practice management
When starting a
practice should you
Compiled by
Heath Stewart
INCORPORATE OR
REMAIN A SOLE TRADER?
This is quite a hot topic at present and there is significant
misinformation in the marketplace around the rules of operating
a company when you are a healthcare professional. Our practice
has fielded dozens of calls in the last few months on expressly this
point. What has been of paramount concern to our practice is the
breadth of misunderstanding in this area.
summarise the process at the link http://www.asic.gov.au/asic/ASIC.
NSF/byHeadline/Starting%20a%20company%20or%20business
As a basic recap, there are a variety of legal structures used to
operate a dental practice in Australia, including:
On the face of it then, the day-to-day operation of a company
would appear to be very similar to the operation of a practice
as a sole trader. However, appearances can be very deceiving! A
company is a separate legal entity from you as a natural person.
It must prepare accounts, tax returns and comply with the
appropriate federal laws and taxation regulations. Further, many
people take on the role of Director in a company without being
familiar with the statutory responsibilities and duties of a director
or fully thinking through the ramifications and responsibilities that
the role entails.
• Partnerships
• Trusts
• Sole trader
• Associateships
• Joint ventures
• Company’s
However, the most common structures utilised in practice are:
When incorporated Dr Jones would cease invoicing patients directly
in his or her own name and would bill patients under the company
ABN. All expenses would now be invoiced to and paid for by the
company including salaries, wages and superannuation for staff.
• Sole trader only
PERSONAL EXERTION INCOME
• Sole trader with service trust
In many traditional businesses changing from a sole trader to
a company or a trust could trigger capital gains tax and stamp
duty. The reason being that when you transfer the ownership of a
business asset from one entity (you) to another entity (a company)
deemed market value substitution rules apply and the transfer
may be deemed to have happened at arms-length or market
value regardless of the value you, or your advisor, ascribe to the
transaction. The consequences of a change for many businesses
can therefore be catastrophic.
• Company only
• Company with service trust
This article will concentrate primarily on the first (sole trader) and
third (company)* dot points.
SOLE TRADER
A sole trader is a structure whereby the dentist has an ABN in
their own name and invoices their patients directly using their
own provider number. All expenses are also invoiced to and paid
for by the dentist in their own name including salaries, wages and
superannuation for staff.
COMPANY
When that same dentist incorporates he or she would normally
make application via their accountant to incorporate a company.
A name would be selected (e.g., Dr Jones Dentist Pty Limited) and
a Form 201 lodged with the Australian Securities and Investment
Commission (ASIC). Together with the Constitution, this Form 201
and various minutes form the basic set of governance documents
guiding how the company is operated. Within a few days ASIC
would issue an Australian Company Number and your accountant
would then make application with the Australian Taxation
Office for an ABN and a Tax File number for the company. ASIC
*In following months I will conduct a full analysis on the benefits of
service trusts.
The key reason that a change from a sole trader to company, or a
company back to a sole trader, for a dentist does not trigger these
market value rules is the concept of personal exertion income (PEI).
It would be easy to get bogged down in case and legal references
to this concept but it is quite simply defined. Most non corporate
dental practices in Australia derive their income from just the
principal dentist. Ergo the personal exertion of the principal is
what generates the income for the practice. As such, regardless
of the structure that the practice is being run through (sole trader,
company, trust, etc.,) the residual business income after paying for
practice expenses (rent, laboratory, staff, etc.,) must be attributed
(paid to) the principal. In short, it means that even though you
can trade through a company, the income and any goodwill of the
practice is the principal’s in his or her own name. The company is
merely a conduit through which the income passes through until
ultimately paid out to the principal.
This principle is formalised with an ATO ruling It 2503
http://law.ato.gov.au/atolaw/view.htm?docid=ITR/IT2503/NAT/
ATO/00001
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practice management
WHEN IS INCOME NOT PERSONAL EXERTION INCOME?
When all income is earned by the practice principal, it is likely PEI.
When most of the income is earned by associates, hygienists,
nursing staff, sale of goods and or products and others, the
character of the income has likely changed from PEI to general
business income.
PERSONAL SERVICES INCOME
A term many younger dentists may have heard is personal services
income or PSI. The legislation in this area is covered in Division 84
of the ITAA 1997. One specific area often quoted is the 80/20 rule
or the unrelated clients test. I often get questions from dentists
who are potential clients, often working as associates asking the
following question:
“I work as an associate in three practices so I pass the 80/20 rule,
so why should I pay any of the profit out of my company? The
company only pays 30% tax whilst I may pay tax in my own name
at 46.5%”
“...you should have a
prudential review of business
structures every few years,
just to make sure it’s optimal.”
I should also add we are often asked another question very similar:
• There are significant advantages for the sole trader in terms of
cash flow to not use a company
“I have my own practice in Sydney, I pass the un-related clients
test, why should I pay any of the profit out of my company? The
company only pays 30% tax whilst I may pay tax in my own name
at 46.5%”
• A company is required to withhold superannuation and PAYG
from the attributed income it pays to the principal, a young dentist
may have no interest
The misconception in the market place is that if you pass the
PSI tests you can also retain profits in a company and not pay
out the profits to yourself at the end of the year. Unfortunately,
this interpretation is incorrect. Ultimately, all the PSI tests do is
determine if your operation is a business or not. The PSI tests do
not allow you to retain profits in a company.
• Limited liability is not the advantage it used to be and most risks
can be insured
SO WHY USE A COMPANY?
Historically, there was always one compelling reason to incorporate
your practice and that was superannuation. For decades when a
self-employed sole trader made a contribution to superannuation
in their own name they only received a tax deduction for 75% of
the contributions after a small threshold. When trying to maximise
superannuation balances a company was a good solution as a
company received in a 100% deduction for the contributions
made on behalf of the principal.
Additional reasons to still use a company include:
• If you do not provide as per the 4th point you risk penalties and
fines
• It is cheaper to run a sole trader structure than a company
WHAT SHOULD YOU DO IF YOU ARE USING A
COMPANY NOW?
It is recommended that you review the financial accounts of your
company to see if you are attributing all profit of the business
back to yourself. If you aren’t, don’t panic, just engage with your
accountant and get the full picture as there may be a variety of
reasons that profits were retained. You should also revisit if a
service trust and or dropping back to a sole trader is appropriate
for your practice. Just as the treatment plan for patients changes
and develops over time, you should have a prudential review of
business structures every few years, just to make sure it’s optimal.
• Limited liability – which can protect you against some litigation –
although not malpractice which is always personal.
• A good traditional solid structure – most people understand
how they work.
• Ability to stagger tax payments on your salary every month
which can help with cash flow.
• Some asset protection benefits.
• You have a large practice with many dentists working for you
and as such you can retain profits as the income is not personal
exertion income.
WHY NOT TO USE A COMPANY
Notwithstanding traditional wisdom and some asset protection
benefits, companies don’t provide the solutions they used to for
sole practitioners. Further they often don’t provide the solutions to
larger practices. The disadvantages are summarised as follows:
• Rarely can you retain profits (regardless of advice many have
received to the contrary)
• Trading trusts or service trusts usually provide a better solution
with better flexibility
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M A R C H 2 014
Heath Stewart is a Partner of Ecovis Clark Jacobs, Accounting and
Business Advisers, specialising in providing advice to dentists. Advice
includes planning for your financial wellbeing, superannuation, insurance,
practice management, computer software and the buying and selling of
dental practices. For a free assessment of your financial position and to
see how you can achieve your goals, please do not hesitate to contact
Heath on 02 9264 1111.
This article is designed to provide generic information only and should
not be viewed as a recommendation to act. Individuals should seek
advice from a qualified adviser to ensure their actions are commensurate
with their financial needs and requirements.