ATO's PCG 2021/4 explained: What professional firms need to know

Are you a partner in a Professional Services business? Learn the importance of how profit distributions should be taxed in the hands of the partner and the limitations placed on streaming income via a family trust. More importantly, understand the associated risks of not complying with the commissioner's guide on the allocation of profits within professional firms.

Understanding ATO's PCG 2021/4: A Practical Compliance Guideline

The Australian Taxation Office (ATO) released the Practical Compliance Guideline (PCG) 2021/4 to provide a clear compliance framework for the allocation of professional firm profits. This guideline aims to assist individual professional practitioners (IPPs) in understanding how the ATO assesses the risk associated with their profit allocation arrangements and to ensure compliance with relevant tax laws.

This PCG is about arrangements where:

• Taxpayers redirect their income from a business or activity to an associated entity
• That income includes income from their professional services
• The outcome is that they significantly reduce their tax liability

Definition of IPP

An Individual Professional Practitioner (IPP) refers to a professional who derives income from providing professional services and may redirect this income to associated entities. This term is used within the context of the ATO's guidelines to identify individuals whose profit allocation arrangements are subject to compliance assessments.

Purpose of PCG 2021/4

The primary purpose of PCG 2021/4 is to offer a practical administrative approach that helps taxpayers comply with tax laws. By following this guideline in good faith, taxpayers can expect the Commissioner to administer the law in accordance with the outlined approach. This guideline is particularly relevant for IPPs who derive income from professional services and redirect their income to associated entities, significantly reducing their tax liability.

Eligibility to rely on PCG 2021/4

In order to be able to rely on the risk assessment framework afforded by PCG 2021/4, any arrangements must pass two gateway tests:

1. Commercial Rationale Gateway: Before applying PCG 2021/4, IPPs must assess if their arrangement has a sound commercial rationale. Arrangements lacking commercial rationale may appear more complex than necessary, serve no real purpose other than gaining a tax advantage, or operate on non-commercial terms.
2. High-Risk Features Gateway: IPPs must also ensure that their arrangements do not have high-risk features. High-risk features include financing arrangements related to non-arms length transactions, exploitation of differences between accounting standards and tax law, and multiple classes of shares and units.

Risk Assessment Framework

If the arrangement passes both gateway tests, the taxpayer can then rely on the guideline which introduces a risk assessment framework that helps IPPs evaluate the risk level of their profit allocation arrangements. This framework includes specific factors and scoring tables to determine whether an arrangement falls within low, moderate, or high-risk zones.

Risks of Non-Compliance

Failing to comply with PCG 2021/4 can lead to several risks, including increased scrutiny from the ATO, potential tax audits, and penalties as well as a review of all partners party to the arrangement.

By understanding and adhering to these guidelines, professional services businesses can better manage their tax obligations and minimise the risk of non-compliance.

FOR MORE INFORMATION

 Get in touch with our Professional & Business Services team today