Getting an understanding of personal services income

Tax law has a fundamental premise that the income of a person belongs to that person regardless of how they structure their affairs.  And for many smaller operators like IT, legal and medical professionals this concept of bringing the income home to the relevant professional is expressed in the concept “alienation of personal services income”.

The ATO has recently released a tax ruling (TR 2021/D2) that potentially affects many Perth based contractors and how they structure their affairs.  Many professionals will be familiar with the four “personal services business determinations” for their tax affairs as:

  • The results test;
  • The unrelated clients test;
  • The employment test; and
  • The business premises test.

When a family in business is looking at these tests it is always important to take a step back and look at the bigger picture.  And this ruling helpfully clarifies this approach to many tax professionals.  In particular the tests, and the concept of alienating personal services income is only relevant for tax structuring if you are generating personal services income. 

If you are selling or supplying goods you are not generating personal services income.  An example of this can be for a share trader working from home.  The profits from share trading are generated by the shares themselves and not the hours of time spent by the operator trading shares.

Likewise a Perth contractor who hires out machinery and manages the machinery hires is generating income from the machines that are being used.  The manager, while working diligently, is not generating an hourly rate for their efforts in getting the public to use the machines.

In some instances professionals generate income but the work generated by their team is also integral to the overall profits.  In this instance TR 2021/D2 acknowledges that the income generated is a result of the business structure and is not personal services income.

The above distinctions are important.  Quite often we have new families approaching us from other accountants around Perth and they are focused on the above four tests. However when we dive into the heart of the business and how it is operating we uncover that the income is not personal services income – saving the heartache and cost of understanding (and possibly failing) the above tests.

However the ability to escape the personal services income regime is not easily done. And it is becoming apparent that some tax professionals around Perth are engaging in high risk strategies to generate fees.  The simplest way for a family in business is to get their tax advisor to document their advice in advance knowledge that the advice will be presented to another quality tax advisor in Perth.

If the advice is poorly drafted, not considered or highly aggressive such practitioners will typically refuse to assist any further.

Examples of aggressive personal services income tax arrangements include:

  • Selling part of the professionals right to future income to an associated entity who borrows money from the bank to fund the arrangement (effectively clearing the home mortgage).
  • Structuring partners in a partnership who have no voting rights and no choice on their exit mechanisms.
  • Taking advantage of the differences in taxable income to accounting income so as to reduce the amount of cash payable to a corporate entity.

It is fair to say that the fluid and changing nature of taxation law: together with changing employment practices for many high income mobile professionals is challenging the law relating to personal services income.  And the decision by the Tax Office to release a new draft ruling on a very old area of law highlights the needs for families in business to constantly monitor their tax strategy and the tax advice behind it.

If you are generating personal services income and your are considering different tax strategies to assist your family talk to Westcourt.  We have a range of sound approaches for this very topic that can make a large difference to your overall wealth while staying within the new directions from the Tax Office.