You've done the hard yards. You've set up your company, you're invoicing clients, and you're finally earning decent money from your craft or expertise. Then someone mentions the Personal Services Income rule and suddenly your carefully constructed financial structure starts to sound a lot less impressive than it did in the accountant's waiting room.
If you're a contractor, consultant, freelancer, or creative professional operating through a company, trust, or partnership in Australia - particularly in western Sydney - the Personal Services Income (PSI) rule is one of the most important pieces of tax legislation you need to understand. Not understanding it can mean unexpected tax bills, restricted deductions, and unwanted attention from the Australian Taxation Office (ATO).
This guide breaks down exactly what the PSI rule is, who it affects, how the tests work, and what it means for your deductions - in plain language, without the jargon overload.
Personal Services Income is income that is mainly a reward for an individual's personal effort, skill, labour, knowledge, or expertise. Think of it as income where you are the instrument - not a product, not an asset, not a team of people, but specifically your individual effort and capability.
The ATO applies a straightforward threshold to determine whether income qualifies as PSI: if more than 50% of the income received for a contract or invoice was for an individual's labour, skills, or expertise, then all of the income from that contract is classified as PSI. Conversely, if 50% or less was attributable to personal labour or skills, then none of the income is PSI.
To illustrate how the ATO applies this: a management consultant who provides software worth $8,000 and personal services worth $2,000 as part of a $10,000 contract is not earning PSI - only 20% of that contract related to personal skills and expertise.
PSI can arise in virtually any industry - from IT consultants and engineers to medical practitioners, tradespeople, and creative professionals including musicians and performing artists.
The PSI rule applies specifically to individuals, because PSI is - by definition - income from an individual's personal effort. However, the way that income is received matters greatly.
Individuals can earn PSI in two ways:
The PSI rules exist as integrity measures to prevent individuals from routing their income through a lower-taxed entity (like a company) to reduce their overall tax liability, or from claiming deductions they would not be entitled to as an employee. In short, the ATO wants to ensure that if your income is essentially a reward for your effort, it gets taxed accordingly - at your marginal rate.
It's important to note that the PSI rules do not change your contractual relationships with clients, affect your ABN entitlements, or alter your GST obligations. They are purely about how your income is taxed and what deductions you can claim.
Determining whether the PSI rules apply to you follows a clear three-step process:
Step 1 - Is your income PSI? Ask yourself: is more than 50% of the income from a contract attributable to my personal labour, skills, or expertise? If yes, that income is PSI. If no, normal tax rules apply and you can stop here.
Step 2 - Do you qualify as a Personal Services Business (PSB)? If your income is PSI, you then need to determine whether you're operating a Personal Services Business. If you qualify as a PSB, the restrictive PSI rules do not apply. This is where the four PSB tests come in (covered in the next section).
Step 3 - Apply the appropriate tax treatment If you qualify as a PSB: normal business deductions apply with far fewer restrictions. If the PSI rules do apply: deduction restrictions kick in and the income is attributed back to you personally.
This is where the detail matters most. To qualify as a Personal Services Business - and escape the more restrictive PSI rules - you need to pass at least one of four tests. Think of these as four different paths to demonstrating that you're genuinely running a business, not just routing a salary through a structure.
This is the frontline test and the one most contractors should assess first. To pass the Results Test, at least 75% of your PSI must meet all three of the following conditions:
If you satisfy all three conditions for 75% or more of your PSI, you pass the Results Test and do not need to consider the other tests.
Before you can rely on any of the three remaining tests, you must first clear the 80% rule: less than 80% of your PSI in an income year must come from a single client (including that client's associates). If one client accounts for 80% or more of your PSI, the PSI rules apply automatically - unless you obtain a Personal Services Business Determination (PSBD) from the ATO.
To pass this test, you must provide services to two or more unrelated clients (clients who are not associates of each other or of you), and those services must arise as a direct result of a genuine public offer - such as advertising, a website, tendering, or professional directory listings.
Following the ATO's updated guidance in Taxation Ruling TR 2022/3 (effective November 2022), simply having a social media account is no longer sufficient. There must be a direct causal link between your public offering and the work you obtained. This is a meaningful tightening of the rules that many contractors missed.
You pass this test if your entity engages one or more non-associate employees (or contractors) who perform at least 20% by market value of the principal work in the income year - at arm's length rates. Alternatively, having at least one apprentice for 50% or more of the income year also satisfies this test.
You pass this test if you maintain and use physical business premises throughout the year that are:
A home office does not qualify. This test can be passed regardless of whether one client represents more than 80% of your PSI.
This is often where the real sting lies. When PSI rules apply, significant deduction restrictions come into play. The following table summarises what you can and cannot claim:
| Expense Type | PSI Rules Apply - Claimable? | Notes |
|---|---|---|
| Advertising and tendering costs | ✅ Yes | Costs of obtaining work |
| Professional indemnity / public liability insurance | ✅ Yes | Allowable business expense |
| Salary/wages for arm's length employees | ✅ Yes | Not associates doing non-principal work |
| Superannuation for arm's length employees | ✅ Yes | At applicable guarantee rate |
| Home office running costs (electricity, phone) | ✅ Yes (with limits) | Fixed rate: 70 cents/hour (from 1 July 2024) |
| Depreciation of business assets | ✅ Yes | Including simplified depreciation if eligible |
| Rent, mortgage interest, rates, land tax | ❌ No | Even for a partial home office |
| Payments to associates for non-principal work | ❌ No | E.g., family member doing bookkeeping |
| Superannuation for associates doing non-principal work | ❌ No | Bookkeeping, admin duties excluded |
| Car expenses (private use, through a PSE) | ❌ Limited | Only one car claimable if used privately |
All records relating to PSI transactions and expense claims must be retained for five years from the date they are prepared, obtained, or the transactions are completed.
When the PSI rules apply and you are earning PSI through a company, trust, or partnership, the income does not stay in that entity at the lower corporate tax rate. Instead, it is attributed back to you personally and taxed at your individual marginal tax rate.
The entity is required to either pay the PSI to you promptly as salary or wages, or attribute the net PSI to you and withhold and remit tax accordingly. Income splitting with family members or retaining profits in a lower-taxed structure for the purpose of reducing tax is precisely what these rules are designed to prevent.
The ATO may also consider applying Part IVA (General Anti-Avoidance rules) to arrangements where the dominant purpose appears to be obtaining a tax benefit through income diversion - an important consideration for anyone structuring their affairs primarily for tax outcomes rather than genuine commercial reasons.
Understanding where you sit with respect to the Personal Services Income rule isn't optional - it's essential groundwork for anyone earning income primarily from their individual skills and effort. Whether you're a sole trader or operating through a company or trust, the PSI rules can fundamentally alter how your income is taxed and which deductions you can legitimately claim.
The ATO's PSI Decision Tool is available online and can help you assess your situation anonymously or submit directly. Taxation Ruling TR 2022/3, updated in November 2022, is the current operative guidance and applies retrospectively - making it critical reading for practitioners and contractors alike.
The rules are nuanced, the tests have specific conditions, and getting it wrong can be costly. If you're unsure whether the PSI rules apply to your situation, speaking with a qualified chartered accountant who understands your industry is a smart next step.
Ready to crank your finances up to 11? Let's chat about how we can amplify your profits and simplify your paperwork – contact us today.
PSI can apply to both. If you're a sole trader and your income is mainly from your personal effort or skills, it is PSI. However, the most significant tax implications – particularly income attribution – arise when PSI is earned through a company, partnership, or trust (a Personal Services Entity). Sole traders still need to be aware of deduction restrictions if the PSI rules apply to their income.
Yes – if you obtain a Personal Services Business Determination (PSBD) from the ATO. This is a formal application process where the ATO assesses your specific circumstances and may grant an exemption from the PSI rules, even if you don't pass the standard tests independently.
No. The PSI rules are purely about income tax treatment and deduction entitlements. They do not affect your eligibility for an ABN, your GST registration obligations, or your contractual status with clients. These remain governed by separate legislation.
TR 2022/3, effective November 2022, tightened the requirements for the Unrelated Clients Test. Previously, many contractors assumed that having a social media presence or website was sufficient to satisfy the test. Under the updated ruling, there must be a direct causal relationship between your public offer to provide services and the work you actually obtained. Simply existing online is no longer enough.
Yes. Even if you qualify as a Personal Services Business and the restrictive PSI rules do not apply, you are still required to report any PSI you receive on your tax return, answer the relevant PSI questions in your return, and maintain records of your business transactions. The obligation to report exists regardless of your PSB status.
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