Tax Compliance Advice: What You Need to Know About GAAR, PSI & PSB

Navigating Australia’s tax compliance regulations can feel like a journey through a maze, with potential pitfalls at every turn. Understanding these rules is crucial for businesses and individuals to avoid costly penalties. A few essentials for sole traders and small businesses to know are PSI (Personal Services Income), PSB (Personal Services Businesses), and GAAR (General Anti-Avoidance Rules).

Understanding PSI & PSB

Personal Services Income (PSI) is income earned through an individual’s efforts or skills. It typically applies to sole traders, freelancers, and contractors who provide services rather than goods or products. PSI rules prevent individuals from splitting income with others to minimise tax liability or retain profits in lower-taxed entities. However, not all income derived from personal efforts falls under PSI. If a business can demonstrate that it meets specific conditions, it may qualify as a Personal Services Business (PSB). This type of business will be exempt from PSI rules and allowed to operate under a business tax structure.

The Role of General Anti-Avoidance Rules (GAAR)

Even if a business qualifies as a PSB and is exempt from PSI rules, it is not free from scrutiny. The ATO employs GAAR to address tax avoidance strategies that companies or individuals may use to structure income arrangements to gain a tax advantage, such as splitting income or diverting profits to a lower-taxed entity such as a company, partnership, or trust. The ATO considers these actions tax avoidance and GAAR violations involve costly fines - something no business wants. 

When Does GAAR Apply?

GAAR application is based on a detailed assessment of whether the arrangements are designed for tax avoidance. The ATO uses several factors to determine this:

• Is the remuneration commensurate to the value of services provided? The ATO examines whether the salary or wages paid to the individual providing services are proportionate to the income received by the PSB. If the remuneration is significantly less than what the business earned, it could indicate that the arrangement is aimed at minimising tax liability.
• Does the PSB distribute income to associates and not to the business owner? If the PSB distributes income to others, such as associates or family members, rather than paying the service-providing individual, this may be viewed as an attempt to reduce tax.
• Are salaries or wages misaligned? When salaries or wages do not align with skills or services, it raises questions about income distribution and intentions.
• Is a company, partnership, or trust used to retain profits or avoid PSI? Income splitting and misuse of an entity can trigger the application of GAAR if it leads to a lower overall tax liability.

An Example of When GAAR May Apply

Sam is a software developer who offers his expertise through his SX Trust. The trust secures a contract valued at $120,000 for Sam’s services. Over the course of the year, SX Trust pays Sam an annual salary of $50,000 and records $25,000 in deductions. The remaining $45,000 is then allocated to Sam’s wife and children, who are beneficiaries of the trust. The trust falls into a lower tax bracket. The SX Trust meets the criteria of a PSB by passing the results test, so Personal Services Income (PSI) rules don’t apply. However, the ATO could interpret the arrangement as an attempt to reduce tax by distributing income to Sam’s family, triggering a GAAR investigation.

Do You Require Further Assistance?

Understanding PSI, PSB, and GAAR rules and seeking professional advice can help when navigating these complex tax rules and ensure you remain in good standing with the tax office. Contact the Ascent Accounting team for more information or assistance in maintaining compliance.