: July 2016
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Questions and answers | 1. Do the personal services income alienation rules apply to the income of the Trust generated from the sales? | No. | 2. Is the Trust entitled to deduct the tax losses incurred in prior years? | Yes.

Relevant facts and circumstances: The Trust is non-fixed discretionary trust and commenced business trading activities in the income year ended 30 June 20XX. Individual X is the sole beneficiary of the Trust and the sole director and shareholder of the corporate trustee of the Trust. The Trust has operated a business undertaking activity X since the income year ended 30 June 20XX. Individual X carried out all the business activities on behalf of the Trust. The Trust made losses during the 20XX and 20XY income years in relation to the activity X business. Due to the losses incurred in relation to the business, the Trust decided to seek out another income producing venture. The Trust commenced a sales business on behalf of Entity X. The agreement between Entity X and the Trust is an arms-length arrangement and there was no prior relationship between Entity X, Individual X or the trustee of the Trust. Individual X carried out all the sales activities on behalf of the Trust. If errors were made, the Trust would be liable for the cost in the form of reduced commission. Individual X used a vehicle to carry out the work and the vehicle was supplied by the Trust. The Trust received commission for every sale and also received a weekly retainer when it was actively promoting the business. The Trust did not receive a retainer if sale appointments were not made. The Trust proposes to make a Family Trust Election commencing from the income year ended 30 June 20XX. The Trust has passed the family control test and has not made any distributions or present entitlements outside the family group during the relevant period.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 84-5(3) | Income Tax Assessment Act 1997 subsection 86-15(2) | Income Tax Assessment Act 1997 subsection 86-15(3) | Income Tax Assessment Act 1997 section 87-15 | Income Tax Assessment Act 1997 section 87-18 | Income Tax Assessment Act 1936 Division 270 of Schedule 2F | Income Tax Assessment Act 1936 section 270-20 of Schedule 2F | Income Tax Assessment Act 1936 Subdivision 272-D of Schedule 2F | Income Tax Assessment Act 1936 subsection 272-80(4A) of Schedule 2F | Income Tax Assessment Act 1936 section 272-87 of Schedule 2F | Income Tax Assessment Act 1936 section 272-100 of Schedule 2F

Reasons for decision: Summary: The measures contained in Divisions 84 to 87 of the Income Tax Assessment Act 1997 (ITAA 1997) only apply if a taxpayer has income that is personal services income (of an individual). The definition refers to income (including ordinary income or statutory income of any entity) that is mainly a reward for an individual's personal efforts or skills. Subsection 84-5(3) of the ITAA 1997 extends the definition of personal services income to income that is for doing work or for producing a result. The result must be produced from the individual's personal efforts or skills. In this case, Individual X has undertaken work on behalf of the Trust by providing their personal services in regard to the sales business. Based on the information provided, the Commissioner is satisfied that the income generated by the Trust from the provision of the personal services of Individual X is mainly a reward for their personal efforts or skills and is, therefore, personal services income. A personal services entity is a company, partnership or trust whose ordinary or statutory income includes the personal services income of one or more individuals (subsection 86-15(2) of the ITAA 1997). Income from personal services is attributed to the individual performing the work unless the personal services entity conducts a personal services business (subsection 86-15(3) of the ITAA 1997). A personal services entity conducts a personal services business if a personal services business determination is in force or if the entity meets at least one of the four personal services business tests in the relevant income year. The four tests are the results test, unrelated clients test, employment test and business premises test (section 87-15 of the ITAA 1997). Section 87-18 of the ITAA 1997 provides that an entity meets the results test in the relevant income year if, in relation to at least 75% of the personal services income for the year: a) the income is for producing a result; and b) the entity is required to provide the equipment or tools necessary to do the work; and c) the entity is liable for the cost of rectifying any defects in the work performed. In this case, it is considered that: a) the income the Trust received was for producing a result as commission was only received if sales were made and the retainer was only received if appointments were made; b) the Trust was required to provide the equipment or tools necessary to do the work as evidenced by the use of its own vehicle; and c) the Trust was liable for the cost of rectifying any defects in the work performed as evidenced by a reduction in commission payable if errors were made. Based on the information provided, the Commissioner is satisfied that the Trust met the results test in relation to the personal services income received in the relevant income year. Therefore, the income generated from the sales constitutes the income of a personal services business and the personal services income alienation rules do not apply. | Detailed Reasoning - Deduction of trust losses: Trusts retain revenue and capital losses that may be carried forward and claimed as a deduction (or in calculating the trust's net capital gain). Divisions 265 to 272 of Schedule 2F of the Income Tax Assessment Act 1936 (Schedule 2F) contain the rules for trust losses and other deductions. These rules require different categories of trusts to satisfy one or more tests to claim a deduction for revenue losses or bad debts. Subdivision 272-D of Schedule 2F provides the mechanism by which the trustee of a trust may elect to be treated as a family trust. A family trust election can only be made if the trust satisfies the family control test. The test is passed when the family group has power to obtain beneficial enjoyment of income and capital directly or indirectly (section 272-87 of Schedule 2F). For the 2006 and later income years, trustees can make family trust elections specifying an earlier income year provided certain conditions are met. These conditions require that from the beginning of the specified income year until 30 June of the income year immediately preceding the one in which the election is made: • the trust passes the family control test in section 272-87 of Schedule 2F (as mentioned above), and • any conferrals of present entitlement to, or any actual distributions of, income or capital of the trust during that period have been made on or to the individual specified in the election or members of that individual's family group (subsection 272-80(4A) of Schedule 2F). In this case, the Trust passes the family control test and has not made any distributions or present entitlements outside the family group during the relevant period. Therefore, the Trust can make a family trust election specifying the earlier income year ended 30 June 20XX. A family trust is an 'excepted trust' as defined in section 272-100 of Schedule 2F. The provisions of Schedule 2F that impose the various tests limiting the deductibility of tax losses or bad debts explicitly exclude excepted trusts. However, family trusts are treated differently from the other kinds of excepted trusts in that these trusts are still subject to the 'income injection test'. The income injection test in in Division 270 of Schedule 2F provides that a trust will be unable to deduct a loss or other allowable deduction, if: • there is a 'scheme' under which the trust derives assessable income, • a person not connected with the trust (an outsider) injects income or provides some other 'benefit' (directly or indirectly) to the trustee or a beneficiary (or an associate), and • the trustee or a beneficiary (or an associate) also provides a benefit to the outsider, and • it is reasonable to conclude that the arrangement was entered into wholly or partly, but not merely incidentally, because the deduction would be allowable. A 'benefit' is any type of monetary benefit or advantage and/or the doing of anything that results in the derivation of assessable income which includes services, a right, entitlement or debt forgiveness (section 270-20 of Schedule 2F). In this case, the Trust entered into a scheme or arrangement with an outsider to the Trust (Entity X) whereby it provided a sales service in exchange for receiving commission and retainer income from the outsider. From the information provided, it is understandable that the Trust would look to engage in a new income earning activity. It achieved this by entering into an arrangement with an unrelated entity that would be unlikely to be aware of any tax losses the Trust may have previously incurred. Consequently, the Commissioner considers that it is not reasonable to conclude that the arrangement was entered into wholly or partly because the deduction would be allowable. Therefore, the Trust is entitled to claim a deduction for revenue losses incurred in prior years.