Username:
Password:
Forgot Password?

Archived - Service entity ruling and booklet: finalised at last
Print this Article Print this Article
Email this Article

The long-awaited ruling on the deductibility of service fees paid by professional partnerships to service entities, TR 2006/2, was released on 20 April, with a few welcome changes from the draft ruling issued for public comment in May last year. In a nutshell, for service fees to be deductible, service entity arrangements must have substance and the fees charged must not be grossly excessive.  
 
Also released in final form was the accompanying guide, designed to provide affected taxpayers using conventional service arrangements with practical guidance for determining acceptable fees and charges. The guide reflects some movement in the Australian Tax Office's (ATO) approach to service entity arrangements. 
 
Impact on existing arrangements 
The ATO has responded to the delay in finalising the ruling and guide by allowing taxpayers until 30 April 2007 to review their arrangements in light of the ruling and guide. 
 
Practices considered 'high risk' based on previously announced criteria remain at risk of retrospective audit activity. 
 
Acceptable fees and charges 
The guide continues to set out what the ATO regards as 'comparable market rates' for typical services performed by service entities; namely labour hire, recruitment, expense payments, equipment hire and rental. 
 
In addition, the guide provides higher 'indicative rates' for these activities. In effect, these are the upper limit of what the ATO will accept on the basis that the risk to the revenue would not be sufficient to justify an audit of a professional practice if:

  • 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 per cent of the combined profits of the partnership and service entity.
The indicative rates provide a commercial, as opposed to a legal, safe harbour. 
 
The following list summarises the indicative rates for services contained in the guide:
  • Labour hire arrangements: Gross mark-up not exceeding 30 per cent of the salary and benefits of the on-hired staff, providing all direct and indirect operating costs associated with the on-hiring are borne by the service entity* 
     
    or 
     
    Net mark up not exceeding 10 per cent of direct and indirect operating costs associated with the on-hiring of staff 
     
  • Recruitment: Net mark up not exceeding 10 per cent of direct and indirect operating costs associated with recruitment activities 
     
  • Expense payments - bill administration and payment only: Net mark up not exceeding 10 per cent of the direct and indirect operating costs associated with the expense payment activity 
     
  • Equipment hire - owned: Gross mark-up not exceeding 10 per cent of the cost to the service entity of the equipment with all relevant costs being borne by the service entity 
     
  • Rental - owned or leased (no guarantees): Market rates (plus finder's fee where appropriate) 
     
    * For each percentage point by which operating costs are less than 18 per cent of salary and benefits of on-hired staff, the 30 per cent mark-up is reduced by one per cent in the next year. Expenses that can typically be marked up and on charged are set out in the guide.
 
The Institute's Tax Counsel, Ali Noroozi, said 'while there is room for improvement in terms of acceptable fees and charges, the guide is better than the initial draft. We are pleased that the ATO has acknowledged and acted on a number of our concerns'. 
 
Where to from here 
Those members affected should review their service entity arrangements in the light of the ruling and guide. 
 
Members who consider that the returns in the guide are set at artificially low levels and choose to apply their own arm's length economic data may face an uphill battle. Failure to convince the ATO that you are right will result in amended assessments based on the comparable market rates even where the indicative rates would produce a better outcome. 
 
The Institute has consistently questioned the soundness of the comparable market rates and the methods used to determine them. 
 
For more information: 
Last updated: 20 April 2006