Many professionals regularly use business structures such as companies to minimise tax liabilities. The tax rate for small companies is just 27.5% which compares very favourably with the top individual tax rate of 45%.
Clearly, this could be a very effective way of sheltering profits for a small business and for that reason, the ATO often seeks to apply what are known as the personal services income (PSI) rules to regulate such situations.
We often see that the implications of PSI rules are misunderstood by business professionals or these issues are recognised too late.
In practice, professions that are most commonly affected by the PSI rules are lawyers, engineers, business consultants, IT consultants.
The PSI rules are a complex aspect of the taxation area and professional tax advice should be sought! If you believe you may be affected by PSI rules, contact us to discuss your personal circumstances!
Below is the brief summary of PSI rules.
What is PSI?
Personal Services income (PSI) is income that is mainly a reward for the personal efforts and skills completed by an individual. For example, income generated by business analyst who supplied their services through a company is considered as a PSI.
What are consequences of generating personal services income?
Once its been determined that the individual is generating personal services income, the next step is to work out if the PSI rules apply.
If the PSI rules do apply, the following are the consequences:
- the business will not be able to claim certain tax deductions including below:
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- a percentage of rent, mortgage interest, rates & land tax even if the business operates from one of the rooms in the house
- payments to associates for support work
- super contributions for associates who do support work
- car expenses for more than 1 vehicle.
- The PSI will need to be attributed to the individual who performed the work as this income cannot be retained in the business
- The business will need to meet certain tax reporting obligations
- The business is entitled to claim the same deductions that the individual who performed the work could have claimed in the same situation.
Is your business exempt from PSI rules ?
To be exempt from PSI rules, the business must be a personal service business (PSB). To qualify as a PSB, the business needs to meet the primary test – the result test. If unable to meet the result test, the other option is to meet any of the non primary tests – the unrelated client test, employment test or business premises test. To consider these non primary tests, less than 80% of business income must come from one client.
The result test
This test is a self-assessment test and an individual or their trading entity will be treated as a personal services business if they receive at least 75% of the personal services income for producing a result.
To pass the results test, the following must be satisfied:
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- the business works to produce a result?
- the business provides the tools and equipment necessary to produce the result?
- the business is liable for the costs of rectifying any defective work?
- the business is free to delegate work to others?
- the business is free to accept or refuse the work?
- the business can negotiate contracting arrangements?
If an individual (or their trading entity) cannot satisfy the results test, there are three other tests available to self-assess against. The taxpayer can only consider these tests if 80% or more of the taxpayer’s personal service income does not come from one source.
If the 80% threshold is breached, the individual cannot consider the other tests and must apply to the ATO for a PSB determination in order to be classified as a PSB.
The three non-primary tests
- The unrelated clients test: To satisfy the unrelated clients test, the individual or entity must provide services to 2 or more entities that are not associates of each other and are also not associates of the individual or entity. The services must also be provided as a direct result of making offers or invitations to the public at large (or to a section of the public). Making an offer to the public includes advertising, tendering for work, maintaining a website or word of mouth referrals. Services offered through labour hire companies and other such businesses that arrange to provide services directly for clients do not qualify under this test.
- The employment test: The employment test will be satisfied if the individual engages one or more entities during the income year, and that entity, or those entities together perform at least 20% of the market value of the individual’s principal work for the year. For partnerships, the value of work performed by one partner for another in generating any personal services income is taken into account. Both an individual and a personal service entity will also satisfy the employment test if they have one or more apprentices for at least 50% of the income year.
- The business premises test. The business premises test is satisfied by either an individual or personal service entity if at all times during the income year they maintain and use business premises at which the individual or entity mainly conducts activities from which personal services income is gained or produced, and that are –
- used exclusively by the individual or personal service entity;
- physically separated from any other premise that is used for private purposes by the individual or personal service entity or any of their associates which includes:
- a relative,
- a spouse,
- a partner or a partnership of which you are a partner,
- a trust of which you are a trustee or a beneficiary, or
- a company which you control,
- physically separated from the premises of any of their clients (or associates of those clients) to which they provide services.
If you are still unsure about PSI rules and how they are affecting your business, call us! We are here to help!
Sources:
Income Tax Assessment Act 1997
Australian Taxation Office
Disclaimer: The information contained on this site does not constitute tax advice or an accountant-client relationship. You must always seek professional advice regarding its applicability to your own circumstances.
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