Deductions Denied for Intra-group Transactions Lacking “Substance”

The “Substance” (or Lack Thereof)

SNA Group and the trusts had previously executed a services agreement. This agreement stated that a service fee can be charged by the trust for the use of IP, rent roll and employees. The amount of the service fee would be determined each year but should not exceed 8% of the group’s net assets at market value. However, the accounts showed a significant departure from the services agreement (including two years where the fee exceeded 8%). The parties involved in the transactions were the controlled by the same directors, their evidence lacked substance in how the service fee was determined and ultimately it appeared as though the accountant merely determined the amount after the year end and journalled the service fee.

As a personal highlight in the case, oral evidence included the verbatim statement:

“we used to call our meetings at the Chinese restaurant – our – our unit holder meetings, and we would say – he would say, “This is what the charge is going to be.” We would think it would be fair and reasonable.”

Ultimately, the court took issue with the substance of the transaction, there was no corroborative evidence to suggest how the quantum of the service was determined.

The ATO will take a position to deny deductions for intra-group transactions in the absence of documentation, that matches conduct, or sufficient evidence to rationalise the obligations of the parties. The Courts have supported the ATO in this decision. It is a recognition that contract law and documenting corporate decisions should impact tax outcomes. Whilst corporate groups treat the business as a single unit, companies are artificial but separate legal personalities. Separate legal personalities need to show the elements of a contract are met to have an obligation to pay. For this reason the Full Court stressed the issue that entities of the same business group must still show mutual assent to create a legal obligation to pay.

The SME client base often have issues with documenting intra-group transactions. It is an added compliance cost to a business owner who is concentrating on running their business. However, services agreements are important documents that may cover a range of activities. Services agreements should be supported by extrinsic evidence e.g. staff timesheets, project codes or documenting proprietary use. This decision has further ramifications when considering corporate groups regularly utilise payments by direction, assignments and set-off: these transactions should be documented and the appropriate legal evidence should form part of the execution of these transaction.

The execution of a legal agreement is only the initial step and clients should also establish systems and processes, which are documented, to have an easier time supporting intra-group transactions in the event of an audit or review.

Next Steps

If you have any concerns or questions about what you should look to document in intra-group transactions or merely for a tax health check, please feel free to contact the Tax Consulting Team.