By Alisa Sainoski

Personal Services Income (‘PSI’) is income which is mainly a reward for a person’s personal efforts or skills.  The fact the income is payable under a contract does not stop the income being mainly a reward for personal efforts or skills.  Income is classified as PSI when more than 50% of the amount received for a contract was for labour, skills or expertise.

In the event the PSI regime is applied to income derived it must be reported as such to the Australian Taxation Office (‘ATO’).  Application of the PSI regime will also effect the types of tax deductions which can be claimed.  If the PSI rules don’t directly apply, it is possible the business is a Person Service Business (‘PSB’).  There is no change to the tax obligations for a PSB other than the declaration of any PSI (associated with the PSB income) on an individual tax return.  PSI can be received even when income is produced through a company, partnership, or trust (Personal Service Entity (‘PSE’)).  In such situations, the income will be treated as individual income for tax purposes.

PSI has been a source of focus and discussion for many years.  Predominantly this is because a person earning income from their own efforts and paying tax at the top marginal rate could potentially save large amounts of tax by diverting that income into or through an entity such as a trust or a company.  There are two potential benefits in doing this:

  1. the income can be diverted to family members or associates who are on lower marginal rates., this is readily achieved with a discretionary trust by making income distributions; or
  2. the income can be retained through a company where the flat tax rate is currently 30% or 27.5% if the company is a base rate entity.

With PSI the difficulty is in determining whose income is being considered: the individual’s or the entity’s.  For example if a person is operating a small consultancy business from home and charging fees for their own efforts, does that income become a trust’s income by simply forming a trust, opening a bank account and charging the stationery?  No, the PSI rules would apply.

PSI is included in your assessable income and may only be reduced (but not to below $nil) by the amount of certain deductions which the PSE is entitled.  This method statement is used to determine whether, and by how much, the amount is reduced by.   PSI is limited by the deductions the individual can claim against their PSI to the amount the individual would have been able to claim if they had derived the income as an employee.  For example, the individual would be specifically denied deductions on rent, mortgage interest, rates or land tax relating to the tax payer’s residence and payments to associates including superannuation unless they relate to work that forms part of the principal work undertaken by the tax payer.

PSI excludes income resulting mainly from the supply or sale of goods where the labour is incidental, granting a right to use an asset where labour is incidental or a substantial profit-yielding business structure where there are a large number of employees and assets used to produce income.

The consequences that would otherwise arise when income is defined as PSI does not occur when the income is from conducting a PSB.  PSB can be determined by 4 tests.

However, the PSB tests, apart from the results test, do not apply if 80% or more of any individual’s PSI is from one source being a single client.

Check out the Personal Service Income decision tool and find out if your income is under PSI.

If you have any queries in relation to whether income is likely to be considered a part of the PSI regime, please contact us.

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