The ATO has published the long awaited draft revision of the Practical Compliance Guideline PCG 2021/D2 for the allocation of profits by professional firms.
The PCG will take effect from 1 July 2021 and supersedes the previously “Suspended Guidelines” Assessing the risk: allocation of profits within professional firms guidelines.
However, taxpayers may still rely on the Suspended Guidelines for pre 14 December 2017 arrangements for the 30 June 2018 to 2021 income years (or to 30 June 2023 for existing “low risk” taxpayers transitioning to comply with the PCG) if those arrangements comply with the Suspended Guidelines.
Concerns over redirection of income
The ATO has concerns, due to the organisational structure of professional firms, about firm arrangements involving the redirection of income from an Individual Professional Practitioner (IPP) to an associated entity, which could alter the IPP’s tax liability. As such, the ATO is proposing a risk assessment framework to assessing compliance by IPP’s. In order for IPPs to access the framework set out in the PCG, some pre-conditions must be satisfied including meeting the following two ‘Gateways’:
- Gateway 1 - There is sound commercial rationale for entering into and operating the arrangement or structure; and
- Gateway 2 - There must not be certain ‘high-risk features’ as set out in the PCG.
If an IPP’s arrangement satisfies the pre-conditions, including both gateways, the ATO’s risk assessment framework can assist the IPP understand the tax risks that their arrangement exhibits, depending on whether the arrangement is classified as a low (green), medium (amber) or high (red) risk. Generally, the lower the risk the IPP’s arrangement exhibits, the more favourable the ATO’s compliance approach will be towards the IPP.
Where an IPP’s arrangement fails to meet either or both of the two “Gateways”, the risk assessment framework set out in the PCG will not be available to the IPP and the Commissioner may seek to review the arrangement and apply the anti-avoidance provisions under Part IVA of the ITAA 1936.
The PCG cannot be relied upon by non-Equity partners/IPPs.
What must you do now?
Professional service firms should review by 1 July 2021 their existing arrangements and forecast income distributions for FY2022 to assess how they measure up under the relevant Gateways and Risk Assessment Framework.
We attach our detailed Tax Alert here for more information on this matter.
If you are affected by the PCG and require assistance in applying it, please contact your Grant Thornton representative to discuss the next steps on this matter.
We have provided a submission to the ATO requesting further detail around for main points to support professional services firms to understand their obligations going forward.
Below are the key points from our submission:
- The ATO should reinstate the 2014 Suspended Guidelines.
- The ATO should clarify some important issues if the PCG is to be implemented:
- How the PCG applies in an incorporated practice scenario (examples 1 and 2)
- How the PCG will not disadvantage low income practices (example 3)
- How the PCG will not disadvantage part-time IPPs and non-equity partners (examples 4, 5 and 6)
- CGT issues arising from an Everett Assignment (example 7)
- Professions to be covered by the PCG (example 8)
- The ATO should modify the PCG if the PCG is to be implemented:
- Expand the PCG to cover non-equity partners to avoid discrimination against future leaders and part time IPPs
- Exclude Services Trusts from the calculation,
- Modify the risk matrix (as suggested in Submission 3),
- Provide that a risk score of 2 under any factor will result in IPP being low risk (as suggested in Submission 3)
- Provide simple arms-length remuneration tests (as suggested in Submission 3)