Australia: Service Trusts – Where To From Here?

The conducting of service trusts has become one of the most heavily scrutinised areas of tax practice over recent times and the news is that we may have only reached the tip of the iceberg. In 2006 the ATO released Taxation Ruling 2006/2 ‘Income tax: deductibility of service fees paid to associated service entities’ which attempted to clarify the nature and the form that the ATO believed service trusts arrangements with professional practices should take.

Following on from the release of this ruling, there were several submissions made with regards to various industry bodies requesting the ATO clarify what they believed would be acceptable mark-ups and margins on service trusts expenditures. As such, the ATO released a compendium booklet shortly thereafter which sought to detail their views in this regard.

This booklet provided commentary in terms of traditional service trust expenditures such as labour, recruitment, equipment and premises leasing. This included what the ATO believed were acceptable terms for on-charging in light of the benchmarking analysis they had conducted. It also detailed what costs within these categories would ordinarily be expected to be absorbed by the service trust entity as opposed to on charging them to the practice entity. Subject to certain criteria being met, service trust operators were also given until 30 April 2007 to review and adjust their arrangements as appropriate to comply with ATO accepted practices.

Furthermore, the booklet then went on to provide a number of case studies which highlighted the comparative audit risk under certain service trust scenarios, with varying net profit margins. Of note was a section devoted to service trusts of medical practitioners. This detailed the ATO’s view that in an environment with multiple GPs conducting a practice, it is prima facie acceptable for up to 40% of the practice revenue to flow across to the service entity in the form of service fees. This was the case providing that the service entity be responsible for a number of responsibilities and expenditures, including, but not limited to, those connected with administrative labour, premises, specialist equipment, legal & regulatory and those of a general administrative nature.

At present the ATO is believed to be conducting a review of legal practices with service trust arrangements in the $2m - $100m p.a. turnover range. There appears to have been some interesting outcomes of these reviews which could potentially be indicative of the ATO’s position on service trusts, in general, from 1 May 2007. Of particular note in this regard is going forward:

• Net profit margins of 10% or more on activities (primarily being for the provision of labour hire) will not be accepted as being commercial;
• In these instances, the ATO will look to apply their own net mark-ups on costs which range from between 3.5% - 7.5% depending on the type of expenditure, and amend the affected tax returns accordingly; and
• The ATO will also look to potentially conduct an audit of the business’ and/or business proprietor’s tax affairs in instances of non compliance.

It is unclear at this stage whether this stance will or will not be extended to medical practitioners as there does not appear to be any specific activity in this area and it would be presumptuous to assume this to be the case. Of interest however, is that based on recent outcomes, the imposition of the 10% net profit rule per the above does not appear to just be limited to those service trusts which conduct labour hire arrangements, as per the ATO’s compendium document to the ruling.

It is important that given the amnesty period has passed by now, that you review your current arrangements and in light of the current ATO activity, you contact your advisor to discuss your options.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.