Topic: Personal services income (PSI) rules update: ATO’s new guidelines explained

Last reviewed: 17/12/2025

Focus: Accounting Practice Analysis

PSI Rules Update 2025: ATO New Guidelines Explained

Personal services income (PSI) remains a high‑audit focus for the ATO, and the ATO’s newer guidance clarifies—more strictly than many taxpayers expect—when income earned through a company, trust or partnership must be attributed back to the individual who performed the work, and when the PSI rules can be escaped via the personal services business (PSB) tests. For Australian accounting practices, the practical “update” is not a new law so much as clearer ATO expectations: contracts and working arrangements must match the PSB outcome claimed, and contemporaneous evidence (invoices, business premises, staff records, insurance, marketing, multiple clients) is now critical to defend positions.

Featured Answer: The ATO’s latest PSI guidance reinforces that you must assess PSI based on the actual substance of the working arrangement, not just the invoicing entity, and that many common contractor models still fail the PSB tests. If the PSI rules apply, deductions are restricted and the PSI is attributed to the individual (with PAYG withholding and reporting consequences). Practices should review contractor/client arrangements, re-test PSB status annually, and document evidence to support the outcome.

What are the PSI rules and why has the ATO “updated” its guidance?

The PSI rules are integrity rules that prevent individuals from diverting income earned mainly from their personal labour or skills to a company, trust or partnership to access lower tax rates or broader deductions. The ATO’s newer guidance consolidates and clarifies how the law applies in modern contracting and labour-hire arrangements, emphasising evidence and substance over form.

How you determine whether receipts are PSI in the first place
Whether the client/entity qualifies as a personal services business (PSB)
Whether deductions are limited (PSI deduction rules)
Whether income must be attributed to the individual and reported correctly

Income Tax Assessment Act 1997 (ITAA 1997), Part 2-42 (PSI rules and PSB tests)
ATO guidance on Personal services income (PSI) (ATO website)
PSB tests guidance (ATO website, including examples and interpretative positions)

What changed in practice under the ATO’s new PSI guidance?

The ATO’s guidance has shifted the practical risk settings: arrangements that are “contractor in name only” are more likely to be treated as PSI where the individual is effectively working like an employee of the client, particularly under labour-hire style contracts.

Substance over form: Merely interposing a company/trust and issuing invoices does not prevent PSI attribution.
Evidence focus: The ATO expects contemporaneous documentation supporting whichever PSB test you rely on.
Annual re-testing: PSB status is not “set and forget”; you reassess based on current-year facts.
Control and integration signals: Where the client controls hours, location, tools, methodology, and the individual is integrated into the client’s operations, PSI risk increases.
80% rule importance: Where 80% or more of PSI comes from one client (and associates), the ability to self-assess PSB via the tests is constrained, and additional criteria apply.

How do you identify PSI under the ATO’s approach?

Income is PSI if it is mainly a reward for an individual’s personal efforts or skills. The ATO’s guidance requires you to look at what is really being paid for.

The contract is for a specific individual’s labour/skills (not a result or deliverable from a business system)
The individual performs the work personally (minimal delegation)
The client engages the individual similarly to an employee (supervision, set hours, ongoing role)
Payment is hourly/daily rates rather than for a quoted result (not determinative, but relevant)

The entity provides a result-based service (quoted deliverables, rectification obligations)
The entity can and does delegate/subcontract work
The entity provides significant tools/equipment and bears commercial risk
The entity markets broadly and maintains multiple independent clients

It should be noted that PSI can arise in many professions, including IT contracting, engineering, medical services, allied health, project management, and specialist consulting.

When do the PSI attribution and deduction limitation rules apply?

Attribute PSI to the individual who performed the services (even if paid to a company/trust)
Limit deductions to those that an employee could generally claim (with specific inclusions/exclusions under the PSI provisions)
Trigger flow-on obligations such as PAYG withholding and correct reporting

PSI is left in a company and taxed at the corporate rate without attribution
Broad “business” deductions are claimed that are not allowable under PSI deduction rules
The entity treats distributions as trust/company outcomes rather than PSI-attributed income outcomes

How do the PSB tests work under the ATO’s guidance?

You can avoid the PSI rules if you qualify as a personal services business (PSB). The PSB outcome depends on strict factual tests under ITAA 1997 Part 2-42.

What is the 80% rule and why does it matter?

The 80% rule is a gateway test that changes how you can self-assess.

If 80% or more of your PSI is from one client (and associates):
If less than 80% is from one client (and associates):

What are the main PSB tests?

The core PSB tests (as applied in ATO guidance and legislation) include:

Results test: You are paid to produce a result, you supply the equipment/tools (where relevant), and you are liable for rectifying defects.
Unrelated clients test: You have two or more unrelated clients obtained through your own advertising/marketing or tendering (not mainly through labour-hire channels).
Employment test: You have employees/contractors performing at least 20% (by market value) of principal work, or you have an apprentice for at least half the year.
Business premises test: You maintain and use business premises that meet specific conditions (separate from home and separate from clients’ premises, used mainly for work).

Passing a test requires more than superficial indicators (for example, having an ABN and insurance alone is not enough).
The unrelated clients test is commonly misunderstood in labour-hire models where the worker is “placed” with end clients but sourced through an intermediary.

Is the ATO taking a stricter view of labour-hire and “contractor” arrangements?

Yes. The ATO’s compliance stance is that many labour-hire style arrangements are PSI because the worker is effectively selling their labour to one controlling engager, even if there are multiple end clients in the background.

Contractor works under client’s direction, using client systems, in a long-running role
One main engager renews rolling contracts
No real ability to delegate
Minimal business infrastructure (no premises, no staff, no marketing)
Payment is time-based with little or no rectification risk

Income is PSI
PSB tests are not satisfied
Attribution and deduction limitations should apply

What records does the ATO expect you to keep to support PSB status?

The ATO’s guidance makes it clear that defensible positions are evidence-driven. Accounting practices should recommend clients retain:

Contracts and SOWs: showing deliverables, rectification clauses, delegation rights, and result-based pricing where applicable
Invoices: demonstrating milestone/result billing (if relevant)
Marketing evidence: website, ads, proposals, tenders, LinkedIn/service collateral, lead sources
Client evidence: engagement letters with multiple unrelated clients and how they were obtained
Delegation evidence: subcontractor agreements, timesheets, proof of payment, workflow allocation
Premises evidence: lease agreements, floor plans, photos, utility bills (where premises test is claimed)
Insurance and risk evidence: professional indemnity/public liability, rectification costs, warranty work
Working papers: annual PSI/PSB assessment memo documenting facts and test outcomes

For a professional practice, this documentation is best treated as an annual compliance workpaper, not an ad-hoc file note.

What are the most common PSI errors seen in Australian accounting practices?

The most frequent PSI mistakes—especially with IT and professional contractors—include:

Assuming a company/trust “solves” PSI: Interposition does not prevent attribution if the income is PSI.
Incorrectly applying the unrelated clients test: End clients obtained through an agency may not satisfy “obtained by making offers to the public” in substance.
Over-claiming deductions: Claiming motor vehicle, home office, training, travel, or other expenses that would not be allowed (or would be limited) under PSI rules.
Failing to revisit facts each year: A contractor may pass in one year and fail the next due to client concentration or role changes.
Ignoring PAYG implications: Where PSI is attributed, PAYG withholding and reporting treatment must align with the law and ATO guidance.

What are practical PSI scenarios (with outcomes) under the ATO’s approach?

The following scenarios reflect common fact patterns and how the ATO’s guidance is typically applied.

Scenario 1: IT contractor on a 12-month rolling engagement

The outcome is usually PSI if the contractor is essentially filling a role under the client’s direction with no real delegation or business infrastructure.

Facts:
Likely ATO view:

Scenario 2: Engineering consultant delivering fixed-scope projects for multiple clients

The outcome may be PSB if the consultant genuinely produces results for multiple unrelated clients obtained via marketing/tenders and bears commercial risk.

Facts:
Likely ATO view:

Scenario 3: Medical specialist contracting through a service entity

The outcome depends heavily on whether the income is principally a reward for personal efforts and whether any PSB test can realistically be met (often difficult).

Facts:
Likely ATO view:

Disclaimer note: PSI outcomes are fact-specific. Each engagement must be assessed under ITAA 1997 Part 2-42 and current ATO guidance.

How should practices implement the ATO’s PSI guidance in 2025?

The correct approach is to embed PSI into onboarding, annual tax workpapers, and contractor reviews.

Identify PSI exposure early: Ask whether income is mainly from personal effort/skills and whether work is done personally.
Apply the 80% rule: Assess client concentration (including associates) for the income year.
Test PSB status: Document which PSB test is met (if any) and why, using evidence.
Apply attribution and deduction rules where required: Ensure correct tax treatment if PSI rules apply.
Review entity strategy: Consider whether the structure still meets the commercial and compliance objectives.
Maintain an annual PSI memo: Keep it on file to support the position in an ATO review.

How does this affect deductions, PAYG, and year-end tax compliance?

The key impact is that PSI rules can change both taxable income and reporting mechanics.

Deductions: Expenses may be denied or limited if PSI rules apply (employee-like limitation framework).
Superannuation and payroll: Depending on the contracting model, separate issues like deemed employee under super guarantee may arise (distinct from PSI, but often co-exists as a risk area).
Trust/company tax returns: Incorrect retention/distribution of PSI can create audit adjustments and penalties.
Individual returns: Attributed PSI must be returned in the individual’s assessable income consistent with PSI provisions and ATO guidance.

How does this relate to “AI accounting software Australia” and practice automation?

The PSI analysis is legal and factual, but compliance execution is process-heavy: gathering contracts, tracing client concentration, and keeping defensible workpapers. This is where AI accounting software Australia and practice automation meaningfully reduce risk.

Standardise annual PSI/PSB checklists per client
Attach contracts, invoices, and evidence to a single job record
Produce consistent workpapers that document the PSB test outcome and rationale
Track client concentration and engagement changes year-on-year

This is analogous to why practices adopt automated bank reconciliation and automated working papers: the time saving is material, but the bigger win is defensibility and consistency.

Next Steps: How Fedix can help (PSI-ready compliance workflows)

Fedix supports Australian accounting practices that want faster, more defensible compliance delivery—especially where workpapers, reconciliations, and evidence packs must be maintained to ATO standards.

Centralise client documents and working papers so PSI evidence is not scattered across emails and folders
Use automated working paper processes to standardise year-end compliance packs
Reduce manual handling time so senior staff can focus on PSI/PSB technical review rather than admin

If your firm is modernising workflows alongside technical compliance, learn more at home.fedix.ai and consider whether MyLedger’s automation-first approach fits your practice.

Conclusion

The ATO’s newer PSI guidance reinforces a strict, evidence-led approach: PSI is determined by substance, PSB status must be demonstrable, and where PSI rules apply, attribution and deduction limitations follow. For Australian accounting practices, the required response in 2025 is disciplined annual testing, stronger documentation, and workflow systems that preserve evidence and produce consistent workpapers.

Frequently Asked Questions

Q: What is the key takeaway from the ATO’s new PSI guidelines?

The key takeaway is that the ATO expects PSI and PSB outcomes to be based on the real working arrangement, supported by evidence, not merely the invoicing structure (company/trust) or labels in the contract.

Q: If I operate through a company, do the PSI rules still apply?

Yes. Under ITAA 1997 Part 2-42, PSI can still be attributed to the individual even if the client pays a company or trust, unless the arrangement qualifies as a PSB (or another exclusion applies on the facts).

Q: How do I know if I pass the PSB tests?

You must assess the PSB tests against your actual circumstances for the income year, including the 80% rule and the relevant PSB tests (results, unrelated clients, employment, business premises). The ATO’s PSI guidance provides examples, but a documented workpaper assessment is essential.

Q: What happens if the PSI rules apply to my client?

Typically, the PSI is attributed to the individual who performed the work and deductions are limited to what is broadly available in an employee-like setting, with associated reporting and compliance implications.

Q: What should an accounting practice do now for contractor clients?

Practices should implement an annual PSI/PSB assessment process, update checklists and onboarding questions, collect supporting documents (contracts, marketing, delegation, premises evidence), and ensure the tax return treatment aligns with ATO guidance and ITAA 1997 Part 2-42.

Disclaimer: This material is general information only and does not constitute tax advice. PSI outcomes are highly fact-specific and laws and ATO guidance may change. Advice should be tailored by a registered tax agent with reference to ITAA 1997 Part 2-42 and current ATO publications.