Professional profit allocation arrangements — ATO to contact ‘higher risk’ practitioners

Allocation of professional profits — ATO to commence contacting practitioners

The ATO has announced that it will be contacting some individual professional practitioners (IPPs) — who may be in a higher risk category — to find out more about their profit allocation arrangements and assist them with using PCG 2021/4 (the Guideline), which came into effect on 1 July 2022.

The ATO will contact IPPs who may be in a higher risk category to:

• understand their unique arrangements and structures
• provide them with practical assistance and guidance about how they can mitigate any risks that may present.

There is a dedicated team responsible for the oversight and management of profit allocation arrangement risks. If an IPP wishes to discuss their profit allocation arrangement with the ATO, they can email ProfessionalPdts@ato.gov.au.

About the Guideline

PCG 2021/4 is about arrangements where:

• taxpayers redirect their income from a business or activity to an associated entity
• that income includes income from their professional services
• the outcome is that they significantly reduce their tax liability.

PCG 2021/4 applies from 1 July 2022. The Guideline replaces the web material published in 2015, Assessing the Risk: Allocation of profits within professional firms guidelines, which was suspended in December 2017.

ATO guidance on the application of the Guideline, including detailed examples, is available here.

The gateways

The IPP must assess if their arrangement is commercial and does not have high-risk features. The IPP must pass these ‘gateways’ before they can apply the Guideline.

Commercial rationale gateway

The IPP must assess if their arrangement is commercial. An arrangement that shows a lack of commercial rationale can:

• seem more complex than necessary to achieve the relevant commercial objective
• appear to serve no real purpose other than to gain a tax advantage
• have a tax result that appears to be at odds with its commercial or economic result
• result in little or no risk in circumstances where significant risks would normally be expected
• operate on non-commercial terms or in a non-arm’s length manner
• present a gap between the substance of what is being achieved and the legal form it takes.

No high-risk features gateway

The IPP must also assess that your arrangement does not have high-risk features.

Arrangements with high-risk features can:

• have financing arrangements relating to non-arm’s length transactions
• exploit the difference between accounting standards and tax law
• be materially different in principle from Everett and Galland (refer to Everett assignments for information on high-risk features of Everett assignments)
• involve multiple classes of shares and units, including creating discretionary entitlements such as dividend access shares
• involve multiple assignments or disposals of an equity interest
• misuse the superannuation system, including assignments or disposals of an interest to associated SMSFs
• distribute income to entities, other than the IPP, with losses.

Consequences

Risk assessment framework

Where the IPP has passed both gateways, they can self-assess against the risk assessment framework.

1.     Complete the risk assessment scoring table

If the IPP returns 100 per cent of the profit entitlement from the firm in their tax return, they are automatically int eh green zone and do not need to assess against the other risk assessment factors.

The total effective tax rate is the average rate of tax for the entire income received from the firm by the IPP expressed as a percentage. It is calculated using the following formula:

Total tax paid by the IPP, and associated entities of the IPP, on professional firm income
÷ Total firm income collectively received × 100

The total effective tax rate excludes any levies such as Medicare levy.

2.     Work out the risk zone

* The IPP can self-assess against the risk assessment factors 1 and 2 only, only if it is impractical to accurately determine an appropriate commercial remuneration against a benchmark for risk assessment factor 3.

The ATO is likely to further analyse the facts and circumstances of the arrangement or initiate compliance activity if either the:

• IPP’s profit allocation arrangement exhibits high-risk features, or
• arrangement has a moderate or high-risk rating.

Certainty for 1 July 2017 to 30 June 2024

The IPP can continue to rely on the suspended guidelines for 1 July 2017 to 30 June 2022 if their arrangement:

• complies with the suspended guidelines
• is commercially driven
• does not exhibit any of the high-risk factors outlined in the No high-risk features gateway.

The arrangement will be considered low risk for 1 July 2017 to 30 June 2022.

The IPP may find that your arrangement was low risk under the suspended guidelines but has a higher risk rating under PCG 2021/4. If so, the IPP can continue to apply the suspended guidelines until 30 June 2024. If the IPP wishes to transition their high-risk rating arrangement to a lower risk zone they can email ProfessionalPdts@ato.gov.au.

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