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AJML Accountants Update – October 2017

Personal Services Income  (PSI) – 6


Contractors should include a term in their agreement that they are liable for the cost of rectifying any defect in the work performed. Such a term will assist in satisfying this condition for the results test.

Note, the mere existence of such a term in the contract, by itself, does not mean this condition is satisfied. The relevant liability must really exist. Though, if in an audit the ATO questions whether the relevant liability for the cost of rectifying defects really exists, it will be difficult to prove it does unless there has been a prior defect which the contractor has paid for the cost of rectifying.

Physical rectification

In some circumstances, physical rectification may not be possible. For example, the contractor may be an IT consultant and has provided general advice regarding the customer’s IT systems. The Commissioner takes the view in paragraph 138 of TR 2001/8:

“Where physical rectification is not possible, the purpose of the provision would be satisfied where a right to claim for damages exists in respect of faulty or negligent  performance of contractual obligations and the individual or

personal services entity is or would be liable for the relevant component of damages awarded for the faulty or defective work.

A requirement to have indemnity insurance is an indicator that the individual or personal services entity is liable for rectification, where the indemnity insurance is part of the contractual arrangements between the parties. However, the fact that a person may be subject to a disciplinary action by a professional body for misconduct, is not sufficient to satisfy the rectification element of the results test.”

Obviously if physical rectification is possible, then to satisfy the provision, the defect should be rectified at the cost of the contractor.

TR 2001/8 contains two examples that demonstrate the Commissioner’s view of the application of the results test to IT contractors. These are reproduced below. Note that in both examples, the requirement to supply plant and equipment or tools of trade has been satisfied even though the taxpayer uses the client’s equipment.


A government department enters into a contract with Consultant Co for the provision of services by an individual who is nominated in the contract. The terms and conditions of the contract are that the individual works for a maximum number of hours per day (e.g., 8

hours). The contract specifies an hourly or daily rate payable in respect of the work undertaken by the individual. Tasks performed by the individual are at the request of and the manner of performance of the work is subject to the direction of departmental officers,

The individual uses the plant and equipment provided by the department for carrying out the tasks required. If the work performed by the individual is unsatisfactory, the department is entitled to terminate the contract, but the company is not required under the contract to rectify any defects in the work performed.

Consultant Co is a personal services entity because its income includes the personal services income of the individual who does the work.