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Q:
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What is the nature of “Type II” arrangements?
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A:
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Type II arrangement involves deductions being claimed by an unincorporated business for payments, often described as management fees, which are made to a company or a service company controlled by the proprietor or partners of the business.
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Q:
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Under what condition such arrangements are acceptable?
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A:
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If similar arrangement is entered into, it must be emphasized that the service company has to function as a separate business operating on an arm’s length basis during its dealings with the other party. Further, the amount of fee involved should reflect the costs of the service company which are directly attributable to the relevant services plus an appropriate mark-up to provide for the operating expenses and reasonable profit margin of the company. To support and be consistent with the separate status of each party, their respective rights and obligations and dealings with each other should be fully documented. In addition, in respect of a management fee paid by a firm, the nature of the services received from the service company can be categorized as “qualifying services”.
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Q:
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What kind of documents should be documented regarding the discussed above?
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A:
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Such documentation should include
The agreement under which the services are provided (it should specify the relevant services, the basis on which fees are to be paid, the period covered by the agreement, etc.);
Minutes of meetings recording approval of the terms of the service company agreement and any subsequent amendment;
Ivoices and receipts in respect of transactions between the parties;
Working papers in respect of the calculation of the fees charged by the service company;
Bank records in respect of each party; and
Employment contracts in respect of persons employed by each party.
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Q:
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What is the meaning of “qualifying services”?
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A:
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The Inland Revenue Department (“IRD”)’s position is that, “qualifying services” encompasses non-professional services which are required to provide the infrastructure in which the firm operates and to cater for its day-to-day operations, such as provision of premises, staff, plant and equipment and miscellaneous supplies.
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Q:
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What is an appropriate mark-up?
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A:
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An appropriate mark-up, provided that the overall claim does not exceed the expenditure actually incurred, a margin not exceeding 12.5% of the cost element will generally be accepted as being commercially realistic.
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FAQ
