Tax Update - The ATO is Targeting Professional Practices

Over the past 4 years, the ATO has been running a review project on professional practices such as accounting, legal, architectural engineering, medical etc - any business that provides professional services where senior staff have access to or control over equity.Recently, the ATO published additional draft guidelines for risk assessment and audit selection for professional practices. These guidelines will commence for compliance reviews related to 2014/2015 tax year and beyond addressing the way in which Principals are remunerated.

Principals working in a professional practice are to be assessed as higher risk and therefore more likely to be reviewed unless they meet 1 of 3 tests outlined in the guidelines issued by the ATO.

The ATO are concerned that:

• Individual Practitioners are not being adequately remunerated directly for services provided;
• Assets are being transferred (particularly goodwill) into new structures without addressing capital gains tax issues; and 
• There may be tax avoidance reasons for a restructure.

Who is targeted?

The guide first carves out who it doesn’t apply to – if you earn Personal Services Income (PSI), you use the PSI rules and if you are a tradesperson you are also outside this guide. If you are a firm of accountants, lawyers, architects, engineers, financial services providers and the medical profession etc – you need to read on!

What are the tests?

A new risk assessment tool will apply for audit selection for tax returns starting with the 2015 tax year. There is a higher risk of a Tax Audit if you can’t satisfy at least one of the following three tests:

Test 1

The individual receives comparable remuneration in their own hands as an appropriate return for the services they provide to the firm. “Appropriate” is measured as the level of remuneration paid to the highest band of professional employees providing equivalent services to the firm, or if there is no such employee in the firm, industry benchmarks for the relevant region; and/or

Test 2 

50% or greater of the total profit distributions the partner receives in the relevant income year are distributed directly to the individual practitioner (including from associated service entities); and/or

Test 3 

The individual practitioner and their associated entities have an effective tax rate of 30% or higher on the profits derived from the firm, an amount is distributed to the practitioner and there are no other higher risk features to the arrangement (these would include such things as income injection to access carried forward losses, inappropriate access to business profits, avoidance of Division 7A or other tax benefits or non-tax advantages which are dependent on taxable income).

There is no suggestion that the ATO would necessarily apply any of these tests in an actual review or audit. So passing these tests does not ensure you're in a safe harbour. Importantly, these guidelines are still considered draft. 

What can I do?

1. If you’re restructuring, identify the commercial benefits sought in undertaking the restructure:

• New enterprise 
• Limited liability and asset protection 
• Litigation
• Succession
• Commercial reality 
• Bank funding 

2. Review profit sharing arrangements in light of the three ATO tests

• Do I satisfy one of the tests?
• Consider the impact on the practice and equity participants
• Can and will you comply?

3. If you have you restructured ...

• Did you address CGT and GST issues?
• Did you address stamp duty?
• Is the restructure documented?
• What was the commercial benefit?
• What governance steps have been implemented to reflect the structure used. 

4. How much income does an individual professional practitioner need to earn?

• Is the income ‘business income’ or ‘personal services income’?
• ATO risk profile considerations
• Service trust guidelines
• Commercial considerations relevant to circumstances

At Altus, we are encouraging our clients to review their situations and if necessary, take steps during the 2015 year to meet the tests outlined. Our intention will be to review your position on the back of your 2014 year results and structures.