The Australian Tax Office (“ATO”) has released a draft Guideline for a new compliance approach on how professional firms and individual professional practitioners (“IPP”) should allocate their profits (draft Practical Compliance Guideline (PCG) 2021/D2). Whilst this Guideline is currently in the consultation phase, the ATO have stated that the finalised Guideline will apply to all professional firms and IPPs from 1 July 2021, with some transitional measures extending the start date to 1 July 2023.
What are professional firm profits?
These are profits derived from a firm that provides services, which rely on the skills or labour of their employees. Some examples of a professional firm are medical, legal practices, engineering firms, surveying, financial planners and accounting firms to name a few.
What is an individual professional practitioner?
This is an individual who provides services to clients of the professional firm, or is actively involved in the management of the firm.
What is the purpose of the new compliance guideline?
The ATO will be introducing two Gateways and a risk assessment test, which identify professional firms and IPPs who are at a high risk of redirecting their income to associated entities for improved tax outcomes. Firms and IPPs that score as a high risk are much more likely to be audited by the ATO or considered to be in breach of the anti-avoidance provisions. This is the case even if one IPP from a firm is considered high risk and the remaining IPPs are low risk – the entire professional firm is expected to be scrutinised by the ATO.
The ATO have developed a traffic light approach to determining the level of risk for each IPP. The assessment is based on a combination of the following factors:
1) Proportion of practice profits that the IPP declares in their tax return compared to the total practice profits derived by the IPP’s related entities;
2) The average tax rate on practice profits paid by the IPP and related entities; and
3) The profits included in the IPP’s tax return compared to an arms-length assessment of the market remuneration that the IPP should be paid.
Tests 1 and 2 above are given significantly more weighting than the market value salary test. The result is that, in most cases, the amount of income that the IPP will be required to declare in their personal tax returns will have to increase substantially when compared with what has historically been the case. Our firm has done some modelling and, based on the draft guidelines as they are currently drafted and the cases we have looked at, we noted that the IPP’s personal income will have to almost double to qualify as a “green” level of risk to the ATO.
Any IPP’s who are classified under these guidelines as “red risk” will be subject to prompt audit action by the ATO and, if the ATO is ultimately successful, subject to significant penalties and interest.
It must be remembered that the guideline is a risk assessment tool only. It does not mean that the ATO’s view will prevail if ultimately tested by the Courts.
I am an IPP – what might it mean for me?
If you are a partner or owner of a professional services firm who has historically split income with related entities to obtain a lower overall tax liability, it is almost inevitable that you will have to declare significantly more income in your own name from 2023 and will therefore have a higher tax liability.
In most of our modelling, the income that the IPP is required to take under these guidelines to qualify as low risk may be double the amount of historical income levels.
You will be paying more tax under these guidelines – plain and simple.
How can WMS assist?
We have quickly developed a model that can be used to assess your risk assessment under these guidelines. If you wish to discuss how the new guidelines impact you, please contact us and we can undertake the necessary calculations required to obtain your risk assessment score.
What are the next steps?
The Guideline will apply from 1 July 2021 for professional firms and IPPs, so now is the time to start putting a plan in place to ensure you and your firm are ‘low risk’.
Some affected taxpayers may be eligible to receive a grace period where they have up to 30 June 2023 to comply with the new risk assessment criteria.
Should you have any questions or require assistance in putting a plan together, please don’t hesitate to contact our office on (07) 5556 3300 or email@example.com