An AATA decision handed down on 23 August serves as a timely reminder to IT Professionals that the Personal Services Income Rules are intended to target income splitting and ensure taxpayers do not avoid payment of income tax by diverting their PSI income through an interposed entity such as a trust.
The PSI Rules state that if 80% or more of Personal Services Income (PSI) comes from one source, all three conditions of the results test must be passed. Otherwise, the business is not a Personal Services Business (PSB) and the PSI rules will apply. If less than 80% of the PSI comes from one source, the business will be a PSB (and the PSI rules will not apply to that income) if the business can pass any one of the four tests – the results test (all three conditions), the unrelated clients test, the employment test or the business premises test.
To satisfy the results test:
- at least 75% of the income must be for producing a result;
- the entity or individual must supply the plant and equipment needed to perform the work to produce that result; and
- the entity or individual must be liable for the cost of rectifying any defect in the work.
The AATA confirmed that the taxpayer’s income was derived from the exercise of his own intellect, skills and specialist expert knowledge, that less than 80% of his PSI came from one source (it came from four source clients), that he did not have any formal written contracts in place with his clients and his earnings were directed into a trust fund and apportioned at 70:30 for himself and his spouse – that is, he was earning PSI, was diverting his income into a trust, income splitting with his wife and not paying income tax.
The AATA found that payment was on a daily rate and not conditional on completion of a project or result or delayed if a project was not completed, that the taxpayer was not liable for the cost of rectifying any defect in the work and did not supply all the tools required to complete the work (he used laptops from each of his four clients). This meant the taxpayer failed to satisfy all three conditions of the results test.
The AATA also found that:
- the taxpayer did not have any employees;
- the taxpayer’s clients were not unrelated but acquired by existing business contacts/word of mouth;
- the taxpayer did not make any offers or invitations to the public at large or a segment of the public to offer his services; and
- the taxpayer had a home office used solely for that purpose but no separate business premises.
The taxpayer therefore also failed to satisfy the employment test, the unrelated clients test and the business premises test. His wife was not an associate, not an employee and not an independent contractor sub-contracting to her husband. He was therefore deemed to be not carrying on a personal services business making his earnings assessable as ordinary income.
The case is significant because it confirms the criteria previously used to assess the results test and unrelated clients test, particularly in a couple of areas that had been previously challenged.
Whether or not being paid on a daily or hourly rate necessarily precludes a taxpayer from being deemed to be working to produce a result has been challenged in the past. In this case, daily payment was seen as a strong indicator that the taxpayer’s payment was not subject to completion of a result meaning the taxpayer did not satisfy the first condition of the results test.
Also at issue in the past has been whether it is reasonable to expect an IT specialist to supply all, some or most of the tools and equipment required to complete work according to custom and practice in the IT industry. The taxpayer used laptops of the clients – not unusual for IT consultants – but in this case not providing ALL the tools and equipment was seen as a determining factor which meant the taxpayer did not satisfy the second condition of the results test. This is probably the most narrow reading of the legislation in that it fails to take custom and practice in the IT industry into account.
The taxpayer did not have a written contract with any of his four clients stating that he was liable for the cost of rectifying defects in his work. This is clearly poor business practice and a failure to document risk management procedures which ultimately meant the taxpayer failed the third condition of the results test. This in turn meant that he failed all three conditions of the results test.
The AATA also found the taxpayer did not satisfy the unrelated clients test. In spite of the taxpayer having four separate clients, the tribunal found that the taxpayer relied on existing business contacts and did not make offers to the public at large in the form of advertising, etc.. – the legislation says word of mouth is not sufficient though this has been contested in previous decision. This confirms the importance of actively making offers to the public at large rather than exclusively relying on existing business contacts or word of mouth for work where taxpayers are relying on the unrelated clients test to demonstrate they are operating a PSB. Had offers of this kind been made, the taxpayer would potentially have satisfied the unrelated clients test.
Ariss and FCT  AATA 2958 (AAT, File Nos: 2017/5383, 2017/5384, 2017/5385, Evans SM, 23 August 2019)