ATO Targets PSI Alienation: Blending Trades with Professionals

Are your personal services business (PSB) clients (including trades) treating “PSB status” as a green light for income splitting or long-term retention of profits in their personal services entity (PSE)?

The ATO finalised PCG 2025/5 on 28 November 2025 which outlines when Part IVA could potentially  apply to arrangements where personal services income (PSI) of an individual is generated through a PSE that qualifies as a PSB. It brings to attention that even though the PSE passes one of the PSB tests and is therefore carrying on a PSB, it does not guarantee immunity from either being ordinary income under section 6-1 or from the potential application of Part IVA—where the PSI of the individual is alienated by way of income splitting or being retained in the PSE for non-commercial purposes. This compliance posture, first seen in draft PCG 2024/D2, is now final, with additional examples, clearer risk indicators, and a transition period for taxpayers seeking to be classified as “low-risk” by 30 June 2027.

The inclusion of ‘tradespeople’ within the scope of PCG 2025/5, along with the reference to an interposed entity deriving income that is not PSI but is “personal services in nature”, signals that the ATO may extend its compliance approach to the allocation of  professional firm profits under PCG 2021/4 to a wider range of service industries, including tradespeople, as well as more actively seek to apply long-standing older rulings such as IT 2121.

What’s new in PCG 2025/5 compared with PCG 2021/4

PCG 2021/4 focuses on “white-collar” professional firm’s allocation of profits (not PSI) to the Individual Professional Practitioner and their associated entities and uses gateways plus a risk matrix to gauge taxpayer behaviour with Part IVA issues being more in the background rather than being the central engine.

PCG 2025/5 focuses on PSI derived through a PSE carrying on a PSB, with low‑risk and higher‑risk indicators of alienation arrangements in the form of retention/diversion of the PSI of an individual. It adds trades/contractors into the group of taxpayer scrutiny with the possible application of Part IVA being front‑and‑centre.

From the draft PCG 2024/D2 to PCG 2025/5: what changed and why it matters

In comparison to PCG 2024/D2, the final version, PCG 2025/5 retains the drafts’ architecture but includes additional examples to further clarify perceived low and higher-risk PSI alienation arrangements, highlights the risk factors of a spousal partnership carrying on a business that would prompt further review/investigation, record-keeping etc. Significantly, one of the PCG’s examples is about a trade-related businesses.

Example 11 is a new example which illustrates a scenario of a licensed electrician operating through their company (PSE and satisfies PSB status) who is the sole director and shareholder of the company. The company derives PSI of $250K for the year and has non-salary expenses of $35K, so the profit before any labour costs is $215K.  From this, the individual is paid a salary of $189K, with the remaining $26K of profits retained in the company. This structure, although it may satisfy the basic requirements to qualify as a PSB, is classified as a higher-risk arrangement under the guideline. The Commissioner will thus subject it to greater scrutiny under Part IVA, as the retention of profits in the entity appears to lack genuine commercial purpose—i.e., it serves to obtain a tax benefit by deferring income or shifting it to an entity subject to a lower tax rate.

Notably, the example business mostly provides labour and not materials, as the wiring, cabling etc. are provided by the customers, so the example may merely generate uncertainty regarding whether the PCG applies to a trades’ business which does supply materials.

Notwithstanding this concern, the above example shows that where the PSI of an individual is retained by the PSE, this is seen by the ATO as a higher-risk alienation arrangement unless there are commercial reasons (justified by contemporaneous evidence) for retention. It is also to be noted that even where the PSE arrangement is low risk, compliance activities may still arise for other tax issues arising from such arrangement.

Interestingly, the ATO’s decision to not insert “We acknowledge that family arrangements are typically conducted with a greater level of informality than dealings between unrelated parties” in the final PCG may indicate the ATO’s shift require taxpayers to document family dealings as well.  We are not aware of any ATO guidance regarding what such documentation should look like.

What this tells us about the ATO’s evolving view

The direction of travel is clear: the ATO is aligning compliance practice so that PSI (being income that is mainly from personal exertion) ultimately bears tax in the hands of the individual who has generated the income—unless a real business structure or commercial purpose justifies different outcomes. The reliance on PSB status to alienate PSI does not shield a taxpayer from the potential application of Part IVA. Nor is this approach restricted to lawyers, medical professionals and accountants, as per recent practice. Any form of alienation by any type of business where the overall tax payable on the PSI is lower than if the PSI is assessed to the individual could be a Part IVA risk. We can expect sustained focus on substance, quantum, and documentation, across professions and trades alike. The reference by the ATO to IT 2121 may also indicate that the ATO may treat the PCG as a long-settled view when assessing penalties, as that ruling has been around since 1984.

Should you require assistance in reviewing and assessing your clients’ alienation arrangements to ensure alignment with low-risk criteria by 30 June 2027, our team is available to assist.

——-