Personal services income (PSI): what it is, the tests, and what changes if the rules apply to you

What counts as personal services income

Income is PSI when more than half of what you are paid under a contract is a reward for your personal skills, effort or expertise. An IT contractor billing a day rate, a consultant paid for advice, a designer paid to produce artwork, a bookkeeper paid by the hour: all PSI. It does not matter that you have an ABN, a business name or a company.

Income is not PSI when it is mainly for something other than you: selling goods (a tradie whose invoice is mostly materials), letting people use an asset you own (an excavator with an operator), or income produced by a business with staff who do most of the work. Wages from an employer are never PSI; the rules exist for contractors. You work it out contract by contract, so a web developer can have PSI from a retainer and non-PSI income from selling a template.

Your first job is to find out whether you are a personal services business, because a personal services business is free of the deduction limits.

The results test

You are a personal services business for the year if, for at least 75% of your PSI, all three of these are true:

• You are paid to produce a result, not for the hours you put in. A fixed price to deliver a working website is a result; a day rate is not.
• You supply the tools and equipment needed to do the work, where the work needs any. A consultant with a laptop can pass this; a labourer using the client’s machinery generally cannot.
• You are liable to fix defects at your own cost, and your contract says so.

Most time-based contracting fails the first condition, which is why the next section matters.

The 80% rule and the other three tests

If you fail the results test, look at where the income came from. If less than 80% of your PSI for the year came from one client (counting that client’s associates as the same client), you can self-assess against any one of three tests:

• Unrelated clients test: PSI from at least two unconnected clients, won by making offers to the public such as advertising, a website or tendering. Work sourced through a labour hire firm or recruitment agency does not count.
• Employment test: employees or contractors do at least 20% of the principal work by market value, or you have an apprentice for at least half the year. Your spouse doing the invoicing does not count; it has to be the work you are paid for.
• Business premises test: for the whole year you have premises you own or lease, used mainly for the PSI work, exclusively yours, and physically separate from your home and your clients’ premises.

If 80% or more came from one client and you failed the results test, you cannot self-assess. You need a personal services business determination from the ATO, which usually has to show unusual circumstances, such as a contract that ran longer than anyone expected.

What changes if the PSI rules apply to you

If you are not a personal services business, the PSI rules apply and the following claims are switched off:

• Rent, mortgage interest, rates or land tax for your home, even if you work from it. Running costs such as electricity, phone and internet at the business share are still fine; see home office deductions.
• Payments to your spouse, partner or other associates for work that is not the principal work: bookkeeping, admin, answering the phone. Paying an associate for the actual billable work is still allowed.
• Superannuation for an associate beyond what you are legally required to pay on their principal work.
• Any expense you could not claim if you were an employee doing the same job, such as entertainment, or a second car used privately.

Everything else stays: equipment and software, professional development, insurance, registrations, travel between clients, tendering and advertising, super for yourself, and the cost of meeting your GST and tax obligations. For most sole traders the practical effect is the home occupancy costs and the family bookkeeper.

Reporting PSI in your tax return

Whether or not you pass a test, the business section of your tax return asks whether you received PSI. If you did, it asks whether you passed the results test, whether you hold a determination, and if not, which of the other tests you satisfied, then for the PSI amounts and the deductions against them. Your end of financial year checklist is not complete until that block is answered.

The tests are assessed every income year, so passing last year proves nothing about this year. Keep the evidence: contracts and quotes showing fixed prices, your advertising, invoices showing the client split, and the lease if you rely on premises. If one client is heading for 80% by March, you still have a quarter to win a second one.

How FlowFi helps

FlowFi categorises every deposit from your bank statement and keeps the payer on each line, so how much of the year came from one client has an answer all year rather than in July, and the accountant export gives your tax agent income by source and deductions by type in one file. FlowFi does not decide whether the PSI rules apply to you; that is a judgement about your contracts, and your accountant is the right person to make it with these numbers in front of them.