Client often ask whether they could reduce their income tax by diverting income received from personal services through companies, partnership, or trusts. Personal services income (PSI) is income produced mainly from your personal skills or efforts as an individual. Income is classified as PSI when more than 50% of the amount you received for a contract was for your labour, skills or expertise. Before deciding whether to set up a new business structure, the first thing we need to do is work out if any of your income is classified as PSI.
The PSI rules (or alienation of PSI rules) were introduced to ensure that taxpayers cannot reduce or defer income tax by diverting income received from their personal services through companies, partnerships or trusts or by claiming inappropriate deductions against this income. The impact of the PSI rules, for those affected by them, is:
• the PSI is included in the assessable income of the individual taxpayer whose personal efforts or skills generated the income and
• there are restrictions on the deductions that may be claimed by the individual or the entity against the PSI so that they broadly correspond to the deductions available to employees.
Personal services income is income that is mainly a reward for an individual's personal efforts or skills. It does not include income that is mainly:
• for supplying or selling goods (for example, from retailing, wholesaling or manufacturing),
• generated by an income-producing asset (such as a bulldozer),
• for granting a right to use property (for example, the copyright to a computer program), or
• generated by a business structure (for example, an accountant working for a large accounting firm).
Claire Chang