What Is Personal Services Income (PSI) and Why Do You Need To Know About It?

Personal services income, or PSI, is a type of income that you may be entitled to receive if you work as an independent contractor. It’s important to understand what PSI is and how it can benefit you, as there are certain tax implications associated with it.

In 2000, the Australian Tax Office (ATO) introduced various tax rules to address the growing concern that individuals were bypassing the PSI tax implications by setting up by establishing an entity, such as a company, to run their business through.

 

So, here is what you need to know about PSI and how to establish whether the rules apply to you and your business operations. 

When Do the PSI Rules Apply?

The personal services income rules will apply to small businesses and contractors who earn an income directly from their personal skills, expertise, and labour. In other words, they do not derive their income from the sale of goods but rather through the sale of their personal services. 

The ATO categorises a range of professions under the PSI umbrella, but some common examples include: 

• IT consultants
• Engineers 
• Medical practitioners
• Construction workers
• Financial professionals 

For example, in assessing a person’s symptoms and diagnosing them accordingly to provide treatment, a doctor derives income from their personal skills, expertise and labour. Or suppose an IT consultant provides their expert services to a range of companies by addressing their technology challenges. In that case, they are also deriving income from their personal skills, expertise and labour.

If, however, a business owner runs a pharmacy where they sell the medicine prescribed by the doctor or a computer shop where a company can buy computer software, the purpose of the business is to generate income from the sale of these goods – not their personal services. So, the PSI rules will not apply. 

Determining Whether the PSI Rules Apply To You

Because it is relatively complex to establish whether or not the PSI rules apply to your business endeavours, the ATO has suggested going through a few different steps:

The first step involves assessing the different job contracts you have undertaken. If more than 50% of your income received was for your personal skills, expertise or labour, your income is likely PSI.

If, after following the first step, you establish that you are not earning a personal services income, it may be possible that you are running a personal services business (PSB). So, you will also need to establish whether or not this is the case. This is relevant because if your business is considered a PSB, the PSI rules will not apply to that income.  

The second step involves taking a test known as the “results test”. The results test requires business owners to establish whether they meet the following conditions for at least 75% of the PSI being tested. If they do, their business will be considered a PSB:

• you must be paid to achieve a specified result,
• you must provide the equipment or tools necessary (if any) to achieve the specified result, and 
• you must be required to remedy any defective work at your own expense. 

In the third step, you will need to calculate how much of your PSI comes from one particular client (and their associates). If 80% or more of your PSI comes from just one client, the PSI rules apply. However, if your PSI from each client is less than 80%, you should move on to the next step. 

With the fourth step, there are three different tests you have to take: 

• The unrelated client test requires you to determine whether or not you provide your services to two or more unrelated entities and whether or not you provide your services directly from advertising to the general public.
• The employment test involves establishing if you have employees, contractors or partners performing at least 20% of the principal work. 
• The business premises test involves having you own or exclusively lease your work premises to be used for personal service work more than 50% of the time and to be physically separate from your residence and clients premises. 

If you satisfy the requirements of one of the three tests, you will not have to adhere to the PSI rules. But if you don’t meet the requirements of either three tests, the PSI rules will apply to your business endeavours. 

Let’s look at an example of how the steps would apply in a work scenario. 

Example: 

Kurt, an engineer, has established his own company called KLT Engineering (Pty) Ltd and offers his services to four different clients. 

While determining whether or not the PSI rules apply to his business, he establishes, as per step one, that more than 50% of KLT Engineering’s income is generated from Kurt’s personal skills and expertise. So, the income is considered PSI, and he proceeds to the next few steps. 

Kurt bills his clients per consultancy hour, which means he isn’t paid to achieve a specific result. So, according to the results test, KLT Engineering is not a PSB. This essentially means that the PSI that Kurt receives is attributed back to him and not the business entity. So, that income must be declared on his individual tax return. 

If, at this point, the steps still seem a bit confusing to you, don’t fret because the ATO has anticipated that that might be the case due to the complex nature of the steps and developed an easy-to-use online tool that you can access on their website. 

What Is Attributed PSI?

Attributed personal services income involves having your PSI paid to you as an employee through the entity you manage your personal services through, like a company or a trust. 

As per the PSI rules, if your personal services income is paid to an entity, the income (less expenses) is attributed to you unless the entity is classified as a PSB or the income was immediately paid to you by the entity as salary.

Once You Have Established that the PSI Rules Apply, What’s Next?

Essentially, if you earn personal services income, the ATO will consider you in the same position as an employee for tax purposes. Therefore, as with the example above, if it is clear that you earn PSI, you will need to include this income on your annual tax return.

There are also certain limitations regarding the deductions you can claim against your income. To determine what deductions you can claim when receiving PSI, you can visit the ATO’s website. 

If you are a contractor or small business owner and suspect that you may fall under the PSI rules, it may be helpful to contact an expert team of small business accountants to get a rundown of how to best handle the tax implications.