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Monday Ramblings – Personal Service Businesses and Part IVA

In addition to the Commissioner’s new draft guideline on Allocation of professional firm profits that I have “blogged” on before, he has also released a Draft Taxation Ruling covering the operation of the personal services income. It is in Draft Taxation Ruling TR 2021/D2 Income tax: personal services income and personal services businesses

He had previous released two rulings on the PSI rules in 2001. But since then he has unfortunately won lots of cases and so this draft ruling now has numerous new footnotes, each a boast of a judicial victory.

When this Ruling is finalised it will become the Commissioner’s position on all the PSI rules in Part 2-42 of the 1997 Tax Act.

There is no substantial changes to the Commissioner’s position in this draft Ruling, but the draft Ruling reminds us that even if we are a Personal Service Business, the Commissioner still may apply the general anti avoidance rule in Part IVA. 

This is often overlooked. “I beat the PSI rules so I have no worries”… is just wrong as the Commissioner can still apply Part IVA and di so to may arrangement in the 1980 and 1990s.

 The Commissioner states that he will seek to apply Part IVA where there are factors indicating that the dominant purpose of the arrangement is to obtain a tax benefit by diverting or splitting an individual’s Personal Services Income. In making this decision he will consider the following factors:

  • Whether the salary or wages paid to the test individual is commensurate with the skills exercised or services provided and with the income received by the interposed entity for those services
  • Whether the interposed entity distributes income to associates and does not distribute any income to the test individual who provided the actual services, and
  • Whether the salary or wages paid to associates by the sole trader or PSE is not commensurate with the skills exercised and services provided; and the income received by the sole trader or interposed entity is for services performed by the test individual.

He gives this example: 

249. JB is a computer systems analyst who provides his personal services through a family trust, The JB Trust. He also forms a company, JB Pty Ltd, to be trustee of The JB Trust. The beneficiaries of The JB Trust are JB’s wife and three children, who are in a lowest marginal tax bracket. JB Pty Ltd (in its capacity as trustee) enters into an agreement with XYZ Pty Ltd to perform specific computing tasks for a total contract price of $120,000 in the income year. The understanding is that JB will personally undertake the required work. No work will be performed by any of the beneficiaries. Instalments of the contract price are payable on achieving agreed milestones. JB Pty Ltd also agrees to provide the necessary equipment, and to remedy any defects.

250. In the income year, JB Pty Ltd pays JB a salary of $50,000, which is less than commensurate with the value of JB’s services (more likely valued around $90,000) and claims deductions amounting to $25,000. JB Pty Ltd distributes the balance of The JB Trust’s net income, namely $45,000, as follows: each of the three children receives $416 (making a total of $1,248), and the remainder is distributed to JB’s wife. No trust income is distributed to JB as a beneficiary of The JB Trust. No tax is payable by JB’s children, and JB’s wife pays tax on her trust distribution at her marginal tax rate, but the total amount of tax paid between JB, his wife and children is less than what would have been paid if JB had returned the entire net PSI from his personal effort and skills in his personal tax return. The splitting of any of the income that is mainly the reward for JB’s personal effort and skill to an associate that results in less overall tax being paid is a tax benefit.

251. The JB Trust is a PSE because its income includes the PSI of the individual who does the work. JB Pty Ltd is able to self-assess that The JB Trust meets the results test in respect of the PSI of JB. Accordingly, JB Pty Ltd determines that the PSI rules will not apply to JB’s PSI. However, in this case, the Commissioner would consider the application of Part IVA to cancel the tax benefit. Part IVA would apply if, having regard to the matters in section 177D(2) of the ITAA 1936, it would be concluded that there was a dominant purpose of enabling JB to obtain a tax benefit by splitting the income. This would require a detailed consideration of all the circumstances. A likely conclusion would be that the dominant purpose of the arrangement is income splitting to which Part IVA applies.

By Ken Mansell

As a stay at home Dad most of the week this is my way of pretending I am still the tax counsel of ASX and SEC listed companies, working at big 4 firms, working at the Federal Treasury, on the Henry Review and at Parliament House for the previous government.

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