Professional Firms – The ATO might review your profit distribution soon

Early in 2021, the ATO released a draft document that received much criticism from accounting practitioners. In December, it decided nonetheless to finalise that document (PCG 2021/4).

You might be at risk of an ATO review if you are an Individual Professional Practitioner (IPP):

  • you provide services to clients of a firm; and
  • you or your family have legal or beneficial interest in it.

Specifically targeted are the accounting, architectural, engineering, financial services, legal, medical and management consulting professions.

Under the new Practical Compliance Guidelines, ATO officers are now instructed to review professional firms’ remuneration of their owners, to determine whether they committed tax avoidance – a pretty serious breach of the Income Tax Act.

Indeed, they are concerned (inter alia) that owner salaries are too low and that profits are instead being passed to family members by way of dividends to a family trust.

The recently-issued guidelines state that taxpayers should seek ATO rulings/guidance where they fail either of the following “gateways”:

  • The arrangement is commercially driven; and
  • No high-risk features are flagged.
Gateway 1 – Commercial rationale

Is the arrangement straight-forward and in line with what any other employee receives or would expect? If not, you could be failing this test.

Gateway 2 – Risk assessment

This relies on a complex risk rating test, which scores each arrangement based on:

  • The percentage of firm profits that are assessed (directly or indirectly) in the hands of the IPP;
  • The effective rate of tax paid by the IPP and their associates on distributed firm profits; and
  • A comparison of the IPP’s remuneration against commercial benchmarks.

Obviously the third factor is relatively hard to objectively determine.

Your score will land you in any of the low-, moderate- or high-risk zones, with ATO compliance action ranging accordingly from quick review to full-blown audit.

As you would expect, there has been a lot of pushback from the accounting profession on this new policy. They indeed raised serious doubts as to the ATO’s reasoning for considering tax avoidance. At this stage, it seems unlikely that clarity will be found until a case is litigated on this issue.

Unless you have the appetite for a legal battle, please reach out to one of our advisors if you would like your situation assessed, as it is always best to keep in front of these matters. Please do not hesitate to contact us should you need further advice.

About the Author
Will sees himself as a driver of innovation and progress. He challenges the status-quo and helps his clients in planning for the best business solutions and taxation strategies.
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