ATO audit risk assessment factors for application in 2014–15 and beyond for remuneration of principal practitioners.
Historically, in the context of professional service firms, the general anti-avoidance provisions have been applied by the ATO to assess individuals on income generated by their personal exertion or application of their professional skills (i.e. personal services income assessments).
Deviating from this traditional focus, the ATO has released guidelines on how Part IVA has potential application to the allocation of profits or income generated by a business structure of a professional firm. Where an individual professional practitioner’s (IPP) or ‘principal practitioner’ attempts to alienate amounts of income flowing from their personal exertion (as opposed to income generated by the business structure), the ATO may consider cancelling relevant tax benefits under Part IVA.
The ATO will focus on relevant arrangements within professional firms including, but not limited to, those providing services in the accounting, architectural, engineering, financial services, legal and medical professions, and that have the following features:
- 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; and
- the firm operates by way of a legally effective partnership, trust or company; and
- the income of the firm is not personal services income.
In this regard, practitioners need to be aware that just because an arrangement (which results in diverting income) satisfies the tests in the “personal services income” rules, it does not necessarily mean their position is free from risk from an ATO adjustment.
If you are a professional services business operating by way of a partnership, trust or company, each principal practitioner’s allocation of income should be reviewed and assessed in light of the ATO’s risk assessment guidelines.
Does the practice firm satisfy at least one of the ATO’s risk assessment benchmarks? If not, professional firms and their owners need to make a determination as to whether they should seek to satisfy at least one of the three factors to avoid the ATO’s proposed compliance activity (or more closer to satisfying a benchmark to minimise exposure).
ATO risk assessment guidelines – Benchmarks
Taxpayers will be rated as low risk, and will not be subject to compliance action on this issue, where their circumstances indicate they meet at least one of the following benchmarks regarding income from the firm (which includes income by way salary, distribution of partnership or trust profit, distributions from associated service entities, dividends from associated entities or any combination of these). These benchmarks apply now, i.e. the 2014–15 income year and beyond.
Note: Prior ATO guidance dealing with the interaction between the service entity and the professional practice continues to apply. Accordingly, the income from the service entity is included as part of the firm’s income when applying the below benchmarks.
Application to Everett assignments
The ATO have revisited its position and now considers that Part IVA is capable of application to Everett assignments in appropriate cases.
The application of Part IVA will be considered in relation to Everett assignments entered into in the 2015-16 income year and beyond. This means that from 1 July 2015, if an IPP has entered into an Everett assignment, one of the benchmarks needs to be met in order for the assignment to be rated as low risk. If this is the case, the ATO will not seek to invoke Part IVA in relation to the arrangement.
Summary of ATO audit risk categories
Professional firms may be classified by the ATO as high or low audit risk as summarised below.
Low audit risk: Taxpayers meet on of the three benchmarks. No compliance action on this issue.
High audit risk: Taxpayers do not meet any of the three benchmarks outlined above.
Note: The IPP is not obliged to apply the same benchmark each year in order to be ‘low risk’.
Note: In high audit risk cases, the lower the effective tax rate, the greater the likelihood of ATO compliance action being commenced. Relevantly, a firm may be a ‘low audit risk’ in this audit context, but still be categorised as ‘high audit risk’ due to non-compliance with other tax issues.
Note: Business restructures undertaken for the purpose of obtaining a lower effective tax rate (whilst still meeting the 30% benchmark requirement) should be carefully considered as other general anti-avoidance rules may apply.
In light of the above, it is pertinent that your allocation of business profits and service arrangements be reviewed to ascertain whether each IPP or principal practitioner’s income is compliant with the ATO’s published benchmarks and to identify any potential audit risk.
If we can assist you in this regard, please do not hesitate to contact our tax advisory team on (07) 3391 5055.
Disclaimer: This publication contains general information only and is not intended to constitute financial product advice. Any information provided or conclusions made, whether express or implied, do not take into account the investment objectives, financial situation and particular needs of an investor. It should not be relied upon as a substitute for professional advice.