ATO’s PCG 2021/4: What It Means for Profit Allocation in Professional Firms
If you operate a professional services firm—think accountants, lawyers, engineers, medical practitioners—there’s a document from the ATO that you need to be familiar with: Practical Compliance Guideline 2021/4 (PCG 2021/4). This guideline sets out how the ATO expects profits in these types of firms to be allocated and when it may scrutinise arrangements more closely.
This article breaks down what PCG 2021/4 is about and why it matters.
What Is PCG 2021/4 All About?
PCG 2021/4 is not new tax law. Instead, it’s the ATO’s risk framework for how it approaches the profit distribution practices of professional firms. The ATO is particularly concerned with situations where individual professional practitioners (IPPs) are receiving a disproportionately low amount of the profits relative to the economic value of the services they personally provide—especially when the rest of the profits are distributed to related entities (such as family trusts or companies).
These structures may be legal, but the ATO wants to ensure there’s a solid commercial reason for how profits are being split. If the arrangement looks like it exists mainly to save tax, you can expect closer scrutiny.
Who Does This Affect?
The guideline applies specifically to individual professional practitioners who have an equity interest in a firm and who provide services to clients or have management roles. Commonly affected structures include partnerships of discretionary trusts, companies, and unit trusts.
Importantly, it only applies where:
- The IPP is actively involved and holds equity (directly or indirectly).
- The firm’s income is not considered personal services income (PSI).
- The arrangement is commercially motivated (passes Gateway 1).
- There are no high-risk features (passes Gateway 2).
Fail one of these and the PCG does not apply—which could open the door to direct application of anti-avoidance laws like Part IVA.
Personal Services Income
The guideline does not apply to situations where personal services income is being derived. Many professional firms derive personal services income, but, as a general statement, these are only the smallest of professional services firms.
The Gateways: Entry Conditions
- Gateway 1 – Commercial Rationale
Does the arrangement make commercial sense even if you ignore the tax consequences? If the main purpose appears to be tax minimisation, it fails. - Gateway 2 – No High-Risk Features
The ATO has flagged certain red flags, such as non-arm’s length financing or artificial assignments of profit. If any of these exist, the PCG can’t be used.
Only once both gateways are satisfied can the IPP use the risk assessment scoring system.
The Risk Assessment Scoring System
The PCG outlines a self-assessment framework to help IPPs rate their arrangements as:
- Green (Low Risk)
- Amber (Moderate Risk)
- Red (High Risk)
Three scoring factors are assessed:
- Proportion of profit taxed personally to the IPP
- Effective tax rate on firm income
- Remuneration of the IPP compared to a commercial benchmark (optional)
Higher personal income and higher tax rates move you towards green. Lower income or excessive profit diversion to low-taxed entities puts you in amber or red territory.
What If You’re in the Green Zone?
The ATO says it won’t usually look deeper into arrangements classified as low risk. But green doesn’t mean a get-out-of-jail-free card. You still need solid documentation, and you must reassess your position annually. Business conditions change—what is low-risk one year could become moderate or high-risk the next.
Amber and Red: What Now?
- Amber means you’re in a warning zone. You might consider adjusting profit splits or strengthening your rationale.
- Red is serious. These arrangements are likely to attract compliance attention. If clients fall in the red zone, it’s wise to restructure or even contact the ATO proactively.
Annual Reviews and Documentation Are Key
PCG 2021/4 expects an annual self-assessment. This means:
- Reviewing your structure and profit allocation.
- Documenting your commercial rationale.
- Calculating and recording your risk score.
- Keeping evidence to support your conclusions.
If the ATO ever comes knocking, these records are your first line of defence.
A Word of Caution: This Is an ATO Viewpoint
While PCG 2021/4 is useful in understanding how the ATO will engage with taxpayers, it does not change the law. Nor does it offer legal safe harbour. The ATO is effectively saying, “This is what we like and don’t like.” Whether they can enforce their views under Part IVA or otherwise remains legally uncertain.
If a business decides to ignore the PCG, they need to do so with their eyes wide open—and be prepared for a potential fight with the ATO, possibly through the courts.
In short, PCG 2021/4 is a clear message from the ATO: it wants transparency, commercial grounding, and fair tax outcomes from professional firms. If you think this guideline might apply to your circumstances, discuss it with your accountant.