Because of Personal Service Income rules (PSI) it is hard for professionals such as accountants, lawyers, doctors and dentists to share profit with their spouse and Family Trust. The problem is that the professional earns, say, $200k profit - paying tax at almost 50 cents in the dollar. The spouse earns nothing and, therefore, wastes the lower marginal tax rates.
The two methods to get around PSI are:
1. Everett’s assignments; or
2. Service Trust
1. Everett’s assignments
In Everett’s case, the professional transferred part of his partnership interest to his wife for a few thousand dollars. The model later developed to 'selling' part of the partnership to a Family Trust. It is a common practice.
Everett assignments are mechanisms that partners in a partnership use to share the business profits with associated entities. It came from FCT v Everett (1980) 143 CLR 440. This is a 1980 High Court decision. It established that a partner in a firm assigns part of their stake in the underlying assets of that firm. Therefore, the spouse and family trust get part of the future income.
In the ATO old rulings on income splitting and partnership interests, the ATO stated that Part IVA does not apply to an Everett assignment. But this is provided it constitutes a 'no strings attached' disposition of the partnership interest. All rather too loose language for a black letter tax lawyer such as myself. The ATO has revisited this position. It now considers Part IVA is capable of applying to such assignments.
I have never liked Everett’s assignments. I have never been involved in such an arrangement. The ATO has finally caught up and now agrees with me.
While the ATO has no power to change the law it sanctioned Everett’s assignments arrangement under the Guideline: 'Assessing the risk: Allocation of profits within professional firms'. That Guideline has thankfully withdrawn in 2017.
2. Service Trusts
It is common practice for businesses, not just professionals, to use a trust (service entity). A service trust is often a:
1. Family Trust - for a single business owner
2. Unit Trust - if 2 or more business owners
3. Company - not common as profit is trapped and no CGT relief. But useful if you have no family because of the 30% tax rate
Build these 3 types of service trusts on our website.
The service trust is the second business. The service trust provides services to the business. It charges a fee for providing those services. Service trust profits are shared with the business owner's spouse, children and family. They pay tax at a lower marginal tax rate. Therefore, the service trust saves tax. It helps with superannuation benefits and the spreading of income to family members.
But it is not enough to have just a service trust. You need the agreement between the business and the service trust. This agreement is called a Service Trust Agreement. The Service Trust Agreement is a contract. It allows the service trust to supply equipment, staff, receptionist, tools, factory, premises and administration services to the business.
You can read about and build a Service Trust Agreement here.
Adjunct Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, LLM, MBA, SJD
National tax partner everett's assignments
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