Informal related-party arrangements – recent Court decision

This decision is highly relevant for private and family groups that rely on long standing related party arrangements without current documentation. It shows the ATO, and the courts, will look past “how things have always been done” and focus on whether a binding agreement actually exists.

Informal related-party arrangements – recent Court decision

A recent Full Federal Court decision (FCT v SNA Group Pty Ltd) is a useful reminder of the risks that can arise where related-party arrangements allowed to run on an informal basis over time.

In this case, operating entities claimed deductions for service fees paid to related trusts after formal agreements had expired. While the businesses continued to use trust-owned assets and payments continued to be made, the Court found there was no enforceable contract in place. As a result, the deductions were denied.

The key point is that long-standing practice is not enough

Long-standing practice or informal understandings are not enough. Following this decision, deductions for related-party payments will only be available where there is clear evidence that both parties regarded themselves as legally bound, on identifiable and agreed terms.

The Court also made clear that contracts implied from conduct will be unusual, particularly in related-party settings. Year-end journals, inter-entity transfers and, other accounting entries, of themselves, cannot be viewed as ‘substantiation’ nor do they establish a contractual obligation.

How this affects many private closely held groups

This is particularly relevant for groups operating with:

• Trading companies and asset-holding trusts;
• Management or service fee arrangements (including licence fees for software or IP); or
• Informal cost-sharing across related entities.

An example from our Melbourne business advisory team

A family established and grew a successful operating business. In a risk mitigation step, intellectual property developed within the business, including methodologies, software tools and a recognisable brand, was transferred into a family trust for asset protection and estate planning purposes.

The operating business continued to use those assets as it always had. A licence fee was contemplated at the time of the restructure, and an amount was settled on informally. The fee – adjusted occasionally to reflect what seemed reasonable at the time – has been paid annually ever since, supported by a journal entry, workpapers and an email confirmation of the annual fee amount.

From the family's perspective, the arrangement has always made sense and has been applied consistently and in good faith. From a legal perspective, however, there may be no enforceable licence agreement in place at all. If the ATO were to examine the deductions claimed by the operating entity, the question may not be whether the arrangement was reasonable – it might be whether there was ever a binding obligation to pay in the first place.

Under the principles confirmed by the Full Federal Court, the answer may be no.

The decision supports a more robust ATO approach when reviewing these arrangements and increases the risk that deductions may be disallowed entirely where agreements are unclear, expired or not properly documented.

Recommendations from PKF Australia’s business advisers

In light of this decision, we recommend:

• Reviewing all related-party payments to ensure current written agreements are in place
• Ensuring agreements clearly set out the services or assets provided, the fee methodology and payment terms
• Confirming that actual conduct and accounting treatment align with the legal arrangements
• Not relying on informal or historic “understandings” to support deductions.

PKF Australia’s precautionary view

This case reinforces the importance of keeping commercial and legal arrangements up to date and properly documented, even within family or closely held business groups.

For businesses relying on related-party service fees or asset usage arrangements, now is an appropriate time to review those arrangements and address any gaps before they become an issue.