In Fortunatow and FCT  AATA 4621, the taxpayer failed to establish that his company was a personal services business (PSB) on the basis of the results test or the unrelated clients test making the personal services income (PSI) assessable personal income.
If 80% or more of an entity’s PSI comes from one source, the results test must be passed. Otherwise the business is not a PSB and the PSI rules will apply.
If less than 80% of an entity’s personal services income comes from one source, the business will be a Personal Services Business and the PSI rules will not apply to that income if the business can pass any one of the four tests.
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.
In the Fortunatow matter, the Tribunal found that the taxpayer did not satisfy the third condition of the results test above meaning the entity or individual needed to pass any one of the unrelated clients test, the employment test or the business premises test. The taxpayer claimed he passed the unrelated clients test.
The unrelated clients test is set out in s 87-20(1) as follows:
“An individual or a personal services entity meets the unrelated clients test in an income year if:
(a) during the year, the individual or personal services entity gains or produces income from providing services to 2 or more entities that are not associates of each other, and are not associates of the individual or of the personal services entity; and
(b) the services are provided as a direct result of the individual or personal services entity making offers or invitations (for example, by advertising), to the public at large or to a section of the public, to provide the services.”
The s 87-20(1)(b) requirement is further qualified by s 87-20(2):
“The individual or personal services entity is not treated, for the purposes of paragraph (1)(b), as having made offers or invitations to provide services merely by being available to provide the services through an entity that conducts a business of arranging for persons to provide services directly for clients of the entity.”
Both conditions (a) and (b) of the unrelated clients test need to be met to satisfy the test.
The Tribunal accepted that the services provided by the taxpayer were provided to two or more unrelated parties so they satisfied the first condition. The taxpayer claimed that he satisfied the second condition by offering the entity’s services via the IT/HR recruitment firms that acted as an intermediary and by making offers to the public via word of mouth at industry conferences and via a LinkedIn account. The Tribunal accepted an actively updated LinkedIn account constituted advertising to a section of the public but was silent on the claim of word of mouth advertising at industry conferences. The Tribunal rejected the claim that referrals obtained via the intermediary characterised a genuine business operating as an independent contractor. The taxpayer claimed that they did not rely “merely” on referrals from intermediaries but also advertised/offered their services via a LinkedIn account – the Tribunal said there was a lack of evidence directly linking the LinkedIn account with contracted work, noting that all the work presented in evidence was as a result of the intermediary.
The taxpayer was also charged a recklessness penalty of 50%.
- confirms that as well as supply the plant and equipment needed to perform the work to produce a result and liability for the cost of rectifying any defect in the work, even where a contract is in place to produce a report, payment must be conditional upon production of the report rather than for the hours worked to produce it in order to satisfy the first condition of the results test;
- confirms that the clients obtained via an IT/HR recruitment firm are considered unrelated clients for the purposes of the first condition of the unrelated clients test;
- confirms that merely being available to clients via an IT/HR recruitment company is not sufficient to constitute advertising or word of mouth offers/invitations to the public at large or a segment of the public for the purposes of the second condition of the unrelated clients test;
- highlights that in determining whether offers or invitations to the public at large or a segment of the public have been made (the second provision of the unrelated clients test), the tribunal looks for positive or active conduct by the individual or entity rather than passive reliance on, for example, a LinkedIn account – merely saying you’re available is not sufficient;
- confirms that in determining whether offers or invitations to the public at large or a segment of the public have been made (the second provision of the unrelated clients test), the Tribunal will look for evidence that contract work was obtained directly as a result of making these offers to the public;
- highlights the need to seek a Personal Services Business Determination from the ATO where there is any doubt about the status of the entity or individual to avoid the potential application of recklessness or anti-avoidance penalties;
- leaves open the question of whether networking at industry conferences constitutes word of mouth advertising and whether this alone would satisfy the second condition of the unrelated clients test. On the basis of this decision, it seems likely that the Tribunal would seek evidence that contracting work had arisen directly from the industry conference word of mouth advertising;
- is of interest to members as it further clarifies the operation of the tests, but should be read in the context that (i) the PSI regime exists to prevent people from reducing their tax by diverting their income to another person or entity, and (ii) that the taxpayer’s family trust invoiced the company for management services, the taxpayer was not paid by the company for his services and that the company, the family trust and the taxpayer all lodged nil tax returns in the disputed years. As a consequence of the decision, the taxpayer will need to declare the income earned as assessable personal services income and be taxed accordingly.
This advice and comments are provided as general information and should not be construed as legal or tax advice. Separate legal advice relating to the interpretation and implications of this article for your individual circumstances should be obtained.