Firm structures

General matters to consider when choosing and establishing a structure include:

Asset protection

• Consider holding investment and personal assets separately from at risk business exposures
• Consider full range of insurance cover for various business risks not just professional indemnity

Compliance with relevant regulatory requirements

• CPA Australia By-Laws
• Accounting Professional and Ethical Standards Board standards
• TASA, ASIC and ATO requirements in Australia
• Inland Revenue requirements in New Zealand
• Other licensing and regulatory requirements

Constituent documents

• Partnership agreement
• Company constitution
• Shareholder agreement
• Management deed
• Trust deed
• Unitholder agreement
• Service agreements
• Other legal requirements

Key events
Enshrine terms in the constitution documents in order to minimise the risk of future disputes between commercial partners. Common matters include:

• Working capital
• Gearing policy
• Formal voting resolutions
• Dispute resolution
• Profit share
• Valuation of the practice
• Partnership changes
• Entry and exit rules

A sole practitioner, also called a sole trader or sole proprietor, is an individual undertaking business and/or investment activities in their own name for their own benefit. The legal status of a sole practitioner is not separate from the individual.

Liability
A sole practitioner is exposed to the risk of unlimited liability associated with their practice. In the event that the business is sued (e.g. because of negligent sub-standard work or representations made in respect to the undertaking of the work) the assets of the individual will be available to litigants and creditors to settle a claim. In the event that the individual is sued personally, the assets of the business will be available to creditors or the trustee in bankruptcy.

Succession
During the lifetime of the sole practitioner, a transfer of business assets will result in potential tax liabilities in both Australia and New Zealand. In addition, in Australia, significant CGT concessions or rollover relief may potentially be available to reduce or defer any capital gain.

Method of accounting
For Australian entities, if the practice consists solely of the income producing activities of the sole practitioner, then the cash method of accounting should be adopted. If the practice has at least as many non-principal practitioners as principal practitioners, then income is considered to be derived from the business structure and should be accounted for on an accruals basis. A cash basis is appropriate where services rendered by employees are only subsidiary to the professional work for which the practitioner’s fees or costs were charged to clients.

For New Zealand entities, the cash method of accounting may only be appropriate in a very limited number of circumstances. As a general rule, a full-time sole practitioner would likely use the accrual method. This will consider amounts to be derived at balance date if there is an entitlement to bill, even if no actual invoice has been issued.

Losses
Tax losses can be offset against assessable income. For Australian entities, non-commercial loss rules operate to defer the tax deduction for losses incurred in relation to business activities unless the activity satisfies certain criteria.

GST
A sole practitioner is required to be registered if they are carrying on an enterprise and their projected annual turnover meets the registration turnover threshold, which is currently $75,000 for business taxpayers in Australia and NZ$60,000 in New Zealand.

Superannuation
In Australia, sole practitioners can claim a deduction for personal superannuation contributions made to a complying superannuation fund, provided various conditions are met. Alternatively, sole practitioners can set up administration companies to provide themselves with access to employer-sponsored superannuation contributions.

Financing
For Australian entities, any working capital contributions by the practitioner to the practice will be sourced from ‘after tax’ dollars.

For New Zealand entities, interest deductions are available where a nexus exists between incurring an interest expense and deriving assessable income.

Analysis
Sole practice meets all forms of registration simply and is therefore the most inexpensive of all forms of practice structure. The main disadvantage of a sole practitioner structure is unlimited liability which many of the other structures are able to limit. Consideration should be given to personal asset protection, such as in the form of a family trust.

See the tax considerations section below.

A general law partnership is an association of two or more individuals or entities that carry on business in common with a view to making a profit or gain.

A partnership agreement should be entered into which sets out the contractual relationship between the parties. It can be a verbal agreement, or it can be put into writing. While a verbal agreement may suffice at law, a written agreement is preferable.

In New Zealand, a limited partnership is a separate legal entity but is treated as a general partnership from an income tax perspective. A limited partnership must have at least one limited partner and one general partner and parties are required to enter into a written partnership agreement. Restrictions in relation to the management of the partnership may well restrict the ability of CPA Australia members to utilise such a structure and legal advice should be sought in this regard. 

CPA Australia requirements
Under CPA Australia By-Law 9.3(a)(i), the partners of the partnership should be:

1. “only Members who hold a Public Practice Certificate; or
2. at least one Member who holds a Public Practice Certificate together with only the following persons (Approved Controllers):
   1. Members (who do not hold a Public Practice Certificate but who are also members of a body specified in Appendix 1 and are permitted by the constitution of such body to provide Public Accounting Services);
   2. such members of a body specified in Appendix 2 as shall be permitted by the constitution of such body to provide Public Accounting Services; and/or
   3. such other person or entity as the Board may, upon such terms and conditions as the Board may in the discretion of the Board determine, approve either generally or in any particular case taking into account, in the case of a natural person, the following matters:
      1. the tertiary or other professional qualifications possessed by the person;
      2. competence, experience or skill demonstrated by the person in their profession or calling;
      3. the commercial, community or educational status of the person; and
      4. such other matters as the Board may prescribe either generally or in any particular case;
3. a body corporate or bodies corporate complying with By-Law 9.3(b); and/or
4. a trust or trusts complying with By-Law 9.3(c).”

Liability
Individual partners are exposed to the risk of joint and several liability for the debts of the partnership and their liability is unlimited. In the event that the partnership is sued, the assets of the individual partners will potentially be available to litigants and creditors.

Succession
Partnerships do not provide for easy passing of control between generations. Where partnerships are used significant tax planning and the use of tax elections must be relied upon to cost-effectively pass control to the next generation.

In Australia, the ATO will treat a changed partnership as a reconstituted continuing entity if the original partnership agreement incorporated a provision for a change in membership of the partnership and a number of factors are met. In other circumstances, where an existing partner retires or a new partner is admitted, the partnership is deemed to cease and a new partnership created. This requires two tax returns to be lodged in the income year the change occurs, among other steps.

In New Zealand, ITA 2007 provisions provide for safe harbour and thresholds as to when a disposal of a partner’s interest will result in tax liabilities.

Method of accounting
For Australian entities, if the practice consists solely of the income producing activities of the partners, then the cash method of accounting should be adopted. If the practice is conducting an accounting business with multiple employees, then the accruals method of accounting is most likely to be appropriate.

For New Zealand entities, the cash method is inappropriate for professional service firms conducted through a general partnership.

Losses
Tax losses are allocated to the partners, generally in the same proportions as partnership income is distributed. In certain circumstances in Australia, the application of the non-commercial loss rules will need to be considered.

GST
A partnership is required to register if its projected annual turnover meets the registration turnover threshold, which is currently $75,000 for business taxpayers in Australia and NZ$60,000 in New Zealand.

Further, in Australia, the ATO’s view is that, with the exception of a partnership carrying on an activity without a reasonable expectation of profit or gain, a general law partnership carries on an enterprise and may register for GST from the time it is formed. Upon formation, the partners each acquire an interest in the entity. The partners’ consideration for their interests can include capital contributions or the promise to provide services, labour or skills.

Superannuation
In Australia, individual partners can claim a deduction for personal superannuation contributions made to a complying superannuation fund, subject to conditions, including capping concessional contributions to $25,000.

Alternatively, individual partners can set up administration companies to provide themselves with access to employer-sponsored superannuation contributions, as long as the company is established for the purpose of providing employer-sponsored superannuation benefits for professional practitioners. Individuals automatically include an amount equal to the sum of any excess concessional contributions in their assessable income but can claim a non-refundable tax offset equal to 15 per cent of their excess concessional contributions.

Financing
In Australia, capital contributions can be made from after-tax profits of each partner. Interest deductions on borrowed funds are available where a general law partnership borrows money to refinance partnership capital. Only the partners’ contributed capital can be refinanced using interest deductible loans. Interest incurred on borrowings used to finance a distribution from an asset revaluation reserve or an unrealised profit is not deductible.

In New Zealand, interest deductions are available where a nexus exists between incurring an interest expense and deriving assessable income.

Analysis
CPA Australia regulations restrict partnerships to suitably qualified parties holding a public practice certificate. Partnerships otherwise meet all form of regulatory requirements simply.

In Australia, as most partnerships have the size to meet the taxation business test, taxation planning through the use of service trusts (or other service entities) is typically possible. Individual income tax rates apply to a partner’s share of a partnership’s net income but CGT rollovers and exemptions are potentially available.

In New Zealand, individual income tax rates apply and there is unlimited liability of individual partners for the debts of the partnership.

See the tax considerations section below.

A company is a legal entity formed by registration under the Corporations Act in Australia and New Zealand. It is a legal person that acquires legal rights and liabilities (i.e. it can sue and be sued in its name). A company acts through its management, directors and members. Directors and management of a company are its controllers. Members (i.e. shareholders) are the owners of the company.

In addition, New Zealand members may consider a look-through company structure, which is a company which has filed an election with the Internal Revenue Department. It provides for a transparent entity which is a hybrid of a company and a sole trader or partnership. It acts through its management, directors and members. Directors and management of a company are its controllers.

CPA Australia requirements
Under CPA Australia By-Law 9.3(b)(i), being a body corporate:

1. "the directors of which comprise:
   A. only Members who hold a Public Practice Certificate; or
   B. at least one Member holding a Public Practice Certificate together only with Approved Controllers; and
2. any change in Control:
   A. must be notified to CPA Australia by no later than 10 Business Days prior to the change occurring, accompanied by the Structural Profile applying after the change; and
   B. will not be effective unless so notified to CPA Australia; and
3. Public Accounting Services shall be provided at all times in accordance with the minimum professional, ethical and technical requirements from time to time contained in these By-Laws, Code of Professional Conduct and all other rules and pronouncements contained in or made under authority of the Constitution."

Liability
If the business is sued, only the assets of the company are available to creditors. The shareholders’ other assets are protected other than for unpaid share capital. However, shareholders need to be aware of their potential personal liabilities. In some circumstances, a director may be found to be personally liable for certain tax debts. Where such situations occur, the director’s personal assets may be used to pay those outstanding amounts. If the director has insufficient assets, that person may also be made bankrupt.

Succession
Companies have perpetual succession (subject to complying with the law). Succession planning with a company structure can be planned so that the shareholdings and directorships of a company gradually pass to the next generation. Importantly, a company is unaffected by the death of a shareholder. In Australia, the CGT consequences of passing shares to the younger generation will vary depending on the transfer method used.

Method of accounting
For Australian entities, the cash accounting basis would only typically be appropriate where a sole practitioner is conducting a practice via a company as the income derived will be attributable to the personal exertion of that practitioner. If the practice is conducting an accounting business with multiple employees, then the accruals method of accounting is most likely to be appropriate. However, if the company has no fee-earning employees, the cash method should be adopted.

For New Zealand entities, the cash method is inappropriate for professional service firms conducted through a company structure.

Losses
Complex rules govern the way in which companies can use prior year and current year tax and capital losses. Losses are quarantined, meaning they stay within the company and cannot be distributed to shareholders.

For Australian entities, the continuity of ownership test (COT) or the same business test (SBT) must currently be satisfied for a company to use or carry forward prior year losses. Losses cannot be transferred between companies in a wholly owned group, unless the companies are part of a consolidated group for income tax purposes.

For New Zealand entities, the continuity of ownership test must be satisfied for a company to carry forward or offset losses. A look-through company does not retain any losses and instead the losses are passed through to the look-through owners.

GST
A company is required to be registered for GST purposes if its projected annual turnover meets the registration turnover threshold, which is currently $75,000 for business taxpayers in Australia and NZ$60,000 in New Zealand.

Superannuation
In Australia, a company is entitled to claim a deduction for 100 per cent of the superannuation contributions it makes on behalf of its employees who are subject to a concessional contributions cap of $25,000. However, an individual will automatically include an amount equal to the sum of any excess concessional contributions made on their behalf in their assessable income but can claim a non-refundable tax offset equal to 15 per cent of their excess concessional contributions.

Financing
In Australia, a company can refinance its working capital and can deduct interest on the replacement borrowings. A company will not, however, obtain an interest deduction on funds borrowed to finance a distribution of unrealised profits, such as a dividend from an asset revaluation reserve arising on the revaluation of an asset such as internally generated goodwill.

In New Zealand, a company has an automatic deduction for interest incurred. This rule does not apply to a qualifying company or a look-through company.

Analysis
For New Zealand entities, the company structure provides a member with the protection of limited liability and is able to separate management and ownership of a practice. It provides for easy transfer of ownership but is administratively more difficult than some of the previous structures. A look-through company offers the benefit of limited liability while remaining a tax transparent entity attributing all income and losses to the look-through owners. Whilst tax or BAS services and financial advisory services can be conducted by a company, currently audit and insolvency services must be conducted by individuals either as a sole practitioner or in a partnership.

For Australian entities, if the practice derives income which is regarded as PSI, the sole benefit of incorporation is the potential for limited liability to apply. For practices that satisfy the PSI rules, the lower corporate tax rate needs to be compared with potential capital gains tax disadvantages on sale as a company is not eligible to claim the 50 per cent CGT discount on the disposal of its CGT assets.

Whilst tax or BAS services, audit services, and financial advisory services can be conducted by a company, currently insolvency services must be conducted by individuals either as sole practitioners or partnerships. Only an authorised audit company formally registered with ASIC can conduct audit services.

See the tax considerations section below.

A trust is a legal relationship whereby a trustee holds the legal interest or title in trust property for the benefit of others (i.e. beneficiaries). A trust is controlled by one or more trustees, who can either be individuals or companies (i.e. corporate trustees). Trustees owe fiduciary obligations to the beneficiaries of the trust and must act in their best interests. There are two basic forms of trusts, discretionary trusts and fixed trusts.

In Australia, a partnership of discretionary trust structure is simply a number of discretionary trusts acquiring assets in partnership. Typically, they would be governed by a partnership agreement and a corporate manager would be appointed to conduct the partnership’s business.

CPA Australia requirements
Under CPA Australia By-Law 9.3(c)(i), members may practice through a trust:

1. “the trustee(s) of which comprise:
   
   1. Member holding a Public Practice Certificate or Members holding Public Practice Certificates;
   2. a body corporate (or bodies corporate) complying with By-Law 9.3(b);
   3. a Member (or Members) holding a Public Practice Certificate and a body corporate (or bodies corporate) complying with By-Law 9.3(b); or
   4. only a Member (or Members) holding a Public Practice Certificate and/or a body corporate (or bodies corporate) complying with By-Law 9.3(b) and an Approved Controller or Approved Controllers; and
2. which is Controlled by a Member holding a Public Practice Certificate or Members holding Public Practice Certificates or at least one Member holding a Public Practice Certificate together with Approved Controllers; and
3. the trust deed or other instrument constituting the trust contains the Approved Provisions.”
   
   

Liability
If a trustee is sued, the trustee’s own assets may be at risk, hence many trusts use a corporate trustee.

Succession
Trusts offer many succession planning opportunities. The key advantage being that, depending on the type of trust utilised, control can generally pass to the next generation without triggering tax consequences.

For succession issues with a partnership of discretionary trusts, see the Partnerships section.

Method of accounting
For Australian entities, cash accounting will be appropriate if the trustee is a sole practitioner operating through a trust. This is because the income of the trust will be for the personal exertion of the sole practitioner. If the practice is conducting an accounting business with multiple fee earning employees, then the accruals method of accounting is most likely to be appropriate. For methods of accounting with a partnership of discretionary trusts, see the Partnerships section.

For New Zealand entities, the cash method is inappropriate for professional service firms conducted through a trust structure.

Losses
Trusts are not able to distribute losses to beneficiaries and there are also special rules relating to the carrying forward or utilisation of tax losses. Separate complex rules apply, depending on the type of trust.

GST
As the trust itself has no legal entity, it is the trustee who will be required to be register for GST in their capacity as trustee if the projected annual turnover of the trust meets the registration turnover threshold, which is currently $75,000 for business taxpayers in Australia and NZ$60,000 in New Zealand.

For GST issues for partnership of discretionary trusts, see the Partnerships section.

Superannuation
In Australia, a trust will be entitled to claim a deduction for 100 per cent of the superannuation contributions made on behalf of its employees who are subject to a concessional contributions cap of $25,000. However, an individual will automatically include an amount equal to the sum of any excess concessional contributions made on their behalf in their assessable income but can claim a non-refundable tax offset equal to 15 per cent of their excess concessional contributions.

For partnership of discretionary trust entities, the Commissioner of Taxation accepts that one of the purposes for which administration companies have been set up by partnerships has been to enable employer-sponsored superannuation benefits to be provided to the partners. For such entities to be accepted by the Commissioner, there must be no element of income diversion and the superannuation contributions must be made to a complying superannuation fund.

Financing
For Australian entities, a trust can refinance its working capital and obtain an interest deduction on replacement funds borrowed. However, no such interest deduction will be available to fund a payment from an unrealised profit or asset revaluation reserve.

For partnership of discretionary trust entities, capital contributions can be made with after-tax retained profits. Interest deductions are available where a general law partnership borrows money to refinance partnership capital. Only the partners’ contributed capital can be refinanced using interest deductible loans. Interest on borrowings used to finance a distribution from an asset revaluation reserve or unrealised profits is not deductible.

For New Zealand entities, interest deductions are available where a nexus exists between incurring an interest expense and deriving assessable income.

Analysis
CPA Australia rules permit the use of trusts and beneficiaries who are associated with family and entities, although the use of a corporate trustee does not currently meet insolvency registration requirements in Australia. This allows some income tax planning opportunities for trusts that satisfy the relevant requirements. Corporate trustees provide the potential benefit of some limited liability.

In Australia, CGT concessions are potentially available if the relevant eligibility requirements are met. The Tax Practitioners Board does not require notification of a trust relationship but rather regulates the trustee. A partnership of discretionary trusts structure can be registered by the Tax Practitioners Board. This structure owes its popularity to the fact that it offers a number of potential benefits if properly structured.

See the tax considerations section below.

Capital gains tax (CGT)

• Consider your ability to access the 50 per cent CGT discount under Division 115 of the ITAA 1997
• Consider your ability to access CGT small business concessions

Income splitting

When deciding on the most appropriate structure for your practice, you must consider the tax law dealing with alienation of personal services income (‘income splitting’). These arrangements can be challenged under the Income Tax Assessment Act 1936 (the ITAA 1936).

There are specific rules concerning the alienation of personal services income (PSI). PSI is income that is derived mainly as a reward for the personal efforts or skills of an individual (where ‘mainly’ means more than half).

Where the PSI is derived through a company, partnership or trust, such an entity is regarded as a personal services entity (PSE) under the PSI rules. The PSI may be attributed by the PSE to the individual providing the personal services in certain circumstances.

If the PSI rules apply, they affect how you report your PSI to the Australian Taxation Office (ATO) and the deductions you can claim. If the PSI rules don't apply, your business is a personal services business (PSB). When you're a PSB, there are no changes to your tax obligations, except that you need to declare any PSI on your tax return.

You can receive PSI even if you're not a sole trader. If you're producing PSI through a company, partnership or trust and the PSI rules apply, the income will be treated as your individual income for tax purposes.

The first thing you need to do is work out if any of your income is classified as PSI. If it is, you then need to work out if special tax rules (the PSI rules) apply to that income. There's a series of steps to follow to help you do this.

Find out more

• Working out if the PSI rules apply
• What to do when the PSI rules apply
• What to do if the PSI rules don’t apply
• ATO PSI guide for companies, partnerships and trusts (PDF)

Non-Commercial Losses (NCL)

Tax losses of an individual or an individual partner in a partnership may be disallowed as non-commercial losses (NCL) under Division 35 of the ITAA 1997 in certain circumstances. Note that these rules do not apply to trusts or companies but trusts and companies are subject to their own loss recoupment rules.

Under the NCL rules, the loss cannot be offset against the individual or partner’s other income, such as salary and wages, but must be deferred until such time that a taxable profit is returned from that activity (e.g. as a sole trader or individual partner carrying on a business as an accountant).

Typically, NCL will be an issue on the commencement of businesses rather than in subsequent years. However, there are four general exemptions that may potentially apply to an accounting practice and satisfying any of these four tests enables the loss to be claimed in the year it is made.

1. Assessable income test
2. Profits test
3. Real property test
4. Other assets test

In addition, an individual can only deduct the tax losses that meet any of the above tests so long as they also satisfy a personal income requirement.

Failing all of these tests, including the income requirement, the individual or partner can request the Commissioner to exercise his discretion and allow the loss under section 35-55 of the ITAA 1997.

Find out more

• Determine if you offset or defer the loss
• Four NCL tests
• Commissioner’s discretion

Service trusts

Service trusts (or other service entities) operate alongside the practitioner’s practice (which can be an individual, partnership, company, trust or any combination of these) to provide services to the practice which may typically include the provision of plant and equipment; the employment of staff; the payment of overheads and utilities; the lease of premises; and the collection of debtors.

Registered tax practitioners must disclose any services outsourced to any third party including a related service entity or trust. Such practitioners need to make such disclosure in their engagement letters so that clients are notified of any services provided by a service entity.

Find out more

• What is a service arrangement?
• ATO non-binding guide: Your Service Entity Arrangements (PDF)

Substantiation

Consider the substantiation rules for the following:

• Car expenses and business travel expenses

Allocation of professional practice income

The ATO assesses the risk of the general anti-avoidance provisions of Part IVA of the ITAA 1936 applying to the allocation of an individual practitioner’s share of profits from a professional services firm carried on through a partnership, trust or company to associated parties, where the income of the firm did not constitute PSI under Divisions 84 to 87 of the ITAA 1997.

Individual professional practitioners contemplating entering into new arrangements are encouraged to engage with the ATO through:

• early engagement
• email at [email protected]

Converting structures

Where a practitioner decides to convert their business structure, consideration should be given to the possible tax implications. In particular, you should consider whether there is a disposal of a valuable asset for CGT purposes and whether the CGT rollovers or the CGT discount and the CGT small business concessions can apply to defer, reduce or eliminate any capital gain. You should also consider whether the new structure is likely to be eligible for these concessions on any eventual sale. In addition, the transfer of work-in-progress may be separately taxable and the sale of the business will be subject to the GST provisions.

Find out more

• Changing business structure
• Changing, selling or closing your business – things to consider
• Small business restructure rollover
• Small business CGT concessions

Goods and Services tax (GST)

Regardless of the business structure, an entity will have to register for GST if the projected annual turnover meets the registration threshold, currently NZ$60,000.

Income splitting

When deciding on the most appropriate structure for your practice, you must consider the tax law dealing with the derivation of income from personal services and income splitting.

These arrangements can be challenged under the Income Tax Act 2007 (the ITA 2007). In addition, there are specific rules to disallow excessive renumerations being paid to relatives.

General anti-avoidance rules limit the ability of taxpayers to structure their affairs in a manner which would alter the incidence of tax. The Inland Revenue Department has a strong focus on schemes which attempt to reallocate income from personal services.

Find out more

• Inland Revenue: Revenue Alert RA 11/02

Converting structures

Where a practitioner decides to convert their business structure, consideration should be given to the possible tax implications. For example, depreciation recovered and tax avoidance. In addition, the transfer of work-in-progress may be separately taxable and the sale of the business may be subject to GST.

Find out more

• Choose a business structure
• Starting a new business