Tax Guide For Professionals
On this page, we try to provide an understanding of the income tax rules that are applicable to professionals working as independent contractors. We start with a question-answer section to gain a basic understanding of the rules, followed by a flowchart that you can use to assess your business and finally we provide a checklist for tax-deductions.
The primary area of taxation that deals with professionals working as contractors are Personal Services Income (PSI) contained in Divisions 84 to 87 ITAA97. The personal services income regime taxes individual contractors on a similar basis as employees where income is derived mainly from the individual’s own skills, expertise or the provision of personal services. The measures also apply to companies, trusts and partnerships where income is derived by the entity primarily as a result of an individual’s personal efforts or skills.
Tax Regime for Professionals
Personal Service Income
What is considered as personal services income? (PSI)
Income received on a contract is PSI if more than 50% of it relates to an individual’s labour, skills, knowledge, expertise or efforts in the provision of their services.
One can receive PSI in almost any industry, trade or profession. However, some common examples include:
information technology consultants
construction workers and medical practitioners.
The PSI rules will apply regardless of whether or not they operate through an interposed entity.
Eaxample - A taxpayer provides a computer programming service but she does all of the work involved in providing those services and uses the client’s equipment and software to do the work. The income derived would be treated as PSI as it is a reward for his or her personal efforts or skills.
What is not PSI?
To gain a better understanding of the PSI rules, it is important to understand what is not a PSI. If more than 50% of the income is derived from the supply or sale of goods, or derived from the supply or use of an income-producing asset or derived through a business structure with substantial assets or employees.
Why were the PSI rules introduced?
What are the tax-deduction restrictions if PSI rules apply?
When personal services income (PSI) rules apply, there are limitations for deductions that can be claimed against this income. In general, an individual who earns PSI is treated as though they are in the same position as an employee.
- Deductions cannot be claimed for rent, mortgage interest, rates and land tax for a residence
- Payments to associate for non-principal is not tax-deductible, sych as:
- remuneration such as a salary or commission
- super contributions
- an allowance
- reimbursement of an expense
- interest on a loan.
Are there any exceptions?
One of the key exceptions for assessing whether the restrictions in the PSI rules apply to a taxpayer or entity if they are conducting a personal services business.
Go to our next segment to learn all about personal service business (PSB).
Do I pass the 'results test'?
- Income is generated for producing a specific result – must only receive payment when a specific result or outcome has been produced. For example, on completion of a specific job or objective (a tailor contracted to sew an agreed number of uniforms for a business). The results test is likely to be failed for payments received on an hourly basis or daily rate.
- Own plant, equipment or tools are provided – This condition is satisfied if any of the following requirements are met:
- The contractor is required to supply their own equipment or tools of trade that is needed to perform their work.
- The type of work performed does not require plant, equipment or tools of trade.
- The client supplies only minor tools or equipment.
- Rectification of defective work – This condition is satisfied if defects are fixed at their own cost by the contractor, but not if time spent to fix defects may be billed to a client.
What is a personal services business (PSB)?
- passes the results test
- passes the 80/20 test and also satisfies one of three business-based tests,
- the unrelated clients test
- the employment test
- the business premises test.
Lastly, If the taxpayer is in doubt, they can apply for a PSB determination from the Commissioner.
I don't pass the result test, what next? The 80/20 test.
Apply the 80/20 test and the three business-based tests
Satisfaction of the 80/20 test broadly requires contractor to ensure that less than 80% of their income comes from the one client (and/or associates)
Must also satisfy at least one of the three following additional business-based conditions:
(a) Unrelated clients test – this test is satisfied if, the contractor gains or produce income from providing services to two or more entities which are not associates of one another or the contractor. – Their provision of services is a direct result of making offers to the public at large (or to a section of the public). Examples include advertising on magazines or digital platforms such as LinkedIn etc..
(b) Employment test – this test is satisfied in an income year if one or more entities are engaged to perform at least 20% of contractor’s principal work for that year. An alternative method of satisfying the employment test arises where a contractor employs one or more apprentices for at least six months (cumulatively) of the income year.
(c) Business premises test –this test is satisfied in an income year if a contractor maintains and uses exclusive business premise that are physically separate from any premises they use for private purposes (home) ; and that are physically separate from premises of their clients. These premises must be used to conduct activities from which income is gained and must be used throughout the year.
I am a PSB, what are the benefits?
If you are a running a personal service 'business' the restrictions under the PSI rules do not apply. Most of the tax deductions availalbe to general business are available to you.
Can a PSB split income?
I do not pass any of the tests, is it bad news?
How much tax can a professional save by using an interposed entity?
How can a business split income?
The Personal Service Income Rules and its tests are complex. We have designed an easy to use decision tool which works on an easy question-answer format, use it to find out if the PSI restrictions apply to you or not. As a bonus, the decision tool also checks if you are using the best structure for maximising tax efficiency and asset protection.
Flowchart to PSI Rules
Find out what you need to do to be considered as a Personal Services Business at which point the PSI rules no longer apply, We have developed a flow chart where all the tests can be seen at one place. Use it to gain a full understanding of all the tests. Click the flowchart on the right to enlarge it.
Here we have prepared three checklists. The first one contains all the expenses that are deductible if the PSI rules apply regardless of the structure you operate in. The second and third checklist highlights the benefits of operating through an interposed entity.
Many professional are unaware of the benefits that are available to them if they work through an interposed entity. It is a common myth that contractors caught in the PSI rules can't achieve any tax savings by using an interposed entity. We debunk that myth here.
We work out two cases. In the first case, a contractor is restricted by PSI rules but saves $16,000 every year. In the second case, due to the expansion of business, the PSI rules no longer apply, they save $31,500 every year.