The Australian Taxation Office's finalised position on the allocation of profits from professional firms starts on 1 July 2022.

The ATO's guidance uses a series of factors to determine the level of risk associated with profits generated by a professional services firm and how they flow through to individual practitioners and their related parties. The ATO may look to apply the general anti-avoidance rules in Part IVA to practitioners who don't fall within the low-risk category.

The problem

The ATO has been concerned for some time about how many professional services firms are structured — specifically, professional practices such as lawyers, accountants, architects, medical practices, engineers, architects etc., operating through trusts, companies and partnerships of discretionary trusts and how the profits from these practices are being taxed.

Determining the risk rating

The guidance sets out a series of tests which are used to calculate a risk score. This risk score is then used to classify the practitioner as falling within a Green, Amber or Red risk zone.

Before calculating the risk score it is necessary to consider two gateway tests:

Gateway 1 - considers whether there is commercial rationale for the business structure and the way in which profits are distributed.
Gateway 2 - requires an assessment of whether there are any high-risk features.

If the gateway tests are passed, then you can self-assess your risk level against the ATO's risk assessment factors. Those in the amber or red zone who want to be classified as low risk need to start thinking about what needs to change to move into the lower risk zone.