Understanding Personal Service Income (PSI) in Australia

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Many Australians use company and trust structures to operate their businesses. This is a great way to manage your risk and liability, and it can also provide taxation benefits.

To prevent people from abusing this system, the Australian Taxation Office (ATO) has established a set of Personal Service Income (PSI) rules. The PSI rules are intended to correctly reflect the income that’s earned by professionals using their personal skills and efforts.

PSI legislation is still being developed by the ATO, and the system can be complex to navigate. In this article, we’ll discuss PSI in greater detail, and help you figure out whether it applies to your income.

What is Personal Service Income?

Personal Service Income (PSI) applies where more than 50% of the income you earn for a contract is a direct reward for your personal skills, rather than income earned through the use of assets or the sale of goods.

When you pay income taxes, you are required to work out whether your income is classified as PSI. Each contract should be assessed separately.

Where income is classified as PSI, personal tax rates apply, and the range of tax deductions you can claim may be reduced.

If less than 50% of the income you earn for a particular contract was for your personal skills, then none of the income (for that contract) is considered PSI.

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Who do the PSI Rules Apply To?

The PSI rules apply to companies, trusts and partnership entities where your income is largely a result of the personal skills of an individual within the entity.

Generally speaking, the PSI rules apply to practitioners who run small businesses through a company entity or trust. This includes industries like:

  • Medical professionals
  • Accountants and lawyers
  • Architects and engineers
  • Software developers
  • Entertainers

The PSI rules do not apply to:

  • Income that is earned by selling goods (e.g. retail shops or wholesaling)
  • Income that is generated by an income-producing asset (e.g. earthmoving equipment)
  • Income that is generated by granting the right to use property (e.g. selling subscriptions to your software)
  • Income that is generated by a business structure (e.g. income that is generated by architects that are employed by an architecture firm)

Additionally, the PSI rules also do not apply to income that individuals earn as salary or wages from an employer.

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The PSI Results Test

Not all self-education expenses are eligible for a tax deduction. You cannot claim self-education

Once you work out whether you are receiving personal services income, you need to figure out whether the PSI rules apply to that income.
You can do this by assessing whether you are a Personal Services Business (PSB) in the year you received the personal service income.
You can self-assess as a PSB if:

  • At least 75% of your PSI meets the Results Test, or;
  • You meet one of the additional PSB tests and less than 80% of your PSI comes from a single client.

The Results Test is a measure of whether at least 75% of your income is received for producing a “result”. You pass the Results Test if:

  • You produce a result (see the example below for details), and;
  • You provide the necessary tools and equipment to produce the result, and;
  • You are (or would be) liable for the cost of rectifying any defects in your work.

For example, an architect who is contracted to design one building for a fixed price is producing a result. As a contractor, the architect also provides the software used to create their designs. The architect would also be required to cover their expenses if they made a mistake and needed to alter the design.

As such, the contractor passes the Results Test, and is considered a PSB.

On the other hand, an architect that is contracted to design homes in exchange for an hourly rate does not satisfy the Results Test, and is not considered a PSB.

Additional PSB Tests

At least 75% of your personal service income must pass the Results Test to be classified as a PSB.
If you don’t satisfy the Results Test, and at least 80% or your PSI comes from two or more unrelated clients, you can self-assess against these additional PSB tests:

  • Unrelated Clients Test – To satisfy this test, you must provide services to 2 or more clients that are unrelated to each other, and unrelated to you or your business. The services you provide must be a result of advertising your work to the public at large, such as by advertising or tendering.
  • Employment Test – To satisfy this test, you must employ one or more entities, and those employees must perform at least 20% of the value of your work for the year. You also satisfy this test if you employ an apprentice for at least 50% of the year.
  • Business Premises Test – To satisfy this test, you must maintain and use a business premises that is primarily used to conduct business activities. You do not satisfy this test if your business premises are also used for private purposes (e.g. your home, or the home of a spouse, relative or business partner).

You must satisfy at least one of these tests to qualify as a PSB. If you don’t satisfy the Results Test, or if you don’t meet any of these additional tests, your income is subject to the PSI rules.

You will need to apply to the ATO for a PSB determination if you think the results of your self-assessment are incorrect. In uncommon or special circumstances, you may need to speak with a taxation lawyer to ensure you receive the correct PSB determination from the ATO.

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Personal Services Income vs Personal Services Business

It’s important to work out whether your PSI qualifies as a PSB each income year. This is usually done when you submit your tax return. It can be handled by your CPA, or the ATO provides an online determination tool that can be completed alongside an electronic tax return.

Qualifying as a PSB may allow you to reduce your tax and expand your deductibles. In Australia, companies pay lower tax rates than individuals. So, correctly assessing your status as a PSB can substantially reduce your tax liability.

Despite this, it’s important to assess your income honestly. The ATO has rules against any behaviours that are designed to help you avoid your tax obligations. This includes using the PSI and PSB rules in an attempt to pay less tax.

Navigate the Personal Service Income Rules With FP Lawyers!

The ATO’s personal service income rules are designed to keep small companies honest. But the rules are also complex, and you may find yourself dealing with the ATO if you make a mistake on your tax return.

When that happens, it’s time to contact FP Lawyers! FP Lawyers are experienced taxation lawyers. Our principal lawyer, Katherine Parasyn, is also a registered CPA, giving us a unique insight into Australia’s taxation system.

We provide advice, support and representation for people and companies who find themselves dealing with the ATO. If you are being audited, or if you need support to appeal a determination by the ATO, we can help.

Book a consultation immediately if you have been contacted by the ATO about your personal or business tax returns. Acting quickly ensures all timeframes are met, and helps us reach the best outcome possible.

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