There are two areas of concern:
- Homecare tax ruling
- Excessive income splitting and service entities
- Homecare tax ruling
Practices have been given up to 18 months to get compliant or lose out on the Practice Incentive Payments (even though trials are taking place). It is not certain whether the program will actually ever be implemented, given that many practices have expressed concerns about the program.
For those GP practices considering the Healthcare Home program or those in the trials, the ATO has released the taxation treatment of HealthCareHome payments.
In our view, the ruling is at best vague in the situation where there are GP contractors or doctors who are paying a service fee as a percentage of their turnover.
These direct payments to the practice and not the doctor may deem an employer/employee relationship, especially if significant payments are made to the doctors from the patient.
This has significant payroll tax, superannuation guarantee, Fair Work Act and income tax implications that may be difficult to undo.
We have undertaken considerable business and tax compliance modelling of practices who use service entity structures, and continue to believe that the model is viable and will not irreversibly taint your existing arrangements (as detailed below in Excessive income splitting and service entities.)
Unfortunately the ruling gives no extra clarity or protection from current taxation and employment laws.
- Excessive income splitting and service entities
There have been a number of recent tax warnings in relation to income splitting. Over the years we have continually warned readers about these arrangements; now it appears the Tax Office has caught up with the issue. Therefore, practices should urgently review their arrangements.
Income splitting remains a legitimate way to minimise tax, as long as commercial arm’s length arrangements are in place. This includes using appropriate structures for purposes such as asset protection and succession planning that ensure the dominant reason is not to evade income tax.
The following arrangements are tax office targets.
- Practices that are partly or wholly owned by a related self-managed super fund;
- Sole trader (GP Contractor) practitioners who operate out of a practice trust or company to lower their tax;
- Excessive medical practice income splitting to spouses in family trust and practice company structures; and
- Everett assignments of partnership income to a spouse.
Service Trust and Family Trusts are still legitimate commercial and tax planning vehicles
Doctors or their practice managers get into trouble when they say (over the phone to the tax office) “my accountant told me to setup family trust to avoid tax’ or even “I do not know… ask my accountant”. This opens you up to a major audit as you cannot simply retract what you have already said over the phone.
Service trusts and family trusts are still legitimate succession planning and asset protection vehicles, if set up and operated correctly. It is important you understand this as well as your adviser does.
Step one is ask you advisor to explain it to you. If they cannot, find an advisor who can (we can assist here). If the arrangement does not make sense beyond paying less tax, you may have a problem.
Service trusts owned by a family trust remain a useful and legitimate structure for succession planning and asset protection purposes. A service trust is where the intellectual property, premises, plant and equipment, staff and systems are employed and bundled into a service fee (e.g. 40 to 60% plus GST) and charged as a GP’s receipts – so long as it is commercial. The profit made in the service trust is used to sell to a potential owner. It cannot be sold if it cannot make a legitimate profit, any more than you can sell shares in a company that consistently makes no profit.
A higher service fee percentage can be justified
We have successfully argued for a higher service fee percentage. Let me explain how.
The 2006 Service Entity guidelines have not been revised to take into account the impact of inflation. The current ATO ruling continues to determine an appropriate rate of 40% to 45% of a doctor’s gross fees unless a higher rate can be established due to higher practice costs.
However, there is an arguable position (one that is often overlooked by advisers as they do not specialise in this area or keep a 27-year national medical practice benchmark series as we have). The details are somewhat complex, but bear with me.
A common mistake advisers make in relation to setting service fees …
Clearly, a higher rate based on an arms-length arrangement would incidentally and legitimately provide more income to split income to lower-paying taxpayers, such as a corporate beneficiary, spouse or a child attending university, via a family trust. This is done to stay solvent and not primarily to receive a greater tax break. It is so that you can sell your practice, if you are forced to, do so, for a fair market value. However, proof of this must be provided, which some advisers have trouble providing (it’s “all too hard”) so instead they default to the ATO ruling which is quicker but not always in the best interest of the trust, Experienced advisers can demonstrate what you do need to know and do, so as to get it right for a lifetime.
Some advisers do miss this point or the practice fails to ask the right questions. Sometimes there is a failure to ensure the correct documentation, for example service agreements that are PIP friendly, with correct procedures and an audit trail in place.
There is a legal duty-of- care to make a profit, or else you could not borrow money to expand your services. At worst you would be trading while insolvent, which of course is not permissible. Getting a call from a liquidator would be worse than one from the Tax Office, and blaming it on the ATO’s low service fee percentage rates may not be seen as a defendable excuse.
For many years now, bulk billing general practice clinics have faced a multitude of Medicare freezes. These freezes have seen owners needing to subsidise practice costs, if they wish to avoid running at a serious loss, especially if pathology rents fall or are removed from the general practice bottom line. See Pathology Rent Red Book Alert!
However, a radiology practice could easily justify a higher percentage due to the high cost of MRI capital equipment being used to operate their practice. Not to so may run the risk of going insolvent based on the current ATO guidelines of 40% to 45% gross fee. Remember the guidelines are just that, and not law.
We at Health & Life have in the past been quite public in the national media on this issue. In 2007, when the issue was first raised for public comment, one of our key arguments was for the ATO to use percentages of gross fees, which was agreed to by the ATO in its final 2006 Ruling.
The Australian Financial Review May 2007
How do we know all this stuff?
The bottom line is, you must run a solvent business and not make excessive profits from contrived arrangements. They require sound commercial reasons to enter into them.
In a 1973 national referendum, people voted that the Government could not price fix goods and services. This includes service fees and pathology rents. This is why the Service Trust Ruling is not a law but a guideline.
Unlike many advisers, we are on the record on this issue (see BRW in 2007) We have argued to the ATO that a higher service fee is legitimately justified, and within the rules if it is a commercial arrangement. However, it is important to always check that your advisers have interpreted the law correctly (the fine print is important in understanding how the laws actually work).
Sadly, some advisers still do not fully understand the fundamental principles and opportunities of using trust structures correctly, to the frustration of their clients, and at their ultimate cost.
Contact David Dahm at firstname.lastname@example.org for more information if you would like us to confidentially review your arrangements at no cost or obligation.
Please note we are not lawyers, we are accountants and practice advisers. Please seek specific legal advice in relation to your own circumstances. We cannot be held responsible for any errors or omissions in this article. This is for discussion purposes only.