Profit allocation guidelines for professional firms

October 2014

In our September bulletin, we raised some concerns about the ATO's recently published anti-avoidance guidelines, which explain how it will assess the risk of Part IVA applying to the profits from a professional firm carried on through a partnership, trust or company, where the income is not personal services income. 

While the ATO acknowledges that professional practices may operate as business structures, it has stated that it is reviewing remuneration arrangements used by accountants, lawyers or other professionals to ensure that those structures are used appropriately.

Applying the guideline principles

• An individual professional practitioner (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 firm operates by way of a legally effective partnership, trust or company; and
• The income of the firm is not personal services income.

ATO's risk assessment guidelines + compliance 

The ATO has set out some risk assessment guidelines that will be applied and indicated that it plans to allocate compliance resources to taxpayers who fall within the higher risk categories. 

However, taxpayers should be rated as low risk where their circumstances indicate that they meet at least one of the following "safe harbour" guidelines regarding their income from the practice: 

1. Assessable income in return for services: The IPP receives assessable income from the firm in their own hands as an appropriate return for the services they provide to the firm. In determining an appropriate level of income, the taxpayer may use the level of remuneration paid to the highest band of professional employees providing equivalent services to the firm, or if there are no such employees in the firm, comparable firm s or relevant industry benchmarks – for example, industry benchmarks for a region provided by a professional association, agency or consultant.
2. Collective entitlement to 50% or more of the income to which the IPP and their associated entities are collectively entitled (whether directly or indirectly through interposed entities) in the relevant year is assessable in the hands of the IPP.
3. Effective tax rate of 30% or higher: The IPP, and their associated entities, both have an effective tax rate of 30% or higher on the income received from the firm.

Guidelines versus legislation

The area we remain most concerned about is the application of the guidelines without legislation in place, as well as the issue around taxing IPPs at an income equivalent to their highest paid employee.