Personal services income - basic information you need to know
Personal services income - basic information you need to know
Many consultants and contractors operate as a sole trader or through a company, partnership or trust. In many cases, the income received for the work they do may be classified as personal services income (PSI).
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If you operate through a company, partnership or trust, when we say you or your, we are referring to that business.
If you're an employee only earning salary and wages (that is, working for an employer and not under an Australian business number), you don't need to read any further. This information does not apply to your circumstances.
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To work out if your income is PSI, you first need to work out what percentage of the income you receive from each contract you complete is for:
- labour - that is, the skills, knowledge, expertise or efforts of the person who performed the services
- the materials supplied and/or tools and equipment used to complete the job.
If the majority (more than 50%) of your income is for the skills, knowledge, expertise or efforts of the person who performed the services, this income will be classified as PSI.
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Work done
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What was charged
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Is the income PSI?
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Job 1
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- Fixed blocked toilet
- Repaired several leaking taps
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Total amount of $250:
- $225 labour (90%)
- $25 materials (10%)
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Yes, the $250 is PSI as more than 50% of the income received is for Mark's skills and knowledge
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Job 2
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Installs a bathroom vanity
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Total amount of $800:
- $160 labour (20%)
- $640 materials (80%)
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No, the $800 isn't PSI as 50% or less of the income received is for Mark's skills and knowledge
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No matter what industry or occupation you work in, it's important to look at the income you receive from each contract and work out if it's PSI.
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Income that isn't PSI
Your income isn't PSI if 50% or less of it is for the skills, knowledge, expertise or efforts of the person who performed the services.
The income you generate in the following ways is not PSI:
- By selling or supplying goods. Income from selling or supplying goods, such as retailing, wholesaling or manufacturing, is generally not PSI as the income is not mainly a reward for your skills, knowledge, experience or efforts.
- Using an income-producing asset. Income from an income-producing asset, such as a bulldozer or printing press, is generally not PSI as the majority of the income is generated by the asset.
- Granting a right to use property. Income from granting a right to use property, such as copyright to a computer program, is generally not PSI as the majority of the income is generated from the right to use the property.
- Through a business structure. Income from a business structure, such as a large firm, is generally not PSI as the majority of the income is generated by the significant assets, many employees or contractors, sizable operations or goodwill of the business structure.
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For more information about whether your income is PSI, refer to:
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If your income is PSI
If you receive PSI, then certain rules (known as the PSI rules) may apply that:
- limit the deductions you can claim against this income
- affect your reporting obligations, such as tax returns and pay as you go (PAYG) withholding.
If you operate a company, partnership or trust, you need to treat the PSI as belonging to each individual who performed the services - you can't keep the PSI as part of your business profits.
If your income isn't PSI
If you don't receive PSI, then you do not need to read any further. There are no changes to your tax obligations.
Working out if the PSI rules apply
If you work out you're receiving PSI, you then need to work out if the PSI rules apply to this income using a series of tests.
- The results test - use this test first to work out if you've received the income after achieving a specific result or outcome.
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If you do not pass the results test, you need to apply an additional rule, called the 80% rule, to work out if 80% or more of your income comes from one client.
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- The unrelated clients test - use this test to work out if you have received the income from two or more clients who are not connected or related.
- The employment test - use this test to work out if others were employed or contracted to help complete the work that generates your PSI.
- The business premises test - use this test to work out if the location and usage of your business premises meet certain criteria.
The following flowchart shows how to work out if the PSI rules apply to your PSI.
Results test
You'll pass the results test in the income year if you can answer 'yes' to all three of the following questions for at least 75% of your PSI:
Question 1: Under your contract or arrangement, will you only receive payment when the work has been completed - that is, after producing the contracted result?
To answer 'yes', your contract must stipulate:
- you have to produce an outcome before being paid, which may include progressive payments made after finishing specified milestones, and
- you are paid this way.
Example
A carpenter enters into a contract to build five tables. The contract states the carpenter will not be paid until all five tables are completed. The carpenter is paid when he completes all five tables. This contract will pass this first condition of the results test as the payment is linked to producing a result (completing the five tables).
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If you're paid on an hourly basis or daily rate for the services you provide, it's unlikely you'll pass the first condition of the results test as this payment would generally not be linked to producing a specific result or outcome.
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Question 2: Do you need to provide the equipment or tools necessary to do the work?
To answer 'yes' to this question, you need to supply all the equipment or tools that are required to complete the contracted work.
Example
A painter is contracted to paint an office. As part of the contract, the painter has to provide their own tools and equipment including paint brushes, rollers and drop-sheets. As the painter has provided the necessary equipment to complete the work, they would pass the second condition of the results test.
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If no equipment or tools are needed to complete a job, you will pass this second condition of the results test.
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Question 3: Do you have to rectify defects in the work, or are you liable for the cost of rectifying defects?
Example
An engineer is contracted to complete a project. Under the contract, the engineer is liable to rectify any defects in their work at their own expense, even if they have to pay someone else to rectify the defects. This contract would pass the third condition of the results test as the engineer is liable for the cost of rectifying the defects.
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If you are entitled to invoice your payer for the hours you spend in rectifying any defects in your work, you will not pass this third condition of the results test.
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For more information about the results test, refer to:
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If you pass the results test
If you answered 'yes' to all three questions in the results test, you have passed this test and the PSI rules do not apply to this income. See Passing one of the tests - the PSI rules don't apply for more information.
If you don't pass the results test
If you didn't answer 'yes' to all three questions in the results test, you haven't passed this test. Your next step is to apply your circumstances to the 80% rule.
The 80% rule
For the 80% rule, you need to work out whether any of your clients, or their associates, provides 80% or more of your PSI in an income year.
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If you receive PSI from a client and one or more of the client's associates (for example, a company and a subsidiary of that company), this PSI is considered to come from one source.
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Example - one client providing 80% or more of your total PSI
Sasha is an IT consultant who designs software for two different clients in an income year. The income Sasha receives is PSI as the majority of the income is a reward for her knowledge, skill and expertise.
Sasha charges the first client $90,000 and the second $10,000 for the work she completes. This means 80% or more of her PSI comes from one client, as the first client has provided 90%.
Example - each client providing less than 80% of your total PSI
Xavier is an engineer who completes two contracts for two separate organisations in an income year. The income Xavier receives is PSI as the majority of the income is a reward for his knowledge, skill and expertise.
Xavier charges the first organisation $60,000 and the second organisation $40,000 for the work completed. This means each of Xavier's clients have provided less than 80% of his total PSI, as the first client has provided 60% and the second client has provided 40%.
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For more information about the 80% rule, refer to:
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When one client provides 80% or more of your total PSI
If 80% or more of your PSI comes from one client, you will need to apply for a personal services business determination from us to work out whether the PSI rules apply. We'll write back to you with our decision.
If you don't apply to us for a determination, the PSI rules will automatically apply.
When each of your clients provide less than 80% of your total PSI
If each of your clients provided less than 80% of your total PSI, you can use the other tests to work out if the PSI rules apply to the PSI.
The other tests
If you work out that each of your clients provided less than 80% of your total PSI, the PSI rules will apply unless you pass one of the following tests:
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You can apply these tests in any order.
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Unrelated clients test
You'll pass the unrelated clients test in an income year if you answer 'yes' to both of the following questions:
Question 1: Do you receive PSI from two or more unrelated clients?
To answer 'yes' to this question, you need to receive PSI from at least two clients who are not related or controlled by the same individuals or entities.
Example
Bryce is a financial planner who provides investment advice and receives PSI for his services from three clients who are not related or connected in any way. As the PSI is received from two or more unrelated clients, Bryce would pass the first condition of the unrelated clients test.
Question 2: Do you provide your services as a direct result of making offers or invitations (such as by advertising) to the public?
To answer 'yes' to this question, there must be a definite connection between the offer to the public and the engagement for the work. Making offers to the public includes advertising in a newspaper or business directory, maintaining a website, and word-of-mouth referrals.
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You are not making an offer to the public if you list with a labour hire firm or recruitment agency.
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For more information about the unrelated clients test, refer to:
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If you pass the unrelated clients test
If you answered 'yes' to both of the questions in the unrelated clients test, you have passed this test and the PSI rules do not apply. For more information, refer to Passing one of the tests - the PSI rules don't apply.
If you don't pass the unrelated clients test
If you didn't answer 'yes' to both of the questions in the unrelated clients test, you haven't passed this test.
Your next step is to look at whether you pass either the employment test or the business premises test. The PSI rules won't apply if you pass one of these tests.
Employment test
You'll pass the employment test in an income year if you answer 'yes' to one of the following questions:
Question 1: Do you get employees, partners (in a partnership) or other contractors to perform at least 20% (by market value) of the principal work?
Principal work doesn't include incidental work such as bookkeeping, issuing invoices or running your home office.
- another truck driver to drive the truck on long-haul trips
- a bookkeeper to help with invoicing.
Question 2: Do you have one or more apprentices for at least half of the income year?
To answer 'yes' to this question, you don't have to have the same apprentice for the entire six months. Also, your apprentices don't have to work with you for six months continuously.
Example
Chan is a plasterer. Throughout the income year, he has one apprentice from August to November (3 months) and a different apprentice from January to May (4 months). As he has had apprentices for a total period of at least 6 months of the income year, he passes the employment test.
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For more information about the employment test, refer to:
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If you pass the employment test
If you answered 'yes' to either of the questions in the employment test, you have passed this test and the PSI rules do not apply. See Passing one of the tests - the PSI rules don't apply for more information.
If you don't pass the employment test
If you didn't answer 'yes' to either of the questions in the employment test, you have not passed this test.
Your next step is to look at whether you pass either the unrelated clients test or the business premises test. The PSI rules won't apply if you pass one of these tests.
Business premises test
You'll pass the business premises test in an income year if you answer 'yes' to all parts of the following question.
At all times in the income year, were your business premises:
- owned or leased by you
- used for personal services work more than 50% of the time
- used exclusively by you
- physically separate from your residence and your associates' residences
- physically separate from the business addresses of clients and their associates?
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Two common examples that don't pass the business premises test are:
- a home office as this not considered physically separate from your residence
- an office jointly leased with another person/business entity, as neither lessees have exclusive use of the premises.
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For more information about the business premises test, refer to:
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If you pass the business premises test
If you answered 'yes' to all parts of the question in the business premises test, you have passed this test and the PSI rules do not apply. See Passing one of the tests - PSI rules don't apply for more information.
If you don't pass the business premises test
If you didn't answer 'yes' to all parts of the question in the business premises test, you haven't passed this test.
Your next step is to look at whether you pass either the unrelated clients test or the employment test. The PSI rules won't apply if you pass one of these tests.
Passing one of the tests - the PSI rules don't apply
If you pass one of the tests, the PSI rules don't apply to your income. The only change to your tax affairs is that you will need to complete specific questions on your tax return for the PSI received.
If you operate as a:
Passing none of the tests - the PSI rules apply
If you don't pass any of the tests, the PSI rules will apply to your PSI.
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If you are unsure or had unusual circumstances that prevented you from passing one of the tests, you should apply for a determination - refer to Applying for a determination.
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When the PSI rules apply, this means the following applies to you.
Sole traders
If you're a sole trader:
- you won't be able to claim certain deductions against your PSI, including
- rent, mortgage interest, rates or land tax for your home (or your associate's home)
- payments to your spouse (or other associate) for support work such as secretarial duties
- you'll need to declare the PSI you received in your tax return and complete several questions in the Business and professional items schedule (NAT 2543).
Companies, partnerships and trusts
If you operate your business as a partnership, company or trust, you:
- won't be able to claim certain deductions against your PSI, including
- rent, mortgage interest, rates or land tax for your home (or your associate's home)
- payments to your spouse (or other associate) for support work such as secretarial duties
- need to treat the PSI received as belonging to each individual who performed the services and each individual will need to declare that income in their tax return - you can't keep it as part of your business profits
- need to complete several questions in the business' tax return and the Personal services income schedule (NAT 3421) for the PSI received and provide each individual with a pay as you go (PAYG) payment summary
- will have additional PAYG withholding obligations, unless your company, partnership or trust is promptly paying the PSI to each individual who performed the services as salary or wages.
Applying for a determination
A personal services business determination is a notice from us stating the PSI rules don't apply.
You can apply for a free determination from us if:
- you're unsure if you've passed the results test, employment test or business premises test
- you have unusual circumstances that prevent you from passing one of the tests, or
- you don't pass the results test and 80% or more of your PSI is from one client, but you think you may pass one of the other tests.
After we receive your completed application, we'll apply the relevant tests to your circumstances and write back to you to let you know whether or not the PSI rules apply to your income.
For the unrelated clients test, by law we can only provide a determination where unusual circumstances have prevented you from passing this test and/or the 80% rule.
You should apply for a private ruling if:
- you're unsure if you pass the unrelated clients test, and
- less than 80% of your PSI comes from each of your clients.
For more information about PSI, refer to:
Last Modified: Friday, 17 October 2008
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