Thinking | 17 December 2020
Payments to medical practitioners of almost $158 million determined to be not deductible
By Rachel Law and Bradley White
In a considerable blow to the Taxpayer, the Full Federal Court in Commissioner of Taxation v Healius Ltd  FCAFC 173 has overturned the Federal Court’s decision, determining that $158 million worth of lump sum payments made to medical practitioners were capital in nature and unable to be deducted.
Broadly, the Taxpayer operated medical centres and paid lump sum amounts to medical practitioners in exchange for the medical practitioner agreeing to conduct their medical practice from one of the Taxpayer’s centres, usually for five years. The lump sum payments were ultimately determined to be capital in nature on the basis that the Taxpayer was in the business of operating medical centres and by making these payments, was able to expand its business.
While this decision has significance for medical centres and medical practitioners in these types of arrangements, the principles may also be relevant to a broader range of transactions with similar contractual terms.
The Taxpayer was the head company of a tax consolidated group and through its wholly owned subsidiary, owned and operated a series of medical centres at which it provided premises, equipment and administrative services to medical practitioners who, in turn, provided health services to the public. The centres provided a variety of medical services (doctors, dentists, pharmacy, day surgery, pathology, physio, etc), were bulk billed, operated for long hours (sometimes 24/7) and did not require appointments.
During income years ended 30 June 2003 to 30 June 2007, the Taxpayer opened 18 new medical centres and entered into contracts (referred to by the Full Federal Court as the Sale Deed and Practitioner Contract) with 505 practitioners.
As part of the Sale Deed, the Taxpayer agreed to purchase the practice of the medical practitioner (including the goodwill) in exchange for a lump sum payment.
Pursuant to the Practitioner Contract:
- the medical practitioner agreed to render medical services for 5 years exclusively from the Taxpayer’s specified centre;
- the medical practitioner would be subject to a restraint of trade and must not, within the next five years (or three years from the termination of the contract), render medical services at any place within seven kilometres from their old place of work or the centre;
- the medical practitioner agreed to certain work schedules set by the Taxpayer, including minimum hour requirements and shift requirements;
- the medical practitioner agreed to conduct themselves in a harmonious way with other practitioners and staff at the centre;
- the medical practitioner agreed to use their best endeavours to expand the turnover, profitability, quality and image of the services provided at the centre;
- the Taxpayer was responsible for providing the medical practitioner with the administrative services, facilities and equipment that were necessary for the medical practitioner to render medical services from the centre and the medical practitioner would pay the Taxpayer 50% of the fees earned from providing medical services at the centre;
- the medical practitioner must use their best endeavours to promote the interests and welfare of the practice and must observe all lawful directions of the Taxpayer concerning the operation or management of the centre and the business conducted from the centre; and
- the Taxpayer retained ownership of all property and documents, including patient lists, patient records, brochures, manuals and financial records.
The Federal Court decision
This case involved a consideration of the test for general deductions found in section 8-1 of the Income Tax Assessment Act 1997 (1997 Act), and more specifically, the first negative limb of the test set out in section 8-1(2)(a) which prevents the deduction of a loss or outgoing if:
‘it is a loss or outgoing of capital, or of a capital nature …’
Following the test set out in Sun Newspapers, in attempting to characterise the lump sum payment, the primary judge considered the following:
- the character of the advantage sought;
- the manner in which the advantage is to be used, relied upon or enjoyed; and
- the means to obtain the advantage.
The primary judge noted that the critical question in determining the character of a particular payment is the advantage that the taxpayer sought to secure in making it. In considering the terms of the relevant contractual arrangements, he determined that the principal benefit obtained by the Taxpayer was the promise from the medical practitioners to practise only from the Taxpayer’s centre, viewing the restraint of trade imposed on the doctors as being merely an ancillary advantage.
The primary judge determined – due to the fact that he considered the business of the Taxpayer to be restricted to the provision of support services to medical practitioners – that the recruitment of practitioners did not add to the structure of the business. Instead, the primary judge analogised the recruitment of the practitioners to expenditure incurred to win customers. The primary judge also viewed the payments as being recurrent in nature (given the volume made over the period), and due to the usual five-year term, did not consider they provided any enduring benefit to the Taxpayer.
Due to this interpretation of the benefit obtained from the lump sum payments and the business of the Taxpayer, the Federal Court ultimately decided that the lump sum payments were on revenue account and therefore deductible.
Key issues on appeal
The Commissioner of Taxation appealed the decision and the key issues to be determined by the Full Federal Court were:
- what was the business of the Taxpayer; and
- what was the purpose of the lump sum payments (and what did they secure).
If the payments secured a benefit/advantage that added to or maintained the profit-making structure of the business, they would be a capital expenditure.
Nature of the Taxpayer’s business
The Full Federal Court determined that the primary judge took too narrow a view of the Taxpayer’s business and it was incorrect to characterise the business of the Taxpayer as the provision of a comprehensive range of services to general practitioners. Instead, the evidence showed that the Taxpayer was in the business of operating medical centres in a manner that included the activities of causing, ensuring and facilitating the provision of medical services to the public.
In reaching this decision the Full Federal Court considered the following:
- through the Practitioner Contract, the Taxpayer decided every commercial aspect of the manner in which the medical services would be provided at its centres including the way they looked, the equipment needed, when practitioners would work and what fees they could charge;
- the Taxpayer’s prospectus contained comments and descriptions that indicated it was essential to the Taxpayer’s business that a particular mode of practice was adopted by its practitioners and this was relied on to attract patients and generate revenue;
- the patient records and lists of the medical practitioners were owned by the Taxpayer (even on termination of the contract). If the business of the Taxpayer was limited to the provision of services to medical practitioners, it would not need this information;
- evidence given by the Taxpayer’s CFO that, from a commercial point of view, an objective of the Taxpayer was to make the medical centres as attractive to the public as possible; and
- revenue generated by the Taxpayer was directly linked to attracting patients to the centres through the 50/50 revenue split with practitioners, rather than upon the payment of some form of licencing fee by the medical practitioners.
The purpose of the lump sum payments
The Full Federal Court found that lump sum payments made by the Taxpayer to the practitioners were not simply to secure the practitioners as customers of the Taxpayer, rather, the payments were made for the practitioner:
- to cease operating an existing practice (or otherwise practising independently of the Taxpayer’s centres);
- to commence trading as part of the Taxpayer’s centres by adopting the Taxpayer’s required mode of practice; and
- during the arrangement, as well as thereafter, to accept a restraint on establishing a medical practice that would compete with the Taxpayer’s centres.
In order to operate its medical centres, the Taxpayer required practitioners that would ‘give up their independence and join the hive’ , abiding by the Taxpayer’s required mode of practice. The Taxpayer could not conduct its business of operating the centres and could not derive a profit without the commitment of these practitioners. Therefore, by paying practitioners these lump sums to bind themselves in this way, the Taxpayer was expanding its business, or when the contracts were extended, maintaining the structure of its business.
The Taxpayer did not raise section 40-880 of the 1997 Act as an alternative argument so this was not discussed.
What this decision means
The level of control exercised by the Taxpayer over the way its centres were run as well as the fact that operating the centres was a core component of its business model, caused the Full Federal Court to reach the decision that the lump sum payments expanded the Taxpayer’s business.
If all the Taxpayer did was enter into contracts with the practitioners as customers, under which a lump sum payment was payable upfront, the payments may have been analogous to cases like BP Australia, National Australia Bank and Tyco. The Full Federal Court distinguished these cases that were relied on by the primary judge. Unlike in those cases, there was no minimum payment requirement, no refund provision if certain revenue targets were not hit, and no detailed calculation of the actual amount of services that may be required by the relevant practitioners.
The Full Federal Court also noted that the primary judge interpreted these cases differently on the basis that he had a different view as to the nature of the Taxpayer’s business which emphasises the importance of accurately defining the business structure in a capital/revenue case.
The recurrent nature of the payments, which often leads to a conclusion that an amount is on revenue account, was outweighed by the fact that the payments were made to establish and expand the profit-making structure of the business which is a reminder to taxpayers to look beyond the frequency of payments when determining whether an amount may or may not be deductible.
Overall, the key consideration seems to be the level of control exercised by the Taxpayer over the medical centres and therefore the medical practitioners. If your business operates these types of arrangements it may be worthwhile reviewing any similar kind of payments that you make and the conditions that attach to them to ensure they are being treated correctly for tax purposes.
This case only looks at the way the payments are treated from the perspective of the payer (ie the medical centre) rather than from the recipient’s point of view.
The ATO made a comment on its website in 2017 regarding lump sum payments received by healthcare practitioners, which at this stage has not progressed to formal guidance. The ATO’s view is that the tax treatment of lump sum payments received by healthcare practitioners will depend upon the facts and circumstances in respect of the particular healthcare worker.
Medical practitioners should carefully consider the tax treatment of any lump sum payments they may receive to ensure that the payments are treated correctly for tax purposes.
 Sun Newspapers Limited v Commissioner of Taxation  HCA 73; (1938) 61 CLR 337
Commissioner of Taxation v Healius Ltd  FCAFC 173 
 BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386
 National Australia Bank Ltd v Commissioner of Taxation  FCA 1394; (1997) 80 FCR 352
 Tyco Australia Pty Ltd v Commissioner of Taxation  FCA 1055
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