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Allocation of profits within professional firms

The Australian Taxation Office (“ATO”) has recently warned professional firms about the allocation of profits amongst individual professional practitioners.

Over recent years we have seen the establishment of different structures for professional practices (e.g. practice companies, partnerships of trusts). There has been, perhaps, a reduction in the more traditional partnership of natural persons in conjunction with a service trust.

These new structures for professional practices have, however, led the ATO to express concerns about the allocation of profits.

The ATO has announced ‘risk assessment guidelines’ that purport to adopt a commercial and pragmatic approach to risk assessment for the allocation of profits amongst professional firms. Broadly, the ATO claims that if a professional firm satisfies one of the risk assessment guidelines, then the professional firm should consider itself at low risk of ATO challenge.

These ATO guidelines apply if:

  1. an individual professional practitioner (“IPP”) provides professional services to clients of the firm, or is actively involved in management of the firm and, in either case, the IPP and/or associated entities have a legal or beneficial interest in the firm;
  2. the firm operates by way of a legally effective partnership, trust or company; and
  3. the income of the firm is not personal services income.

The ATO suggests that compliance with their guidelines will lead to low risk of ATO action regarding alienation of income. However, the ATO is certainly announcing that aggressive income splitting via utilisation of a new professional practice model (a non-compliance with the guidelines) may well come under ATO scrutiny.

By releasing the ATO material now, it allows professional practices in the 2014/15 year to self-assess and review their profit allocation. The ATO has announced, as part of its 2014/15 strategy, that it will be communicating with entities that appear to be involved in these arrangements prior to the ATO applying compliance resources to address the high risk arrangements through the course of 2015/16 income year.

Cowell Clarke’s Tax & Revenue Group are of the view that it is appropriate that 30 June 2015 profit allocations be considered in light of the ATO announcement. In that way, professionals will be able to ensure that the profit allocation fits within the low risk measures, so that your professional practice firms and clients are not at risk during 2015/16 of a high risk review.

If you have any queries please do not hesitate to contact us.

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