Service entity arrangements for retiring professionals: structural unwinding at retirement

For Australian professional practices — medical, legal, dental, accounting, consulting — operating through service entity arrangements, retirement of the principal professional triggers a specific structural transition that requires careful planning. Service entity arrangements, sometimes called "Phillips-style arrangements" after the 1978 Federal Court decision that established their legitimacy, split a professional practice into two related entities: a principal entity (the professional individually, or a partnership) that earns the professional fees from clients; and a service entity (typically a discretionary trust or company controlled by the professional's family) that provides administrative, office and support services to the principal entity for a fee. The arrangement was tax-effective during the professional's working years — splitting income to lower-marginal-rate family beneficiaries and accumulating retained earnings at concessional company tax rates. At retirement, the structure no longer serves its original purpose, and the unwinding raises specific tax, Division 7A and stamp duty considerations. For retiring professionals who have operated these structures for decades, planning the unwinding two to three years in advance — rather than at the last minute — is essential to a clean and tax-efficient exit.

The basic service entity structure has been a common feature of Australian professional services for over 50 years. The principal entity (the doctor, lawyer, accountant, consultant, or partnership) earns the professional fees from clients. The service entity — typically a discretionary trust controlled by the professional with family members as potential beneficiaries, often paired with a corporate trustee and sometimes a corporate beneficiary — provides administrative services to the principal entity: office space (where the service entity owns or leases the premises), equipment, support staff, IT systems, telephone and supplies. The service entity charges the principal entity a service fee for these services. The fee flows through the service entity to family beneficiaries (in trust structures) at lower marginal rates, or is retained in a corporate beneficiary at the company tax rate — producing tax savings compared to having all the professional income in the individual's personal hands. The FC of T v Phillips (1978) decision established that such arrangements are legitimate in principle, provided the services are genuinely provided and the fees are realistic and not in excess of commercial rates. The ATO's Taxation Ruling TR 2006/2 is the operative guidance: it sets indicative benchmark mark-up rates — broadly a 30% gross mark-up on the salary and benefits of on-hired staff (reduced where absorbed operating costs are below 18%), and a net mark-up on costs at or below around 10% — as a "low audit risk" safe harbour for arrangements within the benchmarks.

What tax benefits do service entities provide during the working years?

The tax benefits during the working years flow from the income-splitting effect. For a high-income professional on the top marginal rate of 47% (45% plus 2% Medicare levy), having all the practice's net income in their personal hands is the highest-tax outcome. By contrast, distributing some of the practice's economic value through service entity fees to a spouse on a middle marginal rate (for FY25-26, 30% applies between $45,001 and $135,000 after the Stage 3 rate changes — the old 32.5% bracket no longer exists), to adult children at lower rates, or to a corporate beneficiary at the company tax rate (25% for a base rate entity with turnover under $50 million and no more than 80% passive income, otherwise 30%), produces meaningful tax savings. Over a 20-30 year career operating the structure, the cumulative tax savings can be substantial. The structure also allows retained earnings to accumulate in a corporate beneficiary at the concessional company rate, building franking credits that can be used in subsequent dividend distributions. The retained earnings represent post-tax economic value available for distribution to the professional and their family over time, including in retirement when their personal marginal rates may be lower.

What triggers the wind-down at retirement?

The end of the service requirement at retirement is the trigger for unwinding. Once the professional ceases practice, the service entity no longer has a genuine ongoing service to provide — the original justification for the arrangement ends. The service entity's service charges to the principal entity cease (because the principal entity has ceased operations or been sold). The wind-down involves several elements: ceasing the service charge flow; addressing the service entity's owned assets (office premises, equipment); distributing accumulated retained earnings to ultimate beneficiaries; resolving any Division 7A issues with corporate beneficiaries and trust unpaid present entitlements; and closing the corporate structures through ASIC voluntary deregistration. The timing and sequence of these elements affect the tax outcome — particularly the distribution of retained earnings, which is best streamed over multiple years of retirement to use lower marginal rates and the tax-free threshold.

How should accumulated retained earnings be distributed?

The accumulated retained earnings distribution is often the most consequential element of the wind-down. Service entities operating for decades may have substantial accumulated retained earnings — both in corporate beneficiaries (taxed at company rates with accumulated franking credits) and in trust capital accounts. The distribution of these earnings to ultimate beneficiaries (the professional, their spouse, their children) is a multi-year exercise. Streaming distributions across five to ten years of retirement spreads the income across multiple years — using each year's tax-free threshold and lower marginal brackets — rather than concentrating it in a single high-tax year. Where the corporate beneficiary has substantial franking credits, dividends can be franked, meaning the professional in retirement on lower marginal rates may receive distributions that are tax-effective, with the franking credits providing offsets or even cash refunds where they exceed the tax payable (articles/2026-05-04-franking-credits-refundable-imputation-retirees). The distribution plan should be modelled across the multi-year horizon to optimise the outcome.

How does Division 7A interact with the wind-down?

The Division 7A interaction is the technical area that requires specialist attention. Where the service entity is a trust with unpaid present entitlements (UPEs) to a corporate beneficiary, the ATO's current view in Taxation Determination TD 2022/11 is that a UPE (or an amount held on sub-trust) created on or after 1 July 2022 can constitute the provision of "financial accommodation" — and therefore a Division 7A loan — unless the trustee acts before the company's tax return is lodged to either pay the entitlement across or put it on a Division 7A complying loan agreement. This replaced the older sub-trust framework that applied to pre-2022 entitlements. At the wind-down of the service entity, any outstanding UPEs need to be addressed — typically by paying the UPE across to the corporate beneficiary (which then makes franked distributions to the professional) or by working through the complying-loan consequences. This is a specialist area; engaging a specialist tax adviser during the wind-down is essential, and the analysis is too complex to be handled as an afterthought.

How do small business CGT concessions apply to a practice sale?

The practice sale and small business CGT concessions intersect with the service entity unwinding in valuable ways. Where the professional sells the practice to a successor (often a family member, partner, or external buyer), the sale of the practice's goodwill and assets may qualify for the small business CGT concessions under Division 152 of the Income Tax Assessment Act 1997 — particularly the 15-year exemption (for a CGT asset held at least 15 years where the taxpayer is 55 or over and the disposal is in connection with retirement, producing a fully CGT-free gain), the retirement exemption (capped at $500,000 lifetime, unindexed), and the 50% active asset reduction (articles/2026-05-04-small-business-cgt-concessions-retirement). The structure of the sale determines which entity disposes of which assets: the principal entity typically disposes of the goodwill (the right to the practice's client relationships); the service entity may dispose of office premises and equipment if it owns these. Both entities may qualify for the concessions under specific conditions. Crucially, proceeds that qualify under the 15-year exemption or the retirement exemption can be contributed to super under the lifetime CGT cap, which is $1,865,000 for FY25-26 — a major retirement contribution opportunity that sits over and above the ordinary concessional and non-concessional caps.

What stamp duty issues arise on property transfers?

The stamp duty considerations on property transfers during wind-down are state-specific. Where the service entity owns the practice's office premises, transferring the property out of the service entity — to the professional personally, to the buyer of the practice, or to family beneficiaries — typically attracts transfer duty under state and territory revenue laws. The duty rates and any concessions vary by jurisdiction; some states have specific concessions for transfers as part of a genuine business restructure, but they are not automatically available and have strict eligibility conditions. State-specific stamp duty advice during the wind-down is essential, particularly for high-value property holdings where the duty can run to $50,000-$100,000 or more on a $1 million-plus property.

Worked planning examples

These two cases show how service entity unwinding plays out in practice. Illustrative only — not personal advice — using FY25-26 figures.

Case 1 — Dr Robert, 64, GP, operating his practice as a sole-trader principal with a family discretionary trust as the service entity. The trust has operated for 28 years. Accumulated retained earnings in a corporate beneficiary: approximately $380,000. The service entity owns the office premises (worth $850,000). Robert plans to sell the practice in 18 months to a junior partner. On these facts the wind-down planning needs to start now. The sale of the practice goodwill and assets to the junior partner may qualify for the 15-year exemption — Robert will be 65 or 66 at sale (over 55), the goodwill has been held well over 15 years, and the sale is in connection with his retirement, so on satisfying the basic conditions the gain on goodwill can be entirely CGT-free. The exempt proceeds can then be contributed to super under the $1,865,000 lifetime CGT cap (FY25-26), well beyond the ordinary caps. The office premises sale by the service entity needs separate analysis — transfer duty for the buyer, and CGT consequences for the trust that may also be SBE-eligible. The $380,000 of accumulated retained earnings should be distributed across five to seven years of retirement as franked dividends, using the franking credits to keep the tax efficient at Robert's lower retirement marginal rates. On these facts the rational steps are to engage specialist tax and stamp duty advice now, model the sale-and-wind-down sequence, plan the retained-earnings distribution across multiple years, address any UPE under TD 2022/11 before the relevant company return is lodged, and voluntarily deregister the corporate beneficiary once the funds are fully distributed.

Case 2 — Margaret, 67, partner in a small accounting firm, recently retired. Her service entity (discretionary trust plus corporate beneficiary) has $180,000 of accumulated retained earnings with $77,000 of accumulated franking credits. She has no remaining service-providing role. On these facts the wind-down is more contained. Margaret has retired, so the service entity has no ongoing role. The rational approach is to distribute the $180,000 of retained earnings across four to five years of retirement as franked dividends carrying the $77,000 of franking credits. For Margaret in retirement on a low marginal rate, the franked dividends produce a strong tax outcome — quite likely a partial franking credit refund where the credits exceed her tax. After all earnings are distributed and the corporate beneficiary has no remaining purpose, she can voluntarily deregister it through ASIC (the deregistration application fee is modest). Any UPE between the trust and the corporate beneficiary should be cleared as part of the sequence with reference to TD 2022/11. The wind-down extends four to five years but produces an orderly, tax-efficient exit from the structure.

For retiring professionals with service entity structures, the wind-down is a multi-year project requiring specialist tax advice, multi-year distribution planning, Division 7A awareness, small business CGT concession application, and stamp duty consideration. The advice work is to identify professional clients with service entity structures well before their planned retirement, inventory the structure including accumulated retained earnings and franking credits, plan the wind-down sequence (cessation of service charges, practice sale, asset disposal, retained-earnings distribution, entity closure), apply the small business CGT concessions where the practice sale qualifies, address Division 7A and UPE positions under TD 2022/11 with specialist input, plan the retained-earnings distribution across multiple years to use franking credits efficiently, address state-specific stamp duty for any property transfers, and coordinate the wind-down with super contribution opportunities (the $1,865,000 CGT cap and the ordinary caps). The structures that were tax-efficient during the working years can be unwound tax-efficiently at retirement with deliberate planning — the difference between deliberate and reactive unwinding can be substantial in dollar terms.

Sources

• Australian Taxation Office (ATO) — Service entity arrangements
• Australian Taxation Office (ATO) — Taxation Ruling TR 2006/2
• Australian Taxation Office (ATO) — Taxation Determination TD 2022/11
• Australian Taxation Office (ATO) — Small business CGT concessions
• Australian Taxation Office (ATO) — Contributions caps