A business is generally entitled for income tax deduction (and GST input tax credits) for the expenditures incurred during the business in order for earning income. There must be nexus between income earning and the expenditure to be deductible in tax purpose, and for certain expenditure, the Commissioner of Taxation does not allow as deductions (e.g. entertainment, fines and meals etc). This is the general rule. So under this rule, you are entitled to claim tax deductions as well as GST credits for what you incur for earning the business income under your business structure.
However, there is a special tax regime called personal services income (PSI) to prevent individuals from reducing their tax by alienating their PSI to an associated company, partnership, trust or individual (sole trader), or by claiming inappropriate “business” deductions.
Where it applies, the PSI regime has the following main effects:
- PSI is included in the assessable income of the individual whose personal efforts or skills generated the income, notwithstanding that it may have been alienated to another interposed entity such as your company.
- There are restrictions on the deductions that may be claimed by the individual or interposed entity, so that they broadly correspond to the deductions available to employees, e.g. expenses relating to the individual’s private residence, certain travel expenses and payments made to spouses or other associates.
- Interposed entities may have additional PAYG withholding obligations.
The PSI regime does not apply if:
- The income is not PSI (income which is mainly a reward for an individual’s personal efforts or skills is the individual’s personal services income (PSI), regardless of whether it is income of another entity (e.g. a company, trust, partnership)
- The income is derived as an employee or office holder, or
- The income is derived as part of a personal services business. There is a series of tests for determining whether such business exists.
Although the PSI regime is intended to level the playing field between an employee and a contractor who has PSI, it does not deem contractors to be employees and does not alter the legal relationship between the parties (ITAA97 s.84-10)
So the matter is:
Whether your income is derived from personal services “BUSINESS” i.e. PSB.
To qualify for the PSB regime, you need to pass tests below.
Result Test
For an individual to satisfy the result test in a particular income year, the individual must satisfy the following three conditions in relation to at least 75% of his or her PSI during the year.
- The income is for producing a result
- The individual is required to supply the plant and equipment or tools of trade (if any) needed to perform the work
- The individual is, or would be, liable for the cost of rectifying any defect in the work performed. Where physical rectification is not possible, this condition will be satisfied if the individual is liable for damages in relation to the defect
The 80% Rule and Additional Tests
If the result test above is not satisfied, it is necessary to consider the 80% rule.
- If 80% or more of an individual’s personal services income (PSI) in the income is from one entity, the income will be subject to the PSI regime unless the individual obtains a personal services business determination from the Commissioner.
- If 80% or more of the PSI is not from one entity, the income will be exempt from the PSI regime if the individual satisfies any of the following tests:
The unrelated clients test
An individual or personal services entity meets the unrelated clients test in an income year if the service provider gains income from providing services to two or more entities that are not associates or the service provider
The employment test
An individual service provider meets the employment test in an income year if at least 20% of the individual’s principal work for the year is performed by an entity or entities engaged by the individual. The entities cannot be non-individuals that are associates of the individual.
The entity (PSE) meets the employment test where the 20% criterion above is met and the entity or entities engaged are neither:
- Individuals whose PSI is included in the PSE’s income, nor
- Non-individuals that are associates of the PSE
The business premise test
An individual or a PSE (Service Providing Entity) meets the business premise test in an income year if, at all relevant times during the year, the service provider maintains and uses business premises:
- At which they mainly conduct activities from which PSI is gained
- Of which they have exclusive use (this would typically require ownership or a lease)
- That are physically separate from any premises that the service provider or service provider’s associate use for private purposes, and
- That are physically separate from the premises of the service provider’s client or client’s associate
The following diagram shows the tests required to qualify as Personal Services Business (PSB)
