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Broadly, the concept of ‘alienation of income’ is a process of separating income which would otherwise attach to a particular person or property, such that the income is legally derived by, and assessable to, some other person. (A worker as a contractor.)

In relation to income from personal services or personal exertion, the term alienation of income effectively relates to the interposing of an entity between the individual who actually performs the service which generates the income and the person who is paying for that service, such that the income is received by the interposed entity.

The obvious question is ‘What is income from personal services?’ The term ‘income from personal services’ is defined in section 6(1) of the ITAA, and is said to include such things as wages, salaries commissions etc. However, income from personal services is a broader concept. In ruling IT 2639, income from the provision of personal services is said to be;

” income that an individual taxpayer earns predominantly as a direct reward for his or her personal efforts by, for example, the provision of services, exercise of skills or the application of labour”

This form of income must be distinguished from income generated from property or assets. This distinction is crucial to whether or not a particular arrangement will be effective for taxation purposes or not.

The interposing of an entity is the only potential means of alienating income from personal services. Unlike property where the right to future income from that property can, under certain circumstances, be assigned to another person and that other person be liable for the tax in respect of that future income, there is a generally accepted principle that personal exertion income ( eg salary and wages) cannot be assigned to another person. The income will always be considered to have been derived by the individual performing the services and taxable to that person.

Example: John Brown is employed by ACME Publishing as an Editor. He is an employee paid a salary of $80,000. If John were to enter into an arrangement whereby he assigned 50% of his future salary to his wife, the assignment would not be effective. Although ACME could pay the $40,00 to his wife, John would continue to be assessable for the tax on that money.

Whilst it may be clear taxation principle that income from personal exertion cannot be effectively assigned for income tax purposes, income can be effectively alienated (ie. The same effective result as an assignment can be achieved.) by interposing an entity to take receipt of the income. This is achieved by having a direct contractual relationship between the interposed entity and the person requiring the services such that an entity is directly related to the source of the income. The interposed entity contracts to provide the services and receives the income generated by those services.

Example: Mary Jones is offered a position by ACME Consulting as a Computer Programmer. Mary has operated as a contractor for the last 5 years through her company Jones Technology Pty Ltd. Jones Technology Pty Ltd enters into a contract to provide consulting services to ACME and employs Mary to provide those services on its behalf. Jones Technology Pty Ltd invoices ACME on a monthly basis and is paid on the basis of those invoices. Legally, the income is received and derived by Jones Technology Pty Ltd and, in the first instance it is liable for the tax on that income.

It is often assumed that there is a general principle that income from personal services cannot legally be diverted to an interposed entity. However, this is incorrect. It is quite clear from the Tupicoff case that there is nothing preventing a person from establishing an interposed entity. However, whether the arrangement is successful in preventing the individual from being personally assessed on the income received by that entity is another matter.

The main concern of the ATO in this regard is where such an arrangement results in income splitting. That is, once the income is received by the entity, the entity is used to divide that income among various persons (usually family members of the individual performing the services) so that multiple tax free thresholds are utilised and lower marginal tax rates apply. The ATO would also have a concern if a small salary was paid to the individual who performed the services and the balance of the income was retained in the interposed company. As the current company tax rate (36%) is much lower than the top marginal rate (48.5% including Medicare), the retention of income in the company creates another tax benefit. The retention of income within the entity can still constitute income splitting.

Example: In the above example, assume that Jones Technology Pty Ltd worked solely for ACME, it received fees of $120,000 in the year for providing the services of Mary to ACME, and it paid a salary of $40,000 to her husband and after expenses had a profit of $10,000 which it retained. This is the type of arrangement that the ATO would potentially seek to apply the general anti avoidance provision. Although the income is legally that of Jones Technology Pty Ltd the ATO would argue that the main purpose of the arrangement was to gain a tax advantage.

What will be acceptable to the ATO and the Courts is a very fine line. The arrangement will not be successful where the income of the entity has been generated by the provision of employee like duties of one individual and the income has been split between various persons.

As a general rule, the alienation of income from personal services to an interposed entity for the purposes of income splitting will not be effective for taxation purposes. In such cases, the anti avoidance provisions will be used to negate the tax benefits and assess the income to the person performing the services which generated the income.

However, it must be noted that it is quite legitimate to conduct a genuine business through any form of entity for the ultimate benefit of the owners. Where the income received by an entity is income received by it in the course of business the general anti avoidance provisions would not be used (in relation to the alienation of income) to assess the income to the individuals behind the entity.

To determine whether or not the income of a particular entity is personal services income or bona fide business income it is necessary to consider a number of factors.

This article is not a substitute for independent professional advice. We do not warrant the accuracy, completeness or adequacy of the information or material in this article. All information is subject to change without notice. We and each party providing material displayed in this article disclaim liability to all persons or organisations in relation to any action(s) taken on the basis of currency or accuracy of the information or material, or any loss or damage suffered in connection with that information or material. You should make your own enquiries before entering into any transaction on the basis of the information or material in this article. Please ensure you contact us to discuss your particular circumstances and how the information provided applies to your situation.


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