13 – Service trusts
Service trusts became popular following the decision of the Federal Court in 1978 in Federal Commissioner of Taxation v Phillips (1978) 8 ATR 783.
As is often the case, this popularity led to abuses and misuses. In 2006 the ATO released Taxation Ruling TR 2006/2 Income tax: deductibility of service fees paid to associated service entities: Phillips arrangements. This ruling in effect re-states the position on service trusts and makes it clear that they are acceptable for income tax purposes provided the service fees are commercial and are not excessive.
The ruling meant service trusts became much less popular, and many were taken down and replaced with simpler structures.
What is a service trust?
A service trust can take many forms. The most common form involves a professional setting up a trust for the purpose of providing services to the professional. The service trust owns the plant and equipment, employs the non-professional staff, owns or leases the space, and generally controls the infrastructure and logistics required to run the practice.
The practice pays an arms-length (ie market) fee for these services. This fee includes a reasonable profit, and this means profit is in effect moved from the highly taxed hands of the professional to the lesser tax hands of the service trust’s beneficiaries.
A service trust arrangement can be shown as follows:
Do service trusts have a role to play in your practice?
Yes, since 2006 service trusts have become less popular. But we are not sure this is sensible. Quite often closer investigation shows that the asset protection advantages plus some, albeit limited, tax advantages combine to make a good case for setting up and running a service trust.
This is particularly the case for high billing solo practices deriving personal services income and not business income.
Points to remember
Points to remember with service trusts include:
- the charges should be made on a monthly basis (at least) and appropriately worded tax invoices should be issued and paid on a timely basis. Book entries put through after June each year will often not pass muster if the tax office decides to challenge them.
- the basis of rendering charges should be reviewed regularly and this review should be properly documented at the time it is completed.
- a properly executed management contract should be put in place to provide a firm legal basis for the rendering of the services.