PSI in TR 2022/3 – steps 7 to 9 is about the employees test, business premises test as well as ATO PSI Determinations and of course the special agent rules.
PSI in TR 2022/3 – Step 7 to 9
In the last two episodes, ep 418 and 419, we covered Steps 1 to 6. In ep 418 we spoke about the 50% PSI test, identifying the test individual, allocating the income to them and then the 75% results test. And in ep 419, we covered steps 5 and 6, the 80% hurdle, and the second PSB test, the unrelated clients test.
So in this episode, Neil Brydges of Sladen Legal in Melbourne covers the employees test, business premises test, PSB determinations and special agent rules with you and of course Part IVA with you.
Here is what we learned but please listen in as Neil explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
PSI in TR 2022/3 – Step 7 to 9
As before, we have shortened the examples and also renamed all the protagonists to just one, called Bob – Bob, his wife Sheila, their two college kids and then Bob also has a company and a trust.
Step 7 – Employee Test
All your employees together must perform at least 20% of the principal work of your business. So it is not 20% of the employees’ work that must be principal work. That could be less than 20% for all it’s worth.
It is 20% of all principal work performed by your business that employees must work on if you want to pass the employee test.
So let’s say you have two employees, and one does 11% of the business’ principal work by market value and the other one does 9%, then you are fine, because together they do 20% of the business’ principal work. So you pass the employee test.
But now let’s say you only have one employee and that employee does only do principal work, they don’t do anything else, so 100% principal work, but if this work is less than 20% of all your business’ overall principal work, you fail the test.
So do you see the difference? It is about the business’ principal work. And not the employee’s work. Because otherwise, you could employ somebody for one day, have them do principal work all day, so 100%, and then you would have ticked the mark. So that is not how it works, it is about the business’ principal work.
Now let’s say you have one employee, and they do principal work for only 10% of their time working for you, but in that time they produce 20% of the principal work your business performs, in that case you pass.
Example
Here is example 30 in TR 2022/3 to illustrate the 20% threshold.
Bob has 2 clients in the income year and also engages his wife Sheila, who has the same qualifications.
- Client #1: $100,000, of which $22,000 (22%) was for Sheila’s principal work.
- Client # 2: $40,000, of which $4,000 (10%) was for Sheila’s principal work.
Total amount paid = $140,000 ($100,000 + $40,000)
For Sheila’s work = $26,000 ($22,000 + $4,000), 19%, hence fails the Employees Test
This example seems harsh, but makes sense. Otherwise, every professional would just get a contractor to do 21% of a tiny ($10) contract to qualify as a PSB.
So for the unrelated clients test it is enough if you pass for some of your clients. But for the employment test, you must pass on the total of all contracts.
Step 8 – Business Premises Test
Exclusive use must be for the full year, correct. Premises can change as long as there is exclusive use for the full year.
Example
Here is example 34 in TR 2022/3 to illustrate the need to have exclusive work of the work premises.
Bob rents an office in commercial premises. The rental agreement doesn’t give Bob exclusive use of the room. Bob fails the premises test since no exclusive use.
Shared reception, waiting area, kitchen and bathrooms are ok, but the actual work area needs to be exclusively used for the full year (365 days).
Example
Here is example 35 in TR 2022/3 to illustrate how you can pass the business premises test.
Bob leases an office from a third party. Bob’s office is adjacent to a suite of offices occupied by other professionals. Each occupant jointly leases a shared reception and waiting area from DEF. None of Bob’s activities are done at the premises of his clients (or their associates) or from his (or his associates) private premises. Bob passes the business premises test.
Business premises must be separate from the main residence.
Example
Here is example 36 in TR 2022/3 to illustrate that the business premises must be separate from the main residence.
Bob has a garage that is separate from his home. On the ground floor, there is the actual garage for his car and also an entertainment room that Bob and his family frequently use for parties. On the top floor is Bob’s office where he does all his work and sometimes meets clients. Bob fails the test since his business premises are not physically separate from premises that the family uses for private purposes.
The issue is the entertainment room. If the entire garage was only used for business (no private parties) and the whole building had a separate entrance, not accessible from the main residence, then the garage would pass.
Step 9 – Consider Special Rules
The three areas to consider are a) ATO PSB Determination, b) Special Agent Rules and c) Part IVA
a) ATO PSB Determination Due to Unusual Circumstances
If you fail all tests, you can still apply to the ATO For an ATO PSB determination if you failed due to unusual circumstances.
Example
Here is example 38 in TR 2022/3 to illustrate how first year of operation could create unusual circumstances.
Bob starts in May and gets his first PSI client through a friend. The contract is Bob’s only contract in the year. Bob would qualify on the grounds of unusual circumstances since only 2 months operating BUT ONLY IF Bob passes the unrelated clients test in the following year.
You need to separate between circumstances that affect the number of clients and the direct result requirement. If in the following year Bob still had no direct result since just word of mouth, then the application would fail.
b) Special Agent Rules
TR 2022/3 covers the special agent rule in paragraph 11o:
Para 110 of TR 2022/3:
An agent may treat the clients of their principal as the source of their PSI for the purposes of the 80% rule if the agent
- is not an employee of the principal,
- receives income from the principal for services that the agent provides to customers on the principal’s behalf
- receives at least 75% of that income as a commission or results-based payments (and not a salary or retainer)
- actively seeks customers for their principal, and
- does not provide services from premises owned or leased by their principal (or the principal’s associates) unless the agent uses the premises under an arm’s length arrangement.
The special agent rule is important whenever somebody works under the umbrella of another business. For example, financial advisers who work under an umbrella to cover marketing, licencing and insurance.
Another example would be travel agencies etc selling flights and package deals under a brand (for example Flight Centre) and receiving a commission.
Example
Here is example 40 in TR 2022/3 to illustrate that a lack of entrepreneurial risk will block the special agent rule.
Bob works as an agent (for example travel agency). Bob receives an 80% commission ($70,000) plus a $2,500 per month retainer ($30,000 per year). Bob bears a risk of re-commission (70%), but the retainer (30%) is risk-free. As less than 75% of Bob’s income is a performance-based payment, he does not bear the level of entrepreneurial risk required. Bob is therefore unable to use the modified rules for agents.
c) Part IVA
If you do something with the dominant purpose of obtaining a tax benefit, for example splitting the PSI income to family members, then Part IVA might apply.
Example
Here is example 41 in TR 2022/3 to illustrate the application of Part IVA.
Bob provides his services through a family trust that distributes all trust profits to Sheila and the kids. If the only purpose of the trust is to split the PSI and avoid it being taxed at Bob’s marginal tax rate, then Part IVA might apply.
The splitting of PSI income to an associate that results in less overall tax being paid is a tax benefit. The Commissioner would consider the application of Part IVA to cancel this tax benefit.
Less, No more than, Exactly, At Least, or More?
Here are the five percentages relevant for PSI and their relevant cut-off. Is it less than, no more than, exactly, at least, or more?
With the 50% PSI test, the keyword is ‘mainly’.
So exactly 50% is no good. Doesn’t get you out of jail. With exactly 50% you still have PSI. To avoid PSI, you need to have less than 50% for efforts and skills. So it is LESS THAN 50%.
The 75% results test is at least 75%. So 75% is fine. If 75% ore more of your PSI passes the Results Test, you are all good. So it is AT LEAST 75%.
Then the 80% hurdle. Less than 80% from one client. If you have exactly 80% from one source, no good. You fail the 80% hurdle. You must have less than 80% from one client. So it is LESS THAN 80%.
The unrelated clients test doesn’t have a percentage, you just need two clients you got from advertising. So no percentage.
The employee test is AT LEAST 20%. Your employees all together must perform at least 20% of your business’ principal work. So it is AT LEAST 20%.
And for the business premises test the key phrase is ‘at all times during the income year’. So you must have had business premises for 100% of the time where you did most of your work that had exclusive use for, that were not connected with your main residence and not connected with a client. So it is 100%.
So it is
LESS THAN 50%.
AT LEAST 75%.
LESS THAN 80%.
AT LEAST 20% and
EXACTLY 100%
So this is a rough summary of what we discuss in this episode. Please listen in since we go into a lot more detail in this episode.
MORE
PSI in TR 2022/3 – Step 1 to 4
PSI in TR 2022/3 – Steps 5 and 6
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