Myth – Company Structure & Medical Practitioners’ Personal Service Income (PSI)
A frequently asked question from medical practitioners, “I would like to use a company structure and quarantine a portion of my income in the company to minimise my tax” or “my friend is using a company to minimise the tax”.
Before that, we need to understand that patient fees generated by medical practitioners are a personal service income (PSI) (TR 2001/7 ATO Link).
In layman’s terms, PSI is income that is mainly a reward for an individual’s personal efforts or skills. There are special tax rules around PSI to improve the integrity and equity of tax system. They prevent taxpayers from reducing or deferring their income tax by diverting income they’re received from their personal services through companies, partnerships and trust.
ATO IT 2503 (ATO Link) further emphasises that medical practitioners using a company structure must pay out all PSI to the practitioner. Therefore, practitioners must never quarantine or leave their PSI in the company.
ATO IT 2639 paragraph 8 explains what income is a business income.
Extracted from ATO IT 2639 (ATO Link)
8. Whether a taxpayer derives income from rendering personal services is a question of fact and degree to be determined in the circumstances of each case. The crucial issue is the extent of the connection between the income concerned and the services rendered by the particular taxpayer involved. The following factors need to be considered in determining whether a taxpayer derives income from personal services, though no one factor is determinative.
a. The nature of the taxpayer’s activities
The activities of salary and wage earners and professionals practising on their own account clearly generate personal services income. Radiologists or pathologists who operate on their own account, however, often employ many technical staff and operate an array of technical equipment. Their income is generated from the business structure rather than from their rendering of personal services. The activities of consultants, salespersons, journalists, life insurance agents and tradespersons are also likely to give rise to income from personal services. These examples are far from being exhaustive.
b. The extent to which the income depends upon the taxpayer’s own skill and judgment
The more the income producing activities involve the exercise of the taxpayer’s own skill and judgment the more probable it is that the income will be derived from personal services rather than from the business structure.
c. The extent of the income producing assets used to derive the income
The more substantial the income producing assets employed within a practice the more likely it is that the income of the practice will be derived from the business structure rather than from the rendering of personal services. For example, the array of equipment used by radiologists and pathologists may often suggest that their income is being derived from the business structure. However, minor equipment such as the drawing board of an architect or the heart monitor/blood pressure machine of a medical practitioner would not suffice to change what would otherwise be personal service income into income from the business structure. The expression “income producing assets” is used in this context to include any investment of the practice in tangible business assets such as premises, fixtures and fittings, plant, equipment and industrial or intellectual property (whether owned or leased). However, the significance of these assets would have to be weighed against their relevance to the derivation of income – given the other factors mentioned in this paragraph.
d. The number of employees and others engaged
The more substantial the number of employees, practitioners or technicians used in a practice the more probable it is that the income is derived from the business structure rather than from the rendering of personal services (see Henderson v. F.C. of T. 70 ATC 4016; (1970) 1 ATR 596). For example, large accounting and legal firms with tens, or even hundreds, of practitioners but without extensive or substantial equipment would also be considered to be generating their income from their business structure.
It is frustrating that we are seeing some accountants’ incorrect treatment of PSI in the company or intentionally!
If the ATO conducted an audit, the taxpayer would face the tax-avoidance penalty (Part IVA) ATO Link and lengthy questions. Penalties will be imposed, i.e., back paying tax otherwise would be taxed in the taxpayer’s personal name, general interest charge (ATO Link), shortfall interest charge (ATO Link) and minimum 25% failure to take reasonable care penalty (ATO Link) to say the least.
The burden of proof is always on the taxpayer. Ignorance is not an excuse.
Your accountant will not be let off the hook. The ATO will question whether there is a systematic problem in your accountant’s client base.
Can you recover damages against your accountant? Yes, you can. Should you claim damages against your accountants? Over to you. That’s your call.
