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The submissions in response to PCG 2024/D2 only lightly address the major concerns surrounding the PSI legislation and all of the ATO's related rulings.
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Opportunity to rectify problematic PSI rules slipping past
25 October 2024
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In my view, the most confusing part of the Australian income tax law for tax practitioners is the personal services income (PSI) rules. The release by the ATO of PCG 2024/D2 presented an opportunity to confront this perplexing area of the tax provisions.
I fear that the opportunity is going to be lost and that tax practitioners will be even further confused when PCG 2024/D2 is finalised.
I have had the benefit of reading the joint submission by CA ANZ/IPA and the submission of the Tax Institute in relation to the draft PCG. I am a member of all three professional bodies, and I thank them for their efforts in making submissions on behalf of the members.
However, I have to say that I am somewhat disappointed with the submissions by the professional bodies as they only lightly address the problematic enigma that is the PSI legislation and all of the related rulings that the ATO considers relates to this aspect of the tax law.
The key problem with PCG 2024/D2 is the starting position of the ATO. The ATO’s position is built on a foundation of a technical flaw. This starting position is only subtly challenged by the professional bodies. This is that a genuine business that has passed the tests in the PSI rules (thus being a personal services business), has a higher risk of Part IVA applying whenever there is splitting of income or retention of profits by the entity conducting the personal services business.
This paradigm is based on cases and ATO rulings that preceded the introduction of the PSI rules by many years. The ATO’s thinking is out of date and does not take into account the reasons why the PSI rules were introduced as outlined in the Ralph Review (1999).
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Except in the most egregious tax avoidance cases, the prospect of the ATO, in practice, being able to successfully apply Part IVA (the general anti-avoidance rule) to a genuine personal services business that retains some of its profits or has some of its income taxed to a person that did not personally derive that income is quite low. This is the point that should have been driven home by the professional bodies.
In my view, the ATO knows that it only has a low prospect of Part IVA being successful in the ‘higher risk’ situations outlined in the draft PCG. This is why there has been an almost complete absence of cases on this topic argued in the courts or AAT over the past 20 years or so. The ATO does not want to lose such a case because it will substantially reduce its ability to control taxpayer behaviour through making pronouncements on the issue.
Particularly since Part 2-42 ITAA 1997 (PSI rules) was enacted in 2000, it is difficult to believe that a court would find that the sole or dominant purpose of the creation of a genuine business structure was to obtain a tax benefit.
Every year there are many thousands of businesses that set themselves up in a corporate or trust structure. For the most part, no one ever considers Part IVA will have application to these structures even if they retain profits and there is a splitting of income. Will courts adopt the view that Part IVA should apply to a business structure that does these things simply because the income being derived is PSI?
It is to be remembered that Part 2-42 is, itself, a large and complex anti-avoidance provision aimed fairly and squarely against the use of the tax system to gain benefits when there is, in substance (but not in form) an employee/employer relationship in existence. The purpose of the introduction of Part 2-42 was to stop people who were, in substance, employees obtaining benefits from the tax system as if they were carrying on a genuine business.
The CA ANZ/IPA submission does make this comment:
‘While we agree that Part IVA can apply, it appears to be too high a threshold to set that any alienation should automatically trigger a higher risk of review, when alienation of PSI derived through a personal services business is generally legal and contemplated by the PSI provisions’.
Accordingly, the CA ANZ/IPA does touch on the issue, but it seems to be more of a ‘side argument’ than a main point. I would have preferred for these two joint bodies to have put this as their main, opening point.
The TIA submission does raise the issue, but in quite a subtle way. It invites the ATO to provide references to support the use of the phrase by the ATO ‘existing guidance and judicial decisions’. This sentence was used by the ATO to support its view. That is, the TIA is asking for the ATO to provide some backup for its position.
The TIA also makes the point that the support the ATO advances for its position is based almost entirely on judicial decisions and ATO rulings that occurred long before Part 2-42 was introduced. This is a point that I think should have been emphasised and is the basis of the technical flaw in the ATO’s position.
All of the professional bodies rightly point out that the ATO’s position in the draft PCG lacks commercial reality. This is the key focus of the professional bodies’ submissions. Even if you accept the ATO’s fundamental technical position, the ability of businesses to do what the ATO requires, in practice, will be quite problematic.
I suspect that when PCG 2024/D2 is finalised it will not look too much different from the original draft. There may be a few more examples and a little ‘tweaking’ of existing examples. However, the basic position of the ATO will not change in that the Part IVA ‘sword of Damocles’ will remain over the heads of the hundreds of thousands of individuals that conduct personal services businesses and their advisors.
The most confusing part of the Australian income tax law will remain so.
John Jeffreys provides tax training and produces tax information for tax professionals. He is a director of John Jeffreys Tax Pty Ltd.
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