Ever walked into an accountant’s office hoping to get some tax advice about distributing some business income to your spouse or children but were told that it is not possible as you are earning ‘Personal Services Income’?
What is Personal Services Income?
Personal Service Income (PSI) is income produced via your personal skills or efforts as an individual. It is not something that is derived through the sale of goods. Income is classified as PSI when more than 50% of the amount you received is for your labour, skills or expertise.
You can receive PSI in almost any industry, trade or profession. Some common examples are medical practitioners, finance professionals, information technology consultants, engineers, architects, lawyers, etc. since their income derived comes from their personal skill or expertise.
Note: PSI does not affect you if you’re an employee receiving only salaries and wages. But, if you are operating through an entity, such as a company, partnership or trust, and are an employee of that entity then the PSI rules may still apply.
Why are there tax rules aimed at PSI?
This is to improve integrity and equity in the tax system. PSI rules aim to treat individuals who are earning income derived from their personal exertion the same way that an employed individual would be treated, i.e. in the hands of the individual deriving it. Accordingly, it also limits the deductions that you can claim.
Common Errors Relating to PSI
Some common errors relating to PSI rules include:
- making payments to your spouse, or other associates, for non-principal work, such as, secretarial and administrative duties
- expenses that you would generally not be able to deduct as an employee eg. occupancy expenses for home office
Tests to Determine Whether PSI Rules Apply
The main tests to determine if PSI rules apply are:
Step 1: Have you received PSI? – Look at each separate contract. Then calculate what percentage of income from each contract was for:
(a) your labour, skills, knowledge, expertise or efforts for the services you provided
(b) anything else, such as the materials supplied or tools and equipment used to complete the project.
If more than 50% of the income received for a contract was for your labour, skills or expertise, then all income for that contract is PSI.
Step 2: Results Test: To pass the results test, you need to determine whether you are:
- Paid to produce a specific result
- Required to provide the equipment or tools
- Required to fix mistakes at your own costs
Step 3: 80% Rule: If you’ve worked through the results test but did not pass, your next step is to apply the 80% rule. If 80% or more of your PSI comes from just one client, then the PSI rules apply. If your PSI from each source is less than 80%, you can proceed to the remaining self-assessment tests in Step 4.
Step 4: 3 different tests are to be applied.
Unrelated Clients: This involves determining whether or not you provide your services to 2 or more unrelated entities and whether or not you provide your services as a direct result of advertising to the general public.
Business Premises Test: This requires your work premises to be owned or leased exclusively by you; to be used for personal service work more than 50% of the time, and to be physically separate from your residence and clients premises.
Employment Test: This involves determining whether you have employees, contractors or partners performing at least 20% of the principal work.
If you meet one or more of these tests, your PSI is taken to be generated in the course of conducting Personal Services Business (PSB), and the PSI rules will not affect your tax obligations. If the Personal Services Income is paid to your company, partnership or trust, rather than to you directly, then the entity is your personal services entity.
You also have an option to get a Personal Services Business determination if you do not pass the above tests due to circumstances beyond your control.
What does it mean to conduct a PSB?
If you are conducting a personal services business, PSI rules do not apply. This means you can pay market rate for non-principal work to an associate and claim a deduction (ie. employ family members at market rate and pay them wages and superannuation.)
In theory, income from personal services businesses can be split with associates. However, be aware that where personal exertion income is split inappropriately with associates, the ATO is likely to consider this to be tax avoidance and ignore any tax benefits obtained.
ATO requires that the PSI earned is paid to the professional who did the work after payments of reasonable salary and superannuation contributions for an associate and other genuine business expenses.
What is the alternative option?
The alternative is to change your PSI/PSB into business income.
This may involve hiring employees who will contribute more than 50% of the business’s total income (ie. income earned by the principal is now reduced to less than 50%).
Disclaimer: This blog post has been simplified to cover some key points of PSI and PSB. This should not be construed as advice from Glint Accountants. There are many other factors to be considered and each person’s situation is unique. Therefore, we encourage readers of this blog post to contact Glint Accountants for assistance with their specific situation.
Geraldine Lee is a Fellow of CPA Australia. Contact us at Glint Accountants for assistance with your PSB Determination application or for tax advice regarding your PSI situation.