Historically, most professional firms were partnerships of natural persons. Professional firms are now structured in a variety of ways, reflecting the economic and legal choices made by owners of those firms. In some cases, these structures may be used in ways that give rise to different tax consequences and resulting tax compliance risks.
The ATO is concerned about arrangements involving the redirection of income to an associated entity from a business or activity which includes professional services where it has the effect of significantly reducing their tax liability.
In simple words, the ATO is not happy with income being allocated to Company and Trust structures where dividends or distributions are then not taxed on the individual who provided the services and generated that income.
The Commissioner’s view is that the profit or income of a professional firm may comprise different components, reflecting a mixture of income from the efforts, labour and application of skills and income generated by the business structure.
The difficult part here is how to separate the income generated from the ‘business structure’ and the income generated directly from the efforts, labour and skills.
Therefore, the ATO has created guidance PCG 2021/4 for professional firms to self-assess the level of risk they are in. Basically, a way to say how likely are we to review your books.
Here’s a summary in 4 simple steps to make sure you are on top of it.
1. Are you a professional services business?

A professional is a member of a recognised profession. The term ‘profession’ is not defined by tax legislation. But the ATO consider the following as indicators of a professional:
• those who are required to be accredited and adhere to ethical guidelines in order to enter into and maintain practice in the relevant field
• those who are accepted by the public as possessing special knowledge and skills in a widely-recognised body of learning, derived from research, education and training at a high level and who are prepared to apply this knowledge and exercise these skills in the interest of others
• their behaviour and practice are beyond the personal moral obligations of an individual
• they uphold a high standard of behaviour in respect to the services provided to the public and in dealing with professional colleagues.
A couple of easy examples would be, Accountants, Architects, Engineers, Lawyers, Medical Practitioners, etc.
2. What business structure are you using?

Gateway 1 considers the structure arrangement and whether it is commercially driven and not only for tax purposes. One example would be, the arrangement is likely to enhance, assist or improve the business’ ability to produce income or make profits. The ATO considers it is best practice to record the commercial rationale for the decision to adopt the arrangements used and for the way in which profits are distributed.

If you are a sole trader or a traditional partnership, then you are not covered by this guidance. However, if you are holding shares in company and those shares in held in trust where the distributions are allocated to your spouse and kids, well you need to look closely at this guidance.

A couple of key items the ATO considers high risk or not commercially driven are:
• Interposed entities only to access tax concessions.
• Non-recourse or limited recourse loans
• Put options
• Financial arrangements (such as lower interest rates on loans)

3. High Risk features

Financing arrangements relating to non-arm’s length transactions
Arrangements with related parties generally involve a greater level of potential tax compliance risk. The Commissioner does not accept there is a commercial purpose when an associated entity of the professional utilises finance to acquire an existing portion of the equity interest in a professional firm. Therefore, financing arrangements involving associated entities that give rise to a tax benefit are considered high risk.
Exploitation of the difference between accounting standards and tax law
Arrangements that create artificial differences between taxable income and accounting income. Some arrangements create differences which are exploited to have the income assessed to individuals or businesses that pay little or no tax while allowing others to enjoy the economic benefits.
Arrangements that are materially different in principle to Everett and Galland
Arrangements where a partner assigns a portion of their partnership interest:
Arrangements purporting to admit an individual as a partner, where the individual is not an owner or equity holder in the partnership, and
Arrangements where the IPP’s relationship has characteristics indicating their relationship with the partnership is akin to a contractor or employee.
Multiple classes of shares and units held by non-equity holders
The ATO considers the issuing of multiple classes of shares in a company or units in a unit trust in a professional firm, without the accompanying voting rights, to be a high-risk feature due to the potential for alienation of income by professionals that are non-owner or non-equity holders in a structure. Further, the discretionary nature of these shares or units is usually linked to the personal performance of the non-owner or non-equity holder in order to receive any distribution or dividends.
4. The scoring table

Risk Assessment Factor Score
1 2 3 4 5 6
(1) Proportion of profit entitlement from the whole of firm group returned in the hands of the IPP >90% 75% to 90% 60% to 75% 50% to 60% 25% to 50% <25%
(2) Total effective tax rate for income received from the firm by the IPP and associated entities >40% 35% to 40% 30% to 35% 25% to 30% 20% to 25% <20%
(3) Remuneration returned in the hands of the IPP as a percentage of the commercial benchmark for the services provided to the firm >200% 150% to 200% 100% to 150% 90% to 100% 70% to 90% <70%

Risk zone Risk level Aggregate score against first two factors Aggregate of all three factors*
Green Low risk
Amber Moderate risk 8 11 & 12
Red High risk

You can self-assess your profit allocation arrangement using:
• risk assessment factors 1 and 2 only, or
• all three risk assessment factors.

If you are considering restructuring in a way that may not be assessed as low risk (Green) pursuant to this Guideline and would like to mitigate your compliance risk or to obtain a greater level of certainty, we encourage you to contact Link Advisors about your proposed restructure.