Throughout your medical career, you may have come across or be familiar with the terms Personal Services Income (PSI), Personal Services Business (PSB) and personal exertion. These are complex taxation terms that can often be misunderstood, which may lead to unforeseen tax issues for you in the future.
Therefore, it is necessary for you to ensure you understand these terms and how they can impact on your medical revenue earned. To that end, last year, the Australian Taxation Office (ATO) issued Practical Compliance Guideline (PCG) 2024/D2 to provide clarification for medical professionals on when the ATO will consider applying compliance resources to assess potential tax avoidance arrangements involving PSI.
Definitions
As a handy refresher, we have provided definitions for these key tax terms below:
Personal Services Income (PSI) is when the majority of the income derived by an individual is a reward for your personal efforts or skills, rather than being generated by the use of assets, sale of goods or from a business structure. This means that most income generated by a medical professional will generally be considered as PSI.
Generally, when you earn PSI income (and the PSI rules apply to you), you are effectively treated as though you are in the same position as an employee earning salary and wages. As such, the PSI is required to be included in your tax return as assessable income. However, this also means that the types of deductions you can claim are more limited than under a business structure without PSI. For example, if you operate a medical practice from your home and you do not satisfy any of the Personal Services Business (PSB) tests, you cannot claim rent or mortgage interest relating to your residence like an employee cannot claim these deductions if they work from home.
Personal Services Business (PSB) is when an entity (be it an individual, company, partnership, or trust) receives PSI, and has passed the relevant tests set out by the ATO to indicate that the PSI has been generated under a business structure. For medical professionals who have assessed and determined they do operate a PSB, there are no changes to deductions that can be claimed against this income.
Personal exertion income pre-dates the introduction of the PSI and PSB and continues to exist alongside these rules. Broadly, income from personal exertion means an income amount that is earned, derived or received by a person by way of payment for personal exertion. It is very similar to PSI however does not have the “majority” requirement that PSI does.
Given the complexities of the law here, it can often lead to incorrect application. Some business and medical professionals may be of the understanding (albeit incorrect) that in the presence of a PSB, the PSI generated may not necessarily be required to be included in the assessable income of the individual whom it was derived from. This interpretation has caused some medicos to incorrectly treat some of this PSI to either be retained in the business or be distributed to another entity that may have a lower tax rate. This is referred to by the ATO as an alienation arrangement (i.e. alienating the PSI from the individual producing the PSI), which for some businesses can provide flexibility and/or a tax effective approach to “splitting” the PSI in a PSB.
However, for medicos, any PSI earned ultimately needs to end up in the taxable income of the person whose personal efforts and skills earned it, through the payment of wages or dividends. We at Pilot have always known and actioned the correct application of these rules, however, some accountants appear to have been poorly advising their clients – particularly medical professionals – in these matters.
This PCG from the ATO only serves to reinforce that these rules have always existed, but also that it is an area of tax law that the ATO knows people are getting wrong.
What is this new ATO guideline all about?
The recently issued PCG 2024/D2 outlines the ATO’s views of how the anti-tax avoidance rules (Part IVA, the general anti-avoidance provisions in Australian Taxation Law) may come into play in the treatment of the PSI generated in a PSB.
This PCG provides guidance on how the ATO will now be looking into PSB and their alienation arrangements. The ATO will now determine whether any PSI that has not been passed onto the individual deriving that income, will likely contribute to a scheme to achieve tax benefits, and thereby Part IVA will apply for tax avoidance.
The draft guideline provides a framework to identify low-risk and higher-risk arrangements and includes examples to assist taxpayers in understanding the ATO’s approach.
In summary some of these examples are illustrated below:
| Low Risk | Higher Risk |
| Net PSI distributed to the individual generating the PSI and tax at their marginal tax rate | Net PSI distributed to another entity whose tax rate is lower than that of the individual generating the PSI |
| Remuneration to the individual received from the PSB is more than proportionate to the PSI the individual generated | Remuneration to the individual received from the PSB is less than proportionate to the PSI the individual generated |
| Remuneration to an associate for non-PSI type work performed in the PSB is at an appropriate and commercial rate. | Net PSI is reduced as a result of over-remunerating an associate for non-PSI type work performed in the PSB. |
| The retention / deferral of net PSI is a result of a timing difference, commercial or practical reasons, and the PSI has subsequently been distributed to the individual generating the PSI. | The retention / deferral of net PSI is solely to achieve a tax advantage by avoiding the PSI being taxed at the individual’s otherwise higher marginal tax rate. |
What does the new ATO guideline mean to my business and me?
As mentioned above, these rules are not new to medical professionals, but the PCG serves as a timely reminder to reassess and ensure that you and your medical business are acting within the guidelines and not operating a higher-risk arrangement that you could be unaware of.
As this is quite a complex area and further changes may still be evolving, we recommend you consult with your tax advisor to discuss your situation and structure to minimise the risks of being targeted by the ATO.
Contact Pilot
If you would like to learn more about this area, or would like assistance with these matters, please contact Kristy Baxter or Angela Stavropoulos at taxmed@pilotpartners.com.au or on 07 3023 1300.