ATO crackdown on profit restructuring leading to higher tax bills: RSM

The ATO released this guidance following concerns that professional service practitioners’ earnings were not being appropriately taxed as personal income.

Kristy Binns, RSM Australia corporate tax leader, said the PCG applied to professional services businesses that used structures such as trusts to distribute profits.

“Historically, professional firms enjoyed flexibility in using trusts and other structures to reduce tax, but that era is now over,” she said.

“The guideline requires that a fair share of profit, at least 50 per cent for a full equity partner, be reported as personal income.”

Binns noted that the ATO’s definition of “professional services” went beyond the usual suspects of doctors, lawyers and accountants, for the purposes of this guide. Instead, it applied to anyone who charged for expertise.

The PCG would result in higher personal tax bills for affected professionals, RSM noted. For example, a partner earning $1 million who previously took $200,000 personally and distributed the rest through a trust would have to report at least $500,000 as personal income.

Binns said the PCG would cause structuring and liquidity dilemmas for affected individuals, who would have to alter the way they engaged in tax planning.

“The ripple effects are significant. Mid-tier partners who once relied on trusts for negative-geared investments now face dilemmas,” Binns said.

“Some may sell assets or move them into personal names, which solves cash-flow issues but removes asset protection, increasing exposure if professional legal claims arise.”

For example, she recalled encountering an engineering firm partner that had previously only reported 30 per cent of their profits as personal income, and had to restructure to minimise ATO audit risk.

“We recently came across a partner in an engineering firm who was in the red zone, reporting only 30 per cent of profit personally.”

“They had to restructure to a 50 per cent personal and 50 per cent trust distribution. This reduced audit risk but increased personal tax by $70,000 annually.”

Binns encouraged professionals to ensure they were compliant with the updated PCG. While restructuring could lead to higher tax bills, she warned that ignoring the ATO’s guidance could lead to amended assessments and penalties later down the line.

“The best approach is to accept the new reality and work with trusted advisers to ensure compliance.”

“The immediate effect is higher personal tax, but ignoring the guideline could lead to even greater costs if the ATO challenges allocations.”