Tax rules in Australia are pretty confusing. Most people do not know if the income can be categorised under Personal Service Income (PSI).
As per the Australian Tax Office (ATO), PSI rules determine the reporting obligations as well as the deductions you are allowed to take.
The Understand Personal Service Income (PSI) Rules, this blog thereby helps you understand the requirements the ATO has set forth.
What is personal services income (PSI)?
When more than 50 percent of what one income earns contractually is generated by his personal skills, efforts, expertise, or knowledge rather than through beneficial business assets or structures, personal services income (PSI) comes into the picture.
Key Characteristics of PSI
To ascertain whether income is from PSI or not, the ATO advises looking at each of the contracts in isolation.
Some of the major indicators of PSI are as follows:
- Labour-Centric Income: Most of the income is for one’s personal efforts or skills.
- Minimal Asset Involvement: Much income is without major reliance on assets or equipment.
- Industry-Relevant: Common professions generating PSI include IT consultants, medical practitioners, engineers, and other skill-dependent trades.
| Income Type | Examples |
|---|---|
| PSI | IT consultancy, freelancing, medical services. |
| Not PSI | Earnings from selling goods or significant use of equipment. |
Who does PSI apply to?
PSI applies to individuals working as:
- Sole traders.
- Through a company, partnership, or trust (referred to as a personal services entity or PSE).
The ATO’s rules are designed to prevent tax avoidance strategies, such as income splitting or unfair deductions, which may reduce taxable income.
How to assess PSI applicability
The ATO provides several tests to determine if PSI rules apply:
- Results Test: If you deliver a specified result for a client and meet specific conditions, PSI rules may not apply.
- Unrelated Clients Test: Having multiple unrelated clients through genuine business efforts could exempt you.
- Business Premises Test: Operating from your own exclusive business premises may also mean the rules don’t apply.
What happens when PSI rules apply?
If PSI rules are applicable, they significantly influence income reporting and deductions:
- Income Attribution: PSI must be declared in the individual’s tax return, even if earned through a PSE.
- Limited Deductions: Some common business expenses may not be deductible unless they directly relate to the generation of PSI.
| Deductible Expenses | Non-Deductible Expenses |
|---|---|
| Work-related travel expenses | Payments to associates for non-essential contributions. |
| Tools or equipment directly used | Rent for premises not exclusively for PSI activities. |
Exemptions from PSI rules
If your income doesn’t meet the PSI definition or you pass one of the ATO’s tests, the rules won’t apply.
However, you must still declare PSI in your tax return. Under these circumstances:
Standard Deductions Apply: You can claim general business deductions without PSI-specific restrictions.
Focus on Accurate Reporting: Transparency in reporting ensures compliance and avoids penalties.
Importance of accurate record-keeping
Maintaining proper documentation is crucial for individuals receiving PSI. Accurate records help determine whether the PSI rules apply and substantiate claims made in your tax return.
| Record Type | Examples |
|---|---|
| Contracts and agreements | Written work contracts, terms, and scope of services. |
| Time tracking logs | Diaries or timesheets specifying hours worked. |
| Financial documents | Tax invoices, bank statements, receipts. |
Common misconceptions about PSI
There are a lot of myths about PSI that may bring some compliance problems.
For instance, income generated through a company is said to be non-PSI. But the truth is that the PSI rules apply if the income is mainly for individual skill-related activities.
It is a myth that passing one test exempts all income from PSI rules. But the reality is that all contracts are assessed on a case-by-case basis.
Consequences of non-compliance
Non-compliance with the PSI rules can attract many penalties-including interest charges on unpaid taxes as well as a risk of:
- Incorrectly claiming deductions.
- Failing to declare PSI accurately.
- Being engaged in income-splitting arrangements which would not be ATO-compliant.
The way out is to regularly review your contracts and see a registered tax consultant.
PSI and business structures
One key differentiation the ATO makes is between PSI and income earned from a business structure. The latter is income generated through substantial assets, multiple employees, or significant goodwill, which is not subject to PSI rules.
Factors that indicate a business structure:
Ownership of significant income-generating assets.
Employment of multiple workers contributing to operations.
Evidence of goodwill, such as a strong customer base.
| PSI Indicators | Business Structure Indicators |
|---|---|
| Income primarily from personal skills. | Income attributed to multiple contributors or assets. |
| Minimal to no reliance on assets. | Use of significant tools, machinery, or goodwill. |
How to stay compliant?
Staying compliant with PSI rules involves:
Regularly Reviewing Contracts: Ensure your income source aligns with PSI definitions.
Maintaining Comprehensive Records: Proper documentation supports accurate reporting.
Seeking Professional Advice: A registered tax professional can provide tailored guidance.
Ready to navigate PSI rules with confidence?
Understanding the ATO’s Personal Service Income (PSI) rules is essential for accurate tax reporting and compliance. If you need assistance in determining how these rules apply to your situation or help with managing your PSI income and deductions, KPG Taxation is here for you. Contact our tax accountants today to ensure your tax matters are handled with precision and care.
