Episode 88: Personal Services Income (PSI)
Apr 10, 2024
In this episode, Trudi and Sarah discuss the concept of Personal Services Income (PSI) and its tax implications. They clarify the distinction between contractors and employees and explain how PSI is determined based on the source of income. They highlight the restrictions on distributing and streaming PSI and the impact on claiming business expenses. The Personal Services Business (PSB) test is introduced as a way to determine if a business qualifies for different tax treatment. They emphasize the importance of seeking professional advice and understanding the complex rules surrounding PSI.
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Just two industry experts (and guests) having a friendly chat and sharing our knowledge. We aim to raise your knowledge base and dis-spell any myths surrounding finance. tax and a range of other financial topics.
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DISCLAIMER- The information and material in this podcast, and supplementary and associated information available, is for general information only. It should not be taken as constituting professional advice from the podcast owners, and we recommend you seek independent suitable advice that is specific to your unique circumstances.
Podcast Transcript Available Here
Duration: 27:15
Trudi Cowan (00:09.898)
Hello, hello, welcome back again, Sarah.
Sarah (00:12.671)
Thanks! Well, and all of our listeners. We're actually getting up there in um, listens? We're pushing 9 ,000 nearly, I think. It's over 8 ,000. I know that much. That little podcast is taking off. I told you we'll be Joe Rogan before we know it.
Trudi Cowan (00:15.06)
all of that listening of course. Welcome back to all of our listeners.
Trudi Cowan (00:22.312)
Yeah, great. Not speaking to you.
Sarah (00:32.671)
or one of, you know, the top podc -
Trudi Cowan (00:32.968)
I you, I wish you the best. hope to step on your vision board.
Sarah (00:36.767)
Picture of Joe Rogan? No. But, you know, nonetheless, today we are talking about a topic that gets very regularly confused and it's not well known about how it impacts you, which is personal services income and personal services of businesses. It is a tax implication. Is that the way to describe it?
Trudi Cowan (00:38.026)
Yeah.
Trudi Cowan (01:00.618)
Yeah, it's an implication of how your certain income is going to be treated for...experiences.
Sarah (01:07.231)
Yeah. So a lot of, a lot of businesses have fancy structures, whether they be trusts or companies with distributions, um, to mitigate their tax liability and try and, um, ensure that they are paying. Yeah. Well, it's a tax minimization strategy really, right? Um, but PSI puts a nice spanner in a lot of that works for people if they're not across it correctly. And if their accountant's not across it.
Trudi Cowan (01:21.546)
to reduce it. Really?
Trudi Cowan (01:34.462)
Yeah and look I often put the spanner in people's works when they come to me and say that my mates said that I should go as a contractor because I'll pay less tax if I'm a contractor than if I'm on wages. And this is where I pull out this little PSI and kind of ruin their party.
Sarah (01:44.703)
Yeah, just crazy.
Sarah (01:50.143)
Yeah, no doubt enjoy doing the ruining of said party.
Trudi Cowan (01:54.73)
Well, I don't actually always enjoy it. It kind of frustrates me that people get their advice from their mates in the pub. But at least they do come to me and ask me questions sometimes. But what we're talking about when we're talking about personal services income is when more than 50 % of the income you're earning from a contract is for your personal exertion or time or your brain power, rather than because you are supplying a good or a product. So.
Sarah (02:00.649)
Oh, the old pub test.
Sarah (02:16.285)
Mm -hmm.
Sarah (02:21.503)
Okay, so somebody like me. Yep.
Trudi Cowan (02:22.314)
Typical examples are your cantons, your lawyers, your brokers. But it does also apply to your labourers. If you're not actually providing any of the goods, all you're doing is providing your time, it applies to you as well.
Sarah (02:28.127)
professional service providers.
I was about to say.
Sarah (02:38.321)
So if you're a carpenter that is not sourcing and providing materials and is working as effectively labour hire, that income is all personal services income. Interesting. So if you're a trust and that is what you're doing and you're distributing 50 % to the husband and 50 % to the wife.
Trudi Cowan (02:48.692)
all personal services income. Okay.
Trudi Cowan (03:01.45)
then you're in trouble. Okay. So let's just take a step back. What personal services income means from a tax perspective is that your income is going to be taxed in the same way as if you were an employee, which means your deductions are restricted as if the same ways if you're an employee. So a really easy one is that as an employee, you don't have any advertising costs. You advertise yourself as an employee. So if you're earning personal services income, you're not able to claim advertising costs as a deduction.
Sarah (03:13.341)
Hmm.
Sarah (03:17.023)
Mm -hmm.
Mm -hmm.
Sarah (03:31.231)
Yeah, wow.
Trudi Cowan (03:32.49)
Okay. It also means that because it's going to be taxed like it was a wage, you can't distribute it or stream it to anybody else. In your example, you can't be giving half to your wife because it all needs to 100 % come back to you. And then the next question I go is, well, can I employ my wife to do some admin? No, no, you're being taxed like you're an employee. An employee does not need an admin person on their payroll. So no, you can't be giving some of it to your wife. It 100 % comes back to you.
Sarah (04:02.911)
Regardless of the structure that you've got.
Trudi Cowan (04:04.138)
Okay, and it's a really important point. Regardless of the structure you've got. So it doesn't matter if you're trading through a trust, it still has to get distributed all the way to you. If you're trading through a company, then if you don't pay wages equivalent to the income that you've earned, then it gets attributed back to your personal return through the tax rules anyway.
Sarah (04:20.881)
Yeah. Yeah.
Sarah (04:27.071)
I would assume that that would impact things like claiming of a car as well. Like a company vehicle.
Trudi Cowan (04:32.554)
Yep. So look, as an employee, potentially you can claim a car if you're using your car for work, right? So potentially you can still claim it, but it just comebacks to, you know, those rules, you know, would I have been able to claim this if I was an employee? And if you were, then yes, you can still claim those costs. But if you couldn't have claimed it as an employee, you cannot claim it under the PSI rules.
Sarah (04:38.463)
Yes, depending on your job role.
Sarah (04:54.687)
So for everyone that's listening this has just had their head exploded. I hope you weren't driving at the time and have not had a car accident. There are some further clarifications around this.
Trudi Cowan (04:58.128)
I'm
Trudi Cowan (05:07.818)
this, there are. So that is the PSI is the basic test. Okay. But there's also a rule that you can be a personal services business. Okay. So if you are earning more than 50 % of your income from your personal exertion, I'm a prime example. Yes, I am earning more than 50 % of my income from my, my time and my labor, not because I'm providing a physical product, right? Um,
Sarah (05:17.651)
Yes.
Sarah (05:23.325)
Yeah. Yeah.
Sarah (05:30.847)
Yes.
Trudi Cowan (05:32.522)
but the personal services business test allows you to say, well, am I, yes, I'm earning it from my personal exertion, but am I earning it from a genuine business structure? Okay. And the way that we look at, am I a genuine business structure is who am I earning the income from? So am I earning 80 % or more of my income from one client or one customer?
If you are earning more than 80 % from one client or customer, then yes, you're still in personal services income rules.
Sarah (05:59.487)
Mm -hmm.
Sarah (06:06.239)
You should also probably have been an employee of that actual company.
Trudi Cowan (06:09.322)
Yeah, and an interesting point around this is if you're technically employed by a labour hire, but then they may hire you out to five different places, you're still earning your income from the labour hire. So therefore you're still personal services income, even though labour hire may have passed you around to five or six different businesses throughout the year.
Sarah (06:22.207)
Correct.
Sarah (06:30.751)
Hmm. So the difference there, especially in the financial services industry, because I know this conversation gets thrown around regularly that a mortgage broker, for example, is personal services. But if you are not employed and we are, we work on contract with what's called a head agreement and the head agreement goes to our aggregation service provider, mine's the Stute Financial Services. Who are fantastic, might add. There's lots of different ones out there.
Trudi Cowan (06:58.058)
Hehehe.
Sarah (07:00.815)
They get paid they collect on behalf of the lender and they help us with our accreditation and then they distribute so effectively They're like a collection house. They're not an employer because they take a clip off the top for their services And then they pass the full amount on That means that we're a personal services business, but I don't want a personal services income Because right, okay
Trudi Cowan (07:23.594)
There's another test that we look at when it comes to broken, which is the results test. So, the test applies to everybody. So are you earning your income for your time or for a set result? So for example, if you only get paid, if you can provide a set result in your case, delivered alone, then you're working on a results basis. So it doesn't matter how many hours you put into the job.
Sarah (07:29.471)
Right, so that test applies to everybody, but if you don't meet the first two.
Sarah (07:38.431)
Yes. Yeah. Mm -hmm. Complete the work. Yeah. Yeah. Yes.
Sarah (07:52.287)
Yes. Yeah.
Trudi Cowan (07:53.386)
If you don't get that result, then you don't get paid.
Sarah (07:56.863)
And the same for financial planners that might be placing insurances because they're still paid on commission for a real estate agent that gets paid on commission for an insurance broker on commission.
Trudi Cowan (08:04.522)
on commission, they're only, yeah, real estate agents are a good one because if they don't get the result, they don't get paid. Now they may be on a base salary, we're kind of ignoring that for the moment, but if they're on a pure commission, they don't sell the house, you don't get paid. So they're for your results basis and that can get you out of the PSI rules as well. Okay.
Sarah (08:22.385)
Right. So I think the important thing when it comes to PSI is one, to know that it exists and what it is. Two, the implications of the PSI tests and how they impact your business. And then three, an advisor that knows what they're talking about and the differences between the tests. What are some of... Yeah.
Trudi Cowan (08:27.986)
Mm -hmm.
Trudi Cowan (08:33.852)
Yep.
Trudi Cowan (08:40.362)
Yeah. Yeah. And look, we haven't even gone through all the tests yet. Only let me halfway explain the 80 % test.
Sarah (08:49.023)
I think because, we'll go back to that, I think because this is a concept that it gets so confused so quickly, I'm trying to break it down for people.
Trudi Cowan (08:54.346)
It does get really confusing. And there's lots of different rules and tests around how it works. But at the end of the day, if what you are doing is based on your time, then it's something you need to be aware of and make sure that you have considered in terms of how you're treating your income for tax purposes.
Sarah (09:06.973)
Yeah.
Sarah (09:13.471)
So somebody that has a shop, retail shop, a pub or cafe or a clothing shop, because they're selling a product, personal services doesn't apply. But if they were a beautician...
Trudi Cowan (09:16.444)
Hmm
Trudi Cowan (09:23.4)
Yes.
doesn't apply because they're generating their income and their profits from selling a good. So again, you could spend all day at a shop and not sell anything, right? So you're not making any money. So it's not based on your time and your labor. It's based on whether you sell that good or product.
Sarah (09:35.837)
Not sell anything.
Sarah (09:42.719)
But if you were a shopfront that was a beauty therapist or a beautician and you offered facials...
Trudi Cowan (09:46.802)
Hmm.
potentially. So then it comes down to is 50 % is 50 % from your skill and effort and or more from your skill and effort or is it from the products that you're providing? So say most massage places I go to would be selling moisturizing creams and oils and various other things within their business. So how much of that business is from the product and how much is from your time? And it also relates to a specific individual.
Sarah (09:50.911)
potentially are you concluding product?
Sarah (10:04.479)
Uh huh.
Yes, yes.
Trudi Cowan (10:18.89)
Right? So as an individual, how much of your time is spent? Are you just the massage therapist and you have nothing to do with the sales of the products? In which case you're very time -based, right? Where all you could be split on doing both. So it can get really complex when we start to get into the detail of things like that and exactly what are you doing.
Sarah (10:19.805)
Yes.
Sarah (10:28.703)
Yes.
Sarah (10:33.703)
I'm busy.
Sarah (10:37.823)
How do you as an accountant, how do you clarify that for your clients as to the messiness? Lots of questions, right? So yeah.
Trudi Cowan (10:42.922)
lots of questions, lots of questions and fully understanding what the client does on a day to day basis, how they charge, how many clients do they have. And that's where some of the other tests come into place. So if you satisfy the 80 % rule in that you've got, you don't just have that really large single client, you've got lots of different clients, there's some other tests that you can then go and look at, right? And these are the unrelated clients test.
Sarah (11:02.175)
More than one client. Yep. Yep.
Trudi Cowan (11:11.882)
and the employment test and the business premises test. So unrelated clients, have you got two or more clients that aren't related to each other? Right? So if my only clients were you and your sister, right, they're not unrelated. So I can't treat you as separate clients, right? But if my, this is the relationship between the two of you. Yep. Right. Whereas if my two clients were you and somebody else that you don't know,
Sarah (11:15.359)
Okay?
Sarah (11:22.527)
Mm -hmm.
Sarah (11:28.639)
because there's a technical relationship because my sister is my immediate family member.
Sarah (11:41.287)
Don't know, yeah, yeah.
Trudi Cowan (11:41.482)
then I have two unrelated clients. I might be earning my income 50 -50 from the two of you. I technically have a personal services business.
Sarah (11:49.343)
Yes. So there's a difference between PSI as an income for you individually and PSI as a business. And I don't know if we've actually qualified for people yet. What is a personal services business?
Trudi Cowan (11:53.066)
Yes.
Trudi Cowan (11:59.658)
Right? So a business is you are earning an income from personal services. At a base level, I have personal services income, but I don't fall into the personal services income tax rules because I meet the tests that I'm running a business. Okay. And so, and so I don't have to be restricted by the deductions that an employee would have. I can...
Sarah (12:07.677)
Mm -hmm.
Sarah (12:16.135)
Okay.
Trudi Cowan (12:25.162)
Claim the advertising and the website and all the other costs associated with running a business like any other business could.
Sarah (12:32.543)
So you would disclose to the ATO in that instance that you're not a PSI, you're a PSB and therefore everything applies in the traditional way that you'd be able to claim.
Trudi Cowan (12:37.93)
Okay. The main restriction though that can still apply to personal services businesses is that at the end of the day if I am the only accountant in my business I am the one still generating the income and therefore the majority of that profit should be going to me. Okay so potentially I could employ my husband to do some admin or to help out with
Sarah (13:00.189)
Yes.
Sarah (13:04.509)
Mm -hmm. Yeah. Yeah.
Trudi Cowan (13:06.346)
the business, I can only pay him at a market rate wage and he needs to actually be doing work in the business. But the majority of that income still needs to come to me because at the end of the day, I am the one generating that income. Okay.
Sarah (13:11.263)
Yes, that's associated. Yeah.
Yes.
Sarah (13:24.927)
generating the income. And I'm assuming if you're wondering why the bloody ATO has done this, it's literally to ensure that they're encapsulating the tax that would have been paid on that person had they not had. So it's to stop people like you said that are not necessarily actual businesses, but like would set up as a company as a contractor to avoid paying the tax that they would pay if they had just been employed as it. Yeah.
Trudi Cowan (13:41.832)
Hmm.
Trudi Cowan (13:45.802)
Look, let's go really typical example. You set up a company, husband and wife, husband's doing all the work, wife doesn't work, right? But husband pays 50 % of the income to his wife and therefore they're both earning lower amounts and therefore paying tax at lower tax rates and therefore paying lower tax. So as the husband and wife, you're going, you pay less tax. As the ATO and society community, we're going, well, that's less revenue. Why do they get to pay less tax?
Sarah (13:58.599)
Mm -hmm.
Sarah (14:05.023)
Yeah. Yeah.
Trudi Cowan (14:15.112)
when effectively he's just earning a wage.
Sarah (14:18.567)
Exactly.
Trudi Cowan (14:19.37)
Right? And that's where these rules come into play to say, well, you're effectively earning a wage, so you should be taxed like you're earning a wage. Okay.
Sarah (14:24.447)
Yeah. So everybody else that is actually just earning a wage and doesn't have the capacity to set themselves up as a company and pay wife or vice versa, wife pay husband. Cause I've seen it go multiple ways or wife pay adult child. It goes in a whole different range of ways. You know, again, completely different podcast episode as to what our tax gets paid for and how it gets used.
Trudi Cowan (14:32.33)
Yeah. Yeah. Right, definitely. Yep.
Sarah (14:49.535)
But the reality is that there are rules around this that are designed to protect everybody and make it fair and equal for everyone. And PSI and then the PSB is designed to impact that. So that it is an equality of people that should be taxed at the rate they would have been taxed had they just been employed.
Trudi Cowan (15:08.618)
Yeah. And look, so the other tests are your employment tests. So maybe I'm not the only accountant and maybe I actually employ five other accountants. And they're all able to what we what we would call fee earning. So they're bringing in money and profits to the business just maybe not just as much as I am, but they are also generating profit and business to the business. So therefore the profits, I am running a genuine business. Maybe for me it's labor and I'm not selling a widget, but
Sarah (15:17.311)
Yeah, so five sets of paper.
Sarah (15:22.663)
Yes.
revenue producing. Yeah. Yeah.
Sarah (15:34.975)
Mm.
Trudi Cowan (15:38.762)
I'm still running a genuine business. So therefore I shouldn't necessarily have to pay all the profit to me because it's not just me generating those profits. And we all know the way businesses work. I might pay my employee $100 ,000 but I'm hoping to make profit of 150 or 200 ,000 from that person. Right? Right? So that 50 ,000 or 100 ,000 of profit that I'm making off that employee working for me.
Sarah (15:41.823)
Yeah.
Sarah (15:47.103)
No, because it's a genuine business. You literally have other income producing.
Sarah (15:59.231)
Why would you do it otherwise, right?
Trudi Cowan (16:05.866)
is not me generating that income, that's someone else. So in those circumstances, there is ability to start to split some of that income. The way the ATO looks at it is as long as I'm still receiving what would be considered a fair remuneration for the work that I am doing. So I can't pay my employees 100 ,000, but myself only 50, because I'm streaming the income to lots of other family members. ATO is not gonna let that fly. I've still gotta be paying myself a decent wage.
Sarah (16:07.879)
No. Exactly.
Sarah (16:20.607)
for the wage for the work that you like, if you were employed by a big, yeah.
Sarah (16:29.791)
No. Yeah. Yeah, okay. Yeah.
Trudi Cowan (16:34.89)
or what is considered a decent wage for the industry that I'm in and the work that I'm doing within that business.
Sarah (16:41.279)
guys I have been back and forth on this conversation multiple times for Trudy not just for my own circumstances but for clients that have been getting some well you know advice that perhaps doesn't match yet it's not always incorrect I didn't want to say it was incorrect but it's inconclusive shall we say or it doesn't meet the full test strip and so again every time I hear this my head still gets exploded because there's so many it's so nuanced as to how do you qualify it.
Trudi Cowan (16:50.89)
interesting advice.
Trudi Cowan (16:57.054)
Yeah.
Trudi Cowan (17:05.962)
Hmm.
Sarah (17:08.223)
and how do you calculate it and how do you come out the other side? So I think the important part again is to one, as we said earlier, understand what PSI is, two, understand how it impacts you, two, don't take your tax advice from the bloke at the pub or friend in the shop, Trudy's pet, hey there, and three, get quality advice. And here's the thing, if your accountant or your advisor,
Trudi Cowan (17:18.026)
having awareness.
Trudi Cowan (17:26.762)
Hahaha!
Sarah (17:38.879)
says that no, and you really think that you meet the business test the way Trudy's described it. Perhaps it's time to look to get a second opinion. I see this all the time, specifically in my space in the finance world space, for the reason that Trudy and I discussed earlier, like there's the results test, and a lot of them are in a position where they might actually engage their spouse to do their back end processing and administration work.
and are told that they cannot split their income with them, but they can only pay them whatever the equivalent role would have been and they have to wear the rest. But the reality is that they only get paid if the deal settles. So therefore it meets the results test, which and so the like, I think knowing what the tests are is really helpful because then you can kind of work it out for yourself.
Trudi Cowan (18:18.218)
to.
Trudi Cowan (18:23.594)
Yeah and there is flowcharts available online of you know and that can really help you clarify and the other thing that I think is really important is that a lot of people ring accountants and just get advice over the phone. Ask them to put something in writing as to why they think that that's the reason, why do they get to that particular result for two reasons. One it helps you to understand exactly what they're saying and how they're getting to that position.
Sarah (18:28.063)
So everyone loves a good flowchart.
Sarah (18:32.703)
Yeah.
Sarah (18:37.023)
Yeah.
Sarah (18:44.805)
pay for the advice to start with.
Trudi Cowan (18:51.882)
But two, if you disagree with them, having it in writing allows you to go away, think about it, maybe do your own research or get a second opinion and come back to them and say, well, but what about this? Or have you considered? Right? And you shouldn't have to, hopefully your accountant's giving you the correct advice the first time, but having it down in words, it's just a better way of getting your advice than constantly getting everything over with.
Sarah (19:03.113)
Yeah? Yeah?
Sarah (19:15.935)
Well, it also means that if you think the other thing here is having a lack of understanding of what the concept is may mean that you misinterpret potentially what is said to you because it's effectively like speaking a foreign language. Like I said, we've talked about this, I reckon, 35 times and every time I hear it, I'm like, wait, hold on. And so at least if it's written down, you can read it. And then if you do need a second opinion, you can take that and say have
Trudi Cowan (19:25.898)
Yeah. Yeah.
Trudi Cowan (19:42.12)
Mm -hmm.
Sarah (19:43.263)
have I interpreted this correctly? Have I understood the advice that I've been given, etc. etc.
Trudi Cowan (19:46.066)
Yeah.
I did one recently where a client came to me to get the second opinion and I gave the opinion in writing. And they actually then took that back to their original accountant who went, oh yeah, okay, maybe that's right.
Sarah (19:53.309)
Yeah.
Yeah.
Sarah (20:02.655)
Shit. Hey, Neil, count it. Exactly.
Trudi Cowan (20:03.69)
Right? So also having any writing allows you to take it somewhere else and say, well, do you agree with this?
Sarah (20:11.199)
But would it also then mean that say the ATO came down on you like from a professional advisory position that you've then also personally got a fallback? Well, my accountant has given me the advice on this and this is why my account.
Trudi Cowan (20:23.946)
So the way that comes into play, it comes down to penalties because as a taxpayer, you've taken reasonable steps to get advice and you'll follow that advice. So when the penalties come down, the ATO has like a range of penalties depending on whether you've just gotten it wrong because circumstances or whether you've deliberately got it wrong or whether you were reckless. You know, we intentionally try to avoid paying tax, right? So.
Sarah (20:33.247)
Yep. Mm -hmm. Yep.
Okay.
Sarah (20:49.663)
Because we sign off on our tax returns that, you know, the accountant doesn't sign off on the tax return. It's we that take responsibility for what's in the tax return.
Trudi Cowan (20:57.098)
Well, we do, but yeah, it still is you that is ultimately responsible for it. But having that written advice can help you say to the ATO, well, I didn't deliberately avoid paying tax. I wasn't reckless. I went and got advice and I followed that advice. So I think what I could, so the ATO may still apply a penalty, but it's going to be a much smaller one than if you didn't have any written advice at all, well, the potentially ATO could go, well, you were really reckless.
Sarah (21:01.311)
Mm -hmm. Yeah.
Sarah (21:10.781)
No.
Yeah, the advice.
Sarah (21:19.391)
should be.
Trudi Cowan (21:25.898)
or you've done this deliberately, and they might try and argue a higher penalty.
Sarah (21:31.199)
So Ms Cowan, I would like my advice now in writing about PSP for my videos. No, I have it in writing already. It's already included in my notes because, you know, I couldn't resist. Yeah, strong topic to try and wrap your head around guys. You might need to listen to it twice or 45 times.
Trudi Cowan (21:33.866)
That's fun.
Trudi Cowan (21:37.674)
You
Trudi Cowan (21:47.434)
But definitely hit us up if you've got any questions or if you're not sure if you've been doing it right. Always happy to provide a second opinion or send you some guidance on what you should be looking at.
Sarah (21:57.087)
Yeah, fantastic. Until next time, guys, you've been listening to Financial Fofu
Trudi Cowan (22:02.922)
Thanks.