The Commissioner of Taxation has finally released the long-awaited draft PCG 2021/D2 on 1 March 2021, outlining the Commissioner’s proposed compliance approach to the allocation of profits in professional firms (including the accounting, architectural, engineering, financial services, legal and medical professions).
Advisors will be aware that the Commissioner’s concerns with respect to the allocation of professional profits centres around arrangements whereby professionals redirect their income to associated entities, resulting in a decrease in the taxpayer’s tax liability in respect of their professional services income.
The approach outlined in the PCG will apply in the following circumstances:
- an individual professional practitioner (IPP) provides professional services to client of a firm or is actively involved in the management of the firm and in either case, the IPP and/or associated entities have a legal or beneficial interest in the firm;
- the income of the firm is not personal services income;
- the firm is structure as a partnership, trust or company;
- the IPP holds full rights to participate in the voting, management and income of the firm; and
- ‘Gateway 1’ and ‘Gateway 2’ are both satisfied
Gateway 1 will be satisfied where the arrangement, and the way that it operates, is commercially driven. Further commentary in relation to the nature of arrangements which are ‘commercially driven’ is included in the PCG.
Gateway 2 will be satisfied where the firm and IPP do not demonstrate any high-risk features. An IPP will determine which risk zone they are in by considering the following factors (noting that factor 3 is optional as the ATO recognise it may be difficult to determine accurately):
| Factor | Risk Assessment Factor | Score | |||||
| 1 | 2 | 3 | 4 | 5 | 6 | ||
| 1 | Proportion of profit entitlement from the whole of the firm group that is returned in the hands of the IPP | >90% | >75% to 90% | >60% to 75% | >50% to 60% | >25% to 50% | 25% or less |
| 2 | Total effective tax rate for firm income received by the IPP and any associated entities | >40% | >35% to 40% | >30% to 35% | >25% to 30% | >20% to 25% | 20% or less |
| 3 | Remuneration returned in the hands of the IPP as a % of the commercial benchmark for services provided to the firm | >200% | >150% to 200% | >100% to 150% | >90% to 100% | >70% to 90% | 70% or less |
An IPP will then determine what risk zone they fall within, based on the scores above:
| Risk zone | Aggregate score applying factors 1 and 2 | Aggregate score of all three factors | ATO treatment |
| Green (low risk) | Less than 7 | Less than 10 | Will only apply compliance resources to review allocation of profit in exceptional circumstances |
| Amber (moderate risk) | 8 | 11 and 12 | Will likely conduct further analysis of arrangement |
| Red (high risk) | 9 and above | 13 and above | Reviews are likely to be commenced as a matter of priority and cases may proceed directly to audit |
However, it is important to note that the risk assessment analysis outlined in the PCG does not replace or alter the operation of the law, relieve the practitioner of the their legal obligation to comply with the tax laws, nor does it operate as a ‘safe harbour’ in relation to the allocation of professional profits. Rather, the Guideline should operate only for the purpose of determining the level of risk associated with the IPP’s profit allocation arrangements (and resulting expectation of the level of engagement with the Commissioner with expect to such arrangements).
Keep an eye out for our in-depth analysis of the draft PCG.
For further information on any of the issues raised in the alert, please contact a member of our tax team below.