The Australian Taxation Office (“ATO”) is targeting high wealth individuals and their private groups, as well as arrangements that seek to minimise tax by extracting profit through artificial means. With this in mind, now is a good time to conduct a ‘health check’ of your operating structures to ensure there are no surprises should the ATO put your Group structure under review.
Some simple checks include:
Ensuring the personal services income (PSI) provisions are not breached;
Ensuring mark-up charges of service arrangements are within the ATO’s safe harbours; and
Ensuring profit allocation by professional firms are within the ATO benchmarks.
Satisfying any relevant ATO guidelines will lower your audit risk, however you must also be able to demonstrate the commerciality of any arrangement otherwise the ATO may seek to cancel the tax benefit where they are satisfied there was a dominant purpose of obtaining a tax benefit.
Areas to pay close attention to include:
1. Personal Services Income derived through an entity
Any attempt to minimise tax by diverting personal services income into an entity that is not conducting a personal services businesses (PSB) will be caught by the PSI rules.
When reviewing your structures, consideration will need to be made as to whether the income is derived by the business structure, or by the individual personally. Small business operators may find it difficult to pass the relevant tests, by satisfying either the results test or one of the three personal services business tests. If you cannot satisfy one of the tests, the PSI rules operate to ensure that income that is mainly a reward from your personal efforts or skills is assessed in the hands of the individual and only limited deductions will be available.
2. Service Entity Arrangements
Service entity arrangements will come under scrutiny where non-commercial fees have been charged to facilitate tax minimisation by income splitting.
Service arrangements should be reviewed where the fees are disproportionate or grossly excessive or where service fees are calculated without having regard to the value of the services provided by the service entity. The ATO guidelines set out a number of methodologies to determine if the fees have been correctly calculated, either by applying the indicative rates, by obtaining comparable market prices, or by using the comparable profits approach.
Where the indicative rates are used and the profits of the service entity do not exceed 30% of the combined profits of the professional firm and the service entity, the risk of an audit will be low.
3. Allocation of Profits of Professional Firms
The ATO will be reviewing professional services businesses such as services in the accounting, architectural, engineering, financial, legal and medical professions on the lookout for arrangements where there are distribution of profits to persons other than the Individual Professional Practitioners (“IPPs”) who provided the services to the firm.
Arrangements will be classified as low risk if at least one of the ATO benchmarks is satisfied, being either the appropriate remuneration, the 50% entitlement, or the 30% effective tax rate.
What to do next
If you are unsure how these measures apply to you or would like more information please contact WMS.
DISCLAIMER: This article is intended to provide a general summary only and should not be relied on as a substitute for professional advice.