If you're a professional or tradesperson who operates through a company or trust, the ATO has released new guidance that puts a spotlight on how profits from your business are split or retained. Before getting into what that guidance actually says, it's worth stepping back to a more fundamental question. one the ATO expects you to have already answered correctly: is the income your business earns actually Personal Services Income (PSI)?

Why this classification matters

PSI is a defined tax concept, and getting the classification right determines which set of rules applies to how your income can bedistributed or retained within your business structure. Broadly, PSI is income that is mainly, meaning more than 50%, a reward for an individual's personalefforts or skills, whether that income is earned directly or through a company or trust.

For a professional, this typically means fees for consultations, reports, advice, or treatment where the client is paying predominantly for your skill and time,. a management consultant's workshop fee, a doctor's consultation fee, an engineer's design fee.

For a tradesperson, the test looks at the invoice as a whole. If more than half the value of an invoice reflects your labour, the entire invoice is treated as PSI, even the materials component. A plumber who charges$500 to fix some taps, with $400 of that being labour and $100 materials, has $500 of PSI, not just the $400 labour portion.

When income is not PSI

Not all income earned by a professional or tradespersonthrough their business counts as PSI. Some common examples:

Income from a genuine business structure‍

Where a business has substantial income-producing assets, a meaningful number of employees, or established goodwill, its income is more likely to reflect the profit-generating structure of the business rather than one person's personal effort. The ATO looks at factors like the number of arm's length employees relative to the earning activity, the existence of goodwill, and how much of the income depends on one individual's personal skill.

Investment income

‍Income the business earns from investments sits outside the PSI rules entirely and is dealt with separately.

Income mainly from selling goods

‍Where a business genuinely sells goods, like a carpenter selling furniture online and at trade fairs, that income isn't PSI, even though the carpenter's skill went into making the product. This is different from a case where goods or materials are only a minor part of delivering a service (for example, the wiring an electrician installs, or the art supplies a graphic designer uses), in those cases, the income is still treated as PSI.

Income mainly from the use of significant assets

‍Where income mainly reflects the value of supplying and using an asset, such as a business hiring out a large piece of earthmoving equipment along with an operator, the income can fall outside PSI if the asset (rather than the operator's skill) is what's really driving the earnings.

If it is PSI, are you a "Personal Services Business"?

Once income is established as PSI, the next question is whether your business qualifies as a Personal Services Business (PSB).If it does, the strict PSI rules, which significantly limit how income can besplit or what deductions can be claimed, don't apply to you. Broadly, you canself-assess as a PSB if you meet either

• The results test for at least 75% of your income, or;

• The 80% rule (less than 80% of income from one source), combined with satisfying one of the unrelated clients test, employment test, or business premises test.

If you can't self-assess, it's possible to apply to the ATO for a formal determination.

Why this is just the starting point

Qualifying as a PSB is often treated, incorrectly, as theend of the analysis, on the assumption that once the strict PSI rules are out of the picture, profits can be freely split or retained within the business without further tax consequence. That assumption is exactly what the ATO's newest guidance is designed to correct: even where the PSI rules don't apply, Part IVA (the general anti-avoidance rule) can still apply to arrangements that split or retain profits away from the person whose skill and effort actually generated them.

We cover what the ATO now considers low-risk versushigh-risk in these arrangements in a follow-up article, but the first step forany professional or tradesperson operating through a company or trust is making sure the PSI and PSB classification underneath your structure is actually correct. Getting the classification wrong undermines everything that follows.

This article is general information only and does not constitute tax advice. Whether your income is PSI, and whether your business qualifies as a personal services business, depends on the specific facts of your situation. Contact Causbrooks to review your business structure and income classification.