Personal Services Income (PSI)

A special tax regime for Personal Services Income (PSI) applies to prevent individuals from reducing their tax liability by alienating PSI to an associated company, partnership, trust or individual or by claiming inappropriate “business” deductions.

What is PSI?

PSI is income that is mainly a reward for an individual’s personal efforts or skills. It does not include income that is mainly:

• For supplying or selling goods (eg from retailing, wholesaling or manufacturing);
• Generated by an income producing asset (such as an excavator);
• For granting a right to use property (eg the copyright to a computer program); or
• Generated by a business structure (eg an engineer working in a large engineering firm).

There are special PSI rules contained in the Income Tax Assessment Act that basically aim to provide similar tax treatment of PSI, whether derived by an employee or a contractor. Accordingly, the PSI rules affect the individuals deriving PSI directly (eg as a sole trader) or indirectly through a company, trust or partnership (referred to as a Personal Services Entity or PSE)

For individuals, the PSI rules operate to limit the type of deductions that can be claimed. For PSE’s deriving PSI, the income (net of certain allowable deductions) is attributed to the individual who directly performed the work or services.

The rules do not apply to the PSI derived by an employee unless the individual is an employee of a PSE. It is also important to note that the PSI rules do not alter any legal or contractual relationships that are in place. Further, the PSI rules do not apply to PSI derived as part of a Personal Services Business (PSB). A PSB is an entity that passes at least one of the following four tests:

• The Results Test

For an individual or PSE to satisfy the results test in a particular year the individual or PSE must satisfy the following three conditions in relation to at least 75% of his or her PSI during the year:

1. The income is for producing a result (eg delivering a completed software component);
2. The individual or PSE is required to supply the plant and equipment or tools of trade (if any) required to perform the work; and
3. The individual or PSE is, or would be, liable for the cost of rectifying any defect in the work performed.

• The Unrelated Clients Test

An individual or PSE meets the unrelated clients test in an income year if:

1. The service provider gains income from providing services to two or more entities that are not associates of each other and are not associates of the service provider; and
2. The services are provided as a direct result of the service provider making offers or invitations (eg by advertising) to the public at large.

• The Employment Test

An individual or PSE meets the employment test in an income year if at least 20% (by market value) of the individual’s or PSE’s principal work for the year is performed by an entity or entities engaged by the individual or PSE.

• The Business Premises Test

An individual or PSE meets the business premises test in an income year if, at all relevant times during the year, the service provider maintains and uses business premises:

1. At which they mainly conduct activities from which PSI is gained;
2. Of which they have exclusive use;
3. That are physically separate from any premises that the service provider or service provider’s associates uses for private purposes; and
4. That are physically separate from the premises of the service providers client or client’s associate.

The Importance of PSE’s and Common Errors

The ATO is particularly interested in PSE’s as they believe a number of people are using them as a tax avoidance/deferral type of arrangement. There has been a number of recent cases that the ATO has won in relation to PSE’s and they have also announced that they will be undertaking data matching activities with employment agencies to ensure the PSI rules have been properly adhered to.

The ATO has also recently issued a fact sheet outlining common mistakes that PSE’s make, these include:

Results Test

Common Mistake: Self assessing that the first condition of the results test has been passed when paid on an hourly basis or daily rate.

To pass the first condition of the results test, the income you receive under a contract or arrangement must be paid to you as a result of achieving a specified result or outcome.

If you are paid on an hourly basis or daily rate for the services you provide, it is unlikely that you will pass the first condition of the results test.

Unrelated Clients Test

Common Mistake: Self assessing that the unrelated clients test has been met when the services provided are not a direct result of making offers to the public

A condition of the unrelated clients test is that the services must be provided as a direct result of making offers to the public.

To make an offer to the public, there needs to be a definite connection between the offer of services and the engagement for work.

Making offers to the public includes:

• Advertising in a newspaper, magazine or business directory;
• Maintaining an internet web-site; or
• Word of Mouth referrals

Retaining Profits

Common Mistake: Retaining profits from personal services income

If your company makes a profit from personal services income you need to promptly:

• Pay this profit as salary and wages; or
• Attribute it the individual who performed the services

Pay as you go (PAYG) Withholding

Common Mistake: Not complying with the additional PAYG Withholding Obligations

If you are affected by the PSI measures you will have additional PAYG withholding obligations.

Companies and trusts must:

• Apply normal PAYG withholding rules to any of the income that is promptly paid out to the individual as salary or wages within 14 days after the end of the relevant period (ie monthly or quarterly); and
• Report and pay additional PAYG withholding on the attributed income (ie personal services income that has not been promptly paid as salary or wages)

Partnerships must:

• Attribute the personal services income to the individual who generated it; and
• Report and pay additional PAYG Withholding on the attributed amount

With the PSI regime an ATO target at the moment it would be a good idea to discuss these issues with your accountant to ensure you comply with all the necessary requirements.

Author: Matt Beasley, July 2008

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