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Lecture 8

Lecture 8 - Tax Planning and Anti-Avoidance Provisions

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Queensland University of Technology

LECTURE 8 – TAX PLANNING AND ANTI-AVOIDANCE PROVISIONS ALIENATION OF PERSONAL SERVICES INCOME ONLY ASSESSABLE SECTION Outline of the provisions (Part 2-42 (Divisions 84 to 87) – apply from 1 July 2000) The provisions are aimed at limiting:  the alienation of PSI (ie the diversion of income generated by personal services through an interposed entity); and  The over-claiming of income tax deductions by individual contractors and interposed entities providing personal services.  The PSI provisions do not apply where an individual or interposed entity is conducting a personal services business and do not affect the legal status of an interposed entity or deem an individual to be an employee; i.e. there are no adverse effects or additional burden on the service acquirer if the income is assessed income to the individual. What is alienation of PSI?  Alienation of PSI occurs when the services of an individual are provided through an interposed entity rather than directly by the individual who performs the services.  A personal services entity is a company, trust or partnership, the income of which includes the personal services income of one or more individuals. o The entity is usually one that is interposed between an individual who provides his or her personal labour, skills or services (the service provider) and an entity that requires those services (the service acquirer). o A personal services entity usually acts in accordance with the wishes of the service provider. o However, the establishment of a personal services entity by itself does not lead to the conclusion that there is an income splitting purpose.  When alienation occurs, income may be retained in the entity and either taxed at the lower rate available to the entity and/or diverted to various associates, allowing a lower rate of tax to be paid on that income.  The use of interposed entities is also perceived as a means to obtain tax deductions that would not be available to an individual providing the same services as an employee. o In addition to the tax consequences, individuals have been able to reduce their taxable income and limit other obligations such as Medicare levy surcharge. Meaning of personal services income  S 84-5 defines personal services income as income derived directly or through an entity (e.g. a company, partnership or trust) from the personal efforts or skills of an individual. Subs 84-5(3) extends the definition of personal services income to income that is for doing work or for producing a result. o However, the result must be produced mainly from the individual’s personal effort or skills. Personal Services Income (PSI) is assessable in the hands of the individual.  Income from personal services is to be distinguished from income that is mainly: o For the supply of goods; or o For the granting of a right to use property; or o For the use of assets in the income producing activities; or o Generated by the business structure. It must be remembered that it is only "individuals" that can have PSI. Income from the supply of goods  Where the income generated by an activity can be substantially related to a supply of goods rather than to the remuneration of the personal skills or effort of an individual, the income will not be personal income.  Some instances where the supply of materials may be regarded as ancillary to the rendering of personal services in situations such as: o The supply of art supplies by a graphic designer; o The supply of nails and glue by a carpenter in carrying out repairs; o The supply of paint by a painter; o The supply of wiring by an electrician; and Income from the supply and use of assets  While income must be derived mainly from personal efforts or skills of an individual, it does not preclude situations where the provision of personal services involves the use of some equipment, for example: o A personal computer of a computer consultant; o Tradespersons’ hand or electrical tools; o Off-the-shelf computer software packages used by service providers; and o The drawing board of a draftsperson.  It must be determined whether the contract is for the supply and use of assets in the activity that gains or produces income; or the use of plant and equipment by the individual in the activity. o In the latter, the contract would generally be regarded as one that is for the personal effort, or the skills of the individual.  Income from that effort or the exercise of those skills, in these circumstances, would be regarded as personal services income. o This is to be differentiated from particular assets to be supplied and used under the contract and without those assets an individual or a personal services entity would be unable to perform their contractual obligations.  Income, in these cases, would not = personal services income (s 84-5.  Where the asset: o Is large-scale or high value, and o Is essential to performing the work, and o Is specified in the contract, It is more likely that the income is being generated by the asset rather than by your efforts or skills and therefore is not personal services income.  In relation to the use of property in the activity that generates income, regard will be had as to whether or not the contract is for the supply and use of assets in the activity that gains or produces income.  Where a contract does not require the supply or use of assets, but where plant and equipment are used by the service provider in that activity, the contract would be regarded as one that is for the personal effort, or the skills of the service provider. Income from that effort or the exercise of those skills, in these circumstances, would be regarded as personal services income.  Distinctions will need to be drawn between those cases where plant and equipment or tools of trade are used by an individual or a personal services entity under an agreement that is for the personal efforts or skills of an individual, and those where the supply and use of the plant or equipment or other assets is the main source of the income of the individual or the entity.  Where components of a contractual obligation are integral to the performance of that obligation, judgment is required to determine whether the income is mainly the result of the use or supply of assets, or the provision of personal efforts or skill.  In determining if income is from the supply and use of income producing assets in these circumstances, the following factors are relevant considerations: o The market value of the supply and use of the asset, compared with the market value of the personal services; o The basis on which the contract price has been calculated and the extent to which the contract price relates to the costs borne by the individual or personal services entity in supplying and using the plant and equipment or other assets in the income-producing activity; o The significance or uniqueness of the assets in the income-producing activity; o The gross value of the asset in relation to the income of the individual or personal services entity from the particular activity; and o The role the asset plays in generating the income. Examples of income generated by the business structure  Where the income of an entity is generated by a business structure rather than the personal services of an individual, it is not personal services income.  This depends on a number of factors, including: o The extent to which the income depends upon the efforts, expertise or skills of an individual, o The number of employees or contractors engaged by the entity to perform work, o The nature of the activities being conducted by the entity that generate the income, o The existence of goodwill or substantial income-producing assets, and o The size of the business operation. Attributing personal services income  An individual will be required to include in his or her assessable income any income that another entity gains for the individual’s personal services. (subs 86-15(1))  However, this rule does not apply if: o The other entity gains the income in the course of conducting a personal services business (PSB); or o The income is promptly paid to the individual by the entity as salary or wages (ie the entity pays that income as salary to the individual within 14 days of the relevant PAYG payment period); or o The income is non assessable income of the entity  PSI included in the individual’s assessable income may be reduced by deductions to which the other entity is entitled. Deductions for an entity may fall into three classes: (s 86-20) o Personal services income deductions that are amounts that can be claimed against personal services income. o Entity maintenance deductions which are offset against other income and, in some circumstances, personal services income. o Other income deductions incurred in earning other income (these deductions cannot be used to reduce personal services income where attribution applies). Deductions relating to PSI (Division 85)  Entities other than individuals will use the rules in Subdivision 86-B to determine the deductions that can be claimed against personal services income.  Where the PSI is not paid to the individual, the deductions that the entity is entitled to offset against the amount treated as the individual income are limited to: o Superannuation contributions (subject to certain limits), o The cost of maintaining the entity structure and o Cars used entirely for business purposes, expenses of one private car and the associated FBT liability.  Where the PSI is paid to an individual, he/she will only be able to claim those deductions that an employee would be able to claim. o Deductions will not be allowed for rent, mortgage interest, payments to associates (unless to meet GST obligations/relates to principal work), home to work and back travel (Subs 85-10(1)). o However, an individual is not prevented from deducting amounts that relate to:  Gaining work (advertising, tendering and quoting for a job);  Insuring against loss of income or income earning capacity (sickness, accident and disability insurance);  Insuring against liability arising from acts or omissions in the course of earning income (public liability insurance and professional indemnity insurance);  Engaging an individual who is not an associate to perform work;  Engaging an associate to perform work that is part of the principal work for which an individual gains or produces personal services income;  Superannuation contributions so that the individual can obtain superannuation benefits or
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