The 12 month period for reviewing whether fees charged under service entity (or 'Phillips') arrangements ended on 30 April 2007. Many professional service firms (accounting, legal, medical etc.) may need to review their arrangements to reduce the likelihood of a tax audit. Paul Ellis and Gerard Healy

---

'Phillips' arrangements

Around March 2006, the ATO announced that it was allowing a 12 month period for people to review their Service Arrangements to ensure that the service entity was not charging fees in excess of commercial rates. This period ended on 30 April 2007. Any businesses that have not reviewed their Service Arrangement to address the ATO's concerns may face income tax adjustments and penalties.

A typical Service Arrangement involves:

• the owners of a professional services business setting up a wholly-owned service entity;
• the service entity providing the business with a service (for example: labour hire of support staff, lease of premises, provision of office equipment) at increased prices; and
• the business claiming the fees paid to the service entity as a tax deduction

Periods to review has ended

For many years professional service businesses have commonly had a service entity arrangement in place - also known as a 'Phillips' arrangement (Service Arrangement). These arrangements govern how support services are provided to the business.

If a Service Arrangement complied at the end of this period, then the parties to that arrangement have a reduced chance of being audited on this basis.

How to assess whether a Service Arrangement measures up?

Reviews of Service Arrangements had to consider whether the service fees and charges were reasonable in the circumstances. For instance:

• Could it be explained how the Service Arrangement helps run the business?
• Were the service fees and charges correctly calculated?
• Were there sufficient records that explain transactions between the business and the service entity for tax purposes?

These questions continue to be relevant to persons entering into new Service Arrangements, as does the ATO's Guide on this topic.

ATO Guide

The ATO's Guide released in April 2006, 'Your service entity arrangements', outlines the market rates that the ATO considers are commercial benchmarks for typical Service Arrangements. These rates are based on standard market rates: but they also include higher rates that the ATO considers indicate a degree of divergence from comparable market rates. If a Service Arrangement involves these rates (or higher rates), then they could prompt an audit.

One example of these acceptable rates is set out in the following table:

Arrangement	Characteristics	Acceptable fees and charges
Labour hire - temporary staff	The service entity employs staff on a casual basis or on short-term employment contracts; The service entity on-hires the staff to you for a limited period; You pay a service charge; The service entity meets the cost of premises and equipment and employs staff who are responsible for recruiting; The service entity meets all the costs.	Comparable rate: Net mark-up on costs - labour hire fees that result in the service entity deriving a net mark-up not exceeding 5% on the direct and indirect operating costs associated with its on-hiring of the temporary staff.

Conclusion

If a Service Arrangement has an objective commercial connection with a business and its activities, and the business is confident that the service fees and charges are correctly calculated, then those fees and charges may well be deductible and less likely to prompt an ATO audit. However, parties to existing and new Service Arrangements need to consider reviewing these matters to ensure compliance with the ATO's standards.

More information?

For further information, you can go to the ATO website at www.ato.gov.au and see the Guide. For advice concerning Service Arrangements, call Maddocks on 03 9288 0555 (Melbourne) and ask for a member of the Tax & Revenue team.