Law Firms and Accountancy Practices using Discretionary
In September 2014 the Tax Commissioner released a document
headed "Assessing the risk: allocation of profits within
In broad terms, the Commissioner is very unhappy that
professional firms can use trusts and other structures so that less
tax is paid than if the relevant profits were taxed directly in the
hands of the individual lawyers or accountants who own the
The ATO position is that professionals who structure their firms
as partnerships of discretionary trusts, for example, may be doing
so for the dominant purpose of getting a tax benefit, so that the
anti-avoidance rules in Part IVA of the Income Tax Assessment Act
1936 will apply.
Why it is that professionals who use discretionary trusts may
now be tax avoiders when the hundreds of thousands of other
businesses operating through trusts with owners who provide skilled
input are not targeted by the ATO campaign has not been fully
We do know that the ATO has had professionals and income
generated from personal services on its radar for more than 30
years, through cases like Everett, Galland, Tupicoff and Mochkin
(and many others), multiple tax rulings and the introduction of the
Personal Services Income (PSI) regime in 2000.
The law in this space can be stupendously complex, but what the
ATO is now saying (as best we can understand it) is this:
If you are a sole practitioner and operate through a
discretionary trust (for example) and the PSI rules don't
otherwise apply, the ATO may apply Part IVA to tax you on the trust
income personally, on the basis that all that income is generated
by your effort and skill;
If you are involved with a firm that has discretionary trust
partners and the ATO accepts that the firm income is generated by a
"business structure" (because of its size or number of
employees, for example) the ATO says that you must still be taxed
on those parts of profit that accrue to the discretionary trust
partner which represent the income derived by the firm from your
Just how you work out your value to the firm is another
question, but the Commissioner has sidestepped that issue by
providing us with these guidelines which tell us the ATO view of
the tax outcomes that can make you a low risk audit target.
The ATO says you will not be audited for Part IVA purposes if
one of the following tests is satisfied:
You receive income representing an "appropriate"
return for your services to the firm – perhaps equal to the
highest paid employee or reflecting industry benchmarks;
50% or more of the income which flows to you and associated
entities is taxed in your hands; or
Your associated entities and you have an effective tax rate or
30% or more on income from the firm.
If you can't tick the box on even one of these three tests
you become a high risk, high priority target for a tax audit and
the application of Part IVA.
What to Do
The Commissioner's campaign is targeting 2015 and later
financial years, so the ATO is providing a clear choice for
professionals using these structures - roll on as before and
prepare to engage with the ATO auditors when they come knocking, or
satisfy one or more of the tests in the ATO guidelines, pay more
tax for 2015 and beyond, and continue to enjoy the quiet life.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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