Personal Services Income Rules for Australian Contractors and Consultants: A 2026 Tax Agent Guide

If you earn income primarily through your personal skills or efforts — as a contractor, consultant, IT professional, engineer, or sole trader — the Australian Taxation Office's Personal Services Income (PSI) rules may significantly affect how your income is taxed and what deductions you can claim. Understanding these rules is essential for compliance and for structuring your affairs efficiently in 2025–26.

What Is Personal Services Income?

Personal Services Income is income where more than 50% of the payment you receive for a contract or invoice is a reward for your personal labour, skills, or expertise. The classification is made on a contract-by-contract basis, not across your entire business.

PSI is common across a wide range of industries, including information technology, financial services, engineering, construction, and healthcare. It is not PSI if the income is derived from the sale of finished goods, the use of income-producing assets (such as renting machinery), or the licensing of intellectual property.

The PSI rules apply whether you operate as a sole trader or through a personal services entity (PSE) — such as a company, trust, or partnership. The ATO looks through the structure to attribute the income to the individual who performed the work.

Why the PSI Rules Exist

The PSI rules are integrity measures designed to prevent two forms of tax avoidance. First, they stop individuals from splitting income with associates — such as a spouse or related entity — who are taxed at lower marginal rates. Second, they restrict the claiming of business deductions that would not be available if the individual were classified as an employee.

Without these rules, a contractor earning $300,000 per year could theoretically route income through a company taxed at 25%, distribute profits to family members, and claim a wide range of deductions — all while performing work that is functionally identical to employment. The PSI rules close this gap.

The Personal Services Business Tests

If your income is PSI, you must determine whether the PSI rules actually apply to you. They do not apply if you qualify as a Personal Services Business (PSB). There are four PSB tests, and passing any one of them (subject to the 80% rule) means the PSI rules do not restrict your deductions.

The 80% Rule

Before applying most PSB tests, you must check the 80% rule. If 80% or more of your PSI in a financial year comes from a single client (including that client's associates), you cannot use the Unrelated Clients, Employment, or Business Premises tests. Your only path to PSB status in that scenario is the Results Test.

The Results Test

The Results Test is the most rigorous and the only test available when the 80% rule is failed. To pass, at least 75% of your PSI must satisfy all three conditions:

• Outcome-based payment — You are paid for a specific result, not an hourly or daily rate
• Tool provision — You supply the equipment and tools necessary to complete the work
• Liability for defects — You are contractually responsible for rectifying defects at your own cost

The Unrelated Clients Test

To pass this test, you must receive PSI from at least two clients who are unrelated to each other and to you, and the work must be obtained through genuine public offers — such as a website, public tender, or industry directory listing. Word-of-mouth referrals generally do not count, and responses to labour hire firms or recruitment websites are excluded.

The Employment Test

You pass this test if at least 20% of the principal work in your business is performed by one or more employees or subcontractors who are not your associates.

The Business Premises Test

This test requires that you maintain business premises that are used exclusively for your work, are not your home or a client's premises, and are available to the public during normal business hours.

What Deductions Are Restricted Under PSI Rules?

If the PSI rules apply to you, your allowable deductions are limited to those that would be available to an employee. Permitted deductions include advertising costs, professional indemnity insurance, registration fees, and specific home office expenses such as lighting, heating, and internet costs.

Deductions that are not permitted under the PSI rules include rent or mortgage interest on your home, payments to associates for non-income-producing work, and superannuation contributions for associates beyond what is required under the Superannuation Guarantee.

Sole traders must still disclose PSI in their annual tax return and complete the Business and Professional Items schedule, regardless of whether the PSI rules ultimately apply.

PCG 2025/5: A Major Regulatory Update

In November 2025, the ATO released Practical Compliance Guideline PCG 2025/5, which fundamentally changed the compliance landscape for PSI arrangements. Previously, passing a PSB test provided a degree of certainty that the general anti-avoidance provisions of Part IVA of the Income Tax Assessment Act 1936 would not apply.

Under PCG 2025/5, that certainty no longer exists. Even if your arrangement passes a PSB test, the ATO may still apply Part IVA if the arrangement exhibits high-risk features. These include:

• Significant profit distributions to associates who do not meaningfully contribute to the business
• Retention of profits within a company primarily to access the lower 25% corporate tax rate rather than for genuine commercial purposes
• Diversion of PSI to entities holding prior-year tax losses
• Arrangements where the individual's effective tax rate is substantially lower than the top marginal rate without a clear commercial rationale

The ATO has encouraged taxpayers with higher-risk arrangements to transition toward compliant structures by 30 June 2027. This makes professional tax advice more important than ever for contractors and consultants operating through entities.

Australian Regulatory Context

The PSI rules are contained in Part 2-42 of the Income Tax Assessment Act 1997 (ITAA 1997) and are administered by the Australian Taxation Office (ATO). The key ruling governing their application is Taxation Ruling TR 2022/3, which provides detailed guidance on what constitutes PSI and how the PSB tests are applied.

Tax agents who advise on PSI matters must be registered with the Tax Practitioners Board (TPB) and are bound by the Tax Agent Services Act 2009 (TASA) and the Code of Professional Conduct. From 1 July 2025, the TPB's expanded Code obligations require registered tax agents to maintain higher standards of transparency and disclosure when advising on complex arrangements such as PSI structures.

The ATO also provides an online decision tool to help individuals self-assess their PSI status, though the tool is a guide only and does not replace professional advice for complex situations.

Common Mistakes and Red Flags

Many contractors and consultants make avoidable errors when dealing with PSI. Being aware of these pitfalls can save you from costly ATO audits and penalties.

• Assuming a company structure eliminates PSI obligations — The rules apply to personal services entities as well as sole traders
• Failing to assess each contract separately — PSI status is determined contract by contract, not across your whole business
• Relying on word-of-mouth referrals for the Unrelated Clients Test — These generally do not satisfy the public offer requirement
• Claiming deductions that are only available to genuine businesses — Rent, mortgage interest, and associate payments are commonly disallowed
• Ignoring PCG 2025/5 — Assuming that passing a PSB test provides full protection from Part IVA is no longer correct
• Not seeking a PSB determination when uncertain — The ATO can issue a formal determination confirming your PSB status, which provides greater certainty

Questions to Ask Your Tax Agent

If you earn income through personal skills or expertise, these are the key questions to raise with a registered tax agent:

1. Does my income qualify as PSI on a contract-by-contract basis?
2. Do I pass the Results Test, and can I document the three required conditions?
3. If I operate through a company or trust, does my structure comply with PCG 2025/5?
4. What deductions am I entitled to claim, and which are restricted?
5. Should I apply for a formal PSB determination from the ATO?
6. Are there any Part IVA risks in my current arrangement that I should address before 30 June 2027?
7. How should I document my contracts and business activities to support my PSI self-assessment?

How MyMoney® Can Help

Navigating the PSI rules — especially in light of the significant changes introduced by PCG 2025/5 — requires expert guidance from a registered tax agent who understands contractor and consulting arrangements. Getting this wrong can result in disallowed deductions, back taxes, interest, and penalties.

MyMoney® connects Australian contractors, consultants, and sole traders with qualified, registered tax agents who specialise in PSI, personal services businesses, and complex contractor tax structures. Whether you need a one-off review of your current arrangement or ongoing tax compliance support, our platform makes it easy to find the right professional.

Post a Brief to receive tailored proposals from registered tax agents who understand PSI rules, or Browse Tax Agents on the MyMoney® Marketplace to compare professionals and find the right fit for your situation.