Douglass v Commissioner of Taxation

The relevant provisions of the 1997 Act 5 Division 86 deals with the alienation of personal services income. In brief, income from the rendering of a taxpayer's personal services is treated as the taxpayer's assessable income if it is the income of another entity and is not promptly paid to the taxpayer as salary. That does not apply, however, if the other entity is conducting a "personal services business" (the meaning of which is set out at [11] below). 6 The object of Div 86 is set out in s 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. 7 Division 87 of Pt 2-42 in Ch 2 of the 1997 Act deals with the subject of "personal services businesses". Section 87-1 describes what Div 87 is about: 87-1 What this Division is about Divisions 85 and 86 do not apply to personal services income that is income from conducting a personal services business. It is not intended that the Divisions apply to independent contractors. A personal services business exists if there is a personal services business determination or if one or more of 4 tests for what is a personal services business are met. Regardless of how much of your personal services income is paid from one source, you can self-assess against the results test to determine whether you are an independent contractor. The results test is based on the traditional tests for determining independent contractors and it is intended that it apply accordingly. However, you cannot "self-assess" whether you meet any of the other 3 tests if 80% or more of your personal services income is from one source. In these cases, you need a personal services business determination in order to be treated as conducting a personal services business. 8 Section 87-5 contains a diagram which illustrates the operation of the division. It is as follows: 87-5 Diagram showing the operation of this Division This diagram shows how this Division operates to ascertain whether personal services income is income from conducting a personal services business 9 The object of Div 87 is described in s 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. 10 A taxpayer's assessable income includes the income of a "personal services entity" that is the taxpayer's "personal services income" subject, however, to two qualifications (s 86-15(1)). 11 Before identifying the two qualifications, it is as well to note the definition of a "personal services business" in s 87-15 (emphasis in original) and to set out the "results test" as referred to in s 87-15(2)(a): 87-15 What is a personal services business? (1) An individual or *personal services entity conducts a personal services business if: (a) for an individual - a *personal services business determination is in force relating to the individual's *personal services income; or (b) for a personal services entity - a personal services business determination is in force relating to an individual whose personal services income is included in the entity's *ordinary income or *statutory income; or (c) in any case - the individual or entity meets at least one of the 4 *personal services business tests in the income year for which the question whether the individual or entity is conducting a personal services business is in issue. Note 1: For personal services business determinations, see Subdivision 87-B. Note 2: Under subsection (3), the personal services business tests, apart from the results test under section 87-18, do not apply if 80% or more of your personal services income is from one source (but they can still be used in deciding whether to make a personal services business determination). (2) The 4 personal services business tests are: (a) the results test under section 87-18; and (b) the unrelated clients test under section 87-20; and (c) the employment test under section 87- 25; and (d) the business premises test under section 87-30. (3) However, if 80% or more of an individual's *personal services income (not including income referred to in subsection (4)) during an income year is income from the same entity (or one entity and its *associates), and: (a) the individual's personal services income is not included in a *personal services entity's *ordinary income or *statutory income during an income year, and the individual does not meet the results test under section 87-18 in that income year; or (b) the individual's personal services income is included in a personal services entity's ordinary income or statutory income during an income year, and the entity does not, in relation to the individual, meet the results test under section 87-18 in that income year; the individual's personal services income is not taken to be from conducting a *personal services business unless: (c) when the personal services income is gained or produced, a *personal services business determination is in force relating to the individual's personal services income; and (d) if the determination was made on the application of a personal services entity - the individual's personal services income is income from the entity conducting the personal services business. Note: Sections 87- 35 and 87-40 affect the operation of subsection (3) in relation to Australian government agencies and certain agents. (4) Subsection (3) does not apply to income: (a) that the individual receives as an employee; or (b) that the individual receives as an individual referred to in paragraph 12-45(1)(a), (b), (c), (d) or (e) (payments to office holders) in Schedule 1 to the Taxation Administration Act 1953 ; or (c) to the extent that it is a payment referred to in section 12-47 (payments to * religious practitioners) in that Schedule. 12 The "results test" for a personal services business is defined in s 87-18 of the 1997 Act: 87-18 The results test for a personal services business (1) An individual meets the results test in an income year if, in relation to at least 75% of the individual's *personal services income (not including income referred to in subsection (2)) during the income year: (a) the income is for producing a result; and (b) the individual is required to supply the *plant and equipment, or tools of trade, needed to perform the work from which the individual produces the result; and (c) the individual is, or would be, liable for the cost of rectifying any defect in the work performed. (2) Paragraph (1)(a) does not apply to income: (a) that the individual receives as an employee; or (b) that the individual receives as an individual referred to in paragraph 12-45(1)(a), (b), (c), (d) or (e) (payments to office holders) in Schedule 1 to the Taxation Administration Act 1953; or (c) to the extent that it is a payment referred to in section 12-47 (payments to * religious practitioners) in that Schedule. (3) A *personal services entity meets the results test in an income year if, in relation to at least 75% of the *personal services income of one or more individuals that is included in the personal services entity's *ordinary income or *statutory income during the income year: (a) the income is for producing a result; and (b) the personal services entity is required to supply the *plant and equipment, or tools of trade, needed to perform the work from which the personal services entity produces the result; and (c) the personal services entity is, or would be, liable for the cost of rectifying any defect in the work performed. (4) For the purposes of paragraph (1)(a), (b) or (c) or (3)(a), (b) or (c), regard is to be had to whether it is the custom or practice, when work of the kind in question is performed by an entity other than an employee: (a) for the *personal services income from the work to be for producing a result; and (b) for the entity to be required to supply the *plant and equipment, or tools of trade, needed to perform the work; and (c) for the entity to be liable for the cost of rectifying any defect in the work performed; as the case requires. 13 As noted at [10] above, there are two qualifications to the proposition set out in s 86-15(1). The first qualification relates to "personal services businesses" and is set out in s 86-15(3): Exception: personal services businesses (3) This section does not apply if that amount is income from the *personal services entity conducting a *personal services business. Note: Even if the entity is conducting a personal services business, it is possible that some of its income is not income from conducting that business. 14 The second qualification relates to amounts promptly paid to the taxpayer as salary or wages and is contained in s 86-15(4). It is not necessary to set out that provision.

The AAT's reasons summarised 15 The AAT summarised the relevant provisions of the 1997 Act concerning personal services income. It noted that the only test relied upon by Mr Douglass for his claim that the "personal services business test" was satisfied in the 2013 and 2014 tax years was the "results test". The AAT noted at T[16] that in determining whether any of the "results test" criteria had been met required regard to be had to any "custom or practice" (when work is performed by persons who are not employees) in relation to the matters to which the particular criterion relates (referring to s 87-18(4) of the 1997 Act). 16 In construing the relevant statutory provisions, the AAT referred to relevant parts of the July 1999 Report by the Commonwealth Treasurer's Committee titled "Review of Business Taxation: A Tax System Redesigned" (Ralph Report). That report contained recommendations concerning the erosion of the tax revenue base by the increasing use of personal and corporate service contractors where the legal structure of the relationships did not really change the fundamental employer-employee relationship. The AAT also relied upon various statements by Allsop J (as the Chief Justice then was) in IRG Technical Services Pty Ltd v Deputy Commissioner of Taxation [2007] FCA 1867; 165 FCR 57. The AAT referred to relevant extracts from Taxation Ruling TR2001/8, which picked up various parts of the Explanatory Memoranda relating to amendments to the 1997 Act concerning personal services businesses. The AAT also considered other relevant AAT decisions, including Skiba v Federal Commissioner of Taxation [2007] AATA 1705; 67 ATR 682; Taneja v Federal Commissioner of Taxation [2009] AATA 87; 75 ATR 111 and Park v Commissioner of Taxation [2011] AATA 567; 84 ATR 672. As will emerge below, Mr Douglass contended that these cases all reflect the same misconception. 17 The AAT's key legal analysis and conclusions may be summarised as follows: (a) The available contractual documents and invoices of the partnership for 2011 - 2014 provided no factual basis for concluding that its contractual arrangements either involved any obligation to produce a specific "result" or linked the partnership's payment entitlement to such a "result" (T[63]-[68]). (b) The results criterion requires characterisation of the income received as for producing a result. The mere fact that a taxpayer has been engaged to carry out specific tasks and is subject to specific duties directed to achievement of those tasks, does not suffice to require a conclusion that the income received is for producing a result. The description of those specific tasks and duties may provide evidentiary basis for concluding that the income is not properly to be characterised as being for producing a result. Mr Douglass's specific responsibilities in the project during the relevant tax years were to provide professional and management services as part of a team of people engaged in the many disparate activities involved in the project. While, Mr Douglass's role description may have indicated he had overall responsibility for the delivery of the project, the income received by the partnership was "for" the work Mr Douglass performed in leading the team whose co-operative efforts were required to complete the project. It was a misnomer to describe the income related to the Mr Douglass's role as "lead engineer" in the relevant years as income "for producing a result" (T[69]-[74]). (c) The evidence of "custom and practice" adduced by Mr Douglass did not establish any adequate basis for accepting the contention that there was an operative contractual "custom or practice" whereby independent contractors derived their income for producing a result. Rather, the evidence was said to indicate the unremarkable reality that they were typically engaged, and paid, for the provision of their services in the course of contributing to, or having some management responsibility in, the completion of complex, multi-disciplinary infrastructure projects for the purpose of performing particular tasks. Mr Douglass's evidence was said to suffer from an inadequate awareness of the conceptual distinction between the basis of the contractor's entitlement to remuneration and the underlying reason for engagement of the contractor's services (T[75]-[92]). (d) The AAT assessed the evidence adduced by Mr Douglass in support of his contention (which was directed to s 87-18(4)) that, in any event, custom or practice required characterisation of the partnership income as having been derived for "producing a result". Five witnesses were called by Mr Douglass for this purpose. The AAT concluded at T[92] that none of the evidence supported Mr Douglass's claims that the custom or practice was for independent contractors working on projects like his to be engaged to produce results and receive income for doing so: 92. There is no difficulty in accepting Mr Douglass' proposition that time based payment entitlements are typical of the contracting arrangements with which he was involved in the 2011 to 2014 tax years. Nor is there any difficulty in accepting that such arrangements were typical of the contracting arrangements involving other independent contractors engaged to work on large mining and resources infrastructure projects. But there is no adequate basis for accepting his contention that there was an operative contractual "custom or practice" whereby independent contractors were engaged to produce "results" and paid for so doing. The highest the evidence went was to point to a generality that "all" engineers were engaged for the purpose of working towards the successful completion of projects or the achievement of desired outcomes. That generality has no practical significance in the present context. It is undermined by its very generality. It is further undermined by the additional evidence that performance obligations in relation to project completions or outcomes were typically neither possible nor practical to express at the time of contracting. They were typically articulated only in the course of the work - in supplementary documentation or "by word of mouth discussions between the contractor consultants" (per Mr Phillips's evidence). That latter description powerfully reinforces the applicability of views expressed in Skiba and IRG (see paragraph 80 above) to Mr Douglass's situation. Those views (sic) lead to the conclusion that the payments the partnership received in the 2011 to 2014 tax years were not "income … for producing a result". (e) Although that was sufficient to dismiss Mr Douglass's review application, the AAT proceeded to state in obiter that the partnership could not satisfy the equipment support criterion in s 87-18(3)(b). It said there was some artificiality in considering this criterion having concluded the partnership did not satisfy the "results test", but assuming it did following the approach in IRG and Skiba, the AAT concluded the material concerning custom or practice on this topic showed that independently contracted engineers were typically not required to, and were often prohibited from, providing computer systems or software, and were required to use the project principal's equipment. This conclusion precluded satisfaction of the equipment supply criterion (T[93]-[99]). (f) Similarly, also in obiter, the AAT found that, on the basis of the available evidence of the contractual arrangements and the evidence of custom and practice adduced by Mr Douglass, he had not established that he was liable for the cost of rectifying any defect in the work performed. The highest the evidence went was affirmation of the existence of a service quality standard, but the existence of such a standard was consistent with arrangements relevantly similar to the "fundamental employer-employee relationship" (T[100]-[107]). Thus the rectification criterion in s 87-18(3)(c) was also not met. 18 The AAT affirmed the Commissioner's decision to impose an administrative penalty on Mr Douglass on the basis of recklessness. It found that Mr Douglass's failure to include the income from the partnership in his returns for 2013 and 2014 was grossly careless, a result of a self-interested misunderstanding of the relevant statutory provisions and was reckless in the relevant sense (T[126]-[127]), thereby attracting a penalty at the rate of 50 percent. In reaching this conclusion, the AAT cited and applied the approach to "recklessness" established in cases such as Commissioner of Taxation v R & D Holdings Pty Limited [2007] FCAFC 107; 160 FCR 248 at [70] and Hart v Commissioner of Taxation [2003] FCAFC 105; 131 FCR 203 at [43] per Hill and Hely JJ.

Supplementary notice of appeal 19 In his supplementary notice of appeal Mr Douglass identified three questions of law, but only the second and third questions (and the related grounds of appeal) were pressed. The two remaining questions are as follows (emphasis in original): 2. In the application of the "custom or practice" test in s 87-18 ITAA97, did the Tribunal err in not first deciding the question (yes or no) as to, whether it is the custom or practice" that the "work of the kind in question" is not performed by employees? (or a formulated similar question based on s 87-18(4)), and if answered in the affirmative then having direct "regard" to that in answering the tests in s 87-18 ((a) producing a result, (b) plant and equipment, etc., (c) costs of rectification)? 3. In the requirement "to do over again" of the objection decision pertaining to penalties, did the Tribunal err in applying the wrong test as to recklessness, where the Tribunal was required to determine where on the scale as between - reasonable care - failure of reasonable care - recklessness - intentional disregard the purported "misleading statement" was, and the Tribunal failed to make this finding?

Mr Douglass's submissions summarised 20 In support of question of law 2 and the related grounds of appeal, Mr Douglass identified as a primary issue for determination the question of whether and how s 87-18(4) operates to modify s 87-18(1) and (3) and then ascertain whether the AAT properly applied the provision. 21 In brief, Mr Douglass contended that the AAT inverted the operation of s 87-18(4). He contended that, on its proper construction, that provision operated such that an individual taxpayer would meet the first criterion in s 87-18(1)(a) (i.e. the requirement that the income is for producing a result) even if the taxpayer's income for the relevant year is not income for producing a result, as long as there was evidence that the income of the taxpayer's peer group was not income for producing a result. Mr Douglass contended that s 87-18(4) operated in a similar fashion in respect of the other two criteria in s 87-18(1)(b) and (c). 22 Mr Douglass's position regarding the meaning and operation of s 87-18(4) is reflected in his counsel's oral submission at T13, line 32 (which is partly expressed by reference to the second element which is set out in s 87-18(1)(b) concerning the supply of plant and equipment): So we say that's really important that if the independent contractor isn't required to provide tools, and the custom and practice is that true independent contractors also don't need to provide tools, then sub (b) may be satisfied. So we say it follows that if the independent contractor does not earn income for obtaining a result, and the evidence is that independent contractors do not earn - the peer group do not earn their income for producing a result, then sub (4) indicates that (a) is satisfied. Now, with the greatest respect to the tribunal, we say the tribunal looked for the complete opposite, and we say that by looking for the complete opposite in order to pass (4), the tribunal was trying to establish that the peer group was diametrically opposed to the individual or the taxpayer in order to pass the results test. 23 Mr Douglass contended that the AAT adopted an erroneous construction of s 87-18(4) by focussing on the wrong question, namely whether or not there was some evidence upon which findings of fact could be made on custom or practice, with the consequence that if there was, even though the individual taxpayer could not show that his or her income was for producing a result, that criterion is satisfied if the evidence of custom or practice enables a finding to be made that the income of the peer group was for producing a result. Mr Douglass submitted that this erroneous approach was first manifested in Taneja at [19], [22] and [23], an approach which was adopted and applied erroneously by the AAT here. In particular, Mr Douglass referred to [80] and [92] of the AAT's reasons for decision here. Paragraph 92 is set out in [17(d)] above. Paragraph 80 is as follows: 80. Nothing that Messrs Lacy, Janossich and White had to say was at all informative in relation to the "custom or practice" urged on Mr Douglass' behalf. Their evidence was gravid with ambiguity and correspondingly undermined by its imprecision. Nothing that any of them said went close to providing justification for a conclusion that there was any meaningful practice where independent consultants derived their income "for producing a result". Their evidence indicates the unremarkable reality that independent contractors will ordinarily have been engaged to provide their expert services in the course of contributing to, and having some management responsibility in, completing complex, multi-disciplinary infrastructure projects for the purpose of performing particular tasks. It also indicates that in contributing their services contracting engineers will typically be expected to meet performance standards (commensurate with their professed skill and experience) in relation to the quality of their work. But it also indicates that they are typically engaged, and paid, for the provision of their services. Consequently, the overall effect of their evidence closely parallels the evidence and the conclusions in Skiba (see paragraphs 28 to 30 above) and by Allsop J in IRG (see paragraph 39 above). 24 Mr Douglass contended that his construction was supported by what Allsop J said in IRG at [113] and [114]: 113. In taxation ruling 2001/8, the ATO has given the following guidance: …[H]aving regard to the words of the law and the purpose of the provision, …if no equipment or tools are needed, it is arguable that the provision will always be met in these circumstances. Also, [s 87-18(4)] allow[s] regard to the custom or practice of individuals or entities (other than employees) "to be required to supply" the equipment or tools "needed to perform the work", "as the case requires" suggesting that equipment and tools are not required if they are not needed to perform the work. They also highlight the distinction between independent contractors and employees. This reflects the purpose of the "results test", the object of the condition in [s 87-18(3)(b)] being to ensure that individuals or personal service entities who claim to be independent contractors do in fact provide the necessary equipment or tools where genuine independent contractors would be expected to do so. 114. With respect, that is a well-expressed and serviceable working exposition. To give the provision (as it should be given) a sensible working meaning conformable with its place in the context of the jurisprudence concerning independent contractors, I am prepared to adopt this approach. 25 Thus, in Mr Douglass's submission, once it is accepted that it is the custom or practice that work of the kind in question is not performed by an employee, then the operation of the test is modified based on that practice before applying the results test. If the taxpayer meets the custom then the results test is satisfied. 26 In contrast, the Commissioner contended that Mr Douglass was wrong to suggest that s 87-18(4) "modifies" the results test. Rather, he contended that the provision "identifies a matter which is potentially probative of it, which the decision-maker is directed to have regard to in forming a conclusion about the circumstances of the individual tax-payer". The Commissioner submitted that, on Mr Douglass's construction, the provision operated in effect to displace or discard each of the three criteria in s 87-18(1). For example, if an individual taxpayer cannot satisfy the first criterion in paragraph (a) (namely that the taxpayer's income is for producing a result), merely because the evidence demonstrates that the income of the peer group is similarly not for producing a result does not excuse the taxpayer from having to meet that criterion. 27 Furthermore, the Commissioner contended that Allsop J's obiter observations in IRG were supportive of the Commissioner's position that evidence of custom or practice is a matter which informs the ultimate conclusion whether or not a criterion is satisfied, but is not itself a separate inquiry. Thus, for example, Allsop J indicated that if the evidence reveals for a particular kind of work that there was no requirement to supply plant and equipment or tools of trade that may mean that the relevant criterion is taken to be satisfied. Evidence of custom or practice may assist that factual enquiry. The Commissioner's counsel submitted, however, that s 87-18(4) is "not an invitation to have regard to a custom or practice not to require the provision of tools or equipment as somehow displacing or discarding the need for that satisfaction or the element of the results test, and that, I think, is the way the taxpayer seeks to treat it". 28 On Mr Douglass's case, the AAT's findings at T[78] and T[80] that the work done by him was ordinarily done by an independent contractor and that it is the custom or practice that work of the relevant kind is not performed by an employee, meant that the results test in s 87-18(4) was satisfied. This is simply because on his case, on its proper construction, s 87-18(4) requires a finding whether it is the custom or practice that work of the kind in question is not performed by an employee, and if that question is answered affirmatively, then unless there is specific rebutting evidence, the results test is passed. Mr Douglass cited IRG at [157] in support of that contention. There, Allsop J said: 157. For the same reasons as I concluded that the income of Mr Green was not for producing a result, I conclude that the income of Mr Owen was not for producing a result. Like Mr Green, Mr Owen worked in the business of the KJV, controlled in the sense that I discussed in relation to Mr Green, being paid by the hour for doing the skilled and specialised work of an instrument engineer. In my view, for the same reasons which I expressed in relation to Mr Green, it would be a misuse of language to say that he was paid for producing a result or results. He was paid to work as a skilled engineer and expected in that work to produce data sheets. That is not being paid for results. The work was completed in an iterative fashion, through teamwork and co-ordinated skill and experience of a group of engineers working in the KJV's business designing the plant. All the documentation was produced in the business of the KJV, on the KJV computer system. Like Mr Green, Mr Owen did not produce his own documents. He participated in the production of documents which were the product of coordination, co-operation and supervision in which not only he, but others, signed off. The deliverables were the product of the work of Mr Owen (and Mr Green) and their colleagues. 29 In brief, Mr Douglass contended that the AAT's error lay in its insufficient appreciation that there is a two stage step in applying s 87-18(3)(a), namely: (a) first, ascertain what the custom and practice was around producing a result (which the AAT did do in this case by finding that project outcomes were typically identified only in the course of the work); and (b) secondly, then ask whether the test in s 87-18(3)(a) was, in the circumstances, as modified by s 87-18(4), satisfied. 30 Mr Douglass contended that the AAT did not undertake this second step. 31 Mr Douglass's submissions on penalty may be summarised as follows. After outlining the four levels of the sliding scale for base penalty as contained in the various items in s 284-90 of Sch 1 to the Taxation Administration Act 1953 (Cth) (TA Act), he submitted that the AAT erred by not first asking whether there had been a failure of reasonable care, which would attract a base penalty of 25 per cent. Instead, the AAT went straight from the question of whether there was a reasonably arguable position (see T[114] to [117]) to recklessness (T[118]ff). 32 Mr Douglass also contended that the AAT erred at T[126] which indicated that its approach involved comparing his conduct to what a reasonable person ought to have done, whereas the AAT's finding at T[126] was in substance one of failure to take reasonable care and not recklessness.

The Commissioner's submissions summarised 33 Reference has been made above to some of the Commissioner's submissions. To avoid duplication, I will not summarise all the Commissioner's submissions on the second and third questions of law because they are substantially reflected in my reasons below for dismissing the appeal. 34 It is desirable, however, to set out in full [11] to [13] of the Commissioner's outline of written submissions because counsel for Mr Douglass helpfully identified these paragraphs as capturing the issues in dispute regarding the results test (without alteration): 11. Third, the second way the taxpayer asserts that s87-18(4) "alters" or "modifies" the "results test" in s87-18(1) and (3) (in AS[19]) turns s87-18 on its head. The inquiry into "custom and practice" which s87-18(4) directs, "[f]or the purposes of" par. (1)(a)-(c) and (2)(a)-(c) is "whether it is custom and practice … for", in effect, the three elements of the results test to be satisfied (emphasis added). Both the grammar and the logic of s87-18 suggests that an affirmative answer to that question is to be regarded as a factor pointing towards a conclusion that the "results test" in s87-18(1) and (3) is satisfied. This is how the Tribunal approached the matter, concluding that the evidence established no relevant custom or practice which pointed towards a conclusion that the "results test" was satisfied. In contrast, the construction contended for by the taxpayer takes a negative answer to the inquiry into custom and practice directed by s87-18(4) as a basis for discarding the corresponding element of the results test in s87-18(1) and (3). What part of the text of s87-18 mandates this surprising approach is never adequately explained by the taxpayer; what aspect of the context or structure of s87-18 demands this counterintuitive result is never pointed out. The taxpayer's construction of s87-18(4) gives it an operation which is, with respect, perilously close to absurd. 12. In support of the construction of s87-18(4) which the taxpayer advances, he relies (at AS[19]-[20]) on the approval by Allsop J at [113]-[114] of IRG of a passage in Taxation Ruling 2001/8 concerning the operation of the second element of the results test (that in s87-18(1)(b) and (3)(b) concerning a requirement of the personal services entity to supply plant or equipment or tools of trade). The point being made in the passage approved by Allsop J was that if plant or equipment or tools of trade were not needed to perform work of the relevant kind, the absence of a requirement to supply plant or equipment or tools or trade would not be fatal to a conclusion that a personal services entity satisfies the results test. In assessing whether plant and equipment or tools of trade were needed to perform work of the kind in question, regard was to be had to custom and practice. So much may, of course, be accepted. However, that says nothing in favour of the taxpayer's contention that a negative answer to the inquiry into "custom and practice" directed by s87-18(4) mandates that the corresponding limb of the "results test" in s87-18(1) and (3) is discarded or "tempers" the operation of the "results test" (cf., AS[35]). 13. At T[92] the Tribunal made two relevant findings as to "custom or practice" insofar as it bore on the element of the "results test" in s87-18(3)(a); namely, "the income is for producing a result". First, that time based payment was typical of the contractual arrangements involving independent contractors engaged to work in large mining and resources infrastructure projects. Second, that engineers were engaged for the purposes or working towards the successful completion of projects or the achievement of desired outcomes, but that the engineers' performance obligations were typically articulated in the course of work and not at the time of contracting. Those findings were fatal to any conclusion that it was the custom or practice, when work of the kind performed by the taxpayer is performed other than an employee, for the work to be "for producing a result" (cf., s87-18(4)(a)). They also tended against the conclusion that the taxpayer satisfied the first element of the "results test" in s87-18(3)(a). The taxpayer's attempt (at AS[28]-[39]) to convert the findings at T[92] into a basis for concluding that the first element of the "results test" was somehow modified so that the taxpayer could satisfy it is without support in the text or context of s87-18 and ought to be rejected.

(a) Question of law 2: construction and application of s 87-18 35 It is well to commence with a summary of the pertinent parts of Allsop J's influential judgment in IRG, to which both parties referred. First, there was no dispute that his Honour's statement at [21] of the relevant principles of statutory construction applicable, also applies here (authorities omitted): 21. … The relevant words of the statutory provision are read in the context of the statute as a whole and in their legal and historical context, having regard to the aim and purpose of the provision and the legislation, to any established canons of legal construction and to any inconvenience or improbability of result of any given construction. Such inconvenience or improbability of result may assist the Court to reach an available alternative construction reasonably open and more clearly conforming with the legislative intent otherwise discovered. No initial textual or other ambiguity need be divined before context is examined. Fundamental to the task is the giving of close attention to the text and structure of the relevant provisions as the words used by Parliament… 36 Secondly, the Ralph Report was a relevant aid to construction and assisted in identifying the mischief to which the 2001 amendments (by which s 87-18 was inserted into Div 87 of Pt 2-42) were directed; namely to ensure that income is correctly attributed for taxation purposes to an individual who carries out personal services in a manner broadly similar to the way those services would be carried out if that person was an employee of the person or entity who required the services (at [25]-[28]). 37 Thirdly, after referring to both the Ralph Report and the Explanatory Memorandum which preceded the 2001 amendments, Allsop J observed at [34] that, although the expression "employee-like" or "employment-like" are not used in the Explanatory Memorandum, the guide or the operative provisions of Pt 2-42, what is conveyed by those expressions could be seen to be at the heart of Pt 2-42 and the operation of the results test. 38 Fourthly, while the results test is based on the common law criteria for characterising an independent contractor as opposed to an employee-employer relationship, the results test must be satisfied by meeting the three specified statutory criteria. Consequently, it is not necessary for the purposes of s 87-18(3) that all the recognised common law criteria for an independent contractor be present as long as the three statutory criteria are satisfied (at [37]). 39 Fifthly, the whole purpose of s 87-18(3) is to bring "an eye guided by substance, not form, to the circumstances of the provision of the personal services to the party who acquires or receives them" (at [50]). 40 Sixthly, after stating that the meaning and operation of s 87-18(3)(b) in the particular circumstances in IRG was "not straightforward", Allsop J described the guidance provided by the ATO in Taxation Ruling 2001/8 as "a well-expressed and serviceable working exposition" of that provision (at [112]-[114]). That guidance was as follows: …[H]aving regard to the words of the law and the purpose of the provision, …if no equipment or tools are needed, it is arguable that the provision will always be met in these circumstances. Also, [s 87-18(4)] allow[s] regard to the custom or practice of individuals or entities (other than employees) "to be required to supply" the equipment or tools "needed to perform the work", "as the case requires" suggesting that equipment and tools are not required if they are not needed to perform the work. They also highlight the distinction between independent contractors and employees. This reflects the purpose of the "results test", the object of the condition in [s 87-18(3)(b)] being to ensure that individuals or personal service entities who claim to be independent contractors do in fact provide the necessary equipment or tools where genuine independent contractors would be expected to do so. It might also be noted that Allsop J acknowledged that custom and practice will be important in applying s 87-18(3)(b), and he added that it might also be difficult to detach the "test" from the criterion in s 87-18(3)(a) (i.e. that relating to income) (at [112]). 41 Seventhly, strictly speaking, Allsop J's observations on s 87-18(3)(b) are all strictly obiter as explained by his Honour at [111]. 42 For the following reasons, I do not view what Allsop J said in IRG at [112]-[114] and [157] as lending any support for Mr Douglass's case. (a) The obiter observations at [112] to [114] are plainly directed to s 87-18(3)(b) and not to the other two criteria of the results test. (b) Criterion (b) has two aspects to it, namely that where plant/equipment or tools of trade are needed to perform the work, the personal services entity must be required to supply such materials (which aligns with the usual position with an independent contractor doing that kind of work). (c) Justice Allsop agreed with the emphasis given in the Taxation Ruling to the custom or practice of independent contractors in addressing criterion (b) and the importance of the fact that s 87-18(4) operates in its own terms by reference to "as the case requires". (d) Where the evidence reveals that plant, equipment or tools are not needed to perform the work, no issue of "required" arises and element (b) will generally be satisfied. (e) There was no evidence of custom or practice of independent contractors in IRG and Allsop J made no findings about that matter. Having regard to the nature and scale of the project (the design and construction of a multi-billion dollar liquefied natural gas train or plant) it was plain that such materials were needed to perform the work being done by the two engineers in IRG. But his Honour found that the principal did not require engineers working on the design to supply those materials (notwithstanding that, in fact, the two engineers supplied some limited tools of trade even though they were not required to do so). (f) Justice Allsop's analysis and reasoning lends no support for Mr Douglass's proposition in respect of criterion (a), namely that if there is evidence of a custom or practice that the income earned by independent contractors for doing work of the relevant kind is not income for producing a result, element (a) satisfied. (g) In particular, I see nothing in IRG which supports Mr Douglass's central proposition that s 87-18(4) operates to modify s 87-18(1) and (3). Rather, in my respectful view, Allsop J approached s 87-18(4) as being, in effect, a probative provision to assist fact finding on the taxpayer's individual case, which operates on the footing that independent contractors and employees are distinguished and there is a need broadly to align the position of a personal services entity with an independent contractor (and not an employee). (h) I accept the Commissioner's submission that the point being made in the passage approved by Allsop J was that, if plant or equipment or tools of trade were not needed to perform work of the relevant kind, the absence of a requirement to supply plant or equipment or tools or trade would not be fatal to a conclusion that a personal services entity satisfies the results test. That conclusion flows from the text of s 87-18(3)(b) itself. In assessing whether plant and equipment or tools of trade were needed to perform work of the kind in question, regard was to be had to custom and practice. However, that says nothing in favour of Mr Douglass's contention that a negative answer to the inquiry into "custom and practice" directed by s 87-18(4) mandates that the corresponding limb of the "results test" in s 87-18(1) and (3) be discarded or "tempers" the operation of the "results test". 43 Mr Douglass contended that s 87-18(4) modifies ss 87-18(1) and (3) in two ways. First, it is contended that s 87-18(4) substitutes for the three criteria of the results test in s 87-18(1) and (3) the question of "whether it is the custom or practice [that] work of the kind in question is [not] performed by an employee" and that, if that question is answered "Yes" (ie., it is "custom or practice" for work of the kind in question to be performed by someone other than an employee), the "results test" is taken to be passed. Secondly, and alternatively, it is contended that s 87-18(4) requires an ascertainment of whether it is the custom or practice, when work of the kind in question is performed by a person other than an employee, for the elements of the "results test" to be satisfied (eg., that the "income from the work … be for producing a result"). If the answer to that question is "No", it is then contended that the element of the "results test" is discarded. 44 I accept the Commissioner's contention that neither the text nor context of s 87-18 support Mr Douglass's position. It also confronts the following additional difficulties. 45 First, the first way in which Mr Douglass says s 87-18(4) "alters" or "modifies" the "results test" in ss 87-18(1) and (3) misstates the relevant "custom or practice" to which s 87-18(4) directs attention. The question is not whether it is "the custom or practice [that] work of the kind in question is [not] performed by an employee". The "custom or practice" to which s 87-18(4) is directed is "whether… when work of the kind in question is performed by an entity other than an employee" each of the criteria of the "results test" in s 87-18(1) and (3) is satisfied. The finding on custom or practice may then be probative in assessing the taxpayer's individual circumstances. As the condition on which s 87-18(4) operates indicates, the premise of Part 2-42 is that the taxpayer is not an employee of the person to whom he or she provides the services which generate the personal services income. The policy reflected in Pt 2-42 of the 1997 Act is that, nonetheless, the income has a character which makes it appropriate, as a matter of substance, to treat the personal services income as income of the taxpayer (see s 86-10 and IRG at [25]-[51]). If Pt 2-42 was denied application whenever it was the custom or practice for work to be performed by persons who were not employees, the Part would be very substantially denied any operative effect. 46 Secondly, the second way Mr Douglass asserts that s 87-18(4) "alters" or "modifies" the "results test" in s 87-18(1) and (3) turns s 87-18 on its head. The inquiry into "custom and practice" which s 87-18(4) directs, for the purposes of ss 87-18(1)(a)-(c) and (3)(a)-(c) is "whether it is custom and practice… for", in effect, the three criteria of the results test to be satisfied (emphasis added). Both the grammar and the logic of s 87-18 suggest that an affirmative answer to that question is to be regarded as a factor pointing towards a conclusion that the "results test" in ss 87-18(1) and (3) is satisfied. This is how the AAT approached the matter, concluding that the evidence established no relevant custom or practice which pointed towards a conclusion that the "results test" was satisfied. In contrast, the construction contended for by Mr Douglass takes a negative answer to the inquiry into custom and practice directed by s 87-18(4) as a basis for discarding the corresponding criteria of the results test in ss 87-18(1) and (3). This is unsupported by both the text and the context of the provision. 47 There are additional difficulties with this aspect of Mr Douglass's appeal. The first is that at T[92] the AAT made two relevant findings as to "custom or practice" insofar as those matters bore on the first criterion of the "results test" in s 87-18(3)(a) (namely, "the income is for producing a result"). First, that time based payment was typical of the contractual arrangements involving independent contractors engaged to work in large mining and resources infrastructure projects. Secondly, that engineers were engaged for the purposes or working towards the successful completion of projects or the achievement of desired outcomes, but that the engineers' performance obligations were typically articulated in the course of work and not at the time of contracting. Those findings informed the conclusion that it was the custom or practice, when work of the kind performed by Mr Douglass is performed other than by an employee, for the work to be "for producing a result" (cf., s 87-18(4)(a)). They also tended against the conclusion that Mr Douglass satisfied the first element of the "results test" in s 87-18(3)(a). Mr Douglass's attempt to convert the findings at T[92] into a basis for concluding that the first element of the "results test" was somehow modified so that he could satisfy it is without support in the text or context of s 87-18. 48 The second difficulty relates to the AAT's conclusion that Mr Douglass did not satisfy the elements of the "results test" in either s 87-18(3)(b) (concerning requirement to supply plant and equipment or tools of trade, at T[93]-[99]) or s 87-18(3)(c) (concerning liability for rectifying defects (see T[100]-[107]). Mr Douglass contended that the AAT's finding at T[107] (that the workplace situation was likely to be a "co-operative endeavour") was a finding of "custom and practice" which "modifies" the element of the "results test" in s 87-18(1)(3)(c). The point made by the AAT at T[107] was to the effect that the co-operative process in which engineers such as Mr Douglass was engaged involved a process of defect identification and rectification which made it very unlikely that any contractual liability for defects would be visited on the engineer. This is inconsistent with any "custom or practice" which could assist Mr Douglass to satisfy the element of the "results test" in s 87-18(3)(c) of the 1997 Act. Likewise, the last sentence of T[99] (in which the AAT found it was necessary for contractors such as the taxpayer to resort to the principal's equipment to complete the project) is inconsistent with any "custom or practice" which could assist Mr Douglass to satisfy the criterion of the "results test" in s 87-18(3)(b) of the 1997 Act. 49 For these reasons, this aspect of Mr Douglass's appeal is rejected.

(b) Question of law 3: Penalty 50 Mr Douglass's contention that the AAT overlooked the capacity to impose a penalty of 25 percent of the "shortfall amount" if the shortfall arose from a failure to take reasonable care is without substance. 51 The AAT specifically noted at T[108] and T[111]-[112] that there was a capacity to impose an administrative penalty on the basis of a failure to take reasonable care. 52 Nor do I accept Mr Douglass's contention that the AAT's findings did not satisfy the requirement of "recklessness" in the relevant sense. At T[126]-[127] the AAT found that Mr Douglass's failure to include in his returns for the relevant years the personal services income generated by the work he performed on the project "merits characterisation as gross carelessness" and his subjective view as formed from a "self interested misunderstanding of the legislative provisions". This, as the AAT noted at T[109], equated to recklessness in the sense explained by Cooper J in BRK (Bris) Pty Limited v Federal Commissioner of Taxation [2001] FCA 164; 46 ATR 347 at 364 (which has twice been approved by the Full Court of this Court: Hart at [43] and R & D Holdings at [70]). As the AAT concluded at T[128] Mr Douglass's "conduct amply justifies characterisation as involving recklessness". 53 For these reasons, this aspect of Mr Douglass's appeal is also rejected.

Conclusion 54 For these reasons, the appeal will be dismissed, with costs. I certify that the preceding fifty-four (54) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Griffiths.