Tax basics for small business – personal services income (PSI)

If you’re a contractor or consultant and you
earn personal services income, special tax rules may affect what amounts you include
in your assessable income and what deductions you can claim. Personal services income rules
can apply to sole traders, partnerships, companies or trusts. But only individuals can have personal
services income. If the income you earn in a contract is more than 50% for your effort
or skill in that contract, then you classify this income as personal services income. Your
income can be a mixture of personal services income and other income. So you’ll need to
work out whether more than 50% of the income you earn is for your effort or skill for each
contract. Take JASON for example. He’s in the landscaping
business. It’s his personal effort or skill in each contract that is generating the income;
it is not the sale of a product or the operation of certain equipment that generates the income.
So JASON’s income is personal services income. JASON will need to apply some tests to see
whether the personal services income rules will affect him. The first test we need to look at is known
as the ‘Results Test’. You’ll satisfy this test if you can answer yes to each of these
questions in relation to at least 75% of your personal services income. Under your contract
or arrangement, will you only receive payment when the work has been completed, that is,
after producing the contracted result? Do you need to provide the equipment or tools
necessary to do the work? Do you have to rectify or are you liable for the cost of rectifying
the defects in the work? The Results test simply looks at whether the
engagement of your services and the payment due is dependent on a certain result being
achieved. So, I win a contract for a job, it is a fixed
price for a fixed outcome. This satisfies the results test, I don’t get paid until the
job is complete. But if I was engaged on a daily or hourly rate and wasn’t dependent
on achieving a certain result to receive my income, this would not satisfy the results
test, is that right? That’s right. If your personal services income
does not satisfy the Results test, the next step is to apply the 80% rule . Generally
the rule is if 80 % or more of your personal services income comes from the same client
(or the client and one of their associates), the personal services income rules will apply
to you. You should seek advice if you’re not sure or you can apply to the ATO for a determination.
If you find that each of your clients provided less than 80% of your personal services income
your next step is to work out if you pass at least one of three tests. These tests are
the unrelated clients test, the employment test and the business premises test. The unrelated clients test is satisfied if
your business provides services to 2 or more clients who are not associates of each other
or associated with you. So if I provide landscaping work to two clients
that are not related to each other or to me, I will pass this test? That’s right. And if JASON doesn’t pass this
test, he’ll need to consider the employment test. The employment test is satisfied if
you get employees to perform at least 20% by market value, of the work that you are
being paid for. You’ll also pass the employment test if you have one or more apprentices for
at least half the income year The business premises test is satisfied if at all times
of the year the business premises are used solely for the operation of the business and
are not connected in any way to your residence. As can be seen, of these 3 tests JASON could
pass both the Unrelated Clients test and the Employment Test… He only needs to pass one
of these three tests to satisfy the personal services income tests. Since he does this,
the personal services income rules do not affect JASON. If JASON did not pass the tests, he will not
be able to claim certain deductions. For further information on the personal services income
rules and how they may impact on you, visit forward slash PSI or seek professional
advice from your tax adviser.

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