Fine-tuning the ATO’s magnifying glass: more scrutiny over professional practices

by | Sep 14, 2015

The ATO have released updated and expanded guidelines to their risk classification matrix for professional practices, and specifically about how much of the profits arising therefrom it expects to end up in the tax returns of individuals who own or control the equity owners.

I wrote about the original guidelines here, setting out the background of the ATO’s project which culminated last year in the original guidelines, including the three benchmark tests that it will apply; invoking the famous quote from Donald Rumsfeld about ‘knowns’, ‘known unknowns’ and ‘unknown unknowns’ to describe the various parts built on hard facts and case law, the parts built on assumptions and the parts built on wishful thinking.

At the time of the release of the original guidelines the ATO indicated that it would apply these guidelines to the 2015 income tax returns of the professional practitioner in assessing the revenue risks posed by the behaviour of such individuals. These guidelines have now been built into the ATO’s risk assessment software tools and as returns are lodged by individuals connected with professional firms they will be judged against these guidelines. Those found wanting may be reviewed further, and their business partners and the practices themselves may find that they themselves also come under review. The ATO has also expanded the range of these guidelines, using this document to put up an argument that Part IVA can apply to service trust arrangements (even those which comply with the safe harbour rules) and, from 1 July 2015, also to Everett assignments.

In the guidelines the ATO acknowledge that a legally and validly constructed business structure is just that. They also acknowledge that the guidelines have no place where the PSI rules already provide a framework to determine whether income is from either a business or from personal exertion. Further, the ATO concedes also that the service entity guidelines and safe harbour rules are still accepted by the ATO (even though they then go on to attack their own safe harbour rules by bringing service entity income in as part of the overall income that is tested under these guidelines).

Having set out the law, the core principles upon which the guidelines are based then depart from these, so the fundamental approach taken under these guidelines still suffer from not being based in law.

The starting point of the ATO is that a valid business structure that does not generate PSI for the relevant individual will be reviewed and the ATO may seek to attribute profit generated by that business to that individual, without regard to the entity with the legal entitlement to said profit. Isn’t that what the PSI rules do? So the ATO is seeking to apply a PSI-like outcome to businesses that would pass the PSI tests, all without any legal basis other than that it thinks that Part IVA might apply.

Having played bad cop with the implicit suggestion that review and/or audit activity will be imposed on taxpayers, the ATO then plays good cop by offering the guidelines, essentially saying if you adjust your business structure to ensure that enough business profit is taxed in the hands of the ‘at risk’ individuals then you are low risk of an audit from them.

Given the relative financial strength and appetite for a fight that the ATO has when compared to most businesses it is unsurprising that many businesses are merely moving to ensure that they satisfy one or more of the guidelines, even if they have reservations about whether the ATO’s analysis is correct. That way the ATO succeed in modifying taxpayer behaviour without having to go through the expensive and uncertain process of lobbying the Federal Government for a change in the law or asking the Courts to rule in their favour. Perhaps they are fairly certain what the outcome here would be?

If the ATO’s view of how the law should work has a sound basis, then why are the guidelines only applied to professional practices? If these guidelines were applied to husband and wife partnerships where only one of the two actually works then the profit wouldn’t be split 50%/50%. If a retail business paid the principal individual below market salaries, leaving the profit to flow out to equity owners/beneficiaries and these rules were applied then the individual would not be low risk. Surely if the law woks in the way that the ATO is proposing it should apply to all taxpayers equally?

I’d be interested to know how Donald Rumsfeld would describe these rules!

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