Personal Services Income
Are you earning other income apart from your employment and you are not sure of how to classify them? Income from employment is not the only source of income that one needs to pay taxes on. Income from your rental property, interest income, dividends or income from your personal exertion are some of the few examples that are part of your taxable income.
Income primarily produced from your personal skills or effort as an individual is referred to as a Personal Service Income (PSI). Income is classified as PSI when more than 50% of the total received for a contract was your labour, skills or expertise. PSI can be received in almost all industry, trade or profession, and does not have any impact on you or your employment income. Examples include financial professionals, information technology consultants, engineers, construction workers and medical practitioners.
It is important to properly identify if any of your income is classified as PSI as there are different tax rules applicable and a series of other steps that you need to follow to complete this. Once you’ve classified any of your income as PSI, you need to work out if the PSI rules – special tax rules, is applicable to your income. If these rules apply, how you report your PSI on your tax returns and the deductions claimable will be affected. However, if the PSI rules do not apply, your business is a personal service business (PSB). Being a PSB means that there are no applicable changes to your tax obligations, apart from declaring your PSB on your tax returns.
If the PSI rules apply and you are producing PSI through a company, partnership or trust, the income received will be treated as your individual income for tax purposes.
Claiming deductions when receiving PSI
There are limitations for the deductions that you can claim against your PSI. In summary, an individual who earns PSI is treated in the same manner as an employee. This means that your business can claim PSI deductions if you:
incur expenses in relation to producing your income, OR
would be entitled to the deduction (as an individual who earns the income)
You need to show if the expenses incurred relates to your PSI or any other income. Thus, records of your transactions, including expense claims, must be kept for 5 years after they are prepared, obtained or completed the transaction, whichever occurs later.
Where PSI is generated by multiple individuals in a business, the deductions claimable has to be allocated in relation to the income received by each individual.
Deductions that are not claimable against your PSI
The following income received cannot be claimed as a deduction against your PSI, even when the PSI rules apply:
rent, mortgage interest, rates and land tax
payments to associates for non-principle work
super contributions for associates’ non-principal work
When your expenses such as rent, mortgage interest, rates and lax tax for a residence relate to your PSI, you cannot claim any of these expenses as a deduction. For example, Sarah owns a business called Sarah’s Financial Services, where she conducts her operations in one of the rooms in her residence. All of her income earned relates to her skills, knowledge and expertise, thus the income received is classified as PSI. Sarah has also worked out that the PSI rules apply, therefore she cannot claim rent, mortgage interest, rates or lax taxes relating to her residence against the PSI generated.
Payments to associates (e.g. spouse, child or any other relative) is not allowed as a deduction for performing non-principal work. Principal work refers to the work a business must perform under a contract to receive payments. On the other hand, non-principal work refers to incidental or support work that is not central to meeting contract obligations. i.e. bookkeeping, issuance of invoices, secretarial duties and running a home office.
Payments to associates include remuneration (salary or commission), allowances, expense reimbursements, rent or interest on loan. For example, John owns a marketing consultancy firm that generates PSI. He employs his wife, Jenna to assist in the business by issuing invoices, banking receipts and administering the home office. The wages paid to Jenna are non-deductible as issuing invoices, banking and administering the home office are not principal work.
In addition, super contributions for associates are not allowed as deductions if the associates does non-principal work. Deductions are only allowed when the associate conducts principal work which contributes to the business’ PSI. Deductions are allowed up to the minimum % that you would have to contribute to meet superannuation guarantee (SG) for that associate.
Contributions above the minimum SG is only allowed if, you pass the employment test as your business is a PSB and the PSI rules are not applicable. The PSI rules do not apply to instances whereby the associate completes work produces income other than PSI. Moreover, the PSI rules do not affect deductions for super contributions that are made for yourself.
For example, David is an engineer who produces PSI and hires his daughter, Mary, to perform principal work. Mary completes 5% of the principal work and is paid a salary of $5,000. Thus, David contributes $2,500 to Mary’s super fund. David is allowed to claim a deduction against his contribution to Mary’s super fund, but the amount is capped at the amount that he would have to contribute in order to avoid an individual SG shortfall for Mary (9.5% of her total salary payment in that income year).
Allowable deduction = 9.5% SG x $5,000 = $475
However, if David meets the employment test by employing Mary, and is a PSB, he is entitled to claim to entire $2,500 as a deduction.
Do seek professional help if you are having doubts on whether if your income is a PSI or what expenses you incurred can be claimed as a deduction!