It’s quite common for people to structure their professional affairs by setting up an entity to run their business through. This could be a trust, a partnership or, most often, a company.
The tax rate for small companies is just 28% which compares very favourably with the top personal tax rate of 47%. In addition, companies can claim a wider range of tax deductions and have the freedom to distribute franked dividends to shareholders (or alternatively to retain the profits in the business). Clearly, this could be a very effective way of sheltering profits for a small business and for that reason, the ATO often seeks to apply what are known as the personal services income (PSI) rules to regulate such situations. The impact of the PSI rules, for those affected by them, is twofold:
- Income within the so-called interposed entity (typically a company) can be attributed back to the individual taxpayer
- The range of deductions available is limited to those typically available to individuals.
In short then, if you fall into the scope of the PSI rules, you can find the ATO “looking through” your business structure and taxing you as an individual.
Who is affected?
The measures apply to companies, trusts and partnerships where the income of the entity is derived primarily as a result of the personal efforts or skills of an individual.
The rules do not apply to income that is mainly:
- for supplying or selling goods (for example, from retailing, wholesaling or manufacturing), or
- generated by an income-producing asset (such as a bulldozer) or
- for granting a right to use property (for example, the copyright to a computer program), or
- generated by a business structure (for example, an accountant working for a large accounting firm).
In practice, the rules would impact the following professions where the practitioner is running their small business through another entity:
- Medical practitioners
- IT consultants
CPS Pty Ltd provides computer programming services but David does all the work involved in providing those services. David is the only employee of CPS Pty Ltd. David uses the client’s equipment and software to do the work. CPS’s income from providing the services is David’s personal services income because it is a reward for his personal efforts and skills.
Source H & R Block
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