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 requirements
• ASIC registrations
• ATO registrations and requirements
• 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

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, however, significant CGT concessions or CGT rollover relief may potentially be available to reduce or defer any capital gain. If business is transferred upon the death of a sole practitioner, any future CGT liability on the assets is transferred to the estate and/or the beneficiary.

Method of accounting
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 is conducting an accounting business with multiple employees, then the accruals method of accounting is most likely to be appropriate. The ATO’s view is that, where the taxpayer’s individual circumstances do not provide clear direction as to which accounting method is appropriate, the accruals basis should be used unless it is an ‘artificial, unreal and unreasonably burdensome method of arriving at the income derived’.

Losses
Tax losses can be offset against assessable income. 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.

Superannuation
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
Any working capital contributions by the practitioner to the practice will be sourced from ‘after tax’ dollars.

Analysis
If income derived by the practice is not regarded as PSI the main disadvantage of a sole practitioner structure is unlimited liability compared with the benefits of potential limited liability if operating the practice via a company structure or a trust with a corporate trustee.

Sole practice meets all forms of registration simply and is therefore the most inexpensive of all forms of practice structure.

If the business test is satisfied the practice has by definition achieved leverage and size. Consideration should then be given to converting the practice to some alternative form of entity, particularly from an asset protection perspective.

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 operating under a general law partnership. It can be a verbal agreement, or it can be put into writing. While a verbal agreement will suffice at law, a written agreement is preferable so that there is no misunderstanding amongst the partners, especially concerning the terms under which partners are admitted or retire or how profits and losses are shared.

CPA Australia requirements
A member, with prior approval, may practice with a member or members of a body specified in Appendix 2 of CPA Australia’s By-Laws. A member may practice with other persons or entities that the Board may approve provided the partnership:

• has a majority of capital under the control of members with a CPA Australia public practice certificate (PPC) and abide with the By-Laws regulating the holding of a PPC
• ensures that partners who are members are liable for the provision of professional services and conduct of any non-member partners
• abides with all other regulatory matters including quality assurance, professional and mandatory standards and professional indemnity insurance
• discloses on all stationery and other information provided to clients and potential clients the qualification and professional and business affiliations of partners.

Liability
Partners under a general law partnership 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 personal assets of the individual partners will therefore be potentially available to litigants and creditors.

If a partner is sued personally, the partner’s portion of the assets of the business will be available to creditors/trustee in bankruptcy. To partly mitigate such a liability, a prospective partner may consider holding their interest in a general law partnership via a company (or a trust with a corporate trustee) rather than as an individual partner.

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 in respect of trading stock and depreciating assets must be relied upon to cost-effectively pass control to the next generation of partners.

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 the following factors apply:

• the partnership is a general law partnership
• at least one of the partners is common to the partnership before and after the reconstitution
• there is no period where there is only one ‘partner’
• the partnership agreement includes an express or implied continuity clause or, in the absence of a written partnership agreement, the conduct of the parties is consistent with the continuity of the partnership’s business
• there is no break in the continuity of the enterprise or firm.

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. Further, each partner of the old partnership is taken to have disposed of part of their interest in the partnership asset and a CGT liability may arise. There are also separate tax implications arising from the transfer of trading stock and depreciating assets as well as collecting income from work-in-progress and debtors.

Method of accounting
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.

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

GST
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. A partnership is required to register if its projected annual turnover meets the registration turnover threshold, which is currently $75,000 for business taxpayers. 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
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
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 refine 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.

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

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 Capital Gains Tax rollovers and exemptions are potentially available, including the CGT discount and the CGT small business concessions on the disposal of a partner’s fractional interest in a partnership asset or business.

See the tax considerations section below.

A company is a legal entity formed by registration under the Corporations Act 2001. 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.

CPA Australia requirements
A member, with prior approval, may practice in an incorporated structure with a member of a body specified in Appendix 2 of CPA Australia’s By-Laws. A member may practice with other persons or entities that the Board may approve provided that in the incorporated entity:

• a majority of voting shares are held by members holding a CPA Australia public practice certificate (PPC) or a member of Chartered Accountants Australia and New Zealand (Chartered Accountants ANZ) holding a practising certificate
• a majority of directors’ voting rights are held by members holding a CPA Australia PPC or a member of Chartered Accountants ANZ holding a practising certificate
• the holding of the balance of any voting shares or the occupation of the office of a director by non-members shall be subject to the approval of the Board. Such non-members shall:
• hold such tertiary or other professional qualifications as may from time to time be approved by the Board or
• have demonstrated such competence, experience and skill in their profession as may be acceptable to the Board or
• be of such other commercial, community or educational status as the Board may approve.

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 Corporations law). Succession planning with a company structure can be well 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. The CGT consequences of passing shares to the younger generation will vary depending on the transfer method used.

Method of accounting
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.

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. 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.

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.

Superannuation
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
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.

Analysis
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 being the beneficiaries of the trust. 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.

CPA Australia requirements
A member, with prior approval, may practice through the medium of a trust with a member of a body specified in Appendix 2 of CPA Australia’s By-Laws. A member may practice with other persons or entities that the Board may approve provided that:

• the trustee of the trust is either
• a member or members all of whom hold a PPC issued by CPA Australia or
• an incorporated entity approved by the Board in accordance with By-Law 9.3, the majority of the directors of which are holders of a PPC issued by CPA Australia or
• if there is more than one trustee, a member or members who hold a PPC issued by CPA Australia and a member of his or her or their family as defined in the By-Laws.

• the ability of the member to conduct the practice is not impaired in any way by the trust arrangement
• the practice conducted by the member maintains an adequate working capital
• control of the practice and of any trust, its assets and income remain with the member, the partners or directors and shareholders holding a CPA Australia PPC
• the trust is not so arranged as to result in any creditors receiving less than they would have received if the member practised in corporate form
• the practice is conducted in a manner which complies with the Constitution, By-Laws and Code of Professional Conduct of CPA Australia
• income from the trust is shared only by beneficiaries who are:
• members or their family
• entities of which a member or their family or both, are the sole owners
• non-member directors of a practice company approved by the Board or entities of which those persons or their families or both, are the sole beneficiaries.

Liability
If a trustee is sued, the trustee’s own assets may be at risk. A company is often appointed as the corporate trustee, and its only asset (other than share capital) is generally its right to be indemnified under the trust deed to the extent that the trust has net assets. The appointment of a corporate trustee together with a carefully drafted trust deed can provide some form of limited liability protection.

Succession
Discretionary trusts offer many succession planning opportunities. The key advantage is that control of a trust can generally pass to the next generation without triggering stamp duty or CGT liabilities.

Method of accounting
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 employees, then the accruals method of accounting is most likely to be appropriate.

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 whether the trust is a fixed or non-fixed trust for tax loss purposes. However, losses may be able to be transferred if the trust is a subsidiary member of a consolidated group.

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.

Superannuation
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.

Financing
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.

Analysis
CPA Australia rules permit the use of trusts, although the use of a corporate trustee does not currently meet insolvency registration requirements. The Tax Practitioners Board does not require notification of a trust relationship but rather regulates the trustee, which can be an individual or a company. Corporate trustees provide the potential benefit of some limited liability if the trust deed is appropriately worded.

As CPA Australia rules permit beneficiaries to include associated family and entities, income tax planning opportunities exist for trusts that satisfy the relevant income tax requirements. Capital gains tax concessions including the 50 per cent CGT discount and the CGT small business concessions are potentially available if the relevant eligibility requirements are met.

See the tax considerations section below.

A partnership of discretionary trusts 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. This corporate manager would be the party that would deal with the public.

CPA Australia requirements

Refer to information in the above Partnership and Trust sections.

Liability

Discretionary trusts with corporate trustees provide the beneficiaries with asset protection if the trustee’s right of indemnity is limited to the net assets of the trust under the trust deed. Any losses of the partnership cannot be passed through the discretionary trust to be utilised by the beneficiaries but may be applied to reduce other assessable income if appropriately structured. The discretionary trust, but not the beneficiaries, will be able to claim interest deductions on borrowings used to acquire an interest in the partnership. If the discretionary trust has any other assets, those assets will be exposed to the risks to which the partnership is exposed. Therefore, it is often recommended that new trusts be established, which become the partners.

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 in respect of trading stock and depreciating assets must be relied upon to cost-effectively pass control to the next generation of partners. Generally, the ATO will treat a changed partnership as a reconstituted continuing entity if the original partnership agreement included a provision for a change in membership or shares and the following factors apply:

• the partnership is a general law partnership
• at least one of the partners is common to the partnership both before and after reconstitution
• there is no period where there is only one partner
• the partnership agreement includes an express or implied continuity clause or, in the absence of a written partnership agreement, the conduct of the parties is consistent with continuity
• there is no break in the continuity of the enterprise or firm (that is, the partnership’s assets remain with the continuing partnership and there is no change to the nature of the business).

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. Further, each partner of the old partnership is taken to have disposed of part of their interest in the partnership asset and a CGT liability may arise. There are also implications for the transfer of assets such as trading stock, work-in-progress, debtors and depreciating assets.

Method of accounting

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 the conduct of an accounting business with multiple employees, then the accruals method of accounting is most likely to be appropriate.

Losses

Generally, trusts are not able to distribute losses to beneficiaries and are also subject to special rules when carrying forward or utilising losses. Separate complex rules apply depending on whether the trust is a fixed or non-fixed trust for tax loss purposes. However, losses may be able to be transferred if the trust is a subsidiary member of a consolidated group.

GST

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. A partnership is required to be registered if its projected annual turnover meets the registration turnover threshold, which is currently $75,000 for business taxpayers. Upon formation of a partnership, 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

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

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.

Analysis

This structure owes its popularity to the fact that it offers a number of potential benefits if properly structured, including access to the CGT discount and the CGT small business concessions and offers potential limited liability if the trustee is a corporate trustee whose right of indemnity is limited to the trust’s net assets. A partnership of discretionary trusts is a structure which can now be registered by the Tax Practitioners Board under TASA irrespective of whether the trustee is an individual or a company.

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’).

There are two ways such arrangements can be challenged. The general anti avoidance rules in Part IVA of the Income Tax Assessment Act 1936 (the ITAA 1936) can apply in certain circumstances to cancel any tax benefit obtained because of income splitting. In addition, there are specific rules concerning the alienation of personal services income (PSI) which are contained in Part 2-42 of the Income Tax Assessment Act 1997 (the ITAA 1997).

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). For example, an accounting practitioner who derives income mainly through their personal efforts would prima facie appear to be deriving PSI.

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)
• Tax office takes on professionals over income splitting

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.

The Tax Agent Services Act 2009 (the TASA) requires, amongst other things, that 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 Professionalspdts@ato.gov.au

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