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Should I Incorporate my Pharmacy?

Malcolm Wells
From and Accountant Perspective

Issue 37: May 2005
Page: 1 of 1 Author's Profile | Send to a Friend | Printer Version

Editor's Note: Malcolm Wells is a practising Victorian accountant and has a growing number of pharmacists as clients. Victoria is the only Australian state to embrace formally the concept of a company pharmacy within its Pharmacy Act (not just a service company).
When we talk about company pharmacies we refer to companies that are private companies (large or small) that have only pharmacist directors and shareholders.
This is distinct from the Woolworths vision of a corporate pharmacy i.e. a public company with any person to act as a director or a shareholder.
Because of its vision, the state of Victoria, in the opinion of i2P, will represent one of the few growth areas for pharmacy in the coming years.
While Malcolm Wells talks about the advantages and disadvantages of company pharmacy from an accountant perspective, there are other structural advantages for management, professional development and young pharmacist investment, all combining to offer a highly competitive model.

This is a very vexing question and one that should not be answered without firstly consulting your professional advisors.
There are many advantages to incorporating your pharmacy and they mostly relate to taxation issues. The disadvantages of incorporating your pharmacy relate to the record keeping and the duties required by the office holders.

Let’s look at the advantages in relation to taxation issues. Capital Gains Tax, Income Tax, and Superannuation are the main taxation issues that will be addressed.

Capital Gains Tax
Capital Gains Tax is payable on the sale of your pharmacy.
If you currently own your pharmacy as a Sole Trader or in a Partnership, you will be able to apply for rollover relief and avoid capital gains tax if you choose to incorporate your pharmacy.
If your pharmacy is currently being run as a sole trader or via a partnership, then you will pay capital gains tax at a rate of no more than 24.25% when you dispose of the pharmacy.
However, if you incorporate your pharmacy then the Capital Gains Tax Rate increases to 30%.

Income Tax
The tax rate for a company is a flat rate of 30%, on the profits retained in the company. Whereas, for an individual the tax rates are as follows: -

Taxable Income
(2005/2006)

Tax on
Column 1 ($)

 

% on excess
(marginal rate)

 

6,000

21,600

63,000

80,000

Nil

2,652

15,072

22,212

17

30

42

47

As you can see from the table above, the 30% tax rate for an individual is applied on all income over $63,000.

If you were incorporated, you could take a salary from the Pharmacy of $63,000 and retain the balance of the profits in the company to be taxed at 30% as opposed to being taxed at 42% or 47% (plus the Medicare Levy of 1.5% or 2.5% if you don’t have private health insurance).
This could result in considerable taxation savings.
A Pharmacist on $80,000 if they were to incorporate, would save $2,040 income tax every year.

There are a couple of rules associated with companies that you need to be aware of.
Firstly the money in bank is not your money. It belongs to the company… and it can sue and be sued. If you take more money than your wages you potentially expose yourself to Division 7A.
This means that the excess can be deemed to be a dividend, and it will be taxable at 48.5% without any benefits for franking tax credits.

Secondly, you will also be imposed a Franking Deficit Tax. That means you have paid out a dividend, and don’t have enough franking credits (franking credits only arise after the company has paid income tax on its profits). The Franking Deficit Tax is not a tax, but a penalty, and the rate of the penalty is 30% of the deficit.

Superannuation
Each year an employer can make contributions on behalf of employees on an Aged Based Deduction Limit. The following table shows the value of those contributions.

Age of employee in years

Deduction Limit

$

Under 35

35 to 49

50 and over

13,233

36,754

91,149

As an incorporated pharmacy you could make those sale contributions to a complying superannuation fund and receive a tax deduction for the contribution.

However if you don’t incorporate you can still claim the above amounts as a tax deduction but you need to contribute significantly more to receive the tax deduction.
A tax deduction for personal superannuation contributions is limited to the first $5,000 plus 75% of the excess of the total amount contributed over the $5,000.

Therefore to claim the maximum contribution you would need to contribute the following amounts: -

Age of employee in years

Deduction Limit

$

Under 35

35 to 49

50 and over

15,977

40,672

119,865


As you can see the amount needed to be contributed to receive the maximum taxation benefits are quite considerable – particularly if you are over 50.
A further saving in relation to superannuation relates to the Superannuation Contribution Surcharge. If your combined taxable income and superannuation contributions exceed $99,710 your superannuation fund will pay an additional levy of 12.5% p.a. on your superannuation contributions.

By incorporating your pharmacy you can take steps to reduce the amount of the Superannuation Surcharge payable by your superannuation fund.

So what are the disadvantages?
If you're a director or secretary of a small company, you must follow the requirements set out in the Corporations Act 2001 (the Act).

Who can be a Director?
You must not act as a director or secretary (or manage a company) without court consent if you:

  • are an undischarged bankrupt
  • are subject to a personal insolvency agreement or an arrangement under Part X of the Bankruptcy Act 1966 that has not been fully complied with
  • are subject to a composition under Part X of the Bankruptcy Act 1966 and final payment has not been made, or
  • have been convicted of various offences such as fraud or offences under company law, such as a breach of your duties as a director or insolvent trading.

If you have been convicted of one of these offences you must not manage a company within five years of your conviction.
If imprisoned for one of these offences, you must not manage a company within five years after your release from prison.
If you become bankrupt, enter into a personal insolvency agreement or are convicted of a relevant offence at a time when you're a director or secretary then you automatically lose that office. The company must then notify the Australian Securities & Investments Commission (ASIC – they are the regulatory authority) that you're no longer a director or secretary of the company.
ASIC can also ban you from being a company director in certain situations.

If you're not allowed to be a company director or secretary, you're not allowed to manage a company. It is a serious offence to set up dummy directors while you really manage the company.

Directors must also be 18 years or older.

What are your Responsibilities?
As a director, you must:

  • be honest and careful in your dealings at all times
  • know what your company is doing
  • take extra care if your company is operating a business because you may be handling other people's money
  • make sure that your company can pay its debts on time
  • see that your company keeps proper financial records
  • act in the company's best interests, even if this may not be in your own interests, and even though you may have set up the company just for personal or taxation reasons, and
  • use any information you get through your position properly and in the best interests of the company. Using that information to gain, directly or indirectly, an advantage for yourself or for any other person, or to harm the company may be a crime or may expose you to other claims. This information need not be confidential; if you use it the wrong way and dishonestly, it may still be a crime.

What work must you do as a Director?
You and any other directors will control the company's business. Your company's constitution (if any) or rules may set out the directors' powers and functions.

You must be fully up-to-date on what your company is doing:

  • Find out and assess for yourself how any proposed action will affect your company's business performance, especially if it involves a lot of the company's money.
  • Get outside professional advice when you need more details to make an informed decision.
  • Question managers and staff about how the business is going.
  • Take an active part in directors' meetings.

Only be a company director or a company secretary if you are willing, able and have enough time to put in the effort.

Avoid any company where someone offers to make you a director or secretary on the promise that 'you won't have to do anything' and 'just sign here'.
You could be exposing yourself to many legal liabilities.

What about record Keeping?
As a director, the law makes you personally responsible for keeping proper company records.

You must see that the company keeps up-to-date financial records that:

  • correctly record and explain its transactions (including any transactions as a trustee), and
  • explain the company's financial position and performance.
  • All companies must have financial records so that:
  • true and fair financial statements of the company can be prepared if needed
  • financial statements can be conveniently and properly audited if necessary, and
  • the company can obey the tax laws.

If your company is a 'small proprietary company' (as defined in the Corporations Act 2001) it will generally not have to prepare formal financial reports under the Corporations Act each year and lodge them with ASIC.
However, you must still keep financial records, and may need financial reports for managing and monitoring your company's financial position and performance for tax purposes or for raising finance.

Large proprietary companies and public companies - even non-profit public companies - must prepare financial reports, have them audited and lodge them with ASIC.

What are financial records?
Below are some of the basic financial records that the law may require a company to keep:

  • general ledger, recording all the company's transactions and balances (revenues, expenses, assets, liabilities etc.) or summarising transactions and balances detailed in other records
  • cash records - e.g. bank statements, deposit books, cheque butts, petty cash records
  • debtor and sales records - e.g. a list of debtors and their balances, delivery dockets, invoices and statements issued, a list of all sales transactions
  • creditor and purchases records - e.g. purchase orders, invoices and statements received and paid, unpaid invoices, a list of all purchases, a list of all creditors and their balances
  • wages and superannuation records
  • a register of property, plant and equipment showing transactions and balances in relation to individual items
  • inventory records
  • investment records, e.g. contract notes, dividend or interest notices, certificates
  • tax returns and calculations, e.g. income tax, group tax, fringe benefits tax and GST returns and statements
  • deeds, contracts and agreements.

A company would also normally prepare the following statements regularly (say, monthly) to manage its business performance and provide to lenders, etc:

  • Statement of Financial Performance - a statement showing the company's revenues and expenses and the profit or loss that results from these items
  • Statement of Financial Position - a statement showing the things of value the company owns and the debts the company owes, and
  • Statement of Cash Flows - a statement summarising cash inflows and outflows.

Get professional advice if you have any doubt about the content or type of financial records to keep. The lists above give examples only, because the financial records you need will vary from company to company.

You may keep some financial records electronically, but you must be able to convert them into hard copy so that you can give them to anyone entitled to inspect them. Make backup copies of electronic records regularly, for example weekly or daily.

 What if your company can't pay its debts?
You must ensure that your company is able to pay all of its debts as and when they become due for payment.
A company is 'insolvent' if it cannot pay all of its debts as they become due and payable.

By law, you must prevent your company from incurring a debt when it is insolvent or about to become so.
This means you must consider whether you have reasonable grounds to believe that the company will be able to pay a new debt when it becomes due, as well as pay all the other debts.

You may expose yourself to criminal prosecution, substantial fines or to action by a liquidator, creditors of the company or ASIC to recover amounts lost by creditors due to your actions. Your personal assets - not just your company's - may be at risk.

Common signs of financial trouble are:

  • low operating profits or cash flow from the main business
  • problems paying trade suppliers and other creditors on time
  • trade suppliers refusing to extend further credit to the company
  • problems with meeting loan repayments on time or difficulty in keeping within overdraft limits
  • legal action taken, or threatened, by trade suppliers or other creditors over money owed to them.

If your company is in financial difficulty or in danger of being insolvent, seek immediate advice from an insolvency professional.
They will be able to explain your options to you. Your options may include re-structuring your company's affairs, changing your company's activities or appointing a voluntary administrator or liquidator to the company.

Do not assume that you will be able to trade out of the problem.
Delay could be damaging to the company and to you personally, and may reduce the options available.

More Record Keeping!!!
All company officers must make sure that the company attends to some basic 'housekeeping' matters. The directors remain ultimately responsible for the company's compliance with the Corporations Act.

When a company is set up, you must:

  • register your company name with ASIC and obtain an Australian Company Number (ACN)
  • have a registered office. (If your company doesn't occupy the same address as the registered office, then you must have written consent from the person who occupies the registered office.)

Make sure that you:

  • display the company name at every place at which your company carries on business and that is open to the public. Also, a public company must display its name and the words 'registered office' prominently at its registered office.
  • display the company name, the words 'Australian Company Number' (or 'ACN') or 'Australian Business Number' (or 'ABN') and the relevant number on:
    • the common seal (if the company has one)
    • every public document of the company
    • every negotiable instrument (e.g. cheque, promissory note etc.) of the company, and
    • all documents lodged with ASIC.

Your company must keep:

  • registers of members (shareholders)
  • registers of option holders (if you have them)
  • minutes of general meetings
  • minutes of meetings of directors
  • registers of charges created by the company over company property, and
  • financial records that enable an assessment of the company's financial position and performance and are sufficient for financial statements to be prepared (and audited if necessary) for at least seven years after the transactions are completed

In Conclusion… Should I Incorporate?

I can’t give you the answer to the question.

As I stated at the beginning this is a very vexing question?
You should speak to your advisors before you decide.
The duties and responsibilities of being a Director are quite onerous, but a good advisor can assist you with those requirements and you are most likely adhering to most of the requirements in your business today.

The taxation benefits are quite attractive even though from a capital gains tax perspective there is a small penalty.
(However, capital gains tax can be legally avoided in certain circumstances).


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