PCG 2021/4: allocating professional firm profits

Practical Compliance Guideline PCG 2021/4, Allocation of professional firm profits: ATO compliance approach, sets out how the ATO decides which arrangements to look at when a principal of a professional firm has firm profits taxed in the hands of related entities rather than their own. It applies from 1 July 2022. It replaced guidelines the ATO first published in 2015 and suspended in December 2017.

The guideline does not change the law. It tells you how much compliance attention an arrangement is likely to get. An arrangement in the low risk zone is still subject to the law, including Part IVA of the Income Tax Assessment Act 1936, but the ATO says it is less likely to spend resources reviewing it. This guide works through the guideline in the order you apply it, with the ATO's own worked examples and a short self-assessment at the end.

The ATO publishes the guideline in its legal database and summarises it on its web page Allocation of profits within professional firms. The scores, zones and examples below are taken from the ATO web page, which was reviewed for this guide.

Who the guideline is for

The guideline is written for an individual professional practitioner, which the ATO shortens to IPP. In plain terms that is a principal, partner or practice owner who:

• provides professional services through a firm, such as an accounting, legal, consulting, engineering or medical practice, and
• has some of their share of the firm's profits directed to an associated entity, such as a family trust, a spouse, or a company the practitioner controls, so that those profits are taxed at lower rates than if the practitioner had received them personally.

The ATO's examples include a management consultancy partnership, a legal practice run through a company, and an accounting partnership. The structure of the firm itself does not decide whether the guideline is relevant. What matters is how the practitioner's own entitlement is taken.

The ATO page does not deal with how the guideline fits with the personal services income rules. For a sole practitioner or a small practice, check those rules separately before relying on a score.

Step 1: the two gateways

Before any scoring, the arrangement has to pass two gateways. If it fails either one, the risk scores are not available and the ATO says it may consider Part IVA or other integrity rules.

Gateway 1: commercial rationale

The ATO asks you to assess whether the arrangement has a sound commercial rationale. It lists signs that a rationale may be missing:

• the arrangement is more complex than the commercial objective needs
• it has no purpose apart from gaining a tax advantage
• the tax result is at odds with the economic result
• there is little risk where you would normally expect significant risk
• the terms are not commercial or not at arm's length
• the legal form does not match what is achieved in substance

Most practice structures can answer this with ordinary reasons: limited liability, admitting and retiring partners, holding assets away from professional risk, succession, or funding the practice. Write the reasons down when the structure is set up. They are much harder to reconstruct later.

Gateway 2: no high-risk features

The second gateway is passed only if the arrangement has none of the features the ATO treats as high risk. The ATO lists:

• financing arrangements relating to non-arm's length transactions
• exploiting differences between accounting standards and tax law
• arrangements materially different in principle from the assignments in Everett and Galland (the two cases about a partner assigning part of a partnership interest)
• multiple classes of shares or units, including discretionary entitlements such as dividend access shares
• multiple assignments or disposals of an equity interest
• misuse of the superannuation system, including dealings with associated self managed super funds
• distributing income to entities, other than the practitioner, that have losses

Financing arrangements need care in practice groups. A firm that lends to principals, or a service entity that funds a principal's related entities on terms no stranger would accept, can trip this gateway even when the profit split itself is ordinary. Where money moves out of a private company in the group, Division 7A is a separate question with its own rules. See the Division 7A guide.

The ATO has a separate page on Everett assignments. One of its examples treats an assignment by a non-equity partner, on a fixed salary and with no voting rights, as materially different from Everett and Galland, and so high risk. A salaried partner in name only who assigns part of a "partnership interest" is the typical problem.

Step 2: the three risk assessment factors

If both gateways are passed, you score the arrangement against up to three factors. Each factor scores from 1 (lowest risk) to 6 (highest risk). The scores are added and the total places the arrangement in a zone.

Factor 1: share of profit entitlement returned personally

This measures how much of the practitioner's profit entitlement from the whole firm group is returned in the practitioner's own tax return. Amounts that flow to a family trust, a spouse or a company count as not returned personally. Where the firm retains profits for commercial reasons, the practitioner's share of the retained profit is part of the entitlement.

Share returned in the practitioner's own return	Score
More than 90%	1
More than 75% to 90%	2
More than 60% to 75%	3
50% to 60%	4
More than 25% to less than 50%	5
25% or less	6

If the practitioner returns 100% of their entitlement personally, the ATO treats the arrangement as low risk and the other factors do not need scoring.

Factor 2: total effective tax rate

This is the average rate of tax on all the income received from the firm by the practitioner and their associated entities, taken together:

Total tax paid by the practitioner and associated entities on firm income, divided by total firm income received by them, multiplied by 100.

Leave out levies such as the Medicare levy and Medicare levy surcharge. Include tax on the practitioner's share of retained profits, for example tax paid by the firm entity on profits it keeps.

Total effective tax rate	Score
More than 40%	1
More than 35% to 40%	2
30% to 35%	3
More than 25% to less than 30%	4
More than 20% to 25%	5
20% or less	6

Factor 3: remuneration against a commercial benchmark

This compares the remuneration the practitioner returns personally with an appropriate commercial remuneration for the services they provide. The ATO asks you to set the benchmark by reflecting on the practitioner's duties, responsibilities, risks and roles. Its examples use an industry benchmark for equivalent services, and commercial remuneration for similar roles.

Remuneration as a percentage of the benchmark	Score
More than 200%	1
More than 150% to 200%	2
More than 100% to 150%	3
More than 90% to 100%	4
More than 70% to 90%	5
70% or less	6

Factor 3 is optional in one situation. If a benchmark cannot practically be worked out, the ATO accepts a self-assessment against factors 1 and 2 only. The zone thresholds are different for the two-factor and three-factor totals.

Practical points when scoring

Start from the whole entitlement

Factor 1 and factor 2 both divide by the practitioner's total entitlement from the firm group. Get this number first. The ATO's examples count everything attributable to the practitioner, whether paid as salary, partnership share, trust distribution or dividend, plus their share of any profit the firm retains. Using a smaller base makes the percentages look better than they are.

Count every recipient's tax

The effective tax rate is a group figure. Add the tax paid by the practitioner on firm income, by each family member who received a distribution, and by any company that received firm income. In the ATO's examples, company recipients are taxed at 26%, and beneficiaries on lower incomes pay little. Those amounts pull the group rate down, which is the point of the factor.

Franking

Julie's example shows the dividend grossed up: the $420,000 dividend is made up of $294,000 cash and $126,000 franking credits, and the full $420,000 forms part of her $800,000 entitlement. Follow the same approach where profits pass through a company as franked dividends, so the entitlement and the tax are measured on a consistent basis.

Choosing two or three factors

Scoring all three factors usually helps a practitioner who pays themselves a market salary, because factor 3 then scores low and the higher three-factor thresholds apply. It hurts a practitioner whose personal remuneration is well under market, as Ashley's example shows. The two-factor option is there for when a benchmark cannot practically be set, not as a way to leave out an unfavourable factor 3.

Step 3: the risk zones

Zone	Risk	Factors 1 and 2 only	All three factors
Green	Low	7 or less	10 or less
Amber	Moderate	8	11 to 12
Red	High	9 or more	13 or more

What each zone means

Green. The arrangement is low risk. The ATO's framework is about the type of compliance attention it gives, and low risk arrangements are the ones it is least likely to examine. Green does not mean the arrangement is correct at law, and it does not protect an arrangement that failed a gateway.

Amber. Moderate risk. The ATO says it is likely to analyse the facts and circumstances further, and may start compliance activity, for amber arrangements.

Red. High risk. The same statement applies, and in practice red is where review is most likely. A red result is a reason to look again at how much of the entitlement the practitioner takes personally and whether the remuneration reflects the work done.

The same follow-up applies to any arrangement with a high-risk feature, whatever its score would have been.

Transitional arrangements and when they ended

The ATO gave practitioners certainty for the period from 1 July 2017 to 30 June 2024, in two parts:

• For 1 July 2017 to 30 June 2022, an existing arrangement could rely on the suspended 2015 guidelines and be treated as low risk if it complied with those guidelines, was commercially driven, and had none of the high-risk features in Gateway 2.
• Where an arrangement was low risk under the suspended guidelines but rated higher under PCG 2021/4, the suspended guidelines could still be applied until 30 June 2024.

Both periods have now ended. For the 2024-25 income year and later, every arrangement is assessed under PCG 2021/4 alone. A practitioner who relied on the transitional period and has not restructured should score the current arrangement now. The ATO points to private rulings for anyone worried about the tax consequences of a proposed restructure.

Worked examples

These are the ATO's examples, with its figures. Tax figures are as the ATO states them.

Brooke: low risk on two factors

Brooke assigns 30% of her partnership interest to a discretionary trust. Her entitlement from the partnership is $425,000.

Recipient	Income	Tax
Brooke personally	$297,500	$104,542
Brody (trust beneficiary)	$50,000	$6,717
BB Pty Ltd (trust beneficiary, 26% company rate)	$77,500	$20,150
Total	$425,000	$131,409

Factor 1: $297,500 is 70% of $425,000, score 3. Factor 2: $131,409 divided by $425,000 is 30.92%, score 3. Brooke decides a benchmark is not practical and scores two factors. Total 6, green. Her rental losses are ignored because they are not related to the firm income.

Chris: retained profits

A firm of five equal principals makes $5,000,000. It pays $500,000 to each principal as directors' fees and retains $2,500,000 for commercial reasons. Chris's share of the retained profit, $500,000, will be paid to him when he retires at the end of the next income year.

Chris's entitlement is $1,000,000, of which he returns $500,000, so factor 1 is 50% and scores 4. For factor 2, the ATO adds the tax on his share of the retained profit ($150,000 at 30%) to the tax on his fees.

Julie: moderate risk on three factors

Julie's entitlement is $800,000: a salary of $380,000 and a fully franked dividend of $420,000 ($294,000 cash plus $126,000 franking credits) paid through a trust.

Recipient	Income	Tax
Julie personally (salary)	$380,000	$141,667
Company X Pty Ltd	$370,000	$96,200
Kurt	$50,000	$6,717
Total	$800,000	$244,584

Factor 1: 47.5%, score 5. Factor 2: 30.57%, score 3. Factor 3: her $380,000 is 116.9% of a $325,000 industry benchmark, score 3. Total 11, amber.

Ashley: high risk on three factors

Ashley's firm makes $2,100,000 and her entitlement is $700,000.

Recipient	Income	Tax
Ashley personally	$147,000	$39,457
James (spouse)	$130,000	$33,167
Ashley Investments Pty Ltd	$423,000	$109,980
Total	$700,000	$182,604

Factor 1: 21%, score 6. Factor 2: 26.09%, score 4. Factor 3: $147,000 against a $250,000 benchmark for similar roles is below 70%, score 6. Total 16, red.

What the examples show

Julie and Ashley have similar effective tax rates. The difference is factors 1 and 3: Ashley takes about a fifth of her entitlement personally, and pays herself well under market for her role. A practitioner who wants to move from red towards green usually has two levers: return more of the entitlement personally, and make sure the remuneration taken personally reflects the market value of the work.

Risk zone calculator

The calculator below applies the gateways, the three scoring tables and the zone tables exactly as set out above. It reproduces the ATO's Brooke, Julie and Ashley results. You supply the entitlement, the amount you return personally, the total tax and, if you use factor 3, the benchmark. It does not work out any of those figures for you, and it does not model the transitional period.

Records worth keeping

The ATO page describes the process as a self-assessment. It does not set out a separate reporting requirement. Even so, a short file note each year is the simplest protection:

• the commercial reasons for the structure, dated when it was set up
• the gateway review, and why none of the high-risk features apply
• the profit entitlement for the year, how much was returned personally and where the rest went
• the tax paid by each recipient on firm income, and the effective tax rate calculation
• how the remuneration benchmark was set, or why one could not be set
• the scores and the zone

The retained profits section of the ATO page refers to consistency from year to year. Re-score whenever the profit split, the number of principals or the structure changes.

Self-assessment checklist

Related reading

Practitioners who take profits through a private company also need to manage Division 7A. See the Division 7A guide and the Division 7A calculator. For distributions from a family trust, the trust distribution checklist covers the year-end steps.

Questions

When does PCG 2021/4 apply from?

From 1 July 2022. Transitional relief let some existing arrangements rely on the suspended 2015 guidelines, but that ended on 30 June 2024.

What are the PCG 2021/4 risk zones?

Using all three factors, 10 or less is green (low risk), 11 to 12 is amber (moderate) and 13 or more is red (high). Using factors 1 and 2 only, 7 or less is green, 8 is amber and 9 or more is red.

What happens if I return all of my profit entitlement personally?

The ATO treats the arrangement as low risk and the other factors do not need to be scored.

What are the high-risk features in Gateway 2?

Non-arm's length financing arrangements, exploiting differences between accounting and tax, arrangements materially different from Everett and Galland, multiple share or unit classes such as dividend access shares, multiple assignments of an equity interest, misuse of super including associated SMSFs, and distributions to loss entities.

Is the Medicare levy included in the effective tax rate?

No. The ATO says to exclude levies such as the Medicare levy and Medicare levy surcharge.

Does a green score mean the arrangement is safe?

No. It means the ATO is less likely to apply compliance resources. The law, including Part IVA, still applies, and the score is not available at all if a gateway is failed.

Sources

• ATO, Allocation of profits within professional firms (PCG 2021/4 summary, factors, zones, examples, last updated 26 September 2024)
• ATO, Professional firms section (print view, including Everett assignments)