Post Budget meeting of ATO’s ‘Professional Firms Working Group’ – income splitting guidance after crimping Small Business CGT relief exposes many ‘Everett’ assignments again

The ATO has established a ‘Professionals Firms’ Working Group’ to consult on what is acceptable, and unacceptable, allocation of profits within professional firms (put bluntly: how much income splitting is ok).

This group has been meeting since the Commissioner suspended his guidance, on this subject, on 14 December 2017 [see related TT Article]. This group met on 11 May 2018 (the second day after the Federal Budget announced measures that would, effectively, curtail ‘Everett‘ assignments’ of partnership interests [see related TT Article]).

The following is a summary of the meeting, by one of the members of the Group, with some of my [commentary] noted in square brackets.

Budget announcement – there was a lengthy discussion on the budget announcement in relation to removal of access to the small business CGT concessions for Everett assignments.

1. There was some debate about whether it was intended to apply in all cases or only for partnerships that would not themselves qualify for the small business concessions, and the precise impact it would have. [I thought the budget announcement was pretty clear, that the change to the small business CGT concessions, was relevant to Everett assignments (but not limited to them), and that the effect was to leave only partners, of ‘small’ partnerships, able to claim the concession – and thus keep the possibility of doing an Everett assignment alive. See related TT Article.]
2. The ATO indicated that they would pass on feedback to Treasury, who would establish their own consultation process on the measure. [This is a worry if the scope of the measure wasn’t clear to the ATO, much less if Treasury doesn’t know what it’s announced in the budget].

 Potential approaches for provision of certainty – there was general agreement, among external participants, that the new guidance should:

1. apply to lawyers, accountants and other professionals who are governed by an ethical regime and have been subject to historical structural restrictions. [It’s always been invidious that bricklayers can trade in a company, or partnership, and split their income with their spouse, and professionals couldn’t. It is true that, historically, there were restrictions on the structure, in which a professional could practise, and with whom they could share income. These restrictions were designed to keep, the regulated professional standards strong. And, that historical regulation, made other structures stand out, and look tax motivated. But, regulation is now largely ‘structure neutral’, and non-qualified people can share the profits, so long as it qualified people that do the professional work, and/or are in charge. I summarise the tax law that is relevant to this in a related TT Article. The conclusion I reach, is that it is really only the General Anti-Avoidance Provisions, that could apply, and there is much less chance of those provisions applying, now, because these the nature of this regulation has changed. It is now common to have professional firms carried on in a wide range of structures. For this reason, I think it is unfortunate, to be perpetuating a class of taxpayers, by reference to superseded historical restrictions.]
2. focus on economic outcomes and continue the structurally neutral approach.
3. in terms of sequencing, first address the “ongoing” tax treatment of an existing structure, and then address the question of the tax implications associated with “how you get there” (i.e.. restructuring of existing practices or interests in those practices). [One might have thought the time sequence might have been the other way around. If the real problem was the ‘mis-deeds’ by which people restructured, the ATO could have tackled that first, and we could deal with the more ‘nuanced’ income splitting issue, over time. But it was the looming 1 July 2018, start of the new financial year, and the luminous crop of new Partners, that was driving the practitioner agenda. They urgently wanted ATO guidance, on what they could do, and couldn’t do, without attracting attention.]
4. the existing benchmarks, which are simple, should continue to apply (but see below).

Potential framework for guidance – the ATO anticipates providing draft guidance to the working group in the next couple of weeks, and then giving external participants one to two weeks to consider it before the next meeting.  The new guidance will:

1. contain more guidance on the issue of “commerciality” for restructures;
2. identify areas that are considered “high risk”; and
3. include a grading of factors for assessment of risk around profit allocation (rather than bright line benchmarks as under the old regime). [This sounds like the ‘green, orange, red – traffic light’ system we see elsewhere.]

25.5.18

[FJM; LIV minutes; Tax Month May 2018]

Study Questions (answers available)

1. Was it 12 days after the budget that this consultation group met?
2. Was the Budget announcement, to reduce the number of partners who can claim ‘small business CGT concessions’ that was significant.
3. Was the ambit of this announcement clear, to the meeting?
4. Is this ‘income splitting’ guidance going to apply to brick layers and lawyers alike?
5. Does the profession want the guidance (on income splitting) to be ‘structure neutral’?
6. Is the guidance going to ignore restructuring that professional firms might undertake to get to a more ‘amenable’ entity.
7. Does the profession want a ‘traffic light’ style of risk assessment, rather than a ‘bright line’ approach?