ATO Discrimination

ATO discrimination – plain and simple

What would you think of a headline that trumpeted ‘Packer subject to personal tax on $700 million Crown Resort profit’? Or maybe ‘Frank Lowy and family subject to personal tax on their contribution to the Westfield Group’s $1.6 billion annual profit’?

You would probably think you have entered a parallel universe.

This is what would happen if the ATO’s guidelines on the application of Part IVA to the income of professional practices were applied in a non-discriminatory way to all businesses.

Will this ever happen? Will all business owners be required to return profits from their businesses as personal services income if they are involved in the business? Will they be required to earn a ‘market wage” (whatever that is)?

Not likely.

So why is the Tax Office picking on professional services businesses? How did all this come about?

Well, you need to go back a fair way to put this particular question in some honest perspective.

In the beginning, professionals did not get a choice as to what business structure they could adopt. The ‘professional standards’ of their regulatory bodies (such as the Institute of Chartered Accountants, the AMA and the various Law Societies) dictated that professionals must be personally responsible for their actions in order to remain ‘professional’. Hence, any structure that afforded them any level of ‘asset protection’ was disallowed. The historical structure of professional services businesses was all about asset protection (or a mandated lack of it) and nothing to do with tax.

A bi-product of this ‘professionalism’ was really bad tax outcomes. Not only would people running large professional services businesses go to work each day and risk the roof over their family’s head – but they would also be paying personal tax on 100% of their ‘business’ profits. Another adverse by-product was the almost impossibility of raising capital.

No other businesses suffered this disadvantage.

Eventually the professional bodies caught up with reality and realised that most of their professional concerns could be more than allayed through mandated insurance levels and mandated continuing professional education – and hence professional business structures were ‘deregulated‘.

But the Tax Office has been getting a free-ride all these years – taxing professional services businesses at the full marginal tax rates of their owners – and the Commissioner was not going to give this up lightly.

There is no rule in either of the Tax Acts, and no case law, that says a business owner must pay themselves a ‘market wage’. Not one. How many fish and chip shops have numerous family members all working in them for no wage? How many billions has the Packer family accumulated within their business empires, rather than having to pay tax on it in Kerry or James’ personal name?

At the same time, professional services businesses have become just that – businesses. The sole practitioner is a fading anachronism in the professional services landscape. Further more and more professionals are relying on capital-intensive equipment and software to effectively service their clients.

So rather than accept that professional service businesses are now ‘genuine businesses’, the Tax Office wants to turn back the clock, (or at least stop the clock). It wants to do everything possible to ensure that it continues to receive a discriminatory windfall from professionals who own a part of their business.

And what has the reaction of the ‘professions’ been? Acceptance! In the same way that they accepted being told by their professional association for decades that they could not have the benefit of limited liability and a reasonable rate of tax, they are now accepting that even as a genuine business they must continue to suffer the ignominy of a discriminatory tax approach.

We accept the Commissioner’s approach to service trust arrangements (reluctantly, as his ‘safeharbours’ are very shallow…). We also accept the potential application of Part IVA to obvious ‘restructures’ – although we think this is unfair, given the initial structure ‘choices’ available to professionals was severely constrained by the professional bodies.

However, we should not accept blatant discrimination.

If the Government wants to bring in a rule to tax all business owners on a given proportion of their profits – so be it. Or if the Government wants to enact a domestic ‘transfer pricing’ rule to govern dealings between a business and related parties – fine. We will accept that. But until the Government does that, the Tax Office needs to apply the law in a non-discriminatory and fair manner to all business owners. To allow anything less is cowardice and stupidity on the part of the professions.
 


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Andrew

Lawyer to entrepreneurs and investors

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