If you operate a professional services firm now is the time to assess how your professional firm profits are being distributed. The ATO has recently issued new guidance that expresses concerns about profit allocations that might allow professional practitioners to avoid paying their fair share of tax on the profits of the firm.
The new guidelines will apply from 1 July 2022 to assist professional firm practitioners to assess if their current arrangements are within the ATO’s expectations and considered low risk. Professional firms can include but are not limited to, engineering, architecture, accounting, law, financial services, law, medicine and management consulting.
Under the new guidelines, you will need to assess the firms profit allocation arrangement against two ‘gateways’.
The first gateway is the ‘Commercial Rationale’ of the arrangement. The decisions behind the arrangements of the firm and the way in which profits are distributed should be commercially driven. For example, the remuneration received by a professional from the firm should be paid on commercial terms as reward for their personal efforts and skills. Actions taken to gain a tax advantage rather than achieve a commercial objective will not meet the first gateway.
The second gateway is concerned if the practitioner’s arrangement contains any ‘high-risk features’. The guideline outlines a number of high risk features to consider such as non-arm’s length finance arrangements or issuing multiple classes of shares to non-equity holders.
If both gateways can be satisfied, the individual practitioner may use the risk assessment framework to self-assess which risk category they belong, which in turn gives an indication to the potential ATO attention they may receive.
| Risk Assessment factor | Score | |||||
| 1 | 2 | 3 | 4 | 5 | 6 | |
| (1) Proportion of profit entitlement from the whole of firm group returned in the hands of the individual professional practitioner
|
>90% |
>75% to 90% |
>60% to 75% |
>50% to 60% |
>25% to 50% |
25% or less |
| (2) Total effective tax rate for income received from the firm by the individual professional practitioner and 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 individual professional practitioner as a percentage of the commercial benchmark for the services provided by the firm |
>200% |
>150% to 200% |
>100% to 150% |
>90% to 100% |
>70% to 90% |
70% or less |
When applying the risk assessment factors, you may use factors one and two only, or alternatively all the three. The third factor relies on a commercial benchmark which may be hard to ascertain.
After determining which score your arrangement falls into, you can then self assess if you are low, moderate or high risk. The lower the risk level, the less likely the ATO will analyse the arrangement and potentially proceed with an audit.
| Risk Zone | Risk Level | Aggregate score against the first two factors | Aggregate score of all three factors |
| Green | Low | 7 or less | 10 or less |
| Amber | Moderate | 8 | 11 and 12 |
| Red | High | 9 or more | 13 or more |
For example, an individual professional practitioner who receives 100% of the profit would fall into the category of low risk.
By assessing your risk level you can determine if a change is needed and potentially reduce future headaches from the ATO. The risk assessment and guidelines can be complicated; it is important to speak to your accountant if you are concerned about the commerciality of your firm’s arrangement or profit allocations.
Author: Allan Edmunds
Email: allan@faj.com.au
