Private ruling: Partnership, Personal Services Income and Part IVA of the ITAA 1936
Published: June 2012
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Will the income derived from the provision of a specialist's services be income from a personal services business and thus not be required to be attributed to the specialist by the personal services provisions in the Income Tax Assessment Act 1997 ? Will the Commissioner apply the provisions contained in Part IVA of the Income Tax Assessment Act 1936 to the conduct of the specialist practice through a partnership with the specialist's spouse? | A1: Will the income derived from the provision of the specialist's services be income from a personal services business and thus not be required to be attributed to him by the personal services provisions in the Income Tax Assessment Act 1997 ? Yes Will the Commissioner apply the provisions contained in Part IVA of the Income Tax Assessment Act 1936 to the conduct of the specialist practice through a partnership with the specialist's spouse? Part IVA is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with a scheme and it can be concluded that the scheme, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled. No, Part IVA of the Income Tax Assessment Act 1936 will not be applied

Relevant facts and circumstances: The applicant has applied for a private binding ruling on behalf of a specialist (the specialist). The specialist has been employed by hospitals as a medical practitioner. The specialist has achieved a specialist qualification. Having achieved this qualification, the specialist proposes to leave or significantly limit his employment with hospitals. The specialist proposes to commence a business in partnership with his spouse, with a view to providing medical services to patients for profit. The specialist qualification obtained by the specialist entitles the specialist to practise in his field of expertise, without reliance on the licence of a hospital. The partnership will invoice for fees to patients or other practitioners for services provided on a conventional basis for specialist medical practitioners. It is understood that the conventional basis for specialist medical practitioners is to invoice on a fee for service or per treatment basis. The partnership will be formed in accordance with the laws of an Australian state by a deed, and the state's Partnership Act will apply. The specialist is not prohibited legally or professionally from acting in partnership with their spouse. The paperwork has not been concluded but will be an 'off the shelf' partnership deed and insurance will be arranged to cover the partnership. The partnership structure was chosen as a result of the substantial financial contribution that has been made by the specialist's spouse. It was considered the only proper vehicle for the derivation of income from the practice. The partnership will entitle the specialist to a larger percentage and the specialist's spouse to a smaller percentage of the profits and/or losses of the business. The partnership distribution split was based upon: · the initial working capital paid or invested to establish the partnership · the specialist's spouse willingness to support the practice through their property holdings as well as their financial support for the specialist to obtain accreditation as a specialist medical practitioner and · the fact that the specialist is the partner who provides the medical services. The specialist and the specialist's spouse will be jointly and severally liable for partnership debts and any capital required by the partnership to maintain its business from time to time will be paid in accordance with the percentages defined in the partnership agreement. The specialist's spouse will be exposed to risk by entering into a partnership. In particular, if there was an adverse medical outcome, the specialist's spouse would potentially be fully exposed given that liability operates jointly and severally in the context of partnerships. Income will be received into the partnership bank account and associated expenses for the partnership will be paid out of the partnership accounts. Both partners will have the power to transact on the partnership accounts and bind the partnership in any commercial dealings. The specialist will fulfil the role of managing partner. There will be visible public recognition of the partnership through partnership billing of patients, dealing with creditors and letterhead. The partners will maintain rented chambers. The partnership will apply for a tax file number and an Australian Business Number with the ATO and be required to submit returns in the usual way. Drawings will be taken by the partners in accordance with their respective interests and in accordance with the deed of partnership. It is anticipated that the specialist will derive most of the income for the partnership as the holder of the requisite medical registrations. The specialist's spouse will undertake and assist in the non income producing aspects of the business. Other activities necessary for the proper operation of the practice will be outsourced or attended upon through the engagement of staff. The number of hours worked by the partners will vary dependent upon the patient list. It is proposed that the average number of hours that the specialist's spouse will work will be 50 hours per week. The specialist's spouse is not the holder of any medical registrations. Further, the specialist's spouse has not attained medical or other qualifications. The specialist's spouse has office administration skills. The specialist's spouse will contribute to the partnership by way of provision of administrative services which include the supervision of: · billing · practice compliance work · the preparation of partnership tax returns · organising the insurance and financial accommodations for the partnership · booking and scheduling of appointments for the practice · issues pertaining to the rental of chambers and · liaising with external advisors and staff. The specialist's spouse's role will be carried out from the rented chambers and as designated by the partnership. Work will be carried out by staff employed by the partnership and supervised by the partners, or the work will be done by the partners themselves. As the specialist's spouse, the spouse will have knowledge of the specialist area and thus be better able to deal with issues than an unrelated person. The applicant says that knowledge of the specialist area is needed for the effective management of the practice as well as developing the practice managing lists and the like. The applicant advises that the partnership may offer support services to another specialists or other specialists in the future. The applicant has advised that there will not be other entities, such as a service trust or medical practice company, associated with the specialist and the specialist's spouse involved in the partnership. The following information was supplied by the applicant in respect of the personal services income results test: · the result to be produced was the organisation, delivery and billing of specialist medical services to patients. · the tools and equipment required to produce the result are identified as being the professional memberships and accreditation with each institution where services are to be provided permitting the provision of medical services as described above. · the partnership will be liable for the cost of rectifying defective work. Evidence of the exposure to liability is the payment of insurances and personal risk liability.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 84, | Income Tax Assessment Act 1997 Division 85, | Income Tax Assessment Act 1997 Division 86, | Income Tax Assessment Act 1997 Division 87, | Income Tax Assessment Act 1997 Subsection 84-5(3), | Income Tax Assessment Act 1997 Subsection 84-5(4), | Income Tax Assessment Act 1936 Part IVA, | Income Tax Assessment Act 1936 Section 177A, | Income Tax Assessment Act 1936 Section 177C, | Income Tax Assessment Act 1936 Section 177D and Partnership Act (Australian State)

Reasons for decision: Detailed Reasoning - Personal Services Income: 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 refers to income (including ordinary income or statutory income of any entity) that is mainly a reward for an individual's personal efforts or skills. Subsection 84-5(3) of the ITAA 1997 extends the definition of personal services income to income that is for doing work or for producing a result. The result must be produced from the individual's personal efforts or skills. The services provided by the specialist are specialist medical services. Based on the information provided, the Commissioner is satisfied that the income from specialist medical services is mainly a reward for the specialist's personal efforts or skills and is therefore personal services income. | Detailed Reasoning - Results test: The results test as specified in subsection 87-18(3) of the ITAA 1997 provides: A personal services entity meets the results test in an income year if in relation to at least 75% of the personal services income of one or more individuals that is included in the personal services entity's ordinary income or statutory income during the income year: · the income is for producing a result; and · the personal services entity is required to supply the plant and equipment, or tools of trade, needed to perform the work from which the personal services entity produces the result; and · the personal services entity is, or would be, liable for the cost of rectifying any defect in the work performed. In considering the results test, regard must be had to the custom or practice as specified in subsection 87-18(4) of the ITAA 1997 which states: For the purposes of paragraph (1)(a), (b) or (c) or (3)(a), (b) or (c), regard is to be had to whether it is the custom or practice, when work of the kind in question is performed by an entity other than an employee: · for the personal services income from the work to be for producing a result; and · for the entity to be required to supply the plant and equipment, or tools of trade, needed to perform the work; and · for the entity to be liable for the cost of rectifying any defect in the work performed; · as the case requires. The totality of the relationship between the parties will be relevant to whether the contract is properly to be construed as one for the production of a result. | Detailed Reasoning - Producing a result: To satisfy the first condition for the results test the personal services income must be for producing a result. The meaning of the phrase producing a result means the performance of a service by one party for another where the first-mentioned party is free to employ his/her own means (i.e., third party labour, plant and equipment etc) to achieve the contractually specified outcome. The essence of the contract has to be to achieve a result and not to do work. The consideration often is a fixed sum on completion of the particular job as opposed to an amount paid by reference to hours worked. If remuneration is payable when, and only when, the contractual conditions have been fulfilled, the remuneration is for producing a given result. You state that the result to be provided is the organisation, delivery and billing of specialist medical services to patients. Payment would be dependent upon the provision of the specialist medical services. In a contract for a result payment must be contingent upon the achievement of a contractually required outcome. Payment on the basis of specialist medical services to individual patients is payment for a result. Based on the information provided remuneration would be payable on the basis that a result in the form of specialist medical services is provided. Therefore the requirements of paragraph 87-18(3)(a) of the ITAA 1997 are met. | Detailed Reasoning - Required to supply the plant and equipment, or tools of trade, needed to perform the work: The second condition for the results test is that you are required to supply the plant and equipment or tools of trade, needed to perform the work that produces the result. Having regard to the custom and practice in relation to particular work there may be an expectation that a genuine independent contractor would be required to supply the plant and equipment or tools of trade necessary to perform the work. Where such an expectation exists, or where the contractual arrangements require the supply of necessary equipment or tools, such equipment or tools have to be supplied in order to meet the results test. There are situations where, having regard to the custom and practice of the work, or the practical circumstances and nature of the work, no plant or equipment or tools of trade are necessary to perform the work from which you produce the result. If no equipment or tools are needed the provision will always be met in these circumstances. Information provided states that the partnership would be required to supply the tools and equipment needed for the specialist to produce the result contracted for . As the partnership would supply the tools and equipment needed to produce the result the requirements of paragraph 87-18(3)(b) of the ITAA 1997 are met. | Detailed Reasoning - Liable for the cost of rectifying any defect in the work performed: The third condition for the results test requires that the individual or the personal services entity is or would be liable for the cost of rectifying any defect in the work performed. The emphasis here is on liability for the cost of rectifying faulty work. That is, the key underlying consideration is whether the individual or entity is exposed to commercial risk in terms of a liability to cover the cost of rectifying defective work. This is consistent with the focus on the chance of profit and the risk of loss as a traditional indicator that a taxpayer is an independent contractor conducting their own business. Paragraph 87-18(3)(c) of the ITAA 1997 makes it a requirement of the results test that you must meet the costs associated with rectifying the defect. It is only the cost of rectification of their defective work that must be met by you. There is no requirement that you actually perform the work which rectifies the defect so long as you pay for it. Nor does it matter whether the relevant exposure to a liability for the cost of defective work arises before or after payment by the service acquirer or delivery of the result. The existence of a term in an agreement that you are liable for the cost of rectifying any defect in the work performed would support the conclusion that liability to make good any faulty workmanship exists, particularly where you and the service acquirer are dealing with each other at arms length. However, the term in the agreement should not be merely window dressing, and regard may be had to all the circumstances of the case in determining whether the relevant liability really exists. The phrase rectifying any defect literally means to put right any fault or imperfection. Clearly, not all work is capable of rectification if that phrase is given its narrow literal meaning. It is arguable on this narrow view that if the work is not capable of rectification then the results test cannot be passed. The Macquarie Dictionary definition of rectify includes to remedy which can mean legal redress or the legal means of enforcing a right or redressing a wrong. Consequently, being liable to rectify the cost of any defect could be inclusive of a rectification achieved by the acquirer of the services pursuing a legal remedy for damages, in circumstances where the defect is incapable of physical repair. Information supplied states that the partnership would be liable for the cost of rectifying defects. Information provided states that evidence of the exposure to liability is the payment of insurances and personal risk liability. The Commissioner is satisfied, based on the information provided that the partnership would be liable for the cost of rectifying any defect in the work that the specialist performs. Accordingly the requirements of paragraph 87-18(3)(c) of the ITAA 1997 are met. | Summary: As all of the conditions in paragraphs 87-18(3)(a)-(c) of the ITAA 1997 are satisfied the requirements of the results test would be met in respect of the services of the specialist. As the requirements of the results test would be met, there would be no requirement that the personal services income generated by the efforts of the specialist that formed part of the partnership's income be attributed to the specialist under the personal services legislation. | Detailed Reasoning - Part IVA: Part IVA gives the Commissioner the discretion to make a determination to cancel a tax benefit that has been obtained, or would but for section 177F of the Income Tax Assessment Act 1936 , be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. Before the Commissioner can exercise the discretion in section 177F(1), the requirements of Part IVA must be satisfied. These requirements are that: · a 'tax benefit' as defined in section 177C, was or would, but for section 177F(1) have been obtained · the tax benefit was or would have been obtained in connection with a 'scheme' as defined in section 177A and · having regard to section 177D, the scheme is one to which Part IVA applies. The definition of scheme in section 177A is very broad and includes any agreement, arrangement, plan or proposal. The arrangement with regard to the proposed partnership as described is a scheme as defined in section 177A. In particular, for the purposes of Part IVA the scheme is as follows: · the creation of a partnership between the specialist and the specialist's spouse with the terms of the partnership allowing for the distribution of partnership income between the partners at a larger percentage and smaller percentage respectively and · the distribution of partnership income in accordance with the partnership agreement. Tax benefit is defined in section 177C(1) to relate broadly to: · an amount not being included in the assessable income of the taxpayer of a year of income · a deduction being allowable to the taxpayer in relation to a year of income · a capital loss being incurred by the taxpayer during a year of income or · a foreign tax credit being allowable to the taxpayer. Section 177C provides for two ways of determining whether a tax benefit has been obtained in connection with a scheme. The first is that the relevant tax benefit would not have been obtained if the scheme had not been entered into or carried out. The second is that the relevant tax benefit might reasonably be expected not to have been obtained if the scheme had not been entered into or carried out. Section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which the taxpayer has obtained a tax benefit if, after having regard to eight specified factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the taxpayer to obtain a tax benefit. Taxation Ruling IT 2330, at paragraph 13 provides as follows: A taxpayer in business may take his or her spouse into partnership in the conduct of the business and, provided a genuine partnership exists, it is accepted for income tax purposes. The Commissioner stated the following in the publication 'Refocus of the income-splitting test case program' dated 13 December 2005: | Detailed Reasoning - Personal services income where Part IVA is unlikely to apply - 'husband and wife' partnerships: A consideration of 'husband and wife' partnerships that derive personal services income provides a useful illustration of this approach. Suppose a husband and wife conduct a personal services business in partnership and, as the relevant Partnership Act provides, share equally in profits and losses, notwithstanding that only one of them performs the main bulk of the work. This arrangement has the effect of dividing equally notwithstanding that only one of the partners is the generator of the income of the partnership. However, in the ordinary case, the arrangement also has the very real financial consequence of exposing each partner to full liability for the debts of the partnership. The equal division of profits and losses is not solely explicable on its face by the purpose of obtaining a tax benefit: it is what the Partnership Act prescribes as the normal consequence of forming a partnership. Moreover, entering into a partnership is an ordinary means for a husband and wife to conduct a business together. Therefore, absent unusual features, it would be difficult to conclude that having regard to the section 177D factors that the dominant purpose of such a partnership arrangement was the obtaining of a tax benefit through the equal division of profits and losses. Of course, each case turns on its own facts. Different considerations could arise if, for example, · the use of the partnership is prohibited by regulatory or other laws or · a contract with a partnership represented a disguised employment relationship · losses of the partnership were allocated differently to profits having regard to the partners' respective tax positions. In this case, the Commissioner has formed the view that the dominant purpose of a person in entering into or carrying out the relevant scheme as described above is not to enable the taxpayer to obtain a tax benefit in connection with the scheme. Therefore, Part IVA of the ITAA 1936 will not apply to the proposed arrangement as described in the facts.

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