If you operate through a company or trust, or work as a contractor providing services primarily through your own skills, you’ve probably heard the term “personal services income.” But many business owners — even those who’ve been operating for years — aren’t certain how the rules apply to them or what the consequences of getting it wrong can be.
This guide explains exactly what personal services income (PSI) is, how the ATO determines whether your income is PSI, and what it means for your tax position and ability to claim deductions.
What Is Personal Services Income?
Personal services income is income that is mainly a reward for your personal efforts or skills. The concept exists because some taxpayers use companies, trusts, or partnerships to reduce their tax obligations in ways that wouldn’t be available to an employee doing equivalent work.
Under the Tax Assessment Act 1997, your income is classified as PSI if more than 50% of it is earned from providing services where that income is mainly a reward for your personal skills, knowledge, or efforts — rather than from the use of assets, the sale of goods, or the efforts of other people you employ.
Common examples of PSI earners include IT contractors, consultants, engineers, lawyers working as sole practitioners, bookkeepers, and financial advisers who provide services under their own name or through their own entity.
When Do the PSI Rules Apply?
The PSI rules don’t apply to every contractor or self-employed person. They only apply when your income qualifies as PSI and you fail the “results test.” If you pass the results test, you are classified as a Personal Services Business (PSB), and the PSI rules don’t restrict your deductions or require attribution of income.
There are four tests in total. The first — and most important — is the results test. If you pass that, you stop. If you fail it, you can then look at three more tests to see whether you can still qualify as a PSB.
The Results Test
You pass the results test if all three of the following are true for at least 75% of your PSI income in an income year:
- You are paid to produce a specific result or outcome
- You supply the tools and equipment needed to do the work
- You would be liable to fix defects in your work at your own cost
This test distinguishes genuine contractors from those who operate more like employees. If your engagement looks like employment in all but name — fixed rate per hour, tools supplied by client, no liability for errors — you’re unlikely to pass.
The Unrelated Clients Test
If you fail the results test, you can still qualify as a PSB if at least 75% of your PSI comes from two or more unrelated clients, and you genuinely offer your services to the public. Working through a labour hire firm or recruiter typically doesn’t satisfy this test, because the end client is engaged by the agency — not directly by you.
The Employment Test
This test is satisfied if you hire employees who perform at least 20% of your principal work — not administrative tasks, but the actual service delivery work. One valid employee generating 20% of the work output is enough to pass.
The Business Premises Test
Finally, you can pass this test if you maintain business premises that you own or lease, use exclusively for your business, and that are physically separate from both your home and any client’s premises. A home office typically does not satisfy this requirement.
Want to know how this applies to your business?
Book a consultation with Mina to get advice tailored to your specific situation.
Book a Consultation →What Deductions Are Restricted Under PSI Rules?
If your income is classified as PSI and you fail all four tests, the ATO imposes strict limits on what you can claim as deductions. Costs that would ordinarily be deductible to a business are denied under the PSI regime when they exceed what an employee could claim under the same circumstances.
Specifically, deductions are denied for:
- Rent, mortgage interest, and rates on your home or home office (beyond what an employee could claim)
- Payments to associates (such as a spouse or child) for services that aren’t genuine arm’s-length work
- Super contributions for associates who perform work in the business
- Capital allowances on items that produce income but aren’t assets used to produce the PSI
Normal business expenses — including tools, professional memberships, software, and direct work-related expenses — remain deductible even when PSI rules apply.
PSI and Income Attribution Through a Company or Trust
One of the most important consequences of the PSI rules is income attribution. If your income is PSI and it flows through a company or trust, the ATO requires that income to be attributed (i.e., taxed) to the individual who earned it — regardless of what the trust deed or company structure says about distributions.
This means you cannot use a trust to split PSI between family members at lower tax rates, or retain PSI in a company to take advantage of the lower corporate rate. The income is treated as if it were earned directly by you personally, and taxed at your marginal rate.
This is a key reason why many business owners who think they’re saving tax through a trust or company structure are actually creating a compliance risk. If you’re operating a service-based business and channelling income through an entity, the PSI tests should be reviewed annually — ideally before year end. See our guide on company vs trust structures for a broader comparison of how each entity type is taxed. If you are a sole trader weighing up incorporation, our guide on moving from sole trader to company covers the triggers, rollovers, and practical steps involved.
PSI vs. Alienation of Personal Services Income
The PSI regime targets what the ATO calls “alienation of personal services income” — the practice of diverting income earned by an individual through an associated entity to reduce tax. The rules have been in place since 2000, and the ATO has consistently taken an aggressive compliance stance toward arrangements that look like alienation.
The risk isn’t just tax adjustments. If the ATO determines you’ve incorrectly applied the PSI rules — and in particular, if it finds the structure has no legitimate commercial purpose — you may face penalties and interest on top of the unpaid tax. In serious cases, the general anti-avoidance provisions in Part IVA of the Tax Assessment Act may also apply.
If you’ve been operating through a company or trust and generating most of your income from your own skills, it’s worth having your structure reviewed. This is especially true if your super contributions or associate payments are being run through the entity. See also our explainer on Division 7A, which often intersects with PSI arrangements involving companies.
Super Contributions and PSI
If you are subject to the PSI rules, your superannuation position changes. You can still make deductible personal super contributions (subject to the concessional contributions cap), but your ability to claim super contributions made on behalf of associates through your company or trust is restricted.
For sole traders earning PSI, super contributions are straightforward — you claim them personally. For those operating through an entity, the rules are more complex, particularly if the entity is also paying wages to associates. Our guide to superannuation strategies for business owners covers the interaction between business structures and super in more detail.
Practical Steps to Stay Compliant
The best protection against PSI issues is maintaining contemporaneous records that demonstrate your business genuinely operates as a PSB — or that PSI isn’t the dominant income type.
Steps worth taking:
- Review your contracts: Do they specify deliverables, not just hours? Do you bear liability for defects? Do you supply equipment?
- Diversify your client base: If 90% of your income comes from one client, the unrelated clients test is off the table. Actively acquiring multiple clients matters.
- Document your employees’ work: If you rely on the employment test, keep records of how much of the principal work your employees actually perform.
- Review associate payments: Any salary or super paid to a spouse or family member must be at market rates for genuine services — not a mechanism to split income.
- Run a PSI test before year end: Don’t wait until your tax return is prepared. If you’re close to the 75% threshold on any test, planning before 30 June can make a material difference.
Frequently Asked Questions
Can I still operate through a company if my income is PSI?
Yes, you can. But if your income is PSI, the tax advantages of operating through a company — such as retaining profits at the lower corporate tax rate — are neutralised. The income is attributed back to you personally regardless of how it’s distributed.
Does PSI apply to all service businesses?
No. PSI rules only apply where more than 50% of income is a reward for your personal efforts or skills. If your business generates income from a team of employees, from assets, or from a genuine product — rather than primarily your own labour — PSI is less likely to apply. A businesses with genuine employees doing the work typically fails the PSI threshold.
What happens if I get the PSI assessment wrong?
If the ATO reviews your return and determines that PSI applied but you didn’t apply the rules, you’ll face a tax adjustment plus interest (currently around 11–12% per annum). If there was a lack of reasonable care, shortfall penalties of 25% on top of the additional tax also apply. Voluntary disclosure significantly reduces penalties.
Can I get a PSB determination from the ATO?
Yes. If you don’t pass any of the four standard tests but believe you’re genuinely running a personal services business, you can apply to the Commissioner for a PSB determination. These are granted case-by-case and provide certainty for that income year. They don’t automatically carry forward to future years.
Frequently Asked Questions
What is personal services income?
Personal services income (PSI) is income earned mainly from your personal skills or efforts as an individual, rather than from selling goods, using assets, or a genuine business structure. Consultants, contractors and professionals often earn PSI even when they invoice through a company or trust.
Why do the PSI rules matter?
If your income is PSI and you do not pass the PSI tests, the income is attributed back to you personally and certain deductions are limited, regardless of the entity you use. This stops individuals from splitting or deferring tax simply by contracting through a company or trust.
How do I know if the PSI rules apply?
Work through the ATO tests: the results test first, then if needed the 80% rule, the unrelated clients test, the employment test and the business premises test. Passing means you are a personal services business and the attribution rules do not apply to you.
Can I still use a company or trust for PSI?
Yes, you can operate through a company or trust, but if the PSI rules apply the net income is still taxed in your hands and deductions are limited. The structure does not change the tax outcome, so getting advice before relying on one is important.
This article contains general advice only and does not take into account your specific circumstances. Please speak with a qualified accountant or tax adviser before making financial decisions.
Getting PSI right protects the tax minimisation strategies that a well-designed structure makes possible.
Ready to do Business with Us?
Join the Melbourne business owners who work with a CPA and Chartered Tax Advisor, so you can focus on growing your business while we take care of the numbers.