If the income you earn is primarily a reward for your personal skills, knowledge, or effort, the Australian Taxation Office (ATO) may classify it as personal services income (PSI). This is a critical distinction that can significantly affect how your income is taxed and what deductions you may be able to claim. Understanding these rules is a foundational step for any independent professional in Australia seeking to build and manage their finances with foresight and discipline.
Written by Panbo Ye, CFP® | FCPA | SSA | Founder, Everglow
At its heart, personal services income is money earned mainly from your personal labour or skills. It’s the income you generate because of who you are and what you know, rather than from selling goods or using major income-producing assets. The PSI rules exist to ensure professionals are taxed in a manner similar to employees, even when operating through a company or trust.
Who is Typically Affected by PSI Rules?
These rules apply to many independent professionals and contractors paid for their individual expertise. While not an exhaustive list, individuals in these fields often need to consider the PSI rules:
- IT Consultants building software or managing complex technology projects.
- Engineers providing specialist design and advisory services.
- Medical Professionals, such as doctors, dentists, and allied health practitioners, working as independent contractors.
- Management Consultants and Financial Professionals paid for their strategic advice.
- Creative and Media Professionals whose income is tied to their individual contributions.
It’s crucial to understand that PSI relates to the nature of the income, not just your job title or business structure. Grasping this distinction is fundamental for managing your tax affairs correctly.
How the ATO's PSI Tests Work
If your income is identified as potential PSI, the next step is to determine if you are operating a Personal Services Business (PSB). A PSB is the ATO’s term for a professional who is genuinely in business for themselves, rather than being a 'disguised employee'.
Passing the PSB tests is key. If your activities meet the criteria, you may be exempt from the restrictive PSI rules and can generally claim tax deductions like any other business. These tests are designed to assess the substance of how you operate.
The Results Test
The results test is the primary gateway to qualifying as a PSB. If you pass this test for at least 75% of your personal services income, no other tests are required for that income year. To pass, you must meet all three of the following conditions:
- Paid for a specific outcome: Your contract is based on delivering a finished product or result, not just for the hours you work.
- Supply your own tools: You are required to provide the significant tools or equipment needed to complete the work.
- Liable for rectifying defects: You are responsible for fixing any errors in your work at your own expense, demonstrating you carry commercial risk.
Failing even one of these conditions means the income from that contract cannot count towards the 75% threshold. Careful review of your client agreements is essential.
The Other PSB Tests
If you do not pass the results test, other pathways may be available, provided you first clear the 80% rule. This rule states that if 80% or more of your PSI comes from a single client and their associates in one income year, you generally cannot self-assess as a PSB.
If you earn less than 80% of your PSI from one client, you may still qualify as a PSB by passing one of the following three tests:
- Unrelated Clients Test: You must provide services to two or more unrelated clients, and that work must be a direct result of making public offers (e.g., via advertising or a public-facing website).
- Employment Test: You must hire others to perform at least 20% of the principal work by value. This does not include purely administrative or support staff.
- Business Premises Test: You must own or lease a physical business space that is separate from your home and your clients' premises at all times during the year.
If you fail the results test and also receive 80% or more of your income from one client, the PSI rules will almost always apply unless you obtain a specific determination from the ATO. If the rules apply, this changes how your income is treated for tax purposes. For a detailed exploration of this, you may find our guide on tax planning for high-income earners useful.
The Tax Implications When PSI Rules Apply
When your income is classified as PSI and you do not qualify as a PSB, a key tax concept known as attribution comes into effect. The ATO essentially looks through your company or trust structure and treats the net income as if it were paid directly to you, the individual performing the work. This attributed income is then added to your personal assessable income and taxed at your marginal tax rate.
This prevents income from being retained in a company at a lower corporate tax rate or split with family members in lower tax brackets who did not directly earn it.
Impact on Tax Deductions
A significant consequence of the PSI rules is a strict limitation on the tax deductions you can claim. Your ability to claim expenses is generally restricted to what a typical employee could claim.
Deductions that are generally not allowed against your PSI include:
- Payments to Associates: You generally cannot claim deductions for paying a spouse or family member for non-principal work, such as bookkeeping or administration.
- Occupancy Expenses: Deductions for rent, mortgage interest, rates, or land tax for your home office are typically not permitted.
- Certain Motor Vehicle Expenses: Travel between your home and your main place of work is generally considered a private expense, similar to an employee's daily commute.
Careful planning is required to navigate these restrictions. For a deeper understanding of business structuring, our team can provide tailored business tax and accounting advice.
What Deductions Are Still Permissible?
Even when the PSI rules apply, you may still be able to claim deductions directly related to earning your income. These typically include:
- Superannuation Contributions: Your company can make super contributions for you (up to the concessional cap) and claim a deduction.
- Professional Indemnity Insurance: The cost of your professional indemnity and public liability cover is generally deductible.
- Registration and Licensing Fees: Mandatory fees to maintain your professional status are also typically deductible.
Sound financial stewardship means understanding both the opportunities and your responsibilities.
Navigating PSI Risks and Responsibilities
Misinterpreting the PSI rules can lead to significant financial consequences. The ATO actively monitors this area, and non-compliance can result in back-taxes, interest, and penalties. The most common pitfall is assuming a company or trust structure automatically negates the PSI rules—it does not. The substance of your working arrangements always takes precedence.
For example, a medical professional operating through a service trust must ensure any service fees charged are commercially realistic. As highlighted in ATO guidance on PSI and the medical profession, inflated fees designed to shift profits to a lower-tax environment are a major compliance red flag.
The key to managing this risk is diligent record-keeping and a clear understanding of your obligations. You can explore more on the ATO's compliance and penalty approach to appreciate the importance of getting this right from the start.
Practical Next Steps for Professionals
If you believe your income may be classified as PSI, disciplined and thoughtful action is required.
- Review Your Income Source: Determine if more than 50% of the payment for any single contract is for your personal skills or labour.
- Assess Your Business Structure: Evaluate your contracts against the PSB tests, particularly the results test. Document your assessment clearly.
- Maintain Meticulous Records: Keep all contracts, invoices, and evidence supporting your PSB assessment. The ATO provides a useful record-keeping checklist for PSI.
- Seek Professional Guidance: The rules are complex, and the consequences of an error can be costly. Professional advice tailored to your circumstances is often a prudent investment.
Navigating personal services income requires careful planning and a clear understanding of the rules. By taking a measured and informed approach, you can ensure your business structure is both compliant and effective for your long-term financial wellbeing.
If you would like clarity on how these principles may apply to your own circumstances, you may wish to speak with a qualified adviser. You can contact Everglow on 1300 913 929 or email contact@everglow.au to arrange a discussion.
General Advice Warning: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation, or needs. Before acting on any information, you should consider whether it is appropriate for your circumstances and seek personal financial, tax, or legal advice from a qualified professional.
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