Allocating Profits within Professional Firms
The allocation of profits within Professional Firms, such as accounting, architectural, engineering, financial services, legal and medical professions, continues to be under close scrutiny by the ATO.
In 2015 the ATO issued guidelines for practitioners outlining how its general anti-avoidance legislation could apply to professional firms that allocate profits from a professional firm (including partnerships, trusts or companies). The guidelines included “Assessing the Risk: Allocation of profits within professional firms” and also the “Everett Assignment” web materials.
However, effective 14 December 2017, the ATO announced that these guidelines were suspended having become aware that “they are being misinterpreted in relation to arrangements that go beyond the scope of the guidelines”.
Currently, that ATO advises that individual professional practitioners thinking of entering into new arrangements from that date are encouraged to engage with the ATO through its Early engagement process or via email at Professionalpdts@ato.gov.au.
A re-fresher on income splitting
Professional firms can be structured in a range of ways, depending on the choices made by the owners, but the ATO has warned that in some cases the way a business is structured “can be used in ways that give rise to different tax consequences and resulting tax compliance risks”.
Its concerns about tax compliance in these instances are based on where arrangements are set up so that a practice’s income is treated as being derived from the business itself, even though the source of that income is actually the provision of professional services by individuals.
High and low risk
In the now suspended guidelines, the ATO advised that taxpayers would be rated as low risk and not subject to compliance action if they meet one of the following requirements regarding income from the firm (including salary, partnership or trust distributions, distributions from service entities or dividends from associated entities):
• the practitioner receives assessable income from the firm in their own hands as an appropriate return for the services they provide to the firm. The benchmark for an appropriate level of income will be the remuneration paid to the highest band of professional employees providing equivalent services to the firm, or to a comparable firm
• 50% or more of the income to which the practitioner and their associated entities are collectively entitled (whether directly or indirectly through interposed entities) in the relevant year is assessable in the hands of the practitioner
• the practitioner, and their associated entities, both have an effective tax rate of 30% or higher on the income received from the firm.
Where none of these guidelines are satisfied, the ATO says the practitioner’s arrangement will be considered higher risk, with increased chance of compliance action. The lower the effective tax rate of an arrangement, the higher the ATO may rank the compliance risk.
Until further guidance is provided by the ATO, there will remain uncertainty as to how anti-avoidance legislation could apply to professional firms. The ATO has been consulting with interested stakeholders, and we expect some indication on replacement guidance or transitional arrangements shortly. Practitioners should note that new guidance will apply prospectively.