The ATO has long had a focus on entities who generate income from the personal exertion of individuals. The Personal Services Income (PSI) rules were introduced to ensure that where an entity did not meet the conditions of being a Personal Services Business (PSB), the PSI earned by the entity would be attributed to the individual who generated that income.
This has also led to the assumption by some, that if the entity meets the condition of being a PSB, the entity can then deal with its income as it sees fit. While the statutory PSI rules do not require any income to be attributed directly to the relevant individual, where the income is not applied for the benefit of the individual, the ATO may seek to apply the Part IVA General Anti Avoidance Rules.
The ATO is of the view that Part IVA may apply where the arrangement was entered into for the purposes of splitting, diverting, or retaining the income in order to obtain a tax benefit.
The ATO has recently issued a Draft Practical Completion Guide 2024/D2 that provides indicators of what it considers to be low risk and high-risk arrangements for entities that qualify as a PSB, which are summarised below:
Low Risk Arrangements
- The entity distributes the net PSI of the individual to that individual, who is taxed at marginal rates
- The entity pays remuneration to the individual that substantially equivalent to the value of their personal services
- The entity pays a market value wage to an associate for providing bona fide services relating to earning the PSI
- Where there is a timing difference between the entity earning the PSI and the entity distributing the PSI to the individual. The timing difference needs to either be arising for reasons outside of the control of the parties or explainable for reasons unrelated to tax.
- The entity makes superannuation contributions for the individual
- Where there is a temporary retention of profits in order to purchase an asset. There must be a clear commercial purpose for purchasing the asset.
High Risk Arrangements
- The entity distributes the PSI to another entity where it is taxed at a lower rate than if the individual had earned the income in their own name.
- The entity pays remuneration to the individual that is less than the equivalent to the value of their personal services
- The entity does not distribute any income to the individual.
- All or some of the PSI is split with an associate of the individual, which results in an overall lower tax liability.
- The entity pays an above market value wage to an associate for providing bona fide services relating to earning the PSI
- Some or all of the PSI is retained by the entity, even if the entity lent the funds to the individual under a Division 7A loan arrangement.
The PCG provides 13 examples that explore the above type of arrangements further.
The PCG also outlines the ATO’s expectation regarding record keeping. While noting that there can be a general informality between an individual and the entity, the ATO still has the expectation that sufficient records are retained in order to explain why the entity entered into the arrangement to provide the individual’s services (as opposed to the individual providing the services directly), and why the entity has chosen to deal with the PSI the way it has.
Notwithstanding that contemporaneous and substantive records may be kept, the ATO can still apply Part IVA to the arrangement.
Whilst the PCG doesn’t necessarily tell us anything new, it does combine the ATO’s views on the questions of how and where the profits of PSB’s should be taxed and unsurprisingly, that is in the hands of the individual that derived the PSI.
If you have any questions on your client’s treatment of their PSI, please contact Ross Prosper.