Worked Example: Applying PSI Rules to a Contractor
Let’s apply the rules to a real-world scenario.
Meet Sarah, an IT Project Manager
- Situation: Sarah is an IT project manager contracting through her own company, “Sarah Tech Pty Ltd”.
- Contract: She has a 12-month contract with a single large bank, earning $150,000. She works from the bank’s office, uses their laptop, and is paid a daily rate.
- Income Type: The income is for her project management skills, so it is personal services income.
- PSI Tests Application:
- Results Test: Sarah fails. She is paid a daily rate (not for a specific result), uses the client’s equipment, and is not liable for fixing project defects at her own cost.
- 80% Rule: She fails this too. 100% of her PSI comes from one client.
- Conclusion: The PSI rules apply to Sarah’s income. This means Sarah Tech Pty Ltd must attribute all net PSI to Sarah as salary, and she can only claim deductions that a regular employee could claim.
This common PSI example for Australia shows how easily contractors can fall under the rules, especially when working for a single major client.
What Deductions Are Allowed and Disallowed Under PSI
If the PSI rules apply to you, the biggest impact is on the tax deductions you can claim. The ATO’s goal is to prevent contractors from claiming business deductions that an employee cannot.
PSI Deductions Disallowed
Under the PSI rules, you generally cannot claim deductions for expenses that a regular employee wouldn’t be able to claim. These include:
- Rent, mortgage interest, rates, or land tax for your home office.
- Payments to a spouse or other associate for non-principal work (e.g., bookkeeping, admin).
- Superannuation contributions for an associate performing non-principal work.
- Most travel expenses between your home and place of work.
These limitations are strict. Attempting to claim disallowed PSI deductions is a major red flag for the ATO.
Allowed Deductions
You can still claim deductions for legitimate business expenses directly related to earning your income, such as:
- The cost of gaining work (e.g., registration fees).
- Insurance premiums (e.g., professional indemnity).
- Salary or wages paid to the individual who performed the services.
- Superannuation contributions for the individual who performed the services.
- Certain expenses that an employee could also claim, like work-related travel to a client’s alternative premises.
For a broader overview, check our guide on work-related tax deductions in Australia.
PSI for Companies, Trusts and Partnerships
If you operate your contracting business through a company, trust, or partnership (known as an interposed entity), the PSI rules have an extra layer: income attribution.
The attribution rules for PSI are designed to stop individuals from leaving profits in a company to be taxed at the lower corporate tax rate. The ATO essentially looks through the business structure and treats the income as if it were earned directly by the individual who performed the services.
This means the net personal services income earned by the entity must be “attributed” (paid out as salary or wages) to the individual who did the work in the same financial year it was earned. This ensures the income is taxed at their personal marginal tax rate, just like an employee.
Compliance Requirements: ATO Reporting and Record-Keeping
Staying compliant with PSI rules goes beyond just understanding them; it requires meticulous reporting and record-keeping. The contractor tax obligations for PSI are specific and non-negotiable.
When you lodge your tax return, you must declare any PSI at specific labels. This signals to the ATO that you have self-assessed your status and are following the correct tax treatment for PSI. This applies to both your individual and your business tax returns.
Common Mistakes & How to Avoid Them
It’s easy to make mistakes that can attract unwanted ATO attention. Here are the most common traps and how to avoid them.
- Assuming you’re a PSB without testing: Many contractors assume they are a business without formally applying the PSI tests.
- Fix: Use the official ATO PSI tool every year and save the report as evidence of your assessment.
- Claiming disallowed deductions: Claiming home office rent or paying a spouse for minor admin tasks are red flags when PSI rules apply.
- Fix: Be strict. Only claim deductions an employee could claim, and keep excellent records. Check current ATO guidance on deductions.
- Ignoring income attribution: Leaving PSI profits in a company or trust is a major compliance breach.
- Fix: Ensure your payroll process attributes 100% of the net PSI as salary to the relevant individual before the end of the financial year.
- Incorrect BAS Reporting: PSI also impacts your Business Activity Statement (BAS) reporting, particularly for PAYG instalments.
- Fix: Ensure your BAS reflects the attributed income correctly. Our complete guide to ATO activity statements can help.
PSI Compliance Checklist
Use this copy-paste checklist at the end of each financial year to ensure you’ve covered all your PSI compliance obligations.
- Review all income sources: Have I determined which income is personal services income?
- Apply the PSI tests in order: Have I passed the results test or, if not, do I qualify as a PSB via the other tests after clearing the 80% rule?
- Document my PSB assessment: Have I saved a report from the ATO’s PSI tool as proof?
- Scrutinise my deductions: Are all my claimed expenses allowable under the relevant PSI or PSB rules?
- Confirm income attribution: (For companies/trusts) Has all net PSI been paid out as salary to the individual who performed the work?
- Check tax return labels: Am I prepared to report PSI at the correct labels on my business and personal tax returns?
Frequently Asked Questions
What is the difference between PSI and business income?
PSI is income earned mainly from your personal skills or labour. Business income is earned from the sale of goods, the use of significant assets, or the combined work of a team. The key difference is whether the client is paying for your expertise or the output of your business.
How does the PSI 80% rule work in practice?
If 80% or more of your PSI in a financial year comes from a single client and their associates, you generally cannot self-assess as a Personal Services Business (PSB). The PSI rules will automatically apply, limiting your deductions, unless you get a specific determination from the ATO.
Can I pay my spouse a salary from my PSI?
Generally, no. If the PSI rules apply, you cannot claim deductions for payments made to associates (like a spouse) for non-principal work, such as basic bookkeeping, issuing invoices, or administration.
What happens if I fail all the PSI tests?
If your income is PSI and you do not qualify as a PSB by passing the tests, the restrictive PSI rules will apply. This means you can only claim deductions that a regular employee could claim, and if you use a company or trust, you must attribute all net PSI to the individual who performed the service.
Do I still need to charge GST if my income is PSI?
Yes. The PSI rules are for income tax purposes and are completely separate from your GST obligations. If you are registered for GST (or required to be), you must continue to charge GST on your invoices and lodge your BAS. Learn more in our GST registration guide.
Can an IT contractor pass the results test?
It’s possible, but it depends entirely on the contract. To pass the results test, the contract must be for a specific outcome at a fixed price, the contractor must provide their own tools, and they must be liable for fixing defects. A contract based on a daily or hourly rate will almost certainly fail this test.
Does PSI apply to sole traders?
Yes. The sole trader PSI rules are the same. While income attribution is not an issue (as the income is already in your name), the limitations on deductions still apply if you don’t qualify as a PSB.
Is a real estate agent’s commission considered PSI?
Typically, no. The commission is earned by the real estate agency (the business entity), not the individual agent directly. The agent receives a wage or a share of the agency’s business income, which is not considered personal services income under the ATO rules.
Get Expert Help with Your Personal Services Income
Navigating the complexities of personal services income, the PSI rules ATO sets out, and the various tests can feel overwhelming. Getting it wrong can be costly, but you don’t have to do it alone. Ensuring your business structure is sound and your tax claims are compliant is our specialty. The expert team at Nanak Accountants & Associates is here to provide clear, practical advice tailored to your situation.
Book a consult with Nanak Accountants & Associates. Call us on 1300 NANAK TAX (626 258) or visit our website at https://www.nanakaccountants.com.au.
If you’re a contractor, consultant, or freelancer in Australia, understanding personal services income (PSI) isn’t just a suggestion, it’s critical for your tax compliance. Getting it wrong can lead to disallowed deductions and ATO penalties, while getting it right ensures you operate on a secure financial footing.
So, what is personal services income? In short, PSI is income earned mainly from your personal skills, effort, or expertise. It’s distinct from business income, which typically comes from selling goods or using significant assets. The Australian Taxation Office (ATO) has specific rules for PSI that can dramatically change your tax obligations, and this guide will walk you through them step-by-step.
Key PSI Takeaways
- What is it? Personal services income is income produced mainly (more than 50%) from your personal skills or efforts as a contractor or consultant.
- Why does it matter? The ATO’s PSI rules can limit the tax deductions you can claim, preventing you from accessing many standard business deductions.
- What are the tests? To avoid the restrictive PSI rules, you must qualify as a Personal Services Business (PSB) by passing specific ATO tests, like the results test.
- What’s the 80% rule? If 80% or more of your PSI comes from one client, the PSI rules will generally apply automatically.
- What about companies? If you operate through a company or trust, any PSI earned must be attributed (paid out) to the individual who performed the work.
- What’s the goal? The PSI rules are designed to ensure contractors can’t claim deductions that regular employees are not entitled to.
Personal services income (PSI) is income mainly earned from your personal skills or effort, such as contracting or consulting work. If your income is PSI, special ATO rules may limit deductions and may attribute income back to the individual. Whether PSI applies depends on specific tests. Always check current ATO guidance.
What Is Personal Services Income?
According to the ATO, personal services income (PSI) is income produced mainly (more than 50%) from your personal skills, labour or expertise, rather than from the sale of goods or the use of assets. It’s a concept designed to identify individuals who are essentially working like employees but operating through a business structure.
Think of an IT consultant hired for their coding ability, a project manager paid for their industry experience, or a graphic designer creating a logo. In these cases, the client is paying for the individual’s direct effort. This is the core of what is personal services income and why the tax treatment for PSI is different.
PSI vs Business Income
The key distinction between PSI and standard business income is what the client is paying for. Are they paying for you, or for the output of your business structure?
- PSI: The income comes directly from your personal effort. The value is tied to you as an individual.
- Business Income: The income comes from selling products, using significant equipment (e.g., a truck driver who owns their rig), or a team of employees working together. The value comes from the business as a whole.
This isn’t just tax jargon, it’s a fundamental distinction that determines which tax rules apply. Misclassifying your income can lead to the ATO disallowing your deductions and applying penalties.
PSI Indicators vs Non-PSI Indicators
Use this table to quickly identify whether your work arrangements point towards personal services income or standard business income based on common ATO indicators.
| Factor | Points Towards Personal Services Income (PSI) | Points Towards Business Income (Non-PSI) |
|---|---|---|
| Payment Basis | Paid for your time (hourly/daily rate). | Paid a fixed price for a specific result. |
| Tools & Equipment | The client provides most of the necessary tools. | You provide your own significant tools and equipment. |
| Risk | You are not liable for the cost of fixing defects. | You are financially responsible for rectifying mistakes. |
| Control & Delegation | The client has a high degree of control over how, where, and when you work. | You have the freedom to delegate the work to others. |
| Client Base | More than 80% of your income comes from a single client. | You provide services to two or more unrelated clients. |
| Business Premises | You work mainly from the client’s premises. | You operate from your own separate business premises. |
Getting this right is crucial. With professional and technical services being a major contributor to the Australian economy, the ATO pays close attention to how contractors classify their service-based income. Always check current ATO guidance before making a decision.
The PSI Tests Explained
If your income is PSI, you aren’t automatically subject to the restrictive rules. The ATO provides a pathway to operate as a Personal Services Business (PSB), which allows you to access standard business deductions. To qualify, you must pass one of the PSI tests.
Think of these as gateways to proving you run a genuine, independent business, not just an employee in disguise. Here’s how the personal services business tests work.
The Results Test
The results test is the first and most important hurdle. If you pass this test, you are a PSB for the year and don’t need to consider any other tests. To pass, you must meet all three of the following conditions for at least 75% of your personal services income:
- Paid to produce a specific result: Your contract specifies you are paid to achieve a defined outcome, not just for the hours you work.
- Provide your own tools: You are required to supply the plant, equipment, or tools of trade needed to complete the work.
- Liable for fixing mistakes: You are responsible for the cost of rectifying any defects in your work.
The 80% Rule
If you don’t pass the results test, you must check the PSI 80% rule. This rule states that if 80% or more of your PSI in a financial year comes from a single client (and their associates), you cannot self-assess as a PSB using the remaining tests.
The 80% rule is a critical checkpoint. If you fall into this category, the PSI rules will automatically apply unless you get a specific PSB determination directly from the ATO.
If no single client provides 80% or more of your PSI, you can proceed to the other three tests. You only need to pass one of them to qualify as a PSB.
- The Unrelated Clients Test: Do you provide services to two or more unrelated clients during the year? These clients must have been found as a direct result of making offers to the public (e.g., through advertising, a website, or a directory).
- The Employment Test: Do you hire others? You pass if employees or contractors perform at least 20% (by market value) of the principal work.
- The Business Premises Test: Do you own or lease a dedicated business space that is separate from your home and your clients’ premises, and is used exclusively for your business for more than 50% of the time?
How to Work Out If PSI Applies
Navigating the PSI rules ATO provides can feel complex, but it’s a logical, step-by-step process. Follow these steps to determine your status.
- Is your income PSI? Review each of your contracts. Is more than 50% of the payment for your personal skills, labour, or expertise? If yes for any contract, that income is personal services income.
- Apply the results test. Can you satisfy all three conditions of the results test for at least 75% of your PSI? If yes, you are a PSB, and the PSI rules do not apply. You’re done.
- If you fail the results test, check the 80% rule. Does 80% or more of your PSI come from one client and their associates? If yes, the PSI rules apply. You cannot self-assess as a PSB unless you get a private ruling from the ATO.
- If less than 80% of PSI is from one client, apply the other tests. You only need to pass ONE of the following:
- Unrelated clients test
- Employment test
- Business premises test
- Determine your final status. If you passed one of the tests in step 4, you are a PSB, and the PSI rules do not apply. If you did not pass any of these tests, the PSI rules apply, which will limit your deductions.
Pro Tip: The ATO offers a free Personal services income decision tool online. Using the ATO tool for PSI is a great way to confirm your assessment and keep a record for compliance purposes.
Worked Example: Applying PSI Rules to a Contractor
Let’s apply the rules to a real-world scenario.
Meet Sarah, an IT Project Manager
- Situation: Sarah is an IT project manager contracting through her own company, “Sarah Tech Pty Ltd”.
- Contract: She has a 12-month contract with a single large bank, earning $150,000. She works from the bank’s office, uses their laptop, and is paid a daily rate.
- Income Type: The income is for her project management skills, so it is personal services income.
- PSI Tests Application:
- Results Test: Sarah fails. She is paid a daily rate (not for a specific result), uses the client’s equipment, and is not liable for fixing project defects at her own cost.
- 80% Rule: She fails this too. 100% of her PSI comes from one client.
- Conclusion: The PSI rules apply to Sarah’s income. This means Sarah Tech Pty Ltd must attribute all net PSI to Sarah as salary, and she can only claim deductions that a regular employee could claim.
This common PSI example for Australia shows how easily contractors can fall under the rules, especially when working for a single major client.
What Deductions Are Allowed and Disallowed Under PSI
If the PSI rules apply to you, the biggest impact is on the tax deductions you can claim. The ATO’s goal is to prevent contractors from claiming business deductions that an employee cannot.
PSI Deductions Disallowed
Under the PSI rules, you generally cannot claim deductions for expenses that a regular employee wouldn’t be able to claim. These include:
- Rent, mortgage interest, rates, or land tax for your home office.
- Payments to a spouse or other associate for non-principal work (e.g., bookkeeping, admin).
- Superannuation contributions for an associate performing non-principal work.
- Most travel expenses between your home and place of work.
These limitations are strict. Attempting to claim disallowed PSI deductions is a major red flag for the ATO.
Allowed Deductions
You can still claim deductions for legitimate business expenses directly related to earning your income, such as:
- The cost of gaining work (e.g., registration fees).
- Insurance premiums (e.g., professional indemnity).
- Salary or wages paid to the individual who performed the services.
- Superannuation contributions for the individual who performed the services.
- Certain expenses that an employee could also claim, like work-related travel to a client’s alternative premises.
For a broader overview, check our guide on work-related tax deductions in Australia.
PSI for Companies, Trusts and Partnerships
If you operate your contracting business through a company, trust, or partnership (known as an interposed entity), the PSI rules have an extra layer: income attribution.
The attribution rules for PSI are designed to stop individuals from leaving profits in a company to be taxed at the lower corporate tax rate. The ATO essentially looks through the business structure and treats the income as if it were earned directly by the individual who performed the services.
This means the net personal services income earned by the entity must be “attributed” (paid out as salary or wages) to the individual who did the work in the same financial year it was earned. This ensures the income is taxed at their personal marginal tax rate, just like an employee.
Compliance Requirements: ATO Reporting and Record-Keeping
Staying compliant with PSI rules goes beyond just understanding them; it requires meticulous reporting and record-keeping. The contractor tax obligations for PSI are specific and non-negotiable.
When you lodge your tax return, you must declare any PSI at specific labels. This signals to the ATO that you have self-assessed your status and are following the correct tax treatment for PSI. This applies to both your individual and your business tax returns.
Common Mistakes & How to Avoid Them
It’s easy to make mistakes that can attract unwanted ATO attention. Here are the most common traps and how to avoid them.
- Assuming you’re a PSB without testing: Many contractors assume they are a business without formally applying the PSI tests.
- Fix: Use the official ATO PSI tool every year and save the report as evidence of your assessment.
- Claiming disallowed deductions: Claiming home office rent or paying a spouse for minor admin tasks are red flags when PSI rules apply.
- Fix: Be strict. Only claim deductions an employee could claim, and keep excellent records. Check current ATO guidance on deductions.
- Ignoring income attribution: Leaving PSI profits in a company or trust is a major compliance breach.
- Fix: Ensure your payroll process attributes 100% of the net PSI as salary to the relevant individual before the end of the financial year.
- Incorrect BAS Reporting: PSI also impacts your Business Activity Statement (BAS) reporting, particularly for PAYG instalments.
- Fix: Ensure your BAS reflects the attributed income correctly. Our complete guide to ATO activity statements can help.
PSI Compliance Checklist
Use this copy-paste checklist at the end of each financial year to ensure you’ve covered all your PSI compliance obligations.
- Review all income sources: Have I determined which income is personal services income?
- Apply the PSI tests in order: Have I passed the results test or, if not, do I qualify as a PSB via the other tests after clearing the 80% rule?
- Document my PSB assessment: Have I saved a report from the ATO’s PSI tool as proof?
- Scrutinise my deductions: Are all my claimed expenses allowable under the relevant PSI or PSB rules?
- Confirm income attribution: (For companies/trusts) Has all net PSI been paid out as salary to the individual who performed the work?
- Check tax return labels: Am I prepared to report PSI at the correct labels on my business and personal tax returns?
Frequently Asked Questions
What is the difference between PSI and business income?
PSI is income earned mainly from your personal skills or labour. Business income is earned from the sale of goods, the use of significant assets, or the combined work of a team. The key difference is whether the client is paying for your expertise or the output of your business.
How does the PSI 80% rule work in practice?
If 80% or more of your PSI in a financial year comes from a single client and their associates, you generally cannot self-assess as a Personal Services Business (PSB). The PSI rules will automatically apply, limiting your deductions, unless you get a specific determination from the ATO.
Can I pay my spouse a salary from my PSI?
Generally, no. If the PSI rules apply, you cannot claim deductions for payments made to associates (like a spouse) for non-principal work, such as basic bookkeeping, issuing invoices, or administration.
What happens if I fail all the PSI tests?
If your income is PSI and you do not qualify as a PSB by passing the tests, the restrictive PSI rules will apply. This means you can only claim deductions that a regular employee could claim, and if you use a company or trust, you must attribute all net PSI to the individual who performed the service.
Do I still need to charge GST if my income is PSI?
Yes. The PSI rules are for income tax purposes and are completely separate from your GST obligations. If you are registered for GST (or required to be), you must continue to charge GST on your invoices and lodge your BAS. Learn more in our GST registration guide.
Can an IT contractor pass the results test?
It’s possible, but it depends entirely on the contract. To pass the results test, the contract must be for a specific outcome at a fixed price, the contractor must provide their own tools, and they must be liable for fixing defects. A contract based on a daily or hourly rate will almost certainly fail this test.
Does PSI apply to sole traders?
Yes. The sole trader PSI rules are the same. While income attribution is not an issue (as the income is already in your name), the limitations on deductions still apply if you don’t qualify as a PSB.
Is a real estate agent’s commission considered PSI?
Typically, no. The commission is earned by the real estate agency (the business entity), not the individual agent directly. The agent receives a wage or a share of the agency’s business income, which is not considered personal services income under the ATO rules.
Get Expert Help with Your Personal Services Income
Navigating the complexities of personal services income, the PSI rules ATO sets out, and the various tests can feel overwhelming. Getting it wrong can be costly, but you don’t have to do it alone. Ensuring your business structure is sound and your tax claims are compliant is our specialty. The expert team at Nanak Accountants & Associates is here to provide clear, practical advice tailored to your situation.
Book a consult with Nanak Accountants & Associates. Call us on 1300 NANAK TAX (626 258) or visit our website at https://www.nanakaccountants.com.au.
