STATEMENT OF ADVICE PREPARED FOR DR BRAD MICHAEL AND ANGELA MICHAEL 20 SEPTEMBER 2004

Transcription

1 STATEMENT OF ADVICE PREPARED FOR DR BRAD MICHAEL AND ANGELA MICHAEL 20 SEPTEMBER July 2004 Prepared by McMasters (VIC) PTY LTD ABN Corporate Authorised Representative No of Dover Financial Advisers Pty Ltd ABN: AFSL Tulip Street Cheltenham Victoria.

2 PART ONE WHAT THIS STATEMENT OF ADVICE IS ABOUT This statement of advice confirms the advice provided at our meeting and contains the information you need to decide whether to rely on our advice. This is a limited purpose SOA and only covers the advice provided at our meeting. It does not discuss any other matter. You have requested advice about your current financial circumstances, and how they can be improved. You are particularly interested in setting up an administratively simple practice structure, reducing non-deductible debt, buying a home, and improving your cash flow. You have requested specific advice about an offer to sell your practice to Primary Health Care and use it as your service provider for the next five years. You are concerned about the income tax implications, and any other implications, of accepting this offer. This statement of advice sets out our initial thoughts on what you should do, and why. It confirms the advice provided at our meeting and contains the information you need to decide whether to rely on our advice. The scope of this SOA is limited to the matters discussed within it, and does not consider all your financial circumstances. You can read more about our general approach to financial planning for GPs here: The GPs' Guide to Financial Planning. Financial services guide The McMasters financial services guide (FSG) was provided to you as part of the fact finder process and a further copy can be accessed here: McMasters' FSG document. Basis of our advice The advice contained in this Statement of Advice is based solely on the personal information provided by you. Take time to review all the information summarised at the end of this document. Should any of these details be incorrect or inaccurate, please contact me immediately as this may affect the advice in this SOA. 1

3 PART TWO OUR ADVICE A. A large corporate offer A large SA based start-up corporate group (LGC) has approached you and offered to buy your practice for $500,000. The catch is you have to retain LGC as your service provider for at least five years and practice at its site for at least 50 hours a week. Is the $500,000 taxable as ordinary income or is it a tax-free capital gain? The LCG representative said the upfront payment is tax-free under the small business tax concessions. You are not sure the ATO will agree with this, and have asked what our experiences with other clients have been. In summary, we have some cases where the ATO said the $500,000 is a tax free capital gain, and we have some cases where the ATO said it is not a tax free capital gain, and is in fact an inducement to enter into the five year 50% management fee contract and is taxed as ordinary income. Obviously it s a big issue. There is a huge difference between a tax-free capital gain of $500,000, and $500,000 taxed as ordinary income, on top of your practice income (estimate to be about $150,000). The tax is about $225,000, meaning you only get $275,000 after tax. There is really only one way to be absolutely certain the LGC payment will be a tax-free capital gain and that is to apply for a private ruling from the ATO. It helps that you expect a large proportion of your patients to follow you to LCG, and we feel this will be a critical fact in your favour. In a similar private ruling the ATO held that a $500,000 payment was a tax-free capital gain even though the GP moved over 1,800km from Cairns to Brisbane, and (not surprisingly) no patients followed. In summary, we cannot be certain your LCG payment will be a tax-free capital gain. However, based on our ATO private ruling requests, it probably will be a tax free capital gain. For completeness, we confirm the $500,000 is only completely tax-free if you pay $125,000 to a super fund. The position is as follows: Capital gain $500,000 Less 50% exemption $250,000 Remaining amount $250,000 Less 50% active asset exemption $125,000 Remaining amount $125,000 Rollover superannuation exemption $125,000 Taxable amount Nil Should you accept the offer? You are 39 years old, have a dependant wife, three children under age 10, three lots of private school fees every year, no assets, and a $40,000 credit card debt. It s fair to say you are at the back of the pack in the (age adjusted) wealth accumulation stakes. If you accept the LCG offer you will be at the front of that pack. We have quite a few clients at LCG. It is not always plain sailing but on balance they are happy and earning reasonable incomes. The corporate environment suits a lot of GPs, even if it is just for five years. They enjoy working 2

4 in a large practice with ten or more other GPs and feel there is good on site support and a good mix of patient presentations including an above average number of complex presentations and minor surgical procedures. We are not concerned about the 50-hour week. Realistically you will be working 50 hours a week, or more, wherever you are. LCG has well set out practice premises and the 10k drive each way each day is just about the right balance between distance and convenience. In summary, we believe you should accept the offer to buy your practice for $500,000. LCG Legal documents Please make sure our legal team check the documents before you sign. They usually comprise a sale of practice agreement and a five-year service agreement, and are usually in order to sign. But obviously they need to be checked for appropriateness before you commit. B. Practice structure We believe you should set up a personal services income practice trust (PSI trust) to run your practice. There are two main reasons for this: 1) the PSI trust will shield you from any joint and several liability based argument that you are somehow linked to a negligent act or omission of another GP at the LCG site or any other site you may practice at (for example, your annual Cambodian orphans health clinic); and 2) PSI trusts break even automatically, since net income is distributed 100% to you every year and there is no need to calculate salary. This means the ATO requirement that all the profit is flushed out to the GP every year is easy to comply with and there is no risk of making an expensive mistake. The PSI trust does not need to pay you a salary (compared to your existing practice company, which does have to pay you a salary). This means your cash flow in the first 12 months will be better than otherwise, since there will be no tax remittances in this period. Trust income is taxed under the Pay As You Go Instalment Rules, not the Pay As You Go Withholding rules. This means tax is typically paid later than otherwise. For example, if you moved off the Pay As You Go Withholding System on 1 July 2004, you would not have to pay tax under the Pay As You Go Instalments System until about March 2006, ie about 21 months later. The same amount of tax is ultimately paid, but the deferral will help take the pressure off and get you back on to your financial feet. We believe you should use the higher cash flow during the deferral period to pay off expensive nondeductible loans particularly the new home loan. Make sure you budget for that tax bill in March 2006, and the instalments that will follow soon after. Many GPs have been caught short here, and banks do not like lending just to pay tax (unless there is heaps of pre-existing security). It s much better if you have the cash ready to pay the tax. The PSI trust can employ Angelina for 8 hours of genuine work each week, at arms length rates of pay. The trust can superannuate Angelina up to her age-based limits notwithstanding that this is greater than the market value of the work she does for the PSI trust. We stress that Angelina really has to do this work. This must be able to be proven should the ATO for any reason question the integrity of the arrangement. Handwriting, cheque signatures, s and telephone records could be relevant in such an investigation. Angelina can drive a company car provided to you as a taxable fringe benefit. This is even though this car is not used in the practice and is very much a private troop carrier, used to ferry the kids around safely. The car will be provided under the statutory method of computing FBT, which is not influenced by the relative proportions of business use and private use. Instead, FBT is an inverse function of total kilometres travelled over the FBT year, which ends on 31 March. Any GST paid on a new car for Angelina will be refunded in the next Business Activity Statement. 3

5 Who will be the trustee? Your existing company, Brad Pty Ltd, will be the trustee of the PSI trust. This company s sole purpose will be to act as trustee of the medical practice trust, and to make sure the provisions of the trust deed are observed at all times. This includes the clause requiring all net income to be distributed to you and not to any other person. This clause is needed to comply with the ATO s public rulings on trusts deriving personal services income. Who will be the beneficiary? You will be the only beneficiary of the PSI trust. This is a condition of the PSI trust being accepted by the ATO under Income Tax rulings IT 2503 and IT This means 100% of the PSI trust s income must be distributed to you. (We make sure this is the case by drafting the trust deed so that it specifically says all the income must be distributed to you and no income can be distributed to any other person.) C Buying your home You are concerned that you are renting and do not own a home. Homes are expensive and at present you do not even have a deposit. We recommend you buy as much home as the bank will lend you. We believe Adelaide s fashionable suburbs will be an excellent investment over the next two to three decades and that buying the best home you can afford now makes a lot of sense. The $375,000 from LCG (ie $500,000 less $125,000 rolled over to a super fund) should be used to help pay for the home, with the rest being borrowed from a GP specialist bank. Angelina should own the home, not Brad. This is to protect against the unlikely risk of a patient litigation not covered by professional indemnity insurance. No GP has lost a home in circumstances like these, but we do not want you to be the first. There is no downside to Angelina owning the home, and for completeness we note that nominal ownership is irrelevant for family law purposes: if for any reason your relationship breaks up it does not matter whose name the home is in, or in whose name any other asset is in, for family law purposes. Buying in Unley Park at around $800,000 makes sense. The home should be funded by: (i) the LCG payment (the first $20,000 should be used to pay off the credit card); and (ii) the loan from a GP specialist bank, secured by a registered first mortgage and a guarantee from Brad. The interest cost will be about $20,000 a year. This is quite affordable and is less than what you are paying for rent. It s fair to say that Unley Park is a bit up-market. But it s close to Angelina s parents (and baby sitting), near your preferred schools and a quick 10 kilometres to Brad s new practice. The Unley Park convenience factor is high, and overall it makes sense. Pay off the home loan as fast as you can You have to earn nearly $40,000 a year to get the cash to cover the home loan interest of $20,000. Looking at this another way, paying off the home loan is the same as earning about 10% per annum, capital guaranteed, taxable income on an alternative investment. We recommend that all spare cash flow be paid off the home loan as fast as possible. Interest offset account 4

6 The spare cash flow should not be paid directly off the home loan, but should instead be paid into an interest offset account (IOA). The bank does not pay you interest on the IOA, instead the interest you pay the bank on the home loan is reduced, which means you in effect earn about 10% per annum, capital guaranteed, taxable income on an alternative investment. If you decide to up-grade your home the IOA allows you to move your equity from the old home to the new home and the interest on the old home will be deductible once it is available for rent. This is a simple and safe strategy that allows you to minimise non-deductible interest and retain the old home as an investment when you up-grade the home. GP specialist bank We generally recommend you use a GP specialist lender. We find they provide better service and better interest rates. They understand the financial profile, and the financial potential and will typically lend more than other lenders, for the same security. In one case we had a Sydney specialist successfully borrow 120% of the value of his home. The extra security was in effect his (heavily insured) future income of more than $1,000,000 a year. We doubt if any other bank would have done this. D Superannuation Your super is with HESTA and you each have about $10,000 invested in the balanced option. We recommend you remain in HESTA but change to the Australian Shares option. HESTA is a well-run fund, does not pay commissions, has low operating costs and is not for profit. We see no reason to change your super arrangements for the foreseeable future, other than this switch to the higher growth Australian shares option. Economic theory predicts it is probable, but not certain, that growth investments such as Australian shares will outperform bank deposits and similar low risk investments over the long term, say thirty years or more. This is the time frame for your super investments. Hence you should invest now for future growth, and to maximise Australian franking credits. You can instruct HESTA to adopt this strategy by logging on to its Member Online website and following the instructions to switch your investment options to Australian Shares. Let us know if you need any help doing this this. Getting the super snowball finally started is an imperative. You are behind most of your age peers, and you need to catch up. If necessary you should open a line of credit in the name of the PSI trust, secured against the home to get the best possible interest rate, and use this line of credit to pay the deductible employee super contributions each year. Doing this means you can maintain your other strategies, such as paying off the home loan as fast as possible and ideally paying it off completely within five years (via an interest offset account). Product Disclosure Statement ( PDS ) The HESTA product disclosure statement was provided at our meeting and a copy can be accessed at the HESTA website. You should read this PDS carefully. This PDS deemed to be part of this statement of advice for disclosure purposes. 5

7 E Risk insurances We are concerned that you do not have any life insurance or income protection insurance. We have asked one of our insurance specialists to contact you to arrange a more detailed meeting, but at this time our advice is to arrange life insurance and income protection insurance as follows: Sum Insured Insurer Premium Comments Life insurance policy no. 1 Brad Life insurance policy no. 2 Brad Life insurance policy Angelina $500,000 AIA $2,000 $500,000 HESTA $1,200 $500,000 HESTA $1,000 Commission free under McMaster s Commission rebate Scheme Buying extra units in HESTA is the cheapest way to get extra life insurance. Buying extra units in HESTA is the cheapest way to get extra life insurance The commission rebate is $2,000 in the first year and about $200 a year thereafter. Using HESTA to arrange extra life insurance deserves comment: this is the cheapest way to arrange extra life insurance but is rarely recommended by financial planners. This is because HESTA does not pay commissions to financial planners. McMasters routinely recommends industry super funds such as HESTA as the cheapest way to arrange extra life insurance cover. However, industry super funds such as HESTA do not provide adequate income protection insurance. The sum insured is too low for GPs, and the cover only runs for two years. GPs need much lager sums insured and the cover must run to age 65. Our recommendations are tabulated here: Sum Insured Insurer Premium Comments Income protection insurance policy Brad Income protection insurance policy Angelina $12,000 pcm AIA $3,000 Nil NA NA 90 day waiting period. Commission free under McMaster s Commission rebate Scheme Look at this again when Angelina rejoins the full time work force as a nurse We recommend a 90 day waiting period because Brad has the reserves to cover a short term incapacity, and can borrow from Angelina s parents if really need be. This reduces the premium and allowed a higher sum insured, which meant Brad is better covered against the real risk: a catastrophic health event that means he can no longer earn an income as a GP. The commission rebate is $3,000 in the first year and $320 every year thereafter. The under-insurance problem The recommended sums insured are less than the amounts that would be recommended by many other financial planners, and some would say you are under-insured. You are aware of this, and have compromised on the sums insured due to competing claims on your budget. The recommended sums insured are sensible compromises and, in summary, we believe they are appropriate to you having regard to your overall financial profile. 6

8 Let me know if you are concerned about under-insurance or the sums insured. Product disclosure statements (PDSs) PDSs are created by the product maker and explain how the product works. Copies of PDSs for all recommended products accessed by clicking on this link: AIA PDS Paper copies are available on request. Please see enclosed quotes. Commissions and the Commission Rebate Scheme As discussed during our meeting, McMasters does not accept commissions and instead rebates them back to clients subject to a small handling fee. The details of the McMasters Commission Rebate Scheme are set out here: Commission Rebate Scheme We will arrange for your insurance policies to be placed on the Commission Rebate Scheme and be rebated back to you as soon as possible. Reasons for our advice The reasons for our advice include: (i) by making your income protection insurance to a 90 day waiting period the premium falls (you are not really concerned about no income for between 31 and 90 days); (ii) AIA has an excellent reputation for paying claims quickly and efficiently as this is their commitment to their customers; and (iii) AIA insurance provides good value for your money as opposed to other insurance policies and it is much simpler to have your insurances with the one provider. F Estate planning You do not have any wills in place at the moment. It is important to arrange for your wills to be prepared. As discussed during our meeting, a simple will, will work perfectly fine given your simple circumstances. It is a document that leaves your estate to the beneficiaries of your choice. We recommend that in the event of one death, everything goes to the survivor (your spouse) and in the unlikely event of a double premature death then everything would go to a testamentary trust for your children. This trust will remain until the youngest child is 35 years old. We suggest your siblings be the guardians and the trustees. You can read more about estate planning here: Estate planning. This guide was written for financial advisers but works just as well for GPs. G Expected tax profile, and use of any spare cash We expect that, working hard, Brad will net about $220,000 a year at LCG. This estimate is based on other clients in similar circumstances over the last five years or so. We expect your tax profile will look like this: Income Income Tax Brad s net income $115,000 $35,000 Angelina s salary $15,000 $1,530 Superannuation $70,000 $10,500 Deductible car costs (two cars) $20,000 Nil Total $220,000 $47,030 or 21.3% 7

9 Any spare cash left after running the practice and the household, and paying super, should be used to pay off the remaining $320,000 non-deductible home loan. Paying off the home loan is the best investment that presents to you. It in effect earns nearly 12% per annum, capital guaranteed, on an equivalent after tax basis. Bear in mind that your credit card debt will be gone, that tax will be paid later than otherwise using the PSI trust. This means there should be a reasonable amount of after tax cash available to pay off the home loan, and that the back of the envelope calculations suggest the home loan will be gone after about five years. H A five year plan We stress that this is a five-year plan. The five year plan lines up nicely with the LCG contract, and the cash-flow works out very well, so you will be left owning your home, debt free, and with a good amount of super at the end of the five years. This means you leapfrog forward, coming from the back of the pack now, to close to the front of the pack in five years time. We can work out what comes next then. It could be to stay with LCG, it could be to move to another practice or even buy into another practice. I Five year restrictive covenant You will appreciate that the LCG documents contain a five-year restrictive covenant. We believe this is a reasonable clause and one you should agree to. Its needed to give the arrangement commercial efficacy: LCG would be less likely to help you develop your practice under their roof if you could set up shop next door whenever you wanted, and take the patients with you. Contrary to what some say, restrictive covenants are very enforceable. But even if the restrictive covenant is not enforceable we recommend you observe it, because ethically it is not appropriate for a GP to chase patients and commercially there is no need to: there is a shortage of GPs and most practices have too many patients. The restrictive covenant is only for a limited time and a limited zone. We strongly recommend you observe the restrictive covenant and if you set up your own practice down the track do not solicit any of your old LCG patients and make sure you are an appropriate distance away from any LCG site. You will find your new practice to be just as successful. Most of Adelaide is outside of the restrictive covenant area, and it s really not an impediment to your future in any way. 8

10 PART THREE OTHER MATTERS Capacity in which advice is provided Dover Financial Advisers Pty Ltd ( Dover ) ABN holds Australian Financial Services License (AFSL) Dover is located at 71 Tulip Street, Cheltenham, Victoria, McMasters (Vic) Pty Ltd ABN is an authorised representative of Dover. Mina Andrawis is also an individual authorised representative of Dover Financial Advisers Pty Ltd. All taxation advice is provided by McMasters (Vic) Pty Ltd ABN as a registered tax agent. Our fees The fee for attending the meeting and preparing this statement of advice is nil. Legal fees are charged on a timespent basis. A quote will be provided before any work commences. We charge $1,056 for setting up the income protection insurance, but this will be taken out of the upfront commission and the balance is rebated to you. We also charge $176 each time we rebate the trailing commissions to you. The next step You should read this SOA carefully and contact us if anything is not clear or requires further explanation. There is no problem with another meeting: just let us know. If you decide to proceed please sign the client declaration and return it to us and we will implement our advice for you. Client declaration I have received a FSG, all documents incorporated into this SOA by reference and copies of all PDSs referred to in this SOA. I have read this SOA and I understand its content and accept its recommendations. I authorize my Adviser to provide my details to the financial product providers. Dr Brad s signature. Date. Adviser declaration I declare that this Statement of Advice is an accurate record of my advice. I declare that I only provided advice on products for which I am authorised to advise on and that these products are appropriate to my client. Terry s signature. Date. 9

11 Appendix: information upon which this SOA is based This section has information about you that we used in preparing our advice. Please advise us if you think this information is wrong or incomplete. General Information Name Brad Michael Angela Michael Age Date of birth 02/01/ /3/1970 Occupation GP Nurse/Administrator Taxable income $180,000 $nil Assets and Liabilities Description Owner Asset Liability Net value Superannuation Brad $10,000 $ $10,000 Superannuation Angela $10,000 $ $10,000 Credit card Joint - $20,000 $12,000 Total $20,000 $20,000 Nil Dependents You have 3 children. Tim age 6, Dim age 8, and Sim age 9. Risk profile We discussed your attitude towards the risk of your investments losing value in the short-term at our meeting. We considered your age, occupation and stable income and in summary we believe you can be classified as Growth investors. This means that you are prepared to incur short-term losses for potentially higher long term, ie 20 plus year gains. Your investments will therefore be in high growth assets such as Australian equities (direct shares and managed funds) and real estate. 10