Do you operate your business through a company or trust? Be aware of the PSI rules
It is fairly common for professionals, such as IT specialists, engineers and business consultants, to operate their business through a company or a trust. If you are in this position, you need to be aware of the rules that will treat the income earned by the company or trust from the provision of your own services (personal services income or PSI) as your personal income. These rules (the PSI rules) also deny a deduction for certain types of expenditure.
The wording in relation to personal services income can be confusing. Here are definitions for PSI, PSE and PSB.
Personal services income (PSI): income received for the reward of an individual’s personal efforts or skills.
Personal services entity (PSE): an entity (company, partnership or trust) that an individual operates through and which receives income for the reward of the individual’s personal efforts or skill.
Personal services business (PSB): an individual or other entity who receives income as a reward for the individual’s personal efforts or skill but is regarded as a personal services business and is not affected by PSI legislation.
Please note, PSI does not include income that is mainly:
for supplying or selling goods (e.g. from retailing, wholesaling or manufacturing)
generated by an income-producing asset (e.g. a semitrailer)
for granting a right to use property (e.g. the copyright to a training manual)
generated by a business structure (e.g. an accountant working for a large accounting firm).
What are the PSI rules and when will they apply?
If you operate your business through a company or a trust, income earned by the company or trust from the provision of your personal services (PSI) will be attributed to you (i.e. treated as your income and included in your individual tax return) and therefore subject to the PSI rules, unless:
the company or trust is carrying on a personal services business (PSB); or
the PSI was promptly paid to you as salary or wages.
The company or trust will be conducting a personal services business (PSB) if at least one of a number of tests are satisfied. These are:
the results test (the most important test) - this is based on common law criteria for characterising an independent contractor (in contrast to an employee/employer relationship). It considers three factors: 1) are you paid to produce a specific result? 2) are you required to provide the equipment or tools? 3) are you required to fix mistakes at your own cost?; If you do not pass the results test and 80% or more of your PSI (with certain exceptions) is income from one client (or the client and their associate(s)) the company or trust will need to obtain a PSB determination from the ATO. Otherwise, the company or trust will not be conducting a PSB and the PSI rules will apply. If the results test is not met, the taxpayer can self-assess against the other tests (see below) for an income year if 80% or more of their PSI does not come from only one source.
the unrelated clients test – this requires the PSI to be earned from at least 2 unrelated clients who contract your services as a direct result of an advertisement or other public offer of your services. A recent Full Federal Court case has confirmed that the test can be satisfied if your services are advertised through LinkedIn and the work is obtained as a direct result of that advertising;
the employment test – this requires at least 20% (by market value) of your work to be performed by employees who are not your associates;
the business premises test – this requires you to use business premises that meet certain conditions (eg you have exclusive use of the premises and the premises must be physically separate from any premises you use for private purposes).
Refer to the ATO website for detailed information on how to assess your income against the above tests, click here.
This table details the steps involved in determining if the PSI rules apply:
If the PSI rules apply, the company or trust cannot deduct certain amounts that relate to gaining or producing your PSI, unless you could have deducted the amount as an individual or the company or trust received the PSI in the course of carrying on a PSB.
The PSI rules limit the following deductions:
occupancy expenses such as rent, mortgage, interest, rates or land tax for your home (or your associate's home)
payments to your spouse, or other associate, for support work such as secretarial duties (even if you report the wages and PAYG withholding to the ATO). This includes superannuation paid. These payments are only deductible if the payments are made for work that forms part of the 'principal work' from which the PSI is derived.
expenses that you would generally not be able to deduct as an employee.
If the company or trust does not conduct a PSB, additional PAYG withholding obligations can arise.
Note - the above can also apply to sole traders in certain situations.
The ATO has issued a draft ruling (TR 2021/D2) providing general guidance on the operation of the rules. The draft ruling considers a number of issues including:
the meaning of PSI and income that does not qualify as PSI;
determining whose PSI it is;
the effect of the PSI rules; and
the various tests to determine if a PSB is being carried on (the results, unrelated clients, employment and business premises tests).
Even if the PSI rules do not apply where your services are hired out through a company or trust, the ATO points out that the general anti-avoidance rules may still apply to the arrangement.
Tip! The PSI rules (and the general anti-avoidance rules) are complicated. Talk to us if you have any questions.
PSI examples are listed in the ATO Tax Ruling TR 2001/7 and the draft TR 2021/D2 linked above.
Please ensure you understand all necessary information before making any decision regarding a PSI or PSB.