Private ruling: Income - PSI - business structure
Published: July 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Questions and answers | 1. Is the income derived from the professional practice income from a business structure? | Yes. | 2. Is the income derived from the professional practice personal services income? | No.

Relevant facts and circumstances: You are both partners in a professional practice, along with another entity. Your directors are each treated as an employee of the firm. In additional to the other entity and the two directors, the practice currently has two arm's length employees with another one or two additional staff to be engaged in the very near future. All current staff members are income producing. You bought into the practice in a specific year. The valuation of the goodwill at that point was $X. You believe that the current goodwill is at least $X. You borrowed money from the bank to purchase your share of the practice and it was purchased at arm's length. You consider the goodwill of the practice as a very important factor and the most valuable asset within the practice and you have a good name in the community and obtain referrals from clients and other businesses as a result of that good name. The practice has an annual turnover of approximately $X. Your costs of business, excluding payments made to related parties, are in excess of $X per annum. The practice uses the following assets to derive its income: • printers leased at $X per annum • computers and servers (owned outright) but at cost of $X • desks and similar furniture at a written down value of $X • rent of premises at $X per annum • software licencing fees of $X per annum • printing and stationary required to produce our work at a cost of $X per annum • communication costs of $X per annum The size of the business premises, which are rented, is around X square metres. You have systems in place that make your work efficient. No single person generates income specifically because of his/her personal exertion. You spend over $X per annum on products that you sell to clients. If an owner/director resigned or was unable to work in the practice, this would not affect the turnover or profitability of the practice.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 84-5.

Reasons for decision: Summary: The measure contained in Divisions 84 to 87 of the Income Tax Assessment Act 1997 (ITAA 1997) only applies if a taxpayer has income that is personal services income (of an individual). The definition of personal services income is contained in subsection 84-5(1) of the ITAA 1997 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). The alienation measure does not apply to businesses that have a substantial profit-yielding structure. The distinction between income that is mainly a reward for personal efforts or skills and income from a business structure will need to be made having regard to factors such as the number of arms-length employees or others engaged to perform work, the presence of goodwill, the extent to which income-producing assets are used to derive the income, the nature of the activities carried out, the size of the operation and the extent to which the income is dependent upon a particular individual's own personal skills, efforts or expertise. Taxation Ruling TR 2001/7 Income tax: the meaning of personal services income provides examples of the distinction between income derived from personal services and income derived from the supply and sale of goods, use of income-producing assets, and business structure. Taxation Ruling IT 2639 Income tax: personal services income expands upon the factors that are considered when determining whether income is from a business structure. Income derived by a firm or practice which has substantial income producing assets, or many employees, or both, is more likely to be generated from the income yielding structure of the business rather than from the rendering of personal services. Paragraph 8 of IT 2639 states that the extent of the connection between the income concerned and the services rendered by the particular taxpayer involved is crucial in determining whether or not the income is the personal services of the individual or whether it is from a business structure. The paragraph identifies factors that need to be considered in determining whether a taxpayer derives income from personal services, although no one factor is determinative. The factors identified are the nature of the taxpayer's activities, the extent to which the income depends upon the taxpayer's own skill and judgement, the extent of the income producing assets used to derive the income and the number of employees and others engaged. These factors are discussed below. Paragraph 10 of IT 2639 states that, as a general rule of thumb, if there are as many non-principal practitioners as there are principal practitioners, then this may indicate that the income is from the business structure rather than from the personal services of an individual. However, all the factors in paragraph 8 of IT 2639 need to be considered. Paragraph 11 of IT 2639 defines a practitioner as professional and non-professional staff whose function is to derive material fees for the practice. The term practitioner does not include clerical or support staff. | Detailed Reasoning - The nature of the taxpayer's activities: The activities of salary and wage earners and professionals practising on their own account clearly generate personal services income. Radiologists or pathologists who operate on their own account, however, often employ many technical staff and operate an array of technical equipment. Their income is generated from the business structure rather than from their rendering of personal services. The activities of consultants, salespersons, journalists, life insurance agents and tradespersons are also likely to give rise to income from personal services. These examples are far from being exhaustive. | Detailed Reasoning - The extent to which the income depends upon the taxpayer's own skill and judgment: The more the income producing activities involve the exercise of the taxpayer's own skill and judgment the more probable it is that the income will be derived from personal services rather than from the business structure. | Detailed Reasoning - The extent of the income producing assets used to derive the income: The more substantial the income producing assets employed within a practice the more likely it is that the income of the practice will be derived from the business structure rather than from the rendering of personal services. For example, the array of equipment used by radiologists and pathologists may often suggest that their income is being derived from the business structure. However, minor equipment such as the drawing board of an architect or the heart monitor/blood pressure machine of a medical practitioner would not suffice to change what would otherwise be personal service income into income from the business structure. The expression "income producing assets" is used in this context to include any investment of the practice in tangible business assets such as premises, fixtures and fittings, plant, equipment and industrial or intellectual property (whether owned or leased). However, the significance of these assets would have to be weighed against their relevance to the derivation of income - given the other factors mentioned in this paragraph. Paragraph 31 of TR 2001/7 states that the determination of whether income is mainly a reward for the personal efforts or skills of an individual or whether it is generated by the sale of goods, granting of a right to use property, supply and use of assets or business structure, requires practical judgement as to whether the value contributed by the efforts or skills of the individual exceeds the value of other inputs such as plant and equipment, intellectual or other property or goodwill. | Detailed Reasoning - The number of employees and others engaged: The more substantial the number of employees, practitioners or technicians used in a practice the more probable it is that the income is derived from the business structure rather than from the rendering of personal services. For example, large accounting and legal firms with tens, or even hundreds, of practitioners but without extensive or substantial equipment would also be considered to be generating their income from their business structure. | Detailed Reasoning - Application to your circumstances: In your case, you are deriving income from professional practice, you have a number of employees and no single person generates income specifically because of his or her personal exertion, the practice has significant goodwill which you purchased at market value in an arm's length transaction, you use many assets of considerable value in deriving your business income and you have a substantial annual turnover. Taking into account these factors as a whole, the circumstances of your situation are such that the income you derive from the practice is from a business that has a substantial profit-yielding structure and therefore the income is not PSI.