Do you offer products or services that are based on your skills and labour?
If so, it’s likely that the income you receive is classified as personal services income (PSI).
For sole traders, understanding how much PSI you earn is important as it can affect what tax deductions you can claim.
What is PSI?
You earn PSI when more than 50% of the income you receive from a contract is for your skills, knowledge, expertise or efforts.
You don’t earn PSI if:
less than 50% of your income from a contract is for your skills, knowledge, expertise or efforts
you receive income from selling or supplying finished goods, even if you made these goods
you receive income from an income-producing asset, such as renting a vehicle or piece of machinery
your income comes from licencing your intellectual property, such as a patent.
Susan is a management consultant operating as a sole trader. She recently completed contracts for two of her clients.
Contract 1: Susan provided a 1 hour training course for a client. She charged $1 000 for her course, which included training materials that cost $100. Since $900 (90% of the contract) is for her skills and expertise, this is personal services income. Susan is able to report the $1 000 as PSI.
Contract 2: Susan was contracted to provide management software for a client. Susan charged $10 000 in total, of which $8 000 covered the cost of the software licence. Since $2 000 (20% of the contract) is for her skills and expertise, this is not personal services income. Susan is unable to report PSI for this contract.
Like Susan in the example above, your taxable income can be a mix of PSI and other income.