Fortunatow v Commissioner of Taxation

Federal Court of Australia|2019-08-12|Before: Mr J, Griffiths J

The appeal be allowed.
The decision of the Administrative Appeals Tribunal be set aside.
The applicant's application for review be reconsidered by the Administrative Appeals Tribunal according to law.
The first respondent pay the applicant's costs, as agreed or assessed. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

Introduction 1 This appeal from a decision of the Administrative Appeals Tribunal (AAT) relates to the AAT's construction and application of various provisions of the Income Tax Assessment Act 1997 (Cth) (1997 Act) relating to what is known as the "unrelated clients test", which is an aspect of the personal services income regime in Pt 2-42, Divs 84 to 87 of that legislation. As the AAT explained, the basic rule is that an individual is required to include in his or her assessable income any income that another entity gains for the individual's personal services notwithstanding that the income may have been alienated to another interposed company. The rule does not apply to personal services income which is income from conducting a "personal services business" as defined in s 87-15 of the 1997 Act, which requires the relevant person or entity to satisfy one of four personal services business tests as set out in s 87-15(2). One of those tests is the "unrelated clients test" which is set out in s 87-20. 2 The AAT's decision and reasons for decision are reported as Fortunatow v Commissioner of Taxation [2018] AATA 4621. Relevantly, the AAT concluded that the taxpayer did not pass the unrelated clients test in s 87-20 of the 1997 Act.

Notice of appeal 3 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. The taxpayer's counsel submitted that it provided "a complete answer" and that the other two questions of law fall away (which related to the AAT's findings on the "results test" and penalties respectively). The taxpayer contended that the AAT misconstrued s 87-20(2) of the 1997 Act and gave that provision too wide a meaning in its interaction with s 87-20(1)(b). 4 Curiously, the relief sought in the notice of appeal did not include an order setting aside the AAT's decision. The relief sought was that the "decision be remitted to the Tribunal for redetermination according to the reasons of the Honourable Court", as well as costs. It may be implicit in the relief sought that the decision be set aside in order to facilitate the requested redetermination.

The AAT's reasons summarised 5 It is sufficient to focus only on those parts of the AAT's reasons which relate to question of law 2. Before setting them out, it is desirable to outline the general background. 6 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. 7 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. 8 Section 87-20 of the 1997 Act provided: 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. 9 After setting out the terms of s 87-20, the AAT cited the Full Court's decision in Cameron v Federal Commissioner of Taxation [2012] FCAFC 7; 202 FCR 301 as identifying the following five elements of the unrelated clients test: (a) an identification of each income year; (b) an identification of the income in question; (c) whether that income was gained or produced from providing services to two or more unrelated entities and the identification of those unrelated entities; (d) whether the individual or personal services entity made any offers or invitations to the public at large or to a section of the public to provide those services; and (e) if so, whether the services provided to the unrelated entities were so provided as a direct result of the individual or personal services entity making those offers or invitations. 10 The first three elements are drawn from s 87-20(1)(a) and the fourth and fifth elements are drawn from s 87-20(1)b). In the AAT and here, only the fourth and fifth elements identified in Cameron were in issue. The applicant contended that he met the fourth element because of his active profile on LinkedIn and his marketing by word of mouth at industry functions. He said that he kept his LinkedIn profile up to date and that he included a note that the Company would be available for a new assignment on a certain date, namely after completion of his current assignment. He said that his LinkedIn profile was a form of advertising. 11 Although the AAT accepted that the taxpayer's advertising on LinkedIn constituted the making of an offer or invitation to the public, it concluded that s 87-20(2) operated in a way which meant that the fourth element in Cameron was not satisfied. 12 In the event it was wrong on the operation of s 87-20(2), the AAT went on to consider the fifth element of Cameron, namely whether the services were provided to the unrelated entities as a direct result of the individual or personal services entity making offers or invitations to the public to provide the services. The applicant had made two alternative contentions on this issue. His first contention was that his advertising was directed to end-clients as well as intermediary companies, and that some of those end user clients had relied on his LinkedIn profile or word of mouth referrals in obtaining his services. This reliance was said to establish a "direct link" between the advertising and the client. The AAT rejected this contention on the basis his evidence was inadequate for various reasons. The applicant's alternative contention was that he could establish the necessary causal relationship by evidence the end-clients or an intermediary had relied on his advertising as the services provided would be a direct result of his advertising. The AAT accepted this alternative contention, but held that the involvement of the intermediary brought s 87-20(2) into play and this meant the applicant still failed to satisfy the unrelated clients test. Accordingly, the AAT found that although it would have found that the fifth element in Cameron had been made out, applying its view of the meaning and effect of s 87-20(2) (the terms of which are set out at [8] above), meant the fifth element had not been made out. 13 At T[62], the AAT described the effect of s 87-20(2) as being "to narrow or qualify what might otherwise have been considered as advertising under subsection (1)(b)" and that it operated "to exclude from the operation of s 87-20(1)(b) any "offers or invitations to provide services merely by being available to provide the services through" an intermediary". 14 The AAT considered that this construction was supported by what was said in Taxation Ruling 2001/8 at [174] and in the Explanatory Memorandum to the legislation which introduced the relevant provisions, where it was stated at [1.93] that an individual or personal services entity does not satisfy the condition about offering services to the public by registering with a labour hire firm or placement agency. 15 The AAT rejected the taxpayer's construction of s 87-20(2) and, in particular, his contention that the word "merely" narrows the operation of the exclusion in that provision to a situation where he or the Company does no more than offer personal services through an intermediary. The applicant contended that because his LinkedIn advertising was directed at end-user clients as well as intermediaries he was doing more than offering services through an intermediary, with the consequence that s 87-20(2) did not apply. 16 The core of the AAT's reasoning is at T[69] to [74]: 69. Section 87-20(1)(b) directs attention to the means by which the Company obtained the business of the clients: Federal Commissioner of Taxation v Yalos Engineering [2009] FCA 1569 at [4]. If the applicant's business is actually obtained through an intermediary (as opposed to coming directly from a client) then the exclusion applies because it is the conduct of the applicant advertising to the intermediaries that has caused the work to be obtained. This means that when considering whether there is a causal relationship under s 87-20(1)(b) the applicant will not be treated as having made an offer if the work obtained arose from an intermediary. The fact that the Company advertises beyond intermediaries is not relevant for the purposes of s 87-20(1)(b) because that subsection requires an analysis of how the services actually came to be provided; in this case through a contact from an intermediary "and nothing more". 70. All of the work obtained and carried out by the applicant in the two relevant years was through an intermediary. In effect, the applicant received referrals from intermediaries and allowed those intermediaries to take responsibility for obtaining and dealing with customers. This is not the conduct of a genuine business operating as an independent contractor because the clients are referred from a recruitment company which then takes responsibility for those clients by contracting with them. It would be a perverse result and be contrary to the object of Division 87 if s 87-20(2) did not operate due to the applicant's advertising beyond the intermediaries, despite that advertising having no material causative effect on the work being provided. 71. Section 87-20(2) does have work to do in this case because the Company made itself available to provide services through an intermediary by maintaining a relationship with the intermediaries often facilitated by its profile on LinkedIn. The applicant considered the intermediary as "kind of like a business partner … where we're all connected via LinkedIn." 72. Consequently, the Company is not treated as having made offers or invitations for the purposes of paragraph (1)(b). The exclusion provided for by s 87-20(2) applies such that the applicant is not treated as having made the requisite offer or invitation under s 87-20(1)(b). In other words, the applicant is deemed to have not made the offer or invitation that is required to satisfy s 87-20(1)(b) because of the involvement of the intermediary. Consequently, the applicant fails to satisfy the unrelated clients test. 73. It would be open to the applicant to satisfy s 87-20(1)(b) if he could establish that the LinkedIn advertising had been relied upon by two or more unrelated clients resulting in work for them. That situation is provided as an example in Taxation Ruling 2001/8 which says: 175. This is to be contrasted with the situation where an individual or personal services entity makes offers or invitations to the public at large (e.g. by newspaper advertisement) as well as registering with a labour hire firm. The test would be met in this case if two or more unrelated clients engaged the individual or personal services entity as a result of the advertisement. 74. The applicant does not fall within the above example because none of the clients engaged the applicant or his Company as a result of the LinkedIn advertising. Rather, the clients were engaged by the intermediary in the circumstances provided for in s 87-20(2). 17 In the event that it was wrong concerning the construction and application of s 87-20(2), the AAT then proceeded to consider and determine whether there was a causal connection between the offers or invitations and the services provided. It viewed the issue of "direct result" as requiring the taxpayer to establish a causal connection between the offers or invitations and the services provided (see at T[76]). The AAT concluded at T[78] that the evidence before it did not establish that end clients relied upon any form of advertising by the taxpayer in relation to any of the services provided under the relevant contracts and that there was no direct link between the advertising and the end clients. 18 The AAT then addressed the taxpayer's alternative contention that it was sufficient for him to establish that the services were provided as a direct result of the advertising and that the necessary causal relationship can be established by evidence of reliance on the part of either the end clients or an intermediary. The AAT found at T[82] that some of the recruitment or similar intermediary agencies contacted the taxpayer 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. As to the other three contracts, the AAT found that the services were provided as a result of the taxpayer's relationship with the relevant 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 the taxpayer. The AAT then noted at T[83] that the unrelated clients test would be satisfied if the taxpayer demonstrated that the relevant requirements were met with respect to two non-associated entities in each relevant taxation year. 19 The AAT described the taxpayer's alternative contention as having "merit because s 87-20(1)(b) does not say that the offer or invitation…from the [taxpayer] must be made to, or relied upon, by the client". Although the AAT accepted the taxpayer's alternative contention, it concluded that the fifth element in Cameron was not established. The AAT reasoned that this was because the involvement of an intermediary (namely a recruitment or similar agency) in the provision of the personal services triggered s 87-20(2) and its interaction with s 87-20(1)(b).

The applicant's submissions summarised 20 The applicant contended that his case regarding question of law 2 was "simple". It was that, having found in his favour for the purposes of s 87-20(1)(b) (citing T[59], [82] and [84]-[85]), the exclusion in s 87-20(2) no longer had a valid role to play. He said that it was wrong of the AAT to undo its favourable finding for the purposes of s 87-20(1)(b) by resorting to and applying s 87-20(2). 21 The taxpayer contended that the AAT's approach revealed the following five errors: (a) there was no warrant to construe s 87-20(2) as fundamentally modifying s 87-20(1)(b) such that if an intermediary is involved in the engagement, then the advertising is ineffective, with the consequence that even where the advertising is broader the exclusion is triggered merely because the taxpayer's services are available through an agency; (b) it was erroneous of the AAT to apply the legislation in a way which treated LinkedIn as constituting "merely by being available to provide the services through an [agency]"; (c) the AAT adopted an unduly complex analysis of how s 87-20(2) operates; (d) there are inconsistencies at T[70] and [82] of the AAT's reasons; and (e) on a proper construction of s 87-20, the exclusion in s 87-20(2) does not radically alter s 87-20(1)(b), but rather informs that provision. 22 The applicant submitted that the AAT's reasoning at T[69] and [84] was in error because: (a) s 87-20(2) only concerns itself with the offers or invitations to provide services and is not concerned with the provision of services or any causal connection between the offers/invitations and the provision of services; (b) s 87-20(2) is not engaged to modify the prima facie result under s 87-20(1)(b) where an individual or personal services entity makes offers or invitations which go "beyond intermediaries"; (c) s 87-20(2) is engaged where the individual or personal services entity is only available to provide services by being "registered" with an intermediary and does not advertise more broadly; and (d) there is no requirement to address causal connection under s 87-20(2) itself because that issue arises under s 87-20(1)(b). 23 The Court was informed by the applicant's counsel that both parties accepted that the advertising described by the taxpayer was made to both the intermediaries and end clients.

The Commissioner's submissions summarised 24 The Commissioner did not dispute the five elements of s 87-20 as identified in Cameron. He also accepted that the first three elements were not controversial in this case and that the fourth element (the existence of advertising) was determined by the AAT in the taxpayer's favour (although there may be some tension between this submission and what appears in T[75]). The Commissioner emphasised, however, that the fifth element was found by the AAT not to have been established on the evidence before it, in circumstances where the taxpayer failed to call as witnesses any representative of the clients to support his claim that his roles with them came about as a direct result of his LinkedIn advertising. 25 The Commissioner supported the AAT's construction of s 87-20(1)(b), such that if the taxpayer's advertising is directed at recruitment agencies/labour hire/personnel firms the advertising does not count for the purposes of satisfying s 87-20(1)(b). Similarly, the Commissioner said that s 87-20(2) informed both the fourth and the fifth elements of Cameron. 26 But even if the AAT erred in its construction of the relevant provisions, the Commissioner submitted that the end result would remain the same because the AAT found that the requisite "direct result" was not established because of the absence of a causal connection between the LinkedIn profile and the applicant or Company securing the eight contracts. In oral address, Ms Clark for the Commissioner, submitted that the Court had to grapple with the question whether a direct result can be established in circumstances where the advertising attracts a recruitment or labour hire firm, but does not attract the end client. She did not deny that there was evidence of end client representatives looking at the taxpayer's LinkedIn profiles but she submitted that the evidence did not support a finding that the profiles were "a driver for the end clients". 27 The Commissioner submitted that the taxpayer and the Company were chosen by the end client because they had been put forward by the intermediary. The Commissioner relied upon the AAT's reasoning at T[77] to [78], under the heading "Direct link between the advertising and the client?", where the AAT found that the evidence did not establish that the end clients relied upon any form of advertising by the applicant in relation to any of the services provided under the eight contracts, with the consequence that there was no direct link between the advertising and the end clients. The Commissioner contended that, to establish the unrelated clients test, a causal connection had to be shown between the advertising and the provision of the personal services to the end client. To satisfy the "direct result" requirement it was insufficient to show that the advertising merely attracted the intermediary. The Commissioner submitted that T[82] should be read as a finding by the AAT that there was a connection between the advertising and the intermediary, but that the AAT never found any causal connection between the advertising and the end clients, a reading which he said was confirmed by T[78]. As the taxpayer pointed out, none of these matters was raised by the Commissioner by way of notice of contention. This may not have any particular significance in a proceeding such as this. 28 The Commissioner accepted that there was evidence that some of the end clients may have looked at the taxpayer's LinkedIn profile by way of confirmation that they should progress his engagement to provide services through the intermediary company. But it was submitted that this did not establish the relevant causal connection. The Commissioner submitted that while the taxpayer's intention in maintaining his LinkedIn profile may have been to advertise beyond recruitment agencies, the evidence did not establish that any of the personal services he provided under any of the eight contracts resulted from a causal connection between the advertising and the end clients' decisions to retain his personal services. The Commissioner accepted that the position would be different if, for example, an end client was influenced by the taxpayer's advertising to engage his services but then was told that the only way that this could occur would be via an intermediary or recruitment agency. Ms Clark submitted that "when looking for a direct result it has to be something more than a side exercise of checking the profile after somebody has already been either recommended or short-listed". 29 Accordingly, the Commissioner submitted that if the Court found that the AAT had misconstrued s 87-20(2) and its interaction with s 87-20(1)(b), the matter should not be remitted to the AAT for rehearing as sought by the applicant. The Commissioner urged the Court to use the AAT's factual findings and dismiss the appeal on the basis that any error of construction is immaterial.

Analysis and determination 30 I consider that the AAT misconstrued s 87-20(2) and misapplied its interaction with s 87-20(1)(b). In my view, the exclusion or exception in s 87-20(2) has no application where, in a case such as this, there is evidence that the taxpayer (or Company) advertises his services to the public or a segment thereof through a forum such as LinkedIn, and also obtains work through the involvement of a recruitment or other similar intermediary company. In my respectful view, the AAT's error is especially evident in T[69] of its reasons for decision. Although the AAT accepted that the LinkedIn advertising constituted an offer or invitation to the public to provide the taxpayer's personal services, it viewed as fatal to the taxpayer's case that the taxpayer's work came through a recruitment or similar intermediary agency. This gives too broad a meaning to the term "merely" in s 87-20(2). In my view, that provision is not engaged in circumstances where there is evidence that the taxpayer or personal services entity advertises to the public or a part thereof (including via LinkedIn), and is also available to provide personal services through a recruitment or other similar intermediary agency. 31 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. 32 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. I reject the Commissioner's submission that s 87-20(2) informs the whole of s 87-20(1)(b) and not just the advertising component of it. 33 In my respectful view, for these reasons the AAT adopted too broad a view of the meaning and effect of s 87-20(2) of the 1997 Act. 34 For the appeal to succeed, however, the applicant must demonstrate that the AAT's error of construction was material to its ultimate decision to dismiss the application for review. I now turn to address that question. 35 The Commissioner challenged the AAT's acceptance at T[84]-[85] of the taxpayer's alternative contention in the AAT that it is sufficient for the unrelated clients test that services provided to the end client are a result of the intermediary being influenced by the advertising (as opposed to the end client). As noted above, however, the alternative argument did not ultimately prevail below because the AAT said that the intermediary's involvement engaged s 87-20(2). Thus, the AAT repeated the same error concerning the meaning and effect of s 87-20(2) in considering the taxpayer's alterative argument, which error also infected its reasoning at T[59] and [69] to [74] concerning the fourth element in Cameron. It erroneously viewed that provision as being engaged simply and only because an intermediary was involved in the retention of the taxpayer's services by the end client, the intermediary being a recruitment or similar agency. For the reasons given above, the AAT erred in adopting and applying this construction. 36 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". 37 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] 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] above). 38 Nor do I consider that this is an appropriate case for the Court itself to resolve the issues which remain in dispute, relying on s 44(7) of the Administrative Appeals Tribunal Act 1975 (Cth). As is evident from my summary of the Commissioner's submissions at [25] to [28] above, the issues are not straightforward and there is also uncertainty as to the extent to which the misconstruction may have affected the AAT's fact finding. The AAT is the primary finder of fact and it is appropriate that the matter be remitted to it for further reconsideration according to law and in the light of any further relevant evidence which the parties might seek to adduce. 39 The AAT's decision should be set aside and remitted to it for reconsideration according to law. The Commissioner must pay the applicant's costs, as agreed or assessed.

Conclusion 40 For these reasons, the appeal will be allowed, with costs. The AAT's decision will be set aside and the matter remitted to it for reconsideration according to law. I certify that the preceding forty (40) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Griffiths.

Income Tax Assessment Act 1997(Cth)ss 87-15, 87-20

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