About Brendan Campbell

Brendan has over a decade of accounting and taxation experience managing a variety of clients from varied industries.

He is an Associate Director in Prosperity’s Business Services and Taxation group, based in Brisbane. Previously he held the position of Partner at a mid tier accounting firm.

Brendan specialises in advising clients on a broad range of business issues. In particular, he supports his clients’ needs by advising on business strategies, structuring, business advisory, taxation planning and minimisation strategies.

Making debt structuring work for you in your Medical Practice

Debt structuring is something that’s easy to do but often not done well. If it’s done correctly it can add significant advantages for you and your practice.

Given the Medicare freeze, many practices are finding that top line growth isn’t where they’d like it to be this year and in the future, so they’re looking more towards reducing their expenses to increase their profit. Sometimes we need to think outside the box; can increasing an expense increase your overall profits? It can if a side effect is creating a tax deduction, but not reducing your cash flow.

What interest is tax deductible?

Interest can be deductible for a number of reasons; it might be borrowing to buy an investment property, it could be borrowing to buy shares or borrowing for business expenses. For this article we will focus on borrowing in relation to business expenses.

Interest is deductible under Section 8.1 of the Income Tax Assessment Act 1997:

General deductions

(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or
(b) it is necessarily incurred in carrying on a * business for the purpose of gaining or producing your assessable income.

Note: Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income.

As you can see, (b) refers to interest being deductible as it’s necessarily incurred in carrying on a business gaining or producing assessable income. Therefore, if the debt relates to a business loan, then it will be deductible under the second limb of Section 8.1.

For an Associate Doctor, borrowing for their business can be a variety of things; it might be borrowing for staff superannuation, for staff wages, for service fees, or just to pay normal business expenses. If that’s the case, and if they’re genuine expenses for the business, then that interest will be tax deductible.

What is the purpose of borrowing?

This is something that should be asked more regularly, because it’s the purpose of the borrowing that makes the interest tax deductible. If you were to borrow $10,000 to pay some of those business expenses mentioned earlier, then that interest would be tax deductible. It’s important to understand the purpose of the borrowing to make sure you are borrowing for business expenses and that it’s done correctly.

Example

If Dr A is running a business and borrows $10,000 to pay service fees, then the interest on that borrowing would be tax deductible.

Dr B works at the same practice, in a very similar situation. He spends all his money on paying his business expenses, finds he is a little short on funds for that month and borrows $10,000 to top up, which he then transfers out through drawings, or through the trust account, down to his personal funds.

Where Dr A borrowed $10,000 specifically to pay for business expenses, Dr B already paid his business expenses, so when Dr B borrowed his $10,000 it was essentially for private use, because he transferred it to himself for personal purposes. Therefore, Dr B wouldn’t get a tax deduction for his borrowing.

As you can see, they are very similar examples and both of them are in the same situation, but Dr A has structured his debt better and he has borrowed for the right purpose. Neither of these doctors have higher debt than the other, but Dr A has deductible interest, and Dr B unfortunately does not have deductible interest.

How big a difference can debt structuring make in your situation?

It might not sound like much, however it does make a big difference that can build up over time.

Example

Dr A is a contracting doctor, running a business and working at a practice. Dr A borrows $50,000 over the year to pay for his service fees. The borrowing for those service fees would then be for business purposes and therefore the interest would be tax deductible.

The same doctor has a reasonably aggressive strategy in relation to trying to pay down his home loan, so when he gets his income from the practice, he’s paying down as much as he can, through trust drawings (and structuring to get that right is important) to his personal account, to pay off his home loan as quickly as he can. Coincidentally, that might be a similar amount that he’s paid off his home loan ($50,000) and he therefore doesn’t have any higher debt exposure, he just has some debt as tax deductible.

In this situation, his borrowings for a year would be $50,000 (assuming 5% interest). If his home loan is at a similar rate, he’s probably reduced the interest in his home loan by about $2,500 for the year, but he’s also got interest in his business loan of about $2,500. In this situation, the business borrowing is tax deductible, and therefore he is getting a tax deduction on that loan. Now, that might not sound like a lot of money, but if we extrapolate that over five years, all of a sudden the numbers start building up and it works out to be a bit over $18,000 over five years (in this example).

Please note, the above example was fabricated for this article, is very specific and has controlled variables. It is important to make sure the structuring is right, the personal affairs are right and the tax advice is right, not only with the business loan but the personal borrowing as well. Make sure you seek professional advice in relation to this, to make sure you have it done correctly. It can make a significant difference, but you have to make sure you are borrowing for the right purpose and doing it for the right reasons and that it is part of a genuine strategy for your business. Please seek advice when you can regarding this.

What is your practice worth?

There are many variables to look at when valuing a practice and if you are looking to sell you need to start planning earlier than you think. This article discusses the important factors that are considered in a valuation as well as what you can do to improve it before you are ready to sell.

Do GP practices actually have a value in the market independent of a payment for the plant and equipment and the structural aspects of a practice?

There is room for a practice to have a value, however there is a threshold. Often we find a smaller practice may only be a worth a small amount of money if anything at all, while a larger, well-run practice can be worth a significant amount of money.

A very simple way to calculate the value of your practice is if you remove your owner Doctor billings from the Profit and Loss Statement, then consider your billing the same as you would a contractor (say 35% for the practice), would there be anything left? Effectively, are you subsidizing the practice, because if you took 65% as a contracting doctor, there would be nothing left? If that is the case, then it is a good indication that at the moment your practice isn’t really worth anything.

What should we keep in mind when valuing a practice?

The value of a practice is subjective; it’s important to keep in mind that the value is what someone in a free market is willing to pay for it, and what you’re willing to take for it. As the vendor, your value may be higher than the value of buyer. Essentially the value of your practice is somewhere in the middle.

Another thing to consider is if corporates become involved, that metric can change. A trap to be aware of is, if a corporate or large entity comes in, they will often offer big numbers, higher than most GPs would be expecting. However, the devil is in the detail of the contract, so it is important to understand it and talk to a specialist about it. For example, there may be big numbers offered up front, but restraints put on you as part of the contract. This could include requiring you to work in the practice for 5 years, at a contracting rate of 50% instead of 65%, meaning essentially they haven’t bought the business per se and have tied you up generating profit for them at the same time. While there may be some big money out there, it may not always be the best option and it is always best to talk to someone who can break it down for you, so you understand the long term effect.

What is a common approach to valuations?

There are a number of different valuation methods, but to keep it simple from a GP perspective, the business cap rate (also known as an EBIT multiple) is the most common. This method is where you work out the future maintainable earnings by looking at the adjusted profit for the last number of years, then apply this multiple by that number to work out what it’s worth. That is, how many years’ genuine profits or regular profits would you be willing to pay to take over the practice? Is that 1 years’ worth of Profit or 5 years’ worth of Profit?

Profitability: what are the principals involved in working out the adjusted profit of a practice?

I would recommend looking at your profit and loss over a number of years, say 3 as a benchmark. From that profit, add back any non-genuine wages you or your family have drawn and any expenses for you personally (eg motor vehicles, superannuation, etc). Likewise, take out any fringe benefits tax reimbursements you have contributed. Once you have this core business figure, apply the contracting rate for any owner Doctors (say 65%) to the owner Doctor billings, and this profit is the adjusted profit for the year.

In addition, you might also want to add back any abnormal expenditure over the 3 year period (eg large pieces of equipment or any other expenses you don’t consider “regular”). This will “annualise” a true profit of the business over the 3 years. You then also need to “weight” each of the years. This means that you will not look at the profit made each individual year, or the average of the profit over the 3 years, rather you would consider which years were more “regular” income years and give them a higher weighting than any years which were less “regular”. This gives you the weighted average EBIT.

How does a valuer work out what multiple to use in arriving at a valuation?

This is the harder bit; it’s not something you can just come up with or guess at. As a rough guide, a multiple of 1 to 5 years profit, however it depends on a number of factors. You should speak with someone who knows the medical industry and will also get to know your practice well. Once you have a rate, you will effectively multiply it by the weighted average profit figure.

There are a number of industry factors to consider in working out the multiple, for example:

  • Changes in Government policy will not only affect the industry, but your practice specifically;
  • Changes in healthcare, for example changes to the way public hospitals are run. If it were to become an option for patients to visit their public hospital as opposed to a GP clinic, that would affect your profit;
  • External environmental factors, for example practice location. Practices on busy roads are easily accessible, ample car parking and proximity to a train station will see a positive impact on the multiple. Practices which are difficult to access, don’t have street frontage or difficult car parking will see a negative effect on the multiple;
  • Demographics, for example areas with young families who are inclined to visit the doctor regularly versus areas with more elderly patients who may be bulk billed this will affect your practice performance;
  • Socioeconomic status, for example affluent areas where patients are happy to pay more to see their doctor, versus low socioeconomic areas which may be traditionally bulk billing areas.

It’s important the process is undertaken thoroughly to get an indication of what your business is worth.

Is that the final number?

This Cap rate approach will help determine the goodwill (or value) of the business, however don’t forget that the value of any plant and equipment should also then be added to this number if a sale does occur.   This could be minimal value or it could be considerable if there was a recent fit out. The value of this equipment should always be considered at market value, not the price it was purchased for.

Is market competition important?

Most definitely. If you’re a small practice and a multi-clinic opens up a couple of streets away, that will affect your value. This may not be fully reflected in the numbers, which is why it’s important for the person making the assessment to understand the business.

What are some of the factors inside the practice that are relevant?

Growth is an important factor to consider; is there any room for growth within the practice? If you’re running a small practice with, for example, four rooms, and they’re at capacity, not much can really be done with the practice as there really isn’t a lot of room to grow.

If someone is coming in to buy that practice, they’re not going to want to pay a higher multiple for the profit of the practice if they can’t really grow it or do much more with it. Whereas if a practice is not at full capacity, has space for more rooms or opening hours, there’s room to expand.

Fit out is also something to consider; is the practice fit out current and modern, or does it need to be updated, which could cost money in the future?

Is the staff and contracting team relevant?

The team is very relevant. A practice who has doctors on contracts who are happy working in the practice, who have regular patients who visit the practice to see them specifically, will be more appealing to someone coming in to buy the practice compared with a practice where the doctors aren’t on contracts and are not tied to the practice. For someone coming in to buy a practice where the doctors aren’t on contracts, they have to consider whether the patients will follow if the doctors leave.

Likewise, with nursing and admin staff; perhaps the practice has a great receptionist who knows all of the patients by name and the reason the patients visit that practice is because they feel at home there. These types of things will affect the value of the practice, and that isn’t something which can be seen in the financials.

Is there anything Prosperity Health can do to help our clients work out where they sit in that spectrum?

A good starting point for practices is to see how they compare to other practices. Prosperity Health run an annual GP Benchmark Report which is a useful tool for practices to gauge where they sit on the spectrum in terms of how they operate, whether their expenses are high and their income low.

The next step is to work out why you want to know what the practice is worth; whether it is for your own peace of mind, or because you want to sell the practice or for some other purpose. There are rules and guidelines that are followed when determining the value of the practice and how much detail goes into it will depend on the reason you want to know your practice’s worth. Valuing a practice is not something that should be done for the sake of it.

How long before wanting to sell your practice, should you start that conversation?

Practices should start the conversation several years out because once they get to the point where they want to sell and are trying to work out what their practice is worth, the first step is looking at the last 3 years. If the last 3 years aren’t great, the practice isn’t going to be worth much. If you start planning 5-7 years away from selling the practice, you have time to implement some changes and improve the practice, and ultimately its value. Again, our GP Benchmark Report is a good place to start to see what changes and improvements can be made.

The positive side of the multiple factor is that if the practice is making more money each year, the multiple will increase, meaning the practice will be worth exponentially more. If the worst case is practices are making more money each year by starting early, then that’s not a bad downside!

 

Recent case highlights the need for diligence when it comes to Service and Facility Arrangements and the interaction with payroll tax for Medical Practices

It’s common place for medical practices to use a Facility Fee arrangement where a Practitioner derives an income and the practice charges them a Facility Fee for the use of the premises, support staff, etc. This is typically excluded from payroll tax. A recent decision in NSW highlights the challenges for practices in getting this approach right and the implications if they get it wrong, or don’t follow the agreement in practise.

Written in conjunction with Prosperity Health BS&T Manager, Moien Khan

A recent and important decision given by the New South Wales Civil and Administrative Appeals Tribunal, in the case of Winday International Pty Ltd vs Chief Commissioner of State Revenue, sought to impose payroll tax on Winday’s service agreement with its practitioners.

We want to share with you the outcomes of this case and what it means for medical and dental practices when it comes to payroll tax obligations.

What is payroll tax and what payments are subject to payroll tax?

Payroll tax is a state imposed tax on wages paid to employees and certain deemed employees if the wages paid by the tax payer exceed a threshold amount which currently is set at $750,000 in NSW and $1,100,000 in Queensland.

What happened in this case?

Quick facts about the Winday International Pty Ltd case:

  1. Winday provided fully operational radiology facilities to radiologists who then provided radiology services to the public.
  2. Each of the radiologists entered into a service agreement with Winday for the use of its facilities.
  3. The practitioners had access to the following provided by Winday:
    1. Place to conduct their services
    2. Specialist plant and equipment required to perform their service
    3. Medical supplies
    4. Staff to assist the practitioner
    5. Administrative staff
  4. Winday collected all the patient fee on behalf of the practitioners and made a net payment to each practitioner after withholding the service fee.

The Tribunal’s decision challenges the agreements from a payroll tax perspective in that the agreement indicated that this was a typical arrangement that would not attract payroll tax, however the Tribunal thought otherwise, and ruled that Winday is incorrect and should be liable for Payroll Tax on its payments to practitioners.  Here are some of the key points that led the tribunal to think the practitioners were actually employees for payroll tax:

  1. Contrary to the agreement, the practitioners were obliged to provide locum cover if they were unable to attend the facility on any day.
  2. Winday ensured that the amount payable to the radiologists would be no less than $2,000 for each day services were provided.
  3. Winday referred to the radiologists as “our staff” on the website they advertised their services.
  4. Winday’s actions and procedures differed from the terms of the agreements.

The Tribunal’s decision has since raised a number of points not usually present in service arrangements in the healthcare space.

What does this mean for medical and dental practices?

It is prudent for practice owners to carefully consider the wording of any contractual arrangements between themselves and their associate practitioners, with all potential tax consequences carefully considered with an accountant and a lawyer. This could help your practice to avoid potential payroll tax consequences down the track.

Further words of caution

If it has been a while since you have reviewed your service agreements, we would recommend that you undertake a review to check that these agreements reflect what they are intended for, and also ensure the clauses in the agreements are being followed in practise. Please note that payroll tax is a state based tax and the specific rules for payroll tax do vary state by state, but are similar.  Also Payroll tax has interaction with income tax, however they are governed by different rules and being assessed as an employee for payroll tax will not necessarily be the same for income tax.

If you are in doubt about whether your processes are compliant or if you change your business model and need assistance to determine how you should deal with payroll tax, please contact a Prosperity Adviser to discuss your circumstances.

 

^Details of the decision in the Winday International Pty Ltd case can be found here.