The Australian Taxation Office (ATO) have now released their ‘guidelines’ regarding the allocation of profits derived by professional services firms. 

The ATO are threatening audit and the potential application of the general anti-avoidance rule where not enough of the income generated from a professional service firm is ultimately derived by the ‘individual professional practitioner’ (IPP) involved in the business (for example a partner or director) or not enough taxation is paid on the income from the business.

The ATO have three criteria by which they will judge individual partners or owners of a practice with the potential for compliance activity to commence from the 2014/2015 tax year.

In the absence of aggravating factors, the ATO have indicated that they will focus compliance activity on ‘high risk’ practitioners that do not meet any of the three criteria.  The three criteria are:

  • the IPP receives assessable income from the firm in their own hands as an appropriate return for the services they provide to the firm which may be determined using the level of remuneration paid to the highest band of professional employees providing equivalent services to the firm
  • 50% or more of the income to which the IPP and their associated entities are collectively entitled from the firm and associated firm entities is assessable in the hands of the IPP, or
  • the IPP and their associated entities both have an effective tax rate of 30% or more on the income received from the firm.

It should be noted that these tests, by their nature, apply to an individual practitioner and therefore there is a prospect that a number of individual partners or owners of a professional service firm could be classified as high risk and subject to ATO audit action where others may not.

While the criteria and ATO approach have no particular basis in law, 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, or plan to at least be sufficiently close to the factors to reduce the risk that the ATO’s proposed compliance activity in the sector is not directed at them.  Alternatively, firms and practitioners need to be prepared for ATO review and at a minimum ensure appropriate compliance with firm and practice arrangements.

While the ATO state that they will take this approach across professions, (e.g. accounting, legal, medical and engineering) the current process does not apply to other businesses where owners provide services such as trades.