Private ruling: Personal Services Income
Published: September 2017
Ruling period: Year ended 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Is the income derived by the practice from the services of Individual A and Individual B considered to be income from a business structure? | A1: No | Q2: Is the income derived by the practice from the services of Individual A and Individual B considered to be personal services income? | A2: Yes

Relevant facts and circumstances: Individual A and Individual B are directors of the Company. Trust A and Trust B are shareholders of the Company. Individual A is the director of Trust A and Individual B is the director of Trust B. The Company is the operating entity for a professional practice (the Practice). The Practice has an arrangement with each of trusts to provide the services of Individual A and Individual B to work in the Practice. The individuals complete X% of the principal work. In addition to them, the Practice currently engages one PAYG employee and one consultant. They perform circa Y-Z% work. The Practice also pays an external outsourcing company for completing circa Y-Z% work. Clients are invoiced by the Practice. At the end of each month, Individual A and B both invoice B% of the income generated for the Practice from their respective trusts. The remaining C% is used to cover the running expenses such as wages, rent, printing and stationary, subscriptions. At the end of each financial year, if profit remained in the Practice, it would be paid to both trusts. The Practice has purchased computers and software to assist staff.

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

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). Section 84-5 of the ITAA 1997 defines the personal services income of an individual as being income which is mainly a reward for that person's personal efforts or skills. A personal services entity is a company, partnership or trusts whose ordinary income or statutory income includes the personal services income of one or more individuals. The personal services income measures do 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. Practitioners include both full-time professional and non-professional staff whose function is to derive material fees for the practice. Part-time staff counts proportionately (Paragraph 11 of IT 2639). | 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. | 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. Paragraph 37 of TR 2001/7 provides an example of 'Jim' who works as an accountant for a large accounting firm that employs many accountants. None of the firm's 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. | Detailed Reasoning - Application to the taxpayer's circumstances: In this case, Individual A and Individual B are providing their services through a trust to a professional practice. Although the Practice has two other full time equivalent employees, the Practice generates income specifically because of the personal exertion of them. The Practice has computers and accounting software which have been purchased and utilized, but it is the knowledge and personal efforts of the individuals that complete the work. Taking into account these factors as a whole, the circumstances are such that the income derived by the Practice from the services of both individuals is considered to be personal services income and not income from a business structure.