Do You Qualify as a Personal Services Income (PSI)? Or Are You a PSB?

March 30th, 2016

Personal Services Income (PSI) affects anyone who generates revenue from supplying their skills and labour. It’s important you understand if you’re earning PSI, because it can significantly change your tax obligations.

Personal Services Business (PSB)  is essentially the same thing as PSI, except that there are no changes to your tab obligations other than declaring any PSI on your tax return. This means that you are taxed at a business rate instead of an individual tax rate, which can be a difference of as much as 19%.

And if you are operating as a business entity that is a company, trust or partnership that primarily derives its income based on the skills or efforts of an individual, then you most likely qualify as a PSI and so are at risk of being taxed accordingly.

These two classifications tend to be one of the most misunderstood tax-time pains people grapple with.

The basics

So, who is earning PSI? According to the tax office, any person whose income comes from more than 50% of contracts offering their skills, knowledge, expertise or efforts qualifies as earning PSI.

It’s an all-or-nothing deal, too. If you earn more than 50% of your income from a contract as PSI, then all of your income from that contract is considered to be PSI. If you earn less than 50% of your income from PSI, then none of it is considered to be PSI.

Other exclusions that will mean you are NOT receiving PSI income include:

• You receive income from selling or supplying finished goods. This includes if you made them yourself.
• You receive income from an income-producing asset, such as a vehicle or piece of machinery. In other words, if you rent out something, it is not considered PSI income.
• Your income comes from licensing your intellectual property, such as through a patent.
• You receive royalties, such as through the sale of a book you wrote.

An example of PSI

If you’re operating as a sole trader and you are hired on a contract basis to provide a training course to a group of people, it’s possible you’re earning PSI. If you charge $200 for the training course, and $50 of that is to cover the textbook, then you’ve earned 75% of your income for your skills and expertise. Thus, the full $200 for the course is considered to be PSI income.

Professions that could be impacted where the practitioner is running their small business through another entity:

• Medical practitioners
• Dentists
• Accountants
• Lawyers
• Engineers
• Architects
• IT consultants
• Entertainers.

What are the tests involved?

If you think PSI income does apply to you, the next step is to complete the results test. The results test will help determine whether you’re earning PSI or PSB.

The test has three ‘checks’ to consider:

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 costs?

If you pass those three checks then your business is considered a PSB, so the PSI rules may no longer apply.

It gets complicated for people who have multiple contracts and some of them pass the rules for PSBs, while others do not. The tax department considers you’ve passed the requirements for PSB when you meet all three of the above conditions for at least 75% of the PSI you earn in that financial year.

If, after applying the results test, you determine that you are not a PSB, you will need to apply more tests to determine if your income is PSI. The next test is called the ’80% rule’. For this test, you determine whether over 80% of your income comes from a single client and their associates. If it does, the PSI rules apply. If it does not, then there is one more set of tests to take.

First, you go through the Unrelated Clients Test. To pass this test, your income must be produced from two or more clients that are not related or connected. Furthermore, the work must have been obtained by making offers to the public (which includes maintaining a website, applying for competitive public tenders, or advertising).

If the Unrelated Clients Test does not apply to you, you can complete the Employment Test. To pass this test, you must either have employees, partners, or contractors perform at least 20% of the principal work, or alternatively at least one apprentice during at last half of the income year.

The final test you can apply for is the Business Premises Test. Passing this test requires that you have a business premises that is owned or leased by you, used for your personal services work for more than 50% of the time, used exclusively by you, physically separate from your place of residence, and physically separate from the business address of any of their clients or associates.

If at least one of these tests is passed then your business is a PSB, and the PSI rules do not apply. There are two ways you can apply to the ATO for a PSB determination:

What to do if the PSI rules apply

If, after going through all of those tests, the income is determined to be PSI, then it changes how you can report your tax for the year.

Most significantly, it means that there are certain deductions you will not be able to claim otherwise. Note, however, if you earn a combination of PSI and non-PSI income, you will still be able to claim deductions as normal to the non-PSI portion of your income – just make sure that the deductions are allocated individually.

What you are not able to claim under PSI includes:

• Rent, mortgage interest, rates or land tax for your home.
• Payments to your spouse, or other associates, for non-principal work such as secretarial duties.
• Any expenses you would generally be unable to deduct as a normal employee.
• Super contributions for associates for non-principal work. So if you’re making super contributions to a spouse or relative for some work they’re doing for you (such as answering phones), then you wouldn’t be able to deduct this.

The exception to this rule is you can deduct super contributions made to an associate for principal work they do. But you can only deduct the superannuation guarantee amount, and this is based only on the salary or wages paid for the principal PSI-related work. In other words, you’d be able to make a deduction if you paid super for your partner teaching part of your PSI-earning course, but not any secretarial work they might have done. And note you are still able to deduct super paid to yourself.

You will also need to fill out additional sections in your tax return: Personal Services Income and Business and Professional Items.

What you can claim as deductions under PSI

There are a large number of deductions that you can still claim under PSI. These include:

• Costs of getting work (such as advertising).
• Registration and licensing fees.
• Insurance against loss of income, earning capacity.
• Meeting GST obligations.
• Salary or wages paid to the individuals performing the services.
• Salary or wages for an “arms-length employees” (not an associate).
• Complying with worker’s compensation law.
• Running expenses for home offices – heating and lighting, phone and Internet bill, but not rent.
• Depreciation of income-producing assets.
• Fees or charges associated with a bank, credit union, or other financial institution.
• Tax-related expenses, such as the cost of lodging a tax return or activity statement.
• Statutory fees.