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It’s quite common for people to structure their professional affairs by setting up an entity to run their business through. This could be a trust, a partnership or, most often, a company.
The tax rate for small companies is just 27.5% which compares very favourably with the top personal tax rate of 45%. In addition, companies can claim a wider range of tax deductions and have the freedom to distribute franked dividends to shareholders (or alternatively to retain the profits in the business).
Clearly, this could be a very effective way of sheltering profits for a small business and for that reason, the ATO often seeks to apply what are known as the personal services income (PSI) rules to regulate such situations.
The impact of the PSI rules, for those affected by them, is:
In short then, if you fall into the scope of the PSI rules, you can find the ATO “looking through” your business structure and taxing you as an individual.
The measures apply to companies, trusts and partnerships where the income of the entity is derived primarily as a result of the personal efforts or skills of an individual.
The rules do not apply to income that is mainly:
In practice, the rules would impact the following professions where the practitioner is running their small business through another entity:
CPS Pty Ltd provides computer programming services but David does all the work involved in providing those services. David is the only employee of CPS Pty Ltd. David uses the client's equipment and software to do the work. CPS’s income from providing the services is David's personal services income because it is a reward for his personal efforts and skills.
Bert owns and drives a bulldozer that he uses on building sites. The income is not Bert’s personal services income because it is derived mainly by the use of the bulldozer and not by Bert’s personal efforts or skills.
First things first: these rules are complex! Given the scope of the rules to catch the activities of many professionals and the difficulty which many people have in working out if they are caught, it is essential that you take professional advice.
If you receive income that is mainly a reward for your personal efforts or skills, you may fall within the PSI rules.
To be exempt from the rules, you need to be a personal services business (PSB).
You qualify as a PSB if:
The primary test under the PSI rules is the results test. This test is a self-assessment test and an individual or their trading entity will be treated as a personal services business if they receive at least 75% of the personal services income for producing a result.
To pass the results test –
If an individual (or their trading entity) cannot satisfy the results test, there are three other tests available to self-assess against. The taxpayer can only consider these tests if 80% or more of the taxpayer's personal service income does not come from one source.
If the 80% threshold is breached, the individual cannot consider the other tests and must apply to the ATO for a PSB determination in order to be classified as a PSB.
Taxpayers can apply to the ATO for a personal services business determination.
This is available regardless of whether the taxpayer derives more or less than 80% of their personal services income from a single source.
For taxpayers who receive more than 80% from a single source, this is the only way to be treated as a personal services business.
For individuals and entities, the Tax Office cannot issue a Determination unless it is satisfied that the individual meets, or has met, in the income year the Determination has effect, the following criteria:
Contact H&R Block for further guidance, particularly if you’re starting out in a career in one of the professions likely affected by the rules (listed above) or if you’re already in one of those professions and aren’t sure you’ve got the most tax efficient structure. Contact our Business Services team on 13 40 42 or email email@example.com
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