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New ATO guidance for Professional Firms

Engineering, Medical, Legal. New ATO guidance for Professional Firms

The ATO has finalised its guidance on the Allocation of Professional Firm Profits (or commonly known as income splitting) that will apply from 1 July 2022.

At WLM, we will review all professional services clients to ensure they meet the new guidelines. This work will be undertaken either during year-end tax planning or as we complete year-end tax work. 

Practical example

Jane Cameron is a director of a Trustee company of the Cameron Family Trust. The Cameron Family trust owns 50% of Medical Heroes Pty Ltd, and Medical Heroes Pty Ltd employs 10 staff and provides facilities to Jane to operate her GP practice. Jane will need to consult her accountant to ensure she is compliant with the new guidelines. The ownership structure will most likely be acceptable to the ATO, but how the net profit is allocated directly to Jane and her trust and how much tax her group of related entities pay will need to be tested.

The ATO Guidance

Please find an extract from the guidance PCG 2021/4. A warning that this is complex and provides the Commissioner with broad flexibility in assessing Professional Firm's Structures.

The old guidelines were suspended after the ATO identified they were being misinterpreted.

 The key changes include:

  • additional examples featuring a wider variety of arrangements and structures used by Individual Professional Practitioners (IPPs)

  • confirming that being assessed as high-risk by the ATO does not automatically result in audit or application of the anti-avoidance provision Part IVA

  • a change in the benchmark percentages used in the ATO Risk Assessment Framework to determine whether an arrangement is low, medium, or high risk

  • a revised application date of 1 July 2022

  • a two-year transitional period until 1 July 2024 for arrangements that were low-risk under the suspended guidelines but moderate or high-risk under the new PCG guidance.

Before an IPP can apply the Risk Assessment Framework, they must satisfy the two gateways.

The two Gateways are:

Gateway 1 Gateway 2

A sound commercial rationale for entering into and operating the arrangement or structure.

There must not be certain 'high-risk features'.


Gateway 1 – Commercial Rationale

Gateway 1 considers whether the implemented arrangement and the way in which it operates are commercially driven. This means there must be a genuine commercial basis for the arrangement and also for the way in which profits are distributed.

The arrangement should reflect the commercial needs of the business. For example, the arrangement is likely to enhance, assist or improve the business's ability to produce income or make profits, or the commercial benefits asserted to be achieved by the arrangement are justified.

There must be evidence that the stated commercial purpose was achieved as a result of the arrangement. For example, the mere assertion of 'asset protection' for an IPP is not sufficient if the arrangement does not actually provide improved asset protection. The ATO considers it best practice to record the commercial rationale for the decision to adopt the arrangements used and for the way in which profits are distributed.

Gateway 2 – High-Risk Factors

If, after considering Gateway 1, you conclude that your arrangement is commercially driven, you must then assess whether your arrangement contains any high-risk features, such as those arrangements covered by a Taxpayer Alert. The Commissioner also considers the following as potentially high-risk features: 

  • financing arrangements relating to non-arm's length transactions

  • exploitation of the difference between accounting standards and tax law

  • arrangements where a partner assigns a portion of a partnership interest that is materially different in principle from Everett [4] and Galland [5]

  • multiple classes of shares and units held by non-equity holders.

Assuming an IPP passes the 2 Gateways, we then apply the ATO recommended Risk Framework to determine whether an IPP is at high risk for ATO audit.

However, where other compliance issues are present, the Commissioner may apply compliance resources to address those risks. Such issues could include but are not limited to:

  • cases of non-recognition of net capital gains
  • transfer mispricing
  • misuse of the superannuation system
  • promotion of schemes
  • failure to lodge returns or a history of late lodgement of returns
  • income injection to entities with carried-forward losses
  • the application of Division 7A of Part III
  • the application of section 100A
  • inappropriate access to low-income tax offsets or other benefits, and
  • non-tax advantages that are dependent on taxable income.

The Risk Framework provides a score to the below factors

  1. The proportion of profit entitlement from the whole of the firm group returned in the hands of the IPP.
  1. Total effective tax rate for income received from the firm by the IPP and associated. [6]
  1. Remuneration returned in the hands of the IPP as a percentage of the commercial benchmark for the services provided to the firm.

The lower the % in the above 3 factors, the riskier the structure.

Lawyers, Doctors, Engineers and any other Professionals who have an ownership interest in their firm should consult with their accountant to see how these guidelines will impact them.

WLM can help

If you'd like help with understanding your obligations or any further information, please contact us today.

The material and contents provided in this publication are informative in nature only.  It is not intended to be advice and you should not act specifically on the basis of this information alone.  If expert assistance is required, professional advice should be obtained.

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