If you contract or consult and invoice through a company or trust, there is a good chance some or all of that income counts as personal services income, and the tax law has specific rules about how it can and cannot be structured. Get this wrong and the ATO can attribute the income straight back to you personally, restrict your deductions, and unwind any income-splitting you had planned.
Personal services income is income produced mainly, meaning more than 50%, from an individual's own skills or effort. It does not matter whether the money is paid to you directly or to a company, trust or partnership you operate through. Income that is mainly from selling goods, from an income-producing asset, or genuinely from running a business structure rather than your personal labour, is not PSI.
Not all PSI is caught by the restrictive rules. If you qualify as a personal services business, or PSB, the attribution and deduction-restriction rules simply do not apply, and the income is taxed like ordinary business income. Qualifying as a PSB comes down to four self-assessment tests.
The results test requires that, for at least 75% of your PSI, you are paid to produce a specific result, you provide your own tools or equipment where relevant, and you are liable to fix any defects at your own cost. Hourly or daily rate work generally fails this test. The unrelated clients test requires income from two or more clients who are not related to each other or to you, obtained by advertising or making offers to the public, not just word of mouth. The employment test requires that employees or contractors, not associates or yourself, perform at least 20% of the work by value, or that you employ an apprentice for at least six months of the year. The business premises test requires premises used mainly for the work, used exclusively by you, and physically separate from both your home and any client's premises.
If 80% or more of your PSI in a year comes from one client and its associates, the unrelated clients, employment and business premises tests are all off the table. The results test becomes your only path to PSB status. This catches a lot of long-term single-client contractors who assume they qualify some other way.
If you do not qualify as a PSB, the net PSI is attributed to the individual who actually did the work, regardless of which entity was paid. Deductions are then restricted broadly to what an employee could claim. There is no deduction for a portion of your home's rent, mortgage interest or rates, no deduction for an associate's, such as a spouse's, salary for work that is not the principal work being performed, and generally only one vehicle's running costs. Deductions for advertising, licensing, insurance, arm's-length wages, and non-occupancy home office running costs are still allowed.
Routing PSI through a company or trust specifically to split the income with a spouse who is not doing the actual work generally fails. The net income is still attributed back to the individual who earned it, and any salary paid to the spouse for non-principal tasks, like bookkeeping or invoicing, is a denied deduction rather than a genuine tax saving. The ATO has flagged increased scrutiny of these diversion arrangements as a current compliance focus, and general anti-avoidance provisions can also apply to contrived structures.
Not sure whether your contracting income is genuinely a personal services business, or worried your current structure might not hold up? Book a free call and we will work through the tests with you.
Assuming one long-term client satisfies the unrelated clients test. A single ongoing contract, however it was won, generally will not pass this test.
Missing the 80% rule. If most of your income comes from one client, the results test is the only test available, and it is the hardest one to satisfy on hourly or daily rate work.
Paying a spouse for non-principal work and claiming it as a deduction. Under the PSI rules, this deduction is generally denied unless the payment genuinely reflects work on the principal task.
Self-assessing without checking the actual tests. The ATO provides a free online PSI decision tool, and it is worth using properly rather than assuming your structure is fine.
If more than half your income comes from your own skills or effort, the PSI rules may apply regardless of which entity is paid. Passing the results test alone, or one of the other three tests plus earning under 80% from a single client, keeps you out of the attribution and deduction-restriction rules. Get the tests wrong and both the structure and the deductions can be challenged.
We review contractor and consulting structures against the PSI tests as part of our standard compliance work, with fixed fees agreed upfront. Book your free call here.
This article is general information only and does not take into account your personal circumstances. Please seek advice tailored to your situation before acting.
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