Taxation and Service Arrangements
Recently we have received many requests from clients relating to the use of service entities as part of their tax planning – in this regard I though I should write a quick article on this matter dealing with the most important issues…
Where you have a related entity (S) providing services to another (normally the income producing) entity (I) there are two requirements that must be satisfied for those expenses to be tax deductible.
There must be a connection….
Firstly, there must be a connection between the arrangement and the income earning activities of (I) – another way of putting this is that there must be a commercial benefit of the arrangement to (I) of having the service entity arrangement.
Should the ATO determine that there is no commercial benefit to (I) of the arrangement and that there is no connection between the arrangement and the income earning activities of (I) – the fees or part of the fees will not be tax deductable to (I)
In general, if the service entity arrangement has been set up for the proper reasons this is not normally that difficult to prove.
The service fees and charges must be correctly calculated
To put this plainly the service fees and charges charged by (S) must not be excessive. The ATO will disallow any fees it considers to be excessive.
To help with this the ATO have provided indicative rates as well as case studies.
The ATO has also indicated that where the indicative rates have been used and the service entity generates profits which are less that 30% of the combined profits of both entities (S & I) then the chance of an audit is low.
The (some) indicative rates are indicated below:
Labour hire arrangements – net mark up on costs not exceeding 10%
Recruitment – net mark up on costs not exceeding 10%
Expense payment services – net mark up on costs not exceeding 10%
It is suggested that you have a look at the case studies provided by the ATO to get a better idea of how these mark ups are determined and how costs are defined.
Documentation to support the arrangement
Over and above the documentation a business would normally be required to keep it may be a good idea to have a separate service agreement drawn up between the parties – this agreement can also document how the service entity arrived at its pricing structure for the services rendered as well as the actual calculations supporting the prices charged.
Medical Practice Arrangements
The ATO has indicated that where a general practioner has an arrangement with a service entity and the service entity conducts the entire business of the medical practice including premises, equipment, medical and office systems and supplies ,patient records ,general administration .marketing, legal and regulatory obligations (excluding the professional obligations personal to the practitioner) and all other costs related to running the practice then a service fee in the region of about 40% of gross fees from consultation and procedures earned by the practioner would be acceptable in most cases.
As indicated in the introduction I have simply touched on some of the more important aspects in this article and clearly a lot of detail has (intentionally) been left out.
Should you require more information feel free to contact our offices.
This post is for general information purposes only.
No action should be taken based on this information alone as your circumstances are unique and it is better to speak to a tax professional.