Personal Service Income
The Personal Service Income (PSI) rules are a set of ATO provisions designed to prevent persons who derive income from their personal services from “splitting” or “alienating” that income with other persons and therefore minimising the overall tax payable.
If you cannot pass one of the tests within the PSI rules and do not have a personal services business determination (PSB) from the Commissioner, then regardless of the trading structure you choose, your PSI income derived will be classified as PSI, which means:
– you will be unable to claim certain deductions against your PSI (basically, your deductions will be limited to those of a normal employee)
– your PSI, less allowable deductions, will be attributed to you, and therefore included in your individual tax return, and taxed at your individual marginal tax rate as though you were an employee. This means that your business income if you operate through a company won’t be taxed at the company tax rate and won’t be able to be paid as a dividend to other shareholders of the company. Or, where you operate through a trust, you won’t be able to minimise the tax payable by distributing the PSI to other beneficiaries of the trust, and
– you will have special tax return obligations.
New ruling
On 23 November 2022, the ATO finalised Taxation Ruling TR 2022/3: Income tax: personal services income and personal services businesses. The ruling combines and replaces the ATO’s previous rulings, TR 2001/7: the meaning of PSI and TR 2001/8: defining a PSB. Both of those rulings have now been withdrawn. Although according to the Commissioner the principles in these now-withdraw rulings have not changed, TR 2022/3 updates and clarifies the ATO’s views around the application of the PSI regime, taking account of judicial decisions handed down since 2001, particularly around the unrelated clients test.
The ruling, which applies retrospectively to income years commencing both before and after 23 November 2022, considers:
– how to identify PSI
– how the PSI rules apply to an individual or entity, and
– the application of the personal services business (PSB) tests.
The ruling finalises draft ruling TR 2021/D2
What is PSI?
PSI can be derived in almost all industries and is essentially a reward for an individual’s personal efforts and skills. Though it can be earned directly as a sole trader it can also be earned via an entity such as a partnership, company or trust (a personal services entity).
As TR 2022/3 notes, income is classified as PSI when more than 50% of the income you’ve received from a contract is a reward for your personal efforts or skills, rather than being generated by the use of assets, the sale of goods, or from a business structure. When working out if your income is PSI, you need to look at the income you have received from each contract separately. If 50% or less of the income received from a contract was for your personal efforts or skills, then none of the income from that contract is PSI.
As the ruling notes (with accompanying examples) income that is not captured as PSI includes:
– salary and wages (an employment relationship must be in play which draws in the employee/contractor distinction, but not the extended definition of employee contained in section 12(3) of the Superannuation Guarantee Administration Act)
– supplying or selling goods (example 5)
– supplying or using an income producing asset (example 4), and
– income from a business structure (this will likely apply where a business has substantial income-producing assets, a number of employees, or both). (examples 6, 7 and 8).
ATO tool
To assist practitioners and taxpayers, the ATO has built a personal service income tool to work out whether PSI has been earned, and if the PSI rules apply to that income. If a taxpayer relies on the verdict provided by the tool, the ATO will not charge them interest and penalties that might otherwise apply if they review the taxpayer’s circumstances in the future and find that they have not met their PSI obligations. However, any tax shortfall will still be payable