Lawyers entering and exiting an incorporated legal practice could be subject to tax on amounts that they will never receive under a series of new determinations recently released by the Australian Tax Office (ATO).
According to Grant Thornton partner Bill Shew, the ATO's Final Determination (TD 2011/26) presents a potential problem for incorporated practices which have a trust as a shareholder, and calls into question the incorporated practice structure.
"If one shareholder is a trust or company, all of the shareholders [of a practice] will suffer the fate of the Determination," Shew told Lawyers Weekly.
"A number of partnerships have evolved over time and [have] either incorporated or [are] incorporating trusts in a partnership arrangement. I'm aware of a number of corporates that have trusts in them and partnerships that have trusts in them and are no-goodwill practices. We're actually talking to them now."
According to Shew, as a result of the ATO's Final Determination and two draft determinations (TD 2011/D9 and TD 2011/D10), all legal practices should review their structures to ensure they are not adversely affected by the views put forward by the ATO.
Targeted at "no goodwill" incorporated practices, Shew said the Determinations have broader implications.
"The ATO will now only accept that principals coming and going from these practices will be taxed at nominal values for their equity where certain narrow conditions are met. A major condition is that the practice cannot be owned, even in part, by family companies or trusts," he said.
"If these conditions are not met, incoming principals may be subject to tax on the difference between the market value of their share of the business and what they pay to enter. Similarly, on exit, principals will be subject to tax on the market value of their shares despite receiving only a nominal payment on exit."
Shew said while legal practices are increasingly using alternative structures, the ATO is still applying concepts that it developed in relation to traditional partnerships, and with the new Determinations, is undermining the commercial basis of these new structures, which will limit their effectiveness.
"As more practices are incorporating, the tax office is concerned about that and potential leakage of revenues," he said. "So it has really come down and said, 'We're happy for you to be an incorporated practice but we believe that each shareholder needs to be an individual'."