Fortune deserts PSI taxpayer
Contributed by Dr Justin Dabner, Principal of Tax Re-solutions, Tax advisory and education services
In “The PSI rules back in Federal Court” (Issue 34 (2019) CCH Australian Tax Week ¶601), the author suggested that the taxpayer in the Federal Court’s decision in Fortunatow v FC of T 2019 ATC ¶20-706;  FCA 1247 was rather fortunate. It now seems that his luck has caught up with him as the Commissioner has won his appeal: FC of T v Fortunatow & Anor 2020 ATC ¶20-758;  FCAFC 139.
The case concerned whether the taxpayer could rely on the (two) “unrelated clients test” in s 87-20(1) of ITAA 1997 to escape the operation of the personal services income (PSI) rules in Pt 2-42 and avoid the attribution of income. That section contains two paragraphs mandating that:
- (a) during the year the entity/taxpayer must produce income from providing services to two or more entities, and
- (b) the services are provided as a direct result of making offers or invitations of service to the public or section of the public.
Section 87-20(2) further provides that the entity/taxpayer is not treated, for the purposes of s 87-20(1)(b), as having made offers or invitations to provide services merely by being available to provide the services through a business of arranging for persons to provide services directly for clients of the entity, ie a recruitment type agency.
The taxpayer provided business analyst services through a company of which he was the sole director. In the two years in question, services had been provided to eight different clients. The problem for the taxpayer was that the company had been engaged through the intervention of recruitment type agencies. This directly raised the exclusion in s 87-20(2) to the effect that the entity was not to be treated as having made offers or invitations to provide services merely by being available to provide the services through such intermediaries. However, the taxpayer was able to point to a LinkedIn profile which Griffiths J in the Federal Court accepted amounted to an advertisement offering his services to the public and he was not “merely” using intermediaries. Furthermore, the services were provided as a “direct result” of the LinkedIn profile given that some of the recruitment agencies had approached the taxpayer upon viewing his profile and then made recommendations to end clients. Justice Griffiths had, therefore, allowed the taxpayer’s appeal from the AAT.
In the earlier article the author suggested that, although the AAT had opined that the result thus arrived at by the Federal Court would be perverse and contrary to the object of the PSI rules (at  of 2018 ATC ¶10-486;  AATA 4621), the AAT’s pre-occupation with the need to find a causal link between any advertising and the engagement by the end clients was not supported by the wording of s 87-20. While the author endorsed the outcome on the PSI measures the taxpayer seemed very fortunate that the ATO had not raised Pt IVA in the circumstances. The facts suggested substantial income splitting (via a family trust) with the taxpayer paid no salary and employing no staff or assets. In the result, no tax was paid on the income at all with even the taxpayer describing the result under cross-examination as “inappropriate”.
The appeal decision
On further appeal, the Full Court zoned in on the phrase “as a direct result” in s 87-20(1)(b) emphasising that there must be a causal connection between the offer or invitation to the public and the subsequent provision of services. As meaning must be given to the word “direct” so the causal connection must be direct. This required an inquiry about what caused the client’s decision to obtain the services. If an offer or invitation is only made to an intermediary and it plays no part in the client’s decision to engage the relevant individual (or the personal services entity), the offer or invitation does not directly result in the provision of the relevant services. In the view of the court, this is because the offer or invitation loses its direct causal effect at the level of the intermediary and the provision of the services can only be seen as the direct result of some other factor, such as the intermediary’s recommendation to the client (at ).
The court said that the language of s 87-20(2) provides contextual support for this interpretation of s 87-20(1)(b). By providing that an individual/entity’s mere availability through an intermediary to provide services is not to be regarded as the making of offers or invitations, s 87-20(2) indicates that it is offers or invitations which operate directly on the client which are relevant, not those which operate on an intermediary (at ).
The result of this case is that where advertising attracts one or more intermediaries it will, nevertheless, be necessary to “look through” to determine whether the end clients were attracted to the service provider by the advertising. This would appear to support the ATO’s views in Taxation Ruling TR 2001/8 at , . It also answers the question as to whether if the advertising to the public only attracted one client to the taxpayer, but who happened to be an intermediary and who was able to find the taxpayer two or more end client engagements, would this satisfy s 87-20? It would appear that in the absence of evidence that the advertising also influenced the end clients, the significance of the intermediary’s recommendations would cause the test to be failed notwithstanding that the advertising did (ultimately) lead to one or more unrelated clients.
Factual scenarios can be envisaged where a client’s decision to engage a service provider was influenced both by the recommendation of an intermediary and also advertising, such as a profile on LinkedIn. In such a case the following passage from the judgment at  may be apposite:
“A direct causal effect might be shown where it is established that an invitation or offer was comprehended by the client, in the sense of received and digested, and that it had at least some influence on the client’s decision to obtain the services. The degree of influence required depends on all of the circumstances.” (emphasis added)
Thus, a difficult factual determination will be required as to the extent to which the profile on LinkedIn was “received and digested” and had “some influence”. The construction by Griffith J would have avoided such difficulties. This author has some sympathy for his Honour’s view that the phrase “as a direct result” is silent as to the type of causal connection and there is no mandate to arbitrarily draw a boundary based on the number of steps or connections between the offer to the public and the provision of services. A “direct result” does not imply that there can be no step between the cause and the effect.
It should be noted that the case deals with intermediaries in the form of a “business of arranging for persons to provide services directly for clients of the entity” (as per s 87-20(2)). This would conceivably not encompass an accountant, business advisor or other professional (eg medical practitioner or solicitor) who recommended the services of another service provider. Certainly, the reliance on s 87-20(2) to support the construction of s 87-20(1) adopted would suggest that the more restricted concept of an intermediary was in the court’s contemplation. In any event, for the unrelated clients test to be enlivened it would still seem that any such recommendation would, itself, need to have been influenced by an offer or invitation to the public.