Personal services income explained

This article was current at the time of publication.

The Australian Taxation Office (ATO) recently finalised a new ruling covering personal services income (PSI).

TR 2022/3 improves guidance on how PSI rules should be applied to individuals or entities.

It combines, updates and replaces two previous rulings – TR 2001/7 Income tax: the meaning of personal services income and TR 2001/8 Income tax: what is a personal services business (PSB).

The new ruling also restates long-established ATO views on the application of PSI rules and includes references to recent case law as well as more examples to help taxpayers understand PSI rules and PSBs.

“The ruling forms part of our view on PSI and should be read in conjunction with TR 2003/6 Income tax: attribution of personal services income and TR 2003/10 Income tax: Deductions that relate to personal services income,” an ATO spokesperson explains.

“TR 2022/3 has no application to income generated from a business structure and does not change the ATO’s view in other taxation rulings.”

These include IT 2121 Income tax: family companies and trusts in relation to income from personal exertion, IT 2330 Income tax: Income Splitting, IT 2503 Income tax: Incorporation of medical and other professional practices, and the application of IT 2639 Income tax: personal services income to those rulings.

What is PSI?

Income is classified as PSI when more than 50 per cent of what an individual receives from a contract is a reward for their efforts or skills.

Income determined to be PSI is attributed to the individual and taxed at marginal tax rates.

PSI can be received in almost any industry, trade, or profession. 

Common examples include professional services, information technology consultants, engineers, construction workers and medical practitioners.

Income generated from a business structure, use of assets or sale of goods is not classified as PSI and therefore not impacted by TR 2022/3.

The revised PSI guidance will also not affect:

• Contractual relationships between individuals and their clients or customers. That is, they do not become an employee or stop being a contractor.
• Entitlements to an Australian business number (ABN) or registration for goods and services tax (GST).
• Whether individuals are still considered to be running a business.

What are the PSI rules?

The ATO says its personal services income rules are designed to ensure a level playing field among individuals.

“They do this by preventing income earnt as a reward from an individual’s efforts or skills from being diverted, alienated, or split with other individuals or entities in an attempt to pay less tax,” the ATO spokesperson says.

“If you earn PSI and the PSI rules apply, there are special rules to ensure the income is attributed to you and not diverted to other individuals or entities. 

“They can also affect the deductions you claim and how you report PSI in your tax return.”

The rules will not apply to individuals earning PSI in the same year they operate a PSB, however, they will still need to report PSI in their income tax return and keep records.

PSI rule tests

A PSB is being conducted if either the sole trader or personal services entity (PSE) meets the results test in relation to at least 75 per cent of their PSI, or less than 80 per cent of their PSI is from the same entity and its associates (the 80 per cent rule) and they satisfy one or more of the other PSB tests.

The results test is met if PSI income is for producing a result and if the sole trader or personal services entity is required to supply equipment or tools to complete work and would be liable for the cost of rectifying defects.

Other PSB tests include the unrelated clients test, employment test, and business premises test.

In some circumstances, those unable to self-assess as a PSB for a specific income year may be able to apply for a PSB determination (PSBD).

“If you are unable to self-assess as a PSB and do not have a PSBD for the relevant year, PSI rules will apply,” it states. 

“You won’t be able to claim certain deductions against PSI and there are special ‘attribution’ rules to ensure that PSI is attributed to the individual who performed the work that generated the income.”

The ATO emphasises that even when PSI rules don’t apply, individuals still need to declare any PSI amounts they receive at the relevant labels on their tax returns and keep records of their business transactions.

Accordingly, it has reviewed and updated its PSI web content to make it easier for individuals and tax practitioners to navigate, understand, and apply the TR 2022/3 tax ruling.

The bottom line

Where individuals are earning income in relation to their personal efforts or skills, either as a sole trader or through an interposed entity, practitioners need to ensure that the PSI rules and PSB tests are correctly applied each year in relation to each test individual. 

Records should include the annual calculation of the test individual’s PSI, the necessary evidence that a PSB is being conducted and receipts for the deductions claimed. 

Regardless of whether the PSI rules apply, PSI amounts must be reported at relevant labels on tax returns.

Clients and practitioners should also be mindful that the ATO may seek to apply Part IVA where there are factors indicating that the dominant purpose of the arrangement is to obtain a tax benefit by diverting, alienating or splitting an individual's PSI or retaining profits in the lower taxed PSB.