Because of Personal Service Income rules (PSI) it is hard for professionals such as accountants, lawyers, doctors and dentists to share profit with their spouse and Family Trust. The problem is that the professional earns, say, $200k profit – paying tax at almost 50 cents in the dollar. The spouse earns nothing and, therefore, wastes the lower marginal tax rates.
The two methods to get around PSI are:
1. Everett’s assignments; or
2. Service Trust
1. Everett’s assignments
In Everett’s case, the professional transferred part of his partnership interest to his wife for a few thousand dollars. The model later developed to ‘selling’ part of the partnership to a Family Trust. It is a common practice.
Everett assignments are mechanisms that partners in a partnership use to share the business profits with associated entities. It came from FCT v Everett (1980) 143 CLR 440. This is a 1980 High Court decision. It established that a partner in a firm assigns part of their stake in the underlying assets of that firm. Therefore, the spouse and family trust get part of the future income.
In the ATO old rulings on income splitting and partnership interests, the ATO stated that Part IVA does not apply to an Everett assignment. But this is provided it constitutes a ‘no strings attached’ disposition of the partnership interest. All rather too loose language for a black letter tax lawyer such as myself. The ATO has revisited this position. It now considers Part IVA is capable of applying to such assignments.
I have never liked Everett’s assignments. I have never been involved in such an arrangement. The ATO has finally caught up and now agrees with me.
While the ATO has no power to change the law it sanctioned Everett’s assignments arrangement under the Guideline: ‘Assessing the risk: Allocation of profits within professional firms‘. That Guideline has thankfully withdrawn in 2017.
2. Service Trusts
It is common practice for businesses, not just professionals, to use a trust (service entity). A service trust is often a:
1. Family Trust – for a single business owner
2. Unit Trust – if 2 or more business owners
3. Company – not common as profit is trapped and no CGT relief. But useful if you have no family because of the 30% tax rate
Build these 3 types of service trusts on our website. All fully structured to take advantages of Fortunatow v FCT  FCA 1247.
The service trust is the second business. The service trust provides services to the business. It charges a fee for providing those services. Service trust profits are shared with the business owner’s spouse, children and family. They pay tax at a lower marginal tax rate. Therefore, the service trust saves tax. It helps with superannuation benefits and the spreading of income to family members.
But it is not enough to have just a service trust. You need the agreement between the business and the service trust. This agreement is called a Service Trust Agreement. The Service Trust Agreement is a contract. It allows the service trust to supply equipment, staff, receptionist, tools, factory, premises and administration services to the business.
You can read about and build a Service Trust Agreement here.
3. An example of “personal service income” – PSI
FCT v Fortunatow  FCAFC 139
The Full Federal Court upheld the Commissioner’s appeal from the decision of a single judge. The single judge held (reversing a decision of the AAT) that the “unrelated clients” test contained in the personal services income provisions of ITAA97 had been met.
The taxpayer was a business analyst and was at all relevant times the sole director of Fortunatow Pty Ltd (company).
Through contracts between the company and various recruitment agencies, the taxpayer provided services to organisations such as government departments, utilities, defence contractors, universities, banks, and large corporations.
In the 2012 and 2013 income years, income of $166,000 and $121,000, respectively, was returned in the company’s income tax returns. The income related to the provision of the taxpayer’s personal services to eight different end clients during those two income years. No remuneration was paid by the company to the taxpayer and he returned no income in his personal income tax returns for the relevant years.
The company transferred income generated by the taxpayer’s personal services to the Fortunatow Family Trust (the family trust) which was characterised as “management fees” payable to the family trust. These fees were claimed as deductions and had the effect of reducing the company’s
taxable income to nil. The trust income was offset against the trust’s rental losses. The Commissioner included the income of the company in the taxpayer’s assessable income on the basis that the company’s income was personal services income. There was no dispute that the income was
personal services income, but the taxpayer contended that the company was conducting a personal services business within the meaning of s 86-15(3) ITAA97.
Relevantly, the taxpayer relied on the “unrelated clients test” in s 87-20 ITAA97. The AAT rejected the taxpayer’s contention and, on appeal at first instance, Griffiths J reversed the decision of the AAT. As indicated, the Commissioner’s appeal from that decision has now been allowed by the Full Federal Court.
The taxpayer contended that he met the requirement in s 87-20(1)(b) ITAA97 (that the services were provided as a direct result of the individual or personal services entity making offers or invitations to the public at large or to a section of the public to provide the relevant services) because of his active profile on LinkedIn and his marketing by word of mouth at industry functions. He said that he kept his LinkedIn profile up to date and that he included a note that the company would be available for a new assignment
on a certain date, namely, after completion of his current assignment. The taxpayer contended that his LinkedIn profile was a form of advertising.
Although the AAT accepted that the taxpayer’s advertising on LinkedIn constituted the making of an offer or invitation to the public, it concluded that s 87-20(2) ITAA97 operated to deny the taxpayer’s claim. That subsection provides that the individual or personal services entity is not treated, for the purposes of s 87-20(1)(b), as having made offers or invitations to provide services merely by being available to provide the services through an entity that conducts a business of arranging for persons to provide services directly for clients of the entity.
The Full Federal Court said that it was necessarily implicit in s 87-20(1)(b) that the client has made a decision to obtain the services. Without such a decision, the services could never have been provided. Accordingly, the inquiry as to whether the services were provided as a direct result of the making of offers or invitations invariably involved an inquiry about what caused the client’s decision to obtain the services.
If the client’s decision to obtain the services was a direct result of the making of offers or invitations, the requirements of s 87-20(1)(b) would be met. A direct causal effect might be shown where it is established that an invitation or offer was comprehended by the client, in the sense of received
and digested, and that it had at least some influence on the client’s decision to obtain the services. The degree of influence required would depend on all of the circumstances.
If the requirements of s 87-20(1)(b) are satisfied with respect to two or more clients who were not associates of each other or associates of the individual or the personal services entity, s 87-20(1)(a) would be satisfied and the “unrelated clients test” would be met.
The Full Federal Court said that, as the Commissioner submitted, an offer or invitation which is only made to an intermediary, and is not passed on to and plays no part in, the client’s decision to procure the relevant services,
cannot be said to have directly resulted in the provision of the relevant services. This is because the offer or invitation loses its direct causal effect at the level of the intermediary, and the provision of the services can only be seen as the direct result of some other factor such as the intermediary’s
recommendation to the client.
On the facts as found by the AAT, none of the clients made their decisions to engage the services of the taxpayer as a direct result of any offer or invitation constituted by the taxpayer’s LinkedIn profile.
The Full Federal Court also rejected an argument advanced by the taxpayer that the Commissioner’s appeal was not competent.
Adj Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, LLM, MBA, SJD
National tax partner everett’s assignments
Legal Consolidated Barristers and Solicitors
Australia wide law firm Everett’s assignments
Mobile: 0477 796 959
National: 1800 141 612 Everett’s assignments
Email: [email protected]