Do you own or operate a services business? Are you considering starting your own services business? PSI tax might affect you. In this article, we’ll explain what PSI tax is and how it applies to your business.
Personal Services Income (PSI) Tax
PSI tax is not really a ‘tax’. In reality, it is a set of rules regarding what tax deductions you are entitled to if you earn PSI. Whilst the effect is that you will end up being taxed more, it is easier to think of PSI tax as a separate set of rules about what you can and cannot deduct when filing your tax return.
Before considering any of the PSI rules, it is important to consider whether you have received any PSI.
Have you Received Personal Services Income?
In assessing whether income is PSI you must look at each contract or job you receive. If more than 50% of income received from a contract or job was for your labour, skills or expertise, then all income from that contract is personal services income.
If you have not received PSI then the PSI rules do not apply to that income and there is no change to your tax obligations.
However, if you have received PSI then the following three steps help you work out if your business is a personal services business (PSB). If your business is a PSB then the PSI rules do not apply.
Is my Business a Personal Services Business (PSB)?
1. Results Test
Income that is PSI must be viewed under the results test. If the income satisfies all of the following three conditions then the PSI rules do not apply. If you do not satisfy each of these three conditions then you must move to the next test (the 80% rule).
The three conditions of the results test are that you in generating your PSI you must be:
- Paid to produce a specific result;
- Required to provide the equipment or tools; and
- Required to have mistakes fixed at your own expense.
2. The 80% Rule
The 80% rule asks how much of the PSI comes from one individual client. If 80% or more of the income is from one client then the PSI tax rules apply. If less than 80% of the income is from one client then you must move to the remaining tests.
3. The Remaining Tests
If you satisfy one of the three remaining tests then your business is a personal services business (PSB) and PSI rules do not apply to any PSI you have received.
Unrelated Clients Test
You pass this test if:
- You generated the income from two or more unrelated clients; and
- You must have a definite connection between offering your work to the public e.g. advertising or maintaining a website and getting the work.
Employment Test
You pass this test if:
- Employees or contractors you engage complete 20% or more of the work; or
- You employ one or more apprentices for at least six months of the income year in which the PSI was earnt.
Business Premises Test
You pass this test if at all times in the income year your business is:
- Used mainly for personal services work;
- Used exclusively for your business;
- Physically separate from your home; and
- Physically separate from your clients.
I have received PSI but the rules don’t apply
Even if the PSI rules don’t apply you need to declare PSI on the relevant label in your tax return. Despite having to declare your PSI, as the PSI rules don’t apply there are no changes to the deductions you can claim.
I have received PSI and the rules do apply
If you have received PSI but fail to satisfy any of the tests in step 4 then the PSI rules apply. Whilst the PSI rules do not affect your contractual relationship with customers, collection of GST or status as a business they do limit the deductions you can claim on your tax return.
Which deductions you can and can’t claim are dependent on your business structure. As this is a highly specific and complex area of tax law any further clarification should come in the form of professional advice.
Summary
Personal services income (PSI) tax is a complex set of rules about which deductions you can claim if you receive PSI. If you do not receive PSI then PSI tax does not affect your income. Similarly, if you are a personal services business (PSB) under any of the tests then PSI does not affect you. If you are affected by PSI then it is best to seek professional advice as the rules for deductions are highly complex and depend on your business structure.
