This article outlines the proposed changes to the income tax treatment of income earned by famous individuals, as well as considerations to be mindful of in planning your tax affairs if the Draft Determination applies to you.
Income tax for famous individuals and public figures
Income tax for famous individuals has been somewhat unclear in recent times following the previous Federal Government announcing a change to the law, which was not enacted before the election.
The release of Draft TD 2022/D3 (Draft Determination) in October 2022 throws another spanner in the works for affected individuals, but does provide some insight into the ATO’s intentions. The Draft Determination appears to marry the tax treatment of income directly attributed to an individual’s fame to legal concepts, departing from the previous Safe Harbour approach.
What does the Draft Determination mean for you?
In this article, we outline the proposed changes to the income tax treatment of income earned by famous individuals, as well as some considerations to be mindful of when planning your tax affairs if the Draft Determination applies to you.
A brief history of income tax for famous individuals prior to the Draft Determination
The 2018-19 Federal Budget papers released in May 2018 announced the Federal Government’s intention to tighten income tax for famous individuals, specifically preventing such individuals from licencing their fame or image to a related entity. This measure was announced with the intention of all remuneration earned in relation to an individual’s fame or image being included in the assessable income of that individual. Further to this, Treasury released a consultation paper titled ‘Taxation of income for an individual’s fame or image’. The consultation paper announced arrangements to apply from 1 July 2019, with responses to this paper forming the basis of Exposure Draft Legislation which was never released.
The ATO also withdrew PCG 2017/D11 (the PCG) which applied to provide a Safe Harbour threshold for famous sportspeople who entered into arrangements whereby related entities were deriving assessable income in relation to the exploitation of their fame or image. This Safe Harbour provided that a maximum of 10 per cent of assessable income derived from such sources could be included in the assessable income of an associated third-party entity. The PCG was withdrawn in August 2018.
The Draft Determination applies to situations where a famous individual establishes a related entity (typically a trust or company) and enters into an agreement which allows the entity to use the individual’s fame. The entity then contracts with third party businesses, allowing those businesses to use the individual’s fame or image for commercial purposes. For example, for inclusion on product packaging or billboard advertisements.
Arrangements to which the Draft Determination does not apply
The Draft Determination specifically does not apply to income derived from the provision of services, the carrying on of a business, and to fees earned by a related entity in relation to the exploitation of intellectual property including copyright, trademarks, registered designs. This exclusion should cover public speaking and appearances, commentary, professional service engagements and business activities involving the sale of goods and services. However, there may be other tax rules to consider in these cases, including the personal services income rules and the general anti-avoidance rules in Part IVA.
Marketing and promotional activities using an individual’s images alone, with no service or value-add component
Individuals deriving income from marketing activities stemming from their fame or image alone would be well advised to review their situation. The ATO is targeting situations in which a taxpayer’s fame alone (name, image, likeness etc) is used for promotional or other purposes whereby a related third-party entity is licenced to exploit the individual’s fame and charges a third-party business for the right to use the fame or image.
An example of this may be a fee in relation to to the authorised use of an individual’s image on product packaging or on a billboard. In these situations, the Draft Determination notes the legal position that an individual has no property in their fame. The ATO considers that this precludes a related entity from being able to be granted a licenced to use that fame, as it is inseparable from the individual. The withdrawn PCG previously allowed up to 10 per cent of total assessable income derived from such sources to be included in the assessable income of the related entity. The Draft Determination notes that all income derived from such sources is to be included in the individual’s income tax return, removing the possibility of income splitting and other tax planning opportunities.
Famous individuals are often engaged to provide services in a range of forms, including making public appearances, speaking, commentary services, coaching, or professional services. While the Draft Determination does not apply to these arrangements, there are other tax considerations to take into account.
Where a famous individual provides services to a third-party business under a service agreement with a related entity, these arrangements may fall within the remit of the Personal Services Income (PSI) rules in Part 2-42 of the Income Tax Assessment Act 1997, subject to not being able to satisfy any of the PSI tests. Where the services are deemed to be PSI, the net income from these activities is attributable to the individual and is included as assessable income in their income tax return.
Where the PSI rules don’t apply to such service arrangements, consideration should be given to the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936, which applies to arrangements enteredwith a principal purpose of obtaining a tax benefit.
Where taxpayers look to engage in income splitting (whereby net income earned from business activities is distributed by a discretionary trust to an individual being taxed at a lower marginal tax rate than the famous individual), the ATO may seek to apply Part IVA depending on the circumstances.
Where the Commissioner applies Part IVA, any assessable income not included in the famous individual’s income tax return may be included, in addition to penalty tax which is usually 50 per cent of the tax avoided (although this rate can be increased or decreased in certain circumstances).
Exploitation of intellectual property
The Draft Determination does not apply where a related party entity of a famous individual generates and exploits its intellectual property (IP). Where income is derived by a related party entity in these situations, any income derived should remain the assessable income of the related party entity.
Caution should be exercised when entering these arrangements, particularly where intellectual property is assigned or transferred from an individual to a related entity. The market value substitution rule may apply in these circumstances, to substitute the market value for the transfer consideration, resulting in a potentially taxable capital gain in the hands of the individual at the time of transfer. Where an alternate assignment or other scheme is entered into with a dominant purpose of tax avoidance, the ATO may also seek to apply the general anti-avoidance rules in Part IVA as outlined above.
What does this mean in practice?
For famous individuals who are parties to arrangements in which their fame or image is licenced to a related party entity, planning for compliance with the Draft Determination’s approach is recommended. The Draft Determination notes that the ATO will not seek to apply the methodology set out in the Draft Determination to assessable income derived prior to 1 July 2023, so long as:
- The agreement had not been entered into prior to the Draft Determination’s release date of 5 October 2022, and
- The arrangement had been carried out in good faith and in accordance with the guidance set out in the PCG.
While not captured by the Draft Determination, clients engaged in service arrangements, exploitation of IP, or other business activities carried on via a related entity need to continue to be wary of the potential application of the PSI rules and Part IVA to these arrangements.
ATO scrutiny has increased in recent times, particularly in relation to income splitting arrangements. Taxpayers would be well advised to review their arrangements, regardless of whether the Draft Determination is directly applicable, for peace of mind.
Our business services team has extensive experience in this area. If you would like to discuss the above further or think it is relevant to your affairs, please reach out to your local BDO adviser.