Private ruling: Income Tax - Personal services income - use of assets or business structure
Published: August 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Does the Trust have income that is mainly a reward from the use of assets or a business structure and not mainly a reward for personal efforts or skills of an individual (an individual's personal services income) for the purpose of Division 84 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No.

Relevant facts and circumstances: The entity concerned is the Trust. The Principal is a specialist in his/her field of practice. The clients are predominately other practices. There have been considerable different clients this year. There is one non-arm's length employee who is employed by the practice to perform duties including clerical and administrative functions, marketing and account receivable. This would entail approximately 8 hours work per week. Any contribution to the income earning activities of the business is only by way of marketing activities during the year. The services provided to other practices are a specialist service. The practices engage the Principal's services due to his/her specialised training in this field. This involved a number of years of supervised training, in addition to the normal required training. The clients are suspected to have a disease on the basis of clinical signs noted by their owners or signs exhibited on examination by the referring clinic. The specialist service is requested to confirm and quantify the diagnosis. The Principal schedules an appointment with the client at the referring clinic. The clients are left with the Principal who then performs the procedure then passes on all the information and recommendations to the referring clinic to give to the owners. The findings are then discussed with the owner and treatment is recommended (based on the Principal's recommendation) by the referring clinic. The specialist services are performed on the clients in the referring clinics using specialist machines provided by the Principal. These machines are fully portable and are taken by car to each appointment. The time taken to perform the specialist service varies. Preparing the report using the machine takes less than one hour per client. Fees for performing these services are based on market rates for these services. The first key piece of equipment was purchased second hand from overseas. The second key piece of equipment was also purchased second hand. Estimated useful life for both machines is 3-5 years due to rapid progression of technology to allow more detailed and accurate gathering of information and also due to stress of being mobile units in their current environment. The machines have little use other than that for what they are commonly used for. The business is relatively small operating from home. Goodwill would be negligible due to lack of specialists in this field in Australia. A specialist becoming qualified could purchase the necessary equipment and become busy reasonably quickly.

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

Reasons for decision: Summary: The income of the Trust is not mainly a reward from the use of assets or a business structure for the purpose of Division 84 of the ITAA 1997; it is mainly a reward for personal efforts or skills of an individual (an individual's personal services income). | Detailed Reasoning - Detailed reasoning: Personal services income is income that is mainly a reward for an individual's personal efforts or skills (or would be mainly such a reward if it was the income of the individual who did the work). Division 84 of Part 2-42 of the ITAA 1997 sets out the meaning of personal services income. Section 84-5 of the ITAA 1997 provides: (1) 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). Example 1: NewIT Pty Ltd provides computer programming services, but Ron does all the work involved in providing those services. Ron uses the clients' equipment and software to do the work. NewIT's ordinary income from providing the services is Ron's personal services income because it is a reward for his personal efforts or skills. Example 2: Trux Pty Ltd owns one semi-trailer, and Tom is the only person who drives it. Trux's ordinary income from transporting goods is not Tom's personal services income because it is produced mainly by use of the semi-trailer, and not mainly as a reward for Tom's personal efforts or skills. Example 3: Jim works as an accountant for a large accounting firm that employs many accountants. Non e of the firm's ordinary income or statutory 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. (2) Only individuals can have personal services income. (3) This section applies whether the income is for doing work or is for producing a result. (4) The fact that the income is payable under a contract does not stop the income being mainly a reward for your personal efforts or skills. Taxation Ruling TR 2001/7 Income tax: the meaning of personal services income (TR 2001/7) explains the meaning of personal services income contained in Division 84 of Part 2-42 of the ITAA 1997. Paragraph 24 and 25 of TR 2001/7 provides clarification in relation to the use of the word 'mainly' in subsection 84-5(1) of the ITAA 1997: The use of 'mainly' in the definition means that the income referred to needs to be 'chiefly', principally' or 'primarily' a reward for the provision of the personal efforts of, or for the exercise of the skills of, an individual. Therefore, the use of tools of trade or plant and equipment does not of itself preclude the income from being personal services income, if they are ancillary to the generation of the income. Implicit in the word 'mainly' is that more than half of the relevant amount of ordinary or statutory income is a reward for the personal effort or skills of an individual. The meaning of personal services income is wider than that which might otherwise be the case under the common law, but it does not include income that is mainly: · from an entity supplying goods or granting a right to use property; · generated by assets an entity holds; or · generated by the business structure. | Detailed Reasoning - Use of assets: Income which is principally generated by assets is not personal services income as it is not paid mainly as a reward for an individual's personal effort or skills. Judgment is required to determine whether the income is mainly the result of the use or supply of assets, or the provision of personal efforts or skill. Example 2 in subsection 84-5(1) of the ITAA 1997 provides an example of income from the use of an asset. The underlying assumption for this example was that the main component of the contract was the use of the semi-trailer rather than the personal services that were also provided. The following factors are relevant considerations in determining if income is from the supply and use of income-producing assets: · the market value of the supply and use of the asset, compared with the market value of the personal services; · the basis on which the contract price has been calculated and the extent to which the contract price relates to the costs borne by the individual or personal services entity in supplying and using the plant and equipment or other assets in the income-producing activity; · the significance or uniqueness of the assets in the income-producing activity; · the gross value of the asset in relation to the income of the individual or personal services entity from the particular activity; and · the role the asset plays in generating the income. The Trust operates a specialist mobile, in-practice service. The service provided to other practices is a specialist service. The Principal is a registered specialist in this field and performs all the work involved in providing this specialist service. The practices engage the Principal's services due to his specialised training in this field. This involved a number of years supervised residency training, in addition to the normal required training. The specialist services are performed on the clients in the referring clinics using specialist machines provided by the Principal. These machines are fully portable and are taken by car to each appointment. The fees charged by the Trust for the Principal to perform these services using the machines is significantly more than the fee charged for a consultation. The fee for the use of the machines when combined with a consultation makes up more than 50% of the total fee charged for these services. In contrast to example 2 in subsection 84-5(1) of the ITAA 1997, whilst the use of these assets seems to account for a significant portion of the fees charged, it is the skills and personal efforts of the Principal that are required to operate the machines, produce reports and interpret the information generated. It is the Principal's opinion and interpretation that is relied on by the service acquirers. Without his specialised knowledge, the machines themselves would be of little use. The gross value of the machines in relation to the income of the Trust from the services provided is below 10%. Their value is significantly less than the value placed on the Principal's personal skills. Whilst the machines play a vital role in helping to generate the income of the Trust, it is the Principal's extensive qualifications and specialist knowledge that ensure other practices engage the services of the Trust. | Detailed Reasoning - Business structure: Personal services income does not include amounts that are generated from the income yielding structure of a business rather than from the rendering of personal services. Example 3 in subsection 84-5(1) of the ITAA 1997 provides an illustration of a situation where income is considered to be from a business structure. In determining the distinction between income that is mainly a reward for personal efforts or skills and income from a business structure a number of factors need to be considered, such as: · number of arm's 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 individuals own personal skills, efforts or expertise. The Trust has one non-arm's length employee who is employed by the practice to perform duties including clerical and administrative functions, marketing and accounts receivable. This would entail approximately 8 hours work per week. Any contribution to the income earning activities of the business is only by way of marketing activities during the year. You consider that the presence of goodwill, due to the lack of specialists in this field in Australia, would be negligible. The practice is relatively small and operates from the home of the Principal. The services provided to other practices are a specialist service which requires an examination of the clients and the interpretation of information generated by the machines. The Principal uses specialist machines to confirm and quantify the diagnosis presented by the referring practice. The income of the Trust is dependent on the Principal's personal skills, efforts and expertise. He is solely responsible for performing the services provided by the Trust. Weighing up these factors, particularly the level of skill and degree of specialisation required by the Principal in generating the income, it would be reasonable to conclude that the income of the Trust is mainly a reward for the personal efforts and skills of the Principal, and not generated by the business structure. | Detailed Reasoning - Conclusion: Therefore, the income of the Trust is not mainly a reward from the use of assets or a business structure for the purpose of Division 84 of the ITAA 1997; it is mainly a reward for the personal efforts or skills of the Principal (i.e. the Principal's personal services income).