What is PSI?
Income is classified as PSI when more than 50 per cent of what an individual receives from a contract is a reward for their efforts or skills.
Income determined to be PSI is attributed to the individual and taxed at marginal tax rates.
PSI can be received in almost any industry, trade, or profession.
Common examples include professional services, information technology consultants, engineers, construction workers and medical practitioners.
Income generated from a business structure, use of assets or sale of goods is not classified as PSI and therefore not impacted by TR 2022/3.
The revised PSI guidance will also not affect:
- Contractual relationships between individuals and their clients or customers. That is, they do not become an employee or stop being a contractor.
- Entitlements to an Australian business number (ABN) or registration for goods and services tax (GST).
- Whether individuals are still considered to be running a business.
What are the PSI rules?
The ATO says its personal services income rules are designed to ensure a level playing field among individuals.
“They do this by preventing income earnt as a reward from an individual’s efforts or skills from being diverted, alienated, or split with other individuals or entities in an attempt to pay less tax,” the ATO spokesperson says.
“If you earn PSI and the PSI rules apply, there are special rules to ensure the income is attributed to you and not diverted to other individuals or entities.
“They can also affect the deductions you claim and how you report PSI in your tax return.”
The rules will not apply to individuals earning PSI in the same year they operate a PSB, however, they will still need to report PSI in their income tax return and keep records.
PSI rule tests
A PSB is being conducted if either the sole trader or personal services entity (PSE) meets the results test in relation to at least 75 per cent of their PSI, or less than 80 per cent of their PSI is from the same entity and its associates (the 80 per cent rule) and they satisfy one or more of the other PSB tests.
The results test is met if PSI income is for producing a result and if the sole trader or personal services entity is required to supply equipment or tools to complete work and would be liable for the cost of rectifying defects.
Other PSB tests include the unrelated clients test, employment test, and business premises test.
In some circumstances, those unable to self-assess as a PSB for a specific income year may be able to apply for a PSB determination (PSBD).
If you are unable to self-assess as a PSB and do not have a PSBD for the relevant year, PSI rules will apply,” it states.
You won’t be able to claim certain deductions against PSI and there are special ‘attribution’ rules to ensure that PSI is attributed to the individual who performed the work that generated the income.”
The ATO emphasises that even when PSI rules don’t apply, individuals still need to declare any PSI amounts they receive at the relevant labels on their tax returns and keep records of their business transactions.
The ATO may seek to apply Part IVA where there are factors indicating that the dominant purpose of the arrangement is to obtain a tax benefit by diverting, alienating or splitting an individual's PSI or retaining profits in the lower taxed PSB.
Tax for medical professionals:
Personal Services Income (PSI) and service entity arrangements
The tax implications of Personal Services Income (PSI) and service entity arrangements can significantly impact medical professionals setting up their own practice.
Starting a new practice is an exciting time; however, there are various tax considerations healthcare professionals need to address before opening for business.
Sorting out areas like PSI and service entity arrangements properly from the outset can save time, energy, and money in the long run.
Let’s explore what PSI and service entity arrangements are and their relevance to medical practices.
What is PSI For medical professionals?
For medical professionals, this typically refers to income earned from services such as consultations, treatments, and advice provided to patients.
PSI affects how income is distributed among shareholders or beneficiaries, as well as how deductions are claimed. When PSI rules apply, the income is treated similarly to that of a sole trader, even if the business is structured as a company or trust.
For example, if a medical professional operates through a trust, normally the profits could be distributed to other family members or associates as beneficiaries of that trust. However, under PSI rules, if the income was generated solely by the doctor’s personal services, it must be taxed in their hands directly, limiting income distribution and tax planning opportunities.
Does PSI Apply to Me?
The ATO has guidelines to determine whether PSI rules apply. This is typically a four-step process:
1- Is the income mainly a reward for personal services or efforts?
If yes, move to the next step.
2- Does the taxpayer pass the results test?
The results test applies when the individual is paid for delivering a specific result, uses their own tools or equipment, and is responsible for correcting errors at their own expense. Generally, this does not apply to health professionals, who are usually paid for the services they provide rather than specific results.
3- Does the taxpayer pass the 80% rule?
The 80% rule comes into play if 80% or more of the taxpayer's PSI is earned from one client. This can limit income-splitting opportunities. For example, if a medical professional derives over 80% of their PSI from one hospital, PSI rules are likely to apply.
4- Other tests:
- Unrelated Clients Test: This checks if the individual earns PSI from two or more unrelated parties.
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- Employment Test: This examines if the taxpayer employs or contracts others to perform the services that generate PSI.
- Business Premises Test: The medical professional’s business must operate from a separate business location that is not related to their home, and the premises should be specifically used for the business.
What Are Service Entity Arrangements?
Service entity arrangements typically involve a structure where a separate entity (like a trust or company) provides administrative, management, or clerical services to the medical practice. The purpose of this structure is to allow medical professionals to focus on patient care while the service entity handles the business’s administrative functions.
For example, a service entity may:
- Hire and manage non-medical staff (e.g., receptionists, administrative assistants).
- Rent the premises to the medical practice.
- Provide equipment and handle maintenance.
Example:
Dr. Smith operates a medical clinic, and she sets up a service entity that rents out the premises and provides administrative support. The income generated from her medical services (consultations) is subject to PSI rules, but the income from the service entity (rental income and service fees) can be distributed to other family members in a more tax-efficient manner.
While service entity arrangements are recognized by the ATO as legitimate, they must be structured correctly to comply with tax laws. Misusing these arrangements charging excessive fees or if the arrangement is set up primarily for tax avoidance will attract scrutiny from the ATO and penalties might be applied.
Need Expert Advice?
The tax implications of PSI and service entity arrangements are complex and can affect income distribution, deductions, and overall tax planning for healthcare businesses. Professional advice is crucial to ensure compliance with tax law and to optimize tax outcomes.
We can assist you to determine how PSI rules can effect your business, also we have experience with helping businesses in the medical sector to navigate everything from tax to billing and business advice.
