Australia
2 March 2021 | Minutes to read: 2

ATO compliance approach to professional firm profits

By Greg Travers and Todd Want

The long-awaited update to the Australian Taxation Office’s (ATO) approach to the taxation of the profits of professional firms has been released in draft form in PCG 2021/D2.

The draft guidelines will apply from 1 July 2021 and will affect accountants, lawyers, architects, engineers, financial service providers, medical practitioners and others providing professional services.

The guidelines adopt a traffic light system for assessing the level of tax risk for a partner in a professional firm.  The risk assessment is based on:

  • The proportion of the partner’s profit distributions that are taxed in their own hands, as opposed to being taxable income for an associate
  • The effective tax rate on the partner’s profit distributions, including those distributed to associates
  • The partner’s personal remuneration as compared to commercial benchmarks.

“Partner” in this context means an individual working in the professional firm where they or an associate also hold an equity interest in the firm.  The guidelines apply to partnerships, companies, trusts, etc. The actual job title of the individual as a partner, director, etc is not relevant.

The ATO has also identified two gateways that need to be satisfied in the remuneration and profit distribution arrangements of a professional firm:

  • That the arrangements have a sound commercial rationale and are implemented in a commercial manner
  • That the arrangements do not exhibit specific high-risk features.

The ATO recognises that income from professional firms is business income not personal services income, and that only part of the income relates to the work performed personally by the partner. Nevertheless, the ATO expects that a substantial portion of the profits of the professional firm is taxable income for the partner personally.

All professional firms will need to review their remuneration and profit distribution arrangements and assess their potential tax risk under these draft guidelines.  Professional firms seeking a low (green) risk profile may need to fundamentally rethink their arrangements, and potentially the basis on which equity is acquired.  This is expected to have significant commercial implications for a number of firms.

 Next steps

We will be considering these measures in more depth and will provide more detailed guidance on the measures. However, with these guidelines proposed to apply from 1 July 2021, prompt action will be required by all professional firms to consider both the commercial rationale of their structure and also the tax outcomes that are being achieved. This will be crucial to ensuring that firms are not inadvertently considered to be in the red zone (high risk) and thereby exposing themselves to the likelihood of an ATO review.

Please call us to discuss how these guidelines will impact your business and remuneration and profit distribution arrangements. 

ATO compliance approach to professional firm profits

Greg Travers

Greg is the national leader of the Tax Services division. Recognised as one of Australia’s leading tax advisors, Greg has assisted countless businesses, individuals and families to deal with the often difficult situation of an ATO or State Revenue audit. Greg also specialises in international tax working with overseas businesses as they set up and operate in Australia, and assisting Australian businesses that are venturing overseas.

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ATO compliance approach to professional firm profits

Todd Want

Todd is a Director in our Tax Services division and National Councillor and Director at The Tax Institute. Todd’s expertise lies in small-to-medium sized enterprise taxation matters. He advises clients on a broad range of tax issues such as capital gains tax, advice relating to structuring and restructuring, the tax consequences of acquisitions and divestments, small business CGT concessions, Division 7A, taxation of trusts, international tax issues and tax risk management.

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