Professional Firm Profits – PCG 2021/D2
On 1 March 2021, the ATO released Draft Practical Guideline PCG 2021/D2 Allocation of professional firm profits – ATO compliance approach (the Draft PCG). This PCG sets out the ATO’s proposed compliance approach to the allocation of firm profits by professional services firms.
This PCG is a significant change from the former guidelines suspended by the ATO in December 2017. The new guidelines are set to apply from 1 July 2021. Importantly, for professional services firms that relied on the old guidelines and had arrangements in place before 14 December 2017, the ATO will allow until 1 July 2023 for these entities to modify their arrangements to comply with the new guidelines.
The Draft PCG
The Draft PCG seeks to address some of the concerns the ATO had regarding certain high risk features that were not adequately dealt with under the previous guidelines. The Draft Guidelines provide a risk assessment framework for IPPs to self-assess whether the ATO would be likely to expend any of its compliance resources on particular arrangements. Before the risk assessment framework can be used, there are two ‘gateway tests’ that need to be satisfied:
- Gateway 1 – this test considers whether the implemented arrangement and the way in which it operates are commercially driven. There must be a genuine commercial basis for the arrangement and also for the way in which profits are distributed. The arrangement should reflect the commercial needs of the business.
- Gateway 2 – this test requires the consideration of whether any high-risk features are present, such as financing arrangements relating to non-arm’s length transactions, exploitation of difference between accounting standards and tax law and the issue of e.g. dividend access shares to non-equity holders whereby distributions are linked to the personal performance of the non-equity holder.
Once the gateway tests are passed, the IPP may self-assess their risk against the following factors whereby a risk rating is worked out:
The ATO has stated that IPPs in the amber risk zone will likely trigger further analysis and for red zones, reviews are likely to be commenced as a matter of priority.
A further analysis of the PGC is required primarily once the consultation period ends and the ATO finalise their position, however we share the following initial thoughts.
- The guidelines state that they are “not a technical analysis of any judicial decisions in this area”. The reality is that there is no legal authority to support the ATO’s views. The ATO is actively seeking to identify taxpayers whose circumstances fall outside the guidelines as a test case for further judicial guidelines. In the meantime, the ATO appears to “encourage” taxpayers into compliance with conservative tax positions.
- It is unclear what the outcomes are of being in the amber or red zones. While the ATO has stated that it will likely expend compliance resources for taxpayers in these zones, it is not clear how the ATO will apply the self-assessment framework, as the information needed is not readily available in tax returns.
Between now and 1 July 2021, we recommend that professional services clients undertake a risk assessment using the framework provided in the Draft PCG. If clients are in the amber or red zones and are uncomfortable with this position, there will need to be a plan for a different profit allocation for a move towards the green zone.
For entities that were relying on the old guidelines, changes can be implemented between now and 1 July 2023.
If you have any queries on this Draft PCG, please contact Gaurav Chitnis.