If you’re a freelancer, consultant, or independent contractor in Australia, it’s important to understand Personal Services Income (PSI) laws and how these can impact your tax obligations.
What is Personal Services Income?
Personal Services Income (PSI) is income that is mainly a reward for an individual’s personal efforts or skills. This could include income from contracting, consulting, or freelance work. If your income is PSI (and you are not classed as a personal services business), then this can impact the tax deductions you can claim and how you report your income to the ATO. Ultimately, you’ll be limited to the tax deductions that you can claim as though you are an employee. If you trade via a company, trust, or partnership – PSI will be attributed to personally to the individual who performed the services.
Personal Service Business Tests
The Personal Services Business (PSB) tests are used to determine if an individual or entity is conducting a personal services business. If you pass any of the following tests, your business is considered a PSB, and the PSI rules do not limit the deductions you can claim. Here are the four PSB tests:
The Results Test
To pass this test, you must meet all three of the following conditions for at least 75% of the PSI you earned during the year:
- The income was for producing a result.
- You were required to supply the plant and equipment or tools of trade needed to perform the work (not including equipment or tools of trade supplied by the client).
- You were, or would be, liable for the cost of rectifying any defect in the work performed.
The Unrelated Clients Test
This test is passed if you provide your services to two or more clients who are not associated with each other or with you, and the work has been obtained by making offers or invitations to the public or a section of the public.
The Employment Test
You pass this test if, during the year, you employ or engage one or more entities that perform at least 20% (by market value) of the principal work. Alternatively, if you have an apprentice for at least half the year, this can also help you meet the employment test.
The Business Premises Test
To pass this test, you must maintain and use business premises that meet the following criteria:
- They are used mainly (more than 50% of the time) for your personal services work.
- They are physically separate from your home, the home of your associates, and the premises of your clients or their associates.
- They are exclusively used by your business.
If you do not meet any of these tests, you may still be considered a PSB if you obtain a Personal Services Business Determination from the ATO. This determination is a decision by the Commissioner of Taxation that, based on your specific circumstances, confirms that you are conducting a personal services business.
Failing the PSI business tests
If you fail the Personal Services Business (PSB) tests (and you have not received a PSI determination), it’s important to consider the following questions to understand your tax obligations:
- Do you meet the 80% rule? If you don’t satisfy the results test and 80% or more of your PSI came from one client and its associates, you cannot self-assess against the other PSB tests unless you have a determination from the Commissioner.
- Are there any exceptional circumstances that may affect your eligibility for a PSB determination?
- Have you reviewed all contracts and engagements to ensure you have not overlooked any that may satisfy the PSB tests? It’s possible that some contracts may meet the conditions of the PSB tests while others do not. Ensure you have thoroughly reviewed all your engagements.
- Can you make changes to your business practices to meet the PSB tests in the future?
- Consider if there are adjustments you can make to your business model, such as diversifying your client base or changing the way you perform your services, to meet one of the PSB tests in the next financial year.
- Have you consulted with a tax professional or the ATO for advice?
The bottom line is that If you fail the PSB tests and do not have a PSB determination, the PSI rules will apply!
If you’re unsure about your status after failing the PSB tests, don’t hesitate to get in touch with our team. We can help you understand your specific situation and provide guidance on your next steps.
