What is PSI or Personal Service income

PSI is income that is primarily a reward for one’s efforts, skills and experience.

What is the purpose of this special tax rule?

The Australian tax system favours small businesses over individuals and large corporations. As such, small businesses pay relatively lower taxes than individuals and large corporations. Therefore, there is an incentive for individuals to divert their income through partnerships, companies and trusts to take advantage of the lower tax rates.

Therefore, the Australian Tax Office (ATO) has rolled out this special tax rule to prevent people from diverting income they have received as a result of their skills and abilities through companies, trusts & partnerships to pay less tax.

Example: Paul who works at PPL Consulting Pty Ltd as an investment Consultant earns an annual salary of $250,000.00. This income may be taxed at a rate of 45%. However, if Paul sets up an investment consultancy firm and earns $250,000.00 in revenue, then that income may be taxed at 26%.

It is this situation that the ATO is aiming to limit through the Personal Service Income tax rule.

What are the most common industries, trades or processions where you may receive PSI?

– Engineering / Engineers
– IT professionals
– Construction workers
– Medical professionals
– Financial professionals

What income is classified as PSI?

If you have earned more than 50% of your income as a reward for your skills, experience, and efforts, then you have earned Personal Service Income.

Working out if the PSI rules apply to your income

– First, you need to identify if your income can be classified as PSI
– Once you have done that, you need to determine if the PSI rules apply to that income
– The easiest way is to use the ATO PSI decision tool

PSI Flow chart

– Step 1 is to find out whether you have earned PSI.
– Step 2 – 4 will help you find out if you are running a personal service business (PSB)

Step 02 – The Results Test

You need to meet the following 3 conditions to pass The Results Test and to qualify as a PSB.
– Paid to produce a specific result
– Required to provide your plant and equipment or tools
– Required to fix mistakes at your own expense

If you pass these three conditions, then your business is a Personal Service Business for that particular income year and the PSI rules will not apply.

Example: Paul, who is an electrician has been hired to install electrical wiring according to a set of plans at the new VIC Roads office in North Melbourne. Any deviation from the specific requirements is subject to the variation clauses in the contract.

Paul takes on the risk of not being able to meet the required specifications and/or not meeting the quality standards, as he must rectify any mistakes at his own expense. Paul must also bring his drill, hacksaw, hammer, wire crimping tool and ladder.

In this case, Paul satisfies The Results Test as he has been contracted to complete a specific job, he has to bring his own equipment and tools, and he is liable for fixing any issues.

Important Note – You must meet all three conditions for a minimum of 75% of the PSI for that particular income year to be considered as a Personal Service Business.

Step 03 – The 80% rule

If you have failed The Results Test, then the next step is to apply the 80% rule. This rule helps you to find out whether you have earned more than 80% of the PSI from one client.

The 80% rule is designed to let the individual or the entity know whether they can self-assess that they are conducting a PSB using the Unrelated Clients Test, The Employment Test or the Business Premises Test.

Step 04 – The Unrelated Clients Test, Employment Test and the Business

– Premises Test

If you have received a result that is less than 80% in the previous test, then you can work tough the remaining three tests.

After working through steps 1,2 & 3 and passing the Results Test or passing either The Unrelated Clients Test/ The Employment Test/ The Business Premises Test, you will be able to determine if your business is a Personal Services Business.

– The Unrelated Clients Test

You can self-assess whether you meet the unrelated client’s test if no one source of your service income is greater than 80%. If the clients are unrelated to you, and they were acquired directly as a result of advertising campaigns directed at the public, then the PSI rules will not apply.

Example: Paul is an engineer who provides his services as a sole trader. He advertises his services on social media and recently secured three new contracts. All three new clients are completely independent and have a connection to Paul or with each other.

Moreover, neither of the three clients provide 80% of Paul’s PSI during the current financial year so he can self-assess as to whether he meets the unrelated client’s test.

In this case, Paul meets the unrelated client’s test as neither of the clients are associated with Paul and because he secured them as a direct result of advertisements that he published on social media.

On the other hand, if Paul acquires contracts through a labour hire agency, then the PSI generated from those contracts will not be treated as unrelated client. This is because he has not acquired those contracts through direct advertising but through the labour hire agency.

– Employment Test

If the business employs someone to perform part of the principle work that produces PSI, which amounts to at least 20% of the principal work, then the firm will pass the employment test and the PSI rule will not apply.

Example: Paul and Peter, who are both accountants have started PP Accountants Pty Ltd, through which Paul provides personal services as a bookkeeper. PP Accountants Pty Ltd has entered into a contract to provide Paul’s bookkeeping services for a restaurant subjected to contractual terms.

PP Accountants Pty Ltd engages Peter, who is more qualified and experienced than Paul to review Paul’s work and to make sure that the work done by Paul is in line with the specific requirements in the contract. In addition, Peter corrects any mistakes done by Paul.

In this case, Peter’s work in reviewing Paul’s work and correcting any mistakes formulates part of the principle work that produces Paul’s PSI. Moreover, if the principal work performed by Peter counts towards 20% of the principal work performed by PP Accountants Pty Ltd on behalf of the restaurant, then the firm would meet the threshold required to meet the employment test.

– The Business Premises Test

If your business activities that produce PSI is being conducted at a premise that is physically separate from your private residence, then the business premises test is met and the PSI rules will not apply.

Example: Paul who is a web designer, contracts through Paul’s Designing Pty Ltd. Paul runs his business at a small office space that he rents three blocks down the street from where he lives. Since Paul conducts his business activities only at his office, which is physically separate from his residence, the business premises test is met against Paul’s PSI. Therefore, the PSI rules will not apply.