Profits of professional firms under ATO spotlight

The Tax Office has revised its guidance on the taxing of profits made by certain professional firms. The professional businesses within its sights include, but are not limited to, firms operating in the accounting, architectural, engineering, financial services, legal and medical professions.

In particular, it is concerned about the risk of arrangements that on the surface comply with tax law but are intentionally designed to dodge tax (what the Tax Office labels as “Part IVA”). Certain professional firms can achieve just this through how they are structured.

Often the result of economic and legal choices made by business owners, business structures can also influence tax consequences. The Tax Office’s concern stems from the risk of Part IVA applying to the allocation of profits from a professional firm carried on through a partnership, trust or company where the income of the business is not “personal services” income.

The Tax Office says its revised guidelines take into account feedback it has received through consultation about the practical issues at work. It says its booklet “Your service entity arrangements” still applies, but that it is committed to reviewing its guidelines “subject to the possibility of judicial guidance pending an appropriate test-case being identified”.

Benchmarks have been established by the Tax Office to use when examining income earned by individual professional practitioners (IPPs) to help it identify situations that it says may require Part IVA risk assessment. There are three such benchmarks:

  • Equivalent remuneration — the IPP should be remunerated an equivalent amount to the upper quartile of the highest band of professional employees providing similar services to the firm, like employees of comparable firms or relevant industry benchmarks
  • 50% entitlement — half or more than half of the income from the firm to which the IPP is entitled (directly or indirectly through interposed entities) should be assessable
  • 30% effective tax rate — the income from the firm to which the IPP (and associated entities) is entitled must be taxed at 30% or more.

The last benchmark will also take into account the taxable value of fringe benefits.

The Tax Office also says it will use gross income when considering the benchmarks, although for assessment purposes deductions, losses and offsets will naturally continue to be able to be utilised.

It says that a professional firm that does not satisfy one of the benchmarks will be considered high risk, especially where the effective tax rate arrived at due to business arrangements is low.