In a recent address to the Tax Institute of Australia, the Deputy Commissioner of Taxation reiterated his concerns about service trust arrangements. According to the Deputy Commissioner, preliminary risk evaluation work had led the ATO to conclude that:
This article reviews service trust arrangements and the characteristics that the ATO is likely to focus on.
In a typical service trust arrangement:
Service trust structures have been widely used to facilitate the provision of non-professional services in a professional practice environment, including:
Service trusts are used for two primary reasons:
Cleardocs provides Service Agreements for use in service trust arrangements here
Although the use of service entities was accepted as valid on commercial grounds in the 1978 case FCT v Phillips, the ATO has concerns about the size of the mark-up some service entities charge.
In Phillips' case, the Commissioner unsuccessfully challenged the deductibility of fees paid by a partnership to a service trust under the former general anti-avoidance provisions.
According to the Commissioner, whether expenditure made under a service arrangement is deductible under section 8-1 of the Income Tax Assessment Act 1997 (Cth) depends on the objective the expenditure was calculated to achieve. This is to be determined from a practical and business point of view — which is a question of fact to be considered on a case-by-case basis.
In effect, the Commissioner is targeting the size of the mark-up on the services provided by the service entity. If the benefits conferred by a service arrangement:
Essentially what this means in practice is that unless a taxpayer can justify (on objective commercial terms) the amount of the mark-up on services acquired, then the Commissioner will seek to deny a deduction under section 8-1 to the entity acquiring the services.
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The Commissioner does not set out any parameters for determining what is an acceptable commercial mark-up. However, he does state that factors working against deductibility are:
If the service trust arrangement provides no commercial benefit and the service fees and charges are not correctly calculated, then the deductibility of the service fees and charges may depend on a range of other factors, including:
The Tax Office has published guidelines to help taxpayers decide whether or not to review their service arrangements in light of TR 2006/2. You can read the guidelines 'Your Service Entity Arrangements - NAT 13086' (Guidelines) here
In broad terms, the service fees charged will probably be deductible under section 8-1 if:
The Guidelines set indicative rates the use of which is likely to reduce the chance of a tax audit. There are comparative economic rates for various services for people who do not to use the conventional arrangements in the guide. (An example is contained in a previous ClearLaw article on this topic which you can view here.)
It is important to review arrangements for which:
Even after all that, it is worth noting that this issue is not necessarily confined to sec.8-1 of ITAA97.
The Commissioner has confirmed that the general anti-avoidance rule in Part IVA of ITAA36 may apply to service arrangements. It will do so if a proper weighing of features would cause a reasonable person to conclude that the service trust arrangement exists for the dominant purpose of enabling a taxpayer to obtain a tax benefit.
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For questions or more information about the above article, please call Maddocks in Melbourne (03 9288 0555) and ask for a member of the Maddocks Tax and Revenue Team.
Paul is a Special Counsel in the Maddocks Commercial team with particular expertise in commercial agreements for the supply of goods and/or services, the Personal Property Securities Act 2009, the National Consumer Credit Protection Act 2009 and the National Credit Code and the Australian Consumer Law.
Paul's key areas of practice include:
Before joining Maddocks, Paul was employed for 13 years with the Victorian Department of Justice, principally as a Deputy Registrar in the Victorian Magistrate's Court, but also as a legislation, policy and project officer for the Department.
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For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of their team.