The long-awaited ruling on the deductibility of service fees paid by dentists to service entities, TR 2006/2, has now been released, 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. Higher risk cases include those where:
- Service fee expenses are over $1 million;
- Service fee expenses represent over 50% of gross fees or business income earned; and
- Net profit of the service entity (or service entities) represents over 50% of the combined net profit of the entities involved;
- Those which raise serious questions as to whether the services were in fact provided by the service entity.
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 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 markup 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 on labour of the direct and indirect operating costs associated with the expense payment activity.
- Equipment hire - owned: Gross markup 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).
The Institute of Chartered Accountant'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 dental practices affected should review their service entity arrangements in the light of the ruling and guide. In particular, ensure that the following are reviewed and updated by 30 April 2007:
- Service entity agreements may need updating to cover new arrangements.
- Service fee calculations will need reviewing to ensure mark-ups are acceptable.
- Consider the ongoing benefit of operating a service entity versus the costs to operate this structure.
- Consider whether such a business structure is appropriate for your situation.
- Ensure operations are paid for and provided by the service entity not by the dentist.
For more information:
For more details, contact Clark & Jacobs for a copy of the Ruling and Booklet or to discuss your situation.
Go to the ATO website to read the Commissioner's press release announcing the release of the Ruling and Booklet: http://www.ato.gov.au/corporate/content.asp?doc=/content/72385.htm
Clark & Jacobs Accounting and Business Advisers specialise in providing advice to dentists. Advice that includes planning for your financial wellbeing, superannuation, insurance, practice management, computer software and the buying and selling of dental practices. For a free assessment of your financial position and to see how you can achieve your goals, call Alison Lacey on (02) 9264-1111.
This article is designed to provide generic information only and should not be viewed as a recommendation to act. Individuals should seek advice from a qualified advisor to ensure their actions are commensurate with their financial needs and requirements.