Transitioning from an executive role to consulting in the mining and resources sector comes with a unique set of tax rules, in particular the Personal Services Income (PSI) regulations.
We find that many consultants, when starting their new business, are generally aware of the PSI rules, but do not necessarily have a clear idea of how exactly they may apply to them or the implications of the PSI rules on their business operations or resultant tax outcomes. These rules can lead to a higher rate of income tax than they might have anticipated, significantly affecting their future financial plans. Understanding the PSI rules is crucial to avoid unexpected tax burdens and to ensure the business is set up in a way that maximises tax efficiency.
Understanding Personal Services Income Rules
For consultants earning fees generated from their skills, talent, or effort, the PSI rules dictate how income and corresponding expenses can be managed. These rules generally apply to restrict:
- Income splitting with lower-income associates.
- Retaining profits in lower-taxed entities, such as companies.
- Certain deductions, limiting available tax breaks.
In our experience, the PSI rules primarily impact consultants who do not satisfy the Personal Services Business (PSB) tests. For those consultants, the income is attributed directly to them, meaning they are taxed as if they earned it personally, regardless of their business structure.
Understanding the PSI Spectrum for Consultants in Mining and Resources
We find the easiest way to understand the PSI rules is that they apply across a spectrum, influencing how your income is treated for tax purposes. Here’s a breakdown:
- Employees: Employees cannot split income or retain profits within an entity. They also face restrictions when claiming certain types of deductions, such as motor vehicle or home office expenses.
- Attributed PSI: Consultants, including those operating through a company or trust, fall under attributed PSI if they don’t pass the PSB tests. In this case, the entity is disregarded, and income is taxed directly to the consultant personally. Deduction limits apply, and income splitting with associates is restricted unless those associates undertake primary consulting work.
- Personal Services Business: Consultants qualify as a PSB if they pass at least one of four tests:
- Results Test: Consultants are engaged and paid to deliver a specific result, they provide their own tools of the trade, and are liable for correcting defects.
- Unrelated Clients Test: Less than 80% of income comes from a single, unrelated client.
- Place of Business Test: The business operates from a genuine place of business outside of the home.
- Employment Test: At least 20% of income comes from work undertaken by employees or contractors.
- If the PSB criteria are met, consultants may benefit from more tax flexibility, including paying market-value remuneration to associates (even those not generating income for the business) and access to a broader range of deductions.
- Full Business: A business moves beyond PSI restrictions when it evolves into a fully operational entity with multiple income earners, a diverse client base, and identifiable business goodwill separate from the owner. These types of businesses can potentially retain profits and split income more freely amongst the owners, provided owners receive market-value remuneration.
Consultants should carefully assess their position on this spectrum, as misclassification can lead to higher taxes, limited deductions, and compliance risks. If you qualify as a PSB, you may gain significant tax advantages, but you need the right structure and business strategy in place from the start.
Avoiding Costly Mistakes by Starting with the Right Structure
With proper structuring, mining and resources consultants may avoid higher taxes than anticipated. To circumvent these pitfalls, business owners should consult with tax professionals to determine whether they qualify as a PSB or if changes to their business structure or strategy are necessary.
Proper planning and understanding of the PSI rules are essential to avoiding costly outcomes. Consultants may face higher taxes due to the inability to split income or retain profits within their business. Additionally, in some circumstances, deductions may be limited, reducing profitability and increasing the tax burden.
Ensure Your Consulting Business is Set Up for Success
Navigating the Personal Services Income (PSI) rules can be complex, but starting with the right structure is key. Early planning and understanding of these regulations help consultants avoid compliance risks and ensure long-term profitability. Seeking professional advice early can make all the difference in structuring your consulting business correctly.
To learn more, please contact Craig Barry for a 20-minute no-obligation discussion. You can call Craig on +61 (0) 7 3007 2000 or email contact@resourcesunearthed.com.au.
To learn more about Craig, visit this link.
Resources Unearthed is a solutions hub that connects senior executives, established professionals and business owners in mining and resources with proven specialist advisers.
This advice is general in nature, please seek professional advice specific to your circumstances.