Are you thinking of becoming an independent contractor, consultant or a freelancer? If you’re embarking on a new career path, take some time to work through the personal services income (PSI) rules.
What is Personal Services Income?
Personal services income (PSI) is income primarily generated from your personal skills, knowledge, expertise or efforts as an individual. If more than 50% of what you receive for a contract is payment for your skills, labour or expertise, the income’s classified as PSI. PSI applies across all industries where you apply personal effort or skills – whether you’re in construction, an IT consultant, a medical practitioner or a graphic designer.
Income generated mainly from selling goods, using income-producing assets, or certain business structures isn’t considered PSI.
These examples show whether income is PSI or not PSI:
Income that is PSI: Jodie, an IT consultant, provides systems analysis services through her company. She enters into a contract to provide her consultancy services to another company. Her contract and invoice show that more than 50% of the payment for her consultancy services is for her personal skills and efforts, making it PSI.
Income that is not PSI: Henry, a carpenter operating a partnership with his spouse Kim, designs and constructs bespoke furniture and sells it through the partnership online and at trade fairs. Since the partnership is paid for the furniture sales and not for Henry’s skills and efforts, this income isn’t PSI.
How the PSI rules affect your taxes
Individuals can earn PSI either directly as a sole trader, or through another entity such as a company, partnership or trust. When an individual earns PSI indirectly through another entity, that entity is referred to as a “personal services entity” (PSE).
The tax treatment of your income depends on whether you’re operating as an individual/Personal Services Entity (PSE) or conducting a personal services business (PSB).
If you’re an individual/PSE and the PSI rules apply, your income is treated as personal income and taxed at individual rates, and certain deductions may be disallowed.
If you qualify as a PSB, the PSI rules will not apply and your income will be treated as ordinary business income with standard business tax rules applying.
To self-assess as a PSB, you either need to:
- meet the results test; or
- meet both the 80% rule and one or more of the other three PSB tests.
Results test
You meet the results test if at least 75% of your income is paid to produce a specific result, where you’re responsible for fixing any defects and you supply your own equipment to do the work.
80% rule
If 80% or more of your PSI comes from one client and their associates, you don’t meet the rule and the PSI rules will apply.
If less than 80% of your income from one client and their associates, and you also meet one of the three PSB tests below, then you can self-assess as a PSB.
Three PSB tests
- Unrelated clients test: you work for at least two unrelated clients who found you through public advertising or similar business promotion; or
- Employment test: you hire others to perform at least 20% (by market value) of your principal work that generates your PSI; or
- Business premises test: you maintain dedicated business premises separate from your home throughout the income year.
If you’re unable to self-assess as a PSB and don’t have a PSB Determination (available in some circumstances from the Commissioner of Taxation), then the PSI rules apply.
Still unsure?
If you’ve reviewed the PSI rules and worked through the tests and assessments and you’re still unsure if the PSI rules apply to you or your business, seek professional advice from a registered tax professional. The ATO can also provide tailored technical advice in some circumstances.
