DP Co has two employees, Mr Silk and his wife, Mrs Silk. The majority of DP Co’s work comes from one company, which contracts him to provide IT maintenance services on a yearly basis. DP Co is paid a fixed fee every six months. The contract states that the work done by DP Co must either be performed or supervised directly by Mr Silk, otherwise the contract can be terminated.
Mr Silk insists that he should not be subject to the PSI rules as his work is done to produce a result – ie, the ‘provision of IT services’ is a result he is required to produce and if he does not produce this result, he does not get paid. Would you agree with Mr Silk that the income received by DP Co is to produce a result?
The above may be a common scenario faced by many tax practitioners. Or maybe you are a taxpayer in a similar situation wondering whether you can rely on the ‘results test’ exception to get out of being subject to the PSI regime.
You may need to rethink your understanding of the results test as it may not be as simple as it seems. This article aims to shed some light on the confusing test to help you determine whether you can rely on this exception. We start however, with a basic understanding of the PSI regime.
Understanding PSI
Basically, the PSI rules are anti-avoidance measures aimed at preventing individuals from reducing their personal income tax by diverting income that has been generated from their personal efforts or skill or personal services to another interposed entity (a company, trust or partnership).
The individual may then be paid a salary for their work, usually at a lower amount than that derived by the interposed entity, or receive a reduced distribution from the company. Alternatively, the individual may choose to draw only a superficial dividend, which they stream to themselves or others, or retain the profits in the company.
Generally this results in income being taxed at a lower rate (eg, 30 per cent through a company, rather than up to 46.5 per cent as a salary for an individual) and higher deductions being allowed (for a company).
The PSI regime works this way:
- PSI rules apply where an individual derives ‘personal services income’, which is income mainly from an individual’s personal efforts and skill
- if PSI rules do apply to an individual, the individual’s assessable income should include the personal services income of the interposed entity (eg, a company) unless a salary amounting to the personal services income is promptly paid to the individual.
However, there is an exception to the PSI rules. Even if PSI has been derived by an individual, the PSI rules do not affect individuals or other entities that conduct a ‘personal services business’ (PSB).
The PSB exception
An individual or entity would be treated as conducting a PSB where at least one of the following tests is satisfied:
- The results test – broadly, where the entity works to produce a result, the entity provides the necessary equipment and the entity is liable for the cost of rectifying any defective work.
- The unrelated clients test – broadly, none of the clients pay more than 80 per cent of the PSI in the income year and there are two or more unrelated clients.
- The employment test – broadly, none of the clients pay more than 80 per cent of the PSI in the income year and you engage an entity (or entities) to perform at least 20 per cent of the principal work for the year.
- The business premises test – broadly, none of the clients pay more than 80 per cent of the PSI in the income year and you exclusively use a business premises that are physically separate from your home.
The latter three tests have definitive and measureable criteria in determining whether each test is satisfied (for example, it can easily be established by looking at the taxpayer’s accounts whether the taxpayer receives income from more than two unrelated clients and no one client pays them more than 80 per cent of their income).
This may be the reason why the latter three tests do not seem to cause as much confusion as the results test, which can be quite complicated to understand.
The results test
For an individual to satisfy the results test in a particular income year, the individual must satisfy the following three conditions in relation to at least 75 per cent of his or her PSI during the year:
- the income is for producing a ‘result’
- the individual is required to supply the plant and equipment or tools of trade (if any) needed to perform the work
- the individual is, or would be, liable for the cost of rectifying any defect in the work performed.
Where physical rectification is not possible, condition 3 will be satisfied if the individual or PSE is liable for damages in relation to the defect.
For each of these conditions, industry custom and practice will be taken into account.
Of the three conditions above, the first condition is the one that can create most confusion amongst taxpayers. The remainder of this article focuses on distinguishing whether the income you receive is for producing a result.
Producing a result
The meaning of ‘producing a result’ is explained in ATO’s Taxation Ruling TR 2001/8 to be, inter alia, a contract to achieve a specified outcome. The ruling relates the test to the traditional criteria for distinguishing independent contractors from employees. The following factors are relevant to this distinction:
- an independent contractor enters into a contract for a specific task or series of tasks
- an independent contractor maintains a high level of discretion and flexibility as to how the work is to be performed
- an independent contractor carries the risk, (stands to make a profit or loss on the task, bears the responsibility and liability for any poor workmanship or injury, may carry insurance and indemnity policies etc)
- an independent contractor provides the assets, equipment and tools, if any, necessary for the work
- an independent contractor may set the hours of work or place of work
- a contract for a result usually does not contain leave provisions or allowances
- payment to an independent contractor is often based upon performance of the contract rather than being at an hourly rate, piece rates or award rates
- an independent contractor is likely to advertise services to the public at large
- an independent contractor may delegate all or some of the tasks to another person.
The contract
In essence, for a contract to be for producing a result, there must be some task required where it is left to the performing party to determine who and by how the task is to be performed. Entitlement to payment in turn must be tied to completing the task.
The essence of the contract has to be to achieve a specific result and not just do work. Indicators that the contract is not to achieve a specified result or outcome:
- you are contracted to provide services with no predetermined outcome specified but your contract lists a scope of work only (indicative of the typical tasks to be undertaken), or
- the outcome you deliver is not determined or cannot be determined at the start of the contract.
Indicators that the income is not paid to achieve a specified result or outcome:
- you are paid on a basis other than to meet the result or outcome specified in the contract
- your contract is rolled over (ie the contract expires but you continue to do work after a specified period) and you continue to be paid
- you terminate the contract before producing the specified result and you are entitled to payment for the services performed up until the time of termination, or
- your payer terminates your contract, for any reason, prior to the expiration of your contract and you are only entitled to be paid for the services you have performed up until the time of termination.
An underlying consideration when interpreting this test is the need to demonstrate commercial risk. How is your profit tied to the result? The contract price should be tied to producing a result, not on a time basis.
Reconsidering Mr Silk
In light of the above discussion, take Mr Silk’s example again provided at the beginning of the article. Would you still agree with Mr Silk that his income is received for producing a result? With the facts provided above, it is questionable that the income received by DP Co is for producing a result. The IT services are akin to professional IT services provided by an IT consultant working for a company who gets paid a fortnightly salary, that is, there is no specific result which DP Co is required to achieve to get paid. There is no end in sight for this IT consultant – his role may be continued, equivalent to a full time employee. If, however, Mr Silk worked on different projects throughout the year and was paid an amount per project, this may point to a results-based contract.
Disclaimer
The views in this article are those of the authors and do not represent the views of Deloitte Private or Deloitte Touche Tohmatsu or any of its related practice entities. This article is provided as general information only and does not consider anyone’s specific objectives, situation or needs. You should not rely on the information in this document.
