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

Ruling: Question and answer | Is the income you derive income from a business structure? | Yes.

Relevant facts and circumstances: You were established in 2012 as a specialist in your industry. You currently have one client, which is Entity X. In order to fulfil your obligations under the contract with Entity X, you are required to undertake the following activities: • research • presentation • delivery, and • legal and compliance. In order to undertake these activities directly relating to the obligations under the contract with Entity X, you have a number of full time staff and part time / casual staff. One of the full time employees is the chief client facing person and the primary contact with Entity X. You also employ a full time administrative assistant. You do not use any substantial income producing assets.

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 a specialist in your industry and you currently have one client, Entity X. In order to fulfil your obligations under the contract with Entity X, you are required to undertake a number of activities. You have a number of full time staff and part time / casual staff whose duties all directly relate to fulfilling the contract requirements. Although one of these employees is the chief client facing person and the primary contact with Entity X, the other employee's duties are all required in order to fulfil the contract requirements. It is therefore considered that the income you derive is not mainly a reward for one employee's personal efforts or skills, as there are other employees whose duties are directly related to fulfilling the contract requirements. You also employ a full time administration assistant, who while may be a necessary part of your business, is not considered to be directly involved in duties fulfilling the contract conditions. Furthermore, it is considered that the relationship between you and Entity X is not that of an agent relationship, as the contract specifically states that there is no agent relationship, you are paid a significant sum of money in addition to the commission, whereas an agent would generally generate income mostly or if not all from commissions, and the services you provide to Entity X go beyond working with Entity X's clients in that you also are required to conduct significant research to which you report to Entity X. You do not use any substantial income producing assets in relation to your business, however this is considered reasonable given the industry you are in, and therefore does not add any weight to the income being either from PSI or a business structure. Taking into account these factors as a whole, the circumstances of your situation are such that the income you derive is from a business that has a substantial profit-yielding structure and therefore the income is not PSI.