Current circulation:
6953
DATE: ISSUE NO:
17 March 2006 117
Welcome to Health & Life’s free email newsletter service. Tell a friend that we would be happy to add their email address to the distribution list. This service is to provide Health and Life’s clients and those who attended our presentations with up to date information on key financial and practice management issues that may affect your practice. Please do not use this as a substitute to seeking professional advice. Writer in charge: Mr David Dahm CPA, BA Acc, FTIA, ASIA, FAAPM,GLF.
Business v Medicine - They Do Not Mix Part I - Is your practice company or service trust at risk? The Problem - Service Trusts and Medical Practice Companies Denied Tax Deductions This is Part 1 of a two part series. This first edition explains the concept of a profit and the need to maintain a clearly identifiable profit in your practice in order to avoid scrutiny from the Tax Office.
New Court Ruling! A recent taxation Court case called Ell v. Commissioner of Taxation (10 February 2006) has denied a taxpayers business all their tax deductions because there was “no intention to make a profit” and therefore it could not be seen to be carrying on a business for taxation purposes. The revenue generated would never exceed the expenses and outgoings that the business incurred or paid. The case decided, “it is not for the Commissioner to dictate to a taxpayer in what way a business should be run. A business may be carried on even though it is not profitable or economical (see Tweedle v FCT (1952) 180 CLR 1), provided it is carried on with the purpose of making a profit (see FCT v Stone (2005) ATC 4234 at 4243”. This decision has wide implications for practices that operate their structures on this basis. Our opinion comes in light of the Tax Office’s position on Service Trusts. Some advisers have recommended practices in order for their services entities to be “safe” that practices should not create a profit in their service entities at all. Clearly we would strongly recommend against this approach. This is then admitting your arrangements are a “sham” and will be struck down for this reason alone. To avoid the scrutiny of the tax office your service entity cannot have a “zero” profit margin (or just a “cost sharing arrangement”), a NIL profit or an excessive profit margin. A practice must set a commercially realistic rate, that can be compared to the industry and/or similar practices. In Part II we will explain why and how medical practice companies and service entities such as trusts are significantly affected by this decision. We note in some instances this Court Ruling will override long held Tax Office opinions and rulings.
Background – Profit: is it a dirty word? To understand this issue it is important to understand the nature of making a profit and why it is necessary and dismissing the myths that exist. Is “Profit” a dirty word in medicine? A doctor once said it is like “oil” and “water” - they do not mix. Many practitioners face this moral and ethical dilemma everyday. Making money out of other peoples’ pain and suffering does not sit well with the Hippocratic Oath. In private practice owners are compelled to provide their service at a profit to stay in practice. The nature of caring for the sick without seeking reward is implied and mandated in the moral and ethical behaviour of all health care professionals. The reality is we all have to get paid to put food on the table and it is unrealistic for anyone to expect healthcare providers or practices to operate without generating a fair income for the risks and ultimate responsibility they have undertaken to provide their services. This “fair income” for employees is called a” wage” and for owners of a business/practice is called a “profit”. At the end of the day they mean the same thing. However, the concept of rewarding providers and practice owners are mutually exclusive concepts. Why should your practice make a profit? A practice that does not profit cannot pay off its loans or improve its facilities and systems so it cannot improve patient care. Can you pay off your home loan if your job does not pay you a wage? Therefore practice has to make a profit from its providers. If you pay a 60% of gross receipts the practice has to be able to make a profit out of the 40% that it receives. The practice is worthless = No succession plan Lets face it if your practice can make you money not based on “eat what you kill” or being at the practice by 8:30 am Monday to Friday it is worth something. This is called goodwill that can be sold to other practitioners seeking to join the practice. A practice that does not show it is making a profit is worth nothing. This perpetuates the myth that there is no goodwill in practice. In fact, if this is the case why would anybody invest in a practice? Would you invest in a company that would never make a profit? If a practice does not subscribe to this belief then it is important to remain pragmatic. The public system remains the only real alternative to the private practice model of care. Every private practice must make a profit from day one. A “No Profit” Thinking Breeds a Poverty Mentality and a High Risk Practice To run a practice on a cost or no profit basis is the wrong belief system and leads to an unsustainable business model and dire consequences for the practice from an operational, legal, accounting and taxation point of view. The lowest cost practice in Australia is not necessarily the most efficient, the most profitable or provides the best care. At the end of the day owners take home profits and not expenses. They also pass the “sleep test” they do not compromise patient care in their pursuits. A saving on costs mentality leads to “poverty thinking” that there is always no money left to run the practice. You can only cut costs so far to the bone. Being reminded of ongoing funding shortages harms staff morale and discourages investment in improving patient care and services as there is always no money to left. Practice owners need to think like shareholders. You do not ask how much money the mining company BHP spends and how it should cut costs. Most shareholders ask how much profit does the company make and how it can increase it through increased sales and running more efficiently without compromise. Owners Should Not Apologise for Making a Living A balance needs to be maintained to reward owners of a practice for the risks of running a practice and not excessively pay workers to the extent you are better off being a worker and not an owner in your own practice. There is a real benefit owners do provide to non-owner practitioners for providing the branding, accreditation, infrastructure and systems that are long term risks and therefore, they have a right to be compensated for this.
Owners are usually compensated in two ways! 1. Dividend or Profit Distributions The first way is through practice profits which should not be based on how many patients they see or sessions completed. 2. Selling your Practice is inevitable'..! Secondly, through the sale of practice goodwill. Practices are worth a lot of money. Most do not realise how much. If we are wrong why are the corporates prepared to pay so much money for your practice? They are either mad or they are not telling you something they already know. One day an owner will have to leave his or her practice - it is inevitable. “Walking off the farm empty handed” should not be a default position. The objective for any small business (“practice”) owner is to ultimately sell their business. This is a rationale and reasonable expectation – giving it away is not a plan and is not very smart. After all this is the owners “9% super”. Generally when there is greater than one provider there is practice goodwill that can be sold in addition to plant and equipment. This is how practices need to think and present themselves to potential owners. Most fail to quantify the value of the practice to keep hard nosed accountants and bankers happy. This is more about better accounting procedures than about nobody is prepared to pay for your practice. Not appreciating the value of your practice and not structuring so it is saleable in the first place is a common mistake. Its like selling a car, no matter how good it is on the inside, you are not going to have much luck selling it unless you give it a clean and polish and actually and show it runs. The first key step is to ensure your practice makes a “commercial profit” and it is declared on your financial statements prepared by your accountant. The second key step is to how to fairly share this income with the owners of the practice which is fair and equitable. We have provided guidance on this issue in our past news alert. See our homepage at www.healthandlife.com.au “The Perfect Profit Sharing Arrangement” for some ideas. The Bottom Line There are some good examples of profit margins and what are fair and equitable arrangements. The bottom line is to have one! The benefits of setting a realistic profit margin are: 1. 2. 3. 4. 5. 6.
Avoid scrutiny from the Tax Office by setting commercially sound rates; The practice can afford to invest in the practice and retire debt; The practice is able to recognise and sell goodwill; The practice is financially more attractive to potential owner doctors; Owners are rewarded for the risks of owning the practice regardless of how many patients are seen or sessions performed and; There are legal tax breaks better than any corporate can offer.
Where to from here?
1. 2.
3. 4.
Understand it is not OK to run your practice with a ZERO profit margin; Review your structures to ensure your arrangements such as practice agreements do clearly state in writing that profits are to be generated and goodwill is to be valued based on the profits generated. Visit our website www.healthandlife.com.au Practice Agreements & Structures; When a profit is made, ensure there is a clear agreement how this profit will be distributed to the owners; Seek professional advice if you are in doubt what the correct arrangement should be for your practice.
Which topics would you like to be covered? If there is a particular topic that you would like covered in one of our future News Alerts, please email pa@healthandlife.com.au and let us know what it is. We will then endeavor to cover your requested topic. Do we have your email address? It is apparent feedback we are receiving that there are persons receiving this regular email who are not on our email list. If you are receiving this email ‘second-hand’ from another source, we would be delighted to receive your email address and we will add you to our list so that you can receive it first-hand on the day that it is sent. This invitation is open to all medical practices. Please send your email address to pa@healthandlife.com.au Do you wish to unsubscribe from our list? Please email pa@healthandlife.com.au if you wish to be removed from out distribution list
Copyright Notice This email, including any attachments, is for the personal use of the recipient(s) only. Republication and re-dissemination, including posting to news groups or web pages, is strictly prohibited without the express prior consent of Health & Life Pty Ltd. Disclaimer Notice Health & Life Pty Ltd’s Best Practice News Alert is designed as a comprehensive and up-todate Accounting and Practice Management news service to alert readers to the latest in practice and related developments affecting the medical and dental profession as they happen. It is published when there is news to report. No responsibility can be accepted for those who act on its content without first consulting us or obtaining specific advice.
Health and Life Pty Ltd (formerly acpm.com.au) Accounting & Practice Management Services. “Looking after your future” PO Box 8145 Station Arcade, ADELAIDE SA 5000 Telephone:
(08) 8415 5400
Fax:
(08) 8231 6767
Email:
pa@healthandlife.com.au
Web Site
www.healthandlife.com.au