There are a number of rules which apply to individuals attempting to reduce or defer their income tax by diverting their personal services through companies, partnerships, or trusts.
In the recent Australian decision of Fortunatow v Commissioner of Taxation [2020] FCAFC 139, the Federal Court clarified uncertainty surrounding one of the key exemptions to these rules, carrying significant implications to individuals.
Personal Services Income (‘PSI’) is income produced primarily from your personal skills or efforts as an individual. This type of income is dealt within the Part 2-42 of the Income Tax Assessment Act 1997 (‘ITAA 1997’) and frequently occurs in the following areas:
Although this income can occur in almost any industry, trade, or profession, PSI does not affect employees receiving only salary and wages, but rather those operating through an entity such as a company, partnership or trust.
There are additionally four key “personal services business tests”, at s 87-15 of the ITAA 1997, which remove what would otherwise be PSI from the assessable income of the individual.
In Fortunatow v Commissioner of Taxation [2020] FCAFC 139, the taxpayer was a business analyst and sole director of a company who had a LinkedIn profile identifying his past experience and skills as well as his availability.
He was engaged to provide services to a number of organizations through contracts between the company and various recruitment agencies.
The income from these services was transferred to a family trust and categorized as ‘management fees’, only to be subsequently written off as deductions so that neither the taxpayer, company or individual paid any tax on the personal services for a two-year period.
Here, the Federal Court considered whether the taxpayer could rely on the ‘unrelated clients test’ to avoid the attribution of the services income in his personal income tax return.
To pass this test the income will need to be produced from two or more clients who are not related or connected and the work must be obtained by making offers to the public or sections of the public. This is per s 87-20 of the ITAA 1997.
Courts have generally inferred that there additionally needs to be a causal connection between the two, meaning the provision of these personal services must be the direct result of the making of offers or invitations.
In the present case, the Federal Court accepted the Commissioner of Taxation’s submission that the LinkedIn profile constituted the making of an offer or invitation within this section and that services were indeed provided.
The center of the challenge was whether the ‘direct result’ requirement was satisfied merely because the intermediaries were ‘influenced’ by the advertising through LinkedIn.
To this point, the Full Federal Court ruled that none of the clients made their decision as a direct result of the LinkedIn profile, and such, that the taxpayer failed to meet the unrelated clients’ test.
The Federal Court’s decision demonstrates that a taxpayer will need to clearly demonstrate that the provision of their services was a direct result of the making of offers or invitations to fall within one of the exemptions.
It is vital to understand how these PSI exemptions operate to individuals operating through an entity such as a company, partnership or trust.
It is highly advisable to seek legal advice when seeking to enter into or change personal arrangements and consider the involvement of intermediaries which could lead to attribution of services on a personal income tax return.
Butlers Business Tax Lawyers have a long history of helping clients with their tax matters and liaising with the ATO and can independently advise or act in a matter and provide expert legal advice and representation if you’d like to appeal an ATO tax assessment or other unsatisfactory decision.
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