The Australian Tax Office (ATO) has expressed concern about the way in which professional practitioners are structuring how Principle Practitioners are remunerated.
To address these concerns the ATO today released additional guidelines to professional practices which they will use to determine the practices likelihood for audit selection.
The information below outlines why the ATO is concerned, what the changes are and what action you should take now in light of these guidelines.
ATO concerns:
- Individual Practitioners not being adequately remunerated directly for services rendered;
- Transfer of assets, particularly goodwill, into new structures without addressing capital gains tax issues; and
- Were there tax avoidance reasons for restructure?
Who does it apply to?
Anyone carrying on professional practice. Whilst the release provides examples related to legal and accounting practices, it is not limited to those professionals and applies to all professional practices including medical, architectural and engineering practices.
What the ATO said
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).
ATO approach As with Service Trusts, the ATO’s position is not that the current law overwhelmingly supports its position, but simply that you either comply with ATO guideline or be prepared to take your case to court. Are you prepared to fund the cost and time to challenge the ATO’s view to establish the correct legal position? Unfortunately, the answer for most is no.
The ATO’s desire to maintain the linkage between ownership and reward for services rendered is becoming redundant and simply overtaken by professional standards legislating changes covering the professional and commercial imperatives such as increased competition, technology changes and globalisation in professional practices. Professional practices are fourth on the list of sectors facing change from what is termed digital disruption.
The ATO’s big stick – Part IVA General Tax anti-avoidance measures
The 2013 amendments to Part IVA are very broad and have the potential to undo the simplest of any tax planning. There is considerable debate as to when these provisions should be used. Are they designed solely for use in large dollar transactions or at an individual level where, although the business operation is commercial, the effect triggers a tax benefit?
In this publication, the ATO indicates that Part IVA will be a consideration.
The critical issue is to consider, what is the amount the law requires a person to be compensated for from the provision of their labour?
This question has not been answered post the 2013 amendments.
What should you do?
If restructuring, identify the commercial benefits sought in undertaking the restructure:
- New enterprise
- Limited liability and asset protection
- Litigation
- Succession
- Commercial reality
- Bank funding
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?
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.
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
Do I need professional help?
If any of these questions are of concern please contact one of our team members or a Partner in Grant Thornton who will put you in contact with the right person to help you. Alternatively send an email to dist.nat.professionalservices@au.gt.com which we will respond to.
Grant Thornton’s Professional Practice Group
Our Professional Practice Group is concerned by the ATO’s approach and is either by direct participation or lobbying through professional associations, seeking greater clarity expressed in relation to the tax treatment of professional practices.
Current issues include goodwill, service trust profits, practitioner remuneration and business income verses personal income.
We would be pleased to hear your view on these issues. Contact us via dist.nat.professionalservices@au.gt.com or call one of our team members to discuss your concerns.
