Private ruling: Personal services income
Published: May 2015
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018
Date scheme commenced: 1 July 2013

Ruling: Questions and Answers | 1. Is the income received by Individual A for consultancy services provided to Entity X personal services income (PSI)? | Yes | 2. Is the income received by the Trust for the sale of goods PSI income? | No | 3. Is the income received by the Trust for the development of a technical product PSI income? | No | 4. Is the income received by the Trust for providing knowledge and development of the technical product, including assistance to the client, PSI income? | No

Relevant facts and circumstances: The Trust receives income from various sources relating to a technical product. The sources are from: • Consultancy services • Selling goods • The development of the technical product and • The design and development of the technical product, including assisting the client with their particular formulation of the product. The Trust has a corporate trustee of which Individual A and Individual B are the shareholders. They have been involved in the formulation of the technical product for a number of years. Consultancy services Individual A derives income from providing consultancy services to Entity X and is paid an hourly rate for this service. This represents around 24 hours a week in time and is only provided by Individual A. Selling goods The Trust derives its income from selling goods. Development of the technical product The Trust receives a payment through the development of the technical product. The Trust is paid per volume of the product sold. Individual A usually comes up with the invention of the product on behalf of the Trust and provides it to the end user who makes a payment to the Trust and this allows them to patent the product if they wish. These amounts are paid to the Trust based on the product knowledge and unique formulations which both Individuals A and B have contributed in the development of these products. Providing product knowledge and development of product formulations The Trust receives a payment through providing product formulation knowledge and the development of product formulations to suit manufacturers. Both individuals A and B play a shared role in coming up with ideas which they present to clients. They work with clients to come up with required features. The Trust receives income based on providing a manufacturer knowledge in regards to specialist product formulation that the manufacturer on sells. The manufacturer pays the Trust a percentage of net profit based on the amount of the product sold. There is an agreement in place covering this arrangement.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 84-5(1) | Income Tax Assessment Act 1997 Subsection 84-5(3) | Income Tax Assessment Act 1997 Subsection 84-5(4) | Income Tax Assessment Act 1997 Subsection 995-1(1) | Income Tax Assessment Act 1936 Subsection 6(1)

Reasons for decision: Detailed Reasoning - Whether personal services income is derived?: Part 2-42 (Divisions 84-87), of the Income Tax Assessment Act 1997 (ITAA 1997) contains the rules for the income tax treatment of personal services income (PSI). The definition of PSI is contained in subsection 84-5(1) of the ITAA97 which states: 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). Personal services income is the ordinary income or statutory income of any entity that is mainly a reward for an individual's (being the service provider's) personal efforts or skills. Subsection 84-5(3) of the ITAA 1997 extends the definition to include income that is for doing work or for producing a result. The result must be produced from the service provider's personal efforts or skills. The fact that income is payable under a contract does not stop the income being mainly a reward for a service provider's personal efforts or skills (subsection 84-5(4) of the ITAA 1997). | Detailed Reasoning - Mainly: The reference to 'mainly' requires more than half of the relevant amount or item of the ordinary income or statutory income be a reward for the personal efforts or skills of an individual. Where the income is derived under a contract and that contract is for the rendering of personal efforts or the provision of the skills or expertise of a particular individual, the income derived under that contract would mainly be a reward for that individual's personal efforts or skills. The use of the word mainly in this context does not preclude the use of some materials, tools or plant and equipment in the rendering or provision of personal services. | Detailed Reasoning - Consultancy services: Individual A derives income from providing consultancy services to Entity X and is paid an hourly rate for this service. This service is only provided by Individual A. Whilst Individual A would use some equipment as part of their consultancy role the amount he receives is mainly a reward for their personal efforts and skills. Accordingly the payments are PSI of Individual A. | Detailed Reasoning - Selling of goods: Income from personal services within the meaning of section 84-5 of the ITAA 1997 may be distinguished from income that is mainly : • for the sale or supply of goods; • for the granting of a right to use property; or • for the supply and use of assets held by an individual or by a personal services entity. The Trust generates some income from the sale of goods. Income from the sale of supply of goods is not PSI as it is not a reward for personal efforts and skills. We shall now consider income derived by the Trust from the development of the product and from providing technical product knowledge and development of formulations for the product. | Detailed Reasoning - Income arising from property: One important objective of the definition of PSI is to exclude income arising from property. Such income might arise as a result of (a) the use of property by the taxpayer (including the use of substantial business assets including goodwill) to generate income; (b) the grant of a right to use property (ie a licence fee, rent or royalty); and/or (c) the disposal of property by the taxpayer. | Detailed Reasoning - Grant of a right to use property: We shall examine the concept of a royalty and see if the income received from the development of property features and/or from providing property knowledge and development of property formulations constitutes a receipt of PSI or a receipt of royalty income and is thus excluded from the PSI rules. | Detailed Reasoning - Royalties: A receipt of royalty income is not PSI income. Under subsection 995-1(1) of the ITAA 1997 the definition of royalty has the meaning given by subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) that states - royalty or royalties includes any amount paid or credited, however described or computed, and whether the payment or credit is periodical or not, to the extent to which it is paid or credited, as the case may be, as consideration for: (a) the use of, or the right to use, any copyright, patent, design or model, plan, secret formula or process, trademark, or other like property or right; (b) the use of, or the right to use, any industrial, commercial or scientific equipment; (c) the supply of scientific, technical, industrial or commercial knowledge or information; (d) the supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as is mentioned in paragraph (a), any such equipment as is mentioned in paragraph (b) or any such knowledge or information as is mentioned in paragraph (c); In this case paragraphs (a), (b), (c) or (d) of the definition of royalty could have application. Taxation Ruling IT 2660 Income tax: definition of royalties (IT 2660) explains the Commissioner's views on the definition of 'royalty' and 'royalties' as provided in subsection 6(1) of the ITAA 1936. Paragraph 10 of IT 2660 details the following features in respect of the meaning of a royalty that has been considered by the Courts: (a) It is a payment made in return for the right to exercise a beneficial privilege or right …. (b) The payment is made to the person who owns the right to confer that beneficial privilege or right ........ However, the payment would still be a royalty if paid to another person or otherwise applied or dealt with at the direction of the owner. Moreover, payments for the use of the right that are made to a person who has been licensed or sub-licensed to deal with the right will also be regarded as royalty payments. (c) The consideration payable is determined on the basis of the amount of use made of the right acquired. (d) The consideration payable will usually be paid as and when the right acquired is exercised. Further, at paragraph 12 of IT 2660 explains that subsection 6(1) of the ITAA 1936 expands the definition of royalty to include amounts paid or credited for: (a) the use of, or the right to use, any copyright patent, design or model, plan, secret formula or process, trademark, or other like property or right; (b) the use of, or the right to use, any industrial, commercial or scientific equipment; (c) the supply of scientific, technical, industrial or commercial knowledge or information (e.g. know-how payments); (d) the supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as is mentioned in paragraph (a), any such equipment as is mentioned in paragraph (b), or any such knowledge or information as is mentioned in paragraph (c); | Detailed Reasoning - Development of product: One of the ways the Trust receives income is through the development of the technical product. The trust is paid per volume sold by the customer. Individual A usually comes up with the feature or invention on behalf of the Trust and provides it to the end user who makes a payment to the Trust and this allows them to patent the product if they wish. These amounts are paid to the Trust based on the product formulation and knowledge that both Individuals A and B have contributed in the development of these products. . The payment falls under paragraph 12(a) of IT 2660 above. It represents the use of, or the right to use a copyright patent, design, or model or secret formula and thus satisfies the definition of 'royalty' in subsection 6(1) of the ITAA 1936 and IT 2660. Thus the income received by the Trust for the development of technical product is a proper royalty and is not PSI. | Detailed Reasoning - Design and research and development of product: The Trust also receives income through providing product knowledge and the development of product formulations to suit manufacturers. Both Individuals A and B play a shared role in coming up with ideas which they present to clients. They work with clients to come up with required features. The Trust receives income based on providing a manufacturer knowledge in regards to specialist product formulation that the manufacturer on sells. The manufacturer pays the Trust a percentage of net profit based on the amount of the product sold. There is an agreement in place covering this arrangement. The payment in this situation satisfies paragraph 12(d) of IT 2660. The clients, such as the manufacturers, receive assistance that is ancillary and subsidiary to the product. They receive not only knowledge in regards to specialist product formulation, but also assistance in how to achieve a formulation which meets the required needs of the client. The payment which the Trust receives is not for the personal services of an individual, but a royalty for knowledge or information and assistance in the formulation of a product. Hence the payment for providing product knowledge and the development of formulations to suit manufacturers is a royalty and not PSI | Summary: The income earned from providing services to Entity X for which Individual A is paid at an hourly rate is the PSI of Individual A as it is mainly a reward for per personal efforts and skills. The income derived from selling goods is not PSI as it is not earned from personal efforts and skills. The payment received from the development of the product represents the use of, or the right to use a patent, design, or model or secret formula and thus satisfies the definition of 'royalty' in subsection 6(1) of the ITAA 1936 and hence is not PSI. Finally the payment for providing knowledge and providing assistance in the development of the product formulations to suit manufacturers is also a royalty and thus not PSI.