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Financial management: Consideration must follow invitation

Every Issue

Cite as: April 2011 85(4) LIJ, p.79

The excitement at being invited into partnership should not overshadow other key factors affecting such a move.

Being invited into partnership is one of the most exciting times in a professional’s career. The decision to invite new partners will not have been taken lightly by the existing partners. But just as equally, partnership issues should not be taken lightly by you as the candidate.

The relevance of the following factors will depend on the size and structure of the firm, practice area, history of the firm, and whether or not the invitation is to become a salary or equity partner.

The key issues for consideration can be broken into:

  • commercial;
  • asset protection; and
  • taxation.

Commercial

Like entry into any business, it is important to understand the commercial implications. Issues to consider include:

  • How profitable is the partnership?
  • Can it sustain new partners?
  • How are profits shared?
  • What is the structure of the practice?
  • Is there a financial contribution required? If so, what is the contribution being made towards?
  • What contributions may be required in the future?
  • How are contributions financed?
  • What are the strategic plans for the practice?
  • What is the age profile of the partners?
  • What is the firm’s external debt profile?
  • What security or guarantees will be required?
  • Are the practice’s financial statements and affairs in order?
  • What are the terms of the partnership agreement?

It is unusual for the invitation to join partnership to be unexpected. In most cases, many of these issues should be discussed and worked through over a period of time preceding the invitation.

Asset protection

With proper planning, the risks and exposures of partnership can be minimised.

The first line of defence is the firm’s professional indemnity coverage. The firm’s level of cover and ability to fund amounts payable that fall below the excess should be well understood.

You should review your personal asset position and determine whether or not those assets are at risk. There are legitimate asset protection strategies that may be used and you should seek professional advice in this area as the changes to the legislation have been quite complex.

For example, while it has been common previously to transfer a partner’s interest in the family home to a spouse or a family trust, this asset protection strategy is now with some risk as the “clawback rules” governing transfers of such assets have changed.

Subject to the tax structure of the practice, the use of discretionary trusts, preferably with a corporate trustee, may enhance your asset protection as a partner.

Estate planning considerations may also change along with risk profile. Consideration should be given to the use of testamentary trusts to manage assets on the death of adult family members.

The best asset protection strategies can come unstuck because of poor estate planning and failure to get professional advice.

Tax

While the tax implications of partnership are important, they should only be considered after commercial and asset protection issues are resolved.

The tax structure with which your investment in the practice will be held is largely driven by the structure of the practice and, in some cases, by the area of law practised. Typical considerations include:

If work in progress (WIP) is being acquired, the cost may be deductible upfront, subject to the WIP’s collectability.

If a discretionary trust can participate in the firm’s profits, are there potential beneficiaries of the trust with a lower marginal tax rate than the partner?

If you have not previously been in the pay as you go (PAYG) instalment system, tax payable on the share of profits may be deferred as far as June the year following the first year of partnership through the use of a tax agent.

Equally, do not forget that although tax may be deferred , it will ultimately be payable, along with PAYG instalments on a quarterly basis, beginning the quarter following lodgement of the first tax return that includes partnership income.

Deductible superannuation contributions may be made subject to personal circumstances.

Most of these issues will be ongoing throughout the period of partnership. However, it is only when you are thinking of entering a partnership that they need to be considered simultaneously.

It is worthwhile spending time with existing partners, the practice’s financial controller, the firm’s accountants and your accountant to properly understand and work through the considerations.

ASHLEY DAVIDSON is a partner in the professional services team of Pitcher Partners in Melbourne. He can be contacted on ashley.davidson@pitcher.com.au. The material and opinions in this column should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.

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