Why You Shouldn’t Divert PSI to Your SMSF

Minimising the amount of tax you pay should always be an important consideration, but it is also important to know the point at which tax minimisation becomes tax avoidance in the eyes of the ATO.

Former tax saving strategies such as distributing profits to lower tax-rate individuals in a business and paying the key person a below market rate for their services are now considered tax avoidance strategies. This guide looks at another practice that has recently fallen under the scrutiny of the ATO; namely diverting Personal Services Income (PSI) to your Self Managed Super Fund (SMSF).

What is Personal Services Income (PSI)?

PSI is income earned mainly as a reward for your personal efforts and skills and most medical professionals would fit into the PSI category as their income is normally generated through their personal skills, rather than from selling a product or operating certain equipment.

However, you must further satisfy the Results Test to avoid the PSI Rules which impose restrictions on what those earning PSI can claim. Most medical professionals satisfy the Unrelated Clients Test (provide services to 2 or more clients who are not associates of each other or associated with them).

Most also pass the 80% Rule (derive less than 80% of their income from one source or set of associated entities) and therefore most medical professionals avoid the PSI Rules which would limit them to only claiming deductions available to an individual taxpayer.

ATO alert

The problem is that while most medical professionals earn PSI, some are now employing (or being advised to consider) a strategy designed to save even more on their tax by diverting their PSI into their SMSF.

The ATO has recently issued Taxpayer Alert, TA 2016/6, which highlights their concern with this arrangement. Their concern is that the strategy is being used with the intention of avoiding paying tax on PSI at even the marginal tax rate and having it concessionally taxed instead or not taxed at all, which in the eyes of the ATO may constitute tax avoidance.

How it works

The strategy under scrutiny generally works in the following manner:

  • You perform services for a client, but instead of receiving any or adequate payment for those services, the client is instead instructed to make remuneration to a company, trust or other entity.
  • That other entity then distributes the income to your SMSF, classifying it as a return on investment, which according to SMSF taxation rules means it is either exempt from tax or only taxed concessionally, rather than at your marginal tax rate.
  • The SMSF may receive the income from more than one entity or from a chain of different entities, or the entity may distribute the income to more than one SMSF of which you are a member.

Why it’s being investigated

The ATO’s view of this practice is as follows:

  • The arrangement may not effectively alienate such income from normal taxation rules and it may still qualify as the assessable PSI of the individual.
  • The amounts received by the SMSF may constitute non-arm’s length income, which is not eligible to be concessionally taxed, not exempt current pension income and may not be compliant.
  • The amounts received by the SMSF may be considered a contribution to the fund (and thus subject to the contributions caps rules) and may contravene superannuation regulatory issues.

Possible penalties

Serious penalties can result if the SMSF is not being maintained for the purposes set out in section 62 of the Superannuation Industry (Supervision) Act 1993 (SISA). Breaches of the Act may result in the SMSF being made non-compliant and the individual(s) involved being disqualified as a trustee.

Those promoting these types of arrangements can also face serious penalties under Division 290 of Schedule 1 to the Taxation Administration Act 1953 for promoters. Registered tax agents who are found to be involved may be referred to the Tax Practitioners Board for possible breaches of the Tax Agent Services Act 2009.

What you should do

Because the ATO recognises the importance of SMSF in providing for individual retirement income, all issues which arise regarding the diversion of PSI into SMSFs will be investigated on a case-by-case basis and dealt within a timely manner to minimise the impact on the funds.

They are in the process of reviewing a number of cases at present and will be talking to taxpayers of interest over the coming months. If you or someone you know has entered into an arrangement of the type described here, you should seek professional advice at the earliest possible juncture.

MEDIQ Financial is the leading financial services provider to medical professionals in Australia and with our absolute focus on doctors and their families, we are well placed to respond to the needs of our customers.

For further information and advice on the issues described here, you can contact us anytime at info@mediqfinancial.com.au or call us on 13000 MEDIQ (63347) to organise a personal consultation.