Practice owners running service entity structures have no option but to fix their setup. People suggesting otherwise might be courting legal trouble.
Payroll tax is not the existential crisis that the RACGP, the AMA and now a bevvy of professional advisors would have you believe.
It’s actually a very simple – albeit for some practices now large – problem.
The biggest current issue in this so called crisis is how much misinformation and confusion is being spread, much of it by parties that should know a lot better.
Of course, I’m not a professional advisor, so what would I know?
Maybe read as far as you can here and if you see any logic emerge that worries you, you can act on it.
Here are some very basic principles which are being ignored by various parties who have been advising practices on this important issue and confusing a lot of them in the process:
1. The services entity structure is not there for tax reasons.
If you’re old enough to remember when this now very common business structure was established, it had nothing to do with managing tax issues.
Technically, if you’re doing your accounts right, it should still have nothing to do with tax, at least directly.
Yet, for some reason, we are seeing some professional tax advisors talk to the media and say they can fix someone’s service entity structure specifically to fix their potential payroll tax problem.
I suspect these advisors have unwittingly announced they intend breaking the law and if you use them based on their pitch, you might end up breaking the law as well.
This is because of very well understood anti-avoidance tax provisions, something that both state revenue offices and the ATO are particularly touchy about. You can’t build or manipulate business structures with tax minimisation as your key goal.
That we are seeing such bizarre activity might be a sign of how badly understood this problem is.
Most service entity structures in Australian GP practices set up more than 10 years ago were not set up with any direct intention to avoid payroll tax. They were set up to avoid malpractice liabilities, to create good succession management and ultimately to help build ongoing value in a practice so that it might be worth enough to sell for good coin once a principle or owner decided to move on.
In a service entity structure, a practice is not liable for the mistakes of a doctor working on its premises because the doctor is a tenant and the practice is effectively just the landlord – it’s a handy bit of separation.
If you don’t have this separation, not only will a practice face potentially catastrophic liability cases created by its doctors, it will likely be worth significantly and permanently less to on-sell, as liability cases have a habit of sitting silently on the books. Anyone doing due diligence before buying a practice might be inclined to devalue the business significantly if it was running the business with its doctors as employees.
One of the reasons we know service entity structures were not initially set up for tax purposes is that back then payroll tax was not a known potential issue. State revenue offices had not thought through the tax implications of these structures and no one was being audited.
But this is not to say that the law as we now understand it through the clarification of cases like Optical Superstore and Thomas & Naaz was not already the law back then.
It was.
2. The law on payroll tax has always been there.
It is not, as is often claimed by some representatives of the AMA and the RACGP, “a new tax”.
It is not “a new interpretation” of the tax law either.
It is quite simply the application of what was always the law.
What is causing the problem here is what you might term “structural drift” in the original construction and implementation of a service entity for a lot of practices.
By that I mean that as time went by some practices, in particular some of the big older corporate practices, started tacking on new ways of doing things within the services entity construct. In hindsight, it’s easy to see these were outside the law.
It is not likely that the owners of such businesses and their advisors ever even contemplated a payroll tax problem when they started making these modifications.
What they likely saw was some simple business maths: if we control how our doctors work a lot more, centralise control and systematise things for volume and profitability, we are going to make a lot more money.
These businesses were running on economies of scale and efficiency. Centralised control can be great for that.
Without any early warning of how they were drifting off track, they upped the ante with things like contracts that included restraints of trade and the monitoring and reporting of consults through centralised patient management system monitoring.
What was going on at these bigger corporates was very visible to most small to medium practice owners and managers.
It was natural to copy aspects of some of what they were doing and many did, mainly for financial reasons.
A big problem that then emerged in the last 10 years or so was that professional advisors – mostly accountants but occasionally lawyers as well – started to copy what they saw when they were helping set up new practices, rather than look at key first principles about what these tack-ons actually meant.
Seeking to save money as times got tougher through Medicare freezes and the like, some practice owners didn’t even seek a lot of advice outside the basic structural setup and also started simply copying what they saw around them.
Often they did this literally – there are a lot of examples of practices using copies of contracts developed by bigger corporates or practices and changing the names and addresses.
That sort of activity at the time looked smart from a financial perspective.
Rather than pay for expensive accountants and lawyers, DIY it.
There’s a very big sleeping problem here for some owners and their advisors because a practice that did actually seek professional advice and ended up starting with a non-compliant payroll tax structure probably has some legal recourse against those advisors.
That’s not all of how we got here of course.
Team-based care has been an important and emerging theme in primary care for the last two decades.
If you’re going to keep pushing team-based care, you’re also likely to add constructs to the original concept of a services entity that will cause it to “drift” off point as well.
This has happened.
But it has happened on the watch of a lot of professional advisors who did not contemplate the payroll tax problem and let it happen to their clients.
Team care and “how GPs have to work to optimise the care of their patients” has been used as an one of the key excuses by the colleges and the AMA to argue to government that they must drop payroll tax.
It’s not just for the doctors, it’s for the patients and the betterment of the whole healthcare system, the argument goes.
As noble an argument as it might seem to those making it, it’s an entirely impractical one. I’ll explain more below.
If you got in a helicopter and went high enough above the whole payroll tax debacle, high enough to look back and see the whole history of how it has evolved, you might see something like this.
When service entities were originally introduced to GP practices many years ago they were a completely logical and perfectly sensible business structure to adopt (they still are if you do them correctly – see further on).
Back then, without all the subsequent tack-ons developed to optimise the business models of some of the big corporates, most of these structures were largely payroll tax-compliant.
Back then, a practice owner was paying for something for a completely different reason to payroll tax and they got it.
Let’s call what they got a standard healthy black horse.
Then some bigger corporate practices decided to paint on some white stripes to optimise their business models: restraints of trade, centralised payments, training on how they consult, schemes for care plans with targets, consult targets, and so on.
Everyone else including the professional advisors started noticing and admiring all the zebras wandering around so started painting some stripes on their own horses.
Finally, we got to the point where people started practices, often with professional advice, with the zebra as their main model.
Today we look a little like the African savannah in the late 1800s: herds of (fake) zebras wandering the plains with a few big white hunters (payroll tax offices) picking off the undefended ones but with designs of coming back with gatling guns and taking out whole herds at a time.
It’s a macabre scene.
What’s most macabre about it is probably that it’s not those big white hunters who are the bad guys here.
It’s the colleges, the AMA and all those advisors, who even today are often giving the wrong and confusing advice to the GP owners community.
On Wednesday night a big accounting firm, William Buck, ran a webinar which is one of many examples of this problem – it’s just one of many communications made by so called professional groups ,college or AMA based communications included, that are confusing the community, giving ill-informed advice and terrifying a lot of GPs and owners.
The webinar missed the mark in two very important ways:
- The professionals treated the payroll tax office rulings as law and told everyone that the situation was officially in stone – and that unless governments could be convinced to drop the tax we had an insoluble problem.
- The RACGP, as it has since the start of this issue, told the audience that it was taking the fight to the politicians to get the tax abolished for doctors, so hold on to that hope.
A payroll tax ruling is not law.
Every practice is different in how they are set up, and technically, if the state revenue offices want to audit every practice and assess them as owing payroll tax according to their ruling then every practice can object to that assessment and fight it.
What is bizarre here is that behind the scenes these challenges are happening and practices are winning, but for some reason the idea that the state revenue offices aren’t right in every case, ruling or not, is not being publicly aired.
Practices that believe they are set up the right way, or have gone to the considerable trouble of reassessing their setup in the light of its original purpose (liability, succession and business exit value) and washed off the white stripes someone painted on because they are not in line with the original purpose, are in many instances beating the state revenue offices.
We aren’t hearing about these cases because the state revenue offices do not want to take them to court and face a potential loss in public.
They simply give in if they see this risk and move on.
Such a case would have the opposite effect of an Optical Superstore or a Thomas & Naaz on the GP community and not help the current payroll tax office campaigns. Both these cases involved businesses that were set up the wrong way, got the wrong legal advice and tried to fight the state revenue offices, and lost.
Such precedent cases are ideal for the state revenue offices.
But in each case the situation was different. State revenue offices have declared it’s about the sum of the whole setup.
The point here is that state revenue offices are not succeeding in every case and when they don’t they just walk away.
By coming out and saying to GPs and owners that the rulings that we are now seeing are somehow the law and that we have to just accept the situation, these professionals are advising GPs and owners that they have no room to move.
You either give in and take an amnesty or pray that the RACGP and AMA can convince every state government to drop payroll tax – just for doctors.
This is playing straight into the hands of the payroll tax offices. If they think they’ve scared the zebras enough they will start escalating exploratory audits and the issuing of back liabilities.
But that is how the colleges, the AMA and now strangely some professional advisors are painting this problem to the owners and GPs.
Amnesties are not friendly reprieves and they are not state governments giving in to the demands of the colleges and AMA. They are a way of state revenue offices getting a much better look at the possible size of the prize for state governments.
Why do you think only Queensland and SA offered amnesties? It’s probably because they did not understand the nature and size of the problem as NSW and Victoria already do, and which notably have not offered amnesties (not yet at least).
The colleges and the AMA are being extraordinarily naive here.
On several occasions during the development of the payroll tax position in Queensland and NSW the AMA came out and said openly that they thought most of their practices were not compliant.
What a thing to say.
How would the AMA and colleges even know how many practices are not compliant? Even if it were true or you suspected it, why would you broadcast it to state revenue officials?
By all the grandstanding the colleges and the AMA have done on this issue, they have without question stoked this fire way beyond the dreams of even the smartest senior executive in a state revenue office.
When it all started most payroll tax offices had no clue how big a catch they might be up for. Then the AMA and the college came out and suggested to them it’s nearly everyone. The logic, I guess, was that if they suggested the problem was that big then perhaps the tax officials would take pity on them because they are doctors and it will affect all patients.
Again, naïve.
By the way, how would it actually look to the public if they ever did succeed in getting payroll tax dropped just for doctors (which they won’t)?
GPs would be up there with the CEO of the Commonwealth Bank in terms of public perception by the time social media finished with them. That’s a bit naïve too.
One thing that should have been emphasised above all other things in the webinar is that every single practice that is running a services entity model is going to be a different case for the payroll tax office and that technically every practice can object to adverse findings and fight them.
It’s not likely that every practice would object. But if enough did, that would grind the whole campaign by the state revenue offices to a pretty quick halt. And buy some time for more practices to start washing away the zebra stripes.
This is a much better strategy than coming out and saying we think we’re all guilty (when no one has any clue if that is true or not), but we’re doctors and so you have to drop the tax.
The other big reason why the colleges, the AMA and some advisors are misleading everyone here is that at no point have they come out and explain the possibly much bigger problem that a practice would likely have if they did choose to give in and take an amnesty.
Let’s say you’ve haven’t been watching carefully and you are one of those practices running a zebra model for say seven years now.
So you think, “Oh cool, an amnesty, I’ll own up so I don’t have to pay any back tax, cop it on the chin and move to the employee model, and like my friendly RACGP representative is telling me, put my fees up by $15 per consult to cover it, which hopefully the RACGP will be able to use to leverage the government to make this whole thing go away one day.”
That almost certainly will not work, and its extraordinary that it has not been explained to practices why not.
If this practice does this, sure it will avoid a possible audit and back assessment on payroll tax (remember though, the state revenue offices have very limited resources so they may not get to you for years, if ever). But then every supposed tenant doctor that it has had on its books for seven years suddenly has a huge problem with their personal income tax because they have been operating as a sole trader for the last seven years, paying at the wrong tax rate and putting in what are now false business deductions.
It will be fascinating to see what happens if this sort of scenario does unfold.
Federal Health Minister Mark Butler is quoted in Nine newspapers yesterday saying that payroll tax is an important issue but not one he can do anything about. He said he feared that the “record $6.1 billion investment in strengthening Medicare could be impacted by new payroll tax obligations being imposed by state governments on general practice at the same time … Payroll tax is ultimately a matter for the states to manage, and I encourage them to consider the feedback from GPs.”
That’s him declaring he doesn’t like payroll tax for GPs, but he isn’t coming to the rescue.
If practices start switching en masse to an employee model, then he will have to be negotiating with his sister department the ATO to forgive all these tenant doctors their years of back tax owing.
Meanwhile, you can imagine that the tenant doctors who did nothing wrong and now have a massive income tax liability hanging over their heads will not be too happy with their practices.
Some will also realise that they are owed a lot of superannuation and other entitlements that they were never paid to them as a tenant.
Some will almost certain sue their practices.
What a mess.
Why then is this problem not being discussed by the colleges and the AMA?
If you have gotten this far in this article, well done, and here’s the whole point.
If you are running a services entity, and you suspect you have a few too many of those zebra stripes on your horse, and what to do about it, you only have one thing you can do.
Fix it.
Fixing it will look very different for every practice.
We know that today a lot of practices have it fixed already.
We know this because some have been audited, assessed for a large sum of back payroll tax, objected and won their objection (take my word for it or ask around, it’s happening). The state revenue offices walked away realising they didn’t want to set any public precedents other GP practices would see and act on.
Some practices have spent the last two years or so fixing the problem and they are now watching it vigilantly with their advisors adjusting as they go.
Fixing the problem, by the way, is not tax avoidance in most cases.
But nothing is perfect. If you have been running with zebra stripes for many years, washing them off now won’t necessarily get you out of a backwards audit. A state revenue office can still demand data going backwards and make an assessment that you did the wrong thing.
On your side, however, is that they can’t audit everyone in one go and it might take a long time for them to get to you. Also, you do not know what your actual exposure is until you get the right advice.
Warning: some professional advisors are still not giving the right advice.
There is no easy fix here. You have to choose the least worst path. You have to look at the most practical fix given the circumstance you now find yourself in.
In most cases taking an amnesty and switching to an employee model is the worst path to choose. Not only will you acquire ATO tax issues for all your doctors, you will expose your business to ongoing liability issues and reduce the value of the business.
The path of sitting back hoping things will sort themselves out – perhaps by the colleges and AMA convincing governments to drop a longstanding tax law that affects most businesses – isn’t a very good one either I’d say.
The only path for most practices that aren’t already addressing any historical issues created in their services entity structure is to start taking the issue seriously, find the right set of advisors and start fixing up any part of your services entity structure which is wrong.
The tax office can’t kill you for fixing errors on a structure that at its heart is not actually about tax.
