MKS TAX update  - NOVEMBER 2005

ATO IS REVIEWING SERVICE TRUST ARRANGEMENTS

Recently the ATO released a new draft ruling and guidance document in relation to service trusts.  The ATO is concerned that these entities are being used to shift profits out of a business entity into the hands of the spouse and family members of the business owner in breach of the taxation rules.  Therefore they are now clamping down on their use.

Service trusts traditionally have been established to separately hold assets used in a related business and/or employ staff used in that business.  They are typically designed to isolate assets away from the business so they are not at risk should the business experience financial difficulties.  Alternatively they are used to isolate the risks of employment, like workcover, discrimination and harassment claims, away from the business.  Therefore they are designed to provide a level of asset protection for the business operators.  Service trusts traditionally make profits from the on-hire of equipment and staff to the business entity and these profits are available to the beneficiaries of the service trust instead of going to the business owners.

The ATO has identified instances where the mark ups on those hire charges have been excessive compared to what would be “arm’s length” charges, and it is concerned that these trusts are being used as a mechanism for shifting profits to the beneficiaries of the service trust resulting in significant tax savings and possible tax avoidance.

The ATO has launched a significant audit programme of these entities and published what it considers to be safe harbour mark ups on these hire costs.  These safe harbour mark ups are extremely conservative and may not reflect fully what is acceptable in the market.  However taxpayers operating service trusts and using mark ups in excess of these safe harbours may eventually attract audit attention and may need to justify their mark ups.

We have set out below a brief checklist to help you determine whether your service trust will pass ATO scrutiny or whether you need to amend your current arrangements:-

• Have you benchmarked your labour and equipment hire mark ups to commercial arm’s length levels for the same services in the same or similar industries?  Is more than 50% of your gross business income transferred to the service trust via these mark ups?
• Do you have a service agreement in place?  If so, do you fully comply with the service agreement?  When was the last time you reviewed your service agreement?
• What is the commercial reason for establishing and operating your service trust?  If it is asset protection, does the arrangement actually provide this?  Is it to reduce tax?
• Can your service trust demonstrate that it is conducting its business activities on a full arm’s length basis separate from the business entity?  Are invoices regularly raised?  Are debts between the business and the service entity collected on normal business terms?  Does the service trust rent its own premises?  Do the controllers of the trust (as against the controllers of the business) control, hire and fire all administration staff?

As service entities are in the firing line of the ATO , we strongly suggest you review any arrangements in place.  Most service trusts have a short period of time to rectify any deficiencies in relation to their operation without audit risk and we suggest you take advantage of this opportunity.  We can assist you in determining whether your service practice arrangement will pass ATO scrutiny – please contact our office for assistance.  

SPLITTING OF SUPER CONTRIBUTIONS BETWEEN SPOUSES FROM 1st JANUARY 2006

As and from the 1st January 2006 members of accumulation funds will be able to split super contributions with their spouses.  This will provide significant tax and retirement planning opportunities to single income families, and to those families where there is a significant difference between the retirement savings of the two spouses.  It will enable the tax exempt retirement threshold to be fully utilised by both spouses and may ensure that one spouse does not fund excess benefits whilst the other fails to fully utilise their RBL threshold.  The split amount will be treated as an ETP rollover for the receiving spouse, but must come from contributions made after the 1st January 2006 .  Both taxed and undeducted contributions can be split, and they retain their nature in the hands of the spouse.

The amount to be split must be determined after each year end.  Self employed contributors will need to lodge their Section 82AAT notice with the fund detailing the tax deducted component before the split occurs.  Once the contribution has been split, the tax deductible status or component cannot be changed.

Whilst the regime is set to commence for contributions made on or after 1st January 2006 , it would appear that the splitting of a contribution cannot occur until 1st July 2006 .  This is because a splitting request can only be made in respect of contributions made in a previous year.

Contributions eligible to be split include:-

• Superannuation guarantee contributions
• Salary sacrificed and additional employer contributions
• Undeducted contributions
• Self employed contributions

It will not be possible to split past or existing balances, ETP amounts (from employers or from other funds) and rollover amounts.  The splitting of the contribution has no impact on superannuation guarantee obligations of an employer or payer who still must meet their obligations for the employee or contractor irrespective of any subsequent split that may occur.

The definition of a spouse includes both legally married as well as de facto spouses.  However they will not include same sex couples.  There will be some restrictions on transfers eg a transfer cannot be made to a current spouse where the contributions have been flagged to be considered in a Family Law Court settlement with a former spouse.

The transfer mechanism cannot be used to access monies out of the superannuation fund.  Therefore a transfer to a spouse will not be allowed where the conditions of release of the funds in the hands of the spouse have been met, for example where the spouse has retired, attained the age of 65 or been permanently incapacitated.  A statement from the receiving spouse will be required confirming that none of these conditions have been met.

However members who have met the minimum retirement age (55 or older depending on their date of birth) can access a non-commutable pension whilst remaining in the work force.  It would appear that these pensions could be financed by “split” contributions.  However such pensions could not be funded out of proposed split contributions and could only be funded from split contributions previously received prior to the establishment of the pension.

Superannuation funds do not have to accept split contribution rollovers and can reject them at their discretion.  They can also reject some split requests where they are not satisfied that there will be sufficient funds left in the member’s account to meet any taxation liabilities, fund charges or pension obligations.

For further information on super contribution splitting, please contact our office.  

NO MERCY SHOWN WHEN TAX FRAUD INVOLVED

A 72 year old woman and two of her adult children have been sentenced to 8 ½ years jail each for defrauding the Commonwealth.  The family had over a 10 year period skimmed the bulk of the cash takings from the family business and transferred it to overseas accounts.  The fraud, which was detected by the Australian Crime Commission through a phone tap, resulted in the family paying an estimated total of $21 million in amended assessments and penalties to the ATO .  The fraud involved the maintenance of two sets of books by the taxpayers.

The ATO and the Courts are  taking a much harder line in these cases, and will show no mercy despite the age of the offenders.  The case demonstrates the significant penalties that can arise where taxpayers deliberately fail to declare all their income by keeping false or incomplete records.