FAQ: What Is Personal Services Income And Do I Earn Any?

I have lost count of the times someone has set themselves up with a company or trust, as a contractor or as an individual, only to be bitterly disappointed when I tell them that all of the benefits of having a company or trust don’t apply to them. The tax act is full of exceptions and conditions, and the rules around personal services income and personal services businesses are just two of them.

What is personal services income?

Personal services income, also referred to as PSI, is income mainly produced from your personal skills or efforts as an individual. Income is classified as PSI when more than 50% of the amount you received from a contract was for your labour, skills or expertise (as opposed to materials and supplies to complete the contract). Some common examples of industries where PSI might be received are:

• Financial professionals

• Lawyers

• Information technology consultants

• Engineers

• Medical practitioners

• Construction workers

What does it mean to have personal services income?

There are two main consequences of receiving personal services income. Firstly, you are limited in what you can claim as a tax deduction and secondly any net income after paying wages must be included as taxable income in your personal tax return.

Limited tax deductions

The PSI rules do not allow anyone earning PSI to claim a tax deduction for any of the following expenses:

• Rent, mortgage interest, rates or land tax from your home (or associate’s home). You only have the same home office expenses allowed as an employee would

• Payments to your spouse, or other associate, for support work such as secretarial or bookkeeping duties

• Expenses that you would generally not be able to deduct as an employee. Our resource What can I claim? for employees might provide you with some inspiration as to what you can claim at tax time.

Attributing PSI

The attribution rules work so as to include any profit remaining in your company or to prevent any trust distribution going to anyone else but you. Your business is essentially required to pay any profits out as a wage/directors fee/bonus to you. You therefore don’t get any benefit by being able to retain profits inside a company at a lower tax rate or being able to distribute income to family members in a trust as unable to let profits accumulate in a company or distribute income to family members if operating through a trust.

Do the PSI rules apply to me?

There are a number of steps to work through to see if the PSI rules apply:

Step 1: Have you received PSI?

Look at each contract or job you have to work out if more than 50% of the income received for the contract was for your labour, skills or expertise compared to anything else such as materials supplied or tools and equipment used. If more than 50% of the contract was for labour, skills and expertise, then all of the income under the contract is PSI and you need to keep reading below. If not, you can continue onto our blog Can I claim that? A guide to tax deductible business costs.

Step 2: Do I pass the results test?

To pass the results test at least 75% of your PSI being tested must:

• Be from being paid to produce a specific result (eg not being paid an hourly, daily or weekly rate)

• Include the requirement to provide your own equipment or tools to perform the work

• Include the requirement for you to have mistakes fixed at your own expense.

If you pass this test the PSI rules don’t apply. However you then need to consider if you are conducting a personal services business. To learn more read our blog FAQ: What is a personal services business and is my business one? If you don’t pass the test then continue to step 3.

Step 3: Do I pass the 80% rule?

To pass the 80% rule you need to look at the income being earned from each of your clients (and their associates). If you earn more than 80% from any one client then you will not pass the 80% rule. For example, you won’t pass the test if you have just one contract, however you will pass the test if you have two contracts where you earn 75% of your income from one and 25% of your income from the other. Again if you pass this test you still need to consider if you are conducting a personal services business. If you don’t pass the test continue to Step 4.

Step 4: Do I pass the remaining tests?

You only need to pass one of the following tests for the PSI rules not to apply, they are:

i) Unrelated clients test

a) Requires you to have two or more unrelated clients; AND

b) Make offers to the public for work. Making offers to the public for work includes: maintaining a website, applying for competitive public tenders, or advertising in a newspaper, industry journal or business directory; or

ii) Employment test

a) requires principal work to be performed by others, where you engage other employees or contractors to perform at least 20% (by market value) of the principal work. Principal work is the work you must perform under a contract for which you are paid; OR

b) requires you employ one or more apprentices for at least six months of the income year; or

iii) Business premises test - requires you to at all times during the income year to maintain business premises that:

a) Are used mainly for personal services work

b) Used exclusively by you

c) Physically separate from any premises you use for private purposes (eg your home)

d) Physically separate from your clients’ premises

If you do not pass any of these tests then the PSI rules apply to you. If you do pass one of the tests, continue on to our blog FAQ: What is a personal services business and is my business one?

The ATO has put together a flow chart, Working out if the PSI rules apply, to help you determine if you are receiving personal services income.

If you would like specific advice tailored to your business and circumstances, Accounting Heart offers affordable service packages where you can work with Sonia one-on-one to help you get your business where you want it to be. Book your FREE Discovery Call to find out more.

Disclaimer: This is general information only and is not advice of any sort. No warranty or representation is provided by Accounting Heart Pty Ltd as to the accuracy, currency or completeness of the information contained in this blog. Readers of this blog should not act or refrain from acting in reliance upon any information contained herein and must always obtain appropriate taxation and / or other advice as may be appropriate having regard to their particular circumstances.