Choosing the optimal business structure for a medical or dental practice is of vital importance. On this page are some brief notes regarding the issues to consider when setting up a business structure and the most common arrangements used. As each situation is different, it is not intended that this discussion be relied upon to choose the form of business structure. It is very important to get good advice regarding your own circumstances.
The following issues should be considered:
The most common business structures together with their advantages and disadvantages are as follows:
A sole trader is an individual trading in the individual’s name. The main advantage is that it is simple and low cost to set up and run. However, trading in your own name means you have no protection of personal assets and it is not appropriate for trading in concert with other practitioners. It may be appropriate for a practitioner who is working in a practice as a non-owner associate, where a fee equal to a proportion of billings generated is paid to the host practice as a service fee.
A partnership of individuals presents similar disadvantages to practising as a sole trader, with the added problem of each partner liable for the actions of other partners. This is known as joint and several liability. A partnership is also not a separate legal entity and so it lacks legal robustness. The partnership structure is to be used, there would be more protection if the partners were not individuals and were companies or trusts instead.
The ownership of a company is determined by the holders of its shares. A company is managed by its directors. It is a robust legal structure with limited liability. It is also an entity which pays tax on its income. The tax rate is currently 30%, though it is proposed to reduce the rate to 28.5% for small businesses with an annual turnover of less than $2 million.
One of the main disadvantages of using a company structure to run a practice are special rules which deem withdrawals from a company to be dividends (Division 7A of the Tax Act). This means that tax breaks are effectively trapped within a company and become taxable as soon as a withdrawal is made. For example, a qualifying practice might save a significant amount of tax by purchasing business assets for less than $20,000 per item, which are eligible for an immediate tax write off. However, if the shareholders then withdraw cash from the company equivalent to the tax saved, tax will be payable on the withdrawal. Tax breaks received by a company therefore only provide a temporary advantage. As soon as shareholders wish to take advantage of the tax breaks personally, the value of the tax break is effectively handed back to the ATO.
The idea of a trust has been described as a ‘nebulous concept’. In simple terms, a trust describes a relationship between a person who holds property (Trustee) for the benefit of another person or persons (beneficiaries). The rules of the trust are usually set out in a written trust deed.
When using a trust for a professional practice, it is usual to set up a company to act as trustee. Using a company to act as trustee provides the trust structure the legal advantages of a company acting on its own. However, it can be a much more flexible structure and overcomes the disadvantages of companies. Provided a trust distributes its income to beneficiaries, the trust does not pay tax. Any tax is born by the recipient of the distribution. Also, Division 7A does not apply to trusts (unless there is a company beneficiary), which means the benefit of any tax breaks applicable to the practice can flow through to beneficiaries.
The distribution of income to beneficiaries by a trust is determined by the rules set out in the trust deed. The deed can provide flexibility to distribute income to a range of beneficiaries (usually called a family trust or discretionary trust), or the distributions can be fixed (a fixed trust or unit trust). This flexibility is a major advantage of using a trust based structure.