If you run your business through a company or trust and you’ve been distributing profits to a spouse, holding income at the corporate rate, or paying management fees to a related entity, this one’s for you.
The ATO has made its position very clear recently, and it’s worth understanding before it becomes your problem.
What is Income Splitting?
Income splitting means directing income earned by one person to someone else, usually a spouse, family member, or related entity sitting on a lower tax rate, with the aim of paying less tax overall.
It’s not automatically a problem. If you and your partner genuinely run a business together, or jointly own an investment property, splitting that income is completely normal and the ATO has no issue with it. The trouble starts when the income is generated by one person’s skill or effort, and the structure around it exists mainly to move that income onto someone else’s tax return.
The classic versions: paying a salary to a spouse who had no real involvement in the work, putting a family member “on the books” for a role they don’t actually perform, or leaving profits sitting in a company at the flat corporate rate instead of drawing them out personally. Each of these can look fine on paper. Whether it survives scrutiny depends on what’s actually happening behind the paperwork.
What Are the ATO’s Rules on Income Splitting?
This isn’t a new fight. PSI rules were introduced specifically to stop personal services income being funnelled through entities to access a lower rate. But here’s the part most business owners miss: the PSI rules and Part IVA (the general anti avoidance provisions) are two separate tests. Passing the PSI/PSB test only tells you that strict PSI provisions don’t apply. It says nothing about whether Part IVA might still catch you.
First: What Is Personal Services Income (PSI)?
PSI is income you earn primarily through your own skills, effort, or expertise rather than through selling goods or using significant equipment or assets.
Think: IT contractors, engineers, consultants, architects, medical practitioners. If the income exists because you showed up and did the work, there’s a strong chance it’s PSI.
The PSI rules have been around for a while. The ATO introduced them specifically to prevent individuals from funnelling personal exertion income through companies or trusts to pay less tax. The framework works like this:
- If your income is PSI, the ATO taxes it as your personal income regardless of what structure sits around it, and limits what you can deduct.
- If you operate a genuine business, you may be exempt from the strict PSI rules by passing the Personal Services Business (PSB) tests. The most common is the “results test”: are you being paid for a result, using your own tools, and bearing the risk if the work isn’t right? Other tests look at whether you have multiple unrelated clients, employ others, or have a business premises.
Passing the PSB tests has historically been seen as the green light. Many business owners assumed it meant: we’re in the clear, distribute as we like.
That assumption is now dangerous.
What Changed with the ATO’s PCG 2025/5?
In November 2025, the ATO released Practical Compliance Guideline PCG 2025/5, and it changed the conversation significantly.
The guideline makes one thing very clear: passing the PSB tests only switches off the strict PSI rules. It does not protect you from Part IVA.
Part IVA is the ATO’s general anti-avoidance provision. It gives the ATO broad power to look past your structure and ask a simple question: was this arrangement put in place primarily to reduce your personal tax bill?
If the answer is yes, or even looks like yes, the ATO can act.
What the ATO Is Actually Looking For?
PCG 2025/5 identifies specific arrangements the ATO considers high-risk. If any of these sound familiar, it’s worth paying attention:
Retaining profits in a company at the corporate tax rate
Parking money in your company to be taxed at 25–30% rather than drawing it as wages at your marginal rate is fine if there’s a genuine commercial reason, such as reinvesting in equipment or funding business growth. Doing it purely to avoid personal income tax is the problem.
Paying a salary to a spouse or family member
If your partner or family member is receiving a salary from the business but had no real commercial involvement in generating that income, the ATO considers this income splitting and will treat it accordingly.
Management fees without genuine commercial basis
Charging “administration fees” to a related entity or family member that aren’t reflective of real services at real market rates is a red flag the ATO is actively looking for.
The consequence of the ATO applying Part IVA isn’t a fine or a slap on the wrist. They can rewrite your tax return entirely, attribute all the redirected income back to you at your highest marginal rate, and add penalties of up to 50% of the shortfall plus interest. For many small business owners, that’s a very uncomfortable number.
There Is a Window, But It’s Closing
The ATO has provided a transitional period until 30 June 2027. If you actively restructure your arrangements to meet their low-risk criteria before that date, they have indicated they generally won’t chase historical penalties.
That sounds like breathing room, but restructuring how your business pays you, how profits are distributed, and how your entity structure operates takes time to do properly. Leaving it until May 2027 is not a strategy.
What to Do Now
If you earn income through your personal skills and operate through a company or trust, the first step is an honest review of how your profits are currently distributed and whether that distribution has a genuine commercial rationale behind it.
The right structure isn’t the same for everyone, and there are legitimate ways to operate that won’t attract ATO attention. The key is making sure your current arrangements hold up against PCG 2025/5, not just the PSB tests.
Book a review with the Nexis team before it becomes urgentÂ
This article is general in nature and does not constitute personal financial or tax advice. Please speak with a qualified adviser about your specific circumstances.
