Over the past few years we have witnessed an increase in non-traditional structures being adopted by professional practices. For example, a legal firm may be structured as a traditional individual partnership structure as well as a company or a partnership of trusts.
As the use of alternate structures has increased, so has the Australian Taxation Office’s (“ATO’s”) disquiet regarding the potential fall in income taxes payable by professional practitioners.
In turn, some professional practices have been reluctant to utilise alternate structures due to fear of adverse ATO action.
Recently the ATO published guidelines on their website expressing their views on the use of alternate structures by professional practices. It was an interesting approach by the ATO. ‘Guidelines’ are considered an administrative statement by the ATO and not a binding document.
The guidelines suggest that stakeholders in professional practices must be taxed on a ‘market value remuneration.’ This rule is not included in Australia’s tax laws and is not presently being imposed on other businesses. In effect, the ATO is seeking to apply the general anti-avoidance provisions in the tax laws to support its stance.
So What are the Guidelines?
The ATO outlines that a stakeholder will be rated low risk if their share of the professional practice’s profit distributions are subject to income tax (within the parameters set by the ATO). This means it’s unlikely they will be subject to compliance action related to their profit allocations.
To be considered low risk, the stakeholder must meet one of the following criteria annually:
- The individual practitioner personally is taxed on sufficient income from the firm as an appropriate return for the services they provide. This may be benchmarked to, as a minimum, the highest paid professional employee providing equivalent services to the firm as the practitioner;
- 50% or more of the income from the firm to which the practitioner and their associated entities are collectively entitled (whether directly or indirectly through interposed entities) is taxable in the hands of the practitioner; or
- The effective tax rate is 30% or higher on both:
- income from the firm to which the practitioner is entitled; and
- income from the firm to which the practitioner and their associated entities are collectively entitled.
Say That Again in English Please?
The ATO is seeking to restrict individual practitioners spreading their income too thinly across their family group to reduce their overall tax liability. This is particularly so if the practitioner is distributing to adults outside of their nuclear family, or where there are losses from other ventures within the family group.
The rules are unlikely to cause too much concern for practitioners who are “sharing” income only within their nuclear family.
Tacit Approval of Alternative Structures
One positive arising from the release of the guidelines is the ATO’s acknowledgement that alternate professional practice structures are valid. Although transactions that seek to alter existing arrangements to alternate structures should be viewed with caution.
Firstly, any shareholder in a professional practice should review their affairs in light of the information noted above.
As a professional practice it may also be prudent to review the firm’s structure. The appropriate steps should be taken to ensure all stakeholders involved are low risk.
Looking ahead, it will also be interesting to see if the ATO will seek to apply these guidelines broadly to other industries in the future.