If you’re working for yourself, then it’s important you know whether ATO personal services income or PSI rules apply to the money you earn.
Since these rules affect the way you report your PSI and the business deductions you can claim, not following them when you should could lead to incorrect returns being filed and underpayments of tax, which could expose you to tax penalties.
To help you build knowledge and recognise when you might need expert advice, we’ll take you through a few key items including what qualifies as PSI and when these rules apply.
Are you earning PSI?
You’re earning PSI if you’re paid mainly for your skills, efforts or expertise. Common PSI examples include money received by contractors and consultants in finance, IT or medical professions – however PSI may be relevant to many other industries as well.
Of course, when you’re paid for the work you’ve done, the amount you receive might cover other things in addition to your labour or skill. But if more than 50% of the payment relates to your personal exertion, then entire income is classified as PSI.
On the other hand, if more than 50% of the income received relates to other things such as materials, supplies and/or equipment, then the entire amount received would not be treated as PSI.
To work out if your income includes any PSI, you’ll have to separately assess every contract or job you had during the tax year in the way described.
Income specifically excluded from PSI
ATO specifies three types of income that are not classified as PSI. These include gains from:
● supplying or selling goods and products
● an asset rather than your skill or effort
● a business structure with substantial assets or employees
While some circumstances are relatively straightforward, deciding whether your income is generated by a business structure can be complex and the advice of an accountant such as POP Business can help you to move forward with confidence.
You have earned PSI, but do the PSI rules apply?
At this point, we want to explain why PSI rules exist in the first place because not all personal services income will be subject to these rules.
Essentially, PSI rules prevent individuals from operating as a company, partnership or trust for the sole purpose of reducing or deferring income tax. PSI doesn’t affect employees receiving only salaries and wages.
Depending on your circumstances, company tax rates can be more favourable than individual tax rates, and some business structures could allow operators to divert their income to a spouse who pays tax at a lower rate.
This is where PSI rules come in. They are designed to discourage individuals from using a business structure solely for tax benefits.
Now, if your income includes PSI, there are a number of tests you can use to establish whether PSI rules apply to your income.
Personal services income results test
The first test is the results test. This requires you to look at the agreement you have in place for the work performed. You pass this test when you’re:
● Paid to produce a specific result
● Required to provide your own equipment and tools
● Required to fix mistakes at your own cost.
PSI rules do not apply if you pass the results test.
If you don’t pass the results test, then you move on to the 80% rule.
The 80% rule
The second personal services income test involves checking whether 80% or more of your PSI comes from the same client. If this is the case, then the PSI rules apply.
However, where less than 80% of your PSI comes from one client, you can move on to the remaining tests.
Remaining tests
If you pass any of the following tests, then the PSI rules won’t apply to your personal services income.
● Unrelated clients test: Does your income from two or more unrelated or unconnected clients? And were you engaged for the work because you make offers to the public? You must answer yes to both to pass this test.
● Employment test: If your business employs or contracts someone to do at least 20% of the principal work that generates your PSI, then you pass the employment test.
● Business premises test: To pass this test, for the whole tax year, your business premises must have been used mainly for personal services work and used exclusively by your business. It must also be separate from your home and your clients.
When PSI rules apply
If you didn’t pass any of the above tests, then PSI rules apply to your personal services income.
The effects of PSI rules depend on whether you operate as a sole trader or through a company, partnership or trust.
Sole traders will need to complete the personal services income question in their tax return. Some deductions are also disallowed, like payments to a spouse or associate for support work for example.
Apart from not being able to claim certain deductions, those who operate through a company, partnership or trust will have to bear in mind the following:
● Attributed personal services income. The PSI will need to be attributed or allocated to the individual who performed the work. This may attract additional PAYG withholding obligations. The individual will also have to declare the PSI on their personal tax return.
● Tax return obligations. Your business will need to answer Business Income and Personal Services Income questions on your tax return
When PSI rules don’t apply
If you passed any of the above tests and PSI rules don’t apply to your personal services income, then your business is a Personal Services Business or PSB.
As a PSB, there are no changes to the deductions you can claim against your PSI, but you’ll still have to report PSI on your tax return.
Additionally, any profits derived from PSI must still be attributed to the individual who performed the service.
Final thoughts
PSI is a complicated tax area that can cause headaches, especially if you’re just starting out as a consultant or contractor in an industry commonly affected by these rules.
Even if you’ve already started working for yourself, getting advice from an expert such as POP Business will be worthwhile, as our professionals can work with you to ensure you’re operating with the most tax efficient structure. We can prepare or review your tax return as well to ensure that it’s accurate. Contact POP Business today!
