The ATO has named income splitting as a 2026 compliance priority. If your business distributes income to family members or retains profit inside a company or trust, here is what the ATO is examining — and the deadline you need to be aware of.
Income splitting is now one of the ATO's stated compliance priorities for 2025-26. In November 2025, the ATO issued a detailed guideline setting out precisely which arrangements it considers higher risk — and confirming its intention to act. Business owners have been given a transition window to bring their arrangements into order. That window closes on 30 June 2027.
This is not a new area of ATO focus. These arrangements have been under scrutiny for some time. What has changed is the formality of that position: the new guideline removes ambiguity about where the lines are drawn and signals a clear shift toward active enforcement.
Income splitting is the practice of diverting income earned by one individual to other people or entities that are taxed at a lower rate, with the effect of reducing the overall tax paid by the family or group.
Australia's progressive income tax system creates the incentive for this. A business owner earning $350,000 pays the top marginal rate of 45% (plus Medicare Levy) on income above $190,000. If that same income can instead be distributed to a spouse on a lower income, to adult children, or retained inside a company at the 25% corporate tax rate, the total tax paid by the family unit is significantly reduced — even though the underlying income is unchanged.
The most common forms of income splitting used by Australian small business owners include:
None of these structures is automatically unlawful. Paying a family member a genuine market-rate salary for real work is entirely legitimate. The ATO's concern is with arrangements where the primary driver is tax reduction rather than commercial reality — where the distribution of income does not reflect who actually earned it or what role others genuinely played in the business.
In November 2025, the ATO released Practical Compliance Guideline PCG 2025/5. This guideline sets out the ATO's compliance approach to income splitting arrangements that operate through personal services businesses — entities that have passed the personal services business tests and therefore sit outside the personal services income rules. It applies both prospectively and retrospectively from its date of issue.
The guideline uses a binary risk framework:
Low risk: The net income earned through the entity is ultimately assessed to the individual who generated it, at their marginal rate, without material deferral or diversion to associates.
Higher risk: The arrangement involves income splitting to associates at lower tax rates, or retention of income within the entity in a way that defers or avoids tax.
Importantly, the ATO is explicit that there is no threshold below which diversion is acceptable. The guideline states: "This Guideline does not establish a 'safe' level of PSI diversion." What it does provide is an administrative commitment: where an arrangement has all the features of a low-risk arrangement, the ATO will not direct compliance resources toward reviewing it.
The legal mechanism the ATO relies on is Part IVA of the Income Tax Assessment Act 1936 — the general anti-avoidance provision. Where Part IVA applies, the ATO can cancel the tax benefit obtained and reassess income at the individual's marginal rate, plus interest and penalties of up to 75% of the shortfall where there has been intentional disregard of the law.
Restructure before this date and the ATO has confirmed it will not pursue prior years under Part IVA, provided the transition to a compliant arrangement is genuine.
30% minimum tax on discretionary trust distributions takes effect (as announced in the May 2026 Federal Budget), removing the tax advantage of distributing income to lower-taxed family members via a discretionary trust.
Where income is distributed from a family trust to a spouse, adult children, or other associates, the ATO is examining two things: whether those distributions genuinely benefit the intended recipient, and whether the amounts distributed are proportionate to the contribution each person actually made to generating the income.
PCG 2025/5 directly addresses arrangements where a professional distributes trust income partly to themselves and partly to a spouse or related entity, without that distribution reflecting the work each party performed. The guideline's worked examples rate these arrangements as higher risk where the associate's share bears no relationship to the services they provided.
ATO reference: Section 100A reimbursement agreements — ato.gov.au
The applicable test is whether the remuneration paid to a spouse or family member reflects what would be paid to an unrelated employee performing the same role. Where a spouse receives $80,000 for work that the open market would value at $30,000, the ATO can disallow the excess and include it in the income of the individual whose personal services generated the revenue.
PCG 2025/5 includes a worked example of an IT specialist whose spouse received $77,000 in combined salary and dividends while working one day per fortnight under supervision. The ATO rates this as a higher-risk arrangement on the basis that the remuneration is disproportionate to the services actually provided. The issue is not whether a family member is paid, but whether the amount paid can be justified by reference to their genuine contribution.
Even where a business structure is correctly established and legitimately operates outside the personal services income rules, the ATO's position under PCG 2025/5 is that income generated through an individual's personal effort should ultimately be assessed at that individual's marginal rate. Retaining that income within an entity at the lower corporate tax rate — particularly where the funds are then accessed personally through loans — represents a clear compliance risk.
The guideline states directly: "the mere fact that PSI is retained is a sufficient indicator of higher risk." The use of Division 7A-compliant loans to access retained funds does not resolve this issue. The ATO's analysis looks through the structure to the economic outcome — whether the individual has in substance obtained a personal benefit from income that was not assessed at their marginal rate.
ATO reference: Personal services income — ato.gov.au
A low-risk arrangement, as defined by the ATO, is one where the income ends up assessed where it was earned. In practical terms, this means:
A useful practical test: if the arrangement would look identical with an unrelated employee in place of the family member, it is on defensible ground.
The 30 June 2027 transition deadline provides meaningful time to act — but the ATO's concession applies only to genuine restructuring. Cosmetic changes made close to the deadline are unlikely to satisfy the standard of a genuine attempt to comply. A structured approach, started well in advance, is the more defensible position.
The starting point is a clear picture of where income goes from the moment it enters the business to where it is ultimately assessed for tax. Where the income ends up assessed primarily at your marginal rate, the arrangement is likely to be low risk. Where it is distributed to associates, retained in the entity, or accessed via loans, those are the areas requiring review.
For each family member on the payroll or receiving distributions, document their actual role, hours worked, and the market rate for that work. Where the remuneration cannot be justified against that analysis, it warrants adjustment — either to bring the pay in line with the market, or to expand the role to reflect the amount being paid.
Where profits have been accumulating inside the entity, consider whether each year's retention had a genuine commercial justification. Retention for the sole reason that the corporate tax rate is lower than the individual's marginal rate does not constitute a commercial purpose under the ATO's framework. Distributing those earnings — and paying tax at the appropriate rate — may be a necessary part of moving to a compliant position.
Any restructuring should be reflected in updated documentation: trust deeds, employment contracts, board resolutions, and payment records. The ATO will look for evidence that changes are substantive, not cosmetic. Documentation that predates the June 2027 deadline carries more weight than records prepared after the fact.
PCG 2025/5 is a principles-based document. The distinction between low risk and higher risk depends on the specific facts of each arrangement — the nature of the business, the quantum of income involved, the genuine role of family members, and the history of prior distributions. General guidance of the kind provided in this article can indicate whether action is required. Determining exactly what that action should be requires advice tailored to your situation.
The 30 June 2027 transition deadline requires meaningful lead time. Reviewing a structure, obtaining advice, and implementing changes properly cannot be left to the final weeks of the window.
At Bizally, we work with Australian business owners to review their structures against the requirements of PCG 2025/5 and identify what, if anything, needs to change. If your arrangement carries risk, we will tell you clearly — and provide a practical plan to address it before the deadline. Contact the Bizally team to arrange a conversation.
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This article is general information only and does not constitute tax or legal advice. You should seek professional advice specific to your circumstances before making any decisions about your tax structure.