Personal services income: Everything you need to know (and be careful of!)
Personal services income can be described as the money you make from your skills and expertise. It’s the cash that flows in when you put your brainpower to work, whether you’re a freelance artist, a tech-savvy consultant, or a wizard with words.
However, the Australian Taxation Office (ATO) might not think it’s so awesome if they classify it as personal services income and start scrutinising your tax returns.
So let’s learn about the PSI rules to ensure you’re doing everything above board.
What is Personal Services Income
Personal services income (PSI) is income received by an individual’s efforts or skills.
PSI income is commonly earned by self-employed professionals, such as consultants, freelancers, contractors, and sole traders.
The ATO has specific PSI rules for determining whether income is classified as PSI, which are based on factors such as the nature of the work performed, the level of control over the work, and the ownership of equipment and tools.
Why it is important to distinguish if your income is PSI?
The PSI rules in place ensure that individuals who earn PSI are not able to use certain tax deductions or structures that are available to businesses.
PSI rules apply to prevent individuals from improperly classifying their income as PSI to claim deductions for expenses, avoid paying taxes or reduce their tax liability.
By distinguishing if your income is PSI, you can ensure that you are meeting your tax obligations and taking advantage of any available deductions or concessions. It can also help you to avoid penalties and fines from the ATO, which can be costly and time-consuming to resolve.
What are examples of Personal Services Income?
Are you earning PSI income and do PSI rules apply to you?
Individuals can earn personal services income in a wide range of professions and industries.
The PSI rules apply to a personal services business including:
Consulting services provided by management consultants, IT consultants, or financial advisors
Creative services provided by artists, musicians, writers, and photographers
Health and wellness services provided by fitness trainers, massage therapists, and dietitians
Technical services provided by engineers, architects, and software developers
Trades services provided by plumbers, electricians, and carpenters
Personal care services provided by hairdressers, beauticians, and aestheticians
Education and training services provided by tutors, trainers, and coaches
Professional services provided by lawyers, accountants, and architects
Hospitality services provided by chefs, caterers, and event planners
What is Personal Services Income vs Sole Trading?
Personal services income and sole trading are two different concepts in the realm of business and taxation.
Under the PSI rules, personal services income refers to income earned by an individual as a result of their efforts or skills, such as consulting or freelancing. It is a type of income that is distinct from personal services business income, which is generated from the sale of goods or services produced by a business entity.
A sole trader, on the other hand, refers to a legal structure for a business in which an individual operates as the sole owner and is personally responsible for all aspects of the business, including finances, operations, and legal obligations.
They are considered to be self-employed and are not a separate legal entity from the owner.
While a sole trader can earn PSI, not all PSI is earned by sole traders. A sole trader may also earn business income, such as income generated from the sale of goods or services produced by the business entity
What is the difference between Personal Services Income and Business Income?
The main difference between personal services income (PSI) and business income is the source of the income.
PSI is income earned by an individual that is directly attributable to their skills, expertise, or efforts of an individual, and it is often earned through activities such as consulting, freelancing, or providing professional services.
On the other hand, business income is generated by a business entity that produces and sells goods or services, and it is often earned through activities such as manufacturing, retail sales, or service provision.
The PSI rules apply to determine whether income is classified as PSI or personal services business income, and these rules can affect the types of tax deductions and structures that are available to the earner.
Checklist for personal services test
To make it easier to help individuals and businesses identify income that is earned from personal skills or efforts, the ATO, as part of their PSI rules, has a set of tests that can be used.
The personal services business determination tests are as follows:
Results Test:
The results test looks at whether the individual or entity is paid to achieve a specific result, rather than being paid for the time worked, efforts or resources used to achieve the result.
Questions you can ask yourself to qualify for the results test include –
Do you have the ability to negotiate the terms and conditions of your engagement, such as the scope of the work to be performed and the timeframe for completion?
Are you responsible for ensuring that the work is completed to a satisfactory standard, and are you required to rectify any defects or faults in the work?
Are you required to provide your tools, equipment, and materials to complete the work, or are these provided by the client?
Do you bear any risks associated with the work, such as the risk of loss or damage to equipment or materials?
Are you able to delegate the work to others?
Do you have the ability to subcontract the work to others?
Are you required to complete the work to a fixed price or timeframe?
If you answered yes to these questions, you pass the results test
Business Premises Test:
This business premises test looks at whether the individual or personal services entity uses their premises to provide the services, or whether they use premises provided by the payer.
Questions to answer the business premises test include –
Do you have a dedicated workspace or office that you use exclusively for your business activities, or do you work from home or other locations?
Do you have a separate business phone line, email address, or website that you use to promote your services and communicate with clients?
Do you have business cards or other marketing materials that promote your business, and do you distribute these to potential clients?
Do you have a separate bank account that you use exclusively for your business transactions, and do you keep detailed records of your income and expenses?
Do you have a registered business name or ABN (Australian Business Number), and do you use this on your invoices and other business documents?
Do you have a written business plan or strategy that outlines your goals, target market, and marketing activities?
Do you have insurance, licenses, or other permits required to operate your business, and do you keep these up-to-date?
Employment Test:
The employment test looks at whether the individual or entity is treated as an employee of the payer for tax purposes.
Answer these questions about the employment test –
Do you not receive paid leave, such as annual leave or sick leave, or superannuation contributions from your employer?
Are you required to provide tools, and equipment to perform the job yourself?
Do you have autonomy over how the work is completed?
Is your income based solely on the hours worked or services provided?
Do you have the ability to negotiate your work schedule?
Do you have the freedom to dress as you choose?
If you answered yes to these questions, you pass the employment test.
The Unrelated Clients Test:
The unrelated clients test looks at whether the individual or entity provides services to a range of clients, or whether they are tied to one particular client.
Here are some questions that qualify for the unrelated clients test:
Do you provide your services to a range of unrelated clients?
Are you free to seek out and accept work from other clients?
Have you previously provided similar services to other clients?
Do you have a history of providing services to a range of clients in the industry or field in which you operate?
Are your services marketed to a range of clients?
Do you have the ability to refuse work from a particular client?
Are your services priced competitively within the industry or field in which you operate, indicating that you are offering your services to a range of clients?
If you answered yes to these questions, you pass the unrelated clients test
The Business Structure Test:
This test looks at whether the individual or entity has a separate business structure, such as a company, trust or partnership, which is different from their personal structure.
Are you a sole trader or do you operate as a company or partnership?
Do you have any employees or subcontractors who perform work on your behalf?
Do you own any assets or equipment used in the operation of your business?
Do you have any business premises, such as an office, workshop, or storage facility?
Are you registered for GST and do you submit regular BAS statements to the ATO?
Do you have a business plan or strategy that outlines your goals, target market, and marketing activities?
Do you have insurance, licenses, or other permits required to operate your business, and do you keep these up-to-date?
Need more help with the PSI rules?
The ATO provides a Personal Services Income tool on their website, which can be used to determine whether income is classified under the PSI rules.
