Federal Court provides clarification on the personal services income rules

This article originally appeared on the Australian Taxation Office website on the 13th of August 2019.

The Federal Court handed down two decisions relating to personal services income (PSI) rules yesterday.

Income is classified as PSI when more than 50% of the income received under a contract is for a taxpayer’s labour, skills or expertise.

The personal services income rules are integrity provisions which ensure individuals cannot reduce or defer their income tax by diverting income for their personal services through companies, partnerships or trusts. If the rules apply, the individual is taxed on the income directly.

The rules do not apply if at least 75% of the individual’s personal services income is for producing a result, where the individual supplies all the required “tools of trade” and is liable for rectifying defects in the work. This is known as the “results test”.

In the matter of Douglass v Commissioner of Taxation [2019] FCA 1246 the Federal Court confirmed that the taxpayer did not meet the “results test”. The taxpayer argued that the “results test” is still satisfied even if they do not get paid for achieving a result, provided they can show this is the custom or practice of independent contractors in their industry. The Federal Court rejected this, agreeing with the ATO’s earlier determination. The ATO applied the PSI laws to tax Mr Douglass’s contract income as his own income rather than income split through a partnership with his spouse, which also meant certain deductions were not allowable.

The Federal Court also affirmed the imposition of penalties for recklessness, noting that the Tribunal had previously found the taxpayer’s failure to include income in his returns “merits characterisation as gross carelessness” and his subjective view as formed from a “self-interested misunderstanding of the legislative provisions”.

In the matter of Fortunatow v Commissioner of Taxation – SAD 9/2019 the Federal Court allowed the taxpayer’s appeal from an earlier Administrative Appeals Tribunal (AAT) decision. The Federal Court found the ATO and AAT had applied an exception for services provided through intermediaries (e.g. recruitment agencies) too broadly and instead the Court preferred a narrow interpretation of the exception. This matter has now been referred back to the AAT to be reconsidered.

The ATO will consider this decision and whether an appeal is appropriate.

The ATO supports partnerships and all legitimate business structures where legal and arising from a business structure of substance. The ATO recognises that a personal services business can exist where the results test is met. In such cases the income is derived by the business entity and not the individual who carried out the work.

Taxpayers may choose to self-prepare returns or engage a professional advisor. In either case, it is vital to understand how the PSI provisions apply to individual circumstances. The ATO encourages anyone seeking to enter into or change their personal arrangements to contact them or seek experienced professional advice.

Information about PSI, including a tool that taxpayers and their advisers can use to determine if they have PSI and if the PSI rules apply, can be found on our website.

Related Tags:
Accountants Gold Coast
Tax Accountant Gold Coast