The Optical Superstore Case

A common feature of many medical legal structures is the use of a “service entity” to provide the practitioners who operate their practices within the structure with the facilities to run their practice, in return for the payment of a service fee. 

Included within these “facilities” are often a licence to use consulting rooms, administrative support and patient invoicing.     

The service entity usually takes the form of a unit trust or a discretionary trust with a corporate trustee and the owner practitioners are the beneficial holders of units / interests in that service entity trust.  As such, the owner practitioners are entitled to distributions from the trust. 

Another feature of a service entity which many practitioners utilise is to direct that all patient fees be paid into the service entity’s bank account which is transferred to the practitioner at the end of each month, less the applicable service fee retained by the service entity. 

This is quite straight forward and has been standard practice for many years.   

Did you know however, that in certain circumstances, the amount paid to the practitioner (which is in effect a return of their patient fees) could be subject to payroll tax in Victoria? 

A recent decision by the Court of Appeal of Victoria confirms that such payments were determined to be deemed “taxable” wages in the hands of the service entity and therefore, as the service entity was over the payroll tax threshold, it was liable to remit payroll tax on these amounts with a retrospective application.  This decision is known as the “Optical Superstores Case” (Commissioner of State Revenue v The Optical Superstore Pty Ltd [2019] VSCA 197). 

This outcome, if it stands and is not appealed further to the High Court, can have a catastrophic effect on the cashflow of a service entity.  Not only that, if there is a historical exposure, penalties and interest may arise on amounts not previously brought to account.   

Quite reasonably, many practices may not have ever turned their mind to a service entity arrangement giving rise to payroll tax at all on the basis that the practitioners are not employees and therefore not deriving wages.  This case demonstrates however, that given a particular factual circumstance, all that is required to trigger a payroll tax obligation is that a “payment” be made in relation to “a contract for services”. This case is also authority for the proposition that even a return of money held on trust, is not outside the scope of payroll tax. 

The resultant effect is that the reach of payroll tax is now far broader than it ever has been. 

It is therefore very important that if you have a service entity arrangement on foot, it be reviewed periodically to determine whether the service arrangement has characteristics that are analogous to the Optical Superstore Case. 

Facts of the case

It is important to be aware of the main features of the service entity arrangement that arose in the Optical Superstore Case which triggered their payroll tax obligation.  These are set out below. 

The Optical Superstore Pty Ltd acted as the trustee (Trustee) of four related trusts.  Together the trusts carried on an optical dispensary business known as the Optical Superstore.  During the relevant period, the Trustee entered into various contracts (Contracts) either directly with optometrists or with their related entities (Optometrist Entities) in relation to the provision of optometry services. 

The Contracts provided the following: 

1. the Optometrist Entities ultimately received money based on the number of hours the particular optometrist worked; 
2. under the arrangement, the optometrists’ consultation fees (which included money earned from bulk billing to Medicare and the money paid by patients) were paid to the Trustee directly who would hold that money on trust for the relevant Optometrist Entities; 
3. the optometrist was required to pay to the Trustee an “occupancy fee” for the use of the Trustee’s premises, and this fee was calculated as “total consultation fees for a particular period less a reimbursement amount”; 
4. the reimbursement amount was calculated by multiplying the number of hours the optometrist was available to see patients in that period by the applicable hourly rate (as opposed to actual patients seen); 
5. the reimbursement amount was calculated at the end of each month and then distributed to the Optometrist Entities from the consultation fees held on trust; 
6. the remaining consultation fees would be retained by the Trustee as the “occupancy fee” and due to the nature of the practice, often no occupancy fee was paid or payable to the Trustee; and 
7. where the reimbursement amount exceeded the consultation fees, the excess was treated as a loan from the Trustee to the Optometrist Entities or as “location attendance premiums” in satisfaction of the occupancy fee. 

The distributions made to the Optometrist Entities by the Trustee were assessed by the Commissioner of State Revenue (Commissioner) as subject to payroll tax pursuant to section 35(1) of the Payroll Tax Act (Act).   

The rationale for this was that the reimbursement amount distributed represented an amount “paid or payable for or in relation to the performance of work”. 

Optical Superstore however argued that the reimbursement amount was not “paid or payable for or in relation to the performance of work” as it was simply a return of money already belonging to the practitioner being an amount that was held on trust for them.   

This position was also supported in first instance by VCAT and then on appeal by Croft J of the Supreme Court of Victoria who did not consider that the amounts were “paid or payable”. 

Croft J went so far as to determine that the meaning of “payment” could not extend to: 

“a return of money by one person to another in circumstances where the second person earned that money from providing services to a third party and directed the money to be deposited in the bank account of the first person and held in trust…. payroll tax cannot be collected in respect of those amounts” [emphasis added]. 

Decision of the Court of Appeal

The Commissioner appealed the decision of Croft J to the Court of Appeals Victoria.  Originally, five grounds of appeal were raised, however only three were allowed. Within these three grounds, the issue of whether the amounts were “paid or payable” within the meaning of the Payroll Tax Act was reconsidered. 

Ultimately, the Court of Appeal determined in favour of the Commissioner, therefore reversing the previous two decisions, and held that the: 

“ordinary meaning of ‘payment’ readily embraces a payment of money to a person beneficially entitled to that money”. 

Accordingly, even though the amounts returned to the practitioners were held on trust for them, as they represented patient fees that the practitioner had derived, on distribution they were still considered to be a “payment” with the effect that the Payroll Tax provisions would apply. 

Please note that for Payroll Tax to apply, there must be a “payment” in relation to a “relevant contract”, which is defined as a “contract for or in relation to the performance of work”.  This issue was not considered by the Court of Appeal as the assumption was made that there was a contract for or in relation to the performance of work, as determined by the previous decisions. 

Moving forward

With any type of court case, it is important to be aware that the ultimate decision reached by the Court of Appeal in The Optical Superstore Case turned on the specific facts of this matter. 

Relevantly, the service entity arrangement with the practitioners involved the following: 

1. there was a contract on foot between the service entity and The Optometrist Entities which included a tenancy arrangement; 
2. the service entity was engaged as an “agent” of The Optometrist Entities to collect patient fees and manage them in a bank account on their behalf; 
3. The Optical Superstore sold optometry products which were considered “in connection with” the services; and 
4. the engagement by the practitioners under the Contract had the flavour of a deemed “employment” relationship.  This is because the practitioners were paid a set hourly rate regardless of attendance and there was a “location attendance premium” which was paid where the reimbursement amount was negative. 

If you have a service entity arrangement on foot which includes any of the characteristics described above, we recommend that you have the arrangement reviewed to determine whether a historical exposure for payroll tax exists as corrective action may be required.  This is because we can no longer rely on the presumption that payments made to practitioners who have a beneficial interest in patient fees held on trust for them by a service entity are excluded from Payroll Tax. 

The High Court refuses the Optical Superstore Appeal

The High Court has refused the taxpayer’s application for special leave to appeal from the decision of the Victorian Court of Appeal in Comr of State Revenue v The Optical Superstore Pty Ltd [2019] VSCA 197.

The High Court said the decision of the Victorian Court of Appeal was not attended by sufficient doubt to warrant the grant of special leave to appeal: [2020] HCASL 16.

If you would like any assistance with obtaining the right legal structure for your clients’ medical practices, please contact us.

We’re here to help.

Ann-Maree Ventura Special Counsel