Session One

Choosing an Appropriate Structure for your Practice

2007

Issues Impacting The Choice of Structure

• Form of organization

• Available legal structures

• Is your practice a business

• Do you need a service entity?

• How much does the structure cost?

• Are your assets protected?

• Our usual preference: practice trusts

Form of Organization: 3 Basic Options

1. Solo Practitioner• Practices in own name• Derives own income• Pays own costs• Income may be business income or personal services income

2. Associate• Practices in own name but shares facilities• Derives own income• Shares costs• Income may be business income or personal services income

3. PartnerPractices in combination with others, shares income and shares costs. Entitled to a share of partnership net incomeIncome may be business income or personal services income

Each of these three basic options may be an individual, a company or a trust and a service entity may or may not be used.

This creates a large number of possible practice structures.

Available Legal Structures: 6 Options

1 Individual, whether solo practitioner, partner or associate, PSI

2 Individual, whether solo practitioner, partner or associate, BI

3 Practice Company, whether solo practitioner, partner or associate, PSI

4 Practice Company, whether solo practitioner, partner or associate, BI

5 Practice Trust, whether solo practitioner, partner or associate, PSI

6 Practice Trust, whether solo practitioner, partner or associate, BI

A Personal Services Income Practice Trust uses a special trust deed that complies with the ATO’s published rulings.

A Business Income Practice Trust may use a discretionary trust deed, a unit trust deed or a hybrid trust deed depending on the

circumstances

Preliminary Question:“Is your practice a business?”

Income Tax Ruling IT 2369 provides two tests:

1 The Commissioner of Taxation’s “rule of thumb”, ie does the practice have more non-owner fee earners than owner fee earners, on an equivalent full time basis?

2 Other factors, such as size, number of staff, plant and equipment, degree of organization, investment in premises, reliance on owner’s skill and judgment

Most doctors who own their own practices can meet these tests if they wish to do so.

Taxation Considerations• Different structures have different tax implications.• Consider:

– Who pays the tax?– At what rate is tax paid? and– When is tax paid paid?– Can other tax planning strategies be used, such

as large superannuation contributions?– The need for simplicity– The costs to set up and run the structure– Employment on-costs

CASE STUDY 1: THE COSTLEY AND KUMBERSOME ASSOCIATESHIP

• Four doctors practice in an associateship• Each doctor uses a practice company• The practice companies pay each doctor a salary• Each practice company pays a management fee to a

service trust • The service trust distributes its net income to the

doctors’ family trusts• The family trusts distribute net income to low tax rate

related persons• The Practice engages a total of 9 equivalent full time

material fee earners

The Costley and Kumbersom Associateship Diagram

CASE STUDY NUMBER 1 PROBLEMS

Complexity – 5 BAS’s, etc Expensive to maintain: 9 sets of accounts, 9 bank statements, etc Staff taking stress leave Tax benefit limited, ie only profit on services able to be shifted to

low tax rate related parties Expensive to maintain Payroll tax on doctors’ salaries (?) Workcover and other payroll on costs Compliance with service entity ruling’ 45% tax rate on doctor’s earnings ,ie very limited tax planning

compared to alternatives Professional indemnity issues

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The Costley and Kumbersome Solution: A Practice Trust

Advantages of a Practice Trust

Hybrid trust gives discretion as to profit share;Units are transferableSimplicity (one BAS, etc)Efficiency (fewer sets of accounts)All income is business income therefore all income

can be directed to lower tax rate family membersFamily trust maximizes discretion on tax planningLower accounting costsMore corporate lookBetter CGT results

LEGAL ISSUES ON CHANGING TO A PRACTICE HYBRID TRUST

• Practice must be a business re IT 2639• CGT issues need to be considered• Unit-holders’ agreement needed• Sale of practice agreements needed• Unit-holders (and their accountants) actually agreeing

can be the hardest thing• Consistent with ATO’s public rulings• Many examples in practice accepted by the ATO

Case Study Number 2: Independent Contractor

• Dr John Smith is 55 year old GP and an independent contractor practising through a practice company called Smith Medical Pty Ltd

• John pays an independent service provider a management fee of 35% of billings

• John pays his own family trust a management fee of 15% for providing all other services needed to run her practice

• John’s gross billings are $300,000, hence an independent management fee of $105,000 and a second management fee of $45,000

PROBLEMS WITH CASE STUDY NUMBER 2

Second management fee is not commercial and will not be accepted by the ATO

John will have a taxable income of close to $195,000 and a tax liability of $75,000

Limited other tax planning options Workcover on salary payments Complex BAS: must pay PAYG Withholdings on

salary payments to John

Case Study Number 2 Solution

• Change John’s practice company to a personal services income (“PSI”) trust

• Transfer John’s practice from company to trust• PSI Trust? Special trust deed that satisfies income

tax ruling IT 2369. See Dox4Dox• New ABN and TFN. Not much more needed• Enjoy a tax holiday switching from PAYGW to PAYGI • Possibility of using enhanced cash flow for other

purposes such as paying off non-deductible debt

Further tax planning issues for Dr John

• Dr John is a good opportunity to digress and consider other tax planning opportunities

• Consider:– Spouse super contributions– Double super contributions– Other super strategies– Debt conversion strategies– Multiple deductible cars– Deductible overseas travel– Employ child over 14 and 9 months– Consider frequently overlooked deductions

Digression! Frequently Overlooked Deductions

• Dedicated credit card interest and charges• Protective shoes• Laundry costs• Mobile phone• Internet connection• Home office depreciation of plant and equipment• Second or third car costs• Salaries to children and spouses• Superannuation related persons• Newspapers and magazines• Travel allowances• Home to work travel with bulky equipment or offensive items• Lap tops, PDA and brief cases• Co-contribution for children

SUMMARY OF TAX SAVINGS• Summary of tax savings

Item Then Now

Income Tax Income Tax

Doctor’s net income/salary $250,000 $101,050 $25,000 $3,360

Spouse’s salary $5,000 Nil

Doctor’s car $10,000 Nil

Doctor’s spouse’s car $15,000 Nil

Doctor’s childs’ car $5,000 Nil

Deductible interest $15,000 Nil

Salary to child $5,000 Nil

Deductible overseas travel $20,000 Nil

Lap top computer $4,000 Nil

Other frequently overlooked deductions

$2,000 Nil

Superannuation spouse $40,000 $6,000

Superannuation doctor (geared)

$104,000 $15,600

Total $250,000 $101,050 $250,000 $24,960

Available cash $148,950 $246,640