• Internal Code :
  • Subject Code : ACC3TAX
  • University : La Trobe University
  • Subject Name : Taxation

Assessment 

Table of Contents

Taxation 

Issue 1- Whether the PSI rules are applicable 

Determination of PSI or PSB by applying the PSI tests 

Issue 2 : Whether income should be reported using cash basis or accrual basis of accounting 

Determination of the suitable method 

Issue 3 – Deductibility of Business expenses 

Determination of the above issue 

Issue 4: Taxability of compensation received from insurance company 

Determination on above issue 

Issue 5: The income earned by Enzo through photography should be regarded as income from business or hobby. 

Determination of above issue 

Calculation of Taxable Income and Tax Liability 

References 

Issue 1- Whether the PSI rules are applicable

In the given case study, Enzo is a tax accountant who is the sole proprietor of the firm “Enzo Tax” and has different unrelated clients. Enzo usually operates through his home office located in Bundoora, except for the times when he works for his client Fallali Pty Ltd at their business premises. Fallali Pty Ltd is his main client and the income earned from this client is around 70 percent of the total revenue earned by the firm.  It is to be noted here that when providing services to this client Fallali Pty Ltd, Enzo exclusively works from the premise of Fallali Pty Ltd. Enzo has employed a part time administrative assistant and is also supported by an intern who is a student of taxation and is doing his internship with Enzo as  a part of his work placement subject. When he works for this (more than 80 percent)client at their premises, he is not accompanied by any of his employees and staff. It is Enzo who carries out the major part of the work related to providing accounting and taxation services to his clients.

The administration assistant only carries on the secretarial duties like attending calls and managing appointments and the taxation intern only carries out the basic data entry work and is not involved in finalization of tax returns or any important taxation or accounting work or advice to be provided to client. The work performed by the taxation intern is just limited to bookkeeping. As far as other clients of Enzo are concerned, the fees generated from them accounts for 30 percent of the total revenue generated by the firm. Enzo does not directly provides services to these other clients but has entered into an agreement with a sub-contractor Hawks Taxation who provides services to these small clients of Enzo tax on its behalf. The above revenues generated by Enzo tax could be in the nature of personal services income that is related to the services provided by Enzo. Therefore, it is important to test the applicability of the PSI Rules to the circumstances described above to find out if the income earned by Enzo Tax is actually Personal Services Income or is income earned through running a Personal Services Business. 

Determination of PSI or PSB by applying the PSI tests

The first step is to check that whether any personal services income has been received. It is considered that PSI has been received when over 50 percent of the income received from a particular client contract is for the skills, knowledge, expertise or actions of an individual.  According to the Step 1 of the PSI rules, if greater than 50 percent of income is related to skills, labour and expertise of a particular individual, then that income is considered as PSI of that individual (ATO 2019b). In the given case- the income received by Enzo Tax can be divided into two categories – (i) income received Fallali from Pty Ltd (directly serviced by Enzo) (ii) income received from other small clients who are serviced by the sub contractor Hawks Tax.The first category of income received by the firm is in the nature of personal services income because the entire income that was received by the firm from Fallali Pty Ltd was directly attributable to skills and expertise of Enzo. Hence, Step 1 of the PSI Tests is met. 

The next Step 2 is the “results test” (also known as PSB tests) which comprises of three tests. If all these three tests are met then, the income shall be considered as a PSI but it shall be considered as income from operating a PSB (ATO  2017b).  First test is specific result test, however nothing provided in the facts of the case indicate that Enzo Tax was paid to produce to produce a particular result, so this test is not met. Second test is the own tools or equipment test. The nature of services provided by Enzo tax do not require and major plant or machinery or tools of trade, so this test is met. The third test is – required to correct mistakes at own cost, nothing in the case study indicates this, so this test is also not met. Since all these tests forming part of PSB tests are not met, the income under question cannot be regarded as income from PSB.

The next step is the 80% rule test which says that at least 80 percent of the income that is considered as personal services income must be earned from one client (ATO, 2017a). 2017. In the given case of Enzo Tax, 100 percent of the income that is being considered as PSI is coming from the contract with client Fallali Pty Ltd, hence this 80% rule is satisfied and the PSI rules shall be applicable to the income received from Fallali Pty Ltd. 

Although the 80 % rule is satisfied and it has become evident that PSI rules are applicable, we would still test if the remaining tests are met or not, so as to be 100 percent sure about the conclusion reached after applying all the tests (ATO 2019a). Three tests are included in the “remaining tests”- unrelated clients test, employment test and business premises test.  The unrelated clients test requires that income under question should have been produced from two or more unrelated clients, who cannot be satisfied in this case as the whole of income in question is coming from one client Fallali Pty Ltd.  The employment test requires that at least 20 percent of the principal work is done by other employees or contractors or there is must an apprentice employed by business for a minimum of 6 months.

The main work does not include supportive work such as bookkeeping. In the given case, as more than 80 percent of the workload was being handled by Enzo (intern was only doing the basic data entry) and the intern was doing work placement subject this shows that he was employed for less than 6 months, and this test is also not met. The business premises test requires that the business premises should have been mainly used for doing the work related to generation of PSI, should be separate from any premises that is used by the business owner for their residence or private purposes and should be separate from premises of the client. Since Enzo was operating from his home-office, this test is also not met. Thus, none of these remaining tests are satisfied and it becomes certain that the PSI rules are applicable. 

Issue 2 : Whether income should be reported using cash basis or accrual basis of accounting

In the given case, Enzo has raised invoices for $64800 out of which only $576000 has been received during the year ending 30 June 2020. The question here is that whether the income for the year ending 

30 June 2020 should be reported as per accrual basis or cash basis of accounting. 

Determination of the suitable method

It can adopt either of the two methods of accounting; however the cash basis of accounting is generally considered appropriate for small business and sole proprietorship service businesses. As Enzo tax is a small business and the turnover of the business is less than $ 10 million, it can report its income on cash basis and can prepare and lodge its business activity statements on cash basis itself ATO  2019d). Moreover as per the Taxation Ruling 98/1, cash basis of accounting is appropriate for personal services income while trading and manufacturing concerns must adopt accrual basis of accounting and reporting (ATO 2017c). Thus, the business should adopt the cash basis of accounting and should report its income in the tax return on the same basis. 

Issue 3 – Deductibility of Business expenses

Whether the business will be able to claim all the expenses incurred by it during the current year.?

Determination of the above issue

As the PSI rules are applicable to this business, it will affect the deductions that the business can claim. According to the PSI rules no deduction can be claimed against the PSI income for the following expenses, however these can be deducted against any other income.

  1. Rent, rates, land tax, mortgage interest for home

  2. Payment for secretarial duties

  3. Expenses that are not usually available as a deduction to an employee

Accordingly, Enzo will not be able to claim deduction for following expenses which were incurred for his business. 

a table representing all the expenses for which Enzo will not be able to claim deduction

Also, Enzo will not be able to claim a deduction for the depreciation on his office equipment against the personal services income.

Issue 4: Taxability of compensation received from insurance company

Enzo has received an amount of $ 5000 from its insurer as compensation for personal injury. It needs to be determined whether this amount should be included in his assessable income for the year 2020 or not.

Determination on above issue

According to section 118-300 of Income Tax Assessment Act 1997, proceeds from the insurer in relation to life insurance, sickness or injury policy are exempt from CGT. Such payments are regarded as capital receipt and are not taxable. Thus, the above amount received by Enzo on 2 March 2020 shall not be included in his assessable income and shall be exempt from tax.

Issue 5: The income earned by Enzo through photography should be regarded as income from business or hobby.

In the given case, Enzo moved to his beach house on April 2020 and decided to do photography in his free time. He bought a professional camera and uploaded the photos taken by him on his Instagram profile.  His profile became very popular and there was a huge increase in the number of his followers. Following the popularity of the photos taken by him, a manufactures of photography offered him to enter into an agreement where they would provide him with free equipment which he can use to test and review his Instagram profile. He had received equipment worth $2500 by the end of year 2020. It needs to be considered that whether this equipment worth $2500 received by him would be regarded as income from his business or hobby. 

Determination of above issue

There is no single factor that could determine whether a given activity is a business or hobby. The factors that need to be considered are:

  1. Whether activity has been set up in a business-like manner

  2. Whether there is an intention to make profit

  3. The scale of activity and the frequency

  4. Whether the activity is organized and carried out in a business like way (ATO 2019c)

In the given case, Enzo decided to do photography in his free time only. Thus, this indicates that he did not have an intention to make a profit from this activity. The fact that he purchased a professional camera is not sufficient to justify that he intended to carry out photography as his profession. Also, he only entered into a informal agreement with the manufacturer of photography agreement. All these facts indicate that this activity did not have a commercial character and was only carried out as a hobby. Accordingly, income from this hobby will not be taxable. 

Calculation of Taxable Income and Tax Liability

a table representing Calculation of Taxable Income and Tax Liability a table representing Calculation of Taxable Income and Tax Liability

References

Australian Taxation Office. 2017a. Step 3: The 80% rule. [Online]. Available at https://www.ato.gov.au/business/personal-services-income/working-out-if-the-psi-rules-apply/step-3--the-80--rule/

Australian Taxation Office. 2017b. Step 2: Results test. [Online]. Available at https://www.ato.gov.au/business/personal-services-income/working-out-if-the-psi-rules-apply/step-2--results-test/

Australian Taxation Office. 2017c. Taxation Ruling TR 98/1. [Online]. Available at https://www.ato.gov.au/law/view/document?DocID=TXR/TR981/NAT/ATO/00001&PiT=99991231235958

Australian Taxation Office. 2019a Employment test for PSI. [Online]. Available at https://www.ato.gov.au/business/personal-services-income/working-out-if-the-psi-rules-apply/step-4--the-remaining-tests/employment-test/

Australian Taxation Office. 2019b. Step 1: Have you received personal services income? [Online]. Available at https://www.ato.gov.au/business/personal-services-income/working-out-if-the-psi-rules-apply/step-1--have-you-received-psi-/

Australian Taxation Office. 2019c. Are you in business?. [Online]. Available at https://www.ato.gov.au/business/starting-your-own-business/before-you-get-started/are-you-in-business-/

Australian Taxation Office. 2019d. Choosing an accounting method for GST. [Online]. Available at https://www.ato.gov.au/Business/GST/Accounting-for-GST-in-your-business/Choosing-an-accounting-method/

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