Many consultants, contractors, professionals and small business owners operate through a company or trust for legitimate commercial reasons. However, if income is mainly generated from the personal efforts, skills or expertise of an individual, it may be classified as Personal Services Income (PSI).
The Australian Taxation Office (ATO) has recently released Practical Compliance Guideline PCG 2025/5, highlighting its compliance approach to PSI arrangements involving Personal Services Businesses (PSBs). The guidance reminds business owners that passing the PSB tests alone may not be enough to avoid scrutiny if income is retained or distributed in a way that delivers a tax advantage.
What Is Personal Services Income (PSI)?
PSI is income that is mainly earned from an individual’s personal efforts, skills, knowledge or expertise rather than from the sale of goods, business assets or a substantial business structure.
Common examples include:
- IT contractors
- Accountants and bookkeepers
- Engineers and consultants
- Medical professionals
- Freelancers and professional service providers
Where PSI rules apply, income may need to be attributed to the individual who performed the work, regardless of the entity through which it was earned.
Understanding PCG 2025/5
PCG 2025/5 outlines the ATO’s compliance focus on arrangements where PSI is earned through a company, trust or other Personal Services Entity (PSE).
Importantly, the guideline does not change existing tax law. Instead, it explains when the ATO is more likely to review arrangements under Part IVA, Australia’s general anti-avoidance provisions.
The ATO’s key message is clear:
- Passing the PSB tests is only one part of the analysis.
- The treatment of profits after they are earned also matters.
- Income splitting and profit retention arrangements may still be challenged if they are primarily designed to reduce tax.
Passing the PSB Tests Is Not Always Enough
Many business owners assume that once they qualify as a Personal Services Business, they can freely retain profits in a company or distribute income amongst family members.
PCG 2025/5 confirms this assumption can be risky.
Even where an entity qualifies as a PSB, the ATO may still consider whether:
- The individual who generated the income has been appropriately remunerated.
- Profits have been retained primarily to access lower company tax rates.
- Income has been diverted to associates who did not contribute significantly to earning the income.
Business owners should ensure their arrangements have genuine commercial purposes and not simply tax-driven outcomes.
Low-Risk Arrangements
According to the ATO, lower-risk arrangements generally ensure that the net PSI is ultimately assessed to the individual who performed the services.
Examples of lower-risk indicators include:
- Paying the working individual a commercially reasonable salary.
- Making superannuation contributions for that individual.
- Distributing income to the individual who generated the PSI.
- Paying associates only for genuine services provided at market rates.
- Retaining profits temporarily for genuine business purposes.
- Maintaining detailed records supporting business decisions.
These types of arrangements are more likely to demonstrate a commercial rather than tax-driven purpose.
Higher-Risk Arrangements
The ATO is paying particular attention to arrangements where PSI is diverted away from the individual responsible for generating it.
Examples of higher-risk indicators include:
- Retaining profits mainly because company tax rates are lower than personal tax rates.
- Distributing profits to family members who perform little or no work.
- Paying associates amounts that exceed market value for their services.
- Underpaying the person generating the PSI.
- Using retained company profits for personal purposes.
- Parking profits in related entities without a clear commercial reason.
Where these factors exist, the ATO may consider applying Part IVA anti-avoidance provisions.
Retaining Company Profits: When Is It Acceptable?
Retaining profits in a company is not automatically a concern.
The ATO recognises that businesses often need to keep funds available for:
- Working capital requirements
- Future tax liabilities
- Purchasing equipment or vehicles
- Business growth and expansion
- Staffing and recruitment
- Managing periods of reduced cash flow
The crucial factor is whether there is a genuine commercial purpose that is properly documented.
Business owners should keep records explaining why profits were retained and ensure the funds are ultimately used for the stated purpose.
Paying Family Members and Associates
Family members can legitimately work within a business and be paid accordingly.
However, the ATO expects:
- Duties to be genuine and measurable.
- Payments to reflect actual work performed.
- Remuneration to be consistent with market rates.
For example, a spouse who performs bookkeeping or administration can be paid a reasonable wage. Problems arise when payments significantly exceed the value of services provided or exist primarily to reduce the family’s overall tax position.
Maintaining employment agreements, timesheets and payroll records can assist in demonstrating compliance.
The Importance of Record Keeping
Strong documentation is one of the most effective ways to support a PSI arrangement.
Business owners should retain records such as:
- Contracts and engagement letters
- Invoices and bank statements
- Payroll and superannuation records
- Company minutes and resolutions
- Trust distribution documentation
- Financial statements
- Evidence supporting retained profits
Good records help demonstrate commercial decision-making and provide support if the arrangement is reviewed by the ATO.
Companies Still Offer Genuine Business Advantages
Despite the increased focus on PSI arrangements, companies continue to offer legitimate commercial benefits, including:
- Asset protection opportunities
- Enhanced business credibility
- Improved succession planning
- Easier business expansion
- Employment of staff
- Access to finance and investment opportunities
However, these benefits should not be confused with an ability to divert PSI for tax purposes.
Where income is largely derived from personal services, business owners should carefully consider how profits are distributed and documented.
Transitional Compliance Approach Until 30 June 2027
The ATO has indicated that it is increasing its focus on higher-risk PSI arrangements.
Where taxpayers take genuine steps to move towards a lower-risk position before 30 June 2027, the ATO has indicated it will take this into account during compliance activities.
This is not an amnesty or safe harbour, but it provides an opportunity for business owners to review existing structures and make appropriate adjustments where necessary.
Final Thoughts
PCG 2025/5 reinforces that PSI compliance involves more than simply passing the Personal Services Business tests. Business owners should ensure that income generated through their personal efforts is treated appropriately, remuneration is commercially reasonable, retained profits have a genuine business purpose, and all arrangements are supported by proper documentation.
Understanding the interaction between PSI rules, Personal Services Businesses and Part IVA can be complex. Obtaining professional advice can help ensure your business structure remains compliant while supporting your commercial objectives.
If you operate through a company or trust and would like guidance on PSI, profit retention, distributions or tax planning strategies, speak with a qualified accountant who can provide advice tailored to your circumstances and ensure the correct application of Australian taxation law.
Speak with our team today to stay compliant and protect your growing business.