Personal Services Income (PSI) and post-retirement consulting: when the company structure doesn't work

For Australian retirees who keep earning after leaving full-time work — typically as consultants or contractors to a former employer, similar businesses, or new clients — the structure chosen for that work carries real tax consequences. A common pattern is to run the consulting through a proprietary limited (Pty Ltd) company or a discretionary trust, drawn by the apparent advantages: the 25% company tax rate for a base rate entity (FY25-26), the ability to spread income across family members, the option to retain profits in the entity rather than draw them out. Those benefits are genuine for genuine businesses. But where the income is fundamentally a reward for the retiree's own efforts and skills, the Personal Services Income (PSI) rules in Part 2-42 of the Income Tax Assessment Act 1997 step in to neutralise the structure — attributing the income back to the individual who earned it and stripping out the entity's deductions. Understanding when the PSI rules bite, how the Personal Services Business (PSB) tests can carve out an exemption, and what the practical tax difference is, is the difference between a structure that helps and one that just adds cost.

The PSI definition is broad and catches most retiree-consultant arrangements. Under section 84-5 of the ITAA 1997, PSI is income that is "mainly a reward for an individual's personal efforts or skills" — meaning more than half the income from a particular contract is attributable to the person's own work, rather than to the use of substantial business assets, the sale of goods, or an income-producing business structure. A retired engineering executive who consults two days a week to their former employer at a daily rate is earning PSI: the rate is a payment for time and expertise, not for an independent business system. A retired tradesperson who supplies both materials and labour may be earning PSI on the labour but not the materials, because each contract is assessed on its own facts. Critically, the PSI rules ignore the legal wrapper — income that is PSI when earned by a sole trader is still PSI when funnelled through a company or trust on the individual's behalf.

The alienation consequences are what make PSI matter. Where a company or trust earns PSI and is not a Personal Services Business, Division 86 attributes that income to the individual whose efforts produced it, taxed at their marginal rates rather than the entity's rate. The entity's deductions are also restricted to what the individual could have claimed as an employee — so salaries paid to a spouse for nominal work are typically disallowed, and motor vehicle, home office and similar claims are constrained. The net effect is that the corporate or trust structure delivers no tax saving while still carrying the overhead of company administration, ASIC fees and accounting. That is a poor outcome, and it arises far too often when a retiree sets up a consulting company without anyone applying the PSI analysis first.

The Personal Services Business tests are the escape hatch. An entity earning PSI avoids the alienation rules if it qualifies as a PSB, which it can do by passing any one of four tests. The results test requires being paid to produce a specific result, supplying your own tools and equipment, and being liable to rectify defective work at your own cost. The unrelated clients test requires earning PSI from two or more clients who are not associated with each other or with you, where the work comes as a direct result of offers to the public — advertising, a website, tenders — rather than word-of-mouth referrals. The employment test is met where employees, subcontractors or other engaged entities perform at least 20% (by market value) of the principal work. The business premises test requires premises at which you mainly (more than 50% of the activities) produce the PSI, of which you have exclusive use (you own or lease them), that are physically separate both from any premises you or your associates use privately and from your clients' premises. Note this is a "more than 50%" threshold, not the higher figure sometimes quoted. Pass any one test and the entity is a PSB, the alienation rules fall away, and the structural benefits become available.

The 80% rule is the most common obstacle for retiree-consultants. If 80% or more of your PSI in a year comes from a single client (and that client's associates), you can only self-assess as a PSB if you meet the results test — the unrelated clients, employment and business premises tests can no longer be self-applied, and you would instead need to apply to the ATO for a Personal Services Business Determination (PSBD). If less than 80% comes from one client and you meet one of those three tests, you can self-assess. The practical bite is severe: a retiree who consults back to a former employer almost always derives well over 80% of their consulting income from that one client, which blocks three of the four tests outright. Their realistic options narrow to passing the results test (project-based work with own tools and rectification liability — rarely how hourly consulting is structured) or obtaining a PSBD (rarely granted where the arrangement looks like a continuation of the old job). Most former-employee consulting arrangements land in the alienation outcome.

The tax-outcome comparison shows why the analysis matters. Take a retiree earning $150,000 a year of consulting income through a Pty Ltd company. If the entity is a genuine PSB, the company pays tax at the 25% base rate entity rate (FY25-26) — $37,500 — and the retiree can draw fully franked dividends, retain profits in the company, or, in a trust, distribute across family members. If instead the same $150,000 is PSI without PSB exemption, it is attributed to the retiree and taxed at their marginal rates — roughly $40,000 if it is their only income (FY25-26 rates plus Medicare), but taxed all the way up to the top 47% on any slice that stacks on other income — with no retention option and no spouse splitting, because the alienation rules restrict those very deductions. The company adds cost and delivers nothing. And even where a PSB exemption is available through a trust, the structure does not give a free pass on income splitting: the ATO can still scrutinise distributions to low-rate family members under the general anti-avoidance rules and the section 100A reimbursement-agreement rules, and drawing retained company profits brings Division 7A into play.

What do worked planning examples show?

These two cases show how the PSI rules apply in practice. Illustrative only — not personal advice — using FY25-26 figures.

Case 1 — Geoff, 62, retired engineering manager. He negotiates a consulting arrangement with his former employer: two days a week at $1,400 a day, indefinitely, expected to bring in about $140,000 a year, all from that one employer. On his accountant's suggestion he sets up a Pty Ltd company. On these facts the income is PSI (a reward for his personal effort) and 100% of it comes from a single client — far above the 80% threshold. That blocks the unrelated clients, employment and business premises tests from self-assessment. The work is paid by the day, not for a result, so the results test does not apply either, and a PSBD would be unlikely to succeed because the arrangement is functionally a continuation of his old role. The PSI is therefore alienated to Geoff at his marginal rates, and the company delivers no tax benefit while adding roughly $2,500–$3,500 a year of ASIC and accounting overhead. On these facts, winding up the company and operating as a sole trader is generally the rational move — same tax result, far less cost. Better still, had the PSI analysis been done first, Geoff would have started as a sole trader and never paid the setup cost.

Case 2 — Patricia, 64, retired senior marketing executive. She builds an independent practice with five ongoing clients (each contributing 15–25% of her income), about $200,000 a year, maintaining a website, running LinkedIn advertising, and attending industry events. She operates through a discretionary trust. Here the income is still PSI (her personal expertise), but no single client provides 80% or more, so the 80% rule is satisfied. She passes the unrelated clients test — multiple unrelated clients, won through genuine offers to the public — so the trust is a PSB and the alienation rules do not apply. The trust can then distribute income across family members and stream different income types, generally producing a materially better outcome than sole-trader status. On these facts, the rational steps are to maintain the client diversity that supports the test, keep evidence of the marketing activity and how each client was won (in case of audit), and keep any family distributions defensible against the section 100A and general anti-avoidance rules rather than treating PSB status as a blank cheque for income splitting.

For retirees weighing post-employment consulting, the structure decision is consequential — but only after the PSI analysis is done. Operating as a sole trader is simpler and produces the same result for work that is stuck in the PSI net. A company or trust pays off only where the PSB tests genuinely apply, which takes deliberate effort to build a real consulting business — multiple unrelated clients, a marketing presence, real infrastructure — rather than to simply continue a single relationship with a former employer. The advice work is to walk through the PSI tests before any structure is set up, recommend the structure that matches the realistic work pattern, document the basis for any PSB claim, and review it each year as the client mix evolves. For too many retirees, "the consulting company my accountant set up" is a structure that delivers no benefit while adding real cost — exactly the outcome that proper PSI analysis up front would have prevented.

Sources

• Australian Taxation Office (ATO) — Working out if the psi rules apply
• Australian Taxation Office (ATO) — Self assessing as a psb
• Australian Taxation Office (ATO) — Unrelated clients test
• Australian Taxation Office (ATO) — Business premises test
• Australian Taxation Office (ATO) — Company tax rates