Take the scalpel to your tax bill with these tips from the experts
Doctors tend to be more fixated on taxation than other professionals. Sure, a lot of money can flow into the coffers but, because this often attracts the top marginal tax rate, a sizeable chunk flows right back out again.
This dynamic can sneak up on the unwary: spending decisions based on gross earnings can lead to financial over-commitment once the BAS (business activity statement) arrives.
But doctors have another disadvantage: those operating their own businesses are not entitled to the 30% company tax rate on any “personal services” income they generate.
Doctors must therefore think outside the box to take advantage of the tax-friendly options at their disposal, such as trust structures and self-managed super funds, say experts.
Here are some of the available options:
Superannuation is the most tax-effective vehicle available to doctors regardless of their employment arrangements, as all doctors are able to contribute money into superannuation pre-tax to reduce their tax liability.
This is known as salary sacrificing, whereby pre-tax income is used to make a contribution to a superannuation fund attracting a 15% tax rate as opposed to the doctor’s marginal tax rate of up to 46.5%. From July 1, those earning over $300 000 will be taxed at 30% for these contributions. Tax experts, however, point to other tax-effective strategies relating to super.
Mr James Gerrard of PSK Financial Services says doctors who are over age 60 could consider commencing a transition to retirement (TTR) pension using the money in their super fund.
Under the TTR pension you can draw up to 10% of your super account each year while still working. For those over the age of 60, super withdrawals are tax-free, so doctors can withdraw from their super account while also salary sacrificing part of their employment income into super and paying only 15% tax on that amount (or 30% for people earning over $300 000).
Another potentially tax-effective move is to utilise your super as a deposit to obtain a loan which allows you to purchase property inside your super fund, Mr Gerrard says. The doctor can salary sacrifice into super (again, attracting a lower tax rate) and then use that money to repay the loan used to purchase the property.
“In simple terms, 85c in the dollar would be used to repay the loan in super, opposed to as little as 53.5c in the dollar if the property was purchased personally, if the doctor was on the 46.5% tax rate. Therefore, an investment loan can be paid off a lot quicker inside of super”, he says.
According to Mr John Fara of Fiducia Advisors, those who own their surgery can actually transfer the ownership of that property into their super fund. This can be arranged without paying stamp duty and with minimal capital gains tax.
Once it’s in super, it’s taxed concessionally so any rent paid into the super fund is taxed at only 15c in the dollar for most doctors.
“The beauty of that strategy is that when the doctor retires and converts the super fund to pension phase, the income generated from that property will be tax-free. Further, the capital gain he makes on the eventual sale of the property will be ignored”, Mr Fara says.
Although the government has plans to reform the way trusts are taxed, these business structures have been around for years and remain a legitimate and tax-effective strategy, says Mr Paul Cooke, a Canberra-based financial planner with Centric Wealth.
“We think that provided they meet accounting guidelines, trusts are appropriate in some instances for doctors”, he says.
Service trusts provide doctors with a practice structure that allows for some appropriate income distribution to family members on lower marginal tax rates. A partner who takes care of a doctor’s diary and deals with some administration in the office, for instance, can be paid a moderate salary via this structure.
This structure suits doctors with rooms and employees. The trust is also allowed a “make-up” profit of 10%, which can be distributed to family members. However, consider your motives when establishing this sort of structure, to ensure you don’t fall foul of the Australian Taxation Office.
Another type of trust that can provide tax efficiencies is an investment trust, Mr Cooke says. It can be set up so doctors don’t have to buy their assets in their own name, and can distribute income and capital to beneficiaries such as family members on a low or no income. This means less capital gains tax if the assets are sold before the doctor stops working.
“Super funds are the most tax-effective investment vehicle you can get, but the next best is an investment trust, and it’s a more flexible arrangement”, he says.
According to Mr Gerrard, an option for doctors who operate through a trust, and who have multiple income sources, is to have a beneficiary that is a company.
This company has the sole purpose of “holding” income generated from the doctor’s business (excluding personal services income earned specifically by the doctor). Because it’s a company, it would be taxed at 30% as opposed to up to 46.5% if received by the doctor personally, he says.
Other income sources could include service trust income or other income-generating services offered by the practice such as physiotherapy or specialist nurse services, according to Mr Fara.
“Practices are moving away from traditional models, and income from complementary services within the surgery should be tracked separately to make sure they’re treated correctly for tax purposes”, Mr Fara says.
Because of doctors’ large tax obligations, they are prone to seek out investments that offer short-term tax advantage at the expense of their long-term investment interests, tax experts say.
However, Mr Cooke says the GFC (global financial crisis) has curtailed this urge, and brought people back to focusing on good, long-term assets.
Although negative gearing makes sense in terms of tax effectiveness (and the higher your marginal tax rate, the more benefit you can reap from it), you do need capital growth to make it pay off.
“Since the GFC, we haven’t seen that capital growth so negative gearing into property and shares hasn’t really worked the way it has in the past and lots [of people] have lost confidence in it”, he says.
“It does also have an upfront cash-flow impact so you have to be more careful about selecting an asset before you move into negative gearing.”
Highland Financial’s Chris Wren says investors are nervous about the markets because of the uncertainties in Europe.
“Investors tend to move away from the share market and property market, generally speaking, in volatile times”, he notes.
He says in this climate, the investment focus should be on more conservative, income-generating assets, such as term deposits and fixed-interest options.
However, he notes that it’s best to check the tax implications with your accountant before implementing new investment strategies that require borrowing or gearing.
“Everyone is different and advice should be given on an individual basis, based on personal circumstances, but make sure you talk to those who understand this environment: those who use structures such as super and trusts themselves.”
Avoidance versus minimisation
Legal question marks hang over some tax-minimisation strategies because although they are technically legal, they may be deemed to fall outside the spirit of the legislation and be classed as tax avoidance. So how do you know on which side of the line a potential investment or business strategy sits?
Mr Jarrod Bramble of Cutcher & Neale accounting firm says Part IVA of the Income Tax Assessment Act has a three-point test to help taxpayers determine this: 1. Is there a scheme? 2. Was a tax benefit obtained? 3. Would it be concluded that there was a sole or dominant purpose of obtaining a tax benefit?
“If you’re only going into elaborate schemes to achieve a tax benefit, you’re going to fall foul of the anti-avoidance provision”, he says.
He gives the following two examples:
If a GP who employed one other GP adopted a service trust structure in order to gain a tax benefit, that would be deemed tax avoidance. If the dominant reason that doctor adopted the structure was to attract other GPs to the practice, it would not.
If a doctor moved an asset into the family trust to gain a tax benefit, that would be deemed tax avoidance. If the doctor moved the asset into the family trust to protect that asset in the case of being sued, it would not.
Ultimately, it is up to the taxpayer to ensure their tax strategies are legal.
Investment red flags
Doctors are understandably attracted to investments that offer a tax advantage. Schemes spruiking such benefits, however, should be approached with caution. According to financial advisers, look out for the following warning signs:
• schemes that are promoted on the basis of tax minimisation
• investments with high upfront fees
• vague explanations of how it all works or overly complex transactions on something you know is simple
• when only one firm or tax practitioner appears to have the insight into the legislation (you may find yourself becoming the test case when the Australian Taxation Office (ATO) challenges it)
• schemes that involve borrowing large amounts of money; borrowing money magnifies both positive and negative investment returns
• schemes that involve exotic offshore accounts. The ATO has severe penalties for tax avoidance and targets overseas schemes
• schemes related to agribusiness (trees, nuts, etc)
• schemes offered by companies that don’t hold an Australian Financial Services Licence
• “capital-guaranteed” investments (check the fine print for hidden costs and high exit fees)
• companies promoting the purchase of property through your super. Become familiar with the terms “business real property” and “sole purpose test” before going down this path
Check websites like https://www.moneysmart.gov.au/scams to get the current listing of scams and ways to identify them.