Personal Service Income and Medical Practitioners 

Setting up a new medical practice is an exciting venture, but it’s important for healthcare professionals to address a range of tax questions before opening for business. The tax implications of Personal Services Income (PSI) and service entity arrangements can significantly impact medical professionals in establishing their own practice. By addressing these areas correctly from the outset, healthcare professionals can save time, money, and energy in the long run.

PSI refers to income generated primarily from an individual’s personal services or efforts, which applies to almost any industry or profession, including health professionals who provide medical assessments and advice to patients. PSI rules dictate how a business distributes its income among shareholders or beneficiaries and how the business claims deductions. 

For health professionals, if PSI rules apply, the income they generate is treated similarly to sole traders tax-wise, regardless of the business structure in place. However, if the income is solely from the efforts of the individual health professional, then the PSI rules may require that the income is passed out directly to them personally, limiting the ability to spread wealth and reducing tax planning opportunities.

To determine whether the PSI rules apply, taxpayers need to follow the ATO’s guidelines, which include four steps. If the income is mainly from personal services or efforts, taxpayers move on to the second step, which is the results test. If the taxpayer passes the results test, they move on to the 80% rule, which applies when more than 80% of a taxpayer’s PSI comes from one client. Other tests, such as the Unrelated Clients Test, Employment Test, and Business Premises Test, must also be considered.

Service entity arrangements involve a group of health professionals setting up a medical practice, where an entity such as a trust or company provides services back to the medical professionals or practice, enabling them to focus on providing professional services to their clients. A service entity typically provides administrative and clerical services, such as staff hire, recruitment, premises rental, plant and equipment costs, and various business and overhead expenses. This entity may also own the building where the practice operates and collect rent from the operating (patient-facing) entity.

A significant benefit of a service entity is that any profits earned by an entity can be distributed legally and tax-effectively to family members or associates of the health professional instead of the health professional themselves. However, it’s crucial to adhere to relevant tax law and follow the rules to maximise tax planning opportunities. The ATO acknowledges service entity arrangements as legitimate, and they can be highly beneficial, provided they are set up correctly.

Regardless of whether the PSI rules apply,PSI amounts must be reported at relevant labels on tax returns. Clients should also be mindful that the ATO may seek to apply Part IVA where there are factors indicating that the dominant purpose of the arrangement is to obtain a tax benefit by diverting alienating or splitting an individual’s PSI or retaining profits in the lower taxed PSB.