Working for yourself? Personal Services Income Rules May Apply
Personal Services Income (PSI) is income produced mainly from your personal skills or efforts as an individual, regardless of your business structure.
Where a business is caught by the PSI rules:
- income within the so-called interposed entity can be attributed back to the individual taxpayer
- the range of deductions available is limited to those typically available to individuals
In short, if you fall into the scope of the PSI rules, the ATO looks past whatever business structure you have in place and treats you as an individual for tax purposes.
The PSI rules were introduced to prevent the shifting or splitting of income with other individuals or entities in an attempt to pay less tax. This may occur when the services of an individual are provided through a business entity (company, partnership or trust) rather than directly by the individual who performs the services.
What income is classified as PSI?
Income is classified as PSI when more than 50% of the amount you received for a contract or job was for your labour, skills or expertise.
If more than 50% or more of the income received for a contract was for your labour, skills or expertise then all income for that contract is classed as PSI. You will then need to work out if you are a Personal Services Business (PSB).
If 50% or less of the income received for a contract was for your labour, skills or expertise, then none of the income for that contract is PSI and there are no changes to your tax obligations.
What happens if your income includes PSI?
If you’ve worked out that your income includes PSI, your next step is to work through the Results Test to determine if you are a Personal Services Business. If you are a PSB, the PSI rules won’t apply to the PSI you’ve received. This means there will be no significant changes to the way you are taxed.
If you’re not a PSB, the PSI rules will apply and deductions you can claim on that income will be limited. For sole traders, companies, trusts and partnerships you won’t be able to claim the following:
- rent, mortgage interest, rates or land tax for your home (or an associate's home)
- payments to your spouse, or other associate, for support work such as secretarial duties
- expenses that you would generally not be able to deduct as an employee
Working out if you qualify as a PSB
You qualify as a PSB if you pass the Results Test. The Results Test is about the nature of your agreement to perform the work, including the basis on which you are paid. If you pass the test, your business is a PSB for that income year and the PSI rules don’t apply.
To pass the results test in an income year, you need to meet the following three conditions:
- You were paid to produce a specific result
- You were required to provide the equipment or tools needed to perform the work
- You were required to fix any mistakes at your own cost
You may find that some of your contracts meet the three conditions of the test and some don’t. To pass the results test, you need to meet all three conditions for at least 75% of the PSI.
If you don’t pass the Results Test, you may still qualify as a PSB
If you are not able to satisfy the Results Test, there are three other tests available to you to qualify as a PSB. However, these rules are only applicable to you if less than 80% of the PSI you have earned comes from one particular source. This is known as the 80% Rule.
You’ll need to work out the amount of PSI that comes from each of your clients (including their associates) in an income year.
If more than 80% of your income is from one client, the 80% rule is not passed and the PSI is all attributed to you as an individual and assessed at your marginal tax rate. The only remaining option for you to be classed as a PSB is to apply to the ATO for a PSB determination.
You satisfy this test because each of your clients provide less than 80% of the total PSI. You may qualify as a PSB if you can then pass any one of the following tests:
- The unrelated clients test
- The PSI income was earned from two or more unrelated clients
- The employment test
- At least 20 per cent of the income earned was generated from work done by employees of the business or other contractors
- The business premises test
- The business is operated from premises that are used exclusively by the business, the premises are separate from the owner's home, and the premises are physically separated from that of clients
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