August 2024 Round Up - Part IVA and personal services income

The new draft practical compliance guideline on the potential application of Part IVA to arrangements where personal services income is derived through a company or trust will create a stir.

We explore the issues and the impact of the new risk ratings.

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Inside this month, Michael Carruthers (Tax Director), Ann Dai (Tax Adviser) and Lisa Armstrong (MD) bring you:

Personal services businesses and Part IVA

The ATO has issued a draft practical compliance guideline on its approach to the potential application of the general anti-avoidance rules in Part IVA to arrangements where personal services income (PSI) is derived through a personal services entity (PSE) conducting a personal services business (PSB).

The guideline is relevant for taxpayers who are generating PSI through an interposed entity (e.g., company or trust) and the PSI attribution rules don’t apply because the entity is able to pass the PSI tests so that it is classified as a PSB.

The ATO’s long-standing position is that when a company or trust is used to generate PSI, the net profits relating to this activity should generally end up being taxed in the hands of the individual who is performing the work, even if the PSI tests can be passed. If any of the profits are distributed to other related parties or are retained in a company and this results in those profits being taxed at a lower rate, then there is a risk that Part IVA could apply to cancel the tax benefit.

The draft PCG sets out some specific indicators of arrangements that the ATO considers “low-risk” and “higher-risk”, along with examples of such arrangements. For example, where the full PSI profit amount is paid to the individual who performed the work and is taxed at their own marginal rate, this arrangement would likely be low-risk and unlikely to be reviewed by the ATO.

The ATO indicates that arrangements can still be classified as low-risk where amounts are paid to related parties for administrative work performed in the business, as long as the amounts paid are not excessive. The ATO also indicates that an arrangement could be low-risk where an amount is retained in a company so that specific business assets can be purchased by the company in the short-term.

Arrangements will be considered higher-risk where a tax benefit is obtained by the individual due to some of the net PSI profit being distributed to another entity, resulting in a lower overall tax rate being applied to this amount. The draft PCG also provides an example of a situation where the business is operated through a company with historical tax losses and the full net PSI profit for the current year isn’t paid out to the individual, indicating that this would be a higher-risk scenario. These higher-risk arrangements are more likely to be received by the ATO.

It is important to note that an arrangement won’t automatically trigger the application of Part IVA just because it is classified as a higher-risk scenario. The draft PCG is simply explaining scenarios that are more likely to be reviewed by the ATO on the basis that Part IVA is brought into question.

Non-resident withholding tax obligations in focus

The ATO is focusing on withholding tax obligations on payments to non-residents for interest, dividends or royalties.

If withholding tax obligations apply, taxpayers need to register with the ATO for PAYG withholding and will need to lodge a PAYG annual report or an annual investment income report.

When determining withholding obligations, it’s important to recognise whether the client is a small, medium or large withholder, and any applicable tax treaties or withholding tax exemptions. For example, some tax treaties ensure that withholding tax doesn’t apply to interest that is paid to an unrelated bank that is a resident of the relevant foreign country.

Australian residents who are required to pay withholding tax on interest or royalties won’t normally be able to claim a deduction for these expenses until the appropriate withholding amount has been paid to the ATO.

The ATO has issued a number of alerts specifically aimed at arrangements dealing with withholding tax, including:

• Taxpayer Alert TA 2018/4 Accrual deductions and deferral or avoidance of withholding tax
• Taxpayer Alert TA 2020/3 Arrangements involving interposed offshore entities to avoid interest withholding tax
• Taxpayer Alert TA 2022/2 Treaty shopping arrangements to obtain reduced withholding tax rates

Additional time for Code of Conduct reform compliance

The 8 additional tax practitioner Code of Conduct obligations introduced by Tax Agent Services (Code of Professional Conduct) Determination 2024 were due to take effect from 1 August. Following lobbying by the professional bodies, the Assistant Treasurer announced transitional rules pushing the start date of the reforms to:

• 1 July 2025 for firms with 100 employees or less, and
• 1 January 2025 for larger firms with 101 employees or more.

In response to industry concerns, WA Liberal Party Senator Dean Smith moved to disallow the determination on 10 September 2024. We’ll bring you more when we know the outcome.

And most recently, the Assistant Treasurer circulated the amended determination with the detail of the transitional rules. He also flagged that there will be consultation on the more contentious measures:

• False and misleading statements – which prohibits agents from making, preparing, permitting, or directing false or misleading statements to be made to the TPB, the Commissioner of Taxation, or other Government agencies.
• The requirement to keep clients informed of relevant matters -- which requires practitioners to advise clients if they are subject to, “any matter that could significantly influence a decision of a client to engage you, or to continue to engage you, to provide a tax agent service.”

The transitional measures only apply to the additional Code obligations introduced by the legislative instrument. They do not apply to other legislated measures including:

• Breach reporting which came into effect on 1 July 2024, or
• The rules prohibiting partitioners from working with disqualified entities unless they have TPB approval to do so, which came into effect on 1 January 2024.