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In February, the ATO released three new publications in relation to the income tax and FBT treatment of employee travel expenses. These are:

Note:
Draft Ruling TR 2017/D6 has been withdrawn. The content has been replaced by TR 2021/1 and TR 2021/D1.

TR 2021/1 — When are deductions allowed for employees’ transport expenses?

What the Ruling says

An employee can only deduct a transport expense under s. 8-1 to the extent that:

• they incur the expense in gaining or producing their assessable income;
• the expense is not of a capital, private or domestic nature;
• the expense is not incurred in gaining or producing exempt income or non-assessable non-exempt income;
• a provision of the Act does not prevent it from being deducted.

Substantiation requirements must also be satisfied for the employee to claim the deduction.

Deductibility of transport expenses — general principles

While transport expenses will only be deductible if they satisfy the requirements of s. 8-1, the following factors (based on relevant case law) would support a characterisation of transport expenses as being incurred in gaining or producing assessable income:

• the travel fits within the duties of employment, that is, the obligation to incur transport expenses arises out of the employment itself and not the employee’s personal circumstances;
• the travel is relevant to the practical demands of carrying out the employee’s work duties or role, that is, the transport expenses are a necessary consequence of the employee’s income-producing activity;
• the employer asks for the travel to be undertaken;
• the travel occurs on work time;
• the travel occurs when the employee is under the direction and control of the employer.

Common circumstances

The Ruling considers the deductibility of employee transport expenses in a range of common circumstances listed below.

The following table summarises the general rule that applies to each category. However each category has conditions and exceptions and it is necessary to read the Ruling for detail.

Application

The Ruling applies both before and after its date of issue (17 February 2021). To the extent that there is any conflict between the Ruling and draft Rulings TR 2017/D6 and TR 2019/D7, the Commissioner will have regard to the earlier draft rulings in deciding whether to apply compliance resources in income years to which the earlier draft applies.

Examples

The Ruling contains 12 examples. Set out below are two examples illustrating different outcomes where an employee travels between their home and a distant work location which requires an overnight stay, and one example about an ‘on call’ employee.

Transport expenses not deductible — travel between home and a distant but regular work location

(Example 5 in TR 2021/1)

Isabelle is a specialist technician who lives in Brisbane. She works as an employee for a company based in Sydney on a part-time basis. On the days she is required to work (Wednesdays and Thursdays), she drives from her home in Brisbane to the airport, catches a flight to Sydney and then a taxi to her company’s office. She stays overnight in Sydney on Wednesday night and returns home on Thursday evening. Isabelle’s transport expenses (travel between her home and Brisbane airport, return flights from Brisbane to Sydney and taxis between Sydney airport and her office) are not deductible. Isabelle’s travel is undertaken to put her in the position to commence her duties and the expenses are not incurred in gaining or producing her assessable income. The expenses are incurred as a necessary consequence of Isabelle choosing to live in Brisbane and work in Sydney and are a prerequisite to gaining or producing her assessable income. Isabelle’s travel between her home and her regular workplace is also private in nature.

Note:
In contrast, where the nature of the employment requires an employee to travel away from home overnight, for purposes explained by their employment and not because of where they have chosen to live, the transport expenses incurred in travelling to the alternative work location will be incurred in the course of gaining or producing the employee’s assessable income.

Transport expenses deductible — Travel between home and distant work location

(Example 6 in TR 2021/1)

Duy works for a company in Rockhampton, where he lives. One of the employment duties attached to Duy’s role is to attend a two-day meeting and meet clients in Brisbane once a fortnight. Duy flies from Rockhampton to Brisbane on the day of the meeting and returns home the following evening. He also catches a taxi from his home to Rockhampton airport and from Brisbane airport to the office. He does the same in reverse when he returns home. The cost of Duy’s flights and taxis between his home in Rockhampton and the office in Brisbane are deductible as the travel occurs while Duy is engaged in carrying out the employment duties attached to his role. Duy has a regular place of work in Rockhampton and in the performance of his duties travel is undertaken to an alternative destination which is not a regular place of work. Duy is required by the specific requirements of his role to carry out his duties of employment both in Rockhampton and Brisbane. The travel to Brisbane is not attributable to Duy’s choice to live in Rockhampton, or do part of his job in Brisbane. Therefore, the transport expenses are incurred in gaining or producing Duy’s assessable income and are deductible.

Transport expenses deductible — Travel between home and work location — employee on call

(Example 10 in TR 20201/1)

Christine is a highly-trained computer consultant who is involved in supervising a major conversion in computer facilities which her employer provides for its customers. This requires her to be on call 24 hours a day. In order to assist in diagnosing and correcting computer faults while she is at home after her normal work hours, Christine’s employer installs specialised equipment at her home. Typically, matters can be resolved by Christine at home with the use of this equipment but if the problem cannot be resolved at home, Christine travels to the office in order to progress the matter further.

Christine’s cost of travel between her home and the office every day is not incurred in gaining or producing her assessable income. They relate to private travel between her home and her regular work location. However, in circumstances where Christine is called to correct a fault after hours and where she commences work on that fault at home but has to travel to her employer’s premises because she cannot rectify it at home, the cost of travel between her home and the office will be deductible. Although this travel is between her home and a regular work location, the cost of these abnormal journeys is deductible because Christine commences substantive work prior to leaving home and then completes that work once she attends the office. Christine does not choose to do part of the work of her job in two separate places, but rather the two places of work are a fundamental part of Christine providing specialised support arising from the nature of her special duties. The expenses she incurs in travelling to the office in such circumstances are incurred in gaining or producing her assessable income.

Note:
A contrasting situation is where an employee waits at home for advice from their employer whether they are required to work, in a sense on ‘standby’, and does not commence any substantive duties at the place where they receive the call or request from their employer. In such a case, when the employee is advised that they are required at their regular place of work, the expenses of travelling to that regular place of work are not deductible.

TR 2021/D1 – Deductibility of accommodation and food and drink expenses

What the draft Ruling says

The draft guidance for when an employee can deduct accommodation and food and drink expenses under s. 8-1 mirrors the guidance in TR 2021/1 in relation to the deductibility of transport expenses. That is, according to the draft Ruling, an employee can on deduct accommodation and food and drink expenses to the extent that:

• they incur the expense in gaining or producing their assessable income;
• the expense is not of a capital, private or domestic nature;
• the expense is not incurred in gaining or producing exempt income or non-assessable non-exempt income;
• a provision of the Act does not prevent it from being deducted.

The applicable substantiation requirements must also be satisfied for the employee to claim the deduction.

Living expenses — not deductible

Living expenses are a prerequisite to gaining or producing an employee’s assessable income and are not incurred in performing an employee’s income-producing activities.

A person must eat and sleep somewhere, whether or not they engage in employment.

Travelling on work — expenses deductible

The occasion of the outgoing on accommodation and food and drink must be found in the employee’s income-producing activities, rather than in the personal circumstances of where the employee lives.

• Employee travelling on work and the occasion of the outgoing will generally be found in the employee’s income-producing activities — where the employee is required by their employer to stay away from their usual residence overnight for relatively short periods of time.
• The occasion of the outgoing will not be found in the employee’s income-producing activities — where the expenses are incurred because the employee’s personal circumstances are such that they live far away from where they gain or produce their assessable income.

Differentiating between travelling on work versus living expenses

If any of the following factors apply, the employee will not be travelling on work and the accommodation and food and drink expenses incurred will be living expenses:

• the expenses are incurred because the employee’s personal circumstances are such that they live far away from where they gain or produce their assessable income;
• the employee incurs the expenses because they are living at a location;
• the employee incurs the expenses as a result of relocating from their usual residence.

[The emphasised expressions are discussed in detail in the draft Ruling.]

Incidental expenses

Incidental expenses are minor, but necessary expenses associated with travelling on work. This might include a car parking fee, a bus ticket or a charge for using the phone or internet for work-related purposes. If an employee is travelling on work and incurs incidental expenses, those expenses will be deductible under s. 8-1.

Apportionment

If accommodation and food and drink expenses are only partly incurred in gaining or producing assessable income, apportionment is required. Only that portion of the expense that relates to the employee’s income-producing activities is deductible.

In cases where there is no obvious method of apportionment, it is to be done on a ‘fair and reasonable’ basis.

Additional property expenses

Employees who travel frequently to the same location may choose to rent or buy a property rather than stay in a hotel or other commercial accommodation when travelling on work.

A deduction is allowable for expenses incurred in financing, holding and maintaining an additional property which an employee purchases or rents if it is occupied by them as accommodation in the course of travelling on work, except to the extent the expenses are capital, private or domestic in nature.

No deduction will be allowed for additional property expenses if the travel undertaken by the employee is a consequence of the employee’s personal circumstances, including their choice about where to live.

Additional property expenses must be apportioned between deductible and non-deductible where:

• the employee’s expenses are disproportionate to what they would have paid for suitable commercial accommodation; or
• the property is used for private purposes, e.g. family holidays.

Employer payments — FBT implications

There may be FBT implications for an employer where the employer:

• reimburses an employee’s accommodation or food and drink expenses; or
• incurs expenditure on accommodation or food and drink in respect of an employee.

Examples

The draft Ruling contains 12 practical examples.

Travelling on work

(Example 6 in TR 2021/D1)

Mario lives and works in Melbourne. He is employed by a large insurance company. Mario’s regular place of work is his employer’s office in the Melbourne CBD. One of Mario’s duties is to train new staff. When his employer engages some new staff in its Warrnambool office (260 kilometres away), Mario is required to travel to Warrnambool to train the new staff on site for a three-week period. Mario stays in a motel near the Warrnambool office from Sunday to Thursday night for each of the three weeks he is giving the training and returns home on Friday evenings for the weekend.

Mario is not living in Warrnambool away from his usual residence for the three-week period he is giving the training because:

• the Melbourne CBD office remains Mario’s regular place of work for the three-week period;
• the length of the overall period that Mario is away from his usual residence is reasonably short;
• Mario stays in short-term accommodation while he is working in Warrnambool.

The expenditure that Mario incurs on accommodation and food and drink during the period of the training is occasioned by Mario’s income-producing activities. Mario is travelling on work and the expenditure he incurs on accommodation and food and drink while he is working at the Warrnambool office is deductible.

Living at a location away from usual residence

(Example 5 in TR 2021/D1)

Yumi works as a senior executive for an employer based in Brisbane. Her employer is setting up a new office in Townsville and assigns her to the new office for a period of four months in order to assist in setting it up. After spending four months working at the Townsville office, Yumi will return to her usual employment in the Brisbane office.

During the period she is in Townsville, Yumi will occasionally travel to other locations around Australia (including Brisbane) for one or two days to attend work meetings or meet with clients. Yumi will live in a two-bedroom apartment close to the office in Townsville and her family will remain in the family home in Brisbane. However, the apartment in Townsville is big enough to accommodate Yumi’s family.

Yumi will be living in Townsville away from her usual residence for the four-month period due to:

• there being a change in Yumi’s regular place of work from the Brisbane office to the Townsville office;
• the extended period of time she is going to be in Townsville (an overall period of four months);
• the longer-term nature of the accommodation that she stays in while she is Townsville;
• the fact that her family could have accompanied her if they had wanted to.

The expenses that Yumi incurs on accommodation and food and drink while she is in Townsville are living expenses and will not be deductible. This would not change even if Yumi returned to Brisbane each weekend to be with her family. However, when Yumi travels from Townsville to other locations around Australia for work meetings or to meet with clients, she will be travelling on work and the amount she incurs on accommodation and food and drink will be deductible.

Additional property expenses

(Example 10 in TR 2021/D1)

Anwar is employed as an engineer. He lives with his spouse in Adelaide near his regular place of work. His employer assigns him to work on a project in Mount Gambier, almost 500 km away, for nine months.

Anwar will have to travel to Mount Gambier twice a month for three nights at a time. He decides to rent a fully furnished unit in Mount Gambier.

During the nine-month period, Anwar stays in the rented property for 65 nights. The rent was $210 per week. Anwar’s additional property expenses for the period amount to $7,560 ($210 × 36 weeks). This is less than the amount he would have spent if he had stayed in a nearby hotel.

Anwar will be entitled to claim a deduction of $7,560 for accommodation expenses and the amount he spent on food and drink for the periods he was in Mount Gambier. Anwar was travelling on work: his regular place of work remained in Adelaide, he continued living at his usual residence and he was only away overnight for short periods of time.

PCG 2021/D1 – Traveling on work vs living away from home

Who the draft Guideline applies to

An employer who provides the following to their employees (who do not work on a fly-in fly-out or drive-in drive-out basis) may rely on the Guideline once finalised:

• an allowance for:
  • travelling on work, which will be a travel allowance that is assessable to an employee and will not incur FBT; or
  • living at a location which may be a LAFHA benefit;
• a reimbursement of or a payment of an amount that would have been deductible to the employee had they purchased the goods or services (that is, it would be otherwise deductible).

The Commissioner’s compliance approach

The Commissioner will accept that an employee is travelling on work and will generally not apply compliance resources to determine if the above listed benefits relate to expenses for living at a location when all of the following circumstances are satisfied:

• The employer:
  • provides an allowance to an employee or pays or reimburses accommodation and food and drink expenses for the employee;
  • does not provide the reimbursement or payment as part of a salary-packaging arrangement and the employee is not given the option to elect to receive additional remuneration in lieu;
  • includes the travel allowance on the employee’s payment summary or income statement and withholds tax, where appropriate;
  • obtains and retains the relevant documentation to substantiate the fact that all of these circumstances are met.
• The employee:
  • is away from their normal residence for work purposes;
  • does not work on a fly-in fly-out or drive-in drive-out basis;
  • is away for a short-term period being:
    • no more than 21 days at a time continuously;
    • an overall aggregate period of fewer than 90 days in the same work location in an FBT year;
  • must return to their normal residence when their period away ends.

Will the 21-day ‘rule of thumb’ return?

The former MT 2030 had since its release in 1986 provided taxpayers with a ‘practical general rule’ that where the period that the employee spends away from their home base does not exceed 21 days the allowance will be treated as a travelling allowance rather than a LAFH allowance.

MT 2030 was withdrawn with effect from 12 July 2017, two weeks after the release of TR 2017/D6. The (now withdrawn) TR 2017/D6 did not stipulate a practical general rule of 21 days or of any other length of time. This was the result of a ‘deliberate move’ away from relying on the 21 day rule or in fact any other line in the sand, in favour of the guidance and examples in the draft ruling (see the minutes of the FBT States and Territories Industry Partnership meeting held on 28 February 2017).

The preliminary practical guidance set out in PCG 2021/D1 reintroduces a quantitative rule of thumb of 21 consecutive days for determining whether an employee should be treated as travelling rather than living away from home, but with additional requirements as set out above — including an aggregate of fewer than 90 days in the same location in the FBT year.

Examples

The draft Guideline contains three practical examples, of which example 1 is reproduced below.

Allowance is not a LAFH benefit — travelling on work

(Example 1 in PCG 2021/D1)

Kate lives in Perth and does most of her work at her employer’s head office in Perth. From time to time, Kate is required to spend a period of no more than 21 days working in various remote locations in Western Australia. Kate returns to her home in Perth for periods of more than a week before her next trip.

The employer pays Kate an allowance which she spends on accommodation and food and drink. Kate is away for a period of fewer than 90 days in total in the same location in the FBT year.

The allowance is included in Kate’s assessable income and Kate may be entitled to a deduction for her accommodation and food and drink expenses.

The employer is able to rely on the Guideline (once finalised) — i.e. the requirements are met such that the Commissioner would accept that Kate is travelling on work. The employer is paying Kate a travel allowance and not a LAFHA. The employer is not liable for FBT on the allowance paid.

Further info and training

Join us at the beginning of each month as we review the current tax landscape. Our monthly Online Tax Updates and Public Sessions are excellent and cost effective options to stay on top of your CPD requirements. We present these monthly online, and also offer face-to-face Public Sessions at locations across Australia. Click here to find a location near you.

If you’re not a current client, we can also present these Updates at your firm (or through a private online session) with content tailored to your client base – please contact us here to submit an expression of interest or visit our In-house training page for more information.

Our mission is to offer flexible, practical and modern tax training across Australia – you can view all of our services by clicking here.

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Tax Determination TD 2021/2 (the Determination), released on 24 February 2021, confirms that a company whose only activity is renting out an investment property cannot claim the small business CGT concessions in Div 152 of the ITAA 1997 even if it is ‘carrying on a business’ in a general sense as described in TR 2019/1 (the Ruling). This article sets out the Commissioner’s view in this recent Determination with references to other ATO pronouncements for context and explanation.

Why the small business CGT concessions do not apply

For the small business CGT concessions to apply to reduce a capital gain arising in relation to a CGT asset, the CGT asset must satisfy the active asset test in s. 152-35 of the ITAA 1997.

To pass the test, the asset must be an ‘active asset’ of the taxpayer for a minimum period of time during the ownership period (see the end of the article for details).

An asset is an ‘active asset’ at a particular time if it is being used in (or — in the case of an intangible asset — it is inherently connected with) a business that is carried on by the taxpayer, the taxpayer’s affiliate, or an entity connected to the taxpayer.

However, an asset whose ‘main use’ by the taxpayer is to derive rent is automatically excluded from the definition of an active asset. See below for details of ATO guidance on when an asset is mainly used to derive rent.

The Determination confirms that it is the Commissioner’s view that such assets are excluded even if they are used in the course of carrying on a business.

Example from the Determination

InveproCo is a company incorporated in Australia. InveproCo owns a commercial property, which it has rented to unrelated third parties at market rates on normal commercial terms since its inception. InveproCo provides no other services in relation to the property and conducts no other activities. InveproCo has produced a profit in each of the income years it has rented out the property. InveproCo is engaged in ongoing activities that have a purpose and prospect of profit, namely letting out the property.

In this situation, the company has derived rental income from the leasing of a property to an unrelated third party. Accordingly, the company carries on a business in a general sense described in TR 2019/1. However, the main (only) use of the property is to derive rent and it is therefore excluded from being an active asset under s. 152-40(4)(e) regardless of whether the activities constitute the carrying on of a business in a general sense. Therefore, the investment property would not satisfy the active asset test in s. 152-35 and InveproCo would not meet the requirement in s. 152-10(1)(d) to be eligible for the CGT small business concessions in Division 152 in relation to the disposal of the investment property.

Further explanation

Company renting out a property can be ‘carrying on a business’

A company whose only activity is renting out an investment may be considered to be ‘carrying on a business’ in a general sense in accordance with the Ruling.

The Ruling states that a company that carries on a business can do so ‘in a general sense’, irrespective of what is the actual business, or it can ‘carry on a particular business’.

The Ruling deals with the question of whether a company carries on a business in a general sense for the purposes of:

• the lower corporate tax rate eligibility criteria for 2015–16 and 2016–17 in s. 23 of the Income Tax Rates Act 1986;
• the small business entity (SBE) definition in s. 328-110 of the ITAA 1997.

Note:
The Ruling does not deal with the meaning of ‘carrying on a businesss’ for the purposes of the active asset test; however it provides useful guidance as to the Commissioner’s views on when a company that passively derives rental income is carrying on a business for those purposes.

In the circumstances contemplated in the Determination, there is no practical difference in the outcome whether or not the company is carrying on a business in relation to the rental activity, given that the asset is excluded from the definition of an active asset if its main use is to derive rent. However the guidance in the Ruling may be relevant in considering whether other types of assets satisfy the active asset test, depending on whether the company is considered to be carrying on a business.

The Ruling makes the following observations:

• where a company aims to make, and has a prospect of profit, it is presumed that the company intends to, and does in fact, carry on a business (Westleigh and American Leaf cases);
• any profit-making activities a company conducts are unlikely to have a domestic or personal character, and are likely to be characterised as being commercial in nature — unlike those of an individual or trust.

The Ruling concludes that:

where a … company is established and maintained to make a profit for its shareholders, and invests its assets in gainful activities that have both a purpose and prospect of profit, it will normally be carrying on a business in a general sense …. This is so even if the company’s activities are relatively limited, and its activities consist of passively receiving rent or returns on its investments and distributing them to its shareholders.

Main use to derive rent

TD 2006/78 provides examples of when the Commissioner considers property is for the main use of deriving rent for the purposes of the active asset test exclusion. In some of the examples, the ATO considers that the income derived is not ‘rent’ and therefore the exclusion does not apply. These arrangements include:

• the provision of commercial storage space;
• an eight-bedroom boarding house where the average length of stay is four to six weeks;
• a holiday apartment complex operated like a motel;
• mixed used of land — 80 per cent of total income derived from the land relates to the taxpayer’s business and 20 per cent from rental.

The active asset test condition

The active asset test requires the CGT asset to be an ‘active asset’ of the taxpayer for:

Further info and training

Join us at the beginning of each month as we review the current tax landscape. Our monthly Online Tax Updates and Public Sessions are excellent and cost effective options to stay on top of your CPD requirements. We present these monthly online, and also offer face-to-face Public Sessions at locations across Australia. Click here to find a location near you.

Our Upcoming April Tax Update will cover this topic in full. If you’re a current in-house or public session client, you can expect complete coverage of this topic in your next session.

If you’re not a current client, we can also present these Updates at your firm (or through a private online session) with content tailored to your client base – please contact us here to submit an expression of interest or visit our In-house training page for more information.

Our mission is to offer flexible, practical and modern tax training across Australia – you can view all of our services by clicking here.

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Podcast:
Check out our new Tax Yak podcast episode of this topic here.

The ATO has released long-awaited draft guidance on its proposed compliance approach to the allocation of professional firm profits. The preliminary guidance is contained in the draft Practical Compliance Guideline PCG 2021/D2 (the draft Guideline). The ATO has also released a fact sheet ‘Assessing the risk: allocation of profits within professional firms’ (QC 42218) in relation to the draft Guideline.

When finalised, the Guideline will replace the professional firm guidelines that were suspended in December 2017 (the Suspended Guidelines).

Comments and submissions

Due Date: 26 March 2021
Contact Officer: Simon Webster
Email address: simon.webster2@ato.gov.au
Telephone: (03) 9275 5328

About the draft Guideline

Background
The ‘Assessing the Risk: Allocation of profits within professional firms guidelines’ and Everett Assignment web material published in 2015 stated that they would be reviewed in 2017. In reviewing the guidelines the ATO has become aware they are being misinterpreted in relation to arrangements that go beyond the scope of the guidelines.
The ATO has, for the years ended 30 June 2018 and 30 June 2019, stated that taxpayers who entered into arrangements prior to 14 December 2017 which comply with the guidelines and do not exhibit any of certain high risk factors can continue to rely on the suspended guidelines.

The draft Guideline explains how the ATO intends to apply compliance resources when considering the allocation of professional firm profit or income in the assessable income of an individual professional practitioner (IPP). The draft Guideline also assists an IPP to self-assess their risk.

The ATO is concerned about arrangements involving taxpayers who redirect their income to an associated entity from a business or activity which includes their professional services, where it has the effect of altering their tax liability.

The use of companies, trusts and other business structures do not of themselves give rise to avoidance concerns. However, the use of those structures can provide the controllers of a business with an opportunity to redirect income from them. When the business involves the provision of services, the ATO will be concerned with arrangements where the compensation received by the individual is artificially low while related entities benefit (or the individual ultimately benefits), and commercial reasons do not justify the arrangement.

The Commissioner’s preliminary view is that the profit or income of a professional firm may comprise different components — reflecting a mixture of income from the efforts, labour and application of skills of the firm’s IPPs (that is, personal exertion) and income generated by the business structure.

Warning — potential application of Part IVA
In some cases, professional firm income has been treated as being derived from a business structure, even though the source of that income remains, to a significant extent, the provision of professional services by one or more individuals. In that context, the ATO may apply Part IVA of the ITAA 1936 where income is redirected away from the individuals, despite the existence of a business structure.

Date of effect

Once finalised, the Guideline will apply prospectively from 1 July 2021. The application of the Guideline will be reviewed from 2022. Revisions will be made on an ‘as necessary’ basis.

Transitional arrangements

Taxpayers who entered into arrangements prior to 14 December 2017 are able to continue to rely on the Suspended Guidelines for the years ending 30 June 2018, 30 June 2019, 30 June 2020 and 30 June 2021, as long as their arrangement complies with those Suspended Guidelines, is commercially-driven, and does not exhibit any of the high-risk features outlined in the draft Guideline.

In recognition that certain arrangements considered low risk under the Suspended Guidelines may have a higher risk rating under the draft Guideline, the ATO is allowing a grace period for those IPPs to take the required steps to modify their arrangements to be lower risk, if they choose. Accordingly, those IPPs may continue to apply the Suspended Guidelines to their arrangements until 30 June 2023.

If a taxpayer identifies that they are no longer low risk, and they wish to transition their arrangements to a lower risk zone, they can inform the ATO of their intentions at any time. If the taxpayer engages with the ATO in good faith, this engagement will be on a ‘without prejudice’ basis.

A taxpayer should also contact the ATO if they are considering restructuring in a way that may not be assessed as low risk under the draft Guideline.

The ATO has a dedicated team for the oversight and management of profit allocation arrangement risks. Email: ProfessionalPdts@ato.gov.au

Protection available to taxpayers

It is important to note that the draft Guideline does not propose a ‘safe harbour’.

However, if a taxpayer’s circumstances align with the low-risk rating, the ATO will generally not allocate compliance resources to test the relevant tax outcomes.

The ATO is continuing work to identify taxpayers whose circumstances fall outside the draft Guideline or who wish to nominate themselves as a test case to obtain judicial guidance.

Key definitions

When the draft Guideline applies

The draft Guideline applies if all of the following criteria are met:

• an IPP provides professional services to clients of the 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 PSI;
• the firm operates by way of a legally effective structure, for example, partnership, trust or company;
• an IPP is an equity holder, that is, an IPP holds full rights to participate in the voting, management and income of the firm;
• the arrangement is commercially driven, that is, it satisfies Gateway 1 (see below);
• the firm and IPP do not demonstrate any high-risk features, that is, it satisfies Gateway 2 (see below).

The proposed risk-based compliance approach

The gateways

The ATO’s proposed risk-based compliance approach requires two qualifying ‘gateways’ to be passed before applying the risk assessment framework.

Gateway 1 — Commercial rationale

Gateway 1 considers whether the implemented arrangement and the way in which it operates are commercially driven.

There must be a genuine commercial rationale for the arrangement for all parties involved and the arrangement must achieve that end.

The arrangement must also be appropriately documented and there must be evidence that the stated commercial purpose was achieved as a result of the arrangement.

Indicators that an arrangement lacks a sound commercial rationale include the following:

• unnecessary complexity;
• a step, or a series of steps, that appear to serve no real purpose other than to gain a tax advantage;
• the tax result appears at odds with the commercial or economic result;
• little or no risk where significant risks would normally be expected;
• the parties are operating on non-commercial terms or in a non-arm’s length manner;
• a gap between the substance of what is being achieved and the legal form.

There must also be a genuine commercial basis for the way in which profits are distributed within the group, especially in the form of remuneration paid. Relevant considerations are whether:

• the IPP actually receives an amount of the profits or income which reflects a reward for their personal efforts or skill;
• the income has been distributed in substance;
• the IPP ultimately benefits from the distribution of income to associates, which is referrable to the personal efforts or skill of the IPP;
• the remuneration is less than a true commercial comparable and would not be perceived as an arm’s length payment;
• there are loan accounts relevant to the arrangement — whose name those accounts are in and whether they are aware of the loans;
• the payment recipients:
• have control in managing the entity’s cash flows and financials;
• actually receive the money and keep it, or whether it is distributed out to others. Where they do receive the money, whether it is available for their use and enjoyment, or is in fact predominantly for the IPP’s use and enjoyment.

Gateway 2 — High-risk features

High-risk features may include:

• arrangements covered by a Taxpayer Alert;
• financial 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 are materially different in principle from Everett and Galland;
• multiple classes of shares and units held by non-equity holders.

The list of high-risk features will be subject to amendment and addition as the ATO becomes aware of further high-risk arrangements.

The risk assessment framework

Step 1: Risk assessment scoring table

Where the taxpayer satisfies Gateways 1 and 2, they may self-assess their risk level against each of the risk assessment factors:

Step 2: Risk zones

The aggregate of the scores determines which risk zone applies:

* Note: The use of the third risk assessment factor is optional as the ATO recognises that it is difficult to determine accurately.

The first two risk assessment factors may be used, instead of all three, where it is impractical to accurately determine an appropriate commercial remuneration against which to benchmark.

Implications
Where an IPP returns 100 per cent of the profit entitlement from the firm in their personal tax return (i.e. risk assessment factor 1), the IPP is automatically within the green zone. There is no need to assess against the other factors.

Proposed ATO treatment

Green risk zone

The ATO will only apply compliance resources to review the taxpayer’s allocation of profit in exceptional circumstances, e.g. where:

• the ATO is not satisfied your self-assessment is correct, or is adequately supported with evidence;
• the ATO becomes concerned that higher-risk features are present in the arrangement;
• the ATO becomes concerned, from its data and analysis, that there is a change in the arrangement causing a shift towards the border of compliance;
• the ATO becomes concerned that the broader arrangements present a compliance risk (e.g. Div 7A);
• the arrangement relates to a broader set of circumstances being reviewed;
• changes to the arrangement may not have been appropriately treated or disclosed.

Amber risk zone

The ATO is likely to conduct further analysis on the arrangement. The ATO may contact the taxpayer to understand the arrangement and resolve any areas of difference.

Red risk zone

Reviews are likely to be commenced as a matter of priority. Cases may proceed directly to audit.

The ATO is likely to use formal powers for information gathering.

Note — Substantiation of assessment
If the taxpayer is unable to provide evidence to support their assessment, the ATO may undertake further compliance activity.

Examples

The draft Guideline includes five examples illustrating how to apply different aspects of the proposed compliance approach and seven case studies.

Case study 2 — IPP disposes of 40% of partnership interest and receives service trust income

Donald is an IPP in a partnership. The partnership has a service entity in its group that provides services to the partnership. Donald has disposed of 40 per cent of his interest in the partnership to a discretionary trust. The beneficiary of the discretionary trust is an associated company. An adult individual associated with Donald is a beneficiary of the service entity.

Donald’s income entitlement from the partnership is $800,000. There is also an entitlement to $80,000 profit from the service trust. Therefore, the aggregate of the total profit entitlement is $880,000.

Donald includes $480,000 of the partnership income in his tax return, the corporate beneficiary includes $320,000 in its tax return, and the service trust income of $80,000 is distributed to the adult individual beneficiary.

The risk assessment is as follows:

Risk assessment factor 1 — Proportion of profit entitlement from the whole of firm group returned in the hands of the IPP

$480,000, or 54.5 per cent of Donald’s entitlement of $880,000 is returned by Donald personally.

Score: 4

Risk assessment factor 2 — Total effective tax rate for income received from the firm by the IPP and associated entities

Using 2020–21 tax rates, the tax paid is:

The total effective tax rate is 32.53 per cent.

Score: 3

Risk assessment factor 3 — Remuneration returned in the hands of the IPP as a percentage of the commercial benchmark for the services provided to the firm

Not applicable. Donald has determined that in the circumstances it is impractical to accurately determine an appropriate commercial remuneration to benchmark against and therefore his aggregate score is determined against the first two factors only.

Score: 0

Total score: 7

The aggregate score of seven places Donald’s arrangement in the green zone.

Further info and training

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