Personal Services Income (PSI): When the ATO Says It’s Your Income

Written on Jul 7, 2026. Posted in News.

In the dynamic economic landscape of Melbourne, many highly skilled professionals are choosing to operate as independent contractors or consultants through their own companies. This structure offers flexibility, autonomy, and perceived tax advantages. However, it also brings business owners into the realm of one of the Australian Taxation Office’s (ATO) most complex and scrutinised areas: the Personal Services Income (PSI) rules.

For consultants, IT specialists, engineers, and other professionals providing specialised skills, understanding these rules is not just a matter of compliance—it’s fundamental to wealth management and financial security. Misinterpreting the PSI regime can lead to unexpected tax liabilities, penalties, and the unwinding of carefully planned financial strategies.

This article provides a comprehensive overview of the PSI rules, the tests used to determine their application, and the potential options for restructuring your business affairs to ensure you remain on the right side of the law.

What Exactly is Personal Services Income?

The ATO defines PSI as income that is mainly a “reward for an individual’s personal efforts or skills.” In simple terms, if more than 50% of the income received for a specific contract is for your labour, knowledge, or expertise—as opposed to the supply of materials, equipment, or products—then that income is considered PSI.

This regime is prevalent in industries where the primary value delivered is intellectual and personal, including:

Information Technology and Software Development
Engineering and Management Consulting
Medical and Allied Health Professionals
Financial Services and Marketing
Media and Creative Professionals

The core principle behind the PSI rules is to prevent individuals who are, for all intents and purposes, acting like employees from accessing the lower corporate tax rate or splitting income with family members to reduce their overall tax burden. The legislation, found in Part 2-42 of the Income Tax Assessment Act 1997, effectively looks through the company or trust structure and attributes the income directly to the individual who performed the service.

Navigating the PSI Tests: A Step-by-Step Guide

If your business earns PSI, you must determine if the PSI rules apply to you. This is done by working through a series of tests. If you pass a test, your entity is considered a Personal Services Business (PSB), and the PSI rules do not apply for that income year. This means you can operate as a normal business, retaining profits in the company and claiming a broader range of business deductions.

Step 1: The Results Test

The Results Test is the primary and most definitive test for establishing a PSB. It is designed to identify businesses that are contracted to produce a specific outcome for a set price, rather than just being paid for their time. To pass the Results Test for at least 75% of your PSI in an income year, you must satisfy all three of the following conditions:

Paid to Produce a Specific Result: The contract specifies an outcome you must deliver. Payment is contingent on achieving this result, not merely for the hours you work.
Provide Your Own Tools and Equipment: You are required to supply the primary tools or equipment necessary to complete the work. This must be more than just a laptop if more substantial equipment is essential to the job.
Liable for Rectification: You are responsible for correcting any defects in your work at your own expense and without further payment.

Example: An IT consultant in Melbourne is engaged to develop and implement a new CRM system for a client for a fixed fee of $80,000. Her contract states the project deliverables, and she uses her own specialised software and diagnostic tools. A warranty clause requires her to fix any bugs found within six months of deployment at no extra cost. She passes the Results Test.

Conversely, if the same consultant was paid $1,500 per day to “provide IT support” using the client’s systems and under their direction, she would likely fail the Results Test.

Step 2: The 80/20 Rule

If you do not pass the Results Test, you must assess the 80/20 Rule. This rule asks: does 80% or more of your PSI in an income year come from a single client and their associates?

If the answer is yes, the PSI rules will automatically apply. You cannot proceed to the other tests unless you obtain a specific determination from the ATO allowing you to be treated as a PSB.

If the answer is no (i.e., your income is derived from multiple, unrelated sources, with no single client accounting for 80% or more), you can proceed to the final set of tests.

Step 3: The Remaining Tests

If you have less than 80% of your income from one client, you only need to pass one of the following three tests to qualify as a PSB.

A) The Unrelated Clients Test
You pass this test if you receive PSI from two or more clients who are not related to each other or to you, and you have publicly advertised your services. “Publicly advertising” means making your services known to a section of the public (not just a single client) through methods like:
* A public-facing website
* An active LinkedIn profile with service offerings
* Advertising in trade journals or online directories

B) The Employment Test
You pass this test if you either:
* Employ one or more other individuals to perform at least 20% of the market value of the principal work, or
* Have one or more apprentices for at least half of the income year.

The work performed by employees must be the core, “principal” work that generates the PSI, not just administrative or support tasks.

C) The Business Premises Test
To pass this test, you must, at all times during the year, own or lease business premises that are:
* Physically separate from your private residence.
* Physically separate from your clients’ premises.
* Used for your PSI-generating activities more than 50% of the time.

A home office, even a dedicated one, will not satisfy this test. It requires a genuine, external commercial space, such as a leased office in the Melbourne CBD or a dedicated workshop.

The Consequences of Being Caught by the PSI Rules

If you earn PSI and do not qualify as a PSB, the consequences are significant:

Attribution of Income: The net PSI is attributed to the individual who performed the services and taxed at their marginal tax rates, regardless of whether the money was left in the company.
Limited Deductions: The range of deductions your company can claim against the PSI is severely limited to what an employee could typically claim. This means deductions for the following are generally denied:
- Payments to a spouse or other associate for non-principal work (e.g., bookkeeping).
- Rent, mortgage interest, and other occupancy expenses for a home office.
- Superannuation contributions for associates.
PAYG & Superannuation: Your company will likely have obligations to withhold tax (PAYG) from payments made to you and pay the Superannuation Guarantee on the attributed PSI.

Proactive Structuring and Legal Advice

Navigating the PSI regime requires careful, proactive planning. Waiting for an ATO audit is a high-risk strategy. For professionals in Melbourne operating through a corporate structure, consider the following:

Contract Review: Ensure your client contracts are drafted to reflect a results-based relationship wherever possible. Emphasise deliverables, liability for defects, and your provision of equipment.
Diversify Your Client Base: Actively market your services to avoid tripping the 80/20 rule. A broad client base is one of the strongest indicators of an independent business.
Consider Genuine Employment: If your workflow allows, hiring another skilled professional to perform a substantive part of the principal work can help you meet the Employment Test.

The PSI rules are notoriously complex, and their application depends entirely on your individual circumstances. Getting it wrong can have a severe financial impact. Seeking expert legal and financial advice is not a cost—it’s an investment in the security and longevity of your professional practice.

Our team of wealth management and tax law specialists in Melbourne has extensive experience in advising contractors and consultants on the PSI regime. We can assist with reviewing your current arrangements, advising on restructuring, and ensuring your business is built on a compliant and tax-effective foundation. Contact us today for a confidential discussion.
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