Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 3 - Amendments relating to personal services income
Outline of chapter
3.1 Schedule 3 to this bill inserts section 61G in the FBTAA 1986 to reduce the taxable value of a fringe benefit by the same amount as is made non-deductible to the provider by virtue of the PSI provisions.
3.2 The Schedule also amends the PSI provisions in Part 2-42 of the ITAA 1997 to ensure that an individual, working through a PSE, can deduct a net PSI loss in an income year.
Context of amendments
Fringe benefits and personal services income provisions
3.3 Under the PSI provisions, an individual or PSE is denied a deduction for certain payments relating to personal services income that would not be deductible if an individual derived the personal services income as an employee. These payments may also be a fringe benefit within the meaning of the FBTAA 1986 and, as such, may give rise to FBT and therefore effectively be subject to double taxation. The amendments address the potential for double taxation by reducing the taxable fringe benefit amount to the extent the payment is non-deductible by virtue of the PSI provisions.
Personal services income losses
3.4 The PSI provisions prevent individuals from reducing their tax liabilities by alienating their personal services income to an associated entity or by claiming inappropriate 'business' deductions that would otherwise not be available if the individual were directly employed.
3.5 Under the PSI provisions, where an individual works through a PSE, such as a company, partnership or trust, the amount of their PSI is generally treated as their own assessable income (except where the PSE qualifies as a personal services business). This is achieved by attributing the personal services income of the PSE to the individual whose personal efforts or skills generated the income.
3.6 The amount of personal services income attributed to an individual can be reduced by certain deductions relating to the PSI that would otherwise be available to the PSE. However, under the current provisions, the attributed PSI cannot be reduced below zero. For a company or trust, this means that a net PSI loss for an income year cannot be attributed to the individual, but is instead, used in the PSE. (If the PSE is a partnership, the partners in the partnership may be allowed a deduction for the net PSI loss, to the extent of each partner's interest in the partnership.)
3.7 Consistent with the PSI provisions generally, the amendments aim to put an individual subject to the PSI provisions in the same situation had the individual been an employee, by allowing the individual, rather than the PSE, to deduct a net PSI loss.
Summary of new law
Fringe benefits and personal services income provisions
3.8 Amendments to the FBT legislation will ensure that the taxable value of a fringe benefit amount is reduced by the amount of the payment that is non-deductible to the provider because of the PSI rules. The provider of the fringe benefit can be either an individual operating as a sole trader or a PSE. This will remove the potential for double taxation.
Personal services income losses
3.9 Amendments to the PSI provisions will allow the relevant individual, rather than the PSE, to deduct the net PSI loss from other income for an income year. If the individual does not have sufficient other income to absorb the loss, they will be able to carry forward the loss under the normal carry forward loss rules contained in Division 36 of the ITAA 1997.
3.10 To the extent that the net PSI loss is attributed to the individual, the amendments will ensure that the PSE will not be able to deduct the loss in the current year or take it into account in calculating any carry forward tax losses.
| New law | Current law |
|---|---|
| The individual or PSE will be allowed to reduce the taxable value of a fringe benefit if:
|
Under the PSI provisions, an individual or PSE is denied a deduction for certain payments relating to personal services income that would not be deductible if an individual derived the personal services income as an employee. If the payment is also a fringe benefit within the meaning of the FBTAA 1986, it may give rise to FBT and effectively be subject to double taxation. |
| The individual, rather than the PSE, will be entitled to deduct a net PSI loss for an income year from other income of that income year or carry the loss forward to future income years where the loss cannot be absorbed by other income of the individual.
The PSE will not be able to deduct the net PSI loss for an income year from other income in that year or take it into account in calculating any carry forward tax losses. |
Under subsection 86-20(1), an individual's PSI cannot be reduced by allowable PSI deductions below zero. In cases where PSI deductions exceed PSI, the PSE can apply the excess to the entity's other income. |
Detailed explanation of new law
Fringe benefits and personal services income provisions
3.11 Amendments to the FBTAA 1986 will provide for a reduction in the taxable value of a fringe benefit in relation to the year of tax if:
- •
- a fringe benefit is provided in the year of tax in relation to the employment of an employee; and
- •
- the provider of the benefit is denied a deduction for the benefit under the PSI provisions (specifically sections 85-15, 85-20 or 86-60 of the ITAA 1997).
3.12 Section 85-20 denies an individual deductions for payments made to an associate, relating to gaining or producing personal services income unless the payment is related to the individual's principal work that produces the personal services income. Section 85-15 denies an individual deductions for rent, mortgage interest, rates and land tax relating to gaining the individual's personal services income. Section 86-60 is a general rule which denies a PSE a deduction for amounts relating to gaining or producing an individual's personal services income unless the individual could have deducted the amount if the circumstances giving rise to the deduction had applied to the individual (unless the PSE is conducting a personal services business).
3.13 The taxable value of the fringe benefit is reduced by the amount that cannot be deducted under the above sections. [Schedule 3, item 1, section 61G]
Personal services income losses
3.14 Amendments will allow an individual to deduct a net PSI loss from other income. An individual will be able to deduct an amount equal to the excess of the individual's 'personal services deduction amount' over the individual's 'unreduced personal services income'. This excess (i.e. the net PSI loss) can be deducted from the individual's other income or, in the case where the individual's current income cannot absorb the loss, it can be carried forward and deducted against future income. [Schedule 3, item 3, paragraph 86-27(1)]
3.15 The individual's personal services deduction amount is the sum of:
- •
- the amount of allowable PSE deductions relating to the individual's PSI; and
- •
- the entity maintenance deductions less any non-PSI income of the PSE, if this amount is greater than zero.
[Schedule 3, item 3, paragraph 86-27(1)(a)]
3.16 The individual's unreduced personal services income is the amount of personal services income that would have been included in the individual's assessable income if there had been no reduction under section 86-20. [Schedule 3, item 3, paragraph 86-27(1)(b)]
3.17 The deductions that the PSE is entitled to are reduced by the amount of the net PSI loss that the individual, whose personal services income is income of the PSE for that income year, can deduct under the new provisions. This ensures that the PSE and the individual cannot both deduct the net PSI loss. For example, where the PSE is a partnership, it will not be able to distribute a net PSI loss to its partners. [Schedule 3, item 4, section 86-87]
Example 3.1
Michael is a computer contractor that provides services through a company, J & M Pty Ltd. In the 2002-2003 year of income, J & M Pty Ltd's accounts are as follows:
PSI $120,000 PSI deductions $110,000 Other PSE income $5,000 Entity maintenance deductions $20,000 Investment related deductions $10,000
Michael's unreduced personal services income is $120,000 and his personal services deduction amount is $125,000 ($110,000 + (20,000 - 5,000)). Michael's section 86-27 deduction for the net PSI loss is ($5,000).
The income position of J & M Pty Ltd would be as follows:
PSI $120,000 PSI deduction $110,000 Other PSE income $5,000 Entity maintenance deductions $20,000 Investment related deductions $10,000 Section 86-87 reduction $5,000 Net loss of company $10,000
The $5,000 net PSI loss attributed to Michael reduces the company's net loss from $15,000 to $10,000 due to the operation of section 86-87.
Application and transitional provisions
3.18 The amendments to the ITAA 1997, which will benefit taxpayers, apply to assessments made for the 2000-2001 income year and each subsequent income year. [Schedule 3, item 6]
3.19 The amendments to the FBTAA 1986, which will benefit taxpayers, apply to fringe benefits provided after 30 June 2000. [Schedule 3, item 5]