The Tax Office has warned partners in law, accounting, engineering and medical firms who reduce their tax bills by income splitting with their spouses that it's reassessing the rules governing the practice, after uncovering abuse linked to self-managed superannuation funds and related-party borrowing.
The ATO abruptly suspended the old rules for allocating profits within professional services firms on December 14 and has advised anybody wanting to enter into new arrangements not to rely on previous rules. The change is applicable to partners in all professional services firms, no matter whether they are run as partnerships, companies or trusts.
Firms exhibiting "high risk" behaviour may be subject to investigation, the ATO has warned. "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 said in an alert.
"We have become aware [the guidelines] are being misinterpreted in relation to arrangements that go beyond the scope of the guidelines," the ATO said. "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."
The ATO has withdrawn two pieces of guidance, one relating to the distribution of profits within professional services firms generally, and another relating to so-called Everett assignments. After a 38-year-old High Court ruling, partners are able to "assign" a portion of their stake in the capital and income of a partnership to their spouse. This is called an Everett assignment and it allows a high-rate tax payer to split their income with a lower-rate taxpayer, affording the couple a lower tax bill overall, a bit like the perk associated with income streaming to discretionary trusts.
Sole purpose test
Tax Institute senior tax counsel Bob Deutsch said the ATO may be concerned with partnership assets being assigned to SMSFs, in what might be a breach of the sole purpose test for superannuation.
Super funds are always attractive for tax planning because they pay very low rates of tax, or even zero tax.
"The Tax Office probably always contemplated a husband might assign an interest in certain partnership assets to his wife, and that's what I think would be considered a plain, vanilla Everett assignment," Professor Deutsch said.
"Now it looks like people have taken this one step further and they've been assigning their partnership interests to their own self-managed super funds through the mechanism of an Everett assignment.
"This is perhaps not something that the tax office contemplated and it raises questions as to whether the holding of partnership assets by an SMSF through an Everett assignment is consistent with the obligation of the fund to be managed for the sole purpose of providing retirement income for its members. I think the answer to that may well be no depending on the precise facts of each case."
There are no published figures on how many partnerships make use of Everett assignments but the practice appears to be common across legal, accounting, engineering, medical, architectural and consulting firms.
Chartered Accountants Australia and New Zealand tax leader Michael Croker said new contribution caps on how much money can be deposited into superannuation might have prompted people to push the boundaries on Everett assignments.
It might be that an underlying interest in a business is being put into the hands of a spouse to maximise his or her super contributions, he said. Or a super fund itself may have been assigned interest in a business.
"The limited information provided by the ATO to date indicates that latest review will explore other aspects of professional firm structuring involving superannuation and financing," Mr Croker said.
"This suggests to us that the ATO has observed planning in response to the caps recently introduced on tax-effective superannuation contributions and increased levels of deductible gearing in some structures."
Institute of Public Accountants senior tax adviser Tony Greco said that while the ATO was comfortable with assignments to a discretionary trust or individual, SMSFs may be a step too far. In any case, the ATO had at its disposal at all times to go after tax avoidance using the general anti-avoidance provision, or Part IVA, he said.
Aside from the mention of related-party borrowing and SMSFs as key concerns, there is no further information from the ATO about how these are being abused. It did not provide further details when approached by The Australian Financial Review.
An ATO spokesman said stakeholders would be consulted on new guidelines, which were expected to be finalised by mid-2018.
"Taxpayers who intend to enter into new arrangements from the suspension date of 14 December 2017 cannot rely on the suspended guidelines," he said. "Those who have entered into arrangements which comply with the guidelines before December 14 can rely on those guidelines."
The Everett assignment guidelines were published in 2015 and were due for routine review in 2017. The ATO has at least twice in the past undertaken similar reviews amid concerns about taxpayers overstepping the mark. The ATO was previously concerned about the use of service entities to shift profit into the hands of lower-rate taxpayers.
This article was published and provided by the Australian Financial Review.