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It is not uncommon for professional people who provide services to set up a separate entity to run their business, be it a trust, partnership or incorporated company.
The allure of course is the lower tax rate that these entities can secure, rather than at the top marginal rate of 47% (or 49% with the Temporary Budget Deficit Repair levy) that an individual would generally wear.
Running a business through such a structure can also lead to a wider range of deductions being available, depending on circumstances. To stop taxpayers dodging their full share of tax, the tax law however has in place a set of rules.
The PSI rules
The measure comes under the banner of “personal services income” (PSI), which broadly defines such income as “a reward for an individual’s personal efforts or skills”. This excludes the sale of goods, as with a retailer or manufacturer, or only using a physical asset like a truck or tractor to generate that income.
As PSI is income produced mainly from personal skills or efforts, you can derive PSI in a wide variety of industries, trades or professions. However, some common examples include construction workers (such as tradies), financial professionals, information technology consultants, engineers and medical practitioners.
The PSI rules operate as an integrity measure to prevent individuals using an entity to direct their income to a lower taxed environment (such as a company) and to access a larger suite of general deductions.
So if, for example, your business structure is assessed to be contrived (an assessment that is based on a series of tests), then income your business earns will be treated as being earned by you as a contractor individually, and taxed at your personal rate rather than taxed to the entity.
Therefore, the tax issues that come with PSI are often misunderstood and can trap the unwary if the ATO’s auditors come calling.
The ATO’s PSI tool
To make things easier, and to help with your tax planning for the year ahead, ask this office about accessing the ATO’s recently developed online “decision tool” to assist you to work out whether you will or have earned PSI, and if the PSI rules will apply to that income.
We can probably help you with a lot of the information required. To answer the questions in the PSI decision tool you may need:
– details of contracts or written agreements with your business’s customers during the income year
– invoices from work performed during the income year
– records of payments to any employees or subcontractors.
What this PSI tool gives you
After answering a series of questions, the tool will provide you with a report that gives you:
– guidance on whether your income is PSI and if the PSI rules apply to you
– a summary of the responses you have provided
– information about what your result means for your tax obligations.
Once done you can save or print a copy of the report, which we can keep for you with your other tax records. We can discuss the outcomes with you to help you plan your tax affairs.
The ATO says that in most cases you will be able to rely on the result provided by the tool, but in our experience, depending on your circumstances, it could be better to apply for a “personal services business (PSB) determination”.
Ask this office if you need help or advice.
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