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Professional Services Firm Profits Under Fire

The Australian Taxation Office (ATO) has been concerned for some time about how many professional services firms are structured – specifically, professional practices such as lawyers, architects, medical practices, engineers, architects etc., operating through trusts, companies and partnerships of discretionary trusts and how the profits from these practices are being taxed.

 

New draft guidance (PCG 2021/D2) released last month from the ATO takes a strong stance on structures designed to divert income so the professional ends up receiving very little income directly for their work, reducing their taxable income. Where these structures appear to be in place to divert income to create a tax benefit for the professional, Part IVA may apply. Part IVA is an integrity rule which allows the Commissioner to remove any tax benefit received by a taxpayer where they entered into an arrangement in a contrived manner in order to obtain a tax benefit. Part IVA may apply to schemes designed to ensure that the professional is not appropriately rewarded for the services they provide to the business, or that they receive a reward which is substantially less than the value of those services.

 

The draft guidance for professional services

Set to apply from 1 July 2021, the draft guidance sets out a series of tests to create a risk score. This risk score is then used to classify the practitioner as falling within a Green (low risk), Amber (moderate risk) or Red risk (high risk) zone and determines if the ATO should take a closer look at you and your firm. Those in the green zone are at low risk of the ATO directing its compliance efforts to you. Those in the red zone, however, can expect a review to be initiated as a matter of priority with cases likely to proceed directly to audit.

 

The risk assessment framework will only apply if the firm first meets two gateway tests.

  • Gateway 1 – considers whether there is commercial rationale for the business structure and the way in which profits are distributed, especially in the form of remuneration paid. Red flags would include arrangements that are more complex than necessary to achieve the relevant commercial objective, and where the tax result is at odds with the commercial venture, for example, where a tax loss is claimed for a profitable commercial venture.
  • Gateway 2 – requires an assessment of whether there are any high-risk features. Potentially high-risk features include financing arrangements relating to non-arm’s length transactions, where income of a partnership is assigned in a way that is not consistent with existing guidelines, and where there are multiple classes of shares or units held by non-equity holders.

 

If the gateway tests are passed, then you can self-assess your risk level against the ATO’s risk assessment factors. There are 3 factors to be considered:

  1. the professional’s share of profit from the firm (and service entities etc) compared with the share of firm profit derived by the professional and their related parties;
  2. the total effective tax rate for income received from the firm by the professional and their related parties; and
  3. the professional’s remuneration as a percentage of the commercial benchmark for the services provided to the firm.

The resulting ‘score’ from these factors determines your risk zone. Some arrangements that were previously considered low risk may now fall into a higher risk zone.

 

For professional services firms, it will be important to assess the risk level and this needs to be done for each principal practitioner separately. Those in the amber or red zone who want to be classified as low risk need to start thinking about what needs to change to move into the lower risk zone.

Where other compliance issues are present – such as failure to recognise capital gains, misuse of the superannuation systems, failure to lodge returns or late lodgement, etc., – a green zone risk assessment will not apply.

 

If you want more suggestions and seek for assistance, call BOA & Co. accountants on 02 9904 7886 and our Specialist will be pleased to assist you.

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The Pandemic Productivity Gap

A recent article published in the Harvard Business Review by Bain & Co suggests that the pandemic has widened the Productivity Gap (is a phrase to describe a sustained difference in measured output per worker (or GDP per person employed) between one country and another) between top performing companies and others stating, “Some have remained remarkably productive during the Covid-era, capitalizing on the latest technology to collaborate effectively and efficiently. Most, however, are less productive now than they were 12 months ago. The key difference between the best and the rest is how successful they were at managing the scarce time, talent, and energy of their workforces before Covid-19.”

 

Atlassian data scientists also crunched the numbers on the intensity and length of work days of software users during the pandemic. The results found that workdays were longer with a general inability to separate work and home life, and workers were working longer hours (predominantly because during lockdowns, there is no set start and end of the workday routine). Interestingly, the average length of a day for Australian workers is shorter than our international peers by up to an hour pre pandemic. Australia’s average working day is around 6.8 active hours whereas the US is close to 7.2.

 

However, working longer does not mean working more productively. Atlassian’s research shows that while the length of the working day increased and the intensity of work increased earlier and later in the day, intensity during “normal” hours generally decreased.

 

So, how do we measure productivity? Bain & Co suggests:

 

  • The best companies have minimised wasted time and kept employees focused; the rest have not. Those that were able to collaborate effectively with team members and customers pre pandemic fared the best. Poor collaboration and inefficient work practices reduce productivity.
  • The best have capitalised on changing work patterns to access difference-making talent (they acquire, develop, team, and lead scarce, difference-making talent).
  • The best have found ways to engage and inspire their employees. Research shows an engaged employee is 45% more productive than one that is merely a satisfied worker.

 

The productivity gap was always there. The pandemic merely brought the gap into stark contrast.

 

If you want more suggestions and seek for assistance about trusts, call BOA & Co. accountants on 02 9904 7886 and our Trust Specialist will be pleased to assist you.

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A New Announcement From ATO of Single Touch Payroll

Single Touch Payroll (STP), is an Australian Government initiative to reduce employers’ reporting burdens to government agencies.

With STP, you report employees’ payroll information to us each time you pay them through STP-enabled software. Payroll information includes:

  • Salaries and wages
  • Pay as you go (PAYG) withholding
  • Superannuation.

 

The ATO has made two important announcements in relation to the Single Touch Payroll (STP) system.

A legislative instrument has been released that extends the deadline for phase 2 reporting through STP from 1 July 2021 to 1 January 2022 (i.e., six-month extension).

STP phase 2 will require additional payroll information to be reported to the ATO, which will be subsequently shared with Services Australia and other government agencies.

The ATO also confirmed that small employers will be required to start using STP for Closely Held Payees (an individual directly related to the entity from which they receive payments) from 1 July 2021. That is, no further extension has been granted.

 

However, the ATO will allow small employers to report payments to closely held payees through STP in three ways:

1. Reporting actual payments in real time

The first option involves small employers reporting each payment to a closely held payee on or before each pay event (essentially using STP ‘as normal’).

2. Reporting actual payments quarterly

The quarterly option involves lodging a quarterly STP statement detailing these payments for the quarter, with the statement being due when the client’s activity statement is due.

3. Reporting a reasonable estimate quarterly

The third option involves reporting broadly in the same manner as the quarterly option referred to above (i.e., a quarterly STP report). However under this option the entity would report estimates of reasonable year-to-date amounts paid to employees. This option is similar in some ways to the PAYG instalment system, with employers potentially subject to penalties if the amounts paid to individuals are under-reported.

 

It is also important to note that small employers with only closely held payees will have up until the due date of the closely held payee’s individual income tax return to make a finalisation declaration for a closely held payee.

These changes should allow some level of flexibility in relation to determining and making payments to closely-held payees (e.g., directors of family companies, salary and wages for family employees of businesses). However, it will still be important to ensure clients are aware of the new reporting obligations and the necessity for ongoing planning throughout the year, to prevent being caught out at year-end. out at year-end.

 

If you want more suggestions and seek for assistance about trusts, call BOA & Co. accountants on 02 9904 7886 and our Trust Specialist will be pleased to assist you.

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setting up a new company in Australia, forming a company

7 steps to set up a company in Australia

 

Setting up a company may be the first step people think of when coming across starting up a business. Although that is not always the case, there are other structures also available for running a business like mentioned in our previous post “comparison-on-business-structures-in-Australia”. Thus a company is still the most common form that people operate their business under. 

 

Here are the 7 steps on forming a company and get ready to operate. 

 

A company is a separate legal entity that is apart from the individuals who run it. You must register a company with the Australian Securities and Investments Commission (ASIC) and operate a business across Australia without having to register in each state and territories. 

 

Assuming you have decided a company as your business structure, the steps to set up a company are set out below.

1. Choose a Company or Business Name

In choosing a company name you should consider the following:

  • You do not have to have a company name if you wish.  If you do not use a company name, you can use the company’s Australian company number (ACN) as the company name such as 123 456 789 Pty Ltd;
  • In Australia, most companies’ names end with proprietary limited or Pty Ltd companies.  
  • You can only choose a name that is available (not been occupied by another company or business name yet). Here, you can search in ASIC and reserve the name prior to registering a company;

 

2. Choose the State/Territory To Register Your Company In

A company can be registered in any state or territory of Australia. You must set up a company in one of the states or territories. You may also be required to register for GST. Once you are registered, you will receive a certificate of registration.

 

3. Choose the Principal Place of Business and Registered Office

A company must nominate a principal place of business and registered office. 

If the registered office is not at premises occupied by the company then the occupier’s consent must first be obtained.

 

4. Prepare Your Company’s Rules or Constitution 

Before you start a company you must decide what rules will apply to govern the company.  This can generally be:

  • the replaceable rules from the Corporations Act, which means that the company does not require its own written constitution; or
  • a constitution; or
  • a combination of the two.

However, if the company is a sole director or member proprietary company, you do not need a constitution.

 

5. Decide Your Shareholders and Officers

You must decide who will be the members (shareholders) and officers (directors and secretary) of the company.  A company’s directors are the people who make decisions in the company.  You must have at least one director ordinarily resident (live) in Australia and each director must be at least 18 years of age.

You must obtain written consent from each person who has agreed to act as a director of the company and who has agreed to become a shareholder of the company.

 

6. Allocate Your Company Shares

After you have chosen your shareholders you must allocate how many shares will they each own and what class of shares will they own.  Ordinary shares are the most common. There is also another class of shares, which may have different rights on voting on company affairs and receiving dividends. 

 

7. Complete the Relevant Paperwork 

After you have made all the decisions in steps 1 to 6 above and obtained the relevant consents then you can register the company with fillup relevant application forms with AISC or through BOA & Co. as registered ASIC agent so we can make the process much easier for you. 

Do you need professional assistance to set up your own company? Call BOA & Co. accountants in Chatswood on 02 9904 7886 and our specialists will be pleased to assist you.

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Dividends for company shareholders

3 Types of Dividends for Company Shareholders

 

Do you know there are 3 Types of Dividends for company shareholders? 

If you have read our previous post “Comparison on Business Structuresyou will find that company is the only structure that can distribute after taxed retain profits to its shareholders. This is so-called Dividends.

What are the dividends?

When companies make a profit they often reward shareholders by distributing some of this profit by way of dividends. Like individuals who earn an income or profit, companies are also required to pay tax on their earnings at the company tax rate of 27.5%. As such, the dividends received by shareholders may be partially, fully franked, or unfranked (that is, have had the tax partially, fully, or unpaid on that income).

dividend-franking-credit-cash-flow_

Here are 3 types of dividends: 

  1. Fully franked – 100% of company tax paid is attached to the dividend as franking credit to be distributed to shareholders,
  2. Partly franked – less than 100% of company tax paid is attached to the dividend as franking credit to be distributed to shareholders,
  3. Unfranked – No company tax paid is attached to the dividend.

This is called the Dividend Imputation system

Franked-Dividend

 

What Is a Dividend Imputation?

According to the Australian Tax Office (ATO), A dividend imputation is an arrangement in Australia and several other countries that eliminates the double taxation of cash payouts from a corporation to its shareholders. Australia has allowed dividend imputation since 1987.1 Through the use of tax credits called “franking credits” or “imputed tax credits,” the tax authorities are notified that a company has already paid the required income tax on the income it distributes as dividends. The shareholder does not then have to pay tax on the dividend income

 

Fully franked dividends

When companies pay fully franked dividends, they have paid the full amount of tax on their profits. Consider the following example: After making a profit and reinvesting some of those funds back into the business, Company ABC Pty Ltd distributes its remaining profit of $1,000 to investors (shareholders) via fully franked dividends. Investor A owns 10,000 shares in the company, and as such, receives a fully franked dividend of $1,000 (10 cents per share). As the dividend is fully franked, this provides Investor A with $275.00 in franking credits which they can use to offset their personal tax liability.

Depending on Investor A’s marginal tax rate, the impact of the imputation credits is demonstrated in the table below:

 

Personal Effective Tax Rate 0.00% 15.00% 30.00% 37.00% 45.00%
Franked dividend paid by a company $1,000 $1,000 $1,000 $1,000 $1,000
plus Franking Credits $275 $275 $275 $275 $275
Company tax rate 27.50% 27.50% 27.50% 27.50% 27.50%
Assessable Income  $1,275 $1,275 $1,275 $1,275 $1,275
Tax on assessable income $0 $191 $383 $472 $574
less Franking Credits $275 $275 $275 $275 $275
Tax Payable/(Refund or Excess credits for tax offset)  -$275 -$84 $108 $197 $299

 

Claiming a refund of franking credits

 In the example provided, it has been assumed that franking credits have been claimed when an investor lodges their personal tax return. However, this isn’t the only way that shareholders can claim their franking credits. For those people who don’t lodge a tax return, imputation credits can be claimed by completing an ‘Application for Refund of Franking Credits’ form which is available from the Australian Tax Office: ato.gov.au.

 

Unfranked dividends 

Companies are also able to pay unfranked dividends in some instances, in which no franking credits are passed on to shareholders. Using the example below, Investor A would receive a dividend of $1,000 on their shares, but no franking credits, meaning that the income will be taxed at their marginal tax rate:

 

Personal Effective Tax Rate 0.00% 15.00% 30.00% 37.00% 45.00%
Franked dividend paid by a company $1,000 $1,000 $1,000 $1,000 $1,000
plus Franking Credits $0 $0 $0 $0 $0
Company tax rate 27.50% 27.50% 27.50% 27.50% 27.50%
Assessable Income  $1,000 $1,000 $1,000 $1,000 $1,000
Tax on assessable income $0 $150 $300 $370 $450
less Franking Credits $0 $0 $0 $0 $0
Tax Payable/(Refund or Excess credits for tax offset)  $0 $150 $300 $370 $450

 

Do you need professional assistance for your tax concerns? Call BOA & Co. accountants in Chatswood on 02 9904 7886 and our SMSF specialist will be pleased to assist you.

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