When choosing the trading structure for a legal practice, it is important to understand and abide by the Legal Profession Uniform Law (NSW), and ensure you meet these obligations where legal services are to be provided.
For a legal practice, there are numerous issues to consider. The difficulty is that there is no single formula or method that will determine the best structure for a particular legal practice. In every case, the practice will have different facts and circumstances that need to be taken into consideration and may affect the choice of structure.
Further, legal practice owners will have needs, goals and outcomes that they will want to maximise over the lifetime of the practice. Many of the desired goals and outcomes may be mutually exclusive. Therefore, some form of compromise will likely be necessary. For example, some structures may provide a good capital gains tax (‘CGT’) result but are a poor way to minimise income tax, or may not be optimal from an asset protection perspective.
In conjunction with determining your trading structure, thought needs to be given to your greater group structure. Some of the structures discussed below while not available for your practice entity, may be suitable for supporting your practice and/or for investment purposes. Giving attention to each part of your structure and the connection (or disconnection) between each can be a valuable step in ensuring optimum outcomes.
It is also worth noting that the structure established today may not be appropriate for what happens tomorrow. The right structure will take into account the future needs of the practice and will be able to grow with the practice owners and afford a considered exit strategy.
While the legal concepts of structuring are generally well understood (the science), it is combining these concepts with the day-to-day practical matters that is most difficult (the art). The appropriate structure will take into consideration several issues including (but not limited to) the following:
- access to the CGT 50% discount;
- access to the small business CGT concessions;
- flexibility to distribute income and capital;
- marginal tax rates of participants;
- ability to recoup losses;
- asset protection;
- potential new partner entry
- future funding requirements;
- exiting and succession planning;
- compliance costs; and
- estate planning.
Below, we have put together a high-level summary of the how the objectives above work with the legal structures available and is a useful guide for a “whole of practice “ approach to structuring.
|
Issue |
Sole Trader |
Partnership |
Discretionary Trust |
Unit Trust |
Company |
|
Can provide Legal Service |
Yes |
Yes |
No |
No |
Yes |
|
Access to the CGT |
Yes |
Yes |
Yes |
Yes |
No |
|
Small Business CGT |
Yes |
Yes |
Yes – subject to the significant individual test in some circumstances |
Yes – subject to the significant individual test in some circumstances |
Yes – subject to the significant individual test in some circumstances |
|
Flexibility to distribute |
None |
Some depending on partnership agreement |
Good |
Limited but will depend on the classes of units on issue |
Limited but will depend on the classes of shares on issue |
|
Tax rate |
Marginal tax rate of the individual |
Tax rate of the partners |
Tax rate of the beneficiaries. Trustee may also be taxed in some circumstances |
Tax rate of the |
25% or 30% depending on if the company is a ‘Base Rate Entity’ |
|
Ability to recoup losses |
Yes - straightforward |
Yes – losses will be available to the partners |
Yes – subject to complex tests |
Yes – subject to complex tests |
Yes – subject to complex tests |
|
Asset protection |
Poor – sole trader personal assets at risk |
Poor – partners are joint and severally liable for debts of the partnership |
Good – increased with use of a corporate trustee |
Good |
Good – corporate |
|
Future funding |
Can only be |
Can only be |
Can only be achieved with debt |
Yes |
Yes |
|
Potential new partner entry |
Difficult |
Difficult |
Difficul |
Yes |
Yes |
|
Compliance costs |
Low |
Low |
Medium-high |
Medium-high |
Medium-high |
|
Exiting and succession |
Requires sale of business assets |
Requires sale of partnership assets |
Requires the sale of business assets unless family succession |
Can be achieved through the sale of units – may be complicated if there is a Family Trust Election is in place |
Can be achieved through the sale of shares |
If you are thinking of starting a business, the team at Cutcher & Neale can help you understand the pros and cons of different business structures, provide professional advice on the tax implications of each and on which structure will suit your needs now and into the future.
