One of the most important decisions doctors have to make when starting a private practice is choosing a business structure. Structuring medical practices can be done in a variety of way. Depending on your specific needs, structures can range from a simple sole trader entity to complex groups involving combinations of different entity types.
A common mistakes doctors make when structuring medical practices is only focusing on the tax outcome. As a result, they often choose incorrect structures under the impression that it would help them pay less tax. While it is important for the structure of your medical practice to be tax effective, it should not be the only concern. In fact, business structuring decisions should not be purely tax driven as it would be regarded as tax avoidance.
The factors you need to consider before making decisions about structuring medical practices include:
- Asset protection
- Effective profit distribution
- Growth strategy
- Attracting investments and funding
- Optimising tax outcome
- Succession and exit strategy
- Personal circumstances
Structuring medical practices requires a good understanding of the fundamental differences, the advantages and disadvantages of each structure. We have summarised the key features of the most common business structures used for structuring medical practices. This summary is only intended to scratch the surface and is by no means comprehensive. You should seek tax advice, preferably in writing, from an appropriately qualified Tax Adviser specialising in the medical industry, and possibly also from a lawyer, before making a decision.
A sole trader is the simplest and the least expensive structure to run and operate. It is often the most appropriate structure for individual practitioners, especially if they are working under contract arrangements at hospitals or in private practices.
If you are conducting your medical practice as a sole trader, your business is not a separate legal entity from yourself. Your business is you.
You may register a Business Name for your solo practice but you do not have to. Most doctors choose to operate under their own name. As an individual, you can operate multiple businesses and have multiple business names but you only can one Australian Business Number (ABN).
You can engage other people as employees or contractors to work for your practice but you cannot employ yourself. The term “self-employed” should not be taken literally.
- Profit you make from your practice (assessable business income less allowable business expenses) is included in your personal tax return and is taxed at your individual tax rates. Drawings you make from business account are not your salary or wages and they do not have separate tax consequences.
- As you cannot be an employee of yourself, you do not have an obligation to pay Super Guarantee payments for yourself. You can, however, make personal super contributions to grow your retirement savings. Keep in mind that you still need to comply with super guarantee, work cover and other employer obligations in respect of other people you employ.
- As business profit from your practice is included in your individual tax return, it can be offset by other income tax losses you make, such as losses from negatively geared investments and prior year tax losses.
- In the unlikely event your medical practice generates a loss in any particular year, the loss may have to be quarantined due to the application of Non-Commercial Losses provisions. Quarantined losses have to be carried forward until they can be deducted from future years profit from the same business activity, or until deductibility criteria are satisfied.
- If your private practice is a small business, you may be able to take advantage of a range of small business concessions, such as the simplified depreciation, immediate asset write-off, Capital Gains Small Business Concessions, and other.
- If you are an Australian resident, you get the benefit of a CGT General Discount of 50% if you dispose of a capital asset that you have held for more than 12 months. This is in addition to CGT Small Business Concessions, which can potentially apply to capital assets used in your practice.
- As there is no separation of legal personality, sole traders are personally responsible for paying debts of their business. Your liability is unlimited and extends to all your personal assets, including any assets jointly owned with another person. Having adequate insurance policies in place mitigates the risks to a certain extent.
- Conversely, the business assets of your medical practice do not have any protection in case of a family breakdown or if you are sued for personal (non-business related) debts.
- Sole traders cannot raise capital from divesting a share of equity in their business as it would effectively amount to restructuring.
- Sole trader businesses do not have “perpetual succession”. As the business is not distinct from the person conducting it, it ceases to exist if the person dies or goes bankrupt. If the person dies, the assets of the business are dealt with under the person’s Will.
- It is easy to restructure from a sole trader practice to another type of entity if needed.
A partnership is not a separate legal entity. It is a relationship between two or more parties conducting a business together. Partnerships may consist of Individuals and/or other entities (such as companies or trusts).
A partnership itself cannot own assets. All assets of the partnership are owned by its partners. The partnership is simply a vehicle allowing the partners to run a business together and share profit in proportions to their contributions.
A partnership structure is inexpensive to set up and run, but complications may arise in the case of a dispute between the partners. If you consider conducting your medical practice business in partnership with other practitioners, it is advisable to prepare a formal partnership agreement, which should include:
- each partner’s role and involvement in the partnership
- each partner’s financial contribution
- dispute resolution procedures
- procedures for dissolution or changing the make-up of the partnership
Partnerships are regulated by Partnership Acts in each state.
Historically, medical practitioners used to operate their practices either as sole traders or in partnership with other medical practitioners, before incorporation of medical practices has become acceptable. Nowadays, a partnership structure is a considerably less popular choice for structuring medical practices due to joint and several liability of the partners and due to practical complexities involved in the process when partners join or leave a partnership.
- A partnership is not a taxable entity but it must lodge tax return to declare business income and expenses, and must have its own ABN and TFN.
- Partnership’s net income is distributed to the partners, and each partner is liable to pay tax on their share of the distribution.
- Partnership’s losses are distributed to the partners and can be claimed against their other income, unless they have to be quarantined under Non-Commercial Losses provisions.
- Capital gains on disposal of partnership assets are assessed to the partners, not to the partnership. The partners may be able to apply CGT concessions available to them on disposals of their share of partnership assets.
- Each individual partner carrying on a business in a partnership can access Small Business Tax Offset up to $1000 if the business satisfies the relevant turnover threshold (currently $5 million).
- Like sole traders, individual partners cannot be employees of the partnership. It is common for businesses conducted in partnerships to pay a form of a remuneration commonly called a “partner’s salary”, to reward partners for their active involvement in the business. However, for tax purposes, such payments are treated as part of the partner’s distribution. Payments of a “partner’s salary” is not tax deductible to the partnership.
- Each partner in a partnership is jointly and severally liable for the other partners’ debts incurred under the partnership. The liability is not limited to partner’s share of the partnership assets. If your partner defaults on their share of the partnership debts, you will be liable for the debt, and your personal assets may be at risk.
- Assets used in a partnership are owned by the partners in proportion to their agreed share, which means they can be exposed if one of the partner runs into financial difficulties, or in case of a marriage breakdown.
When an existing partner leaves or a new partner is admitted to the partnership, it results in dissolving of the old partnership and forming of a new one. A “technical dissolution” occurs if assets of an exiting (leaving) partner are transferred to a new partner, and the business continues without interruption. If changes only amount to a technical dissolution, the partnership can continue using the same TFN and ABN.
A company is a separate legal entity that is run by directors and owned by shareholders (which may or may not be the same persons). Like a natural person, a company can enter into contracts in its own right, make its own profit and is liable for its own debts. A company can own assets in its own name. They are not assets of the company directors or shareholders.
All Australian companies are required to register with Australian Securities and Investment Commission (ASIC) and have an Australian Company Number (ACN).
- Taxable income generated by companies is taxed at a flat rate, which is currently 25% for Base Rate Entities and 30% for other corporate entities. However, when the taxed profit is ultimately distributed as a dividend to individual shareholders, it becomes assessable to the shareholders at their personal marginal tax rates. The amount of tax paid by the company that is attributable to that dividend (called Franking Credits) is added back as taxable income of the individual receiving it, and the individual gets a refundable tax credit for the same amount (resident taxpayers only). This effectively reverses the company tax rate and applies the individual’s tax rate to the distributed income.
- Whether a company can pass franking credits to shareholders depends on the availability of franking credits in the company. If a company generates non-assessable non-exempt income (tax free income on which it does not pay tax), it may not have enough franking credits to pass on when it ultimately distributes that income. In most cases, such income will have to be paid to shareholders as unfranked dividend, which ends up being taxed at the shareholders’ own marginal tax rates.
- If a shareholder attempts to extract company profit taxed at a lower rate without paying tax on it at the individual marginal rates (for example, by “borrowing” money from the company ), it may trigger certain anti-avoidance provisions in Division 7A. Under the provisions, such amounts may be treated as an unfranked dividend in the hands of the shareholder, which means the shareholder will be taxed on the amount but will not get franking credits for the amount of tax already paid by the company. Division 7A can apply to loans and other financial advances, including debt forgiving, made by a private company to its shareholders or their associates.
- Income paid out to shareholders as dividends does not preserve its original character. In most cases, concessions that may be applicable to certain types of income originally made by the company cannot be passed on to the shareholders.
- Companies are not eligible for General CGT Discount of 50%
- From February 2018, shareholders selling shares in their private companies have to pass additional requirements for these shares to be treated as Active Assets for the purpose of Small Business CGT Concessions. High level of passive investments held by the company may jeopardise shareholders’ eligibility for Small Business CGT Concessions on sale of the shares.
- Losses made by a company cannot be passed to its shareholders. They may be applied to reduce taxable income of the company in future years, provided the company satisfies either the continuity of ownership test, or the business continuity test. You can choose when to apply company losses.
- Generally, companies do not have to distribute profit in the same year it is made. This provides flexibility of timing of distributions. However, this does not apply to certain medical companies receiving PSI income (see below).
- A company structure provides the protection of limited liability to its shareholders. This means that the shareholders are liable for the company’s debts but only to the extent of any unpaid amount (if any) of their shares.
- If a company is sued by creditors, personal assets of the shareholders will generally not be at risk as a company is a separate legal entity from its shareholders.
- However, a company structure does not provide protection for equitable interest of the shareholders in the event they are sued for their personal debts.
- While a corporate structure can shelter company shareholder from certain risks of running the business, it should be noted that in the context of medical practices, limited liability and separate legal identity of a company will be ineffective for protecting medical practitioners from liability for their own medical negligence or other professional misconduct.
- A company structure allows to raise equity financing through issue of shares.
- A company structure allows change of ownership without disruption of the business.
- Some tax concessions are only available to incorporated entities (e.g. Research and Development)
- A company structure is more costly to set up and run. Annual Review fees are payable each year to ASIC. Fines apply to late payment of ASIC Fees.
- Incorporated entities generally face significantly higher penalties for not complying with their legal obligations compared to unincorporated entities.
- Company directors have certain responsibilities under the Corporation Act 2001. They may be personally liable for certain debts of the company, and, in some cases, legally prosecuted for breach of director’s duties. For example, it is a criminal offense for a director to allow a company to incur a debt if he or she suspects the company is insolvent, and the director’s failure to prevent the company incurring the debt is dishonest.
- Directors are often required to provide personal guarantee for finance applications made in the company name.
- As a company director, you must make sure the company complies with its income tax, GST and secretarial obligations. Under the director penalty regime, directors can be personally liable for company’s unpaid liabilities for PAYG Withholding, Super Guarantee Charge, GST, Luxury Car Tax and Wine Equalisation Tax if they fail to ensure the company pays its tax liabilities.
Company tax and legal issues can be complex. We always recommend seeking advice from appropriately qualified professionals. It is directors’ responsibility to seek professional advice when needed.
A trust is not a separate legal entity. It is a fiduciary relationship between a trustee, being a legal owner of the trust property, and the beneficiaries for whose benefits the property is held. These relationships are governed by the terms of the Trust Deed. Trusts have traditionally been used as investment structures for asset protection purposes but have also become a popular choice for structuring medical practices. Trusts are often used in combination with other entities in medical practice structures to achieve an optimal result.
A trust does not have a separate legal personality, so it cannot conduct business in its own right. In a trust structure, a trustee (can be an individual or a company) carries on a business on behalf of the trust for the benefits of the beneficiaries. The trustee is legally responsible for the debts of the trust and has a right to be indemnified from the trust’s assets. Appointing a company as a trustee helps achieve protection of limited liability.
There are many types of trusts but the most common ones used for structuring medical practices are:
- Discretionary Trust
- Unit Trust
- Hybrid Trust
A discretionary trust is a popular choice for family run practices as the structure offers flexibility of income distribution and asset protection.
- Trusts do not pay taxes but they must be registered for TFN and ABN if carrying on a business, and for GST if the annual turnover exceeds certain thresholds. The trustee is responsible for lodging Trust Tax Returns and pay tax liabilities.
- Trust income calculated according to the accounting principles is not always the same as its “net income” (taxable income). This occurs, for example, where the trust has discount capital gains or receives franked dividends from companies. The amount of taxable income is required to be allocated to each beneficiary on a proportional basis, which sometimes creates certain practical complexities.
- Trust income preserves its character when distributed to beneficiaries, which allows to pass certain tax benefits to beneficiaries, such as imputation credits, small business offsets and capital gain discounts. These tax benefits are then applied on the beneficiary level.
- Trusts are entitled to 50% General CGT Discount (provided minimum holding period is met) and are eligible for other CGT Concessions, which can be passed to the beneficiaries.
- Tax losses incurred in a trust cannot be passed on to the beneficiaries but must stay in the trust.
- Tax losses may be applied against income in future years if trust loss utilisation tests are met.
- A trustee of a discretionary trust has a flexibility over income and capital distribution, which provides tax planning opportunity by allowing to distribute income to beneficiaries in lower tax brackets.
- There is an ability to stream capital gains and franked dividends to particular beneficiaries who would get the most tax advantage from these sources of income.
- Discretionary trusts may need to make a Family Trust Election to be able to apply prior year tax losses and access franking credits on dividends paid to the trust. If the election is made, distributions to beneficiaries outside the family group will attract penalising tax treatment.
- Trustees are required to make a resolution by 30 June of the current year regarding distribution of income to the beneficiaries. If the trustee fails to make a resolution by that date, no beneficiary will be presently entitled to trust income, which will result in the trustee being assessable on the trust taxable income at the highest marginal rate plus the Medicare Levy.
- Distribution of income and capital of a unit trust is done in proportion to unit holding.
- Distribution of certain non-assessable (tax-free) amounts from a unit trust, can result in a CGT Event E4, which reduces the cost base of the units in the unit trust and may result in a capital gain made by the unit holders.
Taxation of trusts is an extremely complex area. As trusts are governed by trust deeds, the terms of the deed have legal and tax implications. It is important to ensure the trust deed’s terms are adhered to when making resolutions to make them effective.
- When the trust is set up correctly, it can be very effective for asset protection. Care must be taken when drafting a Trust Deed to ensure no beneficiary has equitable ownership in the assets of the trust.
- Due to their effectiveness for asset protection, trusts are commonly used by businesses holding significant assets. It is also common to use discretionary trusts in combination with other types of entities to structure a business.
- Trusts can be costly to set up and run. You may need to seek legal advice from a lawyer to review the terms of the trust deed to ensure it offers adequate asset protection. You will also need to pay registration and renewal fees for setting up a corporate trustee. In addition, you may have to get the Trust Deed stamped and pay a Stamp Duty, depending on your state.
- Even if a company is set up purely for performing trustee functions and is not trading in its own right, its directors still have to comply with the directors’ duties.
- In the case of a discretionary trust, the trustee is required to make a resolution on income distribution by 30 June of the same year to avoid the trustee being assessed on the income at the highest marginal rates.
What To Consider When Structuring Medical Practices
There is no cookie cutter solution when it comes to structuring medical practices. What structure is right for you depends on your overall objectives.
When considering what business structure is right for your medical practice, these are the questions you need to ask yourself and then discuss with your accountant:
- Will I be operating my medical practice alone or with business partners?
- How am I planning to generate funding to set up and grow my practice?
- Will my family members be involved in running the practice?
- How am I planning to distribute profit and reward participants for performance?
- Will I be employing nurses, registrars and other medical support staff?
- Am I planning to engage non-equity practitioners (e.g. associate doctors) to work in my practice?
- What risks are involved in running my practice? Can these risks be mitigated by appropriate insurance?
- Will I be purchasing practice business premises?
- Does my medical specialty require significant investment in purchasing equipment, fitout and other business assets?
- Do I own significant assets in my personal name (including jointly owned assets)?
- What are the potential implications of a family breakdown?
- What plans do I have for the future of my practice?
- How important is it for me to retain control over my practice?
- Can my practice continue operating and make profit without me?
Structuring Medical Practices and Personal Services Income
As medical practitioners are earning income from applying their professional knowledge, skills and expertise, which is deemed to be a Personal Service Income (PSI) under the tax legislation, it is important to consider the application of the PSI Rules and general anti-avoidance provisions when structuring medical practices.
These rules are designed to prevent medical practitioners from splitting or alienating their personal services income by using business structures such as companies or trusts. Such income must be returned and taxed in the hands of the individuals who provided the services in the same year, and cannot be diverted to other persons. Medical companies are also not allowed to retain the profit to manipulate the timing of distributions. Essentially, that means that the profit made in the entity must be paid out to the individual medical practitioners in the same year in which it was received.
Structuring medical practices is often complex and should not be taken lightly. As each taxpayer’s situation is different, it is important to seek professional advice from appropriately qualified professional.
If you need help with structuring your private practice, get in touch with us today.
Prism Accounting a Medical and Dental Accounting specialist firm providing tax advisory services to health professionals and private practice owners.