If you earn PSI and the PSI rules apply to that income, the types of deductions you can claim may be affected. Before working out what deductions you can claim, you need to work out if you are earning PSI and if the PSI rules apply to you.
In general, when you earn PSI you are treated as though you are in the same position as an employee.
This means your business may claim deductions against PSI received, if:
- the expenses are incurred in producing the income
- you (as an individual who earns the income) would be entitled to the deduction.
This applies to all PSI, whether it is earned as a sole trader or through a company, partnership or trust.
You must keep records of your transactions, including expense claims for 5 years after they are prepared, obtained or completed, whichever occurs later. You will also need to show whether the expenses relate to PSI or other income.
Where PSI is generated by more than one individual in a business, you need to allocate the deductions which relate to the income received by each individual.
For more information, see TR 2003/10 Income Tax: deductions that relate to personal services income.
When the PSI rules apply, you cannot claim deductions against the PSI for the following:
- rent, mortgage interest, rates and land tax
- payments to associates for non-principal work
- super contributions for associates for non-principal work.
Deductions cannot be claimed for rent, mortgage interest, rates and land tax for a residence, where those expenses relate to a person's PSI.
Example: deductions not claimable under PSI rules
Sarah has recently set up a business called Sarah's Financial Services, where Sarah provides financial advice and completes tax-related forms including 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 self-assessed that the business does not meet any of the PSB tests and therefore the PSI rules apply to that income.
Since the PSI rules apply, Sarah cannot claim rent, mortgage interest, rates or land tax relating to her residence.End of example
Payments made to an associate (for example, spouse, child or other relative) cannot be claimed as a deduction for performing non-principal work.
Principal work is the work a business must perform under a contract to receive payment.
Non-principal work is incidental or support work that is not central to meeting obligations under a contract. For example, bookkeeping, issuing invoices, administrative duties and running the home office.
Payments to associates include:
- remuneration such as a salary or commission
- an allowance
- reimbursement of an expense
- interest on a loan.
Example: non-principal work
Rodri generates PSI by providing marketing consultancy services, which is the principal work. Rodri employs his wife, Jenna to assist in the business. Jenna issues invoices, bank receipts and administers the home office, but does not perform any marketing consultancy services.
Rodri can't deduct the wages he pays to Jenna because issuing invoices, banking and administering the home office is not principal work.End of example
Super contributions for an associate (for example, spouse, child or other relative) cannot be deducted, if the associate does non-principal work such as, bookkeeping, issuing invoices, administrative duties and running the home office.
However, super contributions for an associate can be deducted, if the associate does principal work which contributes to the PSI. Deductions are allowed up to the minimum percentage that you would have to contribute to meet superannuation guarantee (SG) requirements for that associate.
You can contribute more than the SG minimum percentage if you pass the employment test in engaging an associate, as you will be a personal services business (PSB) and the PSI rules won't apply to that income.
If an associate completes work that generates income that is not PSI, super contribution deductions for that work are not affected by the PSI rules. The PSI rules don't affect super contribution deductions that are made for yourself.
The term 'super contributions' refers to contributions you make to a super fund or retirement savings account. Deductions for super contributions are subject to other tax rules.
Example: paying super contributions for an associate doing non-principal work
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 completes.
Jack's salary is $10,000 for the 2022–23 financial year. Wendy checks the SG percentage rate for that year and contributes $1,050 to a super fund for Jack.
10.5% super guarantee × $10,000 = $1,050
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 $1,050 super contribution (or for Jack's salary).End of example
Example: paying super contributions for an associate doing principal work
David is an engineer who produces PSI. Most of David's income is for his knowledge, skills and expertise.
David hires Mary (an associate of David's) to perform principal work. Mary completes 5% of the principal work (by market value) and is paid a salary of $5,000. David contributes $2,500 to a super fund for Mary.
David is not entitled to claim a deduction for the full amount he contributes to the super fund for Mary. The deduction he is entitled to is capped at the amount he would have had to contribute in order to avoid an individual SG shortfall for Mary. This is the SG percentage of her total salary payments. In this case, in the 2022–23 income year, the allowable deduction is:
10.5% super guarantee × $5,000 = $525
However, if David meets the employment test and is a PSB by employing Mary, David can claim the entire $2,500 as a deduction.End of example
Deductions can only be claimed, if an expense is paid or incurred in gaining or producing assessable income. The expense cannot be a capital, domestic or private expense.
As a sole trader, you claim deductions directly against your PSI in your individual tax return.
If the PSI is earned through a company, partnership or trust, the business reduces the amount of PSI that it attributes to an individual by the amount of the deductions. The deductions are for expenses that are incurred in gaining that individual’s PSI.
There are additional rules for entity maintenance deductions and car expenses.
Examples of allowable deductions include:
- 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 and other expenses in engaging an arm's length employee or contractor (not an associate)
- reasonable amounts paid to an associate for principal work
- complying with workers compensation law
- 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 - you may qualify for simplified depreciation rules for small business
- bank and other account keeping fees and charges
- tax-related expenses, such as the cost of preparing and lodging tax returns or activity statements
- meeting obligations under GST.
Additionally, if the PSI is earned through a company, partnership or trust, the business is entitled to claim entity maintenance deductions. These are:
- fees or charges associated with a bank, credit union or other financial institution account (but not including interest or interest-like amounts)
- tax-related expenses (for example, preparing and lodging tax returns and activity statements)
- any expense incurred for preparing or lodging a document under Corporations Law, except where the payment is made to an associate
- statutory fees.
This is not a complete list, as what can be claimed depends on how the income is earned.
Companies and trusts can normally claim all their motor vehicle expenses, although private use of their vehicles is generally subject to fringe benefits tax (FBT).
A special PSI rule is added for businesses with motor vehicle expenses, specifically for cars. If your personal services are contracted through a company, partnership or trust and the PSI rules apply, your business is only allowed to claim expenses (including FBT payments) for one car if the car is used for private purposes.
If your business has more than one car in private use at the same time, you must choose only one car to claim deductions for. This choice remains in effect for as long as your business has that car.
Where 2 or more individuals work through one company, partnership or trust, the business is able to provide one car to each individual for private use. This only applies if each of the individuals are performing their own work and it is not part of the other individual's work.
Businesses are still entitled to a deduction for car expenses for one or more cars provided to an individual, where there is no personal use of the car.
Non-deductible expenses cannot be claimed against your PSI. These expenses cannot be used to reduce PSI attributed to the individual, which is included in their individual tax return.
To prevent double taxation, where you make a payment to an associate (for example, a salary payment) that is non-deductible under the PSI rules, the amount received by the associate is not included in their assessable income.
Example: salary not deductible
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 pays to Frank because he is not performing principal work.
As Julie cannot claim a deduction for the salary she pays to Frank, the salary Frank receives is not included in his income tax return as assessable income. Any PAYG withholding tax Julie pays on behalf of Frank is credited to Julie when she completes her individual tax return.End of example
Fringe benefits tax on non-deductible expenses
If you have to pay fringe benefits tax 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.Earning personal services income (PSI) may affect the types of deductions you can claim.