If you’re a professional offering your services in return for payment, then your earnings may be subject to Personal Services Income (PSI).
According to the Australian Tax Office (ATO), PSI is income rewarded for a person’s skills, efforts, labour and expertise – rather than for the selling of goods.
As an individual, it’s your responsibility to determine if any of your income is classified as PSI, and fulfil your tax obligations accordingly.
Thankfully, the ATO has established four step to help you decide whether or not you have received personal services income or whether you’re running a personal services business.
Here’s what you need to know
What is Personal Service Income (PSI)?
If you operate within a company, partnership or trust as an employee and perform a service using your personal skills and expertise to generate income, that entity is then known as a personal services entity.
When more than half of your income is a reward for your services rendered thanks to personal skill, it will be classified as PSI. Your company will transfer the income tax liability from the personal services entity to you because you personally performed the work.
You will be paid these funds (after certain deductions) and must then declare the PSI in your income tax return.
Steps to Determine PSI Obligations
The following four steps will help you identify what your tax obligations based on the type of income you earn.
Step One: How to Work Out if You’ve Received Personal Services Income (PSI)
If you have received more than 50% income from a contract by performing labour using your skills or expertise, you will have received Personal Services Income.
If you are an employee that generates an income consisting of a salary or wages by using assets, selling goods or through a business structure such as retailing, wholesaling or manufacturing, PSI won’t apply to you. There won’t be any differences in the normal tax rules.
Common occupations that fall under PSI include:
- construction workers,
- engineers,
- financial professionals,
- IT consultants, and
- medical practitioners.
If you have received PSI, proceed to step two. Otherwise, the rules of PSI do not affect you, and your tax obligations are unaffected.
Step Two: How To Do the Results Test
The results test consists of three different questions regarding income for the financial year.
If you are able to answer yes to all three questions regarding at least 75% of your PSI, you are considered a Personal Services Business (PSB), and PSI rules won’t apply to that income.
Question One
According to the contract or arrangement between your client and yourself, do you receive the payment agreed upon prior once you have completed the agreed-on work? Generally, this doesn’t apply if you submit timesheets or are paid regardless of achieving a specific objective or outcome.
Question Two
Do you provide the tools or equipment necessary to perform and complete your work?
Question Three
Are you responsible for rectifying any mistakes or defects, and are you liable for those costs? If you invoice for fixing the mistakes you make, your answer is no.
If you answered no to any of these questions, you aren’t considered a Personal Services Business and must proceed to step three.
Step Three: How the 80% Rule Works
The 80% rule in the results test is to do with whether more than 80% of your Personal Services Income comes from the same client.
In this case, the rule also applies if the income comes from a client and one of their associates.
So, if your PSI is generated 75% from one company and 25% from a different company, you can proceed to step four.
But, if you received 40% of your PSI from one company and 40% from one of their associates, they fall under the same umbrella, and PSI rules apply. You can skip step four and move on to how PSI rules work.
Step Four: Do You Pass the Remaining Three Tests?
The last three tests are the Unrelated Clients Test, the Business Premises Test and the Employment Test.
If you satisfy any one of these tests, you don’t need to continue the tests as the PSI rules don’t apply. If you fail a test, move on to the proceeding one.
The Unrelated Clients Test
Does your business provide services to at least two clients who aren’t in any way associated with each other?
The Employment Test
Do your employees, contractors or partners complete at least 20% of the work your clients are paying you for?
The Business Premises Test
Is your business premises used 100% of the time for the business operations?
Being connected to your home in any way or being shared with another business is considered not to be 100% for business operation.
Example:
Jade is employed as an engineer operating through a business that services three separate clients.
Jade’s personal skills and expertise generates more than half of the business’ income. Therefore, the income is regarded as PSI.
But, Jade bills her clients per hour. She has calculated that 84% of her PSI is from Client X, and as a result, the PSI received by her personal services entity is accredited back to her.
The company then transfers the income tax liability to Jade, and she becomes responsible for declaring the income she receives on her individual tax return.
What Happens When Personal Services Income Rules are Applicable To You?
There are certain tax deductions you can’t claim against your PSI if you’re a sole trader. But, you are still able to claim deductions for other income earned according to the ATO.
If you operate through a company, partnership or trust and receive PSI and you received PSI as well as other income, your expenses must be appropriately divided between the two income categories.
If PSI has been produced by more than one person in a company, those Personal Services Income deductions must be attributed to each of the individuals who worked for it and will be seen as their individual income thereafter for tax purposes.
If you receive a PSI income and the rules apply to you, you cannot claim for:
- Rent
- Mortgage interest
- Rates or land tax for your home
- Payments to your partner, spouse, or another associate for work such as secretarial duties
- Any other expenses employees are unable to deduct.
Things that you can claim include:
- Advertising
- Registration and licensing fees
- Insurance
- Super contribution
- Home office running expenses such as heating or cooling
- Depreciation of income-producing assets
- Bank keeping fees and expenses
- Tax-related expenses
Key Takeaways
You can complete the four-step test to determine whether you’re running a Personal Services Business:
- Work out if you’ve received Personal Services Income
- Perform the results test
- Calculate whether 80% of your Personal Services Income is generated from the same client
- Do the unrelated clients test, employment test and business premises test.
If you determine that you are earning PSI, your company will transfer the income tax liability from the personal services entity to you because you personally performed the work.
If you need help meeting your tax and PAYG Withholding obligations, or even just with taking the tests and determining whether the PSI rules apply to you or not, contact KNS Accountants today, and our specialist business and tax advisors can assist you in ensuring your compliance.
FAQs
What Is ATO Personal Services Income?
ATO Personal Services Income (PSI) refers to income that is primarily earned by an individual for their personal efforts, skills, or expertise in a particular field.
The Australian Taxation Office (ATO) defines PSI as the income derived from the individual’s personal services rather than from the sale of goods or the use of income-producing assets. If you are a professional or contractor who provides services and your income is mainly for your labour, skills, or expertise, it is likely classified as PSI by the ATO.
What Is the 80% Rule for Personal Services Income?
The 80% rule for Personal Services Income (PSI) is a guideline set by the ATO to determine if the PSI rules apply to your income. If more than 80% of your PSI comes from one client, including their associates, the PSI rules will apply to you.
This rule is part of the results test, which helps to ascertain if you are operating a Personal Services Business (PSB). If you do not meet the 80% rule, you may need to look at the other tests to determine if the PSI rules apply to your income.
What Is Personal Services Income Vs Sole Trader?
Personal Services Income (PSI) and sole trader status are related but distinct concepts. PSI is income earned primarily from your personal labour or skills.
A sole trader is a business structure where an individual runs their business as the sole owner. As a sole trader, you may earn PSI if the income is mainly for the work you personally do. However, not all sole traders earn PSI, as some may earn income from selling goods or using business assets to generate income, which does not classify as PSI.
Am I Personal Services Income or Business Income?
Determining whether you have Personal Services Income (PSI) or business income depends on the nature of your earnings. If more than 50% of the income you receive from a contract is for your personal efforts, skills, or expertise, it is likely PSI.
On the other hand, if your income is generated through a structured business that sells goods, employs other people, or utilizes business assets, it may be considered business income. The ATO provides a series of tests to help clarify your situation, including the results test, the 80% rule, and others.
What is a Personal Services Business?
A personal services business (PSB) is an incorporated business that relies heavily on an individual’s skills and reputation to generate income through providing services to clients. Unlike a regular business, a PSB has little capital investment or other employees.
The success of a PSB depends on the key person providing services based on their personal abilities. Making a personal services business determination is important for tax purposes, since PSB income may be taxed at personal tax rates rather than lower corporate rates.
A PSB contracts with clients to supply the unique skills of the owner-individual, rather than services of the business itself. Distinguishing a PSB helps establish how its income should be taxed.
Disclaimer
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to contractors and small businesses. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal or tax advice. You should, where necessary, seek your own advice for any legal or tax issues raised in your business affairs.
