Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 586

Consulting on the side? Don't fall into these tax traps

A growing trend in recent years has been for experienced senior executives to develop what is known as a “patchwork career”, where they take on a number of advisory roles – including non-executive directorships and consultancy work – as part of their transition to retirement.

This can be a very attractive option, allowing people to utilise their years of experience and knowledge but also provide more flexibility as they approach retirement than a more traditional full-time job. However, there are some traps to be aware of, particularly when it comes to tax, and specifically the Personal Services Income (PSI) tax rules.

These tax rules apply to anyone who is being paid primarily for their personal skills, as a way of ensuring they are taxed in a way similar to an employee. The cut-off is that if 50% or more of a person’s income is generated from personal efforts or skill (rather than from the sale of goods, use of assets, or from a business structure) then it will be counted as PSI and taxed accordingly.

The main intention behind the PSI rules is to prevent income splitting, or income being taxed at a lower rate (such as through a company) and also to prevent a consultant from claiming deductions that they would not otherwise have been able to claim as an employee.

For example, anyone receiving the majority of their income as a consultant based on their personal expertise is likely to be taxed at the marginal tax rate under PSI rules. It also applies to a contractor based on services, or a professional practitioner in a sole practice.

There are a number of tests to help people work out whether they fall within the PSI rules. Two of the most common are the results test and the unrelated clients test. If either of these tests can be satisfied, then people may be able to argue that the PSI rules don’t apply to them.

Results test

The results test has three key criteria, all of which must be met. They are: the consultant is being paid by a client to produce a specific result; they provide their own tools and equipment (where relevant); and are liable for rectifying any defects arising from their work. If all three rules can be satisfied, then the PSI rules don’t apply.

For example, if a consultant is paid based on the number of hours worked, rather than achieving specific deliverables or meeting certain performance targets, then they will be liable under the PSI rules.

Common situations where the results test might apply include where someone is contracted to oversee a specific project such as a marketing campaign to increases sales, or the successful sale of a business. Having specific outcomes that determine the consulting fees or receiving a success fee make the applicability of this test more likely.

Unrelated clients test

A consultant will often have multiple clients that are unrelated to each other. As long as no more than 80% of their personal services income for a year is received from a single client, the PSI test may not apply.

However, a critical part of this test is that not only is the consultant offering their services to the public at large, but that consulting engagements are received from offers to the public or a section of the public.

The most common sources of work for many consultants are referrals from their existing contacts, word of mouth referrals or their strong personal reputation. The ATO’s view as summarised in Taxation Ruling TR 2022/3 is that this is not sufficient to meet the unrelated clients test and the PSI tests may be failed, meaning, for example, that consulting income received through a company may be attributed under the PSI rules to the individual consultant, and some company deductions may be denied.

A common approach is for people to use the fact that they have a website and a LinkedIn profile, and that they undertake promotional activities such as speaking at conferences and publishing articles in industry journals. However unless they can show that there is a direct connection between this promotion to the public and receiving the consulting engagements, it is not enough to pass the test.

In order to satisfy the unrelated client test, it is necessary to show that at least some of the consulting work was obtained from sources such as the website or LinkedIn enquiries, conference attendees or readers of published articles, or from direct advertising, sponsorship or other marketing activities, rather than simply from word of mouth or contact referrals.

It is important for consultants to be aware of the risks of the PSI rules applying, especially where they want to split their income or work through a company. The risks will be reduced if they can clearly show that they have contracted to achieve a result, as none of the other PSI tests will have to be applied.

Failing that, if consultants seek to rely on the unrelated clients test it is critical that they take steps to show that they are offering their services to the public and that they are able to show that at least some of their consulting engagements were received directly through their own promotional activities.

Recent ATO guidance

To make matters even more complicated, on 28 August 2024 the ATO released a “practical compliance guideline” (PCG) on the PSI rules. While still in draft, the PCG makes it clear that the ATO is looking closely at anyone who claims exemption from the PSI tax regime.

If it believes people are using the exemptions to unfairly reduce their tax, the guidance explains that the ATO can still apply the Part IVA anti-avoidance rules. The PCG also outlines the type of arrangements the ATO considers to be high and low risk, although this is still highly subjective which makes it extremely hard for people to have certainty that their arrangements will be accepted by the ATO.

It is therefore more important than ever for people to ensure they are acting in good faith when it comes to their personal tax arrangements and to seek appropriate tax advice.

 

Peter Bembrick is a Tax Partner at HLB Mann Judd, Sydney. This article is for general information only. It should not be accepted as authoritative advice and any person wishing to act upon the material should obtain properly considered advice which will take into account their own specific circumstances.

 

  •   13 November 2024
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

Are you paying tax by not starting a super pension?

How to shift into pension mode

Most people (and the ATO) do not know their super tax

banner

Most viewed in recent weeks

Australian stocks will crush housing over the next decade, 2025 edition

Two years ago, I wrote an article suggesting that the odds favoured ASX shares easily outperforming residential property over the next decade. Here’s an update on where things stand today.

Building a lazy ETF portfolio in 2026

What are the best ways to build a simple portfolio from scratch? I’ve addressed this issue before but think it’s worth revisiting given markets and the world have since changed, throwing up new challenges and things to consider.

Get set for a bumpy 2026

At this time last year, I forecast that 2025 would likely be a positive year given strong economic prospects and disinflation. The outlook for this year is less clear cut and here is what investors should do.

Meg on SMSFs: First glimpse of revised Division 296 tax

Treasury has released draft legislation for a new version of the controversial $3 million super tax. It's a significant improvement on the original proposal but there are some stings in the tail.

Property versus shares - a practical guide for investors

I’ve been comparing property and shares for decades and while both have their place, the differences are stark. When tax, costs, and liquidity are weighed, property looks less compelling than its reputation suggests.

10 fearless forecasts for 2026

The predictions include dividends will outstrip growth as a source of Australian equity returns, US market performance will be underwhelming, while US government bonds will beat gold.

Latest Updates

Economy

Ray Dalio on 2025’s real story, Trump, and what’s next

The renowned investor says 2025’s real story wasn’t AI or US stocks but the shift away from American assets and a collapse in the value of money. And he outlines how to best position portfolios for what’s ahead.

Superannuation

No, Division 296 does not tax franking credits twice

Claims that Division 296 double-taxes franking credits misunderstand imputation: franking credits are SMSF income, not company tax, and ensure earnings are taxed once at the correct rate.

Investment strategies

Who will get left holding the banks?

For the first time in decades, the Big 4 banks have real competition in home loans. Macquarie is quickly gain market share, which threatens both the earnings and dividends of the major banks in the years ahead.

Investment strategies

AI economic scenarios: revolutionary growth, or recessionary bubble?

Investor focus is turning increasingly to AI-related risks: is it a bubble about to burst, tipping the US into recession? Or is it the onset of a third industrial revolution? And what would either scenario mean for markets?

Investment strategies

The long-term case for compounders

Cyclical stocks surge in upswings but falter in downturns. Compounders - reliable, scalable, resilient businesses - offer smoother, superior returns over the full investment cycle for patient investors.

Property

AREITs are not as passive as you may think

A-REITs are often viewed as passive rental vehicles, but today’s index tells a different story. Development and funds management now dominate earnings, materially increasing volatility and risk for the sector.

Australia’s quiet dairy boom — and the investment opportunity

Dairy farming offers real asset exposure, steady income and long-term growth, yet remains overlooked by investors seeking diversification beyond traditional asset classes.

Sponsors

Alliances

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.