A tax dispute over whether an IT consultant was entitled to receive income through a trust and split it with his wife, has shed light on the contentious personal services income rules.
Many people set up a trust or company to structure their business or professional affairs. From a tax point of view, the tax rate for small companies is 27.5 per cent compared with the top personal tax rate of 45 per cent.
Another tax benefit is that income from a trust or company may be distributed to different parties, who may have lower tax rates.
The ATO tests these arrangements against the personal service income rules, which are designed stop people diverting income from “personal services” through companies, partnerships or trusts.
Income is classified as personal services income when more than 50 per cent of the amount received for a contract was for the individual’s labour, skill or expertise. A number of other tests can be applied.
In a case that went to the Administrative Appeals Tribunal, Ariss and Commissioner of Taxation, the AAT was asked to look at whether trust distributions were ordinary income or personal services income.
Terence Ariss is an IT specialist in software systems designed by Oracle Corp and provides professional services to companies. In the income years under review, between 2010 and 2013, he provided services to Wesfarmers Coal Ltd, Fusion Applications, Wesfarmers Resources and Premier Coal.
In each of those years Ariss and his wife lodged tax returns declaring distributions of trust income from Agency Resource Management Services (Global) Trust (ARMS). The distributions were the amount invoiced by ARMS to clients for Ariss’s work, stated as “for professional services rendered by Terence Ariss.”
Seventy per cent of the income went to Ariss and 30 percent to his wife.
In 2013, the ATO audited the Arisses’ returns and issued amended assessments based on its view that the trust distributions were solely attributed to Terence Ariss as salary and wage income.
Ariss objected to the amended assessment and it eventually ended up in the AAT earlier this year, where it was up to the tribunal to determine how Ariss’s income was to be characterised. The AAT looked at the nature of the business, the relationship between Ariss and ARMS and the role undertaken by Ariss’s wife.
Ariss worked on a daily rate and was not dependent on the completion of a project. Payments were never delayed if a project was not completed.
The work was done at home in a dedicated home office that was not used for any other purpose.
Ariss conceded that it was his work clients were paying for but that he would not have been able to manage his client workload without his wife’s involvement in managing his contacts and his schedule. She also conducted research on Oracle software changes, prepared documents and administered bill payments.
Mrs Ariss was attributed 30 per cent of the income, regardless of the hours worked during each payment period.
Ariss was not an employee of ARMS, but rather a sole trader. The tribunal accepted that Ariss entered into the arrangement with ARMS to reduce the administrative burden of running a business and to simplify his business administration.
There was no deliberate intention to unlawfully avoid tax.
The AAT used the “results test” to assess Ariss’s income. The test says income will not be personal services income if: the income is for producing a result; the individual is required to supply the plant and equipment, or tools of the trade, needed to perform the work; and the individual is liable for the cost of rectifying any defect.
It found that in the years under review, Ariss was paid for performing work and providing services, rather than producing a result. It ruled that Ariss did not meet the results test.
He also failed the “unrelated clients test”, which requires that an individual’s services are provided as a result of them making offers or invitations to the public at large to provide the service.
He also failed the “employment test”, which requires that n individual engages one or more people to perform work. The tribunal ruled that Ariss had no formal employment arrangement with his wife and she was, in any case, an “associate” for the purposes of the test.
It ruled that Ariss was not able to establish that the ATO’s amended assessments were excessive or otherwise incorrect.