In an important ruling for incorporated contractors, the Administrative Appeals Tribunal has further clarified the requirements on contractors to pass the “unrelated clients” test of the personal services income section of the Tax Act.

The case involved an oil and gas engineer who was engaged by Manpower and contracted to BHP Billiton to oversee the construction of an offshore pipeline for the Minerva gas field off coastal Victoria.

In June last year, the Administrative Appeals Tribunal in Melbourne upheld the engineer’s right to claim deductions as an incorporated independent contractor, finding that he passed the unrelated clients test, even though Manpower was his sole source of income for two full tax years.

In that ruling, the tribunal found that the contractor had satisfied the test in previous years, and was likely to do so in the future, but delays to the Minerva project had prevented him working for other clients during the two years.

The ATO appealed that decision, and in a hearing this month argued that the unrelated clients test had two requirements, and the engineer had been exempted from passing only the first of those.

The ATO said that as well as working for two or more customers during a tax year, contractors were required to be genuinely offering their services to the public, by “making offers or invitations (for example, by advertising)”.

In finding for the contractor, AAT senior member Bruce Pascoe said the explanatory memorandum to the Tax Act made it clear that one of its purposes was “to ensure that genuine business situations whose services are available to the public at large in the year of income are differentiated from an employee-like situation”.

He said the evidence the engineer gave at the original hearing was that he obtained the BHP contract, via Manpower, as a result of the personal recommendation of a former colleague.

“It was the further evidence of [the engineer] that his expertise is relevant to a very small number of companies engaged in offshore petroleum exploration and mining.

“As a consequence, advertising in a general sense of advertising in newspapers, brochures or other media is clearly inappropriate in this context.”

Word-of-mouth and marketing calls sufficient

Senior member Pascoe said the engineer’s evidence was that he acquired his clients primarily through word-of-mouth, referrals and phone calls he made to the various companies in the oil and gas industry.

He noted that the exact wording of the Act stated that a contractor passed the unrelated clients test if: “the services are provided as a direct result of the individual or personal services entity making offers or invitations (for example, by advertising), to the public at large or to a section of the public, to provide the services.”

“I am satisfied that those companies constitute ‘a section of the public’.”

He said he was also satisfied that the engineer’s regular personal contact with those companies, and promotion of his services through word-of-mouth and recommendations, fulfilled the meaning of “making offers or invitations to provide services”.

“I am further satisfied that the services to BHP Billiton through Manpower were provided as a result of this form of marketing.”

He affirmed the original decision of the tribunal, and ordered the ATO to make a determination excluding the engineer from the personal services income provision during the period.

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Link to Original Article

Yalos Engineering Pty Ltd and Commissioner of Taxation [2010] AATA 408 (3 June 2010)