What is Personal Services Income (PSI) in Australia?
Personal Services Income (PSI) is income that is mainly a reward for your personal effort or skills. If your income is classified as PSI and you do not pass the relevant tests, special rules limit how you can use a company or trust to defer or split that income.
Detailed Explanation
The Personal Services Income (PSI) regime is one of the most important tax rules for contractors, consultants, and freelancers operating through a company or trust in Australia. It is intended to prevent individuals from using business structures to gain tax advantages that would not be available to employees earning the equivalent income.
What is PSI?
PSI is income that is mainly a reward for your personal efforts or skills rather than income produced by: - A business structure generating income independently of your personal effort - Income from assets (plant, equipment, machinery) integral to the work - Income from goods sold - Business income from a genuine business team of employees
More than 50% of the income from the contract must come from your personal effort or skills for it to be classified as PSI.
The PSI tests: how to determine whether the rules apply
To determine whether the PSI rules apply, you must first identify whether more than 50% of your income is PSI. If yes, you must then check whether you pass any of the following tests. Passing any one test means you are carrying on a Personal Services Business (PSB) and the rules do not apply.
Test 1: Results test (the best test to pass) You pass if: - You are paid for producing a result (not simply for your time) - You provide the tools and equipment necessary to produce the result - You are liable to fix defective work at your own cost
Most genuine independent contractors pass this test.
Test 2: Unrelated clients test You pass if you earned PSI from at least two different clients in the income year, both of which were obtained through offers or invitations to the public. Contractors who work for only one client all year typically fail this test.
Test 3: Employment test You pass if you had at least one other person (other than an associate) perform at least 20% of your principal work during the year.
Test 4: Business premises test You pass if you maintained business premises at all times during the year that are physically separate from any home premises and from the premises of any person who engages you.
What happens when PSI rules apply?
If your income is PSI and you fail all four tests: - The income cannot be retained in your company and taxed at 25% company rate — it is attributed to you personally - You cannot split income with associates (paying family members salaries from the PSI) - Certain deductions are restricted (rent, mortgage interest on home office, payments to associates)
Applying to the ATO for a PSB determination
If you fail all four tests but believe your circumstances show you are genuinely carrying on a business, you can apply to the ATO for a Personal Services Business determination. This is a formal ruling process.
Alienation of personal services income
When the PSI rules apply and you operate through a company or trust, the ATO attributes the income to you personally through the alienation rules, and the company or trust loses the tax benefit of retaining or splitting the income. The PSI that has been attributed is included in your individual income tax return as if you earned it directly.
Source: ATO Personal Services Income
Real-World Examples
IT contractor passing the results test
An IT consultant operates through a Pty Ltd and works exclusively for one client, but under a contract that specifies deliverable milestones (not time-based), requires him to fix defects at his own cost, and he provides his own expensive software licences. He passes the results test and is classified as a Personal Services Business — PSI rules do not apply.
Marketing consultant failing all tests
A marketing consultant works solely for one client on a time-and-materials basis (hourly rate), the client provides all tools and the work environment, and she has no other clients. She fails all four PSI tests. PSI rules apply — income is attributed to her personally, and she cannot retain profits in the company at the 25% tax rate.
Common Mistakes to Avoid
- Assuming that operating through a company automatically provides company tax benefits on all income — if PSI rules apply, income is attributed personally regardless of the company structure.
- Paying a spouse a salary from a PSI company without them performing genuine work at commercial rates — this deduction will be disallowed under the PSI income-splitting restrictions.
- Misunderstanding the results test — many contractors believe they pass it simply because they work on a project, but all three elements (result-based pay, own tools, fix defects at own cost) must be satisfied simultaneously.
- Not identifying that income is PSI in the first place — if a sole trader consultant claims home office deductions related to PSI, they may be claiming non-allowable deductions.
Frequently Asked Questions
If PSI rules apply, does that mean I pay all the same tax as an employee?
Not necessarily. The PSI rules prevent income splitting and certain deductions, and attribute income to you personally. You still pay tax at individual marginal rates on PSI attributed to you. But you can still claim legitimate business deductions (work-related travel, equipment, professional development) and you are still self-employed, so super guarantee does not automatically apply to you.
Can I have some PSI income and some non-PSI income?
Yes. PSI rules apply to specific contracts or income streams, not necessarily your entire business. If you earn income from two sources — one where you personally perform the work (PSI) and one from selling products or from a team business (not PSI) — you must identify which income is PSI and apply the rules only to that portion.
What is the difference between PSI and the contractor vs. employee distinction?
They are related but different questions. The contractor vs. employee distinction determines how you are engaged and whether PAYG withholding or super guarantee applies. The PSI rules apply once you are already established as a contractor — they determine whether operating through a company or trust provides tax benefits on your contractor income. You can be a genuine contractor but still have your income subject to PSI attribution rules.
How does the ATO identify businesses with PSI issues?
The ATO data-matches contractor income from TPAR (Taxable Payments Annual Report) submissions by hiring businesses, Single Touch Payroll, BAS lodgements, and company tax returns. It looks for patterns such as one-client contractors with large company retained earnings and minimal salaries, or companies paying high salaries to associated low-income family members.
Practical Tips
- If you operate through a company and primarily work for one client, seek professional tax advice about your PSI position before the end of each financial year — do not assume company structure provides automatic tax advantages.
- Structure your contracts to satisfy the results test where possible: outcome-based pricing, responsibility for defects, and bringing your own tools are all commercially reasonable and legitimate ways to demonstrate PSI independence.
- Keep detailed records of any multiple client engagements and advertising activities used to obtain clients — these support the unrelated clients test if you are ever reviewed by the ATO.
- If you engage family members in your business, ensure all payments are for genuine, documented work at commercial rates to survive PSI scrutiny of income-splitting arrangements.
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