Professional Firm Profit Allocation
Taxation of professional person’s profits…
The ATO has released PCG 2021/4 Allocation of Professional Firm Profits: ATO compliance approach.
The guidance is not law, but it shows how the ATO will view the taxation of profits from professional firms, effective from 1 July 2022.
Definitions of certain terms used in the guideline are:
An 'individual professional practitioner' (IPP) is an individual who provides services to clients of the firm, or to the firm itself, in circumstances where the IPP and/or associated entities have a legal or beneficial interest in the firm.
'Personal services income' (PSI) is income earned mainly as a result of personal efforts or skills of the IPPs, rather than being generated by assets or employees of the firm and is dealt with under the PSI rules in Part 2-42 of the Income Tax Assessment Act 1997.
'Professional firms' offer customised, knowledge-based services to clients in a variety of professions which include, but are not limited to, accounting, architecture, engineering, financial services, law, medicine and management consulting.
A 'professional' is a member of a recognised profession. For a discussion of the term 'profession', see paragraph 33 of the Guideline.
Essentially IPPs can use the framework in the guideline to determine the risk profile of their tax structures, including how they are remunerated, and then know how the ATO will engage with them.
There are different levels of risk associated with different tax planning strategies that involve the allocation of profits (includes revenue) of a professional firm and this Guideline outlines how the ATO will engage taxpayers based on their risk profile - green, amber, red.
The ATO has classified these risks as green zone, amber zone and red zone and will be investigating all amber zone and red zone risks and will not investigate green zone risks.
The key for IPPs is to assess what risk zone their current arrangements fall in and then forecast 2023 revenue and make changes to how they are remunerated to essentially get into the green zone.
It is important to act now to determine what zone an IPP is in and then calculate what additional tax may be required to be paid in 2023 to ensure they are in the green zone, or a zone they are comfortable with from an audit risk perspective.
Act now !