Income Splitting

Income is subject to special scrutiny from the tax office should you wish to consider income splitting (Contractors, Professionals, Sportspeople)

“Personal services income” is income that is gained mainly as a reward for the personal efforts or skills of an individual. Income that is gained by a personal services entity, such as a company, partnership or trust, from the efforts or skills of an individual, falls within the definition of personal services income.

This means that if the payment received by your business is purely for your individual work alone then it is considered not to be able to be split with family members unless it meets the key criteria.

The courts and Australian Taxation Office have very clear views on this and should you be encouraged to fabricate a system to get around these rules the Australian Tax Office will simply impose Part IVa of the Tax Act where if it thinks the only reason for a transaction to exist is to save tax than it can simply over rule that transaction.

IT IS VERY HARD TO BE FACED WITH SEVERAL YEARS OF BACK PAYMENTS OF TAX AND FINES WHEN YOU FIND OUT YOUR MATE OR THE DODGY ACCOUNTANT REALLY DIDN’T KNOW THE RULES.

Important that you contact the highly experienced team at FORSYTHS to discuss your situation, the rules you are subject to, and ways to work within the rules.

The Commissioner considers that whether payments are mainly a reward for personal efforts or skills is determined by having regard to the commercial substance of the agreement under which services are provided. This requires the exercise of practical judgment as to whether the value contributed by the efforts or skills of the individual exceeds the value of all other inputs, such as the efforts of other workers, and the use of plant and equipment or machinery, or intellectual or other property.

The most common sources of personal services income include:

  • salary and wages income, although payments made to an employee (in his or her role as an employee) is not personal services income
  • income of a professional person, practising on his or her own account without professional assistance, but not the income of a partner in a large professional practice, as that income flows from the partnership interest (Taxation Ruling TR 2001/7)
  • income payable under a contract which is wholly or principally for the labour or services of a person – this would cover many contractors – and income derived by consultants in relation to their personal expertise
  • income derived by a professional sports person or entertainer from the exercise of his or her professional skills, but not product endorsements.

Personal services income also includes income that is for doing work or for producing a result, provided that the result is produced mainly from the individual’s personal effort or skills. “Mainly” means more than half of the relevant amount of ordinary or statutory income.

Example: Gianna is an IT consultant. She provides her professional services to a number of clients. One particular client supplies her with the office space, equipment and software that she needs to carry out the contract. She is not paid salary or wages by her client nor otherwise classified as an employee.

 

The money paid by the client to Gianna is personal services income as it is a reward for her personal skills or efforts.
What is not personal services income?

There are three main areas in which an individual’s income is not personal services income.

(1) Income from the sale of goods: if an individual applies his or her own effort, skill or expertise to contribute to the production of goods that are to be sold, the primary source of the income would generally be the contract for the sale of the goods, rather than the personal efforts of the individual;

Example: Chris Com operates a computer spare parts business that sells both computer hardware and software. Chris provides his personal services to install software for clients of the business. The cost of installation is usually built into the price for the hardware, and represents a small proportion of the total price.

 

The income that Chris Com gets from the provision of Chris’ services to install software is ancillary to the sale of hardware and software. Therefore, income from those services would mainly be for the sale and supply of goods. It would not be personal services income of Chris, but would properly be regarded as income of the company.

(2) Income for the use of assets: where an individual brings equipment or property, in addition to personal skills and expertise to a task, payments under the contract may be for use of an asset rather than being a reward for personal services.

Example 1: John owns a semi-trailer, which he hires to another business. John has no employees and does not engage anyone to drive the truck for him. He drives the truck himself.

 

The income that John gains or produces from hiring the semi-trailer to customers is not personal service income. It is not a reward for the personal efforts or skills of John, but rather a fee charged for the use of the truck.

Example 2: Samantha operates a graphic design business and provides her personal services to one major client and several smaller ones. Independently of the services that she provides to her clients, Sam has registered a design and has licensed the use of the design to a particular client in return for a sales-based royalty.

 

Regardless of whether the income Sam gains or produces from providing her services to her clients is personal service income, the royalty income stream is not considered personal service income because it is from the granting of a right to use the registered design and does not rely on Sam’s personal efforts or skills.

(3) Income from a business structure: Relevant factors in distinguishing between income that is mainly a reward for personal efforts or skills and income from a business structure are: the number of arm’s length employees or others engaged to perform work, the presence of goodwill, the extent to which income-producing assets are used to derive the income, the nature of the activities carried out, the size of the operation and the extent to which the income is dependent upon a particular individual’s own personal skills, efforts or expertise.

Example: Jan works as an accountant for a firm that employs 25 accountants. None of the firm’s income is Jan’s personal services income because it is produced mainly by the firm’s business structure, and not mainly as a reward for Jan’s personal efforts or skills.

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