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New ruling and guidance on service fees
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20 April 2006 
 
 
The long-awaited ruling on the deductibility of service fees paid by professional partnerships to service entities, TR 2006/2, was released today, with a few welcome changes from the draft ruling issued for public comment in May last year. In a nutshell, for fees to be deductible it requires that service entity arrangements have substance and fees charged not be grossly excessive.  
 
Also released in final form was the accompanying Guide. The Guide is designed to provide affected taxpayers using conventional service arrangements with practical guidance for determining acceptable fees and charges.  
 
The main change is that, in addition to providing comparable market rates which the Tax Office considers commercially realistic for various activities, the Guide also provides higher ‘indicative’ rates that are, in effect, the upper limit of what the Tax Office will accept. The Tax Office has indicated that taxpayers will have a low risk of an audit if:  

  • The charges for particular services provided by the service entity do not exceed those calculated using the indicative rates; and
    •  
  • The service entity does not earn more than 30% of the combined profits of the partnership and service entity.
 
Practically speaking, the indicative rates provide commercial, not legal, safe harbours.  
 
The Institute of Chartered Accountants Tax Counsel, Ali Noroozi, said while there is ample room for improvement in terms of acceptable fees and charges, the Guide is better than the initial draft.  
 
“In our view the indicative rates are more reflective of reasonable commercial results. We are pleased that the Tax Office has acknowledged and acted on a number of our concerns raised during consultations,” he said.  
 
The Tax Office has responded to the delay in finalising the Ruling and the Guide by allowing affected taxpayers until 30 April 2007 (previously 30 June 2006) to ensure that their arrangements comply with this new guidance.  
 
Taxpayers who consider that the returns in the Guide are set at artificially low levels - and there are a number - and choose to apply their own arm’s length economic data may face an uphill battle. Unless taxpayers convince the Tax Office they are right it will amend assessments based on the comparable rates contained in the Guide even where the indicative rates would produce a better outcome for the taxpayer.  
 
The Institute has consistently questioned the soundness comparable market rates and the methods used to determine them.