Personal Services Income - Contractors beware!
14/11/2016 The Hopkins Group
So, you’re a contractor who runs your business through a company, partnership or trust in order to take advantage of tax planning opportunities, right? Think you’ve got it sorted? Nothing to worry about? Maybe not.
Enter the fun police
Just when you think you’ve got your business structure under control and are enjoying the tax benefits of using an entity, along comes the personal services income (PSI) rules to ruin the fun.
Personal service income is a significant tax issue for contractors. The application and implications of this important set of rules is often misunderstood. The PSI rules simply allow the ATO to ‘look through’ your business structure and tax you as an individual.
The rules concerning the alienation of personal services income were introduced to prevent arrangements where individual taxpayers earning personal services income through a company, partnership or trust structure are able to split income with other family members and claim deductions that otherwise are not available to other taxpayers.
Have we rained on your parade?
Are you worried you’re breaking all the rules and fear this structure will no longer work for you? It’s not necessarily all bad news . . .
We simply need to identify if you are affected by these rules and help you manage your obligations. At The Hopkins Group we work with our clients affected by the PSI rules to manage regular activity statement and PAYG obligations making the process as stress free as possible. Below is a brief summary of when the PSI rules apply and the implications.
The rules are complex and certainly an area where help should be sought! If you believe you may be affected - or not sure if you are - please contact one of our accountants to discuss your personal circumstances.
What is personal services income?
Personal services income (PSI) is income produced mainly from your personal skills or efforts as an individual.
This could be writing copy for a website as a freelance journalist, mowing lawns as a gardener, doing bookkeeping for a few casual clients . . . you get the drift. Anything where the work you do (and not the products you supply) gets the job done. In our experience, professions most commonly affected by the rules are IT consultants, medical practitioners and lawyers.
When working out if you have received PSI, you need to look at each contract or job individually. If more than 50% of the income received for a contract was for your labour, skills or expertise, then all income from that contract is classified as PSI.
An example is Ben who is a computer consultant who provides his personal services through a family company, BenCom Pty Ltd.
The company has a contract to provide IT support services performed by Ben. This is personal services income because it is mainly a reward for Ben's personal skills and efforts. BenCom Pty Ltd also operates a computer spare parts business that sells computer hardware and software.
Ben provides his personal services to install software for clients and the cost of installation is usually built into the price for the hardware, and represents a relatively small proportion of the price.
Income from these services would mainly be for the sale and supply of goods. It would not be personal services income of Ben, but would rightly be regarded as income of the company.
The fall out
If you have PSI income there are fewer deductions you can claim against this income, and you will need to report this income as your own individual income.
For example, you won’t be able to claim the following against PSI:
- rent, mortgage interest, rates or land tax for your home (or your associate's home)
- payments to your spouse, or other associate, for non-principal work such as secretarial duties
- expenses that you would generally not be able to deduct as an employee.
Will I save tax?
If you operate your business through a company, partnership or trust the PSI your business receives needs to be allocated (or 'attributed') to each individual who performed the services and the individual will need to declare the income in their individual tax return. Basically, income from your personal services is treated as your assessable income even through it was earned through a separate entity. This is achieved through paying and/or attributing wages to you from the business. As a result your business will also have additional PAYGW obligations.
The upshot is that because PSI income is ultimately assessed to the individual there is generally no tax saving in operating through a company or trust.
What if I’m a genuine business?
If you received personal service income but are able to pass the following tests then the PSI rules don't apply and your business is a classified as a “personal services business” (PSB). When you are a PSB, there are no changes to your tax obligations.
You are considered a PSB if your business can pass one of the PSB tests:
1. The results test
2. The 80% test
3. The unrelated client test, employment test, and business premises test
Put simply, the income derived in these circumstances has the characteristics of true business income not that of salary or wage income earned by an employee. Therefore, the business is eligible for the usual business deductions and the income is assessed to the entity that earned the income if it is a company partnership or trust.
See here for a handy breakdown of the tests to help you work out if the rules apply to you.
“My employer requires me to contract through a company?”
This is something we see often and it usually has to do with Workcover obligations. If this is the situation you find yourself in then The Hopkins Group can help you with your monthly payroll and quarterly GST obligations.
Taming the wild beast
If you are reading this and have made it through to the end, well done! The PSI rules are a complex animal, but never fear as The Hopkins Group accounting team is here to wrangle your tax affairs into submission and help you to manage your obligations. You are not alone. If you would like to chat to an accountant, drop us a line or give us a call on 1300 726 082 to find out how we can help you.
Income tax Assessment Act 1997 - SECT 84-87
Australian Taxation Office
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