ATO’s compliance approach - allocation of professional firm profits

Joel Ashworth

Senior Manager

16 December 2022 will mark 12 months since the ATO’s release of Practical Compliance Guideline PCG 2021/4 – the new tax compliance approach to the allocation of professional firm profits.

With a commencement date of 1 July 2022, this means that we are now halfway through the first income tax year where these new guidelines apply, and that time is running out to make sure your affairs are structured appropriately to minimise your risk of a tax audit.

Who is subject to the new guidance?

ATO PCG 2021/4 applies to every ‘individual professional practitioner’, being an individual ‘professional’ that provides services to clients of a professional firm, or to the firm itself, and either alone or together with associates has a legal or beneficial interest in the firm.

So who are these professionals? The guidance is broad and states that a ‘professional’ is a member of any recognised profession. This will capture many, many roles, including:

Doctors
Dentists
Accountants
Engineers
Lawyers
Real Estate Agents
Architects
Financial Advisors
Management & Other Consultants

Where a particular professional has applied the now-suspended 2015 guidelines to their arrangements, and their arrangements are commercially driven and do not exhibit any high-risk features, they can continue to rely on the suspended guidelines until 30 June 2024. After this date, only PCG 2021/4 will apply.

Why does the new guidance matter?

ATO PCG 2021/4 sets out the ATO’s compliance approach to reviewing a taxpayers affairs with a traffic light risk rating system that assesses the ATO’s view on whether the taxpayer is at risk of breaching the general anti-avoidance provisions of Part IVA of the Income Tax Assessment Act 1936.

Green rating = low risk and only be subject to ATO review in exceptional circumstances

Amber or Red rating = likely to be subject to review

If you are subject of a review, not only will you be required to prove to the ATO that you are not undertaking any tax avoidance activities in the allocation of your professional firm profits, but you are also opening the door for the ATO to review all aspects of your tax affairs, including:

Cases of non-recognition of net capital gains
Misuse of the superannuation system
Income injection into entities with carry-forward losses
The application of Division 7A
The application of section 100A

How is the rating calculated?

To obtain a risk rating under ATO PCG 2021/4, you must satisfy a number of criteria, including the following two key gateway criteria.

Commercial rationale – there must be a genuine commercial basis for the arrangements implemented
No high risk features – the arrangements must not exhibit any high-risk features, including:
1. Non-arms length financing arrangements
2. Exploitation of the different between accounting standards and tax law
3. Assignment of partnership interest differently to the principles accepted in Everett and Galland
4. Multiple classes of shares
5. Any other arrangement covered by an ATO taxpayer alert

Only once the above gateway criteria have been satisfied can a taxpayer rely on a risk rating calculated in accordance with PCG 2021/4.

The risk rating is a score based on an assessment against three criteria. The criteria and scoring are outlined in the below table from PCG 2021/4:

Risk assessment factor	Score
	1	2	3	4	5	6
(1) Proportion of profit entitlement from the whole of firm group returned in the hands of the IPP	>90%	>75% to 90%	>60% to 75%	>50% to 60%	>25% to 50%	25%
(2) Total effective tax rate for income received from the firm by the IPP and associated entities	>40%	>35% to 40%	>30% to 35%	>25% to 30%	>20% to 25%	20%
(3) Remuneration returned in the hands of the IPP as a percentage of the commercial benchmark for the services provided to the firm	>200%	>150% to 200%	>100% to 150%	>90% to 100%	>70% to 90%	70%

The result of these scores will then determine the taxpayers risk rating as follows:

Risk Zone	Risk Level	Aggregate score against first two factors	Aggregate of all three factors
Green	Low Risk	7	10
Amber	Medium Risk	8	11-12
Red	High Risk	>9	>13

What should you do?

If the ATO PCG 2021/4 applies to you, it is important that you find out your rating so that you can understand your level of risk and exposure to an ATO review.

If your current arrangements don’t have a Green rating, there’s still time to make adjustments to reduce your risk - but time is running out. Once we reach 30 June 2023, your rating for FY23 will be locked in. The sooner you understand your rating, the more time you will have to make any adjustments that are required.

For more information

To have a check up on your arrangements, please get in contact with your local RSM office.

ATO’s compliance approach - allocation of professional firm profits