This week I was asked a fairly straightforward question – I am a sole trader, operating with an ABN, can I claim travel to client premises? What’s the big deal you say, of course she can! But as is always the case with tax, the devil is in the detail. The other part of the email gave me some more facts. There is only one client, payment is made on an hourly rate and the travel involves a three hour round trip by car. Suddenly Personal Services Income (PSI) alarm bells were ringing and the answer becomes much more complex.
What is PSI? PSI is income that you generate primarily from your personal skills, efforts or labour as an individual. It is often associated with professionals and consultants – think accountants, medical practitioners and engineers. However it can also apply to building and construction workers, personal care services, nursing, trades and real estate – so almost any industry. A simple example would be someone working as a labourer, has an ABN and earns their income based on an hourly rate. They might supply their own tools, but the income they earn is based on when they’re on site.
Why does it matter? If the PSI rules apply, there are special rules which are applicable. You need to report the income separately on your tax return and you may be restricted in what deductions you are able to claim.
When is income PSI? Income is PSI if more than 50% of the amount you receive was for your labour, skills or expertise. It doesn’t matter whether it is earned as a sole trader or company. It’s the nature of the income that counts. However, if you are classified as carrying on a Personal Services Business, the PSI rules won’t apply to your income. This is where it becomes complicated!
As a first step, you must first work out if the income you are earning is mostly from your labour or efforts. Once you’ve established that fact, then there are a series of steps to work through to determine whether the PSI rules will apply.
- Results Test: Are you paid to produce a specific result, provide your own tools AND rectify any mistakes at your own cost? Then you will pass this test and income will not be regarded as PSI.
- The 80% rule: Does any one client generate 80% or more of your income? If yes, you will be considered to be earning PSI unless you are able to apply to the ATO for a determination based on special circumstances.
- If you earn no more than 80% of your income from one client, you must still meet one of the remaining tests to be excluded from PSI.
Unrelated clients – you must have two or more unrelated clients and you make offers to the general public for your services (eg competitive tenders, advertising or maintaining a website).
Employment – you must employ an apprentice or a person who performs at least 20% of the principal work (that is, not administration).
Business premises – you maintain business premises that are used mainly for your work, are physically separate from your home and are physically separate from your clients.
To simplify, it will usually it will come down to the unrelated clients test – you will not be considered to be earning PSI income if you have 2 or more unrelated clients where no one client generates more than 80% of your income.
What if you find yourself not meeting any of these tests? Then there are restrictions about what deductions you can claim. Specifically, you cannot claim any deductions for rent, mortgage interest, payment to associates (such as a spouse) and any expenses you would generally not be able to deduct if you were an employee. In my original example, this would mean that travel between home (even if your place of business) and your client will not be deductible. If you receive both PSI and other income, only deductions relating to the PSI income will be affected. In addition, you need to disclose in your income tax return the fact that you have earned PSI.
An important point to note is that if you have set up a company, the PSI rules will still apply. If you don’t meet the tests, then all income must be distributed to you and included in your taxable income in the year it was received.
As you can see, Personal Services Income is a potential minefield and can become quite complicated. If you have further questions about how you are affected by the PSI rules, I’m more than happy to chat with you and offer a FREE 30 minute initial consultation. You can easily book online here and I look forward to helping you sort your taxes!