The Australian Tax Office (ATO) have recently revised their approach for the taxation of Personal Services Income. And the change to the rules will affect the ways that Perth tax accountants interact and advise on how contractors in Perth and the rest of Western Australia approach and document their tax affairs.
What is Personal Services Income?
If the income you are generating is mainly for your own personal efforts then tax law will apply that income to you. Simply because you have say, applied for an ABN, or opted to trade through a company, will not affect the underlying fact that the income you are generating is mainly from your own personal efforts. So tax law, through the PSI tax rules, will make that income your own income.
For example,
Bob works for BHP as an employee engineer. BHP pays Bob a salary and it is taxed to Bob.
For example,
Bob creates a company (Bob Pty Ltd) and now contracts to BHP. Nothing else has really changed. So the tax law will tax all of the income of Bob Pty Ltd to Bob.
In effect the mere creation of a tax business structure, which effectively has no “sole” will not alter the tax outcome that the income is the income of the individual.
What is not Personal Services Income?
Many tax advisors do not look at the underlying contract and properly understand the type of income being generated. However PSI is typically income that is generated from the efforts of the person – however people often generate income from many type of ways.
The following income types are not connected to personal services income
- Income from the sale of goods (like the sale of cosmetic or the sale of bricks)
- Income from the rental of goods (like the hire of a truck or a rental property)
- Income from royalties (like book royalties)
- Income from a PSI Business.
What is a personal services business?
A Personal Services Business (PSB) is not subject to the application of the PSI rules by the ATO. So a PSB might be a family trust, company or partnership. In effect it is a business where the structure of the business itself is generating the income together with the efforts of the person.
There are four tests that an entity can take to determine if they are a tax PSB. The tests are:
- The results test – at least 75% of the income is paid for achieving a result.
- The unrelated clients test – you must generate services to 2 or more unrelated clients
- The employment test – You employ a third party who generates at least 20% of the income
- The business premises test – you have a business premises, separate from your client or your home where you generate the income.
If your tax structure satisfies at least one of the above tests the PSI rules will not apply. So ensuring that your tax law compliance documents contains a discussion of how PSI will not apply is essential.
How are the new PSI changed and how will it affect me?
The ATO have released new guidance (through TR 2022/3) following the decision in FCT v Fortunatow [2020] FCAFC 139.
To pass the unrelated clients test you must now:
- Provide services to two or more clients not connected with each other or connected to you; and
- The services must be provided as a direct result of making offers to the public at large.
In particular word-of-mouth referrals will not satisfy the requirement. The work obtained from a PSB must be a direct result of the offer or invitation. And the ATO understand that advertising can take on a wide range of print and internet advertising – but all offers must make an offer to the public (so an offer to a labour hire agency is not sufficient).
The PSI rules are dangerous
Sadly just because you pass the PSI rules does not mean that you are clear of the PSI regime. Tax law has a myriad of anti-avoidance provisions to catch contractors who, while passing the black-letter law tests, will fail the anti-avoidance tests. For example – just getting a minnow client paying you $45 a year so you pass the “unrelated clients test” will not be enough. And neither will be setting up a cheap $4 per month web page.
When looking at the PSI rules and the tax law surrounding PSI it is important to deal with a tax accountant who has deep technical knowledge in PSI. At Westcourt our primary service offering is tax – and given our service offering is focussed only on families in business we are ideally suited to contractors who are growing and want to properly deal with the PSI tests. Our technical strength, single focus and deep international network through GGI Global means that we are the natural choice for contractors looking at PSI – so why not give us a call?
