The Australian Taxation Office (ATO) is continually clarifying and updating guidelines, and a recent change may affect you if you have a small, service-based business.
This update falls under the draft practical compliance guideline PCG 2024/D2 and applies to what’s referred to as Personal Services Income (PSI).
There are common misconceptions around PSI and it’s important to be up to date with regulations so you avoid being questioned about your tax return.
What is Personal Services Income?
Personal Services Income, or PSI, is income that’s primarily a ‘reward’ for personal effort, skills or expertise rather than being based on the sale of goods or generated from substantial business assets.
Typically, PSI applies to sole traders and certain business structures where the income generated is linked directly to an individual’s work, rather than the broader operations of a business. Common examples of PSI income include consultants, contractors and professionals whose earnings result from providing personal services.
Income derived from a trade business can fall into this category if, for example, it is operated by a husband and wife team, with the husband working full time and the wife helping to manage the books two days per week.
Here’s where things can get tricky:
A business may generate $500k in revenue. The Director pays himself $120k and his partner $120k, even though his partner is only employed by the business two days per week to respond to emails and manage the books. Because of the limited hours the partner is contributing and the nature of the work, PSI is income that could be regarded as a ‘reward’ for personal services, rather than fair pay.
The ATO may request more information if it believes PSI is being paid as a strategy to avoid paying tax.
Revised PSI rules for Australian businesses
The ATO’s new practical compliance guideline, PCG 2024/D2, brings clarity to PSI rules. This is aimed at helping businesses determine if income qualifies as PSI and understand the associated tax obligations.
This guideline addresses ambiguities and provides a framework for assessing PSI eligibility, along with specific risk categories. Here are the key changes:
Clarification on Risk Categories: PCG 2024/D2 introduces clear risk categories—low, medium, and high—to help businesses self-assess their PSI risk. For instance, businesses in the “high-risk” category may be more susceptible to ATO scrutiny, potentially facing closer examination if claiming certain deductions. Understanding where your business falls within these categories will help you avoid possible compliance issues.
Detailed ATO Expectations: With this guideline, the ATO has outlined its expectations on how PSI should be identified and reported. It includes criteria for cases where income might initially appear as PSI but could be exempt based on the nature of the work performed and the contractual arrangements in place.
Compliance Requirements and Evidence: Under PCG 2024/D2, businesses are expected to keep clear records, demonstrating why income may or may not qualify as PSI. For business owners, this means gathering and maintaining evidence of income sources, contracts, and business structures that support their PSI status.
Are you at risk of scrutiny over PSI?
As the ATO explains, PSI rules were introduced to prevent the diverting, alienating or splitting of income with other individuals or entities in an attempt to pay less tax.
The lines around this type of income have been somewhat blurry in the past so if you’re worried that paying yourself or someone else PSI may result in scrutiny by the tax office, seek professional advice.
Given the complexity of PSI regulations and the implications of misclassification, discussing your situation with a tax accountant can help ensure compliance with the latest ATO guidelines. An expert can explain whether your current structure meets the new expectations and, if necessary, suggest steps to pay yourself and your employees within these guidelines.
For tailored advice and support on Personal Services Income and the new PCG 2024/D2 guidelines, contact Mobbs & Co.
