Healthcare practices under payroll tax microscope

Insights29 Aug 2022

By Jim Koutsokostas, Anthony Bradica and Alison Choy Flannigan

A recent payroll tax decision of the NSW Civil and Administrative Tribunal will further embolden revenue authorities in their payroll tax reviews and audits of medical healthcare practices.

By Jim Koutsokostas and Anthony Bradica

Update - 17 March 2023

Further to our August update, the NSW Court of Appeal has dismissed the taxpayer’s summons seeking leave to appeal the NCAT Appeal Panel decision to the NSW Court of Appeal.

This brings to an end the long-running Thomas & Naaz payroll tax dispute. While this is an unfortunate outcome for the taxpayer, it provides the broader medical and allied healthcare market with greater certainty of their payroll tax obligations.

Medical practice operators with structures similar to that considered in Thomas & Naaz (see below) take note – you now face a significantly heightened risk of revenue authorities applying a strict application of payroll tax rules.

While the Thomas & Naaz case dealt with the provisions of the NSW Payroll Tax Act, those provisions are largely mirrored in most other States and Territories, and it is expected that the Revenue Offices outside NSW will use the Thomas & Naaz ruling to impose payroll tax in comparable arrangements.

Operators are encouraged to review their arrangements with contractors and (in particular, their medical practitioners) and seek professional advice on their current arrangements and potential alternatives.

Update – 29 August 2022

The ongoing saga of the Thomas & Naaz case continues. Earlier this year, the Taxpayer appealed the decision of NCAT to the NCAT Appeal Panel. That appeal was dismissed on 6 July and the original NCAT decision was upheld. The Taxpayer has now lodged a summons seeking leave to appeal the NCAT Appeal Panel’s decision to the NSW Court of Appeal.

If the matter proceeds in the Court of Appeal, this will be the first time a court of law will have considered the technical aspects of the issues in Thomas & Naaz since the Victorian Supreme Court decision in Optical Superstore. The outcome of the appeal will likely have a significant impact in shaping the approach of the revenue authorities in respect of the application of payroll tax to the arrangements of medical and healthcare providers.

We will provide further updates as the case progresses.

Medical and healthcare practices using service entities to engage practitioners and to provide administrative services (such as reception and billing services) are in the crosshairs of the revenue authorities. A recent payroll tax decision of the NSW Civil and Administrative Tribunal (NCAT) will further embolden revenue authorities in their payroll tax reviews and audits of medical healthcare practices.

In September 2020, following the Victorian Optical Superstore decision, we cautioned that revenue authorities would be looking into the payroll tax obligations of service entity/contractor business models.

The recent case of Thomas and Naaz Pty Ltd v Chief Commissioner of State Revenue [2021] NSWCATAD 259 (Thomas & Naaz) confirms our earlier concerns and expands the application of the payroll tax ‘contractor provisions’.

It all starts with Optical Superstore

There was a sense of foreboding once the Optical Superstore case ran its course. In that case, Optical Superstore:

owned and managed an optical store;
collected income from optical sales and the provision of eye tests to customers; and
paid a portion of the income from customers to the optometrists.

The Victorian State Revenue Office raised amended assessments for payroll tax on payments made by Optical Superstore to optometrists who provided services to the general public at Optical Superstore’s facilities. The outcome of the case was that the payments to the optometrists by Optical Superstore were held to represent payment for work performed by the optometrists under the ‘contractor provisions’ of the payroll tax law, as the arrangements involved ‘relevant contracts’ in relation to the performance of work by the optometrists to the owner of the clinic.

Initially, it was thought that the decision in Optical Superstore could be confined to its somewhat unique facts. The optometrists in each store facilitated the sale of optical products, so that it could be said that there was a sufficient connection to support the argument that the optometrists were ‘working’ for the Optical Superstore, so that payroll tax applied to the payments made to the optometrists.

Thomas & Naaz case takes it further

Then came the NCAT decision in Thomas & Naaz, upholding Revenue NSW’s payroll tax assessments with respect to payments made to contracted doctors. In that case, the taxpayer operated three medical centres, through which:

contracted doctors bulk billed patients and the patients assigned their Medicare benefits to the doctors;
the service entity then claimed these benefits on behalf of the doctors; and
after the payments were reconciled, doctors would receive 70% of the claimed funds and the remaining 30% was retained by the service entity as a ‘service fee’ for the various other administrative support services it provided to the doctors.

The tribunal considered that the earlier NCAT decision of Homefront Nursing Pty Ltd v Chief Commissioner of State Revenue [2019] NSWCATAD, which was in conflict with the Optical Superstore case, should be confined to its facts and preferred the reasoning in the various judgments made in the Victorian Optical Superstore decisions.

NCAT found that the arrangement in Thomas & Naaz attracted payroll tax under the contractor provisions. The tribunal held that the medical services were a necessary part of the taxpayer’s medical centre business.

Essentially, without the medical services provided by the doctors to their patients, the taxpayer could not operate its medical centre business. This meant that the doctors provided their services not only to their patients, but also to the taxpayer for a payment (ie 70% of the Medicare benefits) – even though the payments were from Medicare claims made by the doctors.

The tribunal held that the payments to the doctors were for or in relation to the performance of work and therefore were subject to payroll tax.

What does this mean?

What can be gleaned from Thomas & Naaz is the approach taken by Revenue NSW in capturing typical administrative service arrangements within the payroll tax net. That is, the concept of a service entity having supplied to it the services of a contractor, for or in relation to the performance of work by the contractor, thereby falling within the definition of a ‘relevant contract’. This is despite the contractor simultaneously providing services to others (eg patients), and payments to the contractor being sourced from funds that have not necessarily originated from the service entity.

Put simply, payments from a healthcare practice to their contracted practitioners may trigger payroll tax obligations with respect to those payments. The risk that those payments are subject to payroll will come down to the terms of the contracting arrangements, as well as what happens on a day-to-day basis in the clinic.

In our experience, those clinics – and this will apply to most of the clinics that operate in the medical and allied health sectors – where consultation fees (including Medicare rebates) are collected by the clinic into its operating account and remitted net of the ‘administration fee’ are at significant risk of being subject to payroll tax.

Arrangements that may have been considered low risk a few years ago are now likely to carry a far higher risk of challenge by the various revenue authorities around the country because of the recent cases in NSW and Victoria.

In our view, the terms of the contracting arrangements with the clinic’s medical practitioners will need to be reviewed and many, if not all, will require some changes. Practically, clinic owners will need to relinquish some of the control that they have in their arrangements with the doctors, including:

the collection of fees;
rostering arrangements;
how the administration fees are set;
the use of consulting fees to pay the clinic’s operating expenses;
restraints of trade; and
ownership of patient records.

Ultimately, the question for clinic owners will be whether they are prepared to pay the price of giving away a possibly significant degree of control, which may impact the goodwill of their own businesses, or live with the high risk of challenge by a revenue authority that is emboldened by a series of successful judgments.

All is not lost however. Even if a clinic owner is prepared to concede the risk of a finding that their arrangements with medical professional constitute a ‘relevant contract’ and are otherwise subject to payroll tax, a clinic owner may yet be able to get on the front foot by gathering the evidence to support the availability of one of the exemptions that can apply to avoid a payroll tax liability.

Where to next?

Now is the time to review your service entity arrangements.

Each business needs to consider its own administrative service arrangements and consider the payroll tax impact arising from the current approach of the revenue authorities. Although the wording of any service agreement between the practice and the practitioner will be important, so too will be the day-to-day operations of the business.

Exemptions may be available where the arrangements do in fact constitute relevant contracts – however, these exemptions can be quite narrow.

Thomas & Naaz and Optical Superstore provide the various revenue authorities with a strong basis to contend that payroll tax obligations apply in typical administrative service arrangements – administrative service arrangements used by many medical and healthcare practices. It would not be a stretch for the revenue authorities to begin targeting other industries and professions where similar service entity arrangements are in place (eg financial services providers, including mortgage brokers and financial planners, and accountants and barristers).