Personal Services Income (PSI) Explained: Rules, Tests and Tax Implications

Setting up an ABN is often the first step towards working for yourself. Whether you’ve landed a contract, started consulting, or gone freelance, there’s a good chance you’ll eventually ask the same question: am I running a business, or am I simply earning income from my own skills?

That’s where the Personal Services Income (PSI) rules come in.

Many contractors assume these rules only apply to large consulting firms or complex company structures. In reality, they can affect anyone whose income primarily comes from their own knowledge, expertise, or labour, even if they operate through a company or trust.

If you’re an IT contractor, engineer, marketing consultant, designer, or tradie, understanding how PSI works can save you from costly tax mistakes and help you structure your affairs correctly from the start.

This guide breaks down what PSI is, when the rules apply to you, how the Personal Services Business (PSB) tests work, and what it all means for your deductions and tax bill.

What Is Personal Services Income?

Personal services income is income that’s primarily a reward for your personal effort, skill, or expertise, rather than income generated by a business structure, assets, or the labour of others.

The ATO’s rule of thumb is simple: if more than 50% of what you’re paid under a contract is for your labour, knowledge, or skill (rather than for materials, tools, or a finished product), that income is PSI.

Here’s the difference:

• A web developer paid to build a website is mainly earning from their own skills, so it’s usually PSI.
• A cabinet business earns from materials, labour, and overheads, so it’s generally ordinary business income, not PSI.

The key question is whether you’re being paid for your personal work or for a business that delivers a broader product or service.

Importantly, PSI can apply no matter what structure you use. Sole trader, company, trust, or partnership, the label on your business doesn’t change whether the underlying income counts as PSI.

Why the PSI Rules Exist

Before these rules existed, it was common for someone doing essentially the same job as an employee to set up a company, get paid into that company at the lower corporate tax rate, and then split income with a spouse or family trust to reduce the overall tax paid. The PSI rules were introduced to close that gap.

In practice, the rules ensure that if you’re really just selling your own labour, as an employee would, you’re taxed roughly the way an employee is, even if the money technically lands in a company or trust first.

When Do the PSI Rules Apply?

Here’s the part a lot of contractors get wrong: earning PSI and having the PSI rules apply to you are two different things.

You can absolutely earn personal services income as a sole trader, through a company, through a trust, or through a partnership. But the rules that limit your deductions and attribute income back to you personally only bite if you don’t qualify as a Personal Services Business (PSB).

So the real question isn’t “do I have PSI?”; for most consultants and contractors, the answer is yes. The real question is “do the PSI rules actually apply to me, or do I pass one of the PSB tests that takes me outside them?”

Personal Services Business (PSB): The Way Out

If you can demonstrate you’re running a genuine business, not just working like an employee under a different label, you may qualify as a Personal Services Business. If you do, the PSI rules don’t apply to that income, and you keep access to normal business deductions.

There are four tests. Passing any one of them (subject to the conditions below) is enough.

1. Results Test

The results test is the simplest way to qualify for PSB status. You pass if, for at least 75% of your PSI, you’re paid for a specific result, provide your own tools, and fix any defects at your own cost.

For example, Elena is paid a fixed fee to deliver a strategy report using her own equipment. In contrast, Michael’s engineering company is paid for completed designs and is responsible for defects. Both pass the results test, so the 80% rule doesn’t apply.

2. Unrelated Clients Test

You pass this if you provide services to two or more clients who aren’t associates of each other or of you, and you got that work as a direct result of advertising or offering your services to the public, think a business website, tendering for work, or advertising, rather than word-of-mouth alone in most cases.

Tom, a marketing consultant, advertises his services and works with five unrelated clients. Since no client provides more than 30% of his income, he passes the unrelated clients test and qualifies as a PSB.

3. Employment Test

You pass this if you engage other people (employees or subcontractors) to perform at least 20% of your principal work by value, the core service you’re contracted to deliver, not admin or support tasks, or you have an apprentice for at least half the income year.

4. Business Premises Test

You pass this if you maintain and use business premises that are physically separate from your home and from your client’s premises, used exclusively for your work.

The 80% Rule

Here’s the catch: if 80% or more of your PSI in a year comes from one client (and their associates), you can’t self-assess using the unrelated clients, employment, or business premises tests. Your only options are to take the results test or to apply directly to the ATO for a formal PSB determination.

Take Priya, an IT contractor. She works through her own company, invoices one bank by the hour, and earns more than 80% of her income from that single client.

She doesn’t meet the results test either. She’s paid for her time, not a defined outcome, and doesn’t carry defect liability. Because the 80% rule shuts the door on the other three tests, she either needs a PSB determination from the ATO or must accept that the PSI rules apply to her.

A Simple Decision Tree

Before diving into the PSB tests, it helps to work through this sequence:

1. Is more than 50% of the income from a contract for your labour, knowledge or skill? If no, it’s not PSI, stop here.
2. If yes, does the results test apply to at least 75% of that PSI? If yes, you’re a PSB, the rules don’t apply.
3. If not, does less than 80% of your PSI come from a single client? If no (i.e. 80%+ comes from one client), you must seek a PSB determination from the ATO.
4. If yes (under 80% from one client), do you pass the unrelated clients, employment, or business premises test? If yes, you’re a PSB. If no, the PSI rules apply to you.

How PSI Affects Your Deductions

This is where the rules really matter financially. If the PSI rules apply to you, your deductions are generally limited to what an employee could claim, even if you’re operating through a company or trust.

That means:

• You can’t claim home rent, mortgage interest, rates, or land tax against PSI because they’re non-deductible occupancy costs. However, you may still claim home office running costs like electricity, internet, and equipment depreciation using a fixed rate or actual costs. Don’t miss eligible deductions due to this myth.
• Payments to a spouse or associate for admin, bookkeeping, or invoicing are never deductible, no matter how fair the rate or how much they actually work. Pay them for principal work (the core service itself), and it’s deductible, but capped at market rate.
• Superannuation contributions for yourself are only deductible up to what is considered “reasonable”; you can’t just funnel excess profit into super to reduce tax.
• Motor vehicle and travel expenses are limited to work-related travel, similar to what an employee could claim.

If you operate through a company or trust, there’s an extra catch: only one vehicle with any private use can have expenses claimed at all; if a second car has any private use, none of its expenses is deductible, even if it’s mostly used for work.

What you can generally still claim includes things like income-producing tools, professional indemnity insurance, self-education directly related to your work, and travel between different workplaces. Our guide on what sole traders can claim covers the broader deduction rules, which PSI narrows but doesn’t replace.

If you do qualify as a PSB, none of these restrictions applies, you get the full range of ordinary business deductions.

Companies and Trusts Don’t Make PSI Disappear

One of the most common misconceptions is that setting up a Pty Ltd company or a family trust automatically gets you out of PSI. It doesn’t.

If income paid to a company or trust is mainly for one person’s work or skills, and they don’t qualify as a PSB, the ATO taxes that income to the individual at their personal tax rate. A company or trust can still help with asset protection or estate planning, but not with reducing PSI tax. Our guide on how your business structure impacts your tax bill looks at what each structure genuinely does and doesn’t achieve.

The ATO has also been actively reviewing arrangements in which PSI is split with family members through a trust or company, particularly where the arrangement appears to exist mainly to reduce tax rather than to reflect how the work is actually done.

One more thing: even if you qualify as a PSB, you’re not automatically in the clear. Under PCG 2025/5 (finalised on 28 November 2025), the ATO can still apply Part IVA if a company or trust is used to park or split income in ways that don’t reflect commercial reality.

High-risk arrangements should be fixed by 30 June 2027, and the ATO says it won’t apply Part IVA while genuine steps are being taken to comply.

Industries Where PSI Commonly Applies

PSI shows up across almost every skilled contracting field, but it’s especially common among:

• IT contractors and software developers
• Engineers
• Management and marketing consultants
• Medical and allied health practitioners working through a company
• Accountants and bookkeepers
• Designers and creatives
• Project managers

Common Mistakes Contractors Make

• Assuming having an ABN means PSI doesn’t apply. An ABN doesn’t determine whether income is PSI. Jack thought having an ABN was enough, but because he worked for one client, used their equipment, and failed the PSB tests, his income was still treated as PSI, and his deductions were limited to employee-style claims.
• Believing a company structure avoids PSI. As covered above, this is one of the most costly misunderstandings out there.
• Confusing PSI with contractor status. You can be a genuine independent contractor for super and employment law purposes and still have PSI for tax purposes. They’re assessed separately.
• Failing to test against the PSB properly each year. Your situation can change year to year, a big client leaving, or picking up a new one, can shift whether you pass the 80% rule.
• Claiming deductions as if the PSI rules don’t apply when they do. This is one of the fastest ways to trigger an ATO review.

Record Keeping Matters

If you plan to rely on one of the Personal Services Business (PSB) tests, good record-keeping is essential. The ATO may ask for evidence to show that you meet the relevant test, so it’s important to keep documents that support your position.

This can include signed contracts, invoices from different clients, records of advertising or tendering for work, payments made to employees or subcontractors, lease agreements for business premises, and working papers showing how you calculated the 80% income rule, where applicable.

When to Get Professional Advice

PSI is one of those areas where a small factual difference, how a contract is worded, how many clients you have, whether you own your own tools, can completely change your tax outcome. If you’re close to the 80% threshold, considering a company or trust structure, or unsure which PSB test you meet, it’s worth getting advice before you lodge, not after the ATO comes asking.

Final Thoughts

PSI isn’t something to worry about, but it does need to be handled properly. The rules are there to ensure that people doing employee-like work pay tax, even if they use a company or trust. Knowing whether the PSI rules apply can have a big impact on what you can claim and how much tax you pay.

If you want to see this explained visually, with the tests and examples walked through step by step, watch our video on this topic on our YouTube channel. And if you’re still not sure where you stand, get in touch with our team at Clear Tax Australia.

We help contractors, consultants, and small business owners properly work through the PSI and PSB tests before they become a problem with the ATO.

FAQs

What is Personal Services Income?

Income that’s mainly a reward for an individual’s personal effort, skill, or expertise, rather than income from a business structure, assets, or other people’s labour.

Does PSI apply to sole traders?

Yes. PSI applies regardless of structure: sole trader, company, trust, or partnership.

Can a company receive PSI?

Yes. A company can receive PSI on behalf of the individual whose effort or skill generates it, and the PSI rules can still attribute that income back to the individual.

What are the PSB tests?

The results test, the unrelated clients test, the employment test, and the business premises test. Meeting any one (subject to the 80% rule) means you’re a Personal Services Business.

Can I avoid PSI by setting up a company?

No. A company doesn’t automatically avoid PSI. What matters is whether you pass a PSB test, not what entity the income is paid into.

Does PSI affect tax deductions?

Yes. If the PSI rules apply to you, your deductions are generally limited to what an employee could claim.

How do I know if I’m a Personal Services Business?

Work through the decision tree: check whether more than 50% of your contract income is for your labour; then test against the results test first, then the 80% rule, and the other three tests if needed.

Do freelancers need to worry about PSI?

Yes, if their income is mainly a reward for their own skill or effort. Most freelancers earn PSI. The real question is whether they qualify as a PSB.