ATO increases scrutiny on medical professionals

Kristy Baxter

Director, Pilot Partners Chartered Accountants

In March 2021 the Australian Taxation Office (“ATO”) released long awaited draft guidance for professionals, including those in the medical field.  Unfortunately, the revised draft guidance is likely to increase scrutiny on medical professionals compared to previously published guidance from the ATO. 

The draft guidelines outline how the ATO intends to determine whether an individual professional practitioner (“IPP”) is declaring an appropriate amount of business profits in their personal tax return relative to the value of the services they personally provide to their business.

The new guidance differs from previously published guidance by referring to the income from the whole of firm group.

This includes income from service entities and other businesses associated with the medical practice, to which the practitioner and their associated entities (including their spouse) are entitled to receive. As it is common for medical practitioners to have a service entity in their group, you need to be aware of how the ATO will apply the new guidance to your circumstances.

While there have been no changes to Australia’s tax laws in relation to the sharing of business profits, the ATO are continuing their approach of issuing non-binding administrative statements in order to encourage medical professionals to pay ‘their fair share of tax’ or risk being audited.

Overview of guidance

The guidance explains the ATO’s risk-based compliance approach and metrics to determine whether an arrangement would be considered low, medium or high risk.

Where arrangements are not low risk or there is a lack of apparent commercial rationale, the ATO is likely to take a closer look at the arrangement and consider whether the anti-avoidance provisions apply. There are strict criteria as to whether the guidance is applicable to an individual or practice, however it is intended to apply to most professional businesses, including medical practices. Importantly, if your business exhibits high-risk features, the ATO will automatically consider the business to be high-risk without applying the scorecard below.

Where the business is not considered to be high-risk and the guidance is applicable, the following risk assessment scoring table will be used to determine your risk level:

Risk Assessment Factor

Score

       

 

1

 2  3  4  5

(1) Proportion of profit entitlement from the whole of firm group returned in the hands of the IPP

>90%

 >75% <=90%  >60% <=75%  >50% <=60%  >25% <=50%

(2) Total effective tax rate for income received from the firm by the IPP and associated entities

>40%

 >35% <=40%  >30% <=35%  >25% <=30%  >20% <=25%

(3) Remuneration returned in the hands of the IPP as a percentage of the commercial benchmark for the services provided to the firm.

>200%

 >150% <=200%  >100% <=150%  >90% <= 100%  >70% <=90%

Source: ATO Draft Practical Compliance Guideline PCG 2021/D2. 

RISK ZONE

RISK LEVEL

 AGGREGATE SCORE AGAINST FIRST TWO FACTORS  AGGREGATE SCORE AGAINST ALL THREE FACTORS

GREEN

LOW RISK

 <=7 <=10 

AMBER

MODERATE RISK

 8  11 & 12

RED

HIGH RISK

 >=9 >=13

Source: ATO Draft Practical Compliance Guideline PCG 2021/D2.

Where it is impractical to accurately determine an appropriate commercial remuneration against which to benchmark, the first two risk assessment factors may be used.

On the surface, most medical practitioners will be low risk, as they derive personal exertion income. This means that the practitioner should already be declaring income from patients in their own tax return regardless of whether the business for earning patient income is structured as a sole trader, company or trust.

Due to the patient income being declared in their personal tax return, the medical practitioner will be paying tax at the top marginal rate.

However, the risk assessment can increase when service entity income is included, along with income from any other businesses associated with the medical practice, as this income is often not declared in the practitioner’s name and may be directed to another associated entity including their spouse.

ATO Treatment

Depending on your risk zone, you can expect the following treatment by the ATO:

RISK ZONE

ATO TREATMENT

GREEN

We will only apply compliance resources to review your allocation of profit in exceptional circumstances, such as where:

  • we are not satisfied your self-assessment is correct, or is adequately supported with evidence
  • we become concerned that higher-risk features are present in your arrangement
  • we become concerned, from our own data and analysis, that there is a change in your arrangement causing a shift towards the border of compliance
  • we become concerned that your broader arrangements present a compliance risk (for example, with Division 7A of Part III of the ITAA 1936)
  • your arrangement relates to a broader set of circumstances being reviewed by us
  • changes to your arrangement may not have been appropriately treated or disclosed.
Where there has been no material change, then we will generally only apply compliance resources to the arrangement to:
  • confirm your calculations were done according to this Guideline
  • confirm the absence of any exclusionary factors (for example, the high-risk features under Gateway 2)
  • provide binding advice where you request it.

AMBER

We are likely to conduct further analysis on your arrangement.
We may contact you to understand the arrangement and resolve any areas of difference.

RED

Reviews are likely to be commenced as a matter of priority.
Cases may proceed directly to audit.

We are likely to use formal powers for information gathering.

Source: ATO Draft Practical Compliance Guideline PCG 2021/D2.

As there have not been any changes to the law, this scrutiny will have an overlay of existing laws such as the general anti-avoidance rules, trust reimbursement arrangements (Section 100A), private company benefit and loan provisions (Division 7A) and other integrity provisions (such as the guidelines to calculate service fees). Once finalised, the guidance is expected to apply prospectively from 1 July 2021 with a review being conducted during 2022.

Example

George is a gastroenterologist and has earned taxable income of $400,000 during the year from seeing patients. He is a sole trader and this income appears in the business schedule of his tax return. George also has a service trust in his group.

The service trust has net income of $80,000 for the year, which has been distributed to George’s wife, Jane. George and Jane have no other income and no other deductions.

The whole of firm income is $480,000. George’s proportion of profit entitlement is 83% (being $400,000/$480,000).

Therefore, under risk assessment factor 1, the group score is 2. George pays tax (excluding Medicare levy) of $150,667 on his taxable income of $400,000. Jane pays tax of $16,467 (excluding Medicare levy) on her taxable income of $80,000.

The total tax paid for the year is $167,134 on the total income of $480,000, which is an effective tax rate of 35%. This gives the group a score of 3 under risk assessment factor 2. The total risk score is 5, which places George’s group in the green risk zone ie. low risk level.

What should I do now?

This draft guidance highlights the importance of ensuring you obtain professional advice prior to restructuring or joining a medical practice. Medical practitioners also need to consider how they calculate service fees for related parties and the distribution of profits from a service entity.

Should you wish to discuss your group’s circumstances to understand how the new guidance applies to you, please contact Kristy Baxter or Angela Stavropoulos from Pilot’s medical services division on (07) 3023 1300 or taxmed@pilotpartners.com.au.


The information in this article is intended only to provide a general overview and has not been prepared with a view to any particular situation or set of circumstances. Any views expressed in this article are opinions of the author at the time of writing and do not constitute a recommendation to act. This article is not intended to be comprehensive nor does it constitute legal, financial or tax advice. While we attempt to ensure the information is current and accurate we do not guarantee its currency and accuracy. You should seek legal or other professional advice before acting or relying on any of the information in this blog as it may not be appropriate for your individual circumstance.


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