On 14 December 2017, the ATO announced that it was suspending its 2015 ‘Assessing the Risk: Allocation of profits within professional firms guidelines’ and ‘Everett Assignment web material’ – saying that it was to be reviewed in 2017.
It says that: “In reviewing the guidelines we have become aware they are being misinterpreted in relation to arrangements that go beyond the scope of the guidelines.
We have observed a variety of arrangements exhibiting high risk factors not specifically addressed within the guidelines, including the use of related party financing and self-managed super funds.
In light of these concerns, the ATO is suspending the application of the guidelines and Everett Assignment web material as of 14 December 2017. Individual professional practitioners contemplating entering into new arrangements from 14 December 2017 are encouraged to engage with us through Early engagement or via Professionalpdts@ato.gov.au.
Those who have entered into arrangements before 14 December which comply with the guidelines and do not exhibit high risk factors can rely on those guidelines. Arrangements entered into prior to 14 December exhibiting any of the high risk factors may be subject to review. We encourage those who are uncertain about how the law applies to their existing circumstances to engage with us as soon as possible.
The ATO will begin consulting with interested stakeholders in early 2018 on replacement guidance and the application of any required transitional arrangements, noting new guidance will apply prospectively.”
The thrust of the suspended guidelines
In the last 10 or so years, it became common for professional firms, that had not otherwise incorporated, to form a partnership which had one or more family discretionary trusts (usually with a corporate trustee). There would be one family trust per ‘principal’, who might have otherwise have been a partner, in their capacity as an individual.
- The implications for the revenue was that individuals, was that the income, from each of those partner trusts, could be distributed to anyone the trustee chose (for instance, evenly amongst family members, achieving income splitting that would not, otherwise be available, or would not withstand general anti-avoidance laws). The prevalence of this kind of structure, followed various regulatory bodies relaxing their rules to allow corporate practitioners.
- The tax result followed from the reasoning, of the High Court, in the Everett case [1980] HCA 6, which decided that a partner’s assignment of a portion of his partnership interest, to his wife, was effective to transfer that portion of the the partner’s partnership income, not only in general law, but also under tax law, without the general anti-avoidance provisions defeating the income-splitting technique. The High Court held that the general anti-avoidance provisions did not to apply, because the ‘tree was transferred and the fruit followed’ – namely, the partnership interest was transferred and the income followed the transferred interest. It’s when you try to transfer the ‘fruit without the tree’ that anti-avoidance law can apply. This ‘tree and fruit’ approach followed despite the the fact that the partner worked in the business. Partnership income was still property income, springing from the partnership interest, and not from the underlying personal exertion (which is one of the reasons we have ‘personal exertion income’ provisions, in Div 84 – Div 87 of the ITAA97).
- ‘Everett assignments’ became harder, to execute, after capital gains tax was introduced (as there was a good chance that the assignment would be taxed, as capital gain, based on the value of the income it generated (given that the assignee did not have to work for that income).
- This CGT difficulty did not present any problem to an individual who entered a partnership with a discretionary trust becoming the partner (as no assignment was necessary).
- This, in turn, left it open to such partners to, theoretically at least, distribute 100% of the profits, coming from its partnership interest, to entities other than the underlying principal, who was doing the work (normally, the individual did not draw a salary either, so all of the relevant proportion of that augmented profit was available for diversion to other parties (in a better tax position).
- A key thrust of this, now suspended, ‘guidance’ was that the principal, doing the work, must end up with personal income that was no less than the amount the firm paid its most senior arm’s length employee (or a hypothetical equivalent) as measure of the individual’s arm’s length return for his/her labour. This could be by way of salary or distribution from their family trust.
- The ATO was hamstrung, rather, by the ‘fruit and tree’ analysis of the High Court, in Everett, but continued to ‘sabre rattle’ on the basis that this wasn’t exactly the same, as an Everett assignment, and arguably went further.
- As a result, this guidance was by way of the arrangements to which the ATO would allocate more audit resources. This left taxpayers assessing how brave they felt, if a more aggressive arrangement were to be litigated.
- It seems, however, even this got stretched, to the point where the Commissioner saw fit, to suspend the (audit) guidance.
[ATO website – suspension of profit allocation guidelines; suspension of Everett guidelines; FJM; LTN 241, 15/12/17; Tax Month Dec 2017]