Allocating profits from professional firms: ATO guidelines released

Taxpayers diverting income to associated entities to significantly reduce their tax liabilities is a long held concern of the ATO.

Professional firms have come into the ATO’s view in particular, resulting in the recently released Practical Compliance Guideline (PCG) 2021/14. This guideline targets professional firms, specifically by focusing on the assessable income of the individual professional practitioner (IPP). The guideline highlights the ATO’s focus on IPP’s working in professional firms, but not showing adequate taxable income for the services that they provide. Instead, profit is distributed to associated entities to obtain a lower tax outcome.

The PCG describes how the ATO will apply compliance resources to arrangements the ATO considers to be high risk. It assesses tax compliance risk across a range of behaviors and/or arrangements.

The PCG applies to IPP’s in a wide range of professional firms which include lawyers, engineers, architects, medical practitioners, accountants, and other similar professions.

If you are a professional providing services to clients of the firm, or, actively involved in the management of the firm (or both), and you (or an entity of yours) hold equity in the firm this guideline may have a significant impact on your tax affairs.

Once some initial gateway factors are passed, the PCG provides a risk assessment framework to apply. The framework presents as a risk scoring table which lists three risk assessment factors focusing on IPP profit entitlement, effective tax rate paid on profits and market value renumeration. The table then imposes a score for each factor depending on the outcome. The total of these scores determines the applicable risk zone which operate as a ‘traffic light’ system.

In summary, the risk assessment factors are:

1. Proportion of profit entitlement - the proportion of the profit that ends up in the assessable income of the IPP compared to that of their associated entities

2. Effective tax rate - the total effective tax rate paid by the IPP and their associated entities

3. Appropriate remuneration – considers the remuneration returned in the hands of the IPP as a percentage of a commercial benchmark for the services provided to the firm.

It is important to note that the just the first two risk assessment factors may be used (instead of all three). It is important that you correctly analyse, score and select the most appropriate factor for your circumstances.

The total score from the risk assessment determines the risk zone that you are flagged in. The risk zones profiles are as follows:

• Green ‘low risk’ – should not attract the ATO’s attention
• Amber zone ‘moderate risk’ – ATO are likely to conduct further analysis
• Red zone ‘high risk’ – ATO will conduct a review which could lead to audit

What do you need to do?

A review of your current business structure arrangements and/or the impact this PCG will have on your tax affairs is prudent.

To discuss this or to discuss any concerns that arise from the guideline, please contact Cutcher & Neale for further assistance specific to your individual.