Business owners always ask how they can reduce their tax. People naturally want to pay as little tax as possible so they structure their businesses primarily to achieve this. However, some rules prevent this from happening, especially where artificial arrangements are put in place to circumvent tax.
The Personal Services Income (PSI) regime ensures all income earned from an individual’s personal skills and effort are taxed in the individual’s name, regardless of the business structure they are operating on. If you receive PSI, you can apply four tests to find out if you are eligible to be classified as a Personal Services Business (PSB) so PSI rules won’t apply on the income you earn.
The four PSB tests are Results test, Unrelated clients test, Employment test and Business premises test. Unrelated clients test and business premises test are considered as the “remaining tests” that will apply only if less than 80% of the income is from one client. This is the 80% rule.
Other tests can be applied but only one has to be passed for the PSI rules to not apply. The tests must be done each financial year and may result to different results depending on the income you earn per year.
It is important to know the difference between the PSI and PSB because it can have a significant impact on the tax you pay. If you pass a PSB test, you can continue as normal and apply all deductions against your income. You can deduct payments to associates for non-principal work, such as administration, secretarial and bookkeeping services. If you are classified as a PSB, there are restrictions that limit the amount of income splitting that you can do.
If PSI rules apply to your income, you will be taxed as if you are an employee, regardless of any structure in place. Deductions available to a PSB won’t be available to you. PSI attribution means the structure’s income will be attributed to you whether or not the money was paid through you.
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To know whether PSI rules apply, find out if any income you have received is PSI by reviewing your contracts to determine if more than 50% of the income from a contract was for your labour, expertise or skills. If it was, take the PSB tests. Work out if you can pass the results test, which is focused on the nature of your contractual agreements and whether there is any entrepreneurial risk involved. To pass the results test, you need to meet all three conditions for at least 75% of the PSI you received during the financial year.
First, the income must have been paid to produce a specific result where you agree with the client upfront on the costs and outcome, you receive payment only after a contract is completed or you are paid to produce a specific number of completed activities or items. If you were paid a daily or hourly rate or required to submit timesheets, you won’t meet this condition.
Second, you must have been required to provide the equipment or tools to complete the work, the work you are doing did not require any equipment or tools, or the client supplied only minor tools or equipment.
Third, you must have been required to fix mistakes at your own costs. If you invoiced your client for the time you’ve spent to fix a mistake, you won’t meet this condition.
If you want to know whether PSI rules apply to you, get in touch with us to discuss this and see how Sky Accountants can help you.
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