On 17 December 2021, the ATO released PCG 2021/4 which outlines its view on allocating risk profiles to practitioners of professional services organisations based on the method by which they seek to structure their profit share entitlements of the practice. The new ruling applies to all professional services organisations which would include (but are not limited to) accounting firms, legal firms, medical practices, financial services organisations, engineers, and architects.
Guidelines on the allocation of profits of professional services organisations stem from concerns the ATO have in relation to the manner in which professional practitioners seek to structure their remuneration arrangements. In PCG 2021/4, the ATO state:
“The ATO is concerned about arrangements involving taxpayers who redirect their income to an associated entity from a business or activity which includes their professional services where it has the effect of significantly reducing their tax liability”.
PCG 2021/4 will apply from 1 July 2022. However, PCG 2021/4 notes that professional practitioners that are classified as low risk based on the now withdrawn guidelines previously issued by the ATO will continue to be classified as low risk until 1 July 2024. As a reminder of the previous guidelines, the ATO classified a professional practitioner as low risk if the professional practitioner received a commercial rate of remuneration, recognised at least 50% of their overall profit share entitlement in their personal name, or otherwise had an overall effective rate of tax of 30% on their profit entitlement share.
PCG 2021/4 assesses risk based on scorecard calculations
In assessing the risk of a professional practitioner based on how they structure their profit entitlements, PCG 2021/4 firstly requires the structure adopted by the professional practitioner to satisfy tests of commerciality.
Assuming the structure satisfies tests of commerciality, PCG 2021/4 introduces a scorecard approach to enable a practitioner of a professional services organisation to determine whether their structured remuneration arrangements are low risk, moderate risk or high risk. In PCG 2021/4, the ATO note that taxpayers who fall within the moderate risk or high risk categories are at risk of having some form of ATO review undertaken of their affairs.
Taxpayers can calculate their risk profile based on a 2-test calculation (test 1 and test 2) or a 3-test calculation (tests 1 to 3) at their discretion. The relevant tests are as follows:
1. The proportion of profit entitlements that the professional practitioner recognises as income in their own personal income tax return.
Under this test, the greater the profit entitlement recognised in the personal tax return of the professional practitioner, the lower the comparative risk.
|Profit share recognised by professional practitioner personally||More than 90%||Between 75% – 90%||Between 60% – 75%||Between 50% – 60%||Between 25% – 50%||Less than 25%|
2. The total effective tax rate that the professional practitioner and their associated entities pay on their profit share entitlements from the professional practice.
Under this test, the higher the overall effective tax rate on the profit entitlements, the lower the comparative risk.
|Overall effective tax rate||More than 40%||Between 35% – 40%||Between 30% – 35%||Between 25% – 30%||Between 20% – 25%||Less than 20%|
3. The profit share entitlement recognised by the professional practitioner personally as compared to the remuneration derived for similar services provided to the firm.
Under this test, the higher the overall profit share entitlements recognised by the professional practitioner personally as compared to the benchmark remuneration recognised by a non-partner who provides similar services to the firm, the lower the comparative risk.
This test only needs to be considered if the professional practitioner wishes to apply all 3 tests in their scorecard calculation. In many instances, it would be presumed that this test would not be applied by the professional practitioner as insufficient benchmark information would be available.
|Renumeration of professional practitioner compared to benchmark||More than 200%||Between 150% – 200%||Between 100% – 150%||Between 90% – 100%||Between 70% – 90%||Less than 70%|
Based on the outcome of the above tests, PCG 2021/4 allocates the risk profile of the professional practitioner as follows:
|Risk Level||2 test score||3 test score|
|Low risk||No higher than 7||No higher than 10|
|Moderate risk||8||11 or 12|
|High risk||9 or higher||13 or higher|
In conclusion, PCG 2021/4 now introduces a complex scorecard approach to determine the risk profile of practitioners of professional services firms. These new parameters should now be considered to determine how they may impact on existing arrangements that practitioners currently have in place.