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ATO’s New Position on Professional Firm Profits – Will you be paying more tax

On 1 March 2021, the ATO released the long-awaited Draft Practical Compliance Guideline PCG 2021/D2 Allocation of Professional Firm Profits. Once finalised, the new Guideline will replace the “old” guidelines that were suspended in December 2017.

The ATO has always had concerns about arrangements involving redirecting income that includes income from professional services, received by individual professional practitioners (IPP) to associated entities, to reduce the amount of tax liability.

The purpose of the new Guideline is to explain how the ATO intends to apply compliance resources when considering the profit allocation of professional firms and to assist the practitioners to self-assess their risk against risk assessment factors.

Proposed date of effect: 1 July 2021 transitional measures extend to 1 July 2023

Professional firms, include but are not limited to those providing services in the accounting, architectural, engineering, financial services, legal and medical professions.  Professional Firm Profits are profits derived from a firm/entity that provides services, which rely on the skills and labour of their employees.  Individual Professional Practitioners (IPP) is an individual who provides services to clients of the professional firm, or is actively involved in the management of the firm/entity.

Two Gateways and a risk assessment test will be introduced by the ATO to identify which professional firms and IPP’s are at a high risk of redirecting their income to associated entities for improved tax outcomes.  Scoring a high risk profile will increase the likelihood of audit by the ATO and/or consideration of breaching anti-avoidance provisions.  One high risk IPP in a firm of many low risk IPP’s may result in the entire professional firm being scrutinised by the ATO.

The proposed Guideline is based on a Green/Amber/Red (Traffic Light) approach to determine the level of risk for each IPP.   The determination of risk will be derived from the following factors:

1. Proportion of practice profits the IPP declares in their tax return, compared to the total practice profits derived by the IPP’s related entities;
2. The average tax rate on practice profits paid by the IPP and related entities; and
3. The profits included in the IPP’s tax return compared to an arms-length assessment of the market remuneration the IPP should be paid.

The first two tests have significant more weighting than the market value salary test. 

The potential result of the proposed guidelines are;

1. The amount of income the IPP will be required to declare in their personal tax return, will increase substantially compared with what has historically been declared;
2. High risk (red) IPP’s will be subject to prompt audit action by the ATO and, if the ATO is ultimately successful, subject to significant penalties and interest.

The guidelines will apply from 1 July 2021 for professional firms and IPP’s, unless you are eligible to receive a grace period, where they will have up to 30 June 2023 to comply with the new risk assessment criteria.

We have developed a model to assess your risk assessment under the guidelines, should you have any questions in understanding the effect on you or require assistance in putting a plan together, please don’t hesitate in contacting our office on (07) 5607 0820 or enquires@oracleba.com.au

DISCLAIMER:  This article is intended to provide a general summary only and should not be relied upon as a substitute to seeking professional advice.