Professional contractors ask us if there are any benefits in setting up a Company or Family Trust and bill the agency or client for their contracting revenue. The answer to the above lies in understanding the Personal Services Income legislation (PSI). This question is not about status as ‘Contractor’. Even though you may meet all the criteria of Contractor and fit the definition of Contracting, this is about how the ATO treats the payments made for tax purposes – as business income or personal income. You need to earn Business income to reap any benefits from
Labour hire/recruitment companies will have to report payments made to contractors who have their company. ATO knows the source of your revenue. So, if you intend to get Company tax rates/distribute the money to another family member on a lower tax rate or claim for certain expenses, beware. You need to satisfy the rules and be a PSB.
What is PSI Legislation?
Personal services income (PSI) is income produced mainly from your personal skills or efforts as an individual. The ATO created rules around PSI to ensure that individuals earning income in this manner cannot abuse the tax system. This includes things like diverting your income through a business structure to different beneficiaries, accessing company tax rates, or having another business entity take on your losses.
The ATO has created a few steps in ascertaining you are income is a PSI or business income. Here are some details from ATO;
When working out if the personal services income (PSI) rules apply, you need to look at the income received from each separate contract or job to determine if you have received PSI. If you have received PSI (including if you have received it through a company, partnership or trust), you then need to work out if the PSI rules apply to that income.
Step 1. Have you earned a PSI
Look at the income you have received from each individual invoice or contract.
- Has more than 50% of this income been generated from your personal skills, labour, or expertise? If so, the total amount of income for that invoice or contract is classified as PSI. Go to step 2.
- If none of your invoices or contracts are classified as PSI, then the PSI rules don’t apply to your business.
Step 2 – The Result Test
To pass the results test in an income year, you need to answer yes to all the three conditions below:
- Paid to produce a specific result or outcome per the contract
- You are required to provide the equipment or tools to undertake the work.
- Are you required to fix defects or mistakes at your own costs per the contract?
If you answer yes to all the above, then your business is a personal services business (PSB) for that income year and the PSI rules don’t apply.
Step 3- The 80% Rule
Should you fail Step 2, then test needs to be passed. For this step, you need to work out the amount of PSI that comes from each client (including their associates) in an income year. If you are paid by a labour hire firm, the labour hire firm is treated as your client.
If you are a company, partnership or trust and you have more than one individual generating PSI, the 80% rule applies to each individual. You need to look at the amount of PSI that you receive for each individual and how much of that amount comes from one client.
The ATO and the courts have clearly mentioned that working through two or more recruitment agencies does not automatically help pass you on this test.
Step 4 – The Other Tests
If you pass one of these tests, then PSI rules do not apply to your business:
- Unrelated clients test. If you complete work for two or more unrelated clients, and you’re actively seeking out new work — whether it’s through your website, referrals, tenders, etc — then you pass the test.
- Employment test. If you hire a contractor or employee to complete 20% or more of your billable work — excluding bookkeeping or administrative tasks — then you pass the test.
- Business premises test. If you run your business operations from separate premises to your other work, then you pass the test.
If you do not pass at least one of these tests you can apply to the ATO for a PSB determination.
How does SDP Solutions assist Independent Contractors?
Contractors without their own PTY LTD Company – If you are contractor who does not have a Company or Business structure, SDP can assist by providing a structure for you to operate from, get all insurances you need as a contractor, invoicing your clients and making payments to you, managing tax payments and super and doing all salary packaging benefits. A hassle-free solution.
PTY LTD Company Contracting – SDP also provides accounting, tax and contract lifecycle solutions to Contractors who want to setup and operate via their company / Trust. Of course, we will guide you through PSI rules and suggest a structure wherein you can save tax legally for income from all sources.
I am a sole trader and have an ABN, Can the Labour hire company pay me full daily / hourly rate?
When you work with an Agency or via SDP Solutions, we are obliged to withhold income tax and superannuation on payments made to you whether they are an employee or independent contractor.
The ATO rules say that even though you are independent contractors:
- don’t need to quote an ABN
- are not entitled to register for GST as they do not meet the definition of enterprise.
- Labour-hire firms and their workers | Australian Taxation Office (ato.gov.au)
- PSI – obtaining work through an agency | Australian Taxation Office (ato.gov.au)
- Questions | Personal Services Income (PSI) decision tool (ato.gov.au)
Please note that this is a general guide for contractors and is not to be treated as tax or financial advice. Please talk to your financial / tax advisor for specific advice.