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What is Personal Services Income?
Personal Services Income (PSI)
Personal services income or PSI is defined under S 84-5 ITAA 1997 as any income resulting mainly from an individual’s personal effort or skills. It does not include any income received from the sale of goods or use of assets. You can receive PSI in almost any industry, trade or profession, Income is classified as PSI when more than 50% of the amount you received for a contract was for your labour, skills or expertise.
PSI Regime
PSI regime came into effect when it became common to use business structures to distribute income from the person that derived that income to family members etc to achieve lower tax rate. Personal services income regime prevents the individual earning PSI to reduce their tax liability by channeling funds to others or by claiming business deductions. Once we have ascertained that the income received is PSI, the question becomes whether the individual circumstance mean the operator is conducting a Personal Services Business or whether they are in fact subject to the PSI Rules.
Personal Services Business (PSB)
TR 2001/8 provides detailed information on what constitutes a PSB.
Results Test
You will satisfy this test if you can answer yes to all the questions for at least 75% of the income–
- under your contract or arrangement, will your business only receive payment when the work has been completed, that is, after producing the contracted result?
- Does your business need to provide the equipment or tools necessary to do the work?
- Do you have to rectify defects in the work or is your business liable for the cost of rectifying defects?
This test looks at the fact that whether you get paid to achieve a defined outcome or not. For example, a carpenter who is contracted to build a kitchen for a certain price. It is a fixed price for a fixed outcome. It doesn’t matter whether it takes the carpenter a week to finish or 2 days. He is being paid to achieve a particular outcome.
The same carpenter who is engaged on a daily or hourly rate is not dependent on achieving a certain result to receive their income, this does not satisfy the results test. Generally, most contractors in professional services like IT, Project management get paid a daily/hourly rate and as such they do not pass the results test
If your PSI does not satisfy the Results test, then you need to pass the 80% rule and one of these three tests:
- The Unrelated Clients Test,
- The Business Premises Test, or
- The Employment Test..
Other Tests
If your PSI does not satisfy the Results test, then you need to pass the 80% rule and one of these three tests:
- The Unrelated Clients Test
- The Business Premises Test
- The Employment Test
The Unrelated Clients Test is satisfied if the business provides services to 2 or more clients who are not associates of each other or associated with the key individual. If you are engaged through a labour hire firm and not directly then the unrelated clients will not be satisfied. Under subsection 87-20(2), you do count clients obtained by listing your name with a labour hire firm, placement agency or similar organization because you are not treated as having made offers or invitations to the public. Activities that are considered to be making offers includes Public tender, Advertising, word of mouth referrals, maintaining an internet website on which availability of services are advertised
The Business Premises Test is satisfied if at all times of the year the business premises are used solely for the operation of the business and are not connected in any way to the residence of the individual performing the services.
The Employment Test is satisfied where more than 20% of the income generated can be attributed to the activities of an employee who is not an associate of the key individual. Alternatively, to this if an apprentice was employed for more than 50% of the year, the employment test can be satisfied.
80% Rule
The 80% Rule is satisfied if not more than 80% of your income comes from one source or associated entities If it is more than 80% of your income, then you need to have a personal services business determination in force or the alienation of PSI measure will apply.
Impact of PSI Rules
However, if you apply these rules to your situation and conclude that the PSI Rules apply, the impact is as follows.
- Your business cannot claim certain deductions against the PSI, you are basically limited to deductions available to an individual tax payer. Such things as paying a salary to a spouse for administrative support, and making superannuation contributions for them is no longer an available deduction,
- The PSI (less relevant deductions) your business received will need to be attributed (treated as belonging) to each individual who performed the services – that is, the profits can’t be retained in the business,
- Your business needs to meet certain tax return obligations
- Your business may have additional pay as you go (PAYG) withholding obligations.
If on the other hand you run the tests over your business and conclude that, due to the Unrelated Clients test and the 80% rule, you are operating a Personal Services Business, the PSI Rules do not apply and you avoid the extra requirements outlined above. Even if you pass the tests and are conducting a PSB, you are still required to disclose that in the income tax return.
ATO Scrutiny
The ATO maintains a high level of scrutiny regarding how you manage your Personal services income through your business.
Conclusion
Even if you pass the tests and are conducting a PSB, you are still required to disclose that in the income tax return. The ATO may apply anti-avoidance rules if you have entered into an arrangement where the main purpose is to obtain a tax benefit.
If you have any questions or would like more information, don’t hesitate to book an online appointment or contact us. Our team of experts is here to help.
