Service Entity Arrangements – time for a checkup again?
31 August 2016
It’s been a decade since the last Tax Ruling (TR 2006/2) was released by the Australian Taxation Office (ATO), and that is probably the last time many practice owners reviewed their service entity arrangements for compliance.
Service arrangements are typically entered into by lawyers, accountants, medical practitioners and pharmacists. These arrangements can vary widely in the exact steps used, but they fundamentally incorporate a practice owner, associated service entity and the ATO. The diagram below highlights the basic setup of a service entity arrangement covered by this tax ruling. A feature of this service arrangement is that a service trust provides protection of the basic functions you need to run your practice (property and equipment leases and staff), should the medical practice itself be subject to litigation or bankruptcy.
How do I know if my service fees are deductible?
The TR 2006/2 Tax Ruling explains that the deductibility of service fees is a question of fact. What is the expenditure for and how does it assist you in the production of assessable income? Can you provide an ‘objective commercial explanation’ for the expenditure? If the service fees are paid for some other purpose other than the production of income, then it is less likely to be deductible.
Once you have established whether it would be commercially reasonable for you to pay service fees to a service entity, you would then need to determine whether the fees you are paying have been correctly calculated and are not overly excessive. Overly excessive fees may indicate that you are not paying the service fees for the provision of services and equipment, but instead for some other purpose such as obtaining a tax benefit. The ATO’s document Your Service Entity Arrangements2 has guidelines to assist you with determining whether the service fees have been correctly calculated.
A good way of looking at whether the service fees are objective and commercial is if an unrelated party were to take the place of your service entity, would you be willing to pay the same amount of service fees to the unrelated entity for the services it provides? This alone in itself however is not proof of a valid service entity arrangement.
What to do from here?
1 Federal Commissioner of Taxation v. Phillips.
2 Australian Taxation Office (2006). Your Service Entity Arrangements, NAT 13086-04.2006.