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Alerts

22 December 2021 – Updated Article is now available

 

In March 2021 the Australian Taxation Office (“ATO”) released long awaited draft guidance for professionals including those in the legal, financial services, medical, architectural and engineering fields.  Unfortunately, the revised draft guidance is likely to adversely impact the allocation of professional practice profits and results in a significant departure from the guidelines previously published by the ATO.  The draft could easily result in a professional who was considered ‘low risk’ under the previous guidance now assessed as ‘high risk’.  Once finalised, the guidance outlines that ‘high risk’ practitioners can expect the following treatment:

  • ATO reviews being commenced as a matter of priority;
  • Cases potentially proceeding directly to audit; and
  • The ATO likely to use formal powers for information gathering.

The draft guidelines outline how the ATO intends to determine whether an individual practitioner is declaring an appropriate amount of business profits in their personal return relative to the value of the services they personally provide to their business.

While there have been no changes to Australia’s tax laws in relation to the sharing of business profits, the ATO are continuing their approach of issuing non-binding administrative statements in order to encourage professionals to pay ‘their fair share of tax’ or risk being audited.

History

In late 2015, the ATO published guidelines for professional practices and their stakeholders which indicated how they would be seen by the ATO if they sought to spread practice profits to associates who were not engaged in the business.  The guidelines outlined that a stakeholder would be rated as ‘low risk’ if their share of the practice’s profit was distributed in a manner which ensured at least one of the following was met:

  1. The individual practitioner was personally taxed on income from the practice equivalent to the highest paid band of (non-principal) employees providing similar services to the firm;
  2. 50% or more of the income from the practice to which the practitioner and their associates are collectively entitled (whether directly or indirectly through interposed entities) is taxable in the hands of the practitioner; or
  3. The effective tax rate on the income from the practice for the individual practitioner and their associated entities is 30% or more.

The above guidelines were suspended in December 2017 and reviewed by the ATO.  In the draft guidelines issued in March 2021, the ATO have advised that taxpayers who entered into arrangements prior to 14 December 2017 are able to continue to rely on the above guidelines (”Suspended Guidelines”) for the years ended 30 June 2018, 2019, 2020 and 2021, provided that the arrangement complies with the Suspended Guidelines, is commercially-driven and does not have any high-risk features such as those arrangements covered by a Taxpayer Alert.

Further, practitioners who were considered low-risk under the Suspended Guidelines but find themselves considered a higher-risk under the draft guidelines can continue to apply the Suspended Guidelines to their arrangements until 30 June 2023.

Revised Guidance

The revised guidance explains the ATO’s risk-based compliance approach and metrics to determine whether an arrangement would be considered low, medium or high risk.  Where arrangements are not low risk or there is a lack of apparent commercial rationale, the ATO is likely to take a closer look at the arrangement and consider whether the anti-avoidance provisions apply.

There are strict criteria as to whether the guidance is applicable to an individual or practice, however it is intended to apply to most professional businesses.  Importantly, if your business exhibits high-risk features such as those arrangements covered by a Taxpayer Alert, the ATO will automatically consider the business to be high-risk without applying the scorecard below.

Where the business is not considered to be high-risk and the guidance is applicable, the following risk assessment scoring table will be used to determine your risk level:

* Where it is impractical to accurately determine an appropriate commercial remuneration against which to benchmark, the first two risk assessment factors may be used.

On the surface, in order to be considered low-risk it appears the ATO requires the practitioner to personally return more than 50% of the firm income collectively received by the practitioner/related parties and pay tax at an average rate of more than 30%.  Under the Suspended Guidelines, a practitioner would have broadly been considered low-risk where they scored a ‘4’ in any single risk-assessment factors.  However, that same set of circumstances is now likely to lead to a moderate-risk or high-risk outcome.

ATO Treatment

Depending on your risk zone, you can expect the following treatment by the ATO:

The impact of this draft guidance is to put practitioners on notice that their affairs will likely be under scrutiny from the ATO if they do not declare a sufficient share of practice income in their personal returns. As there have not been any changes to the law, this scrutiny will have an overlay of existing laws such as the general anti-avoidance rules, trust reimbursement arrangements (Section 100A), Division 7A and other integrity provisions.

Once finalised, the guidance is expected to apply prospectively from 1 July 2021 with a review being conducted during 2022.

This draft guidance highlights the importance of ensuring you obtain professional advice prior to restructuring or joining a professional practice.

Contact Pilot

Should you require assistance with reviewing your structure or profit allocation, please contact Jason Bayliss or Josh Meggs from our Legal Services team.