Australian Tax Law Bulletin - Tax Issues for digital business - Part I - domestic issues
page 62 General Editor’s introduction
Dr Helen Hodgson CURTIN LAW SCHOOL
page 63 Tax issues for digital business — a case study
Part I: domestic issues
Joanne Dunne and Antonella Schiavello MINTER
page 69 Government puts losses back on the table — when is
similar not the same?
Andrew Clements, Sylvester Urban and Anthony
Mourginos KING & WOOD MALLESONS
page 73 ATO’s new individual professional practitioner (IPP)
taxing measure: background, context and policy
Dale Boccabella and Kathrin Bain SCHOOL OF
TAXATION & BUSINESS LAW, UNIVERSITY OF NEW
Dr Helen Hodgson, Associate
Professor, Curtin Law School, Curtin
Michael Blissenden, Associate
Professor of Law, University of
Andrew Clements, Partner, King &
Wood Mallesons, Melbourne
Gordon Cooper AM, Adjunct
Professor in the School of Taxation
and Business Law (incorporating
Atax), University of New South Wales
John W Fickling, Barrister, Western
Dr Paul Kenny, Associate Dean
Academic, Faculty of Social and
Behavioural Sciences, Associate
Professor in Taxation Law, Flinders
Business School, Flinders University
Craig Meldrum, Head of Technical
Services & Strategic Advice,
Australian Unity Personal Financial
Karen Payne, Chief Executive Offıcer,
Board of Taxation
Joseph Power, Senior Associate, King
& Wood Mallesons
Andrew Sommer, Partner, Clayton
Sylvia Villios, Lecturer in Law, Law
School, University of Adelaide
Chris Wallis, Barrister, Victorian Bar
2016 . Vol 3 No 4
Information contained in this newsletter is current as at May 2016
General Editor’s introduction
Dr Helen Hodgson CURTIN LAW SCHOOL
We are now well into the election campaign. I spent
Budget week in Canberra when both parties set out their
economic and tax priorities if elected.
Given the timeline for publication of this Bulletin I
don’t intend to repeat the commentary on the Budget
measures, except to say that I was interested to see the
proposed changes to superannuation, which I think
address some of the issues around whether the superan-
nuation scheme is ﬁt for purpose. The introduction of the
Low Income Superannuation Tax Offset to take effect
when the Low Income Superannuation Contribution
ceases will ensure that low income earners continue to
see some tax advantage in superannuation savings, while
restructuring the caps to allow the rollover of conces-
sional caps combined with a lifetime non-concessional
cap should allow middle to high income earners to
accumulate an adequate sum to fund retirement while
curbing some of the estate planning opportunities.
There were also a number of lower proﬁle measures
in the Treasury portfolio that I expect would be adopted
by whichever party is elected to government: notably the
Div 7A measures that the Board of Taxation recom-
mended, and reﬁnements to the taxation of ﬁnancial
arrangements (TOFA) and consolidations regimes.
As the campaign rolls on I expect that we will see
more announcements regarding taxation and spending
The three articles that we have for you this month
have picked up three issues that are of current interest,
and far less speculative than what might remain in the
Budget after the election.
The ﬁrst article, from Joanne Dunn and Antonella
Schiavello of Minter Ellison, uses a case study to set out
the tax consequences of establishing a digital business.
We considered the GST implications of cross-border
intangible supplies in volume 3 issue 2 of this Bulletin.
This article considers the income tax as well as the GST
implications of a resident company providing digital
services. The second part, which will be published in a
future edition, will consider the consequences when the
digital business expands to become a global enterprise.
The second article, from Andrew Clements, Sylvester
Urban andAnthony Mourginos at King & Wood Mallesons
examine the exposure draft that was released in Decem-
ber in relation to the carry forward loss measures. The
proposed Bill would redeﬁne the notion of what consti-
tutes the “same business” for the purposes of the
company and trust loss measures to allow losses to be
claimed where the business is similar, rather than the
same. It is hoped that this will remove a legislative
hurdle that could prevent a business from changing its
business model to become more proﬁtable.
The ﬁnal article, which was contributed by Dale
Boccabella and Kathrin Bain of the University of New
South Wales takes another look at the Australian Taxa-
tion Office (ATO) ruling on the possible application of
Pt IVA to individual professional practitioners, and a
comparison with the personal services income regime.
I hope that you ﬁnd these articles useful.
Dr Helen Hodgson
Curtin Law School
australian tax law bulletin May 201662
Tax issues for digital business — a case study
Part I: domestic issues
Joanne Dunne and Antonella Schiavello MINTER ELLISON
The digital economy is becoming harder to distin-
guish from the rest of our economy as Australian
businesses embrace technology across a wide variety of
industries. Part I of this article uses a hypothetical case
study to demonstrate some of the tax issues for a small
retail business transitioning to have a digital presence in
Australia. Part II of this article will address the addi-
tional tax issues which arise when that business expands
overseas and establishes an offshore subsidiary. Part II
will also consider digital currency, including recent
announcements in relation to bitcoin and GST.
This article focuses on speciﬁc tax issues affecting
digital business, as opposed to the more generalised tax
and other non-tax issues that would apply to all busi-
nesses, digital or otherwise.
There are also other legal issues that are speciﬁcally
applicable to digital businesses which are also not
touched on in detail in this article. For example, when an
Australian business establishes a digital presence, it will
also need to consider the appropriate business structure,
how to reward employees, how the website will be
hosted, intellectual property law issues, consumer law
issues, how to draft appropriate terms and conditions,
payment security and cyber security, privacy law issues,
cyber-insurance, compliance with the Spam Act 2003
(Cth), and how to promote the business in advertising
and social media.
Putting those other legal issues aside, this article
seeks to demonstrate the tax issues that impact upon the
digital economy by way of the following case study:
Paul Michaelson and Jane Johnson are fashion
entrepreneurs from Fitzroy in Melbourne.
Paul is a well-known personal shopper, and Jane is
a stylist and personal grooming consultant. Paul
and Jane employ four personal shoppers and their
business enjoys a loyal Fitzroy clientele, and elite
clientele from Brighton, Toorak and South Yarra,
as well as Tasmanian based clients.
Paul and Jane operate their business through an
Australian company of which they are the direc-
tors and their family trusts are 50/50 shareholders.
The company, which is registered for GST, is
called It’s The New Black Ltd (ITNB) and has an
office in Melbourne (in Fitzroy). In the last ﬁnan-
cial year ITNB’s aggregate turnover was $1.7
million. ITNB’s assets consist of inventory supply
and advisory contracts with large department stores,
client contracts and event contracts. These assets
need regular renewal and are not long term assets.
ITNB intends to expand its business beyond Victoria
and its current Tasmanian clients.
Paul and Jane have also decided that their business
will grow and develop further in their current
market in Australia if they have an online pres-
ence. Paul and Jane have decided they ﬁrst want to
test interest in NSW, WA, Queensland, the ACT,
the NT and SA by way of an online presence only.
This will enable them to consider whether to open
offices outside of Victoria, by monitoring who
uses the website and where they are located.
Paul and Jane tell you that:
• a website has been designed for ITNB for a fee
by an Australian based design company;
• ITNB has entered into a short term hosting
agreement with Macquarie Telecom in Austra-
lia (with hosting via servers located in Austra-
• ITNB is currently negotiating an agreement
with Paris and London Fashion Weeks to enable
a live signal of particular avant garde fashion
shows to be broadcast exclusively on the ITNB
• ITNB has acquired off-the-shelf software, and
over the past few months Paul has made
innovative adjustments to that software to enable
clients to input their measurements, upload a
photo, advise the event they are attending, and
be instantly recommended a range of outﬁts.
The recommendations would be shown on the
client’s body so they can see before they buy.
An advisory fee and website access fee is
charged by ITNB for this service;
australian tax law bulletin May 2016 63
• they are working to ensure that the website has
functionality so that clients can request groom-
ing and design advice from the ITNB team. An
advisory fee is charged by ITNB for this
• they are also working to ensure that the website
has functionality to enable shoppers to search
for and request particular designer fashion. If a
customer makes a booking, ITNB is paid a fee
by the customer and a commission is also
obtained from the particular designer if a pur-
chase is made;
• ITNB has entered into inventory contracts with
a number of stores and designers in Australia to
be able to access products; and
• the website is expected to “go live” in the next
Paul and Jane have hired a technical person, Brian
Block, to assist them to ensure that at all times the
website is providing fast, effective service to its
A few months after the website goes live, the
business grows at an exponential rate, with turn-
over exceeding $20 million. ITNB has since
developed, tested, and designed an app which
provides the ability for clients to reserve particular
items of inventory as soon as it comes in using
their smart phones.
This article proceeds to consider the tax issues arising
for ITNB from its Australian domestic expansion into
the digital economy.
Income, tax deductions and tax offsets
available to ITNB
Income received through the website, such as ITNB’s
advisory fees, website access fees, booking fees and
commissions from designers will be assessable, as it is
derived by an Australian resident taxpayer from carrying
on a business in Australia.1
The core issue for Australian businesses such as
ITNB is the deductibility of the expenses to develop and
establish the website, and any tax offsets that may be
available. Section 8–1 of the Income Tax Assessment
Act 1997 (Cth) (ITAA 97) provides for a deduction to
the extent the loss or outgoing is necessarily incurred in
carrying on a business for the purpose of gaining or
producing assessable income. However, s 8–1(2) may
prevent a deduction if the expenditure is an outgoing of
capital and, if that is the position, another avenue
provided under the ITAA 97 or the Income Tax Assess-
ment Act 1936 (Cth) (ITAA 36) for a tax offset or
deduction may need to be considered.
Website expenditure and development costs
Website costs that are recurring in nature are likely to
be revenue expenses, and may be deductible under
s 8–1. For example, ITNB should be entitled to claim a
deduction for the ongoing expenses of running and
maintaining their website, such as domain name regis-
tration costs, server-hosting package costs and ongoing
fees paid to Macquarie Telecom.
It is likely that other website development and design
costs incurred by businesses in setting up a website are
capital in nature, because the website establishes a new
earning structure for the business.
In 2009, the Australian Taxation Office (ATO) with-
drew TR 2001/6, which addressed the deductibility of
website development and establishment costs. In April
2016, draft ruling TR 2016/D1 was issued after consul-
tation with tax and industry representatives.2
been a signiﬁcant waiting period for this new ruling,
which is proposed to apply retrospectively. The draft
ruling considers the deductibility of expenditure incurred
in acquiring, developing, maintaining, or modifying a
website, and also the deductibility of content migration
and social media accounts. Generally, the draft ruling
states that the expenditure incurred on a commercial
website may be deductible under s 8–1 if it is of a
revenue nature. Otherwise, the expenditure may be
classed as “in-house software” and deductible under the
capital allowances/depreciation regime. Preliminary views
are provided regarding the treatment of certain expenses,
with practical examples. Recurrent business expenses
such as licensing fees and expenses associated with
routine maintenance are generally considered to be
deductible revenue expenses, whereas acquisition, devel-
opment, modiﬁcations, migrations and social media
costs which upgrade, improve, or add new functionality
or establish a business presence or structural advantage
are generally considered to be capital.
For a small business like ITNB, with an initial
aggregated turnover of less than $2 million, the govern-
ment’s small business tax changes announced in the
2015–16 Federal Budget may provide enhanced upfront
asset write offs. Assuming the expenditure is incurred
between 12 May 2015 and 30 June 2017, s 328–180 of
the ITAA 97 provides that capital expenditure on depre-
ciating assets can be claimed as a deduction in the
income year that the expenditure was incurred (if the
cost is less than $20,000).
If the cost of those assets is $20,000 or more, the
simpliﬁed depreciation rules in Subdiv 328–D of the
ITAA 97 will be applicable if the business elects to use
those rules, or Div 40 will need to be considered. Again,
this is relevant only to the extent that there is a
depreciating asset. The deﬁnition of “depreciating asset”
australian tax law bulletin May 201664
refers to an asset with a limited effective life that can be
reasonably expected to decline in value. The Commis-
sioner has conﬁrmed in TR 2016/D1 that a website is not
a depreciating asset under Divisions 40 and 328, except
to the extent that it can be classiﬁed as “in-house
software” (considered separately below).
TR 2016/D1 does not recognise that intellectual
property, which is a depreciating asset, may also be
contained in a website. The deﬁnition of “intellectual
property” in s 995–1 requires there to be rights in a
patent, copyright or registered design. For example,
there may be rights in the design of the ITNB website
that could be registered, or could comprise copyright. In
TR 93/12, the ATO considered that a computer program
is in essence knowledge or information and may be
considered an item of intellectual property, and may be
subject to copyright.3
Businesses such as ITNB may have copyright pro-
tection over internally created computer programs, such
as the innovations Paul has made to the software or the
creation of the app described in the case study. The
whole of the website will not be protected by copyright,
however, component parts of the website such as text,
images, logos, source code and ﬁles may be protected.4
For capital costs that do not qualify as in-house
software, the following additional issues need to be
• capital gains tax (CGT) assets may arise (eg in the
event that the intellectual property deﬁnition is not
satisﬁed) and the costs may form the cost base for
• section 40–880 could apply, as a last resort, to
provide a deduction over 5 years under the black
suggested that s 40–880 could be applicable.
However, the new draft ruling TR 2016/D1 states
that it would be unusual for commercial website
development expenditure to be deductible under
s 40–880, given the broad deﬁnition of a CGT
Off-the-shelf software and computer hardware
TR 2016/D1 states that the purchase of off-the-shelf
software is capital in nature and therefore not deductible
under s 8–1 of the ITAA 97. However, periodic license
payments made to a web developer for off-the-shelf
software, that is licensed by the business, with no right
to become the owner of the website, are considered to be
deductible under s 8–1. This is contrary to the ATO’s
previous guidance, which suggested that the cost of
commercial off-the-shelf software was generally deduct-
ible in the year of purchase.
Computer hardware is depreciable under Div 40 or, if
elected by a small business, under Subdiv 328–D of the
ITAA 97. Alternatively, as stated above, the upfront asset
write off of up to $20,000 is available to small busi-
nesses, such as ITNB.
Innovations to software and the app
development — in-house software
Special rules apply to deductions for the cost of
developing in-house software for a taxpayer’s own use.
In-house software is computer software that is acquired
or developed and is mainly for use in performing the
functions for which it was developed, and, importantly,
for which no other provision of the ITAA 97 provides a
For that reason, before considering whether Subdiv 328–D
or Div 40 applies to the costs of making adjustments to
the software and any other development costs, a busi-
ness will ﬁrst need to consider the research and devel-
opment (R&D) provisions in Div 355 of the ITAA 97
and any other provisions in the Act.
Research and development
A business with aggregated turnover of less than $20
million may be entitled to receive the 45% refundable
R&D tax offset for eligible R&D activities. In order to
claim an R&D tax offset, the business must register the
R&D activities at Innovation Australia,7
deductions for the purposes of the R&D provisions of at
least $20,000 for the income year, and carry out the
activities for itself (generally) in Australia.
There are a number of factors that a business such as
ITNB will need to consider when determining whether
innovative software amendments or the later design of
an app are eligible R&D activities, including whether
the software development or app development are core
R&D activities or supporting R&D activities.8
For core R&D activities, it will be necessary to
provide evidence of the work completed and show that
the software innovations and app development are
innovative. Case law highlights that evidence will be
needed showing that the work done develops new
knowledge, and that there was technical uncertainty
about the outcome.9
For example, in the North Broken
Hill and Commissioner of Taxation case10
off-the-shelf software were not held to comprise R&D
activities because they were not innovative, as it could
not be shown that the outcome of those innovations was
Innovation Australia issued Guideline 17 in relation
to software development under the former R&D provi-
sions. While that Guideline is not applicable to the
current R&D provisions, it does refer to software devel-
opment as needing to embody algorithms or methodolo-
gies that did not previously exist, and needing to show
sufficient innovation and outcome risk. It also provides
australian tax law bulletin May 2016 65
guidance on how to evidence activities to support an
R&D claim. For example, ITNB could conduct a litera-
ture and technology review to conclude that no algo-
rithm capable of performing image recognition and then
“ﬁtting” the clothes on the client’s photo existed previ-
ously. Evidence would also need to be found that the
outcome of the work done was uncertain.
Evidence of a progressive experimental process will
also be needed to meet the core R&D activities deﬁni-
tion in s 355–25. In the case study, the app was
“developed, tested, and designed”. Evidence of that
process will be needed to show the systematic progres-
sion of work, and documentation will need to be kept,
substantiating the process that was undertaken to develop
the innovations in the software.
To obtain certainty, an advance ﬁnding can be sought
from Innovation Australia11
as to whether the activities
are eligible R&D activities. If a ﬁnding was obtained, it
would be binding on Innovation Australia and the ATO
for the year in which the R&D is conducted and up to
two subsequent years (if activities are being conducted
over multiple years).
ITNB would need to provide further evidence before
an R&D claim can be substantiated.
In-house software — Div 40 and Subdiv 328–D
The software developed by ITNB (Paul’s innovations
and the app) may satisfy the deﬁnition of in-house
software assuming no other provision in the ITAA 97
(such as the R&D provisions) is applicable to provide a
deduction. If the costs of development are less than
$20,000, ITNB may be able to obtain an immediate
deduction under s 328–180 of the ITAA 97.
If ITNB’s software satisﬁes the deﬁnition of in-house
software, the costs of development are greater than
$20,000 and it commenced to be held after 1 July 2015,
the software has a statutory effective life of 5 years and
must be depreciated using the prime cost method.12
1 April 2016, the Australian Treasury released Exposure
Draft legislation which, if enacted, will allow taxpayers
to self-assess the effective life of intangible assets, so
that in-house software can be assessed to have a life
other than 5 years, for assets which started to be held
from 1 July 2016.13
Alternatively a business can choose to allocate in-house
software to a software development pool. There is no
deduction in the income year in which the expenditure
was incurred, but deductions are allowed at a rate of
40% in each of the next two years and 20% in the
following year. Once allocated to a pool, all future
in-house software expenditure must also be allocated to
Another issue for ITNB is whether any payments
made for the fashion week broadcasting rights would be
deductible. A critical factor is whether the payments
would be royalties, as s 26–25 of the ITAA 97 may
prevent a deduction unless withholding tax obligations
have been met. The double tax treaty between Australia
and the relevant countries would also need to be
In Seven Network Ltd v Commissioner of Taxation15
(Seven Network) the Federal Court considered whether
payments (approx $97.7 million) made by the taxpayer
to the International Olympic Committee for the broad-
casting rights for the Olympic Games were a royalty
within the meaning of the Australia/Switzerland Double
Tax Treaty. The case revolved around Art 12(3), namely
whether the use of the ITVR signal was “the right to use
copyright, or any other like property or right” which
could make payments in relation to the ITVR royalties.
The court held that the signal could not be a cinematograph
ﬁlm (for copyright law purposes) and copyright did not
arise in accordance with the Copyright Act 1968 (Cth)
because an item must be able to be reproduced in
tangible or material form to be an embodiment and
comprise copyright. The court also held that the words
“any other like property” in Art 12(3) referred to
intellectual property rights protected under domestic
law, and this required a tangible or material form. The
court held that no such rights arose, and made a
declaration holding that the payments were not royalties
and therefore withholding tax was not required to be
This Commissioner has appealed to the Full Federal
Court and the outcome is expected in 2016.
In considering whether ITNB’s payments for a live
signal from Paris and London fashion weeks are royal-
ties or not, the agreements between ITNB and the
entities involved would need to be reviewed and the
Australia/France and Australia/UK double tax agree-
ments would need to be reviewed. The ﬁnal outcome in
the Seven Network case would also need to be consid-
In addition, whether the website access fees paid by
customers are royalties may also need to be considered.
This is not so much of an issue in relation to ITNB when
it is operating the website domestically only as the fees
will be taxable in any event, the website is hosted in
Australia, and the customers are allAustralian residents.Care
would need to be taken to describe those access fees
appropriately as being for a service. However, the nature
of those fees and the question of whether they are
australian tax law bulletin May 201666
royalties paid in return for a non-transferrable, non-
exclusive right to use the intellectual property or soft-
ware comprised in the website may become relevant in
the future if ITNB builds an international client base and
derives fees from offshore, as withholding taxes might
reduce ITNB’s expected return. The nature of digital
business means that customers can come from other
ITNB must consider whether supplies made by way
of its website are taxable supplies on which GST is
imposed under the A New Tax System (Goods and
Services Tax) Act 1999 (Cth) (GST Act).
One of the requirements of a “taxable supply” is that
the supply is connected with the indirect tax zone (being
Australia). A supply of goods delivered to Australian
customers is clearly connected with Australia and fees
for such supplies are subject to GST. For a supply of
anything other than goods, whether it is connected with
Australia involves asking if the thing (which includes a
service, information or right) is done in Australia or
through an enterprise that the supplier carries on in
Australia. GSTR 2000/3116
states that the location of
where something is done will depend on the nature of
the supply — generally for services this is the location
the services are performed. In relation to ITNB, as
services are performed by staff in Australia to customers
in Australia, those fees are subject to GST.
An interesting issue arises if the terms and conditions
on the ITNB website which set out the arrangements
with customers describes the service the customer receives
as a limited, non-transferable license to use the software
which is part of the website. In this event, for GST
purposes, the thing refers to the computer software and
done refers to where the services are performed.17
supply of services is online software, the location of the
service provider and their servers are relevant. The
Commissioner has in various private binding rulings
determined that the supply of online services by a
foreign company to Australian customers is a thing not
done in Australia where the foreign company’s servers
are not in Australia.18
Where the software was acquired
and developed in Australia, the servers and related IT
infrastructure which support the computer software are
located inAustralia, and anAustralian Macquarie Telecom
is providing hosting services, it is likely that the supply
of the computer software is a thing done in Australia,
and therefore is connected with Australia.
Entitlements to input tax credits may arise for ITNB
on certain expenditure if they are “creditable acquisi-
tions”. This may include costs incurred to establish the
website, the acquisition of the initial software, the
hosting agreement and inventory contracts. To be a
creditable acquisition, the thing being acquired must be
a taxable supply and have the necessary connection with
Australia. The acquisition of software should be a
taxable supply, assuming that the software is supplied in
Australia. The hosting agreement provided by Macquarie
Telecom is likely to be considered a taxable supply
because the server is in Australia and the service is
supplied to ITNB in Australia. The inventory contracts
provide that ITNB has access to a retailer’s stock on
hand if an order is placed by an ITNB customer. This is
a supply of a right to purchase the retailer’s stock as
required. The supply of this right may be said to be done
in Australia, as both the retailer/designer and ITNB are
in Australia. This too should be considered a taxable
Record keeping for tax purposes, including the require-
ments of s 262A of the ITAA 36, need to be considered
when operating a digital business. Records can be kept
in written or electronic form, and include tax invoices,
receipts, sales records, year end records and bank
records. In TR 2005/9, the ATO reminds digital busi-
30. Where a taxpayer conducts business transactions
through the internet or by EDI the Tax Office
position is that the taxpayer is required to keep
records explaining all such transfers that are relevant
for any purposes of the ITAAs. All other require-
ments relating to electronic record keeping systems,
such as the need for controls, are equally applicable.
31. If electronic information systems are used to conduct
business transactions such as those that may be
conducted by websites, but do not function as record
keeping systems, there will be no evidence of those
transactions. Without this evidence your organisa-
tion or business may not be considered to have
complied with its record keeping requirements under
section 262A of the ITAA 1936. There is an admin-
istrative penalty if you do not keep or retain records
as required by this section: see section 288–25 in
Schedule 1 to the Taxation Administration Act 1953.
Taxpayers should remember that the onus of proof is
on them in showing that an assessment is excessive
should the Tax Office amend their taxable income.
The failure to keep sufficient records to explain
relevant transactions for tax purposes would be
inconsistent with the requirements of these obliga-
32. The nature of e-commerce with the recording of
transactions and information and subsequent record
keeping implications will assist taxpayers in the
design and implementation of systems to manage
full and accurate records arising from e-commerce or
EDI for the required periods. [Emphasis added.]
This is a reminder that another factor ITNB will need
to consider when establishing its website is the need for
website functionality to ensure that sufficient and com-
plete records are generated by transactions on the
website to enable ITNB to meet its record keeping
australian tax law bulletin May 2016 67
Part I of this article demonstrates that when a small
Australian business transitions to have a digital pres-
ence, a myriad of legal and commercial issues arise. In
addition, a number of quite speciﬁc tax considerations
arise, particularly in relation to the deductibility of costs,
the nature of income and expenses, and the nature of
supplies being made. The functionality of the Australian
business’ digital presence must also be tested to ensure
that it meets tax record keeping requirements.
Part II of this article will consider the tax implications
when the hypothetical ITNB business transitions to
become a global digital business. The issues of source,
residence, whether there is a permanent establishment,
the nature of income and expenses, and digital currency
will be included in the discussion. Also considered will
be potential law reform arising as a result of the
Organisation for Economic Cooperation and Develop-
ment’s (OECD) base erosion and proﬁt shifting project,
and at a domestic level on multinationals and how that
impacts a business in the digital economy.
1. For completeness, note that the company tax rate for small
businesses, such as ITNB (ie with aggregated turnover of less
than $2 million), was reduced from 1 July 2015 to 28.5%.
2. ATO Draft taxation ruling TR 2016/D1 Income tax: deduct-
ibility of expenditure on a commercial website (6 April 2016).
3. Note that the Copyright Act 1968 (Cth) may apply to provide
protection, and registration is not required for that protection to
be applicable. For protection to arise the work must be in a
material form. This means that a form of the work or an
adaptation of the work is stored and capable of being repro-
duced. The work must be made by a person who is an
Australian citizen or resident of Australia when the work was
made. The work must be an original work that is the result of
the author’s skill and effort.
4. See Australian Copyright Council Websites and Copyright
Information Sheet G057 (December 2014).
5. Given that ITNB is a small business, the various small business
concessions may be available to it in the future in respect of
any such CGT assets.
6. In the context of the research and development provisions,
s 355–715 provides that other than where the adjustment
provisions in ss 40–292 and 40–293 are applicable, if an R&D
tax offset arises, depreciation cannot be claimed under Div 40
or any other Division of the Act as well. That provision also
conﬁrms that considering the research and development pro-
visions ﬁrst will be important.
7. Note the deadline for registration is 10 months after the end of
an income year: see Research and development (R&D) tax
incentive (2016) www.business.gov.au.
8. ITAA 97, s 355–20.
9. Re North Broken Hill Ltd and Commissioner of Taxation
(1993) 26 ATR 1262; 93 ATC 2148; RACV Sales and
Marketing Pty Ltd v Innovation Australia (2012) 129 ALD 32;
(2012) 89 ATR 371;  AATA 386; BC201204554.
10. Re North Broken Hill Ltd and Commissioner of Taxation,
above n 9.
11. See R&D Tax incentive: Advance Finding Information Sheet at
12. ITAA 97, ss 40–70(2)(a), 40–72(2)(a), 40–75 and 40–95(7).
13. Exposure draft inserts for Tax and Superannuation Laws
Amendment (2016 National Innovation and Science Agenda)
Bill: Intangible asset depreciation.
14. ITAA 97, ss 40–450 and 40–455.
15. Seven Network Ltd v Commissioner of Taxation (2014) 324
ALR 13; (2014) 109 IPR 520;  FCA1411; BC201411357.
16. ATO Goods and services tax ruling GSTR 2000/31 Goods and
services tax: supplies connected with Australia (30 June 2000).
17. GSTR 2000/31, para 65.
18. See for example Private Ruling 1011511098475 at ATO
Authorisation Number: 1011511098475, Subject: supply of
online advertising www.ato.gov.au.
19. Taxation Ruling TR 2005/9 Income tax: record keeping —
electronic records (8 June 2005).
australian tax law bulletin May 201668
Government puts losses back on the table —
when is similar not the same?
Andrew Clements, Sylvester Urban and Anthony Mourginos KING & WOOD MALLESONS
Under new measures, companies and listed widely
held trusts should ﬁnd it easier to utilise tax losses where
there has been a change in ownership.
On 7 December 2015, the government released expo-
sure draft legislation (Exposure Draft) setting out the
new “similar business test”.1
The Exposure Draft applies
to companies and listed widely held trusts. The measures
are expressed to encourage entrepreneurship by making
it easier for loss-making companies to return to proﬁt-
ability. The measure is not limited to small innovation
The current same business test has produced harsh or
uneconomical outcomes through its strict application.
The new test is clearly wider than the existing test and is
to be welcomed. These rules do not seek to alter the
existing continuity of ownership tests.
The new measures are proposed to apply to tax losses
incurred on or after 1 July 2015.
The continuity of ownership and same
Under the current law, to claim a deduction for prior
a company (or listed widely held trust)
must satisfy either a “continuity of ownership” or “same
The continuity of ownership test (COT) is failed
when a company undergoes a substantial change in
ownership or control where shares carrying more than
50% of all voting, dividend and capital rights are no
longer beneﬁcially owned by the same persons during
the “test period” (being the period from the start of the
loss year to the end of the income year in which the loss
is to be deducted).
A similar “50% stake test” is applied for listed widely
held trusts, and there must additionally have been
abnormal trading. No changes to the COT are proposed.
To satisfy the same business test (SaBT) a company
or listed widely held trust must show that it was carrying
on the same business, during the relevant income year,
which it was carrying on in the year immediately before
the change of ownership or control which caused it to
fail the COT. The so-called “negative limbs” that apply
throughout the test period are the main obstacle to
satisfying the SaBT.
The limbs look at the undertakings and transactions
of the company or trust and are met if the company or
trust derives assessable income from:
• business — a business of a kind that it did not
carry on before the test time; or
• transaction — from a transaction of a kind that it
had not entered into in the course of its business
operations before the test time.
If either of these limbs apply, the entity will fail the
SaBT and will not be entitled to claim a deduction for
prior year losses.
For prior year losses, the default “test time” to be
used when applying the SaBT is the latest time that the
entity satisﬁed the COT. Where it is not practicable for
the entity to show that it has satisﬁed the COT for any
period since incurring the loss, the default test time is
either the start or end of the loss year, depending on
whether the entity existed for the whole or part of the
The Commissioner of Taxation (Commissioner), in
notes the strict interpretation of the SaBT
established in the High Court in Avondale Motors
(Parts) Pty Ltd v Federal Commissioner of Taxation,5
requiring an “identical business” to be carried on after
the test time.
Currently, what is required is the continuation of the
actual business carried on immediately before the test
time. A company or trust may expand, grow, contract its
activities and discard old operations without breaching
the same business requirement,6
however if the entity
changes its essential character or there is a sudden and
dramatic change in the entity brought about by acquisi-
tion or loss of activities on a signiﬁcant scale, it may fail
Whether the same business is actually being carried
on after the test time is a question of fact and degree.
The relevant factors include:
australian tax law bulletin May 2016 69
• Products sold/manufactured: For example, if a
business which traditionally grows cereals to sell
as seed and grain ceases to do so and begins
grazing cattle on the same land, it is likely a
change of business has occurred.
• Manufacturing process: For example, updating a
model of a product manufactured is not enough to
suggest a change of business. However, if a
company stops producing its only product and
begins manufacturing a separate and unrelated
product this is likely to be a strong indicator that
the business is not the same.
• Market for goods/services: It is relevant to look at
the persons to whom the product is sold or the
service is provided. This factor will have varying
levels of relevance depending on the size of the
company and the number of costumers it usually
• Method of selling: For example, a change from
outright sale to sale on consignment, sale on
terms, sale by hire purchase and so on may be a
factor indicating a change of business.
• Methods and sources of ﬁnance, working capital:
A change in working capital is unlikely, of itself,
to demonstrate a different business is being carried
out. However, it may suggest that other factors
have also changed which have been caused by a
change in business.
• Goodwill, trading name, trademarks, patents: A
wholesale change of intellectual property rights is
usually associated with a change in business,
whereas minor changes may be associated with
research and development within the same busi-
• Location: Distinction should be made between
expanding a business by opening the business in
more locations and closing an old business in a
• Number of employees: Termination of all staff
suggests the old business has ceased. However, an
increase in staff in a particular area of the business
may indicate growth. The former may suggest a
change of business has occurred.
• Management and directors: Resignation and replace-
ment of existing directors or management is unlikely,
of itself, to demonstrate a change of business.
However, such a change coupled with other chang-
ing factors may be indicative of a change of
Essentially, the narrow interpretation allows minimal
changes to the above mentioned factors, namely, those
arising from “mere expansion or contraction” of the
leading to the potential for harsh
outcomes on a strict application of the SaBT.
Potentially harsh or non-economical outcomes
The SaBT and COT were introduced with the follow-
ing purpose in mind:8
The relevant sections of the Act show an intention on the
part of the legislature to impose, in the case of companies,
a special restriction on the ordinary right of a taxpayer to
treat losses incurred in previous years as a deduction from
income. … This restriction is imposed to prevent persons
from proﬁting by the acquisition of control of a company
for the sole purpose of claiming its accrued losses as a tax
The strictness of the limitations may lead to harsh
outcomes. Consider a shareholder who acquires a loss-
making business in the hope of converting it into a
proﬁtable undertaking (by turning assets for proﬁt, not
offsetting taxable income). If the new shareholder alters
certain elements of the company in order to make it
proﬁtable, on a strict application, the SaBT may be
failed even though changes to the business are made for
purely commercial (rather than tax) reasons. This may
include, for example, if the company converts to an
online selling platform, introduces new low-cost prod-
ucts or signiﬁcantly reduces the number of employees
and alters the business management/directorship struc-
The irony of the SaBT is, of course, that a new owner
of a loss-making enterprise is faced with a choice of
either altering the business in an attempt to make it
proﬁtable, and consequently losing what may be a
signiﬁcant asset (ie, the tax loss), or keep the business
unchanged to take advantage of the loss, with a detri-
mental effect on proﬁtability.
Arguably, the need to satisfy a strictly interpreted
SaBT in circumstances such as the above may discour-
age taxpayers from innovating or from adapting to
changes in economic circumstances.
The strictness of the regime has produced harsh
outcomes where the company or trust’s ownership
changes for any other reason. For example, a listed
multinational may have long-term plans to move into a
business that is on the borderline between the “same”
and “similar” to its current business. If the multination-
al’s main shareholders change (failing the COT), the
company may then inadvertently continue with its long
term plans and lose (potentially very signiﬁcant) losses.
What are the proposed changes?
Similar business test
The Exposure Draft replaces the SaBT with a more
ﬂexible “similar business test” (SiBT).
A company (or listed widely held trust) will satisfy
the SiBT if its current business is similar to the former
business. To determine this, there are three main factors
that must be considered:
australian tax law bulletin May 201670
• assets — the extent to which the company or trust
generates assessable income from the same assets.
The Explanatory Memorandum9
makes clear that
the term “assets” extends to both physical and
intangible assets (including goodwill, trade names,
patents, royalty arrangements and other intellec-
tual property (IP) rights of a company or trust).
Goodwill, which is closely linked to an entity’s
ability to draw custom, will be particularly rel-
• sources — the extent to which the entity generates
assessable income from the same sources. The
Explanatory Memorandum refers to “sources” of
the entity’s assessable income in a commercial or
operational sense: “The sources of the company’s
assessable income are the speciﬁc activities or
operations from which it generates assessable
• reasonable expectation — whether any changes
to the former business are changes that would
reasonably be expected to have been made to a
similarly placed business.
The Explanatory Memorandum requires taking a
hypothetical business that is similarly placed to
the former business, and asking whether or not a
reasonable person would expect changes be made
to that business. It is not sufficient that the change
is a reasonable business decision in that it makes
commercial sense, or is a good business opportu-
nity. Rather, there must be something in the
activities or operations of the former business that
make the change “natural” having regard to the
organic connection and continuity between the
former and current business.
Comparison with same business test
Unlike the SaBT, the SiBT clearly provides for
differences between the current and former business that
result from growth or rehabilitation efforts.
The SiBT does not depart from the central principle
that there should be a similarity in the identity between
the commercial operations and activities of the former
and current entity. The rationale remains that corporate
groups should not be incentivised to buy loss-making
entities to shelter their own assessable income. It remains
the case that it is not sufficient for the current business to
be of a similar “kind” or “type” to the former business.
The focus remains on the identity of the business.
While the new test is clearly wider than the existing
SaBT and is to be welcomed, it will continue to involve
much subjectivity and debate, and in some circum-
stances, a taxpayer’s only way to achieve certainty will
continue to be through application for private ruling.
This is because, as with the SaBT, in some instances,
one of the factors may suggest that the SiBT is satisﬁed,
whereas another factor suggests otherwise. This will
require the factors to be weighed up with the relative
importance of each factor depending on the facts of the
It will be important to consider the effect of the new
legislation on the current tax ruling dealing with the
same business test: TR 1999/9.
Practical examples and issues
To illustrate the operation of the new provisions, we
have worked through some of the examples in the
Example 1: Company switches from manufacture to
If a business ceases to manufacture its own product
and instead begins deriving income from purchasing and
reselling another brand of that same product, there will
have been a signiﬁcant change in commercial operations
and activities of the former and current business. The
business no longer generates income from the same
assets (ie its processing plant, equipment and brand
name). The source of income has changed from manu-
facturing to reselling which goes to the heart of the
speciﬁc activities or operations from which the company
generates its income.
Even if it is assumed the third factor is satisﬁed (ie,
the changes are changes that would have been expected
of a similarly placed business), the business may not
satisfy the SiBT. Although it is still selling the same
product, this may be outweighed by the signiﬁcance of
the change from the business producing its own unique
brand of product to reselling another brand. Because of
this, the company’s current business may not be a
similar business to the former business.
Example 2: Addition of new product line
For a successful application of the SiBT, consider the
• A business changes ownership after making a tax
loss in its ﬁfth year of operation.
• The business, which previously designed and sold
into designing and selling mattresses.
• The business retains its brand name and logo but
moves into an online selling platform.
• The company then becomes proﬁtable (20% of
sales are from mattresses and 80% is from the sale
of furniture) and seeks to recoup the tax losses
incurred prior to the ownership change.
australian tax law bulletin May 2016 71
Although a question of fact and degree, the company
would likely fail the SaBT but pass the SiBT. This is
because it uses the same assets, generates income from
the same sources (to the extent that it is generated from
the online reselling of furniture items) and arguably took
advantage of an opportunity that would reasonably be
expected to be made by a similarly placed business.
Although there has been a change, the change is one that
supplements the former business as a subsidiary or
ancillary business activity, rather than replacing it. This
indicates that the current identity of the business is
similar to its former identity.
Proposed start date
It is proposed that the SiBT will apply to tax losses
incurred on or after 1 July 2015.
If a company or listed widely held trust seeks to carry
forward tax losses from pre-1 July 2015 periods, it will
need to satisfy the SaBT for those losses (even though
the losses will be utilised in future years).
King & Wood Mallesons
King & Wood Mallesons
King & Wood Mallesons
The authors would like to acknowledge the assistance of
Lara Moreton and Annabelle Paxton-Hall (Law Gradu-
ates, King & Wood Mallesons).
1. Exposure draft inserts for Tax and Superannuation Laws
Amendment (2016 National Innovation and Science Agenda)
Bill 2016: Access to losses.
2. “Tax loss” generally refers to previous years’ revenue losses,
previous years’ net capital losses, trading stock losses, losses
from writing off bad debts and losses transferred from a
company joining a consolidated group, which has been incurred
prior to a change of ownership or control.
3. Income Tax Assessment Act 1997 (Cth), ss 165–12, 165–13
(companies); Income Tax Assessment Act 1936 (Cth), Sch 2F,
ss 269–55, 269–100 (listed widely held trusts).
4. ATO Taxation Ruling TR 1999/9 Income tax: the operation of
sections 165–13 and 165–210, paragraph 165–35(b), section
165–126 and section 165–132 (23 June 1999).
5. Avondale Motors (Parts) Pty Ltd v Federal Commissioner of
Taxation (1971) 124 CLR 97; 2 ATR 312; BC7100080.
6. Above n 4, at para 13.
7. Above n 4, at para 39.
8. Above n 5, at .
9. Exposure draft Explanatory Memorandum to Tax and Super-
annuation Laws 4 Amendment (2016 National Innovation 5
and Science Agenda) Bill 2016: Access to 6 losses.
10. Above n 9, at para 1.27.
australian tax law bulletin May 201672
ATO’s new individual professional practitioner
(IPP) taxing measure: background, context and
Dale Boccabella and Kathrin Bain SCHOOL OF TAXATION & BUSINESS LAW, UNIVERSITY OF
NEW SOUTH WALES
On 30 June 2015, the Australian Taxation Office
(ATO) ﬁnalised its individual professional practitioner
The guidelines effectively amount to a
new taxing measure:2
practitioner principals in profes-
sional ﬁrms who have been alienating taxable income to
associated entities are likely to come under scrutiny
should they fail to include a minimum amount in their
assessable income from their ﬁrm’s activities. The main
basis supporting the guidelines is that the principal
practitioner’s personal efforts are largely responsible for
the generation of the taxable income.
Aside from this introduction and conclusion, the
article is in three parts. Part 2 brieﬂy sets out how the
courts have approached attempts to alienate personal
exertion income in the past, and also contains an outline
of the personal services income (PSI) regime.3
sets out the ATO’s IPP guidelines, and in particular,
when they apply, to whom they apply and the “safe
harbour” benchmarks within the guidelines. Part 4
analyses the merits and deﬁciencies of the IPP guide-
The article concludes that the guidelines represent a
sensible and equitable development in tax policy con-
cerning “personal exertion income” and “income from a
business structure” in the context of a professional
practice. However, there are considerable deﬁciencies in
and around this area of the tax law, and the guidelines
are not the best solution to address these deﬁciencies.
Tax law in this area aside from the IPP
Personal exertion income to be taxed to person
that provided the services
Putting aside for the moment the PSI regime, there
seems to be two bases that prevent the alienation of most
personal exertion income for income tax purposes.
Provider of exertions or services has no present property
interest to assign and is only assigning future income
This basis draws on property law and rules of equity,
rather than tax law principles, and reﬂects the idea that,
subject to a particular tax provision, the tax law operates
on the general law effect of transactions.4
The key idea
is that only assignments of presently existing property
are effective to alienate income from the property to an
If the purported assignor does not have a
presently existing property right to assign, it is likely the
assignor is merely assigning future income (only an
expectancy) when it arises.6
This is not sufficient to
prevent the assignor from becoming entitled to the
income under the general law when it arises. The tax law
adopts this, and therefore treats the assignor as the one
who has derived the income.
This analysis explains why attempted assignments
(diversions away from the employee) of salary or wages
or earnings from services is not effective for tax pur-
It also explains why sole traders and a profes-
sional practising on his or her own cannot effectively
assign income from their activity so as to avoid deriva-
tion of the income for tax purposes.8
General anti-avoidance rule (GAAR)
If the provider of personal services has successfully
alienated the relevant income by interposing a legally
valid entity between themselves and the end user of the
natural person’s services or has assigned part of their
interest in a partnership, the relevant income is derived
by the interposed entity9
From there, all
the usual rules that apply to that entity will apply.11
However, the ATO has consistently argued that if the
alienated income is personal exertion income, the GAAR
should apply to defeat the attempted alienation so that
the relevant income is included in the assessable income
of the person providing the personal services.12
context of professional services ﬁrms, the ATO states
that if the ﬁrm has at least as many non-principal
practitioners as principal practitioners, the income of the
australian tax law bulletin May 2016 73
ﬁrm will be from the business structure, and not from the
personal services of the ﬁrm’s principals.13
are more principal practitioners than non-principal prac-
titioners, it is likely that the income will be personal
services income but all the circumstances need examin-
The ATO argument has been put under the old
and the new GAAR.16
The courts and the
AdministrativeAppeals Tribunal (AAT) have overwhelm-
ingly supported the ATO and applied the GAAR (both
old and new provisions) in alienation of personal exer-
tion income cases. Further, the courts and the AAT have
applied the GAAR both where the ﬁrm comprises arm’s
and where the ﬁrm comprises non-
arm’s length parties (closely held entity).18
PSI regime (Divs 84–87)
The PSI regime was introduced with effect from July
2000 to largely replace the need for the GAAR in respect
of income alienation of personal services income. Apply-
ing the GAAR on a case by case basis was considered
“labour intensive and an inefficient use ofATO resources”.19
The PSI regime prevents individuals who provide per-
sonal services through an interposed entity from divert-
ing (alienating) their PSI to an associated entity.20
The PSI regime applies only to “personal services
income”, which is deﬁned as income that is “mainly a
reward for your personal efforts or skills (or would
mainly be such a reward if it was your income)”.21
Income that is mainly generated by the sale of goods,
use of assets, or a business structure is not PSI. Income
from a medium or large professional practice would be
regarded as income from a business structure and not
PSI of the principals.22
Even where there is PSI, attribution of the PSI to the
individual will not occur under the PSI regime where the
is conducting a personal services
business (PSB). A PSB exists if the interposed entity
satisﬁes at least one of the four tests set out in Subdiv 87–A:
• the results test;
• the unrelated clients test;
• the employment test;
• the business premises test.24
The GAAR can still apply to PSI income derived by
an interposed entity conducting a PSB, particularly if the
dominant purpose of the arrangement is income split-
The IPP guidelines
Criteria for application of guidelines and the
target of the guidelines
The guidelines will only apply if all three criteria set
out below are satisﬁed.26
IPP provides professional services to the ﬁrm or clients,
and IPP and/or associates have a legal or beneﬁcial
interest in the ﬁrm
An IPP is an individual (natural person) professional
practitioner, and he or she, putting aside for the moment
legal structures, is a principal of the practice entity
(ﬁrm). The IPP must either provide services to clients of
the ﬁrm, or (less commonly) is actively involved in
management of the ﬁrm (eg managing partner).27
The IPP must provide “professional services”. Those
providing non-professional services are not within the
guidelines. The distinction between professional and
non-professional may be difficult to determine at times.
Some guidance may be obtained from the ATO’s com-
ment that the guidelines only apply to “thought related
professions”. In a non-exhaustive list, the guidelines
expressly mention accounting, architectural, engineer-
ing, ﬁnancial services, legal and medical professions.28
The ﬁrm, in the sense of the “entity” that (outside)
clients are contracting with, could be a partnership or a
company. It is less likely to be a trust.29
The focus is on
whether the IPP, as a matter of practical reality, is
providing services to clients of the ﬁrm. The fact the IPP
may be an employee of the company-ﬁrm does not mean
the IPP is not providing services to clients.30
The IPP and/or the IPP’s associated entities must
have a legal or beneﬁcial interest in the ﬁrm.31
suggested that all of the entities in column two of the
table below will have a beneﬁcial interest in the ﬁrm in
Firm type Entities holding a legal or beneﬁcial
interest in ﬁrm
Partnership • IPP is a partner in ﬁrm;
• spouse or relatives of IPP who has had
IPP’s interest in the partnership (or part
of it) assigned to them;
• trustee of trust is a partner in ﬁrm,
where the trust is owned and/or con-
trolled by IPP and/or associates of IPP;
• beneﬁciaries in trust (trustee) that is a
partner in ﬁrm; and
• company is partner in ﬁrm, where the
company’s shares are owned by IPP
and/or associates of IPP.
Company • IPP is a shareholder in ﬁrm;
• spouse or relatives of IPP are sharehold-
ers in ﬁrm;
• trustee of trust is shareholder in ﬁrm,
where the trust is owned and/or con-
trolled by IPP and/or associates of IPP;
• beneﬁciaries in trust (trustee) that is a
shareholder in ﬁrm; and
• company is a shareholder in ﬁrm, where
the company’s shares are owned by IPP
and/or associates of IPP.
australian tax law bulletin May 201674
It appears that the main focus of the guidelines is on
ﬁrms with arm’s length principals (IPPs), for example,
the medium-sized or large accounting ﬁrms. However,
there is nothing to indicate that criterion one and the
broader guidelines do not apply to ﬁrms that are closely
Firm operates by way of legally effective entity
This criterion conﬁrms that the guidelines can apply
no matter what legal structure (ie partnership, trust,
company) is used by the associated parties as their
practice entity (ﬁrm). Where the IPPs are arm’s length
parties, one would expect the practice entity would be
legally effective. Where the IPPs are not at arm’s length
(eg spouses are partners), it is more likely that the
practice entity may be seen as not being legally effective
or a sham. Consistent with the law, the ATO notes that
this will depend on contractual terms, and whether the
practice is conducted in accordance with the contractual
Income of the ﬁrm is not personal services income
The ATO states that in determining whether income
earned by a ﬁrm is personal services income or income
from the business structure, it will apply guidelines in its
Accordingly, the outline at Sub-
Part 2.1.2 applies here.
ATO risk assessment benchmarks for
remuneration of IPPs35
The ATO states:36
In some cases, practice income may be treated as being
derived from a business structure, even though the source
of that income remains, to a signiﬁcant extent, the provision
of professional services by one or more individuals. In this
context, we are concerned that Part IVA [the GAAR] may
have application, despite the existence of a business struc-
ture. … Where an IPP attempts to alienate amounts of
income ﬂowing from their personal exertion (as opposed to
income generated by the business structure), the ATO may
consider cancelling relevant tax beneﬁts under [the GAAR].
Despite this statement, the ATO acknowledges that
historically, the GAAR has not been applied to income
from a business structure of a professional ﬁrm.37
The ATO has created three risk assessment bench-
marks applicable to IPPs and/or associated entities.
Where the IPP satisﬁes one (or more) of the benchmarks,
the ATO will allocate a “low risk” rating, and the
taxpayer will not be subject to ATO compliance action in
respect of income alienation. Where none of the bench-
marks are met, the taxpayer will be allocated a “high
risk” rating, and is more likely to be subject to audit
action and potential application of the GAAR.38
can use a different benchmark from year-to-year to
obtain a low risk rating.39
Each benchmark is discussed
Benchmark 1: equivalent or appropriate remuneration
returned as IPP’s assessable income
To meet this benchmark, the IPP must include in their
assessable income an amount at least equivalent to
paid by the ﬁrm to the lowest paid
employee in the upper quartile of professional employ-
ees who provide services to the ﬁrm that are equivalent
to the services provided by the IPP.41
If there is no
“equivalent employees” in the ﬁrm, which may be the
case in smaller practices, like employees in comparable
ﬁrms or industry benchmarks should be used.
Benchmark 2: 50% of IPP and/or associated entities’
entitlements returned as IPP’s assessable income
To meet this benchmark, the IPP must include in their
assessable income at least 50% of the sum of all
entitlements of the IPP and the IPP’s associated entities
(ie collective entitlement ﬂowing from the ﬁrm).42
where an associate entity’s entitlement accrues through a
chain of interposed trusts, that entitlement will still be
counted in the denominator of this benchmark.43
This also means that entitlements accruing to the IPP
and/or associated entities from a service entity that
services the ﬁrm will be counted in the denominator. An
IPP’s entitlement from a service entity will be counted in
the numerator under this benchmark.
Benchmark 3: effective tax rate of at least 30% on IPP
and/or associated entities’ entitlements
To meet this benchmark, the effective tax rate must be
or more on both:45
(i) the income entitlement of the IPP from the ﬁrm;
(ii) the income entitlement of the IPP and the income
entitlement of the IPP’s associated entities, from
Arguably, if the IPP has no entitlements from the
ﬁrm, which is possible, the ﬁrst requirement ((i) above)
would be satisﬁed rather than failed.46
In other words,
testing for the 30% tax rate for the IPP is only necessary
if the IPP has some entitlement. In regard to the second
requirement ((ii) above), it is the collective entitlement
of all parties that must bear at least 30% tax. There is no
need for each associate that is entitled to bear the 30%
Where the IPP has no non-ﬁrm income, the IPP
would have to include approximately $172,500 of tax-
able income from the ﬁrm to meet his/her 30% effective
australian tax law bulletin May 2016 75
tax rate requirement.47
Where the IPP and/or associated
entities have non-ﬁrm income, the ATO states that in
determining the tax borne on income from the ﬁrm, the
entitlement from the ﬁrm forms the “top slice” of a
natural person’s taxable income.48
For example, for an
IPP with non-ﬁrm taxable income of $60,000 and ﬁrm
income of $80,000, the following result arises:
Taxable income, and compo-
nents of taxable income
Tax on column
Taxable income: $140,000
Non-ﬁrm taxable income: $60,000
Firm taxable income: $80,000
The effective tax rate on the IPP’s ﬁrm income is
35.87% ($28,700/$80,000), which meets the 30% require-
Need for guidelines
The ATO correctly asserts that a certain portion of an
IPP’s entitlement from the ﬁrm, until now viewed solely
as income from a business structure, is generated from
the IPP’s personal exertion.49
The rules prior to the IPP
guidelines (or the old view) of this area has been based
on an “all or nothing” characterisation of the income
(personal exertion or from business structure). The
established rules regarding personal exertion income
(PSI regime) cannot apply to an IPP’s return from the
business structure. The ATO has generally not applied
the GAAR to “alienations” of income from a profes-
sional ﬁrm’s business structure. This is the gap ﬁlled by
the IPP guidelines.
The damage to the integrity of the income tax from a
situation where an IPP could return zero taxable income
from their ﬁrm was most likely the key thing that moved
the ATO to [eventually] take this measure. Inter-taxpayer
fairness may also have contributed, as may the parlia-
ment’s failure to act. One could legitimately ask, why
did the ATO take so long to act?
Legal status of guidelines and use of guidelines
The IPP guidelines and in particular, the three bench-
marks, are not speciﬁc legislation and they do not derive
from case law. However, they are ultimately grounded in
the GAAR. That is, if the ATO seeks to defend their
application to particular taxpayers, the ATO will need to
convince either the AAT or the appropriate court that all
elements of the GAAR are satisﬁed. It is also noted that
the IPP guidelines are not a binding public ruling.50
effect of this is that an IPP and associated entities cannot
obtain the “estoppel type beneﬁt” that comes from a
binding public ruling.51
In terms of legal status then, the IPP guidelines are
merely ATO website content. However, the ATO is likely
to consider itself bound administratively to the guide-
lines. While a taxpayer may be protected from a false or
misleading statement penalty (and any shortfall interest),
they will not be protected from a tax shortfall if the
ATO’s guidelines are later found to be incorrect or
misleading and the ATO seeks to depart from them.52
One would also expect that changes to the guidelines
that are detrimental to taxpayers will only operate
In the ﬁrst instance, the guidelines will act as a “risk
management” or “audit selection” tool for the ATO. If a
taxpayer complies with the guidelines, they will be rated
as low-risk and are unlikely to face audit action. Here,
the guidelines effectively act as a “safe harbour” for
IPPs. While this may provide those taxpayers with
increased certainty, it also means there would be no
incentive for such taxpayers to include any more “per-
sonal exertion income” in their assessable income than
is required by the benchmarks.
If a taxpayer does not comply with at least one of the
benchmarks, they will be rated as high-risk, thus increas-
ing the risk of audit action. However, a “high-risk”
rating will not necessarily result in the ATO attempting
to apply the GAAR to the arrangement; it simply means
that they are more likely to examine the arrangement in
order to determine whether the GAAR should apply.
Appropriateness of taxpayer coverage and
The guidelines are limited in their reach to “profes-
sional ﬁrm arrangements” (eg accounting, engineering,
legal, medical). This means that ﬁrms and businesses
that provide services or products to the consuming
public, for example, “blue collar” service providers (eg
electricians, plumbers) and traders (eg coffee shops) are
outside the guidelines. As with professional ﬁrms, part
of the income in both of these categories of business is
likely to be generated from the personal exertion of the
The ATO claims that the structure of professional
practices in certain “thought related” professions is
unique and has been driven by a combination of factors
(eg reforms to regulatory environments) which has led
to the adoption of a variety of structures. These factors
differ from the commercial drivers in other sectors, such
as those involving physical labour. And, in light of the
greater ﬂexibility provided by regulators, there is greater
potential for the alienation of income.53
With respect, the ATO’s reasoning is not convincing.
If the key objective is not permitting the full alienation
of personal exertion income, it is very hard to see why
this objective should not be pursued in the case of a
australian tax law bulletin May 201676
“blue collar” business or other trading businesses. The
ATO may be working on separate guidelines (although
this is unknown), but at the moment, the absence from
the guidelines of other businesses where a principal’s
personal exertion contributes to the income offends
inter-taxpayer equity and seems wrong in principle.
The benchmarks should be evaluated in accordance
with the overall purpose of the guidelines: to prevent the
full alienation of personal exertion income away from
the provider of the personal exertion. The presence of
three alternative benchmarks and allowing the IPP to
select a different benchmark each year, provides ﬂex-
ibility in determining the appropriate amount to be
included in the assessable income of the IPP. However,
this ﬂexibility means that the benchmark chosen each
year is likely to be the one that results in the smallest
amount of assessable income for the IPP. Further, even if
none of the benchmarks are satisﬁed, it does not neces-
sarily mean that the ATO will seek to apply the GAAR.
The guidelines provide an example where, due to valid
commercial reasons, the ATO will not apply the GAAR
even though none of the benchmarks are satisﬁed.54
The ﬁrst benchmark is making an assumption that the
remuneration being paid to the lowest paid employee in
the upper quartile of employees providing equivalent
services to the ﬁrm is an appropriate reﬂection of the
IPP’s personal exertion. The IPP’s entitlement from the
ﬁrm could be substantially higher than this remuneration
ﬁgure. It is questionable whether any excess allocation
above this ﬁgure is an accurate reﬂection of income
from the business structure and compensation for busi-
The second benchmark, on the face of it, is not set by
reference to an objective industry criterion concerning
remuneration for personal exertion in the market place.
Instead, it requires a minimum of 50% of the IPP’s
overall income entitlement to be included in their
assessable income. This suggests that the remaining
50% is due to the IPP’s portion of the business structure.
The third benchmark makes no attempt to separate
the IPP’s overall income entitlement into a personal
exertion component and a business structure component.
It is merely ensuring that a minimum rate of tax is paid
on the IPP’s income allocation, even if a large portion of
the tax is paid by the IPP’s associated entities. Strangely,
the corporate tax rate, which is usually associated with
the production of business income, has been chosen as
the effective tax rate to apply.55
1 This may not be
appropriate considering the IPP guidelines are based
around the concept of appropriately taxing the IPP’s
personal exertion income component.
While the guidelines are a sensible development, they
may be somewhat generous, with IPPs being able to
“pick and choose” between benchmarks each year. The
ATO’s view may be that taxing some income in the
hands of the IPP is better than nothing, which is what the
current position permits. The guidelines are also narrow
in taxpayer coverage in that they only apply to profes-
sional services ﬁrms. This means that principals of other
businesses where there is a contribution to business
income from the principal’s personal exertion are tax
From a tax system point of view, the GAAR with the
broad nature of its operative concepts, is not an appro-
priate mechanism for taxation of personal exertion
income. It is submitted that the enactment of the PSI
regime in 2000 provides considerable support for this.
Treasury and Parliament should therefore give serious
consideration to introducing a policy-based legislative
regime to appropriately tax IPP personal exertion income,
rather than relying on non-legally binding ATO guid-
Associate Professor of Taxation Law
School of Taxation & Business Law
University of New South Wales
School of Taxation & Business Law
University of New South Wales
This article has been reviewed by an independent
1. Australian Taxation Office, Assessing the risk: allocation of
proﬁts within professional ﬁrms, 18 March 2016, www.ato.gov.au.
The guidelines were modiﬁed on 18 March 2016.
2. There is some doubt about this though, because even where the
guidelines apply to a professional ﬁrm, the ATO has conceeded
that the general anti-avoidance rule (GAAR) will not neces-
sarily apply: see heading “The IPP Guidelines” below.
3. The PSI regime is contained in Divs 84–87 of the Income Tax
Assessment Act 1997 (Cth) (ITAA 97).
4. See for example, FCT v Whiting (1943) 7 ATD 179 at 184; FCT
v Ramsden 2005 ATC 4136 at 4150; Kiwi Brands Pty Ltd
v FCT 99 ATC 4001 at 4012, and the authorities there cited.
australian tax law bulletin May 2016 77
5. Norman v FCT (1963) 13 ATD 13 at 18–19 (per Menzies J) and
at 20–22 (per Windeyer J).
6. Booth v FCT (1987) 87 ATC 5100 at 5103 (per Mason CJ) and
5109 (per Toohey and Gaudron JJ); Howard v FCT (2014) 309
ALR 1; 2014 ATC 20–457;  HCA 21; BC201404440 at
7. FCT v Everett (1980) 80 ATC 4076 at 4083; Liedig v FCT
(1994) 94 ATC 4269 at 4277.
8. FCT v Everett, above n 7, at 4083.
9. See for example: Tupicoff v FCT (1984) 56 ALR 151; 84 ATC
4851; FCT v Gulland; Watson v FCT; Pincus v FCT (1985) 62
ALR 545; 85 ATC 4765; BC8501057.
10. FCT v Galland (1984) 56 ALR 468; 84 ATC 4890.
11. For partnerships, it would be Pt III Div 5 of the Income Tax
Assessment Act 1936 (Cth) (ITAA 36). For trusts, it would be
Pt III Div 6 of the ITAA 36. For a company, the income would
become that of the company as a taxpayer.
12. See for example, Taxation Rulings IT 25 Incorporation of
medical practices (7 August 1981), IT 2121 Income tax: family
companies and trusts in relation to income from personal
exertion (12 December 1984), IT 2330 Income tax: Income
Splitting (30 June 1986), IT 2503 Income tax: Incorporation of
medical and other professional practices (3 November 1988)
and IT 2639 Income tax: personal services income (20 June 1991).
13. Paragraph 10(a) of Taxation Ruling IT 2639.
14. Paragraph 10(b) of Taxation Ruling IT 2639. A principal
practitioner is a practitioner with a share in the ﬁrm. Non-
principal practitioners are full-time professional and non-
professional staff (eg bookkeeper) that derives fees for the ﬁrm:
paragraph 11 of Taxation Ruling IT 2639.
15. ITAA 36, s 260.
16. ITAA 36, Part IVA: ss 177A–177G.
17. See for example: Peate v FCT (1966) 14 ATD 198;  2
All ER 766; BC6600690; FCT v Gulland; Watson v FCT;
Pincus v FCT, above n 9.
18. See for example: Tupicoff v FCT, above n 9; Daniels v FCT
(1989) 20 ATR 1120; 89 ATC 4830; Bunting v FCT (1989) 90
ALR 427; 89 ATC 5245; Egan v FCT 2001 ATC 2185; (2001)
47 ATR 1180;  AATA 449.
19. Paragraphs 1.12–1.13 in the Explanatory Memorandum to the
New Business Tax System (Alienation of Personal Services
Income) Act 2000 (Cth).
20. If the regime applies, there are also limitations in relation to
deductions that can be claimed against PSI: see Div 85 and
Subdiv 86–B of the ITAA 97.
21. ITAA 97, s 84–5(1). Paragraph 25 of Taxation Ruling TR
2001/7 Income tax: the meaning of personal services income
(31 August 2001) states: “Implicit in the word ‘mainly’ is that
more than half of the relevant amount of the ordinary or
statutory income is a reward for the personal efforts or skills of
22. See Example 7 at para 94 in Taxation Ruling TR 2001/7. The
related ruling, Taxation Ruling IT 2639, also provides guidance
as to whether income from a professional practice is considered
personal services income or income from the business strucutre:
see sub-heading “General anti-avoidance rule (GAAR)” above.
23. The legislation refers to the interposed entity as a “personal
services entity” (PSE): ITAA 97, s 86–15.
24. If none of the tests are satisﬁed, a PSB determination must be
obtained from the Commissioner: Subdiv 87–B.
25. Paragraph 264 in Taxation Ruling TR 2001/8 Income tax: what
is a personal services business (31 August 2001). The ATO’s
position on the application of the GAAR to arrangements for
splitting personal exertion income are set out in Taxation
Rulings IT 2121, IT 2330 and IT 2639.
26. See under “Intent of the guidelines” at above n 1.
27. Although not expressly stated, there is good reason to think that
an IPP who only provides services “internally” should also
satisfy this aspect of the criterion (eg education role to
28. See third paragraph of document: above n 1.
29. It is not out of the question that the ﬁrm could be a ﬁxed trust.
A discretionary trust would introduce too much uncertainty
where arm’s length IPPs are concerned. However, note the use
of the discretionary trust as the service entity to a major
accounting ﬁrm in Segelov v Ernst & Young Services Pty Ltd
(2015) 89 NSWLR 431;  NSWCA 156; BC201504847.
30. If the ﬁrm is a partnership of IPPs, an IPP cannot be an
employee of the ﬁrm.
31. The term “associated entities” will generally reﬂect people and
entities coming within the deﬁnition of “associate” in the
income tax legislation: ITAA 36, s 318.
32. The table does not cover the situation where the ﬁrm (practice
entity or operating entity) is a trust. However, adapted for the
nature of a trust, the list of entities in column 2 in regard to the
partnership and company would also feature for a trust.
33. See under “Legally effective partnership, trust or company”:
above n 1.
34. Taxation Rulings IT 25, IT 2121, IT 2330, IT 2503 and IT
2639, above n 12. These rulings express the ATO’s views as to
the possible application of the GAAR to attempted alienations
of personal services income. One doubts that it would matter
much, but the ATO ruling on s 84–5(1) of the ITAA 97
(personal services income is income mainly from your personal
efforts and skills) is not strictly applicable here (TR 2001/7).
35. This heading roughly reﬂects a heading from the IPP guideline
document as it best captures the role of the guidelines.
36. See under “Our concerns”: above n 1.
37. See above n 36.
38. An arrangement that does not satisfy any of the benchmarks
may not be subject to compliance action. However, in such
cases, the lower the effective tax rate of the arrangement, the
higher the ATO will rate the compliance risk, which will
increase the chance of compliance action: See under “Addi-
tional information on the application of the benchmarks”:
above n 1.
39. All IPPs in the same ﬁrm are not obliged to use the same
australian tax law bulletin May 201678
40. The total remuneration package should be recognised. For
example, fringe beneﬁts, any related fringe beneﬁts tax and
superannuation have to be included. See Question 2 under
“Further information: Applying benchmark 1”: above n 1.
41. See under “ATO risk assessment factors for remuneration of
IPPs”: above n 1. A number of factors are taken into account in
determining whether services provided by an employee are
equivalent to IPP provided services.
42. See under “ATO risk assessment factors for remuneration of
IPPs”: above n 1.
43. For example, the child of an IPP obtains a trust allocation at the
end of a chain of three trusts.
44. Tax for these purposes does not include the Medicare levy,
Medicare levy surcharge and any other levies. See Question 2
under “Further information: Applying benchmark 3”: above n
1. This operates to the detriment of the taxpayer as more
taxable income is required to move the effective tax rate to
45. See under “ATO risk assessment factors for remuneration of
IPPs”: above n 1.
46. This will be the case where the IPP has completely or fully
alienated his/her ﬁrm income (eg ﬁrm partnership comprises of
discretionary trusts of each IPP, and the IPP is not allocated any
trust law income from the [family] discretionary trust for the
year). For the remainder of this article, it is assumed that the
IPP does have an entitlement.
47. Tax on $172,500 is $51,772, giving an effective tax rate of
48. See Questions 1 and 2 under “Further information: Applying
benchmark 3”: above n 1.
49. The benchmarks could also, in a broad way, be viewed as
deemed market value rules, similar to the numerous deemed
market value realisation rules throughout the income tax
50. The key reason is that there is no statement saying the IPP
guidelines (or benchmarks) are a public ruling: s 358–5(3)(b)
in Sch 1 to the Taxation Administration Act 1953 (Cth).
51. Section 357–60(1) in Sch 1 to the Taxation Administration Act.
52. Australian Taxation Office, Levels of protection explained,
17 March 2016, www.ato.gov.au.
53. See Question 1 under “Further general guidance on the
Benchmarks”: above n 1.
54. See Question 3 under “Further general guidance on the
Benchmarks”: above n 1.
55. From 1 July 2015, the tax rate for “small business entities”
(businesses with annual aggregated turnover of less than $2
million) has been reduced to 28.5%. With the current pressure
to lower corporate tax rates for all companies, it will be
interesting to see whether this benchmark is kept in line with
corporate tax rates going forward, or whether it will remain
ﬁxed at 30%.
australian tax law bulletin May 2016 79
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