What is Personal Services Income?
Personal Services Income (PSI) is primarily a reward or compensation generated by an individual’s personal efforts and skills. The income earned is categorized as Personal Services Income if more than 50% of the income received can be attributed to the individual’s personal skills, expertise, and efforts, rather than being produced by using some assets, selling products, or through a business structure.
Importance of Personal Services Income
The Australian Taxation Office (ATO) has constituted special tax rules and regulations regarding the tax treatment of Personal Services Income to ensure that individuals don’t take undue advantage of deferring or understating their personal tax return by way of misappropriating the income received as a result of providing their personal services through companies, partnerships or trusts. The objective is to strengthen the integrity and robustness of Australia’s tax system.
The treatment of Personal Service Income affects the amount you include in your assessable income and the kind of tax deductions you can claim. When your income is labeled as PSI, the deductions you can claim reduces.
Impact of PSI on Tax
Usually, sole traders or individuals who work through an interposed entity earn Personal Services Income and thus are subject to the PSI rules and regulations.
If you work as an employee and receive only salary and wages, then PSI does not apply to you. However, if you conduct operations through a different entity, such as a company, partnership, or a trust, and are classified as an employee of that entity, you will be subject to PSI rules.
Which Income is not classified as Personal Services Income?
The income you generate will not be classified as PSI in the following situations:-
1) It is from selling goods or services, such as retailing, wholesaling, or manufacturing.
2) Income generated by utilizing income-producing assets, such as trucks, bulldozers, printing press, etc.
3) Granting a right to use property, such as intellectual property or copyrights.
4) Income created from business structures, such as a large firm or company.
Steps to Understanding Personal Service Income
You need to consider the income received from each separate contract or job to determine if you have received PSI. If it is a yes, you need to check if PSI rules apply to it.
Step 1 – Work out whether your income is PSI.
If your income-earning activity falls under the PSI rules, it will be subject to certain rules with fewer income tax deductions available to you. If they are not applicable, your business is classified as a Personal Services Business (PSB). There will be no adjustments to your tax obligations, except that you must declare any PSI on your tax return.
Step 2 – Use the Personal Service Business (PSB) Tests
These tests help to determine if you are running a Personal Service Business (PSB) or not. The various tests to be taken include (in chronological order):-
1) Results Test
2) The 80% rule
If, after following the steps, you work out that your business is a PSB, the rules won’t apply to your PSI.
What are Fringe Benefits?
Fringe benefits are given to employees, which differ from salary or wages. Some examples include allowing an employee to use a work car for private purposes, reimbursing an expense incurred by an employee, such as school fees and giving an employee a discounted loan, etc.
What is Fringe Benefits Tax (FBT)?
Employers pay this tax on the specific benefits provided to their employees or their family and other associates.
The FBT is separate from income tax and is calculated on the taxable value of the fringe benefit. The employer must self-assess their FBT liability and lodge an FBT return for the relevant year. Employers can generally claim an income tax deduction for the cost of providing fringe benefits and for the FBT they pay.
Conclusion
Understanding Personal Services Income (PSI) is crucial for sole traders, contractors, and individuals working through entities like companies or trusts in Australia.
PSI rules ensure individuals are taxed appropriately on income derived primarily from their skills and efforts. If you’re unsure whether your income qualifies as PSI or navigating the PSI rules and tax implications seems complex, it’s highly recommended that you consult a qualified accountant. An accountant can help you determine your PSI status, navigate the relevant tax tests, and optimise your tax deductions while adhering to ATO regulations.
