Personal Service Income vs Personal Service Business

PERSONAL SERVICE INCOME VS PERSONAL SERVICE BUSINESS

The taxability of personal service income (PSI) depends on its nature, which determines who is responsible for paying tax. Personal service income can be classified into three categories:

1. Personal service income (PSI)
2. Personal service business income (PSB)
3. Personal service income from a business structure

What is Personal Service Income?

Personal service income (PSI) is defined as income where more than 50% of what you earn comes from your personal efforts, skills, knowledge, or expertise, rather than from income-producing assets, the sale of goods, or a business structure. PSI rules are outlined under Part 2-42 of the Income Tax Assessment Act 1997.

Example: Jack, an electrician operating as a sole trader, receives a contract to repair lighting in an office, including the supply of materials. He invoices $500, with $100 covering material costs. Since more than 50% of the income Jack received is for his personal efforts and skills, PSI rules will apply to his income.

What is a Personal Service Business (PSB)?

Personal service business (PSB) income is derived when more than 50% of your income comes from your personal efforts, skills, knowledge, or expertise. However, it is exempt from PSI rules if you meet one of the following tests:

1. The Results Test:
You pass the results test if you answer "YES" to all the following for at least 75% of your personal service income:

Is the income earned for achieving a specific result or outcome?
Are you responsible for providing the tools and equipment required to complete the work?
Are you required to rectify any defects in the work to meet the contractual outcome?

Example: Jack, now working in IT, operates as a sole trader and develops customized software for clients. He employs two workers and rents an independent office. More than 75% of his contracts meet the following conditions:

Jack uses his own tools and equipment.
He can hire employees or subcontract the work.
Payments are based on the completion of the software.
Jack is responsible for fixing any defects.

Since Jack meets the results test, the PSI rules do not apply.

2. The Unrelated Clients Test:
You pass this test if:

You provide services to two or more unrelated clients.
Your clients are obtained through direct marketing to the public (word-of-mouth is generally not sufficient).

Example: Jack advertises his services through direct marketing, and his clients are unrelated. Since he meets the unrelated clients test, the PSI rules do not apply.

Since Jack meets the results test, the PSI rules do not apply.

3. The Employment Test:
You pass the employment test if at least 20% of your principal work (by market value) is performed by others.

Example: If Jack’s two employees contribute more than 20% of the market value of his contracts, he meets the employment test, and PSI rules do not apply.

4. The Business Premises Test:
You pass this test if you rent an independent office space for the entire year to perform your principal work.

Example: Since Jack maintains an independent office year-round, he meets the business premises test, and PSI rules do not apply.

What is Personal Service Income from a Business Structure?

Personal service income from a business structure refers to income generated by a business entity or structure, rather than an individual's personal service. In such cases, PSI rules do not apply. To determine if your income is from a business structure rather than PSI or PSB, consider the following factors:

The size of the business structure
The number of employees involved in principal work
Whether the business has goodwill
The nature of the business activities
The percentage of income derived from the personal skills of an individual

Example: Jack is a plumber in a partnership with his spouse, Kelly, who handles administrative tasks. Jack owns two fully equipped vans and employs three full-time workers who perform plumbing jobs. With more than 100 regular clients and established goodwill, Jack's partnership income is considered to be from a business structure, and PSI rules do not apply.

ATO's Perspective
The Australian Taxation Office (ATO) has issued its official stance on PSI, PSB, and personal service income from business structures in the legally binding tax ruling TR2022/3 – Income tax: Personal service income and personal service businesses.

Need Help?
We offer tailored professional advice based on your business and circumstances. Honest & Young provides customized service packages at reasonable prices. Book a one-on-one call with one of our team members to discuss your business needs.

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Disclaimer: The information provided in this article is general in nature and does not constitute professional advice. By reading this article, you acknowledge and agree that the information is for informational purposes only. Honest & Young advises you not to act or refrain from acting based on any content herein. Honest & Young and the author of this article make no guarantees regarding the accuracy, currency, or completeness of the information. Always seek professional tax or business advice relevant to your situation.

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