Many Australian contractors use a company, trust or partnership for sound commercial reasons. It can help with branding, administration, contracting and separating business activities from personal affairs. But when most of the income is generated by one person’s own skills and effort, the personal services income, or PSI, rules may change the tax outcome.
The key question is not simply whether you have an ABN, issue invoices or operate through a company. It is whether the income is PSI and, if it is, whether you are conducting a personal services business, or PSB. Getting that distinction wrong can lead to restricted deductions, income being attributed back to the individual who did the work, and avoidable ATO attention.
PSI and PSB are not opposite concepts
It is easy to treat PSI and PSB as competing labels, but they answer different questions.
PSI describes the nature of the income. Broadly, income is PSI where it is mainly a reward for an individual’s personal efforts or skills. It can be earned directly by a sole trader or through a company, trust or partnership.
A PSB, on the other hand, is a status that may mean the special PSI rules do not apply to that PSI. In practical terms, a contractor can earn PSI and still be conducting a PSB.
Income is more likely to be PSI where a client is paying primarily for an individual’s:
– professional knowledge or expertise
– labour, judgement or technical skill
– consulting, advisory or project services
– trade skills
– specialised creative or professional services
This can include income earned by IT contractors, engineers, consultants, project managers, designers, professional practitioners and many tradespeople. The label in the contract does not decide the issue. Calling an engagement a “consultancy agreement”, charging by the day, or invoicing through a company does not prevent income from being PSI.
By contrast, income is less likely to be PSI where it is mainly generated by:
– supplying or selling goods
– substantial income-producing assets
– granting rights to use property
– a genuine business structure, including a workforce, systems, goodwill and assets that produce income beyond one individual’s personal output
For example, a business that earns income largely from equipment, products and a team delivering services may have a different PSI outcome from a sole consultant whose clients are engaging that consultant personally.
The analysis can apply to particular streams of income, rather than automatically applying to every dollar earned by a business. A contractor may therefore have PSI from one engagement and non-PSI income from another activity.
Why the PSI rules matter for contractors
The PSI rules are designed to prevent an individual from reducing or deferring tax by directing the reward for their own work through another entity. That is especially relevant where a contractor operates through a company, discretionary trust or partnership but personally performs most or all of the contracted work.
If PSI is earned through a company, trust or partnership that is not conducting a PSB, the net PSI may be attributed to the individual who performed the services. In simple terms, the tax law can treat that income as the individual’s assessable income rather than allowing it to remain in the entity for tax planning purposes.
This means a company structure should not be viewed as an automatic income-splitting or tax-deferral tool for a one-person contracting business.
The rules can also limit deductions. Where the PSI rules apply, restrictions can include:
– payments to associates, such as a spouse or family member, for administration or other support work that is not the principal income-producing work
– certain superannuation contributions for associates
– rent, mortgage interest, rates and land tax relating to a private residence, to the extent connected with earning PSI
– expenses that would not have been deductible had the individual earned the income as an employee
This does not mean all business expenses disappear. Legitimate expenses directly connected with earning income may still be deductible, subject to the ordinary tax rules and the specific PSI limitations. However, the deductions need to be tested carefully rather than assumed to be available because a company or trust paid the bill.
A company may also retain administrative obligations even where income is attributed to the individual. That can create extra compliance work without delivering the expected tax outcome.
Importantly, the PSI rules do not decide whether someone is an employee or contractor for all purposes. They do not change a contract into employment, cancel an ABN or prevent GST registration. Employment status, superannuation obligations, workers compensation, payroll tax and workplace law are separate issues that may require their own review.
The practical pathway to PSB status
If income is PSI, the next step is to determine whether the individual or entity is conducting a PSB for that income year.
There are four PSB tests:
– the results test
– the unrelated clients test
– the employment test
– the business premises test
The results test is available regardless of how concentrated your client income is. The other three tests are generally only available for self-assessment where less than 80 per cent of the relevant PSI comes from the same client and that client’s associates.
That concentration rule is a major risk area for contractors working on a long-term engagement with one organisation, or through a single labour-hire or recruitment agency. Multiple end clients do not necessarily mean multiple sources of PSI if the contractor is paid by only one agency.
The results test
To meet the results test, at least 75 per cent of the relevant PSI must satisfy all of the following conditions:
– the income is for producing a result
– the contractor is required to provide the tools, plant or equipment needed to perform the work
– the contractor is, or would be, liable for the cost of rectifying defective work
The detail matters. A contractor being paid an hourly or daily rate does not automatically fail the test, but it can be harder to establish that payment is genuinely for a specified result. Similarly, a contract clause about fixing defects is more persuasive where it reflects a real commercial obligation and the contractor genuinely bears the cost or risk of rectification.
The legislation also requires regard to the custom or practice for that type of work when performed by a non-employee. For some industries, a client may ordinarily provide access to specialised equipment or worksites. The test should therefore be assessed against both the contract and the commercial reality of the engagement.
The unrelated clients test
The unrelated clients test requires income from services provided to at least two clients that are not associates of each other or of the contractor or entity. The services must also have been obtained directly through offers or invitations made to the public, or to a section of the public.
Marketing activity can be relevant, including genuine advertising, tendering, business development and maintaining a public presence. However, there needs to be a direct connection between those efforts and obtaining the work.
Simply being listed with a recruitment agency or labour-hire business is not, by itself, treated as making offers to the public for this purpose. Contractors who receive work through agencies should be particularly careful when applying this test.
The employment test
The employment test can be met where other people or entities perform a meaningful part of the principal work. It is not satisfied merely because a spouse helps with bookkeeping, a virtual assistant answers emails or an outsourced provider manages administration.
The test focuses on whether one or more non-associated entities perform at least 20 per cent, by market value, of the principal work. Principal work is the work the business must perform to earn income under its contracts, rather than incidental support activities.
Alternatively, the employment test can be met where the individual or entity has one or more apprentices for at least half of the income year.
For a growing contracting business, this test can become relevant where work is genuinely delivered by a broader team. Good records are important. Engagement agreements, timesheets, work allocations, invoices and evidence of market value can all help support the position taken.
The business premises test
The business premises test is deliberately strict. The contractor or entity must maintain and use premises at which it mainly conducts activities producing PSI. The premises must be used exclusively by the contractor or entity and must be physically separate from both:
– private premises used by the contractor or associates
– premises of the client receiving the services, and the client’s associates
A dedicated home office will often struggle to satisfy this test because it is not physically separate from private premises. Likewise, regularly working from a client’s office is unlikely to satisfy the requirement that the premises be separate from the client’s premises.
The test also applies throughout the relevant period of business activity during the income year. A leased office that exists on paper but is not genuinely used to conduct the income-producing activities is unlikely to be enough.
The 80 per cent rule and the risk of relying on one client
A contractor can always self-assess against the results test. However, where 80 per cent or more of an individual’s PSI comes from one client, or from that client and its associates, the contractor generally cannot self-assess against the unrelated clients, employment or business premises tests.
This is sometimes described as the “80 per cent rule”, although it is more accurately a restriction on access to the other PSB tests. It does not mean that earning 80 per cent of income from one client automatically makes someone an employee. Nor does it mean that a contractor automatically fails the PSI rules altogether.
It means the results test becomes particularly important. If that test is not met, a personal services business determination may be needed before the contractor can be treated as conducting a PSB.
Contractors should not try to artificially rearrange invoicing, introduce unnecessary entities or split contracts simply to change the appearance of their client concentration. The tax outcome should follow genuine commercial arrangements.
A better approach is to understand the exposure early. Before accepting a substantial long-term engagement, consider how the contract deals with deliverables, equipment, rectification risk, subcontracting and client control. Those details can affect more than one tax and compliance issue.
When a personal services business determination may help
Where a contractor cannot self-assess as a PSB, it may be possible to apply to the Commissioner for a personal services business determination.
A determination may be relevant where the contractor is unable to self-assess, expects to meet a relevant test, or has been prevented from meeting a test because of unusual circumstances. The legislation includes situations involving a new business or a temporary change in circumstances, but each application turns on its facts.
A determination is not a substitute for proper evidence. An application should be supported by documents that show how the business actually operates, such as:
– signed client contracts and scopes of work
– invoices and records of income by client
– evidence of advertising, tender activity or other client acquisition efforts
– details of workers, subcontractors or apprentices
– proof of business premises and their actual use
– records showing who supplied equipment and who carried defect rectification risk
– an explanation of any unusual circumstances affecting the relevant income year
A determination can be subject to conditions and may cease to apply if those conditions are no longer met. It should therefore be reviewed if the business model, key clients or contracting arrangements change.
A common contractor scenario
Consider a specialist consultant operating through a company. The consultant works almost exclusively for one organisation under a rolling engagement, invoices monthly and performs the work personally. The client provides the systems, equipment and office space, while the consultant is paid for availability and time worked.
The company pays the consultant a modest salary and intends to retain the remaining profit for investment or distribute it within the family group. It also pays a family member for invoicing and general administration.
On these facts, the income may be PSI. If the consultant does not satisfy the results test, and most PSI comes from the same client, the company may be unable to self-assess under the other PSB tests. The PSI rules could then attribute the net PSI to the consultant and restrict deductions for family administration work.
The outcome may differ if the consultant’s business genuinely contracts for defined deliverables, bears rectification risk, supplies the required tools, wins work from unrelated clients through active market-facing efforts, or has a team performing a substantial share of the principal work. The point is that the answer depends on the complete facts, not the business structure alone.
Steps to reduce tax risk before EOFY
A PSI review is most useful before year-end, not after the accounts and tax return have been prepared. Contractors should build the review into their regular bookkeeping and planning process.
Practical steps include:
– identify each income stream and assess whether it is mainly a reward for personal efforts or skills
– track PSI by client, including clients connected through common ownership or control
– retain complete contracts, variations, scopes and correspondence about deliverables
– distinguish principal work from administration and support work
– document subcontractor and employee contributions to income-producing work
– review whether business premises are genuinely separate and exclusively used
– check payments to spouses, family members and related entities before claiming deductions
– consider the PSI position before retaining profits in a company or making trust distributions
– seek advice early where a new major client will make up most of annual income
The central lesson is that an ABN, GST registration, company or trust does not by itself determine the PSI outcome. What matters is how the income is generated and how the contracting business operates in practice.
For Australian contractors, managing PSI risk starts with recognising the distinction between income earned from personal effort and income earned through a genuine business structure. If PSI is involved, understanding the PSB tests can help protect against unexpected attribution rules and deduction restrictions.
This article is general information only and is not personal financial or tax advice. PSI and PSB outcomes are highly fact-specific, so speak with a registered tax agent or accountant, such as, about advice tailored to your contracts, entity structure and business circumstances.