ATO releases compliance guidance: Allocation of professional firm profits
The Commissioner has released a draft practical compliance guideline that sets out the ATO's proposed compliance approach to the allocation of profits by professional firms, and these guidelines are contained in Draft Practical Compliance Guideline PCG 2021/D2 (PCG 2021/D2 click here).
The ATO's revised guidance explains how the ATO intends to apply a risk-based compliance approach when considering the allocation of professional firm profit, or income in the assessable income of an individual professional practitioner (IPP).
Historically most professional firms were partnerships of natural persons. Today, professional firms are now structured with a wider variety of entities, reflecting the economic and legal choices made by the owners of those firms. Different structures may be implemented to give rise to different tax consequences and thus resulting in different tax compliance risks.
While the use of companies, trusts and other business structures does not, of itself, give rise to tax avoidance concerns, the ATO is concerned about arrangements involving taxpayers who redirect their income to an associated entity from a business (or professional services) activity, where it has the consequence of altering their tax liability.
The ATO's risk-based compliance approach requires two qualifying "gateways" to be passed before applying the risk assessment framework, requiring those with non-commercial arrangements, and those arrangements with high-risk features to engage with the ATO before applying the guidance.
Where an IPP passes the gateways, they then self-assess against the risk assessment framework to determine the type of compliance attention that will be given to their arrangement.
PCG 2021/D2 combines three previously separate risk assessment measures into a single methodology, which then gives an overall risk rating of low, medium or high risk, including:
- the proportion of profit entitlement from the whole of the firm group that is returned in the hands of the IPP;
- the total effective tax rate for income received from the firm by the IPP and associated entities; and
- the remuneration returned in the hands of the IPP as a percentage of the commercial benchmark for the services provided to the firm.
Where arrangements featuring high risk features or lacking apparent commercial rationale are identified, the ATO will treat the risk through application of integrity provisions, including the general anti-avoidance provisions in Pt IVA of the Income Tax Assessment Act 1936.
Once finalised, this Guideline will apply prospectively from 1 July 2021.
The ATO notes that taxpayers who entered into an arrangement prior to 14 December 2017 are able to continue to rely on the suspended guidelines (for 2018, 2019, 2020 and 2021 tax years), provided their arrangement complies with the suspended guidelines, is commercially driven, and does not exhibit any high-risk features.
In circumstances where arrangements that were considered low risk under the suspended guidelines may now have a higher risk rating under the new guidelines; the ATO is allowing a grace period for those IPPs to take the necessary steps to modify their arrangements to be lower risk. If the IPP in these circumstances choose, they can continue to apply the suspended guidelines to their arrangements until 30 June 2023.