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Дата канвертавання24.04.2016
Памер26.46 Kb.
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[Insert Client Name]

[Insert Client Position]

[Insert Company Name]

[Insert Company Address]

[Suburb State Post Code]

Dear [Insert Client Name]



Re: SERVICE ENTITY ARRANGEMENTS
The Australian Taxation Office (ATO) has been closely scrutinising service fee arrangements for many years and continues to focus on these arrangements through selected audit and review activity.
The key issues are outlined below.
Executive Summary


  1. The leading case in this area is the Phillips Case

  2. Since the Phillips case was handed down in 1978, the ATO has issued various pronouncements including:

  1. Income Tax Ruling IT 276

  2. Taxation Ruling 2006/2 and the accompanying booklet “Your Service Entity Arrangements

  3. Taxpayer Alert 2013/3

  4. ATO risk guidelines for professional practices




  1. Service Entity Arrangements

It is common for professional practices such as accounting firms, law firms and medical practices to utilise service entity arrangements. The typical arrangement may involve an entity (such as a company or trust) owning or leasing the office premises and employing administrative staff and making the premises and administrative staff available to the professional practice for a marked-up fee (the service entity may also provide other non-core services for the professional practice such as arranging insurance or collecting overdue fees).


In most cases the service entity will be owned or controlled by the associates of the owners of the professional practice.
The leading court decision in relation to the use of service entities is Federal Commissioner of Taxation v Phillips (1978) 8 ATR 783; 78 ATC 4361; (1978) 36 FLR 399 (“Phillips case”).
The Full Federal Court (which upheld the decision of the Supreme Court of NSW) held that the price of the services were realistic and not in excess of what could be expected to be paid to an independent third party. Furthermore, the court held that the anti-avoidance provisions did not apply and the amounts paid by the professional practice for the service trust’s services were deductible.


  1. ATO pronouncements

i) Income Tax Ruling IT 276


Following Phillips case, the ATO released Taxation Ruling IT 276 in which the Commissioner of Taxation (the “Commissioner”) accepted the correctness of the decision in the Phillips case. The Commissioner, however, comments in this ruling indicating that service entity arrangements under which payment for services are grossly excessive would still be examined.
On 29 July 2002, the Commissioner announced a program of review of service entity arrangements. The Commissioner stated that whilst the ATO would not seek to overturn the Phillips case decision, service trust arrangements that vary significantly from those in that case would be examined.
ii) Taxation Ruling TR 2006/2 (and ATO Service Entity booklet)
On 20 April 2006 the ATO released Taxation Ruling 2006/2 titled ‘Deductibility of service fees paid to associated service entities: Phillips arrangements’.
In the ruling, the ATO gives its views as to the deductibility of fees paid by a professional practice to a service entity and also the application of income splitting anti-avoidance rules.
The Commissioner’s view can be summarised as follows:


  • Phillips case is not authority for the proposition that the service fees calculated using the particular mark-ups adopted in Phillips case will always be deductible under section 8-1 of the Income Tax Assessment Act 1997 (“ITAA 1997”)

  • the deductibility of service fees depends on the facts and circumstances of each case

  • in determining whether the service fees paid are deductible, the arrangement must be obviously connected with gaining assessable income or carrying on a business, or the service must be ‘commercially realistic’

  • if a broader examination of all the circumstances surrounding the expenditure, including factors that go to the deductibility under section 8-1 of ITAA 1997, would cause a reasonable person to conclude that a person or persons entered into the service arrangement for the dominant purpose of obtaining a tax benefit relating to the arrangement then the Commissioner may seek to apply the general anti-avoidance rules in Part IVA.


Release of ATO booklet
Accompanying TR 2006/2, the ATO released a 26 page booklet titled ‘Your Service Entity Arrangements’ (NAT13086-04.2006).
The stated aim of the booklet is to provide ‘practical guidance to help you decide whether the payments made under your service arrangement are commercially realistic and reasonably connected to the main business.
The booklet effectively provides a checklist to help determine whether there is a need to review the fees paid under the service arrangement. It also provides indicia for arrangements which the ATO ‘recommends’ be reviewed, and those which the ATO states are ‘critical’ to be reviewed.
ATO approach going forward
The booklet states that the ATO would allow a period of 12 months from the release of the service entity booklet (i.e. until 30 April 2007) for businesses to review arrangements with the benefit of the guidance provided in the booklet. According to the ATO, if at the end of that period, the service arrangement is generally in line with the guidance provided in the booklet, there is little risk that the ATO would audit the arrangement. Given this 12 month amnesty has expired, if you have not reviewed your service entity arrangement you may be exposed to risk from an ATO audit.
The ATO has stated that it will continue with its current audit program for the highest risk cases, which it says are those where the following three tests are met for a given income year:


  1. service fees paid are over $1 million

  2. service fee expenses represent over 50% of the gross fees or business income earned by the professional firm

  3. net profit of the service entity (or service entities) represents over 50% of the combined net profit of the entities involved.

The booklet identifies different levels of exposure depending on the pricing methods used within the service entity arrangement. Having regard to the booklet, the following levels of audit risk can be implied to different arrangements:




Audit Risk Level

Description

High audit risk

Amounts in excess of the indicative rates identified in the booklet subject the entity to a higher risk of a tax audit.

Low audit risk

If the indicative rates outlined in the booklet are used and no greater than 30% of the profits of the service entity are earned from the arrangement, the entity will be subject to a low audit risk.

No audit risk

If the base level comparable market rates identified in the booklet is used, the deductions will be accepted and the entity should not be subject to any audit risk.

In light of the above, it is pertinent that your service entity arrangement be reviewed to ascertain whether the arrangement is compliant with the ATO published guidelines and to identify whether or not the service entity arrangement is likely to be audited by the ATO.


Additional Information
The ATO has released frequently asked questions (“FAQs”) to supplement the ATO booklet specifically for medical doctors and their advisors. These FAQs provides additional information in relation to:

iii) Taxpayer Alert TA 2013/3


On 22 November 2013, the ATO released a taxpayer alert highlighting it is focussing on certain arrangements used by accountants, lawyers and other professionals that operate through partnerships of discretionary trusts and that have the following features:


  • an individual partner purports to make the trustee of a discretionary trust a partner in a professional firm

  • the individual partner is one of the beneficiaries of the discretionary trust

  • the trustee is not actively engaged in the conduct of the firm’s practice

  • the practice is carried on in much the same way as it had been before the trustee purported to become a partner (with the individual rendering substantial personal services to clients of the firm).

The ATO is concerned that such arrangements may not be effective in alienating the individual’s income and can result in an individual’s net capital gain for an income year being incorrectly recognised.


iv) ATO Risk Assessment Guidelines
The ATO has announced it will be allocating compliance resources to consider the application of the general anti avoidance rules in Part IVA to such arrangements. In this regard partners in professional partnerships need to be aware that just because an arrangement (which results in diverting income) satisfies the tests in the “personal services income” rules, does not necessarily mean their position is free from risk from an ATO adjustment.
The ATO website contains the following information in relation to Part IVA risk in respect of the 2014-15 year and beyond for individual professional practitioners (IPP):

“Taxpayers will be rated as LOW RISK, and will not be subject to compliance action on this issue, where their circumstances indicate they meet one of the following guidelines regarding income from the firm (salary, distribution of partnership or trust profit, distributions from associated service entities, dividends from associated entities or any combination of these):



  • the IPP receives assessable income from the firm in their own hands as an appropriate return for the services they provide to the firm. In determining an appropriate level of income, the taxpayer may use the level of remuneration paid to the highest band of professional employees providing equivalent services to the firm, or if there are no such employees in the firm, comparable firms or relevant industry benchmarks – for example, industry benchmarks for a region provided by a professional association, agency or consultant, and/or

  • 50% or more of the income to which the IPP and their associated entities are collectively entitled (whether directly or indirectly through interposed entities) in the relevant year is assessable in the hands of the IPP, or

  • the IPP, and their associated entities, both have an effective tax rate of 30% or higher on the income received from the firm.

Where none of the guidelines outlined above can be satisfied, the IPP’s arrangement will be considered higher risk. In these cases, the lower the effective tax rate, the higher the ATO will rate the compliance risk posed by the arrangements and the greater the likelihood of ATO compliance action being commenced.

If we can assist with a review of your service entity arrangements, please do not hesitate to contact me on [insert telephone number of partner].


Yours faithfully

[Insert name of Partner


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