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Ruling

Subject: Fees paid to a related service party entity

Question 1

Is the taxpayer eligible to claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for service fees paid to a related party service entity?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commenced on:

1 July 2010

Relevant facts and circumstances

The service entity provides a suite of services which are necessary to the conduct of a business operated by the practitioner.

The service entity employs a practice manager, receptionist and all other support staff utilised in the running of the business. It conducts the entire business including hiring of premises and equipment, administration of records and billings, marketing and all other expenses incurred in running the business.

The practitioner's sole function is the provision of professional services for which it receives payment. The practitioner will pay a percentage of its gross fees to the service entity in return for access to the practice including premises, equipment and staff. As part of the service arrangement and also to meet the professional requirements of the practitioner the service entity has had to make a substantial investment in equipment and training.

You have provided a document prepared by an independent body which shows that the total overheads and benefits including owners' salaries and benefits for a practice with income in excess of $X are equal to Z% of the total income of the practice.

There is no formal agreement between the service entity and the practitioner but you have provided a copy of a contract with an arms length contractor and a sessional arrangement letter which is to be read in conjunction with the contract. The agreement with the independent contractor provides for Y% of the schedule fees to be withheld from the payment to the contractor.

The contract and letter with the arms length contractor are said to have been prepared on a similar basis to the arrangement existing between the service entity and the practitioner. The amount withheld from the practitioner is said to be made up of the same components set out above plus a marketing fee. The independent contractor would not be charged the marketing fee unless they become an equity participant at some time in the future.

The fee payable by the practitioner to the service entity is said to produce the following benefits for the practice:

· Release of working capital;

· Relief from the administrative burden of running the practice;

· Access to specialised premises;

· Access to a skilled practice management team;

· Access to the brand name owned by the service entity; and

· Capacity to concentrate on consultations without worrying about practice administration.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 8-1

Reasons for decision

Section 8-1 of the ITAA 1997 allows a deduction for expenditure that is incurred in gaining or producing assessable income or is incurred in carrying on a business, so long as the expenditure is not of a capital, private or domestic nature.

In Phillips v FC of T 8 ATR 783; 78 ATC 4361 the question to be decided was whether the taxpayer could deduct payments it had made to a service trust for the hire of office furniture and equipment, non-professional staff, provision of share registry services, interest on outstanding amounts due to the trust and other incidental charges. A significant effect of the arrangement, in the Commissioner's view, was to divert income from the partners to other entities interested in the trust.

Despite the substantial transfer of income, the taxpayer was able to satisfy the court that the rates charged by the trust were realistic and not in excess of commercial rates. Given the view of the facts which the court adopted, that is, a re-arrangement of business affairs for commercial reasons and realistic charges not in excess of commercial rates, the decision to allow a deduction must be accepted as reasonable.

You have provided a service agreement initiated with an arms length contractor to the practice in which service fees are charged to the contractor at the same rate as those sought here, except for a marketing fee which will be charged in the event of the contractor becoming an equity participant at some point in the future.

Here the service fee is payable by an equity participant and it is therefore considered that the percentage charged of gross fees derived by an equity participant is not unreasonable when compared with similar charges made to arms length contractors to the practice. The benefits conferred under the service agreement therefore provide a sufficient commercial explanation for the expenditure incurred.

Accordingly the service fee will be an allowable deduction to the practitioner.