PSI is a tax provision that has been around for over 20 years however it is still one of the most overlooked tax provisions which catches out a lot of well-intentioned Aussies.

The provision is designed to prevent income earners from splitting their earnings with lower tax rate individuals or tax structures. This stops high income earners spreading their income & reducing their overall tax bill.

The most common PSI scenario is where a individual operates a business where the primary driver for reward is their individual personal skills, knowledge, or effort. Where many business owner falls into PSI issues is when they try to split their income to lower income earning spouse or into a bucket company – trying to reduce their tax payable. Obviously the ATO doesn’t like this, and the PSI rules are implemented to capture this income and assign it solely to the income earner – meaning a higher tax bill.

ATO Example:

Clare is an IT consultant who operates through a partnership with her spouse, Ralph, to provide IT services. Ralph does not engage in any of the principal work of the partnership (that is, IT activities) although he provides Clare with minor administrative assistance. The partnership has no significant assets, no employees or other workers, and has not generated any significant goodwill. The income is not derived from the business structure of the partnership. As Clare is performing all the principal work of the partnership, the income derived by the partnership is Clare’s PSI.

However not all income is PSI. Common examples of when income is not PSI is where 50% or more is generated from:

• The supplying or selling of goods – retailing, wholesaling or manufacturing is not PSI.
• The supplying or using an income-producing asset – using a truck to move cargo is not PSI
  • if the asset is large scale or high value, essential to performing the work or specified in the contract.
• A business structure with substantial assets or employees
  • Your business is less likely to be generating PSI if you have arm’s length employees performing principal work, substantial goodwill, substantial income producing assets & operate at a large scale,

ATO Example:

Jim is an electrician who operates from a discretionary trust with his wife, Jane. Jane does not perform any of the electrical work but performs some of the administrative work and some bookkeeping and marketing. Jim undertakes the work required by clients but also engages three full time employees who undertake electrical work for the business. The trust also owns two vans equipped with the necessary tools and equipment that are used by Jim and his employees. The trust has generated goodwill, having a trade name and approximately 150 regular clients. The income is derived from the business structure of the trust and is not PSI.

There are specific tests you can work through to determine if your income is PSI and whether you are subject to the specific PSI rules or not.

 

PSI Assessment Steps

 

Step 1. Have I received PSI?

If more than 50% of the income you’ve received for is for skills, labour or expertise then you have received PSI.

 

Step 2.  Do I meet the PSB provision?

The PSI catch all special provisions will apply unless your operations meet the definition of a Personal Services Business (PSB).

A PSB is being carried on if your business passes the following tests:

 

1. Results Test 

This test is satisfied if, in the income year, you can answer ‘yes’ to all three of the questions below for at least 75% of the PSI income you have received.

• Outcome – Payment received on completion or producing the contracted result
• Tools – Your business provides all tools / equipment necessary to perform the work
• Rectification – Your business responsible for all rectification of  defects & liable for any costs

The Results test needs to be applied on a year-by-year basis.

If you pass the Results Test, your business is a PSB, therefore the PSI rules do not apply.

If you fail & don’t pass the Results Test, you must then go to the next test being the 80% Rule

 

2. 80% Rule  

Does 80% or more of your Income come from only one client or it’s associated entities?

If Yes – If 80% or more of your income comes from one major client your business fails the 80% Rule and the income is classified as PSI and the PSI rules will apply.

If No – If less than 80% of your income comes from one client, then you must pass additional “The Other Tests” to be classed as a PSB.

 

3. The Other Tests 

If you pass at least one of The Other Tests, your business can then be self-assessed to be determined as a PSB

Unrelated clients test

1. Do you receive income from two or more unrelated clients?
2. Do you provide your services as a direct result of making offers or invitations to the public, advertising, website, marketing etc?

If Yes – you have passed this test and the PSI rules do not apply to you as you are a PSB

If No – continue.

 

Employment Test

1. Do you have employees, partners of a partnership or contractors who perform at least 20% (by market value) of the principal work (the main thing you do)?
2. Do you have one or more apprentices for at least half the income year?

If Yes – you have passed this test and the PSI rules do not apply to you as you are a PSB

If No – continue.

 

Business Premises Test

If at all times of the income year in relation to your business  premises

1. Was used mainly (> than 50%) to conduct your business;
2. You have exclusive use and actually use the premises;
3. Was physically separate from any premises you use for private purposes; &
4. Was physically separate from the premises of any of your Clients, or any client associates.

If Yes – you have passed this test and the PSI rules do not apply to you as you are a PSB

 

If you fail all test you can apply to the ATO for PSB determination if there are special, difficult, or unusual circumstances.

 

Where you have not passed any of the tests above and are determined to be subject to the PSI rules;  you will not be able to split any of your income to a spouse or related entity and you will be limited in your ability to claim certain expenses.

 

How Can Alto Help?

Although it sounds complicated Alto can help you to review your situation and ask some simple questions to help to understand if the PSI rules apply to you and ensure you optismise tax outcomes, while ensuring compliance with ATO requirements. Getting your PSI determination wrong can have disastrous financial outcomes so even if you would just like a second opinion – please don’t hesitate to reach out – we are here to help.

 

Author: Scott Coghlan