The ATO have issued a draft Practical Compliance Guideline (PCG 2021/D2) on 26 March 2021 dealing with the allocation of professional firm profits (“Guideline”). The history to the issue of this ruling is somewhat chequered as previous ATO guidelines on the topic were suspended in 2017 with little ATO guidance in the intervening period.
The Guideline addresses arrangements where the compensation received by an individual professional practitioner (“IPP”), as part of a professional firm, is artificially low while related entities benefit without commercial justification.
The Guideline will be operative where, amongst other things, two “Gateways” are not satisfied.
Gateway 1 requires a genuine commercial basis for the arrangements and also for the way in which profits are distributed. Importantly, the form of the arrangement must equal the substance of the arrangement and there must be evidence that the commercial goals are achieved. For example, if a structure is implemented for asset protection purposes, evidence of the added asset protection characteristic must be present.
Assuming you satisfy Gateway 1, Gateway 2 identifies a number of high-risk features that must be assessed to determine if any are present in the structure. These features include:
- financing arrangements relating to non-arm’s length transactions;
- exploiting the difference between accounting standards and tax law;
- assignments of a partnership interest different from Everett and Galland assignments;
- multiple classes of shares and units held by non-equity holders (including dividend access share arrangements).
Finally, the ATO’s compliance approach will vary depending upon how the Guideline rates the arrangement in terms of its risk rating. The assessment of a structures risk in the eyes of the ATO is determined by reference to the following risk assessment factors:
- proportion of profit entitlement from the whole of firm group returned in the hands of the IPP;
- effective tax rate;
- appropriate remuneration.
In assessing the above risks, the ATO take a scorecard approach to determine the level of risk in the structure, where low risk is coded as “Green”, moderate risk coded as “Amber” and high risk coded as “Red”. The ATO state that they will review both Amber and Red structures and will only apply compliance resources to a Green structure in exceptional circumstances.
The Guideline will apply from 1 July 2021 once finalised.”