In brief - Professionals should start reviewing their remuneration arrangements to determine whether the guidelines apply and their risk rating. Arrangements that have a moderate or high risk rating may need to be revised.
The Australian Taxation Office has finalised the guidelines for the allocation of profits by professional firms in PCG 2021/4.
The final guidelines are essentially unchanged from the draft guidelines, which were considered in my article Allocation of profits by professional firms - draft guidelines released.
To recap, the guidelines replace the suspended and interim guidelines for allocation of profits by professional firms in place since 2014 and will likely result in higher tax liability for professionals.
The guidelines require some conditions to be satisfied, including two gateways. If the conditions are satisfied, the arrangement for the allocation of profits is assessed against three risk assessment factors and allocated a rating of low risk (green), medium risk (amber) and high risk (red). The higher the risk rating, the more likely the ATO will undertake compliance action.
The guidelines do not apply to professionals that are non-equity holders. The ATO considers that all of the profits attributable to a non-equity holder should be returned in their personal income tax return.
Commencement date deferred to 1 July 2022, transitional provisions extended to 30 June 2024
The main changes relate to the commencement of the guidelines and the transitional provisions under which professionals can apply the suspended guidelines.
The commencement date has been deferred a year from 1 July 2021 to 1 July 2022 and the transitional provisions have also been extended by a year.
The transitional provisions are available for the years ending 30 June 2018 to 30 June 2022, provided that the arrangements are commercially driven and do not exhibit any high risk features. Arrangements that are considered low risk under the suspended guidelines can continue to apply the suspended guidelines until 30 June 2024. It is no longer necessary for the arrangements to have been entered into before 14 December 2017.
Overview of changes from the draft Guidelines for the allocation of profits by professional firms
Other changes from the draft guidelines include:
an express statement that the ATO's concern increases the more the remuneration of the professional is linked to their individual performance during the year, but is not reflected in the actual direct remuneration to the individual
amendments to the definition of professional firms to expressly include management consulting firms and to clarify that the guidelines do not apply to professions where the professional is not permitted to provide services through an entity
removal of the definition of equity holder, which will create further uncertainty
additional case studies for the disposal of partnership interests and for professional firms carrying on business through company and trust structures
recasting the requirement for gateway one (commercial rationale) that the arrangement be appropriately documented to instead state that the ATO considers it best practice to record the commercial rationale for the decision to adopt the arrangement
information about how to apply the risk assessment factors to part-time professionals and those that work for part of the year (for example, due to sabbaticals), essentially the risk assessment factors are applied on a pro-rata basis
clarification that all components of remuneration are to be included in the risk assessment (cash, superannuation, fringe benefits, other non-cash benefits and tax paid in respect of superannuation contributions and fringe benefits)
recognition that other factors may affect the risk assessment, including timing differences, retention of income within a professional firm in a particular year for commercial purposes, access to tax concessions and provisions, including accelerated depreciation and instant asset write-offs, and other extraordinary business factors
some minor changes to the metrics in risk assessment factors one and two, which are favourable to professionals
toning down some of the language which referred to audit action and to generally encourage professionals to contact the ATO.
This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2023.