Commissioner of Taxation v Fortunatow

BACKGROUND 4 The primary judge summarised the underlying facts at J[6] and [7] in the following way: The taxpayer is a business analyst and was at all relevant times the sole director of Fortunatow Pty Ltd (Company). Through contracts between the Company and various recruitment or similar agencies, the taxpayer was engaged to provide services to organisations such as government departments, utilities, defence contractors, universities, banks and large corporations. In the taxation years 2012 and 2013, income of approximately $166,000 and $121,000 respectively was returned in the Company's income tax returns. The income related to the provision of the taxpayer's personal services to eight different end clients during those two taxation years. No remuneration was paid by the Company to the taxpayer and he returned no income in his personal income tax returns for the relevant years. The Company transferred income generated by the taxpayer's personal services to the Fortunatow Family Trust (Family Trust) which was characterised as "management fees" payable to the Family Trust. These fees were claimed as deductions and had the effect of reducing the Company's taxable income to nil. The Trust income was offset against the Trust's rental losses. As the Commissioner pointed out, the end result of this structure was that none of the taxpayer, the Company or the Family Trust paid tax on the income generated by the supply of the taxpayer's personal services as a business analyst in the two relevant taxation years. 5 The Commissioner included the income of the Company in Mr Fortunatow's assessable income on the basis that the Company's income was personal services income (PSI) - cf: s 86-15(1) of the ITAA 1997. There was no dispute that the income was PSI: T[2]. In review proceedings brought in the Tribunal under Part IVC of the Taxation Administration Act 1953 (Cth), Mr Fortunatow contended that s 86-15(1) did not apply because the Company was conducting a personal services business within the meaning of s 86-15(3): T[2]. He relied on the "results test" in s 87-18 and on the "unrelated clients test" in s 87-20. The Tribunal rejected the application of the results test and there was no appeal from that finding. The appeal before the primary judge concerned only the unrelated clients test. The appeal to this Court from the primary judge's decision only concerns that test. 6 The "unrelated clients test" is contained in s 87-20, which provides: 87‑20 The unrelated clients test for a personal services business (1) An individual or a *personal services entity meets the unrelated clients test in an income year if: (a) during the year, the individual or personal services entity gains or produces income from providing services to 2 or more entities that are not *associates of each other, and are not associates of the individual or of the personal services entity; and (b) 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. Note: Sections 87‑35 and 87‑40 affect the operation of paragraph (1)(a) in relation to Australian government agencies and certain agents. (2) The individual or *personal services entity is not treated, for the purposes of paragraph (1)(b), as having made offers or invitations to provide services merely by being available to provide the services through an entity that conducts a *business of arranging for persons to provide services directly for clients of the entity. 7 The Tribunal did not accept that the "unrelated clients test" applied. The Tribunal found that: (1) Mr Fortunatow maintained a LinkedIn profile which identified his past experience and skills and contained information as to his availability: T[9], [59] and [66]; (2) the LinkedIn page constituted the making of an offer or invitation to the public within the meaning of s 87-20(1)(b): T[59]; (3) the eight contracts from which the PSI was generated were entered into through an entity (intermediary) that conducted a business of arranging for persons to provide services directly for clients of the entity within the meaning of s 87-20(2): T[61], [70] and [75]; (4) some of the intermediaries contacted Mr Fortunatow as a result of his advertising on LinkedIn and that this resulted in the services being provided in five out of eight of the contracts: T[82]; (5) the services in relation to the remaining three of eight contracts were provided as a result of Mr Fortunatow's relationship with the relevant intermediary recruitment company and that there was no evidence which established that the services were provided as a direct result of any offers or invitations from Mr Fortunatow: T[82]; (6) none of the clients for the eight contracts engaged Mr Fortunatow or the Company as a result of the LinkedIn page or relied upon any form of advertising by Mr Fortunatow in relation to any of the services he provided and that there was no "direct link" between the advertising and the client: T[74], [78]. 8 The Tribunal construed s 87-20(2) as requiring that Mr Fortunatow not be treated as having made offers or invitations for the purposes of s 87-20(1)(b) of the ITAA 1997 in circumstances where the LinkedIn page had only had material causative effect on intermediaries and no material effect on any client: T[70]-[74]. The primary judge concluded that the Tribunal erred in its construction of s 87-20(2) and its interaction with s 87-20(1)(b): J[30]. His Honour explained at J[31] and [32]: The proper construction of s 87-20(2) is that an individual or personal service entity is not treated for the purposes of s 87-20(1)(b) as having made offers or invitations to provide services simply and only because the person or entity is available to provide the services through some association or connection with an intermediary, such as a recruitment agency. To put it another way, simply because an individual or personal services entity is able to provide services through an intermediary, such as a recruitment or similar agency, does not constitute the making of an offer or invitation for the purposes of s 87-20(1)(b). More than that is required for the purposes of the unrelated clients test. But that does not mean that the exclusion in s 87-20(2) necessarily applies, as found by the AAT, where an individual or personal services entity is in fact available to provide personal services through such an intermediary and there is evidence (as was the case here) that, in addition to that fact, the individual or personal services entity has taken other steps to make offers or invitations to the public at large or a section thereof to provide the services. I accept the applicant's submission that s 87-20(2) only concerns itself with the issue arising under s 87-20(1)(b) as to whether "offers or invitations to provide services" have been made. It is not concerned with the separate issue of the provision of services or any causal connection or link between the offers or invitations and the provision of services … 9 The Commissioner does not challenge this aspect of the primary judge's reasons. 10 The Commissioner argued before the primary judge that, even if the Tribunal had erred in the way contended by Mr Fortunatow, its error was immaterial because, on the Tribunal's findings, Mr Fortunatow had not established that the services had been provided as a "direct result" of offers or invitations being made to the public to provide the services as required by s 87-20(1)(b). The Tribunal had said that, in the event it was wrong as to the effect of the operation of s 87-20(2) on s 87-20(1)(b), a "direct link" might be established by showing that the services provided to the client were the result of the intermediary being influenced by the advertising, stating at T[84]: The applicant's alternative contention has merit because s 87-20(1)(b) does not say that the offer or invitation (for example, by advertising) from the applicant must be made to, or relied upon by, the client. The causal relationship is established even when the services provided to the client are a result of the intermediary being influenced by the advertising. Of course, the involvement of the intermediary in the circumstances of this case brings into play s 87-20(2) and therefore the applicant still fails to satisfy the unrelated clients test. 11 The primary judge agreed with the Tribunal that the causal connection in s 87-20(1)(b) was satisfied where the services provided to the client were the result of the intermediary being influenced by the advertising. His Honour explained at J[36] and [37]: As the AAT pointed out at T[84], s 87-20(1)(b) does not say that an offer or invitation from the taxpayer must be made to, or relied upon by, the end client. It stated that the causal relationship is established even where the services provided to the end client are a result of the intermediary being influenced by the advertising. I agree. The phrase "as a direct result" creates a requirement for a causal connection between the services provided and the offer or invitation to the public (or a section of the public). While the phrase does not denote the type of causal connection, I do not consider the answer to lie in arbitrarily drawing a boundary based on the number of steps or connections between the offer to the public and the provision of services. As observed by Taxation Ruling 2001/8 at [49] "a 'direct result' does not imply that there can be no step between the cause and the effect". Accordingly, I do not accept the Commissioner's submission that the AAT's misconstruction of s 87-20(2) is immaterial because of the AAT's finding on the issue of "direct result" as summarised at [16] [sic - [17]] above. I am not persuaded that the AAT would have reached the same ultimate conclusion if it had adopted and applied the proper construction of that provision. That is primarily because of the uncertain effect the misconstruction had on the AAT's fact finding in response to the taxpayer's alternative contentions (see [16] and [17] [sic - [17] and [18]] above).

THE FIRST ISSUE 12 The primary judge correctly observed that the phrase "as a direct result" in s 87-20(1)(b) creates a requirement for a causal connection between the services provided and the offer or invitation to the public or a section of the public. His Honour was incorrect to state that the phrase does not denote the type of causal connection. The causal connection must be "direct". The word direct must be given some effect. 13 The history behind the introduction of the personal services income regime in Pt 2-42, Divs 84 to 87 of the ITAA 1997, was helpfully referred to by Allsop J in IRG Technical Services Pty Ltd v Federal Commissioner of Taxation (2007) 165 FCR 57 at [29]-[33]. One concern was to reduce the ability to achieve different tax outcomes through the delivery of personal services through intermediary entities, such as companies, partnerships and trusts. Section 86-10, which sets out the object of Div 86, entitled "Alienation of personal services income", states: 86-10 Object of this Division The object of this Division is to ensure that individuals cannot reduce or defer their income tax (and other liabilities) by alienating their *personal services income through companies, partnerships or trusts that are not conducting *personal services businesses. Note: The general anti-avoidance provisions of Part IVA of the Income Tax Assessment Act 1936 may still apply to cases of alienation of personal services income that fall outside this Division. 14 The "unrelated clients test" is one of the four "personal services business tests": s 87-15(2). When satisfied, those tests remove what would otherwise be PSI from the assessable income of the relevant individual: s 86-15(3). The "personal services business tests" are used to distinguish "genuine businesses" from "situations that are merely arrangements for dealing with the personal services income of individuals". Section 87-10, which sets out the object of Div 87, entitled "Personal services businesses", states: 87-10 Object of this Division The object of this Division is to define *personal services businesses in a way that ensures that it covers genuine businesses but not situations that are merely arrangements for dealing with the *personal services income of individuals. 15 Against that background, it is clear that it was no accident that the word "direct" in paragraph (b) of s 87-20(1) was used to denote the required type of causal connection between the offer or invitation and the provision of the particular services which gave rise to the relevant PSI referred to in paragraph (a) of s 87-20(1). 16 Section 87-20(1)(b) directs attention to three matters: (1) First, there must be an "individual or personal services entity making offers or invitations (for example, by advertising)". Attention to this objective matter is consonant with the legislative object of distinguishing between "genuine businesses" and mere arrangements for dealing with personal services income. (2) Secondly, services must be provided. The services which must be provided are those mentioned in s 87-20(1)(a). (3) Thirdly, the section requires there be a causal connection between an action and the result of the action. The provision of the services (the result of the action) must be the "direct result" of the making of offers or invitations (the action from which the provision of services must be the "direct result"). The adjective "direct" limits the field of potentially relevant causal relationships between the provision of services and the offer or invitation: Insurance Commission of Western Australia v Container Handlers Pty Ltd (2004) 218 CLR 89 at [21] (McHugh J), at [78] and [90] (Gummow J), at [105] (Kirby J), at [133] (Callinan J), at [153] (Heydon J); Best v R (2015) 46 VR 196 at [74], [78], [79] (Ashley, Redlich and Priest JJA). If the offer or invitation only indirectly resulted in the provision of services, the required type of causal connection would be absent. 17 It is necessarily implicit in s 87-20(1)(b) that the client has made a decision to obtain the services. Without such a decision, the services could never have been provided. Accordingly, the inquiry as to whether the services were provided as a direct result of the making of offers or invitations will invariably involve an inquiry about what caused the client's decision to obtain the services. If the client's decision to obtain the services was a direct result of the making of offers or invitations, then the requirements of s 87-20(1)(b) would be met. 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. 18 If the requirements of s 87-20(1)(b) are satisfied with respect to two or more clients who were not associates of each other or associates of the individual or the personal services entity, then s 87-20(1)(a) would be satisfied and the "unrelated clients test" would be met. 19 As the Commissioner submitted, an offer or invitation which is only made to an intermediary, and is not passed on to, and plays no part in, the client's decision to procure the relevant services, cannot be said to have directly resulted in the provision of the relevant services. 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. 20 As the Commissioner submitted, s 87-20(2) provides contextual support for this construction of s 87-20(1)(b). By providing that an individual or personal services entity's mere availability through an intermediary to provide services is not to be regarded 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. The Commissioner submitted it would be incongruous if, although availability through an intermediary to provide services is not to be regarded the making of offers or invitations, public offers or invitations which have operative effect only on intermediaries and not on the client are to be regarded as having the "direct result" required by s 87-20(1)(b). That submission should be accepted. 21 On the facts as found by the Tribunal, none of the clients made their decisions to engage the services of Mr Fortunatow as a direct result of any offer or invitation constituted by Mr Fortunatow's LinkedIn profile. The Tribunal stated at T[78]: The evidence before the Tribunal does not establish that clients relied upon any form of advertising by the applicant in relation to any of the services provided under the Eight Contracts. There is no direct link between the advertising and the client. 22 In these circumstances, the primary judge ought to have concluded that the Tribunal's error was immaterial as, on a correct application of s 87-20(1)(b), it would necessarily have concluded that the "unrelated clients test" was not satisfied. If the matter were remitted to the Tribunal, it would necessarily so conclude on the facts as it has found them.

THE SECOND ISSUE 23 As mentioned, the first respondent devoted the entirety of its written and oral submissions to an assertion that the appeal was incompetent. The first respondent contended that the question of the proper construction of s 87-20(1)(b) was not before the primary judge and therefore that the issue could not properly be before this Court on appeal. 24 That contention should be rejected. It was necessary for the primary judge to determine the correct construction of s 87-20(1)(b) for at least two reasons. 25 First, it was necessary to determine the correct construction of s 87-20(1)(b) in order to determine the correct construction of s 87-20(2), being the question directly raised by Mr Fortunatow. As the primary judge observed at J[3] (see also J[30]): The taxpayer did not press questions of law 1 and 3 of the notice of appeal. Only the second question of law and related grounds of appeal were pressed. They relate to the proper construction and application of s 87-20(2) and its interaction with s 87-20(1)(b) of the 1997 Act in the context of the unrelated clients test for a personal services business. 26 Secondly, the Commissioner submitted that the Tribunal's error in the construction of s 87-20(2) of the ITAA 1997 was not material to the Tribunal's decision to dismiss the application for review in a way which engaged the issue of the correct construction of s 87-20(1)(b). 27 The Commissioner had submitted that, on the facts as found by the Tribunal and on the proper construction of s 87-20(1)(b), the services were not provided "as a direct result of the … making of offers or invitations … to the public at large to provide the services". That issue was addressed by both parties before the primary judge and his Honour dealt with the issue. For the reasons identified earlier, his Honour dealt with the issue in a way which involved legal error. 28 In oral submissions, the first respondent referred to Comptroller-General of Customs v Pharm-A-Care Laboratories Pty Ltd [2020] HCA 2 at [40], where the High Court stated that it does not necessarily follow from the identification of legal error on the part of the Tribunal in an "appeal" to the Federal Court that the Tribunal's decision should be set aside. Their Honour's explained: That is because, for an error of law on the part of the Tribunal identified in an appeal on a question of law to the Federal Court to result in an order setting aside the decision of the Tribunal, the error must be shown to be material to the decision of the Tribunal in the sense that the decision which was in fact made by the Tribunal might have been different if the error of law had not occurred. 29 For that proposition, their Honours cited Hyundai Automotive Distributors Australia Pty Ltd v Australian Customs Service (1998) 81 FCR 590 at 599 and 3-D Scaffolding Pty Ltd v Federal Commissioner of Taxation (2009) 75 ATR 604 at 614 [35]. 30 The first respondent also referred to Commonwealth Banking Corporation v Percival (1998) 20 FCR 176 at 182 (Davies, Sheppard and Ryan JJ). It had been submitted that a decision of the Tribunal could only be set aside if there was no evidence which would have supported the decision to which the Tribunal came. The Court rejected that argument stating (at 182): The Administrative Appeals Tribunal is, however, required by s 43 of the Administrative Appeals Tribunal Act 1975 (Cth), when giving its decision, to state the reasons for it, to set out its findings of fact and to make reference to the evidence upon which those facts were found. That is an obligation which the Tribunal undertook in the present case and its reasons are lengthy, careful and detailed. Such reasons ought not to be examined with an unduly critical or technical eye but should be read fairly with each sentence being weighed up and considered in the context of the whole. If, on the reading of such reasons, an error of law appears, either by express statement or by necessary implication and if that error of law affected the decision reached, then the decision must be set aside. If a material error of law is so identified, it is of no consequence that the decision reached could have been supported on a different basis, that there was evidence, which, if accepted, would have justified the ultimate decision. This Court is bound by the facts as found by the Tribunal. Under s 44 of the Administrative Appeals Tribunal Act, an appeal to this Court is on a point of law only. Such a point must be considered on the facts determined by the Tribunal. The function of the Court was enunciated by Brennan J in Waterford v Commonwealth (1987) 163 CLR 54 at 77-78 as follows: "A finding by the AAT on a matter of fact cannot be reviewed on appeal unless the finding is vitiated by an error of law. Section 44 of the AAT Act confers on a party to a proceeding before the AAT a right of appeal to the Federal Court of Australia 'from any decision of the Tribunal in that proceeding' but only 'on a question of law'. The error of law which an appellant must rely on to succeed must arise on the facts as the AAT has found them to be or it must vitiate the findings made or it must have led the AAT to omit to make a finding it was legally required to make. There is no error of law simply in making a wrong finding of fact. Therefore an appellant cannot supplement the record by adducing fresh evidence merely in order to demonstrate an error of fact." It is, therefore, not for this Court to review the evidence which was before the Tribunal and to support the Tribunal's decision upon evidence which was not accepted by the Tribunal. Nor is it for this Court to set aside the Tribunal's careful reasons as being of nought. 31 The first respondent also referred to Haritos v Federal Commissioner of Taxation (2015) 233 FCR 315 (Allsop CJ, Kenny, Besanko, Robertson and Mortimer JJ)) where the Court stated at [255]: We reach this conclusion with some reluctance because there was a good deal to be said against the appellants' case, particularly their case that the payments from the Westpac account were loans by the company, and significant aspects of the Tribunal's reasons are unexceptional. However, unless it is quite clear that the result would have been no different without the error of law (and it is not in this case), it is not for this Court to reach its own conclusions on the papers (Rosenberg v Percival (2001) 205 CLR 434; Minister for Immigration and Multicultural Affairs v Rajamanikkam (2002) 210 CLR 222). 32 It was submitted that the reference in that passage to Rosenberg v Percival (2001) 205 CLR 434 was intended to be a reference to Commonwealth Banking Corporation v Percival. That is likely to be correct. The first respondent also referred to what Kirby J had said in Minister for Immigration and Multicultural Affairs v Rajamanikkam (2002) 210 CLR 222 at [113], where his Honour pointed out that a judge in judicial review proceedings has a confined role and does not "substitute a decision on the facts or an opinion on the merits of the evidence for that made by the repository entrusted with such functions". 33 Having referred to these authorities, the first respondent submitted that the question of materiality related only to whether the error was material to what the Tribunal in fact decided and was not concerned with what the Tribunal could have done but did not do. 34 The point made by the High Court in Pharm-A-Care Laboratories at [40] is not as narrow as the first respondent submits. The point is that a decision will not be set aside if the outcome would not have been different even if the decision in fact reached is shown to have been affected by legal error. A Tribunal's decision will not ordinarily be set aside if it is shown that, even if the error had not been made, the outcome would necessarily have been the same on the facts as found. That is the case here. 35 The primary judge concluded that the Tribunal erred in its construction of s 87-20(2) but endorsed the Tribunal's incorrect construction of s 87-20(1)(b). Even on its expansive view of what s 87-20(1)(b) required in terms of causation, the Tribunal held that the provision was not made out. The primary judge was not satisfied that the Tribunal "would have reached the same ultimate conclusion if it had adopted and applied the proper construction of" s 87-20(2). 36 There is no dispute on this appeal that the Tribunal adopted an incorrect construction of s 87-20(2). We have concluded that the Tribunal adopted, and the primary judge endorsed, an incorrect construction of s 87-20(1)(b), being one which was broader than the true construction. The fact finding process of the Tribunal was not shown on appeal to be relevantly affected by any error in construction of s 87-20(2) or s 87-20(1)(b) or misunderstanding of the interaction between the two provisions. The application of the correct construction of s 87-20(1)(b) to the facts as found by the Tribunal could lead only to one conclusion, namely that the "unrelated clients test" was not met. This was the conclusion which the Tribunal reached, albeit in a way which was affected by error. If the Tribunal had not erred, and had applied the correct test of causation required by s 87-20(1)(b), the outcome would not have been any different. It could not be said that "the decision which was in fact made by the Tribunal might have been different if the error of law had not occurred": Pharm-A-Care Laboratories at [40]. It "is quite clear that the result would have been no different without the error of law": Haritos at [255].

conclusion 37 The appeal should be allowed and the orders of the primary judge should be set aside and, in their place, orders should be made dismissing the appeal. In his supplementary notice of appeal, the Commissioner sought orders to the effect that he pay the costs of this appeal and that the primary judge's order as to costs of the appeal determined by the primary judge not be disturbed. The respondent did not dispute those costs consequences if the appeal was successful. I certify that the preceding thirty-seven (37) numbered paragraphs are a true copy of the Reasons for Judgment of the Honourable Justices McKerracher, Davies and Thawley.