A Guide to Understanding Personal Services Income

PSI Income

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You don’t need a shop front or a payroll to distinguish yourself as a business owner!

If you’re part of the over 1.1 million independent contractors currently operating in Australia, chances are personal services income (PSI) rules may apply to you. This will affect how you pay tax.

If you’re wondering what PSI is and how it can impact your tax obligations as a contractor, you’ve come to the right place. Here’s everything you need to know to understand the basics of PSI.

What Is Personal Services Income (PSI)?

How much of the income that you earn or receive is for your labour, skills, or expertise? If more than half the income you earn from a contract is for your efforts or skills as an individual, then you are receiving personal services income.

Conversely, if only half or less of the income is for your efforts or skills, then it does not constitute PSI.

What Income Isn’t Personal Services Income (PSI)?

Generating income from self-employment does not automatically mean you’re a personal services income earner. PSI rules do not affect you if you earn income from:

      • A business structure of an entity

      • Licencing your intellectual property, such as a copyright or patent

      • Selling or supplying finished goods through manufacturing, wholesaling, or retailing

      • Supplying or using an income-producing asset, such as machinery

    The Australian Tax Office (ATO) looks at various factors in determining income that is or that is not PSI. These factors include the:

        • Nature of the work done

        • The level of control over the work

        • The ownership of work tools and equipment and tools

      Jobs and contracts that don’t require putting in significant brainpower and effort as an individual generally aren’t affected by the PSI rules. An online accountant in Australia can help you distinguish if your income is PSI.

      Why Should You Distinguish If Your Income Is PSI?

      As an independent contractor, understanding the PSI rules will help determine how your contract income will be taxed.

      By distinguishing if your income is PSI, you can take advantage of any available deductions, while staying on top of your tax obligations. With digital accountant service, you can avoid time-consuming and costly legal issues that may arise if you fail to comply with the required PSI rules.

      How Can You Tell If PSI Rules Apply to Your PSB?

      To be classified as a personal services business in a particular year, you must meet the results test for at least 75% of your PSI. Alternatively, meet one of the other PSB tests (unrelated client test, employment test, and business premises tests), and less than 80% of your PSI is from the same entity and its associates.

      Each PSB test stipulates specific conditions that must be met to achieve PSB status. The PSI rules will not apply if one of the PSB tests is met for a particular income year.

      With that said, here’s what to know about the four PSB tests:

      The Results Test

      Are you paid to achieve a set result or are you paid for the hours worked? The results test focuses on the outcome rather than the processes involved in the execution of a contract.

      To pass the test, you must meet all three of the following criteria:

          • The income that you receive is for producing a result,

          • You are required to provide the materials, tools, and equipment needed to perform the work,

          • You may be held liable for any defect that is the consequence of your work.

        Satisfying all three of the above conditions indicates your business is a PSB. This means the PSI rules don’t apply. A virtual accountant can help assess your income streams to determine the applicability of the PSI rules.

        The Unrelated Client Test

        Did you offer advice or provide services to a range of unrelated clients within a particular year? Have you provided similar services to other clients in the past? The unrelated client test assists businesses that seek out and accept work from multiple clients within a given year, typically across different industries.

        To pass the test, you must meet all two of the following criteria:

            • You must have provided services to at least two different and unrelated entities

            • You marketed or promoted your services to the general public

          Remember, these entities must not be associated with you or with each other. Meeting these two requirements indicates you’re operating a Personal Services Business. As a result, the PSI rules don’t apply.

          The Employment Test

          Did you enlist the help of other people to complete the work that generated your personal services income within a given year?

          If at least one-fifth of the principal work was done by others or you employed one or more apprentices for at least 6 months of the income year, then you will have passed the employment test.

          The “principal work” describes the main services that directly generated the PSI you received. It excludes ancillary tasks, such as accounting and financial services.

          The Business Premises Test

          During a given financial year, did you have a dedicated workspace from where you conducted your business activities? The business premises test gauges whether you used your premises to provide the personal services.

          To satisfy this test, you must have maintained a business premises throughout the year. The premises must have fulfilled all the following conditions:

              • Be separate from your home or private premises,

              • Be separate from your client’s premises,

              • Used exclusively by you,

              • Used mainly to do PSI-generating work.

            Since working from home or a client’s premises does not constitute separate business premises, it cannot satisfy the business premises test.

            What Does Your Test Results Mean?

            Passing one of the four PSB tests means the personal services income rules might not apply to your income. However, the ATO still requires you to answer specific questions relating to your income for tax purposes.

            If you fail any of the tests, the PSI rules may apply. This will affect the calculation of your taxable income and your tax bill.

            As a contractor, you can be an individual or sole trader working in your own company, partnership, or trust. Here’s what failing all PSB tests means for you:

            Individual/Sole Trader

            If you’re an individual or sole trader working as a contractor, you won’t be eligible for certain deductions against your personal services income. These tax deductions include:

                • Rent

                • Mortgage interest

                • Rates and land taxes

                • Payments to associates for non-principal work.

              Additionally, individual or sole traders cannot claim small business income tax offset. Some allowable deductions for individuals or sole traders working as independent contractors include the following:

                  • Registration and licencing fees

                  • Accounting and book-keeping fees, including bank fees

                  • Reasonable amounts paid to an associate for principal work

                  • Advertising fees

                  • Cost of tendering

                  • Super contributions for an arm’s length employee.

                Knowing the deductions that you are and are not eligible for can help improve your understanding of personal services income, allowing you to meet your tax obligations while saving money where you can. Consider seeking online tax help to improve your tax position as a sole trader.

                Company, Partnership, or Trust

                In Australia, many professionals and service providers, such as consultants, freelancers, and independent contractors, operate as sole traders due to its simplicity and minimal regulatory burden. However, when it comes to earning personal services income, opting for a company structure can often be a more advantageous choice.

                Advantages:

                    • Limited Liability

                  One of the most compelling reasons to choose a company structure for a business earning PSI is the limited liability it offers. When you operate as a sole trader, your personal assets are at risk in case of business liabilities or legal issues. In contrast, a company is a separate legal entity, which means that your personal assets are more protected. This can be crucial in mitigating financial risks associated with your business operations.

                      • Enhanced Professional Image

                    A company structure can lend an enhanced professional image to your business. Clients and partners may view a company as more established, trustworthy, and reliable compared to a sole trader. This perception can open doors to new business opportunities and foster a higher level of trust from your clients.

                        • Business Continuity

                      Companies offer better continuity in the event of changes in ownership or management. If you want to bring in partners or investors, or if you plan to sell your business in the future, a company structure is more suitable for transferring ownership and preserving the business’s legacy.

                      Disadvantages:

                      All PSI received as a company, partnership, or trust must be apportioned to each individual and declared separately. If you’re subject to PSI rules, you’ll still be eligible for certain deductions against your PSI. However, you can’t retain the profits in the company or distribute profits to beneficiaries through a trust.

                      Instead, you’ll be taxed at your marginal rates, thereby eliminating the tax benefits from your company, partnership, or trust. Contractors have specific tax and super obligations to their workers. Make sure you understand these obligations to avoid getting in trouble with the tax authorities.

                      Improve Your Tax Position With Our Expert Business Accounting Services

                      As an independent contractor, you should know your tax and super obligations. Knowing these obligations will improve your tax compliance and save you time, money, and stress down the road.

                      At Accounting 2 Business, we provide online tax assistance to help businesses meet their tax compliance obligations and save money on taxes. Our clients in Capalaba, Queensland, and online across Australia can attest to this claim.

                      You’re welcome to contact us today to learn more about personal services income or to tell us about your business’s accounting and bookkeeping needs.

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