SMEs need to be careful about personal services income rules

The ATO has written to some taxpayers who have reported personal services income (PSI), but who may have incorrectly self-assessed themselves as conducting a personal services business. Being a personal services business means tax rules limiting certain tax deductions don’t apply.

The PSI rules are something of a minefield for SMEs. So with the ATO already writing to taxpayers about the rules, it is timely to explain a few things about them trying, as best I can, to avoid too much technicality (and that’s not easy!).

Personal services income is considered to be income that an individual taxpayer earns predominantly as a direct reward for his or her personal efforts by, for example, the provision of services, exercise of skills or the application of labour. Examples of PSI include:

• salary and wages,
• fees earned by a professional person (eg accountant, lawyer, architect) on his or her own account,
• income payable under a contract for services, where the payment under the contract relates wholly or principally to the labour of the person concerned,
• income derived by a professional sportsperson or entertainer from the exercise of his or her particular skills,
• income derived by consultants, for example, computer consultants or engineers from the exercise of personal expertise.

Examples of income that would not be regarded as being PSI are the price of a painting sold by an artist, fees from the hire of plant and equipment and licence fees for the use of a computer program developed by an individual computer programmer. The income of a trust derived from the use and exploitation of the name, image, likeness, talents, identity, reputation and signature of a professional sportsperson would not be PSI of the sportsperson.

The tax law contains specific rules about the tax treatment of PSI. These rules limit deductions available to individuals in receipt of PSI if they are not able to satisfy the required personal services business tests.

The fundamental rule is that an amount is not deductible to the extent it relates to gaining or producing PSI if the income is not payable to the individual as an employee and the amount would not be deductible if the income were payable to the individual as an employee.

Consequently, an individual is limited to the deductions that can be claimed against salary and wages by an employee. For example, an individual (who is not an employee) who works from an office at home would not be able to claim car or other travelling expenses for a journey from home to a client’s business premises because the individual could not deduct these expenses if he or she were an employee.

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