It doesn’t matter what sort of entity you are using to run your business. You could be operating as a company, trust or partnership, and your income could still be deemed as Personal Services Income.
Personal Services Income is income that is mainly derived from the personal exertion of an individual.
How do I know if I am receiving Personal Services Income?
To work out if any of your income is Personal Services Income you need to look at each individual income contract and answer the following two questions:
- What percentage of my income relates to personal exertion (i.e. labour – skills, knowledge, expertise, personal efforts of the person performing the work)?
- What percentage of my income relates to materials, supplies and/or tools and equipment used to complete the work?
In answering the above questions, if more than 50% of the income you received relates to personal exertion then this income is Personal Services Income.
Subsequently, if less than 50% of the income received relates to personal exertion then the income is not Personal Services Income. Below is a list of some of the types of income that are not considered Personal Services Income:
- Sale or supply of goods
- Income generated by income-producing assets (i.e. bulldozer hire)
- Income from granting a right to use property (i.e. copyright)
- Income generated by a business structure (i.e. large national professional firm)
Ok, I am receiving Personal Services Income so what does that mean?
Once you have determined that you have received Personal Services Income you then need to work out if the Personal Services Income (PSI) rules apply.
To work out if the PSI rules apply to your business you need to work through the following tests in this order:
Results Test – to pass this test you need to meet all of the following conditions:
- Paid to produce a specific result
- Required to provide your own equipment and tools
- Required to fix mistakes at your own cost
If you pass this results test then the PSI rules do not apply. If you do not pass the results test you need to apply the next test which is “The 80% Rule”.
The 80% Rule
- Does 80% or more of your PSI come from the same client? If yes, then the PSI rules do apply.
- Does less than 80% of your PSI come from one client? If yes, you need to move on to the remaining tests to figure out if the PSI rules will apply.
Remaining tests – Can you pass any one of the following tests?
- Unrelated clients test (is your Personal Service Income from two or more clients who are not connected and did you get the work by making offers to the public)
- Employment test (does your business employ others who produce at least 20% of your principal work)
- Business premise test (at all times of the financial year your business was used mainly for work that generates your PSI, used exclusively for your business, physically separate from your home and physically separate from your clients)
What if I passed the above tests?
If your outcome from the above was that you passed the tests then your Personal Services Income is not subject to PSI rules. This means that you are now classed as a Personal Services Business. As a Personal Services Business, other than reporting certain information in your tax return, there are no other changes to your tax obligations and no changes to the deductions you can claim. Please note: the character of the income has not changed so any profits from Personal Services Income must still be attributed to the individual who performed the service. This must be done, regardless of what type of entity you the Personal Services Business operates from.
What if I didn’t pass the above tests?
If you did not pass the above tests then your Personal Services Income is subject to the Personal Services Income rules which means the following will apply:
- Your business won’t be able to claim certain tax deductions including those listed below:
- a percentage of rent, mortgage interest, rates & land tax even if the business operates from one of the rooms in your house
- payments to associates for support work
- super contributions for associates who do support work
- car expenses for more than 1 vehicle
- The Personal Services Income will need to be attributed to the individual who performed the work as this income cannot be retained in the business
- Your business will need to meet certain tax reporting obligations
- Your business may have additional PAYG withholding obligations
- General Deduction Rule applies. This rule only allows businesses to claim the same deductions that the individual who performed the work could have claimed in the same situation. The expense must be an allowable deduction under tax law and relate to producing the PSI income
This is a complex area and if you have any questions or would like further information please contact our office.