Personal services income - are you treating it correctly?

Personal services income - are you treating yours correctly?

Sally Preston

If you earn income mainly from your personal skills, knowledge or labour, you may be earning personal services income, commonly called PSI.

What is PSI?

PSI is income that is mainly a reward for an individual’s personal efforts or skills. The ATO describes this as income where more than 50% of the payment is for the individual’s labour, skills or expertise.

Can PSI be earned through a company, trust or partnership?

Yes. Only individuals can have PSI, but it can be earned directly by a sole trader or indirectly through a company, trust or partnership. Where an entity receives income that is mainly a reward for one individual’s personal efforts or skills, that entity may be a personal services entity. The PSI rules can then attribute the income back to the individual who performed the work and restrict the deductions available.

Who is commonly affected?

· IT consultants and project managers

· Engineers and architects

· Medical and allied health professionals

· Financial professionals

· Lawyers, accountants and consultants

· Construction contractors and specialist trades

Why the rules matter

If the PSI rules apply, income may need to be attributed to the individual who performed the work. Deductions may also be limited to amounts broadly available to an employee. This can prevent income splitting or retaining profits in an entity at a lower tax rate where the income is really generated by one person’s labour.

When is income from a business structure instead?

Income is less likely to be PSI where it is generated by a genuine business structure rather than mainly by one individual’s personal efforts. Relevant factors include whether the business has substantial income-producing assets, employees or contractors performing principal work, goodwill, systems, scale and commercial independence from any one individual.

This needs to be assessed on substance. In many cases, each contract or income stream should be considered separately to determine whether the payment is mainly for an individual’s labour, skills or expertise, or whether it is generated by the broader business.

How the personal services business tests work

Even if income is PSI, the rules may not apply if the individual or entity is conducting a personal services business. The first test to consider is usually the results test. To pass that test, at least 75% of the relevant PSI must satisfy all three conditions: the income is for producing a result, the individual or entity provides the necessary tools or equipment where required, and the individual or entity is liable to rectify defects at their own cost.

If the results test is not met, the 80% rule becomes important. Broadly, if 80% or more of the PSI comes from one client and that client’s associates, the other self-assessment tests are not available unless the ATO issues a personal services business determination. If less than 80% comes from one client and associates, the unrelated clients test, employment test or business premises test may be considered.

Where a company, trust or partnership has more than one individual generating PSI, the tests generally need to be applied separately for each relevant individual. Different individuals in the same structure can have different outcomes.

Practical questions

☐ Is more than 50% of the income from each contract for your personal labour, skills or expertise?

☐ Are you paid to produce a result, rather than paid hourly or daily?

☐ Do you provide and maintain your own major tools or equipment?

☐ Are you liable to fix defects at your own cost?

☐ Do you have multiple unrelated clients?

☐ Do you advertise to the public?

☐ Do you employ or engage others to perform principal work?

Common traps

· Assuming a company automatically gives access to the company tax rate

· Paying profits to a spouse where the spouse did not perform principal work

· Claiming deductions that would not be available to an employee

· Failing to test each contract separately

· Confusing contractor status with PSI status

· Assuming that passing one commercial test removes all income splitting risk

Important warning: Part IVA can still apply

Passing the personal services business tests does not automatically make every profit distribution or retention strategy acceptable. Part IVA can still apply where, viewed objectively, there is a dominant purpose of obtaining a tax benefit by splitting, diverting or retaining income that is really generated by an individual’s personal efforts. The ATO’s Practical Compliance Guideline PCG 2025/5 is particularly important for professional service businesses because it explains the ATO’s compliance approach to arrangements where personal services income is retained in the entity or diverted to associates, even where the personal services business tests have been passed.

Examples of higher-risk arrangements include paying the main worker less than a commercially realistic amount, distributing profits to family members who did not perform principal work, paying associates more than a reasonable amount for their actual services, accumulating profits in a lower-taxed entity without a clear commercial reason, or retaining funds in the entity and later making them available for the individual’s personal use.

Lower-risk arrangements are more likely to involve the individual receiving remuneration that is substantially commensurate with the value of their services, reasonable payments to associates for genuine work actually performed, and only temporary retention of profits for clear commercial purposes such as working capital or specific business investment.

Need help?

Smart Solutions Tax Advisory can help review PSI risks, personal services business tests and structuring for consultants and professional service providers.

Disclaimer: This article contains general information only and should not be relied on as tax or legal advice.

References / Useful links

ATO PSI: Personal services income | Australian Taxation Office

ATO PSI income: Income that is PSI | Australian Taxation Office