PSI Rules for Subcontractors: Employment Test & Principal Work

Most subcontractors who ask us about PSI have already been told the wrong thing: that the rules are about how much you earn, or that a company fixes them. Neither is true. PSI is decided by where the income comes from, and the order in which you test it decides the answer.

Being classified as PSI does not automatically mean the adverse rules bite. The real question is whether you are running a personal services business (PSB). There are four tests, but they are not four equal doors. One stands on its own. The other three are locked behind a client-concentration gate that catches a large share of the trades, because so much subcontract work comes from a single builder.

This guide starts with the question subcontractors ask us most: whether the people you bring onto a job count towards the employment test. It then sets out the full sequence of tests and covers PCG 2025/5, issued by the ATO on 28 November 2025, which explains when the ATO will look at splitting or retaining income after a PSB test is passed. If you are new to PSI, start with what personal services income is.

How Do You Pass the PSI Employment Test?

Keep two percentages separate, because they are often confused. The 20% is the employment test itself: how much of your principal work others perform. The 80% is a gate that applies before you can use the test at all: if 80% or more of your PSI comes from one client and its associates, you cannot self-assess under the employment test, however much of the work others do. The 80% rule is explained below.

This is the test we see argued most often and calculated correctly least often. Three things decide it:

• What counts as principal work
• Who you can count
• How the 20% is calculated, with a worked example

1. What counts as principal work

Principal work is the work that is central to meeting your obligations under the contract with your client. That is the definition in paragraph 26 of Taxation Ruling TR 2022/3. For a plasterer it is plastering and rendering on site. For a bricklayer it is mixing the mortar, laying the bricks and cleaning down the brickwork.

Associated clerical and administrative work is not principal work. For a trade subcontractor that means quoting, invoicing, bookkeeping, answering the phone and scheduling are excluded, however many hours they take. The exception is where the contracted service is itself administrative: for a contract bookkeeper, bookkeeping is the principal work. The ATO's employment test guidance takes the same approach.

TR 2022/3 gives two contrasting examples. In the first, a builder pays his wife to do contract administration, track costs and prepare progress claims. That work is not principal work, so it does not count. In the second, a company engages a second qualified drafter to prepare variations and to check and correct the main drafter's plans. That is principal work, and it counts, even though the same person also does the banking. The mistake we correct most often is paying a family member for the office work and assuming it counts toward the 20%.

2. Who you can count

You count principal work performed by individuals you engage, whether as employees or subcontractors. An individual associate, such as a spouse or adult child, counts if they are engaged to perform principal work (TR 2022/3, paragraphs 110 and 113). What does not count:

• Your own labour, including as an employee of your own company.
• Work performed through an associated company, trust or partnership.
• Where you operate through a company, trust or partnership, work performed by another test individual: a person whose own PSI is earned through the same entity.

Apprentices count for the apprentice limb, including an apprentice supplied through a group training arrangement. Research assistants do not.

3. The 20% calculation, done annually

The measure is market value, not hours and not headcount. TR 2022/3 (paragraphs 118 to 125) accepts this formula: market value amount divided by contract price, multiplied by 100.

• Market value amount: what you charge your client, on an arm's length basis, for the principal work done by the people you engage. It is their charge-out value, not what you pay them, and it will normally be higher than your cost.
• Contract price: the total amount paid under the contract. Where you work under several contracts in the year, add up the contract prices for all of the test individual's PSI, whether or not anyone helped on a given job.
• The year: the test is applied each income year. Where a contract spans two income years, include only the amounts derived in the year being tested.

One practical consequence for the trades: the apprentice limb is often the easier route. If you carry one or more apprentices for at least half the income year, the 20% calculation does not need to be run at all. The ATO describes this as at least 6 months, whether continuous or made up of separate periods in the year, and it need not be the same apprentice throughout. Employing an apprentice brings its own payroll and super obligations, which we cover in our tax compliance work, and the deductions that come with tools and equipment are set out in our guide to tradie tax deductions.

4. The records that support the position

The employment test is self-assessed, so the evidence has to exist before the ATO asks for it. Keep, for each income year:

• Head contracts and subcontracts showing the scope of the principal work.
• Engagement records for each worker: contracts, invoices, timesheets and payroll.
• Charge-out rates and how each worker's time was billed to the client, to support the market value amount.
• The 20% calculation, done separately for each test individual.
• The 80% rule workpaper, with each client and its associated entities grouped together.
• For the apprentice limb, the training contract and the dates the apprentice worked for you.

What Is the 80% Rule for Personal Services Income?

This is often called the 80/20 rule, which is a misleading name. It is not a safe harbour and it is not a test you pass. It is a gate. Clearing it does not make you a PSB; it only unlocks three of the four tests.

For subcontractors this is the single most common failure point. A carpenter who works all year on one builder's sites has 100% of their PSI from one client. Three of the four doors are shut before the analysis begins. The results test becomes the only realistic route, which is why contract terms matter so much (covered below).

Note that associates are grouped with the client. Two related companies in the same builder group count as one client for this purpose, so spreading invoices across entities in a single group does not help. Work through the calculation carefully as part of a tax planning review rather than at lodgement, because by then the year is set.

What Is Personal Services Income?

The PSI regime sits across four divisions of the Income Tax Assessment Act 1997: Division 84 defines PSI, Division 85 limits deductions, Division 86 attributes income, and Division 87 sets out the personal services business tests. The Commissioner's current view is in Taxation Ruling TR 2022/3.

A practical example helps. A bricklayer working for a residential builder, paid for their labour, earns PSI. A project manager who employs a team of bricklayers, carries professional indemnity insurance and accepts liability for project outcomes is generating income from a business structure, not solely from personal effort. The first is squarely within the PSI regime. The second may sit outside it entirely.

One clarification that saves a lot of confusion: PSI is tested contract by contract, not on your total income. A tiler can have one job that is PSI (labour only) and another that is not (supply and install, where materials carry most of the value). The amount you earn is irrelevant. There is no income threshold in Division 84.

In our experience advising Melbourne subcontractors, PSI most often arises in construction trades, consulting, IT contracting and contract labour. ABS figures for August 2025 put independent contractors at 1.1 million, or 7.6% of all employed people, with 280,600 in construction alone. If you operate in the trades, PSI is a question you should expect to face. For sector-specific support, see our accounting for builders and tradies.

How Do You Know If the PSI Rules Apply to You?

The order matters more than the tests themselves. The results test stands alone: pass it and your client concentration is irrelevant. The other three sit behind the 80% rule. Work the sequence in this order:

• Step 1. Is it PSI? More than 50% of the contract value is a reward for your effort or skill. If no, stop. Ordinary business income rules apply.
• Step 2. Results test? Met for at least 75% of your PSI? If yes, you are a PSB. Stop. The 80% rule never applies here.
• Step 3. The 80% gate. Does less than 80% of your PSI come from one client and its associates? If no, you cannot self-assess at all. Go to step 5.
• Step 4. Any one of the other three? Unrelated clients, employment, or business premises. Pass one and you are a PSB.
• Step 5. Nothing passes. Either apply to the Commissioner for a PSB determination, or accept that Divisions 85 and 86 apply for that year.

Two points the ATO is explicit about in its guidance on self-assessing as a PSB. You run this sequence fresh every income year: passing last year proves nothing about this year. And where a company, trust or partnership has more than one person generating PSI, you run it separately for each individual.

If you are weighing your engagement status more broadly, our note on the contractor versus employee distinction is a useful companion, because a worker who is actually an employee never reaches the PSI question.

How Can Subcontractors Pass the Results Test?

The results test is the pathway most subcontractors rely on, because passing it removes the client-concentration problem entirely. It rests on three linked elements, and it is decided largely by what your contract actually says.

1. Paid for a result

You are entitled to payment only once the contracted conditions are fulfilled, typically on completion or delivery of an agreed output. A subcontractor paid $5,000 to build a brick wall to specification is paid for a result. An electrician paid $80 an hour is paid for time, which points towards employment. Progress payments and deposits are acceptable; rolling retainers and vague scopes are not.

2. Supply your own tools and equipment

You provide the plant, tools or equipment needed for the work, including anything the client would reasonably expect you to bring. A plasterer who owns their trowels, stilts and scaffolding satisfies this. A worker handed all tools by the client does not. Where the work genuinely needs no tools, the condition is treated as met. If you are buying equipment, our note on the instant asset write-off for tradies may help with timing.

3. Liability for defects

You bear the cost of rectifying defective work. You do not have to do the remedial work yourself, but you must carry the cost. This is where paperwork undoes people: if you invoice the client for the time spent fixing a defect, or you rectify it during hours the client is already paying for, the client is effectively paying and the condition fails.

Make it explicit. A clause such as "the subcontractor warrants all work for 12 months and bears the cost of rectifying defects discovered in that period" is the kind of term that supports the position. Our view is that this is the highest-value hour a PSI-exposed subcontractor can spend: get the contract right at the front end, because you cannot retrofit it at lodgement.

Can You Pass the Unrelated Clients or Business Premises Test?

The public offer trap

Having several clients is not enough. There must be a direct connection between a public offer and the engagement. The ATO's unrelated clients test guidance states that work obtained through labour hire firms or similar intermediaries, or by responding to advertisements on web-based recruitment sites, does not meet the condition. Word-of-mouth referrals generally do not either, unless the industry is so specialised that there are only a very small number of potential clients.

That closes this test for a large share of subcontractors, because most work comes through builders, agencies or referrals rather than advertising. Advertising, a genuine website, industry journal listings and competitive public tenders do count. Repeat work from an existing client still needs to trace back to your offers to the public in that year.

Business premises is narrower than it looks

A home office fails. A desk at the client's site fails. A shed at the back of your own property fails, because it is not physically separate from your residence. A leased yard or workshop used mainly for the business, held exclusively by you and with its own access, is the kind of arrangement that qualifies. The ATO also requires the premises to be maintained and used throughout the income year, not just for part of it. For consultants and contract professionals the analysis runs the same way, and we cover it from that angle in our work with professional services firms.

What Happens If Your Income Is PSI?

Attribution under Division 86

Division 86 prevents you from diverting PSI through an entity to access lower rates or split income. PSI earned through a company, trust or partnership is treated as your income and taxed at your marginal rate, with offsets to avoid double taxation. A discretionary trust does not help: PSI must flow to the individual who did the work, not be spread across beneficiaries or retained at concessional rates.

Deductions denied under Division 85

Division 85 does not strip every deduction. Ordinary business expenses stay deductible where they are otherwise allowable. The specific denials are:

• Rent, mortgage interest, rates and land tax (s 85-15): no deduction for these costs in respect of premises used for gaining your PSI where the premises are your residence or your associate's residence. This is the one that surprises people running the business from home.
• Payments to associates (s 85-20): no deduction for paying an associate for work that is not principal work. Paying a spouse to do the books is not deductible against PSI; paying an associate to do principal work is not caught by this rule.
• Superannuation for associates (s 85-25): no deduction for super contributions for an associate in respect of non-principal work.
• The general limit (s 85-10): broadly, you cannot deduct an amount against PSI that an employee could not have deducted had they earned it as salary. On cars, the ATO's position is that you can claim for only one car where it is used privately, however many the business owns.

The exceptions in sections 85-30 and 85-35 switch Division 85 off where you are conducting a personal services business, or where you are an employee or office holder. The ATO sets out the practical detail on its page covering deductions when receiving PSI. Confirm each claim against current guidance before lodging.

What Are the Best Structuring Options for Subcontractors?

Sole trader

The simplest option. You report income and claim deductions on your personal return, with no company tax and no Division 7A exposure. The trade-off is that you have no liability protection, so your personal assets are exposed if a client sues. Many higher-risk trades move to a company for that reason. Our sole trader structure guide covers the detail.

Private company

A company still works with PSI, mainly for liability protection: a claim is against the company, not your personal assets. The PSI itself is attributed to you under Division 86 and taxed at your marginal rate, so the usual company tax deferral is lost. Division 7A is a separate risk: payments or loans from the company to you that are not compliant dividends or proper loans can be deemed unfranked dividends. Drawings and loan accounts need active management. See our company structure overview.

Discretionary trust

A trust offers distribution flexibility for non-PSI income and some asset protection, but it cannot split PSI: that must go to the individual who performed the work. It is also more complex and costly to run. Trusts suit family businesses holding assets or earning mixed income, less so a pure PSI earner. Our explainer on how trusts work in Australia sets out the mechanics, and share classes versus a discretionary trust compares the two for genuine business profits.

Genuine non-PSI income is the real variable

Where a business genuinely moves beyond selling one person's time, by employing tradespeople, investing in plant, hiring out equipment or delivering training, the income from those activities is not PSI at all. Company income that is not PSI is taxed at the company rate: 25% for a base rate entity in the 2025-26 and 2026-27 income years, and 30% otherwise. That is a real difference, and it is why growing past a one-person operation matters commercially as well as for tax.

Our view is that this should be treated as a business development question, not a tax structure one. Building a second income stream purely to change the tax outcome, with no substance behind it, is the kind of arrangement the ATO has flagged as a compliance focus. That is the subject of the next section, and it is where we push back on a lot of the structuring advice circulating in the trades. We work through these trade-offs in our CPA advisory and small business accounting services.

Does Passing a PSB Test Let You Split or Retain Income?

PCG 2025/5 does not change the law. The ATO's view that Part IVA can apply to income splitting and retention of profits is long-standing, and the note to section 86-10 of the ITAA 1997 already points to it. What the guideline adds is a practical statement of which arrangements the ATO regards as low risk and which are more likely to be reviewed. It matters because many taxpayers assumed, incorrectly in the ATO's view, that clearing a PSB test made splitting or retention freely available. The guideline applies both before and after its date of issue.

Retaining profit in the entity is not prohibited in itself. The question is whether the arrangement diverts income away from the individual who earned it, or defers tax, without a genuine commercial reason.

The guideline also gives taxpayers a runway. Where there is a genuine attempt to move an arrangement into the low-risk category by 30 June 2027, the ATO says taxpayers should not be concerned that it will apply compliance resources to pursue Part IVA. The ATO has separately flagged PSI as a current compliance focus.

Where this leaves subcontractors: passing the results test or the employment test is still worth doing, because it protects your deductions and avoids attribution. It is not a licence to split the income afterwards. If an arrangement in place today involves paying PSI to a lower-taxed family member, or parking it in a company for the rate difference, it should be reviewed against the guideline well before 30 June 2027. The PSI rules also reach medical and allied health contractors, where the same analysis applies alongside payroll tax; see our note on PSI basics for doctors and our work with doctors, dentists and health practices.

Do the PSI Rules Affect Your Super and PAYG?

Super guarantee

Even if your income is PSI, a payer may still owe super guarantee. Under section 12(3) of the Superannuation Guarantee (Administration) Act 1992, an individual engaged under a contract wholly or principally for their labour is treated as an employee for super purposes, regardless of holding an ABN. Since 1 July 2022 the former $450 monthly earnings threshold has been removed, so there is no minimum earnings floor. The super guarantee rate is 12% from 1 July 2025.

If you contract through a company, trust or partnership rather than personally, the extended employee definition does not apply to the payer's payments to your entity. Where you operate your own company and pay yourself wages, or employ others, you must pay super on those wages. As a PSI earner without an employer paying for you, you build your own super. From 1 July 2026 the concessional contributions cap is $32,500 (up from $30,000 in 2025-26) and the non-concessional cap is $130,000 (up from $120,000), subject to your total super balance. Verify the caps against the ATO key superannuation rates and thresholds before relying on them, and see the ATO's guidance on super for independent contractors.

PAYG withholding

This is widely misunderstood, so it is worth being precise. If you receive PSI directly as a sole trader and the rules apply, you have no PAYG withholding obligation on your own income; you pay tax through PAYG instalments and have withholding obligations only for any staff you employ.

Where the PSI is received by a company, trust or partnership, the position is different. That entity has additional PAYG withholding obligations on PSI that is not promptly paid to you as salary or wages, meaning by the 14th day after the end of the PAYG withholding period in which it was received. It must be registered for PAYG withholding, report and pay the withholding through the activity statement, and issue payment summaries by 14 July that separate salary and wages from attributed PSI. A partnership cannot pay wages to a partner, so for partners it only ever has the additional obligation.

The ATO accepts three ways to calculate the additional amount. The simplest is to work out the withholding on 70% of the PSI received in the period, excluding GST. That 70% is the income base the withholding calculation is applied to, not a withholding rate. The alternatives are a percentage based on the prior year's net PSI, or the actual amount calculated under the legislation. Any amount withheld is credited against the tax assessed on the attributed PSI. Keeping these obligations in order is part of our BAS and IAS work, and builders paying subcontractors should also check their TPAR reporting obligations.

Why Do the PSI Rules Exist?

The policy is simple. Income earned mainly from your own effort should be taxed as yours, whatever entity you invoice through. You should not access lower rates by changing the legal wrapper when the economic reality is that you are selling your labour.

The four tests exist because many people who sell personal services are running genuine businesses. If you have moved beyond selling your time, by employing staff, investing capital, winning multiple clients or holding real business premises, you are taxed as a normal business. The stakes are not trivial: for a subcontractor, the difference between PSI and non-PSI treatment, and the deductions that ride on it, can run to thousands of dollars a year. Getting advice before you structure is far cheaper than unwinding a position later.

Key Takeaways for Subcontractors

• Income is PSI where more than half a contract's value is a reward for your own labour or skill (s 84-5). There is no income threshold.
• Run the tests in order. The results test stands alone. The other three are closed to you if 80% or more of your PSI comes from one client and its associates.
• For the employment test, only principal work counts, measured at its charge-out value and recalculated every income year. A spouse doing the trade work can count; administration on a trade contract counts for nothing, whoever does it.
• Fixed-price work, your own tools, and a written defect warranty are the building blocks of the results test. Never invoice for rectification time.
• Passing a PSB test is not permission to split or retain the income. Review any such arrangement against PCG 2025/5 before 30 June 2027.
• Super guarantee at 12% can still apply to a labour-based contract even where the income is PSI.

Frequently Asked Questions