Mercia | Taxation, Business & Finance Advisers

Personal Services Income (PSI) was introduced on 1 July 2000 intended to prevent individuals who generate income from their personal services from reducing the amount of tax paid by diverting income through a company, partnership or trust and to limit and clarify the work-related deductions available.

The ATO put in place a range of personal services business tests to determine how contractor status would be applied.

Those who did not satisfy these tests would be subject to the PSI rules, those that satisfied the tests  would NOT be subject to the PSI rules and would be regarded as Personal Services Businesses (PSB’s).

The <ATO tests> are summarised below:

1. Step 1 <50% test> –  (PSI Test) – Income is classified as PSI when more than 50% of the amount you received for a contract was for your labour, skills or expertise.
2. Step 2 <Results Test> (PSB test):
   1. PASS – if you pass the results test the PSI rules don’t apply and so you do NOT need to apply tests 3 and 4. However you must still disclose on the tax return that you receive PSI income and that the PSI rules don’t apply – because of this disclosure we recommend that you understand the results test well and take out income tax audit insurance as you may be audited by the ATO to confirm you do indeed pass the results test.
   2. FAIL – of you fail the results test then proceed to step 3 (the 80% test) to see of the PSI rules apply to you
3. Step 3 <80% Rule> (PSB test) –
   1. PASS – if less than 80% of the PSI (income) comes from one client (including their <associates>) then proceed to step 4 (remaining tests) to continue working out if the PSI rules apply to you.
      1. <Commission Agents> – when applying the 80% rule you can treat the clients of the principal as your own clients if certain conditions are met, this means that you PASS the test and you can proceed to step 4 (remaining tests) to continue working out if the PSI rules apply to you.
   2. FAIL – of you fail the results test then proceed to step 3 (the 80% test) to see of the PSI rules apply to you
4. Step 4 <remaining tests> (PSB test) – if your result at step 3 is less than 80% there you must PASS at least ONE of the three remaining tests for the PSI rules not to apply to you:
   1. <Unrelated clients test>  –
      1. PASS – where your PSI income is from:
         1. two or more clients who are note related or connected; and
         2. the clients were obtained from making offers to the public or section of the public.
      2. FAIL – then you can still pass one of the two remaining tests (Employment and Business premises)
   2. <Employment> – your business must employ or contract others to help complete the work that generates your PSI:
      1. PASS this test by meeting one of the following two conditions:
         1. 20% principal work – The employee carries out at least 20% of the Principal work; or
         2. Employ an apprentice for at least 6 months of the income year.
      2. FAIL– then you can still pass one of the two remaining tests (Unrelated Clients test and Business premises)
   3. <Business premises> – you pass the test if at all times in the income year, your business premises meets all of the following:
      1. Used mainly for personal services work
      2. Used exclusively for your business
      3. Physically separate from your home
      4. Physically separate from your clients.

Remember the 4 steps:

Step 1 – if more than 50% of the amount you received was for a contract for your labour, skills or expertise then you are c=receiving PSI income

Step 2 – If you pass step 2 the results test then while you are receiving PSI income, the PSI rules don’t apply, however you must still disclose the psi income in your tax return.

Step 3 – if you did not pass step 2 then if you:

1. fail step 3 you are subject to the PSI rules,
2. pass step 3 then you must pass at least one of the three tests in step 4

step 4 – if you pass either of the three tests then the PSI rules do not apply to you, if you fail all three of the tests then the PSI rules do apply to you. To understand what the PSI rules are <contact us> to find out more.

And remember that you must disclose to the ATO you have PSI income on the tax return, for example for the 2017 year in the company tax return it is shown below at question 14. because it is disclosed in the tax return the ATO is notified you are in receipt of of PSI income and  as such may audit you at some stage, therefore we recommend that tax audit insurance is considered.