Australians have many ways to earn an income. From freelancer, to sole trader to company or trust, there’s a business structure to operate under. Another form of income is made from personal services, known as Personal Services Income (PSI). It might sound like a foreign concept, but it’s not as strange as you might think.
PSI is income generated from personal skills or efforts. This includes labour, or a particular set of skills or expertise that others pay for such as a consultant or specialist that doesn’t include the sale of goods or assets. Sales or wages of employees are not categorised as PSI income.
If you operate as a sole trader, or through a business entity, such as a company, partnership or trust and are an employee of that company, then PSI rules may still apply.
Pro Tax Tip: If over 50% of a charge was for skills or effort, then the income received will be defined as PSI, rather than income generated from the sale of goods or assets or by a business structure.
When PSI Doesn’t Count
Your income isn’t categorised as PSI if:
- you sell or supply finished goods, even if you made them,
- you produce income from the sale of an asset, such as renting a vehicle of machinery,
- from your licensing from an intellectual property or patent.
When PSI Counts
PSI income can come from almost any trade or profession, including
- financial services
- information technology consulting
- construction workers
- medical practitioners
There are different tax rules that are dependent on PSI and non-PSI income and will affect how your tax obligations are reported.
Pro Tax Tip: If PSI rules don’t apply, then your business will be classified as a personal services business (PSB).
To work out if you generate PSI income, you’ll need to determine each separate contract or job through a series of steps. The steps were introduced by the ATO to better regulate and monitor incomes and ensure that contractors are paying their employees correctly and not taking advantage of tax loopholes.
There are 4 tests to determine if your income is PSI:
- The Results Test
- The Unrelated Clients Test
- Employment Test
- Business Premises Test
Generating a PSI income will affect your tax deductions. If your income is categories as PSI, you won’t be able to claim rent, mortgage, interest, rates, land tax, certain payments to associates and will affect how you report your income when you lodge your income tax return.
The Results Test
If you’re paid to achieve a specific result or outcome under a contract and will only be paid when the result is achieved; you have the tool and equipment to do the work; and are liable for rectifying the defects in your work in 75% of the year, you will not be deemed as having PSI income. If the Results Test is not passed, then you’ll need to perform the Unrelated Clients Test if 80% of your income comes from any one client. If each of your clients provides less than 80% of your total PSI, then you’ll need to satisfy one of the remaining tests.
Unrelated Clients Test
If you receive a PSI from two or more unrelated clients (who are not controlled by the same individual or entity); and your service is a result of making offers or invitations to the public you have passed the test and PSI rules do not apply to you.
If you could not answer yes to this test, then you need to proceed to the Employment Test.
If you get employees, partners of a partnership or contractors to perform at least 20% of the principal work that doesn’t include incidental work such as bookkeeping or running from a home office, or have one or more apprentices for at least half of the income year, then your income is not categorised as PSI.
If neither test has been passed, then you’ll need to move to the Business Premises Test.
Business Premises Test
PSI rules do not apply to you if, in the income year, you conducted your business by a property that was owned or leased by you, is used for personal services work more than 50% of the time, used exclusively by you, is physically separate from your residence and that of your associates; and is physically separate from your business clients.
Claimable Tax Deductions
If you’ve determined you have a PSI, there are certain tax deductions that can be made, and include:
- The cost of gaining work, such as advertising, tendering, quotations
- Registration and licensing fees
- Costs related to accounting-keeping
- Bank fees
- Some insurance costs, including public liability and professional indemnity insurance fees
- Salary or wages and super contributions for an arms length employee
- Amounts paid to an associate for principal work
- A portion of home office expenses (heating, cooling, lighting, phone, internet)
Depending on what your business is and your contacts, other tax deductions may apply. When lodging your tax return and declaring your PSI, you’ll need to answer some extra questions to claim your PSI correctly.
Sole traders won’t be eligible to claim certain deductions against PSI rules. If you have PSI income stream and non-PSI income streams, you’ll need to allocate expenses between each category. Under PSI rules, sole traders can’t claim rent, mortgage, rates, land tax on your or you associates home; payments to a spouse or associate for support work; or expenses you would generally not be able to deduct as an employee.
Companies, Partnerships and Trusts
When lodging PSI income, you’ll need to allocate each PSI income to individuals who performed the service. The individual will need to declare the income in their individual tax return. (This will not be allowed to be kept as business profit). PAYG withholding obligations must be followed for amounts paid as salary or wages to the individual who performed the services.
Pro Tax Tip: The business entity, as well as each PSI individual has tax return obligations for PSI received.
PSI income can get complex and messy, and is often surrounded by confusion. Luckily ITP Accounting Professional are experts at detangling confusion as well as claiming maximum tax deductions no matter how your income is defined, or the business structure you operate under. Phone 1800 367 487 and chat with a friendly professional today.