The bad news is: having an ABN or company registered doesn’t always lead you to those tax benefits from running a business.
PSI is the catch here.
Most people probably haven’t even heard of PSI before, and it is notoriously confusing. But it doesn’t mean it is irrelevant to most people or any wrongdoings would be of little consequence. If you are receiving personal service income under an ABN (regardless of business structure), and if you treat it as regular business income in the tax return, you may be paying less tax illegally, that is, tax avoidance in strict terms, which could result in heavy penalties imposed on you.
To find out if you are caught by the PSI rules, you need to examine the below steps carefully.
Step 1: Have you received PSI?
First and foremost, it is only relevant to personal service income (PSI), where more than 50% of the income received for a contract was for your labour, skills or expertise, rather than from providing products, tools or equipment. Therefore, many professionals or tradesmen are caught under this regime. Common examples are:
- financial professionals
- IT consultants
- construction workers
- medical practitioners.
If your ABN income (under sole trader, partnership, trust or company) is categorised as PSI income, you will need to follow the steps (known as the PSB tests) to work out if you are a PSB (personal service business).
- If you are a PSB, the PSI rules don’t apply to you, which is good. You’re genuinely running a business and no changes to your tax obligations;
- If you are not a PSB, the PSI rules apply. You will have to attribute PSI income to your personal name if it’s received in a company/trust/partnership, and below deductions are not allowed to claim:
- rent, mortgage interest, rates or land tax for your home (or your associate’s home)
- payments to your spouse, or other associates, for support work such as secretarial duties
- expenses that you would generally not be able to deduct as an employee.
Knowing the consequences, now let’s look at the PSB tests in order:
Step 2: Results test
This is the first PSB test you will look at, if you pass this test, you are a PSB without PSI rules applying to you. It should be noted that, it doesn’t have to be 100% of your PSI passing the results test. 75% or more is sufficient. If you fail this test, you will need to go to the next test.
Step 3: The 80% rule
You come to this step because you’ve failed the results test. If less than 80% of your PSI is from one single client and its associates, you may be also a PSB if you pass one of the three remaining tests as well which is step 4.
Step 4: The remaining tests
Except for some unusual circumstances, the remaining tests are used only if you pass the 80% rule above. If you pass the 80% rule plus one of the remaining tests, PSI rules don’t apply, you are a PSB and entitled to normal business tax benefits.
Unrelated clients test
To pass the unrelated clients test your PSI must be produced from two or more clients who are not related or connected, and the work must be obtained by making offers to the public. You do not pass the unrelated clients test if you source all your work through arrangements such as a labour-hire firm.
To pass the employment test in an income year, your business must employ or contract others to help complete the principal work.
Business premises test
You pass the test if at all times in the income year, your business premises meets all of the following conditions:
- Used mainly for personal services work
- Used exclusively by you
- Physically separate from any premises you use for private purposes (such as your home)
- Physically separate from your clients’ premises.
What if the PSI rules apply?
If, in any case, you are receiving PSI and failing all the above tests, you are not a PSB and the PSI rules apply. you will be regarded as being in the same position as an employee for tax purposes. All PSI has to be attributed back to the specific individual, and there will be limits to the deduction that you can claim.
It also should be noted that, if more than one individual is generating PSI in your company, partnership or trust, you must follow these steps above for each individual.
PSI rules were introduced to prevent high-income earners to set up “business-like” entities to take advantage of tax benefits under a business structure (e.g. lower tax rate for companies). As a PSI earner (majority income received for your skills, expertise or labour), if you want to avoid being caught under the PSI rules, you need to examine the steps/tests carefully and make sure you either meet the results test or the 80% rule PLUS one of the remaining tests.
If you have any doubts about your own PSI situation, you may want to speak to a tax professional or contact us to find the correct treatment of your income and expenditure.
Please note that this post is intended to be a general guide only, and should not be seen to constitute legal or tax advice. Where necessary, you should seek a second professional opinion for any legal or tax issues raised in your personal or business tax affairs.