With the ATO's imposed 30 April 2007 deadline in mind in recent weeks we have been considering service trust arrangements required by clients to put their tax planning arrangements into proper order.

There has been significant unease and confusion in the wake of  Taxation Ruling 2006/2 and its accompanying Guide on arrangements for service trusts. This Ruling by the Australian Tax Office (ATO) has resulted in apathy among some and panic in others. For clients and tax advisers who have been tracking the ATO's evolving views on trusts, the Ruling is part of a trend requiring ongoing and careful review of tax arrangements involving trust structures.

The Ruling sets out the position of the ATO regarding deductibility of service fees paid by businesses to service entities. The ATO has provided a window until 30 April 2007 for businesses to fix their arrangements for service trusts. The alarm or concern that a tax audit causes can be reduced by proactive and proper preparation. Preparation certainly makes tax audits less excruciating and fearful.

1. Why use a service trust?

A business may use a service trust for various reasons, such as :

• Protection of the business assets from liabilities that may arise in the course of business;
• Protection of the business from liabilities such as those arising from industrial disputes;
• Efficient distribution of income from the business; and
• Better tax planning for succession planning purposes.

2. What is a service trust structure?

A typical service trust structure looks like this:

3. What is mark up and how does it work?

A mark up or gross up is the percentage by which the service entity increases the cost it incurs in order to provide the services to the business. If the cost of hiring  and paying labour is $100,000 per annum, and the mark up is 30%, the corresponding service fees charged to the business will be  $130,000 per annum, the service entity making a gross profit of $30,000 per annum on the labour hire part of its service to the business.

An acceptable mark up remains legitimate under tax law. Although the Ruling has undoubtedly raised some fundamental questions such as whether the tax commissioner can set the limits of mark up that may be acceptable for tax purposes, there is no denying that service trusts fulfil a useful need in business tax planning.

Why is the extent of mark up important? As had been known for years (if not decades) before the Ruling, the extent of the mark up for services provided by the service entity (ie the service trust ) is a crucial consideration under tax law. Getting the mark up right can be the difference between establishing a service trust arrangement acceptable to the ATO verses having an arrangement which is challenged and found unacceptable by the ATO or appeal bodies.

4. What mark ups are acceptable to the ATO?

Set out below are indicative rates of mark up for service trust arrangements suggested by the ATO.  

• Labour hire arrangements Gross mark up on costs of 30% of salary and benefits, all other direct and indirect operating costs included (expected to be 18% of salary & benefits). Net mark up is expected to be 10% of direct & indirect operating costs. 
• Recruitment  Net mark up to be 10% of the direct and indirect costs. 
• Expense payments  Net mark up to be 10% of the direct and indirect costs. 
• Equipment Hire  Gross mark up to be 10% of the cost (all other relevant costs included). 
• Rental  Comparable market price (the rent is at market rates plus finder fees where applicable).

The ATO will allow until 30 April 2007 for people to review their service trust arrangements before sanctions apply.

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