The Australian Taxation Office (ATO) is tightening its grip on professional services firms suspected of diverting profits to evade taxes.
Two recent cases brought before the Administrative Appeals Tribunal have underscored the ATO’s commitment to ensuring that businesses, including lawyers, accountants, architects, medical practices, and engineers, fulfill their tax obligations.
In both instances, the ATO invoked Part IVA of the income tax law, a powerful tool that allows the Tax Commissioner to dismantle schemes designed solely to secure tax benefits. Even if a structure is legally sound, if its primary aim is tax reduction, then Part IVA can be exercised by the Commissioner to nullify any tax advantages obtained through such arrangements. Moreover, offenders under Part IVA may face additional tax liabilities along with hefty administrative penalties of either 25% or 50% of the tax shortfall.
The core of these cases involved a solicitor who oversaw multiple practice trusts generating profits from marketing and facilitating tax planning schemes.
Despite the complexity of these case arrangements involving intricate steps, the core strategy involved the practice trusts channeling their business profits through a series of trusts to entities with existing tax losses or tax-exempt status to ensure that the business profits are being shielded from taxation. However, the actual funds tied to these trust distributions, minus a commission paid to these entities, were funneled back to the solicitor or related entities in the form of loans.
Professional services firms have long been under the ATO’s scrutiny for their profit distribution practices. In 2021, the ATO issued comprehensive guidance on profit allocation within professional firms, establishing risk ratings and gateway tests. These recent cases showed the ATO’s determination to address the matter through litigation, leveraging the Commissioner’s authority outlined in Part IVA.
Professional services firms must be informed of various avenues through which the ATO can challenge their profit distribution arrangement. Here are some scenarios:
1. Personal Services Income (PSI): If a trading entity derives PSI primarily from the skills and efforts of an individual, the ATO expects profits to be attributed to that individual for tax assessment.
2. Business Structure Income: For income derived from professional practice business structures, the ATO scrutinizes arrangements that fail to allocate a reasonable level of profit to individual practitioners.
3. Trust Distributions: For a trust making paper distributions to entities with losses to manipulate deductions, the ATO can refer to the integrity rules under section 100A of the tax law.
Professional services firms must heed these warnings and ensure compliance with tax laws to avoid potential legal and tax repercussions. The ATO’s recent actions signal a heightened focus on combating tax avoidance tactics, underscoring the importance of transparent and lawful business practices within the professional services sector.
Should you please have any question in regards to above, please feel free to contact our friendly team in Pitt Martin Tax at 0292213345 or info@pittmartingroup.com.au.
The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.
By Angela Abejo @ Pitt Martin Tax
