Personal services income guide for small business - Free Accounting Software

This should probably be close to the first thing a business owners considers when starting a business. Unfortunately most business owners don't even know about it until they talk to a tax agent possibly after being in business for some time.


Warren (his friends call him Wazza) hears a politician boast about how they are supporting small business, which are the backbone of this country, rah rah. The politician says that small business will only have to pay a reduced rate of company tax being 27.5%. Wazza is an employee and pays more than that so he decides to start a company.

Since Wazza is a consultant so his income is Personal Services Income. Wazza finds out that the income is attributed to him and he has to pay tax at his personal tax rate anyway. Further, Wazza finds out that he cannot claim a bunch of expenses like rent on the dedicated office he set up in his rented home. Also he has to pay his own super and workers compensation insurance, accounting fees, ASIC fees etc. He also paid his super late so he does not get a tax deduction for that.

After Wazza finds out this reduced company tax rate is available to companies with $10m turnover, Wazza starts to wonder a bit about if they are really trying to support small business. Wazza writes to the politician but does not get a reply.

Step 1 - is the business income Personal Services Income (PSI)?

If the majority (more than 50%) of your income is for the skills, knowledge, expertise or efforts of the person who performed the services, this income will be classified as PSI. PSI does not include income that is mainly (more than 50%) from:

  • supplying goods or granting a right to use property
  • generated by assets an entity holds; or
  • generated by the business structure, i.e. a large number of employees and contractors.

Refer: Taxation Ruling TR 2001/07.

Note if the income is not PSI then you just answer "No" to the relevant question on the tax return and don't need to worry about it.

Step 2 - Do the PSI rules apply - Results test

If the income is PSI then there are tests to determine if the PSI rules apply.

So if you pass the tests the PSI rules don't apply, but it's still PSI. You have to answer "Yes" to the relevant question on the tax return. Also see below about the part IV A rules as well.

You pass the results test if you satisfy all of the following:

  • You work to produce a result(s); and
  • You provide the tools and equipment necessary (if any) to produce the result(s); and
  • You are liable for the cost of rectifying any defective work.

If you are paid by the hour or day or other period of time you do not pass the results test.

The ATO website has more detail on the results test. If you pass the results test you do not need to go on to the other tests. Your income is still PSI but the PSI rules don't apply. You need to refer to the Part IV A provisions see below.

Step 3 - 80% test

If none of your clients pay 80% or more of your personal services income then you need to pass one of the below 3 tests. If one of your clients does pay you 80% then the PSI rules apply.

Step 4 - The remaining tests

The remaining tests are:

  • The unrelated clients test
  • The employment test
  • The business premises test

You need to pass one of these for the PSI rules to not apply.

Unrelated clients test

You have two or more unrelated clients (who were obtained as a result of you making offers to the public at large or to a section of the public)

Employment test

You engage an individual(s) or an unrelated entity(ies) to perform 20% or more (by market value) of the principal work (ie the work that generates the personal services income) or * You have an apprentice for at least half the year

Business premises test

You exclusively use business premises that are physically separate from your home, or from the premises of the person for whom you are working.

Part IV A, the General Anti Avoidance Provisions

So you passed the tests. Congratulations!

You may be able to claim a couple extra things like the market rate for fees for non principal work paid to an associate and occupancy costs on your home office.

Also the income does not get attributed to you, however, the ATO does not want to see any profit retained in the company. If so the ATO has stated that Part IV A the General Anti Avoidance Rules may apply. Refer to this page which states:


"If you operate a PSB through a company and there is no income splitting and profits are not retained in the company then the GAAR will generally not apply."

"If a genuine attempt is made to break-even, a relatively small amount of taxable income may be paid to you by the company, provided that income is distributed to you via a franked dividend in the following year."