Deductions when the PSI rules apply
When the PSI rules apply there will be:
The PSI rules only apply to income that is PSI. You can still claim expenses against other income and normal tax rules apply. If you receive both PSI and other income then you may need to allocate your expenses between each category of income.
Deductions you can't claim against the PSI
The deductions you can't claim against the PSI you received include the following.
Rent, mortgage interest, rates and land tax
You can't deduct rent, mortgage interest, rates and land tax for your (or your associate's) residence, where those expenses relate to your PSI. This also means you cannot deduct these expenses when your business premises are at your home.
Example
Sarah has recently set up a business called Sarah's Financial Services, where Sarah provides financial advice and completes tax-related forms, for example, business activity statements and tax returns. Sarah operates this business from one of the rooms in her house.
All of the income generated is PSI as most of the income relates to Sarah's skills, knowledge and expertise. Sarah has also worked out the PSI rules apply.
Since the PSI rules apply, Sarah cannot claim rent, mortgage interest, rates or land tax relating to her residence against the PSI generated.
Payments to associates for support work (non-principal work)
You can't deduct payments you make to an associate (for example, spouse, child or other relative) for performing non-principal work.
Principal work is the work that must be done under the contract and generates your PSI.
Non-principal work is incidental or subsidiary work that is not central to meeting the obligations under the contract (that is, not the main work for which you get paid). Examples of non-principal work include bookkeeping for your business, issuing invoices, secretarial duties and running the home office.
Payments to associates include:
- remuneration such as a salary or commission
- an allowance
- reimbursement of an expense
- rent
- interest on a loan.
Therefore, you:
- can't claim payments to an associate for bookkeeping, issuing invoices, secretarial duties, running the home office or any other non-principal work
- can claim reasonable amounts paid to an associate for principal work, and salary or wages for an arm's-length employee (not an associate).
Example
Rodri provides marketing consultancy services which generates PSI. Rodri employs his wife Jenna to undertake some of the work.
The work Rodri's wife Jenna does falls into two categories:
- inputting daily sales data into spreadsheets Rodri uses to prepare recommendations and reports, and
- issuing invoices, banking receipts and administering the home office.
As the data entry work is the first stage in the work required to fulfil the obligations under the contract, it forms part of the principal work and is therefore principal work.
However, issuing invoices, banking and administering the home office, is not principal work. Rodri can't deduct the wages he paid to Jenna for issuing invoices, banking and administering the home office.
Super contributions for associates who do support work (non-principal work)
You can't deduct super contributions for an associate (for example, spouse, child or other relative), who does non-principal work such as bookkeeping, issuing invoices, secretarial duties and running the home office
Example
Wendy is an editor who does editing and proofing work. Wendy has little spare time and decides to get her brother, Jack, to do the bookwork and issue invoices for work she completed.
Jack's salary is $10,000 a year and Wendy contributes $900 to a super fund for Jack.
As Jack is an associate (he is Wendy's brother) and he performs non-principal work (bookwork and issuing invoices are not the main work clients pay for), Wendy cannot claim a deduction for the $900 super contribution.
However, you can deduct super contributions for an associate, relating to principal work they do from which you receive PSI. You can only deduct the superannuation guarantee (SG) amount you have to contribute for the associate. The SG amount is based only on the salary or wages you paid the associate for principal PSI-related work (and not non PSI-related work such as bookkeeping).
The superannuation guarantee limit does not apply where an associate does 20% or more (by market value) of your principal work. However, in that situation you pass the employment test and may not be subject to the PSI rules anyway.
The PSI rules do not affect the deduction of super contributions for an associate that relate to work they do for you from which you get income other than PSI.
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The term 'super contributions' in this section refers to contributions you make to a super fund or retirement savings account (RSA). Deductions for super contributions are subject to other tax rules.
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For information on other tax rules applying to super see www.ato.gov.au/super
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Example
David is an engineer who generates PSI as most of the income is for David's knowledge, skills and expertise.
David hires Mary (an associate of David's) to perform principal work. Mary completed 5% of the principal work (by market value) and was paid salary of $5,000. The company contributed $2,500 to a super fund for Mary.
David is not entitled to claim a deduction for the full amount he contributed to the super fund for Mary. The deduction that David is entitled to is capped at the amount he would have had to contribute in order to avoid an individual superannuation guarantee shortfall for Mary. For the 2008-09 income year that amount was $450 (9% of $5,000).
However, if Mary performed 20% or more (by market value) of the principal work, David could claim the entire $2,500 as a deduction.
Deductions you can claim against PSI
You can claim the following deductions against the PSI you received, if you incurred the expenses to generate this income:
- gaining work - for example, advertising, tendering and quoting for work
- registration and licensing fees
- insuring against loss of income, earning capacity or liability for acts or omissions in the course of earning income
- public liability and professional indemnity insurance
- salary or wages for an arm's length employee (not an associate)
- reasonable amounts paid to an associate for principal work
- complying with workers' compensation law, including premiums for workers compensation
- super contributions for the benefit of the individual or an arm's length employee (not an associate)
- running expenses for a home office - for example, heating and lighting (but not rent, mortgage interest, rates or land taxes)
- depreciation of income-producing assets
- bank and other account keeping fees and charges
- tax-related expenses, such as the cost of preparing and lodging tax returns or activity statements
- contributions to a super fund on behalf of an arm's length employee.
This is not a complete list of what you can claim because what contractors do, and how they do it, varies.
Records you need to keep for deductions
You need to keep records of most transactions in English for five years after you prepared or obtained them, or five years after you completed the transactions or acts they relate to, whichever is the later.
What happens if an expense is non-deductible?
If an expense is non-deductible, it means you cannot claim a deduction for the expense against the income you generated.
To prevent double taxation, where a payment to an associate (a salary payment, for example) is non-deductible under the PSI rules, the amount the associate received is not included in their assessable income.
Example
Julie is a sole trader who pays a salary to Frank to do the bookwork and run the home office (that is, non-principal work). Julie is not entitled to claim a deduction for the salary she paid to Frank because he was not performing principal work.
As Julie cannot claim a deduction for the salary she paid to Frank, the salary Frank received is not included in his income tax return as assessable income. Any PAYG withholding tax Julie paid on behalf of Frank is credited to Julie when she completes her individual tax return.
Fringe benefits tax on non-deductible expenses
If you have to pay fringe benefits tax (FBT) on an expense that is non-deductible under the PSI rules, the taxable value of the fringe benefit is reduced by the non-deductible amount.
This prevents double taxation - where an expense is taxable under the FBT system and non-deductible under the income tax system.
Sections within When the PSI rules apply
Last Modified: Tuesday, 29 November 2011