SMEs need to be careful about personal services income rules

Other amounts an individual cannot deduct include rent, mortgage interest, rates or land tax in relation to her or his residence (or part of a residence) to the extent that the amount relates to gaining or producing PSI.

The PSI rules do not apply to individuals or interposed entities carrying on a personal services business. So if the personal services business tests are satisfied, the deduction limitations don’t apply.

The PSI rules are structured so that an individual or a personal services entity carries on a personal services business if:

• the individual or, if the individual’s PSI is included in a personal services entity’s income, the entity meets what is known as the results test; or
• not more than 80% of the individual’s or entity’s PSI in an income year comes from the one client (and associates of the client) and the individual or entity meets at least one of the unrelated clients test, employment test and business premises test; or
• a personal services business (PSB) determination is in force. A PSB determination is necessary if the “80% threshold” and the results test are not met.

The results test is the most important of the tests. If the results test is met, that is the end of the matter and the PSI rules do not apply.

An individual or personal entity satisfies the results test in an income year if, in relation to at least 75% of the individual’s or entity’s PSI during the income year:

• the income is for producing a result;
• the individual or entity is required to supply the plant, equipment or tools necessary to perform the work (the results test is not failed simply because no tools, etc are required to perform the work); and
• the individual or entity is liable for the cost of rectifying any defective work.

As a business can receive PSI and non-PSI, it is important to work out if the income the business receives is PSI. In case you hadn’t already noticed, the PSI rules are complex!

Many small business operators, whether operating as individuals or through interposed entities, may find it difficult to pass the relevant tests to be regarded as carrying on a personal services business.

In fact, it may be said that the legislation has created a new class of taxpayer, a type of “non-employee and non-business operator” to be denied some of the rights and benefits of other taxpayers. However, their status as an enterprise for GST purposes is not affected.

The fact that taxpayers can self-assess themselves as conducting a personal services business is both a good and a potentially bad thing.  Good if they get it right; not so good if they don’t.

As I’ve noted, the rules are complex, so any SME contemplating self-assessing needs to be sure they have a proper understanding of the law. That may necessitate obtaining professional advice.

Terry Hayes is the Editor-in-Chief of tax news reporting at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.