When is tax planning appropriate?
Tax planning should be an on-going process whereby commercial issues and developments are constantly monitored and the implications of income and other tax practices considered.
Tax planning is a legitimate activity and occurs constantly throughout a GP’s career. For example, we encourage GPs to pay large super contributions every year, at all stages of their career. The primary purpose is to ensure a financially secure retirement, but like most strategies there are secondary purposes too. In this case the protection of assets (super is protected in bankruptcy) and reducing tax are common secondary purposes.
The Australian Master Tax Guide (CCH Australia) identifies seven situations where tax planning is critical. Adjusting for the circumstances of GPs, these are:
- When the structure of a practice is being considered, usually before it opens;
- Where there is a change in the circumstances of a practice. For example, an increase in the administrative burdens and costs connected to an existing complicated legal structure;
- Where there is a change in ownership of a practice, or a practice amalgamation;
- Where a new transaction, project or acquisition is considered, such as the purchase or sale of surgery premises, or employment of a new GP.
- Where a GP or a related entity expects an unusually large taxable income;
- Where there is a change in a GP’s circumstances, such as marriage, divorce or retirement;
- Where a GP is considering estate planning options or is making a will.
Traditional tax planning tools
The ATO accepts traditional tax planning tools such as practice companies and practice trusts, service companies and service trusts and SMSFS. These are widely discussed by the ATO in its public rulings and there is no question that they are effective for tax purposes, provided the conditions specified in the rulings are observed.
Published tax rulings
The ATO has published a number of income tax rulings setting out its view on where and how GPs can use companies and trusts to run practices. In summary:
- IT 25 says all profit/taxable income has to be paid out to the GP as salary and as super contributions if the incorporation is to be accepted for taxation purposes.
- IT 2503 says the same thing as IT 25, adding that there should be no diversion of income to related parties, and sound business reasons and commercial reasons (other than reducing a tax bill) should exist before incorporating a medical practice.
- IT 2503 acknowledges the practical difficulty of ensuring an incorporated practice breaks even. It allows the company to derive a small taxable income provided a bona fide attempt is made to avoid this situation. This amount is paid out as a fully franked dividend soon after 30 June in the following year. If a practice fails to comply, the ATO will apply the anti-tax avoidance rules to the arrangement.
- Interest on money borrowed to purchase practice goodwill from a third party will be deductible to the practice. Interest on money borrowed to purchase goodwill from the GP will not be deductible.
- Incorporated practices cannot own income-producing property or plant and equipment unless the property or equipment is connected to the medical practice.
- The basis of accounting for practice income generally will be cash (debtors are ignored in computing taxable income and hence taxation payable).
- Sessional fees from hospitals may be derived by a practice entity.
- Although the rulings predominately speak of practice companies, they specifically state that practice trusts may conduct a medical practice provided where the practice derives personal services income, the GP beneficially derives all of the income from the practice.
- Service entities are acceptable, provided the amount paid is reasonable.
However, these rulings were silent on the question is “what is business income and what is personal services income?” The distinction is important, because these two types of income may be treated differently for tax purposes. Personal services income must be taxed in the hands of the person who provided the service. Business income may be taxed in the hands of multiple owners of the business, regardless of whether they work in the business. As a general proposition, the more people who share income, the less tax that may be paid.
Income tax ruling IT 2639
In 1988 the ATO released a further ruling, IT 2639, clarifying where practice income is business income and where it is personal services income.
This ruling basically says there is nothing special about practice companies and practice trusts that derive business income. They are taxed the same way as other companies and trusts and there is nothing in the law that changes this in any way.
You can read Income Tax Ruling IT 2639 here: Income Tax Ruling IT 2639.
So when is practice income personal services income and when is it business income?
The key to understanding the taxation of practice income is to ask whether it is personal services income or business income. If it is business income, then a practice trust will be effective for tax purposes: there is no need to comply with the rules regarding profit remittance set out in IT 2503. The practice company may retain profits each year and pay tax on those profits at the corporate tax rate of 30% if the directors of the practice choose, and a practice trust, whether it is a discretionary trust or a unit trust, can distribute its net income to its beneficiaries or unit holders even if they are not GPs.
This ruling is recommended reading for all GPs. It provides an accurate (if awkwardly worded) explanation of how medical practice income is taxed. It sets out in detail the ATO’s rules in determining the nature of a practice’s income for taxation purposes.
The ruling says:
“For the purpose of determining whether a practice company or trust falls within the scope of IT 2503 (and only for that purpose), this office will apply the following guidelines as a general rule of thumb:
- If the practice company or trust has at least as many non-principal GPs… as principal GPs, then income is considered to be derived from the business structure (and therefore does not fall within the scope of IT 2503).
- If the practice company or trust has fewer non-principal GPs than principal GPs, then whether it derives income from personal services will still need to be determined by considering the factors contained [earlier in the] ruling and the guidelines in previous rulings on this issue. If these factors indicate that the practice company or trust derives income from personal services, it will fall within the scope of IT 2503. If they indicate that the practice company or trust derives its income from the business structure, it will not fall within the scope of IT 2503.
“GPs include both full-time professional and non-professional staff whose function is to derive material fees for the practice. Part-time staff count proportionately. The term does not include administrative, clerical or support staff. For example, a nurse under the direction of a GP or a legal secretary under the direction of a solicitor are not GPs unless they earn material fees in their own right.
“Principal GPs are those GPs who own or share in the ownership of the practice, whether directly or indirectly. Non-principal GPs are those GPs who are not principal GPs… ”
The question of how to classify a particular type of income is always a question of fact. The ATO accept that income is business income where the rule of thumb set out in paragraph 10(a) of IT Ruling 2639. Where this is not the case, income may still be business income depending on:
- The nature of the practice’s activities.
- The extent to which the income depends on the taxpayer’s skill and judgement.
- The extent to which income-producing assets are used to derive the income.
- The number of employees and others engaged in the practice. As a general principle, you wany more workers than bosses.
For many years the rule of thumb was thought to be a simple and effective way of determining whether a practice derived personal services income or business income, and hence determining its income tax profile. Recent years have seen the ATO muddy the waters and confuse many advisers with inconsistent statements about the taxation of professional practice income.
On one hand in 2005 the Commissioner of Taxation said, in effect, the ATO accepts that a practice trust may derive personal services income provided a reasonable amount is distributed to the GP, with a reasonable amount being an amount commensurate with his or her contribution.
The only problem is this is not what the ATO’s public rulings say, or what the law says. They say all the personal services income has to be distributed to the GP, not just a reasonable amount. So we recommend GPs remain conservative and do not do this unless they have a specific private ruling from the ATO saying they can. That is, we recommend personal services income only be distributed to the GP who generated it, and not be distributed to any other person.
On the other hand, the ATO appears to be saying that if business income is derived through a practice company or trust a reasonable amount must be distributed to the principal, with a reasonable amount once again being an amount commensurate with his or her contribution.
Once again the only problem is that this is not what the ATO’s public rulings say or what the law says. So once again we recommend GPs remain conservative and make sure a reasonable amount is distributed to the GP from the trust each year.
More expansively, GPs do serious work, and they need to sleep well at night. We do not know any GPs who want to be ATO test cases. We therefore believe GPs using trusts to derive business income should be conservative and make sure they include a reasonable amount in their assessable income.
What is a reasonable amount? It’s probably at least $150,000 to $180,000 a year, depending on the practice and the hours worked each week.
Obviously the GP’s other deductions, such as super contributions, deductible gifts, car costs, and negative gearing losses will be deducted from this figure in computing taxable income. It’s not unusual for a GP following this rule to have a taxable income less than $100,000 a year – although obviously each case is unique.
Strained interpretations of IT 2639
Of further concern are reports the ATO is taking aggressive positions on the meaning of words and phrases in IT 2639, to argue that practices that ostensibly meet the rule of thumb are in fact not businesses under this ruling. For example, the ATO has taken a position that $355,000 of non-owner fees was not material, and that “practitioner” does not include persons who are supervised, such as employee dental therapists and hygienists. This is so despite “practitioner” being clearly defined to include employees.
This rule of thumb is not unique to medical practices and applies to all professional practices. Trusts are routinely used to set up and run other professional practices, such as law firms. For example, in the November 2007 Law Institute Journal, Mark Northeast, a partner with Pitcher Partners’ Melbourne office, and a member of the ATO’s Professional Practice Structures Committee, recommends new legal practices be owned by family trusts, and that in the early years all income be distributed to the solicitor and later, as the practice becomes a business, income can be distributed to family members who pay less tax than the solicitor.
Are you breaching Income Tax Ruling IT 2639?
Occasionally, GPs will find themselves in situations where they are not complying with Income Tax Ruling IT 2639 and they are retaining personal service income in companies and paying tax at just 30%, rather than the higher top personal tax rate of 45% plus Medicare Levy. There is no scope for argument or discretion: the rules are clear. The ATO will not accept this profile and will tax the GP on the full amount of the income, and disregard to purported retention of income in the company. Serious penalties are likely.
If you are concerned that you are breaching IT 2639 you should either get a second opinion as soon as possible or ask the ATO for its opinion. Solutions exist, but there is no magic wand and every solution probably involves you paying more tax.
Statutory personal services income rules
The statutory personal services income rules have been part of the Income Tax Assessment Act 1997 since April 2000. These statutory rules do not usually apply to GPs because they derive their income from hundreds or thousands of patients each year, and not from one or two sources. However, the rules are commonly raised by GPs and are often confused with the rules for practice companies and trusts.
The purpose of the personal services income rules is to:
- Attribute personal services income derived by an interposed entity (a company or a trust) to the underlying individual.
- Prevent deductions being claimed that would not be allowable had the income been derived as an employee, subject to certain exceptions and modifications, unless a personal services business is being carried on.
The rules apply where the entity derives 80% or more of its income from one source and the ATO has not determined that the rules should not apply. However, certain income from a personal services business is excluded. A personal services business occurs when:
- The entity derives income from two or more unrelated GPs that are not associates and the services are a direct result of an invitation to the public (probably via advertising).
- In dollar values, 20% or more of the entity’s income arises from engaging another person, whether as an employee or otherwise.
- At all times during the year, business premises are maintained.
If the rules apply to an entity, the personal services income will be treated as being derived by the GP, and certain outgoings will not be allowed as deductions.
It is unusual for these rules to apply to GPs because they are usually either employees, in which case the rules are irrelevant because they are taxed on salary income, or they run their own practice, whether through a practice company or in their own name. Where a GP runs their own practice, the income comes from thousands of sources, being all the patients seen during the year. This is so even if the GP bulk-bills and gets all of their income from the HIC. This is because the HIC is not the patient, but merely the patient’s insurer. The HIC is paying the GP on behalf of the patient, so the payments are really coming from the patients, not the HIC. Most GPs therefore receive their income from hundreds or even thousands of sources, ie the individual patients they see over the year.
The exception occurs where a GP is engaged by a practice or another organisation, such as a community health group or a country hospital, to provide medical services to patients as required during a particular period, and is paid by that organisation and is not paid directly by the patients. Here the GP is squarely within the statutory PSI rules. This means the income derived from the practice will be taxed in the hands of the individual with fewer deductions available, notwithstanding that an entity runs the practice. This usually means a bigger tax bill and, if previous year tax returns have not been completed correctly, the possibility of penalty taxes and interest charges.
For this reason, GPs should ensure they are providing medical services to patients directly, even if this is arranged by another person, in return for a management fee, and are not engaged to be available to patients for a set period of time. This also makes the GST situation simpler. It is clear that the GP is providing GST-free medical services.
This also makes the medico-legal position clearer. Only GP has the relationship with the patient, not the community health group or hospital, which makes sense because only the GP has professional indemnity insurance.
This usually means the entity engaging the GP is better off too because in most cases the GP will be solely responsible for the quality of the work done and is the only person against whom an aggrieved patient can take legal action. Also, it makes it clear that the GP is not an employee and is not subject to the pay-as-you-go withholdings system, the statutory superannuation rules, mandatory annual leave and sick leave rules, workers compensation and, importantly for larger practices, the state payroll tax rules.
Use of service trusts and service companies
Service entities, particularly service trusts were once a standard feature of most general practice structures (other than non-owner GPs deriving personal services income).
In 2006 the ATO published a ruling and related documents dealing with service entities and in effect allowing GPs to use service entities provided the service fee was commercial, and suggesting that a service fee equal to 40% (45% for solo practices or rural practices) would generally be accepted as commercial.
Since 2006 the incidence of service trusts has fallen, largely due to complexity and costs. But they still suit some practices, particularly those which:
Further reading on service entities
You can access the ATO’s ruling on service entities “Income tax: deductibility of service fees paid to associated service fees paid to associated service entities: Phillips arrangements” here: TR 2006/2.
The ATO has released a related booklet for GPs called “your service entity arrangements” and this booklet can be accessed here: Your service entity arrangements
- do not derive business income under the ATO’s public rulings;
- are solo or rural based, and hence “eligible” for the 45% management fee; and
- have higher than usual income and/or lower than usual costs.
GPs using service trusts must remember:
- The charges should be made on a monthly basis (at least) and appropriately-worded tax invoices should be issued and paid on a timely. ‘Book’ entries put through after June each year will often not pass muster if the tax office decides to challenge them.
- The basis of rendering charges should be reviewed regularly and this review should be properly documented at the time it is completed.
- A properly executed management contract should be put in place to provide a firm legal basis for the rendering of the services.
The income tax, capital gains tax and asset protection attached to trusts means that they may be the preferred method of structuring a business or investment activity for GPs.
The major advantages of a family trust are related to intergenerational wealth creation and protection, but they may also have tax advantages. For obvious reasons GPs should observe sound asset protection strategies at all times, and this is a big advantage of investing through a family trust.
The other advantages of a family trust include:
- Confidentiality of information, particularly regarding the financial affairs of the trust. There are no statutory disclosure requirements for trusts. There is no requirement for a trustee dealing with other people to disclose it is acting as a trustee and not in its own right. Thus bank accounts can be opened, leases signed and investments made for the trust without other people knowing.
- There are no formal audit requirements. Accounts have to be prepared but this is only to enable the preparation of an annual income tax return.
- The easy entry and exit of beneficiaries, particularly in terms of who gets income and capital each year and on the winding up of the practice.
- Trusts are cheap to set up and run each year.
- Trusts are relatively simple to wind up.
These advantages should be stressed when the trust is being set up, and should be recorded in writing at the time.
Family trusts cannot be used to derive personal services income unless all the personal services income is distributed to the person who generated it, ie the GP. Family trusts can be used to derive business income, subject to the ATO’s public rulings and public statements on using trusts to own professional practices, and our comments above regarding the need to distribute a reasonable amount to the principal.
One suggested practice structure
The Australian Financial Planning Handbook 2012-13 (Thomson Reuters) looks at the example of John, a 32 year-old financial planner buying a practice and expecting to make a profit of $400,000 to $500,000 a year.
John is engaged to Erin and expects to start a family soon. “John wants to invest free cash flow, including utilising appropriate gearing.” The suggested approach is outlined as follows:
The author, Mr Paul Banister, Partner – Tax of Grant Thornton, a leading firm of Chartered Accountants, explains the suggested approach as follows:
“John’s business would be conducted through a company acting as trustee for a discretionary trust. John would be employed by this entity and draw a salary. He would be superannuated from this entity. Excess profits beyond living needs and tax needs could be distributed to a family company.
The benefit of this approach would be that excess profits would only suffer tax of 30% rather than higher marginal tax rates…
…Given the future objectives of starting a family (including that Erin may be out of the workforce for a potentially lengthy period), a second trust should own the shares in the corporate beneficiary company. This will permit flexibility in later profit distribution.
The second discretionary trust should also be the investment vehicle. This has the benefit of insulating the investment activities from the business activities, thus affording asset protection benefits….
…This structure would provide considerable flexibility for distributing income to optimise the family tax position as well as to meet family needs. This could include having surpluses in one entity being applied to absorb any losses in another entity. To do this, family trust elections and interposed entity elections (are needed)…
Having the shares in company 2 owned by a discretionary trust is a crucial aspect of planning the structure of John’s operations. Once John and Erin have children, if Erin is earning little or no income, the second discretionary trust could distribute the franked distributions to her. If Erin has no other income she could receive $99,261 tax-free each year (based on 2012-13 rates). If she receives less a refund of franking credits would arise. If Erin received more, at least she will receive tax concessions for the franking credits that are attached.
If the dividends are declared when the children are adults, their marginal rates could be used. In this regard, consider the following table (using 2012-13 rates).
|Less imputation credit||$300||$300||$300||$300||$300||$300|
|Tax payable (refund)||($95)||$40||$85||$165||($150)||($300)|
|Effective tax rate||(13.6%)||5.7%||12.1%||23.6%||(21.4%)||(42.9%)|
What do we think about the suggested structure?
We do not agree with everything the author says. Adjusted for the context of GPs, the author over-emphasises the tax advantages and under-emphasises, or even fails to mention, other advantages that for us dominate the analysis.
These dominating advantages include
- Asset protection, that is making sure valuable assets are outside the reach of litigious patients and other claimants, which drives most trust based arrangements.
- The business structure interacts efficiently with the investment structure, allowing cash to move between the two without being derived by individual family members. This means:
- If cash is needed for an investment it can be accessed from the business structure without triggering an unnecessary tax charge, and
- If cash is needed for the business it can be accessed from the investment structure without triggering an unnecessary tax charge.
- The structure genuinely enriches the family trust and creates a real and substantial investment vehicle to provide for the children, and grandchildren when they come along.
- The investment side of the structure is an effective complement to a SMSF for a long-term retirement strategy and for GPs concerned about the pace and direction of future legislative change concerning SMSFs and super generally, it is an effective alternative long-term retirement strategy.
- The structure allows monies to be invested in allied investments, such as business premises or further business start ups or acquisitions that can further improve the profitability and value of the GP’s businesses and investments.
In 2013 the ATO released a Taxpayer Alert (TA 2013/3) dealing with changes in practice structures involving “the purported alienation of income through discretionary trust partners”.
As you can deduce from the title, the ATO is not happy with these structures. You can read Taxpayer Alert TA 2013/3 here: Tax Payer TA 2013/13.
We have never recommended GPs practice through partnerships of discretionary trusts. Some firms do recommend this strategy, perhaps too aggressively, and they are reasonably common amongst larger practices.
The ATO is concerned about cases where form does not reflect substance, and there is no material difference in the practice’s day-to-day doings compared to earlier incarnations where the GPs practiced in their own names.
The Taxpayer Alert does not say partnerships of discretionary trusts are not acceptable structures for running medical practices. They may be quite acceptable. But when the pattern of income changes, and there are no good commercial reasons for the change other than a tax benefit, the ATO will be concerned, at least.
The best planned changes will:
- document the good commercial reasons for the change;
- ensure the reasons have integrity and are not mere words;
- follow up to make sure partnership really runs the practice; and
- make sure the correct players are involved, for example, the trustee companies’ names, ie the partners’ names, are on all relevant documents and they meet in this capacity at regular intervals.
A reasonable distribution
Income that is personal services income cannot be derived through a trust based structure and distributed to someone other than the GP, ie the person who provided the service. Income that is business income can be, but there is mounting evidence that the ATO may require the professional to include “reasonable remuneration” in his or her personal tax assessment irrespective of whether the underlying income is personal services income or business income.
The ATO says it is liaising extensively with the relevant professional organizations and will release further information as its thoughts unfold.
Our approach to medical practice structures
Our approach to medical practice structures is quite straightforward.
Trust based structures are the simplest and easiest ways to run medical practices, minimizing accounting costs and administrative time, maximizing flexibility and achieving other significant commercial advantages, as discussed in the preceding paragraphs.
Two cardinal rules must be observed at all times. These are:
- personal services income must be distributed to the GP who generated it, and not distributed to any other person; and
- business income may be distributed to other persons provided the GP receives reasonable remuneration (including super, car fringe benefits and other benefits) commensurate with their contribution.
This is a conservative view of the law and the ATO’s interpretation of the law. Some would say it is too conservative, but we think it is wiser for GPs to sleep well at night, reassured they are in line with both the law and the ATO’s view of the law, and not exposed to the stress of a tax dispute.
GPs do important work every day, and poor sleep is very distracting and counter productive.
Introduction: why tax planning for investments is important
If an investment generating 10% per annum is owned by a tax free SMSF the after tax rate of return is 10%. If the same investment is owned by an investor with a marginal tax rate of 45%, and the return from the investment is taxable, the after tax rate of return is 5.5% [(ie 100% minus 45%) of 10%, or 5.5%].
This is a huge difference.
Table showing effective after tax rate of return
|Earning rate before tax||Tax rate||Type of Taxpayer||Earning rate after Tax “ERAT”|
|10%||0%||SMSF tax rate (pension mode) and personal tax rate up to $18,200||10%|
|10%||10%||SMSF capital gains tax rate|
|10%||15%||SMSF investment income tax rate||8.5%|
|Earning Tax Type of Taxpayer Earning rate after
rate rate Tax “ERAT”
|10%||19%||personal tax rate $18,201 to $37,000||8.1%|
|10%||30%||company tax rate||7.0%|
|10%||32.5%||personal tax rate $37,001 to $80,000||6.75%|
|10%||37%||personal tax rate $80,001 to $180,000||6.3%|
|10%||45%||top marginal tax rate $181,000 and above||5.5%|
The ERAT of 5.5% for GPs on the top marginal tax rate of 45% is not much: inflation and tax destroy the return on the investment.
Bear in mind the power of compound interest. A difference in earning rate of say 1.5%, ie the difference between the ERAT at the top marginal tax rate of 45% (ie 5.5%) and the ERAT at the corporate tax rate of 30% (ie 7.%). compounded over ten, twenty or thirty years becomes very significant, eventually more than $1,000,000.
This is compound interest at work.
The relative results after fifty years of investing $100,000 at a constant 10% per annum before tax but with different tax rates is shown here:
It is critical that, within the law and subject to the general anti-tax avoidance rules GPs minimise tax on investment income
GPs cannot do much about inflation, although avoiding non-growth assets certainly helps. This is why we always recommend businesses, good quality properties and blue chip shares.
GPs can do something about tax. Effective tax planning for investments boils down to following three simple rules:
- select investments where the return is either tax-free or concessionally taxed;
- use tax efficient investment entities, ie spouses, companies, family trusts and SMSFS, to hold your investments; and
- do not buy and sell investments frequently, instead hold them for the very long term, ie decades or even generations, so the capital gain remains unrealised and therefore not taxable (yet).
Investments where the return is either tax-free or concessionally taxed
An investment where the return is either tax-free or concessionally taxed will have a relatively higher after tax return than an alternative investment.
Which investments are tax-free?
At least three tax-free investments present to GPs. These are:
- the home, where the CGT principal place of residence exemption applies;
- a business, where the CGT small business exemptions apply. This includes most medical practices.; and
- business premises, where the CGT small business exemptions also apply. This usually includes medical practice premises owned and occupied by GPs (or related parties).
So, if you are interested in minimizing tax and maximizing after tax returns on your investments, it makes sense to first invest in your home, your practice and your business premises. By making sure you do not derive taxable capital gains you increase the after tax rate of return and become wealthier faster than otherwise.
Which investments are concessionally taxed?
Most so-called “growth assets” are concessionally taxed. Growth assets are essentially shares and properties. These assets are concessionally taxed because:
- a large part of the return is in the form of a capital gain, ie an increase in value over And capital gains are only taxed if realized, ie if the underlying asset is sold. Unrealized capital gains are not taxed; and
- the Australian tax system encourage people to invest in properties and Briefly, where an asset is held for more than 12 months a capital gain on its disposal will be:
- 50% exempt if derived by an individual or a trust (but not a company); and
- 3% exempt if derived by a SMSF (which means an effective 10% tax rate).
So, to maximize after tax investment returns you should buy blue chip shares and properties and hold them for the very long term, ie decades or even generations, and not sell them unless you absolutely have to.
The nature of the GP’s income, ie its height, stability, scalability and longevity, plus their borrowing ability, means it is rare for a GP to have to sell a quality investment. This means GPs are more able to be long-term investors than most occupations.
Long-term investors pay less tax than short-term investors. This means long-term investors usually make more money than short-term investors. In one way the un-paid tax, the latent tax liability connected to the un-realized and therefore un-taxed capital gain, is an interest free loan from the government that you can use to build further wealth.
Tax efficient investment structures
The second variable in the tax efficient investing equation concerns legal structures. Companies, trusts and SMSFs all have a role to play. This role has two functions:
- diverting investment income to a tax efficient investment entity, via trust distributions or deductible contributions, to be taxed at a lower tax rate than otherwise; and
- owning investments in the name of the tax efficient investment entity so the income is taxed at a lower tax rate than
How are the different legal structures taxed?
GPs pay tax at a range of tax rates depending on their income level. Typically a lot is taxed at 40% or 45% plus Medicare levy, plus, for the years ending 30 June 2015 to 2018, a 2% deficit reduction levy on incomes above $180,000.
Companies pay tax at 30% (28.5% from 1 July 2014). However, the 30% tax payment is just round one of a multi-round game. This is because the ultimate rate of tax is not known until the company’s after tax profits are paid out as franked dividends to an individual shareholder. If the individual’s tax rate is more than 30%, extra tax will be paid, which means the ultimate rate of tax will be more than 30%. If the individual’s tax rate is less than 30%, there will be a part or full refund of franking credits, which means the ultimate tax rate is less than 30%.
Companies create income distribution flexibility over a number of income years.
Trusts are normally not taxed. A trust’s net income is instead attributed to its beneficiaries (unit- holders) and these persons are taxed on the net income depending on their own tax profile. Sometimes net income passes through a series of trusts until derived by an individual or a company, in whose hands it is ultimately taxed.
Discretionary trusts, or family trusts, allow the trustee to allocate net income amongst the beneficiaries, usually family members or trusts and companies controlled by family members, who will pay the least amount of tax on it. Trusts create income distribution flexibility amongst related persons in a particular income year.
We often set up investment companies for clients where the shares are owned by a discretionary trust. This allows the client to get the best of both worlds, that is, multi-dimensional distribution flexibility, over time and between beneficiaries due to:
- the income distribution flexibility amongst related persons within a particular year, created by the discretionary trust; and
- the income distribution flexibility over a number of income years created by the company, and the dividend franking protocols.
Super funds have a more complex tax profile. This profile is best summarized in table form:
|Income||Tax rate in accumulation mode (ie under age 60)||Tax rate in pension mode (ie over age 60)|
|Dividends||15%, less franking credits||Nil %, less franking credits (ie refunds are paid)|
|Realized capital gains < 12 months||15%||Nil%|
|Realized capital gains > 12 months||10%||Nil%|
|Un-realized capital gains||Nil%||Nil%|
Inter-face with practice structure
Nothing exists in a vacuum. In most cases we also have to determine the best practice structure and then integrate the best practice structure with the best investment structure.
Let’s assume the GP does not own a practice and all income is personal services income under the ATO’s public rulings. This income will be 100% taxed in the hands of the GP. In most cases a non- owner GP in private practice will be best served by a PSI practice trust. The PSI income will be distributed 100% to the GP who earned the income, in line with the ATO’s public rulings.
Cash flows from the GP to the investment structure to acquire new investments. This flow can occur in a number of ways, including:
- most commonly, an after tax payment by the GP to investment trust (ie the capital has been previously taxed in the GP’s hands and then gifted as corpus to the trust) and the trust then acquires shares in the investment company
- concessional super contributions paid by the PSI practice trust to a SMSF for the benefit of the GP and/or an employee spouse/partner, with the SMSF paying tax at 15%, and investing the remaining 85% in new investments; and/or
- rarely, an after tax non-concessional super contribution by the GP and or a spouse/partner to a SMSF up to $180,000 a year, or $540,000 in a three year period.
We stress there is no diversion or alienation of personal services income to the investment company. All personal services income is taxed in the hands of the GP.
This structure is very protective of assets, because it is based on a family trust and an SMSF. GPs should never own valuable assets in their own names.
Diagramatically speaking, things look like this:
The investment/reinvestment process is dynamic. Dividends and rents are constantly received, taxed and reinvested, and excess cash from the practice is constantly transferred to the SMSF and the investment company/trust and invested in new investments.
Ideally this process is automated to implement a systematic, stable, diversified and cash flow positive investment strategy, at the same time as significant unrealized, and hence tax-free, capital gains are notched up.
This is a simple, safe and effective way for GPs to accumulate wealth.
The role of debt
Debt is deductible if used to acquire income producing assets.
GPs can use deductible debt to speed up and leverage the wealth creation process.
The idea is to arrange for an equity access facility for an appropriate amount to be held in the name of the investment vehicle, ie either the investment company or the investment trust; and to systematically acquire new investments, using a mix of debt and cash and then focusing on investments expected to generate a high net cash flow as well as capital gains.
Expected income yield
The higher the income-yield the less likely the investment will be owned by a GP, particularly once the yield exceeds the interest rate. It does not make sense to hold high yield assets in the hands of an investor facing a high marginal tax rate.
Most clients are more likely to own a high-income yielding asset in their SMSF (15% tax rate) or in the investment company (30% tax rate). Alternatively they could own the investment in their family trust and distribute and pay the net income to their investment company each year, to limit the tax to 30% (with the possibility of a refund of company tax in a future year). Either way, the tax paid on the investment income will be minimised, and hence the after tax return, will be greater by using a company, a SMSF or a family trust to own the asset.
Expected capital gain
Individuals and trusts enjoy a 50% exemption from capital gains tax on capital gains on assets held for more than 12 months. For SMSFs the exemption is 33% for assets held for more than 12 months. Companies do not enjoy this concession. This means GPs are likely to own the asset in either their family trust or a SMSF to benefit from the CGT exemptions when the asset is ultimately sold.
The less likely the capital gain, or the more remote in time it is, the more likely it will be that the asset will be owned in a company. Some specific comments on the investment company are warranted. The shares in this company will be owned by a discretionary trust, and this trust will probably not do much for a few years until the first franked dividend is paid from the investment company, at which time it will start to distribute franked distributions to low tax rate family members, for example, children once they turn age 18, ideally timed to trigger a refund of franking credits due to the family member’s marginal tax rate being less than 30%.
The purpose of the investment company is to buy and hold new investments, particularly investments that are cash flow positive and expected to be held for the long term. This excludes most residential property, which is rarely cash flow positive.
One downside of an investment company is that it does not enjoy the benefit of the 50% discount on capital gains on assets held for more than 12 months. For many advisors this is reason enough not to use a company for investment purposes. But we believe this view is short-sighted and ignores the other advantages of an investment company. Whether or not these other advantages more than compensate for this CGT disadvantage depends on a number of variables, the relative values of which will only become known as time passes. But we expect that in most case involving long-term investments, ie investments held for decades or even generations, these other advantages will more than compensate for the absence of the 50% CGT exemption. These other advantages include:
- significant asset protection advantages for the GP now, achieved by having the shares in the investment company owned by a family trust;
- perpetual succession, whereby control of the assets can pass through the generations without a disposal of the assets for income tax purposes or stamp duty purposes, and creating significant family law asset protection advantages for future generations;
- tax being no more than 30%, and possibly less than 30% once dividends are paid out to the shareholder trust and then distributed to the ultimate beneficiaries (probably timed to achieve a refund of franking credits which means less equivalent pre-tax income is needed to acquire an asset of a given value, in after tax dollars). This means the same amount of pre-tax income buys a lot more investment, and seriously speeds up the asset acquisition strategy;
- higher after tax rates of return, since the tax on earnings is no more than 30%, and possibly less (see (iv below,) which is less than 48%. That is, there is less tax payable on investment
- earnings in the company, which means after tax rates of return are higher, which in turn means debt reduction and asset acquisitions can occur at a faster pace;
- income tax flexibility achieved by having the shares in the investment company owned by a family trust, with an ability to distribute future franked dividends to family members who will receive a refund of franking credits; and
- the investment company’s future taxable income can be reduced by deductible fringe benefits, like car fringe benefits and deductible super contributions for directors.
If there is a particular project where a significant capital gain is expected within the short to medium term then you should consider whether it should be owned by the family trust or the SMSF.
We generally recommend investments be held for at least twenty years, if not a lot longer. We even recommend the expected holding period cover the generations: that is, we see GPs as investing for their children and even their grandchildren, rather than themselves.
The longer the holding period the more likely it is that the asset will be held in the company rather than the family trust, because the long term nature of the investment means the CGT advantages of the family trust are less important.
The longer the holding period the more likely it is that the asset will be held in the SMSF. Capital gains will be tax-free once the member is age 60. So there is a lot of sense in investing through the SMSF if the return is expected to comprise of long-term capital gains.
There is no CGT advantage of holding an asset in a trust if it is bought and sold within 12 months. The 50% discount is not available unless the asset is held for more than 12 months.
Other issues impacting the choice of structure
There is a range of other issues impacting the choice of structure and they differ from client to client. These include the client’s age, income level, family profile, (material) living standards, and attitude to borrowing.
Most GPs are aged between 35 and 70 and can contribute at least $30,000 a year to a SMSF ($35,000 if 50 years or over), and for most married couples this means at least $60,000 a year can be contributed to a SMSF. Investment earnings in the fund before age 60 are taxed concessionally, at tax rates between 10% and 15%. After aged 60 super benefits can be withdrawn tax-free and the investment earnings in the SMSF become tax-free.
This means there is a powerful tax incentive to invest through a SMSF, and this incentive gets stronger and stronger as age 60 gets closer, to become virtually irresistible from age 55 on. Therefore we usually recommend that GPs pay the maximum possible amount of concessional contributions to their SMSF each year.
We also usually recommend GPs pay maximum non-concessional contributions to their SMSF if at all possible, particularly as they get closer to age 60, ie the age where the tax free status of the SMSF starts.
For example, consider Dr Herb from 2012. Dr Herb was age 55 and was reasonably well off. His youngest child was just finishing psychology training and he and his wife Herbette, age 55 too, felt their time and money as finally their own. Their assets comprised:
|Shares in Herbette’s name||$1,000,000||$1,080,000||Nil||$1,080,000|
|Caroline Springs residential property investments in Herbette’s name||$1,000,000||$900,000||Nil||$900,000|
The advice was simple. In summary it was to migrate the wealth from their hands, particularly Herbette’s hands to the SMSF. The SMSF will be concessionally-taxed on its investment income until age 60 and from then on its investment income will be tax free.
- sell the Caroline Springs residential properties and pay the net sale proceeds of $900,000 to the SMSF as a non-concessional super contributions ($450,000 each) before 30 June that year. These properties were thought to have low future capital gains prospects and the sale realised a capital loss of $100,000 (please note: the limits for non-concessional contributions will fall to $100,000 per year, or $300,000 every three years, from 1 July 2017);
- use the $900,000 in the SMSF to buy a new four bedroom town house in Kew, to be rented out to long term tenants;
- in July 2015 (ie the start of a new three year period) sell the shares and pay the net amount to the SMSF as non-concessional super contributions ($540,000 each – once again, please note that the limits for theis type of contribution reduce on 1 July 2017). The capital gain on these shares ($80,000) was offset against the capital loss of $100,000, which meant there was no CGT actually paid on this transfer;
- use the $1,080,000 in the SMSF to buy blue chip Australian shares;
- reinvest the net earnings in the SMSF in blue chip Australian shares; and
- never sell any investments in the SMSF.
The primary purpose of this strategy was to maximise expected future retirement benefits for Herb and Herbette as members of the SMSF.
By age 60 Herb and Herbette’s only assets comprised the home, which is tax free, and their SMSF, which is tax free too once their pensions started.
Your taxable income
The higher the GP’s taxable income the more likely the GP is to invest through super or an investment company. This is because higher income GPs usually have more cash to invest.
Your family profile
GPs using trusts for investments with dependant adult relatives, such as a spouse, parents (without an old age pension), or children over age 18 can distribute this investment income up to $18,400 to each relative and no income tax will be payable (assuming the relative has no other taxable income). Further distributions will be taxed at the beneficiary’s marginal tax rate, and usually this will be less than otherwise would have been the case if the structure was not used.
Preferred material living standards
Some GPs spend more than others. Tax planning increases the amount able to be spent. But we confess we are usually happier to see the benefits of effective tax planning reinvested in permanent wealth, with possible exceptions for education and family holidays. Some clients just survive on $400,000 a year, whereas others accumulate significant wealth on less than $100,000 a year, and seem just as happy, if not happier, than everyone else.
The higher a GP’s material living standards the less cash is available for investing, no matter what structure is chosen, and it is more likely that a tax inefficient structure will be used, because of the need to access cash for consumption, and the high marginal tax rates faced by individuals.
It’s not just what you make, but also what you spend, that counts.
Your attitude to borrowing
As indicated above, subject to some common-sense cautions, we are generally in favour of borrowing to acquire investment assets. Gearing usually increases the net return on the investment and hence the client’s wealth level. Most GPs who have borrowed money to buy assets over the last two decades have done well. Our common sense cautions include:
- observing prudent debt to equity ratio, both on an overall level and an individual asset level (what is prudent will differ from client to client, but we get uneasy where total debt is 60% or more of total assets, except where the level of assets is low);
- ensuring “representative” assets are acquired, that is, assets which will behave pretty much in line with the general movement in prices for that asset class, and which are less risky than otherwise (which is why we like index funds, blue chip shares and residential property); and
- avoiding too much negative gearing (which is one of the reasons we like cash flow positive investments).
|Table summarising different legal structures||Sole owner||Partnership of Individuals||Partnership of Trusts||Discretionary Trust||Hybrid Trust with a company as a beneficiary||Unit Trust||Company with individual shareholders||Company with discretionary trust shareholder|
|Ability to defer tax under franking credit protocols, and limit current year tax to 30%||No||No||Yes, if the trust has a company as a beneficiary||Yes, if the trust has a company as a beneficiary||Yes, if the trust has a company as a beneficiary||Yes, if the trust has a company as a beneficiary||Yes||Yes|
|Income sharing capability||No||No||Yes||Yes||Yes||No||No||Yes|
|Offset losses against other income from external activity||Yes||Yes||No||No||No||No||No||No|
|Amenable with other tax planning strategies||Low||Low||High||High||High||Moderate||Low-medium||Moderate|
|Cost to set up and run||Low||Moderate||High||Moderate||Moderate||Moderate||Moderate||High|
|CGT 50% discount||Yes||Yes||Yes||Yes||Yes||Yes||No||No|
|CGT active asset exemption||Yes||Yes||Yes||Yes||Yes ( 20% income & capital test)||Yes, but cost base reduced||Yes||Yes|
|CGT retirement concession||Yes||Yes||Yes||Yes||Yes ( 20% income & capital test)||Yes||Yes||Yes, subject to conditions|
|CGT 15 year concession||Yes||Yes||Yes||Yes||Yes||Yes||Yes||Yes, subject to conditions|
|CGT small business rollover||Yes||Yes||Yes||Yes||Yes||Yes||Yes||Yes|
Most GPs are self-employed and run their own practices, either solo or as part of a larger group. This means they are rewarded substantially through profit share, including dividends from practice companies and service trusts, distributions from practice trusts and service trusts, salary payments and fringe benefits.
Increasingly, this is changing. More GPs now choose to work in a practice as an employee, and their reward comes in the form of salary, fringe benefits and superannuation contributions. These GPs are commonly:
- Younger GPs who are still on the GP training program and who must be employed and therefore rewarded as employees.
- Female GPs working part-time during their child bearing and rearing years, who may be part of a husband’s income-splitting devices, and who want the simplicity and ease of being employed. Though this sounds politically incorrect, please forgive us: it is statistically correct and merits mention as a separate category of GPs for whom salary packaging has potential.
- GPs who have salaried positions outside of general practice, whether as a hospital VMO, with an insurance company or some other employer.
- Self-employed GPs who use companies and/or trusts to run their practices and who are in turn employed by those companies and trusts, to provide medical or administrative services to a service company or trust. This can include the employment of related persons such as a spouse. Most GPs who use legal structures to run their practices can avail themselves of the benefits of employee reward packaging to some extent.
Where GPs are employed, there is potential to reduce the total of income tax and fringe benefits tax costs by carefully structuring the composition of the employee’s reward package and its allocation between salary, fringe benefits and superannuation contributions. Each of these benefits has different tax consequences and this creates the potential to improve the cost- effectiveness of a particular GP’s reward package by carefully setting the mix of the three benefits.
How is employee reward packaging different from salary packaging?
It’s the same thing but employee reward packaging is a more descriptive and more accurate phrase. Salary packaging implies salary has some special status in the employee reward mix, and suggests any planning must involve an employee giving up salary and substituting it for lower tax fringe benefits or superannuation. This is not correct.
An employee and an employer are free to agree any combination of employee reward, whether salary, fringe benefits or superannuation contributions. For example, there is nothing wrong in principle with a new employee taking all their reward as a loan fringe benefit and none as traditional salary. However, if an existing employee decides to give up all or part of their salary and take fringe benefits in its place just to get a tax benefit, there is a risk the ATO will apply the anti-tax avoidance rules to the arrangement, particularly if the employee substitutes an existing right to receive salary as an earned bonus for a low-tax fringe benefit. However, there are actually few examples of the ATO doing this. Nevertheless, it is wise to leave a paper trail saying something was not done just to gain a tax benefit, and to in fact make sure something was not done just to gain a tax benefit.
Starting off with the concept of employee reward packaging rather than salary packaging is an important first step in getting the paper trail right.
It is wise not to interfere with the form of existing benefit entitlements. For example, if an employer is due to pay a reward of $8,000 to an employee and it was agreed this reward will be salary, the anti-tax avoidance rules could apply to any subsequent attempt to substitute a less- taxed form of reward, such as super contributions.
This is certainly the ATO’s point of view, as expressed in Taxation Ruling TR 2001/10. You can access this ruling here: Taxation Ruling TR 2001/10.
A word of warning on payroll tax
Increasingly, GPs in group practices are running into payroll tax problems, mainly because salaries paid by the owner-GPs to themselves via practice entities and trusts are included in the practice’s salaries when determining the payroll tax liability. With payroll tax rates across the states and territories running at more than 5% for payrolls of more than $500,000, this is becoming an increasing problem.
Payroll tax needs to be considered when looking at the advantages and disadvantages of one form of reward over another.
Interaction between the income and the fringe benefits tax rules
Since fringe benefits tax (FBT) was introduced in 1987, employee reward packaging has leveraged itself off the differences in the effective tax rates applying to each type of employee reward and, in particular, the low effective tax rates applying to some concessionally taxed fringe benefits.
The basic rules are straight forward. Salary income is included in the employee’s taxable income computation and progressive tax rates are applied to that figure, culminating in a tax rate, including the Medicare levy, of 48.5% on taxable incomes above $60 000 for the 2003 income tax year. Fringe benefits tax is levied on the employer. The tax rate of 48.5% (including Medicare levy) also applies to the taxable value of the fringe benefits, grossed up by a factor of 2.1292 (assuming the employer can claim GST credits and the employee cannot). These factors are designed to create equitable tax treatment between the two different forms of reward, assuming the employee is at the top marginal tax rate.
Grossing up the employer’s taxable value and then allowing a tax deduction the resulting FBT liability means the total effective tax rate is the same irrespective of which form of reward is chosen.
This structural emphasis on a level playing field has two main consequences for tax planning for GPs. These are that giving up salary for fringe benefits will only be sensible where the fringe benefit is a concessionally taxed fringe benefit, and that it will be more attractive when the marginal tax rate faced by the GP is 48.5%.
Employee reward packaging has to be considered within the broader financial planning strategy, particularly the tax planning strategy for the GP and related persons. For example, a large spouse superannuation contribution strategy may work to drag the GP’s taxable income down to a much lower tax bracket and hence render certain employee reward packaging strategies at best unnecessary and at worst counter-productive.
The selection of an employee GP’s reward package should work in favour of the employee and the employer. There is an Australia-wide shortage of GPs, so employer GPs must be flexible about how they engage GPs in their practices. GPs must have the choice of being an employee or some other option and, once the GP chooses to be an employee, they must have choices regarding the mix of salary, fringe benefits and superannuation.
Currently, most employee GPs do not have tax-efficient packages. It tends to be 100% salary, plus mandatory super contributions, and that’s that.
Concessionally taxed fringe benefits are rare. An employer GP who introduces them will find it is easier to attract and retain employee GPs, by being able to provide a greater after-tax value to the employee GP for the same before-tax cost.
Employee reward package negotiations should be a win-win experience for the employee and the employer.
Some basic technical concepts underpin this, including:
- A reward will either be taxed in the hands of the employee as salary, or taxed in the hands of the employer as a fringe benefit; it cannot be taxed as both.
- Where a benefit is specifically exempt from FBT in the hands of an employer it will be exempt from income tax in the hands of the employee.
- The taxable value of a fringe benefit will be reduced by any contribution paid by the employee. The employer has to include the contribution in assessable income. The ATO says these contributions can be made via year-end book entries, without cash being paid, where the employee and the employer are related parties.
- The taxable value of a fringe benefit will be reduced to the extent that the cost of providing the benefit would have been tax deductible to the employee had they incurred the cost. For example, an employer can pay the deductible interest on an employee’s investment loan without triggering an FBT liability but the employee cannot claim the interest because they have not incurred it.
- FBT is a deductible loss or outgoing in the employer’s hands.
Car fringe benefits
The car is the most common fringe benefit provided to GPs. This is not surprising because it is actually what the government wants – deliberate concessional rules for valuing car fringe benefits have been a feature of the FBT rules since they were introduced in 1987. These concessions are intended to keep the new car manufacturing industry alive and well. The fear is that if employers, easily the largest buyers of new cars, stopped buying new cars the industry would die overnight.
The family car is one of the biggest investments and expenditures GPs make, apart from the home, and holding the car in a way that minimises after-tax cost is sensible.
The best way to buy a car is through your family trust and for the car to be provided as a fringe benefit as part of your salary package. The employee then contributes to the cost of running the car such that the taxable value of the car is reduced to nil and no FBT is payable, although the amount of the contribution must be returned as assessable income by the employer. The contribution can be made through a loan account at year-end, so a cash contribution need not be paid to the employer.
An exception to the normal rule that it is cheaper to have a car owned by an employer and provided to the employee as a fringe benefit may arise when the car has a high dollar-value, is driven less than 10,000km a year and has a high business usage percentage. In this situation it can be better to own the car in the practitioner’s name and to claim a tax deduction for the costs of running it, including depreciation and any interest, or lease payments if the car is leased, multiplied by the business percentage.
There is no limit on the number of cars able to be taken as a fringe benefit by an employee or an associate of an employee and there is no requirement that the practitioner drive the car. The practitioner can use the first car, the spouse can use the second car and children or grandparents can use the third or fourth car. The cost of each car is deductible to the employer and there is no tax payable on the benefit. FBT is payable as above. There tends to be little FBT payable on the third and fourth cars. Under the statutory method FBT is a function of cost, and if the car did not cost much in the first place there can’t be much FBT.
What is business travel?
Business travel expenses are summarised by the following extract from the Australian Tax Reporter (www.taxreporter.com.au):
“Travel expenses from home to work are generally not an allowable deduction. The leading case that decided this was the decision of the Full High Court in Lunney v FCT (1958) 7 AITR 166. The reasons are twofold.
“First, merely because certain expenditure must be incurred in order to be able to derive assessable income, in that unless one arrives at work it is not possible to derive income, does not necessarily mean that the expenditure is incidental and relevant to the derivation of assessable income or that it is incurred in the course of gaining or producing assessable income. It is a prerequisite to the earning of assessable income rather than being incurred in the course of gaining that income. Hence, It does not fulfil the positive limbs of s 8-1(1).
“Second, the essential character of the expenditure is of a private or domestic nature, relating to personal and living expenses as part of the taxpayer’s choice of where to live, in choosing to live away from and at what distance from work. The negative limbs of s 8-1 (2) are therefore also breached.
“There are, however, some exceptions. Certain employees such as professional footballers and musicians, have been held to have a base at their home and consequently from the moment they leave that home they are engaged in connection with their work and are entitled to a deduction in respect of the travelling costs incurred: Ballesty v FCT (1977) 7 ATR 411. This is particularly so where transport of bulky equipment is a necessary part of the job: FCT v Vogt (1975) 5 ATR 274. A GP was able to obtain a deduction on these grounds in AAT Case 9235 (1994) 27 ATR 127.” (emphasis added)
Most GPs carry bulky equipment most of the time. A drug bag and an equipment bag probably suffice (Ballesty’s case involved a rugby player’s sports bag). But to be safely within the rules we suggest GPs also carry emergency medicine equipment in their cars.
GST on company cars
An often-forgotten but significant side benefit of a company car is that 100% of the GST IS refunded in the Business Activity Statement for the quarter of purchase.
Remote area housing
GPs in remote rural areas can receive tax exempt housing fringe benefits. These are often used for GPs working with Aboriginal communities in remote areas, and similar groups.
Low dollar-value and irregular gifts can be provided by employers to employees without a FBT charge for the employer or an income tax charge for the employee.
Gifts can be a great way to lift employees’ morale and show appreciation of their efforts. In the employment context, there is much to be said for the old adage “it is better to give than to receive”. It’s a human resources truism that people respond more to empathy and appreciation than they do to just money.
For example, a gift of a $200 shopping voucher to each employee before Christmas can be a great way to say “thanks”. Other shopping ideas include a bottle of spirits, perfume, a food hamper, a CD, a book or a clothes or toy shop voucher. The gift does not have to be consumed on the premises and there IS no reason why it cannot be something that the employee in turn gives to someone else.
The ATO applies some rules in order for the gift to be treated as tax-free. These are that anyone gift must be “modest in value”, and the cut-off appears to be $300 per gift. The gift must not specifically relate to the employee’s work performance and there should be no more than four “special occasions (ie, gifts) per employee per year.
Many GPs travel for business purposes, particularly rural GPs, who regularly commute to the major cities to update their skills at seminars or attend to other business matters.
Many GPs claim the exact costs they incurred, such as airfares, accommodation, taxi fares, meals, etc. For GPs who are employees – and all GPs who practice through a practice company are employees – there is an alternative way that can result in hundreds of dollars of after-tax cash savings.
Rather than paying for or reimbursing costs for accommodation and incidentals, an employer may give the employee GP a travel allowance, which is fully tax-deductible to the practice company, and assessable in the GP’s hands. The GP can then claim expenses against this allowance as work- related expenses. This makes sense.
Provided the claim is reasonable, a GP does not need to satisfy the detailed substantiation requirements normally applying to extended interstate or international travel. In Income Tax Ruling TR 2000/13, the ATO sets out which levels of expenditure they consider reasonable and that consequently need not be substantiated. These levels are often much higher than the actual costs many GPs incur and claim.
The otherwise deductible rule
The taxable value of a fringe benefit will be reduced to the extent that the cost of providing the benefit would have been tax deductible to the employee had they incurred the cost themselves. For example, an employer can pay the deductible interest on an employee’s investment loan without triggering an FBT liability, although obviously the employee cannot claim the interest as well, since they have not incurred it.
GPs travel a lot. The tax law is mainly favourable to their claims for deductions for extended domestic travel and overseas travel, but some basic ground rules have to be followed if the correct tax treatment is to be demonstrated to the ATO.
The basic principles are straightforward. If a GP incurs losses or outgoings when travelling overseas for the purpose of increasing their current or future assessable income, a deduction is generally allowed. The difficulties arise when the trip has is a mix of private and business purposes.
If a GP travels to Vienna for a seven-day conference, and then spends another five days sightseeing, how are the costs divided between the deductible business purpose and the non- deductible private purpose?
The High Court says that there must be a fair and reasonable apportionment based on the facts of each case. This makes sense, but a perusal of cases shows a bewildering array of apportionment methodologies that serves more to confuse than to explain. Some cases are scarcely distinguishable from each other, but somehow the courts and tribunals make distinctions and different tax results flow on from them.
Document, document and the document again
The burden of proof lies with the taxpayer. The basic rule is to document, document and document again so the purpose of the travel may be demonstrated to the ATO. The Tax Act actually creates a special requirement for this. Detailed log books must be kept for all overseas travel and extended domestic travel (ie, more than five days). But more substantiation is needed if a claim is to be put beyond any doubt.
The documentation should cover the whole exercise, from the time the trip is first conceived, through to your return and the implementation of the knowledge you gained.
Case W73 is instructive. Two junior police officers, a wife and husband, successfully claimed $25,000 of costs incurred on a trip to the UK to visit a selection of police stations for the purpose of gaining knowledge of new police methods. Sightseeing was not on the agenda. Case W73 is applicable to GPs as much as police officers. For example, there are many examples of GPs who travel to the UK to visit general practices for the purpose of improving knowledge of community medicine and international standards of care. If a GP does this and can document the purpose of the trip as a business trip, the costs will be tax-deductible.
The emphasis should always be on improving an existing body of knowledge and experience, rather than creating a new one. There is a risk that costs incurred in creating a new body of knowledge and experience will be seen as a non-deductible capital outgoing. Make sure the documents evidence the improvement of an existing body of knowledge and experience.
Purpose counts, not time
The apportionment between private and business will be based on your purpose rather than how you spent your time. A GP visiting the UK does not have to spend the bulk of their time at surgeries, but visiting the surgeries needs to be the primary purpose of the trip if the bulk of the costs are to be treated as deductible. For example, the costs of a 20-day stay in the UK with 15 two-hour visits to different surgeries spread around the country would be 100% deductible if the visits were on average one per working day and the sole purpose of the trip was to visit the surgeries. This is so even if only 15% of time was spent on the surgery visits.
The key word is substantiation. A properly completed log book is just the start. The GP must be able to prove that the purpose of the trip is to improve community medicine knowledge. The paper trail will be important: from the initial requests/advices to colleagues for sabbatical leave, to invitations to visit the UK surgeries, letters to travel agents to organise the logistics, notes taken while visiting, and the dissemination of the information to peers and colleagues on your return to Australia.
It boils down to making sure you can prove why you did it, as well as that you did it. Nothing beats contemporaneously created documents involving third parties as evidence of intention. Simple assertions regarding why you did something have little evidentiary weight if the matter is reviewed by the ATO, but a clear paper trail evidencing what you did and why you did it will make sure there is never any dispute in the first place.