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Corporate Contractors may not be eligible for a 25% company tax rate

Aug 2, 2023 | Blog

By: Rex Ting

In certain industries, it is a prevailing practice for employers to designate their workers as contractors rather than employees. Moreover, workers are often instructed by their employer to establish a limited company through which they can contract their services to their employer, thereby relieving the employer of superannuation obligations towards the worker. 

It is evident that a limited company is generally subjected to a corporate tax rate ranging from 25-30%. In contrast, an individual worker earning $150,000 would be liable to an individual tax rate of 39%. Consequently, one might consider utilising a company as an intermediary to potentially save up to 14% in taxes (calculated as 39% less 25%). However, it is essential to recognise that this tax-saving strategy may not be universally applicable to all situations.

To ensure fairness and accuracy in assessing income tax liabilities, the government legislated Personal Service Income (PSI) rules in 2000.  PSI is an anti-tax avoidance measure to prevent individuals from inappropriately using business structures to reduce their tax obligations.

What is Personal Service Income (PSI)?

Personal Service Income refers to income that is primarily derived from an individual’s personal skills, efforts, or expertise. It includes payments for services provided as a result of an individual’s direct involvement in producing income. The PSI rule applies to contractors, freelancers, consultants, and individuals operating through a company, trust, or partnership structure. Essentially, if the income is a direct result of an individual’s personal efforts, it is classified as PSI.

When will my company be caught by PSI?  

Your company will be subject to PSI if you fail any of the following tests. 

  • The Results Test: This test examines whether the individual is responsible for the end result of the work and whether they are liable for correcting any defects in the work. If the individual is not solely responsible for the outcome, the PSI rule might apply.
  • The 80% Rule: Under this rule, the individual must NOT earn at least 80% of their income from one client or a related group of clients. 
  • The Unrelated Clients Test: If the individual provides services to clients who are NOT related to them, the PSI rule may not apply. This test is to determine if the individual is genuinely running a business with multiple clients.

What happens if my company is subject to PSI?

If your company does not meet the aforementioned tests, its income will be deemed as if it were earned directly by you personally. Consequently, the company’s profits will be taxable in your personal tax return and taxed at the personal income tax rate.