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Partnerships of trusts – an endangered species?

Feature Articles

Cite as: (2005) 79(11) LIJ, p. 54

It seems partnerships of trusts with corporate trustees will no longer be a viable option under the new Legal Profession Act 2004, which comes into effect on 12 December this year.

By Matthew Clarke and Anna Tang

Traditionally Victorian lawyers have traded as sole practitioners or in partnership with other lawyers. While sole practitioners and partnerships remain the most prevalent form of legal practice in Victoria, s289 of the Legal Practice Act 1996 (Vic) (current Act) allows a company to apply to the Legal Practice Board (LPB) for registration as an “incorporated practitioner”. The Current Act not only allows these companies to provide legal services in their own right, provided they do not breach the income sharing provision of the Current Act, they are also able to provide legal services as trustees of the principals’ family trusts.[1]

This flexibility has opened the door for those in the legal profession to adopt another form of partnership – a partnership of discretionary trusts with corporate trustees. However, with the commencement of the new Legal Profession Act 2004 (Vic) (New Act) on 12 December 2005, law firms that have adopted such a structure will need to consider restructuring their practice.

Advantages of partnership of discretionary trusts

Currently 212 incorporated practitioners are registered with the LPB. The bulk of these is likely to be trading in partnerships of discretionary trusts, given the advantages that such structures provide. Unlike a company or a partnership of natural persons, a partnership of discretionary trusts offers principals many advantages, including a degree of asset protection, access to various capital gains tax (CGT) concessions and income distribution flexibility.

Asset protection
In contrast to a traditional partnership, where individual partners are jointly and severally liable for the debts of the partnership, a partnership of discretionary trusts allows each partner (Trust Partner) to limit his or her exposure to the practice’s debts to the assets of the trustee. For this reason, most incorporated practitioners trading in a partnership of discretionary trusts are usually single purpose corporate trustees. Although the South Australian Supreme Court in Hanel v O’Neil[2] has held that directors of a corporate trustee may be personally liable for an insolvent trust’s debts, the federal government has announced that it will enact legislation to overcome this decision.[3]

Tax concessions
A partnership of discretionary trusts provides each Trust Partner with access to various CGT concessions available under the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) that would be lost (or difficult to access) if the legal practice adopted a simple corporate structure, particularly in cases where there are three or more principals.

Division 115 – 50 per cent discount
On sale of the practice (or introduction of a new partner), the Trust Partners are able to apply the Div 115 – 50 per cent CGT discount to reduce by 50 per cent any capital gain created on disposal of the business, provided that the Trust Partners have held the assets of the practice for more than 12 months. This concession is not available to a company that conducts a legal practice on its own account (as distinct from acting as trustee for a trust).

Division 152 small business concessions
In addition to applying the Div 115 50 per cent discount, the Trust Partners are able to apply the Div 152 small business CGT concessions to reduce or eliminate the remaining capital gain. This is provided the net value of the assets held by the Trust Partner, entities connected with it[4] and its small business CGT affiliates[5] do not exceed $5 million.[6]

A corporate entity faces more hurdles before being able to access the Div 152 small business concessions. While these concessions are prima facie available to companies, to be eligible for the main concessions the company must, at the time of selling the practice, have a controlling individual.[7] This means that there must be a person who holds:

  • shares amounting to at least 50 per cent of the voting power of the company; or
  • the right to receive at least 50 per cent of the dividends or capital distributions of the company.[8]

Therefore, where legal services are provided through a corporate entity and there are three or more principals with equal shares in the company, the controlling individual test will not be satisfied and the main small business CGT concessions will not be available.

Even if the company is able to satisfy the controlling individual test, the principals may still experience difficulties in accessing the tax-free gain. If the company distributes the gain to the principals, the distribution will be taxed in the hands of each principal as an unfranked dividend at their marginal tax rate under s44 of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936). If the company is liquidated and the gain distributed to the shareholders, the gain will be deemed to form the proceeds of a share redemption and therefore taxable under the CGT regime.[9]

One of the usual means for improving the tax position of the principals of a company providing legal services on its own account is for the principals to sell their shares in the company, rather than for the company to sell the business. However, this is often difficult to achieve given the purchasers’ usual preference to acquire a business rather than a company (and the history that attaches to that company).

Income distribution flexibility
In addition to asset protection and tax concessions, another advantage of a partnership of discretionary trusts is the ability of each principal to split pre-tax income between themselves and their family members. This enables the principals to produce a similar tax outcome as that achieved through the use of the conventional service trust structure. This is particularly important given the Commissioner of Taxation’s current position on service trusts.

Partnership of trusts under the New Act

Given the benefits a partnership of discretionary trusts with corporate trustees affords, it is not surprising that this type of business vehicle has become common for small and medium enterprises, including law firms. However, under the New Act as currently drafted, legal practices that have adopted such a model will need to adopt a new structure.

Under s1.2.1 of the New Act, a “law practice” is exhaustively defined to mean one of the following:

(a) A “sole practitioner”: a person holding a practising certificate who engages in legal practice on his or her own account;

(b) A “law firm”: a partnership consisting only of natural persons holding practising certificates;

(c) An “incorporated legal practice”: a corporation (the shareholders of which need not be legal practitioners) that engages in legal practice, at least one director of which must hold a current practising certificate;[10] and

(d) A “multi-disciplinary partnership”: a partnership between one or more “Australian legal practitioners” (i.e. natural persons who hold practising certificates) and one or more persons who are not “Australian legal practitioners” where the business of the partnership includes the provision of legal services as well as other services.[11]

As a “law firm” is defined in the New Act to mean a partnership of natural persons, a partnership of trusts with corporate trustees is excluded from this definition. Accordingly, under the New Act, there is no place for a partnership of corporate trustees unless those trustees become members of a multi-disciplinary partnership (in which case at least one partner will have to be a natural person holding a practising certificate). Any partnership of corporate trustees not making the transition to a multi-disciplinary partnership will need to consider having all existing corporate trustees replaced by natural persons holding practising certificates or transferring the legal practice to a company which will then become an incorporated legal practice.

Both alternatives have their drawbacks. The former will result in the loss of asset protection. The latter has significant negative consequences from a tax perspective, particularly:

  • the loss of the Div 115 50 per cent discount; and
  • in the case of any incorporated legal practice which does not have a controlling individual, the loss of the small business CGT concessions under Div 152; or
  • in the case of any incorporated legal practice which does have a controlling individual, the small business CGT concessions under Div 152 will only be available to the controlling individual (i.e. access to the concessions is not available to minority shareholders).

Requirement for the multi-disciplinary partnership to provide “other services”

In order to meet the statutory definition of a multi-disciplinary partnership, the New Act requires these practices to also provide services other than legal services.

While the definition of a multi-disciplinary partnership makes it clear that there must be some service provided that is not a legal service, it remains silent on what might be the nature of such a service. The explanatory memorandum to the New Act does not give any guidance on this point. However, the Victorian Attorney-General, in his second reading speech, states that the adoption of this non-traditional mode of legal practice by the New Act stems in part from a desire to enable legal practitioners to better compete with other service providers by permitting them to create a “one-stop shop”.

Thus, what is envisaged by the “other services” would seem to be something that complements the legal service and may even overlap with it to some extent, so that the business of providing legal services is made more competitive. Case law that discusses the scope of legal practice makes a distinction between someone who provides a legal service and someone whose occupation or profession is something other than the law, but by virtue of their expertise provides an opinion about the law in the area of their knowledge.[12]

Examples may include accountants, tax agents, financial planners, town planners, building surveyors, customs agents, migration agents, patent attorneys, forensic scientists and private investigators. However, the provision of conveyancing or other paralegal services by a law firm appears unlikely to be sufficient to allow it to become a multi-disciplinary partnership.

Is agency a possible solution?

As an alternative to the formation of a partnership of natural persons or a multi-disciplinary practice, the Trust Partners may be able to appoint a company to act as its agent (Agent). The Agent will then become an incorporated legal practice under the New Act and provide legal services on behalf of the Trust Partners. Provided that that the Agent complies with the requirements for an incorporated legal practice, the Trust Partners may not need to fall within one of the four definitions of a “legal practice” as outlined above.

However, there is a competing argument that not only must the Agent comply with the New Act, the partnership itself must also meet the definition of a “legal practice”. Accordingly, it would be prudent to seek a ruling from the new Legal Services Commissioner before such a structure is adopted.


Given the exhaustive definition of a “law practice” under the New Act, the ability for lawyers to continue providing legal services through a partnership of discretionary trusts with corporate trustees is effectively prohibited. Those in the legal profession that have adopted such a structure will need a new structure in place by 12 December 2005, when the new Act comes into effect.

The transition to a new business structure will most likely trigger tax obligations that will need to be understood and managed. The new structure will invariably change the tax profile of the law firm and its principals (and possibly result in the loss of some of the benefits previously available).

Failure to restructure may trigger penalties arising from a contravention of the New Act. Whether or not this consequence was intended by the legislature is not clear from the explanatory memorandum and related supporting materials.

MATTHEW CLARKE is a senior associate at Ambry Legal, practising in commercial law and litigation, including tax litigation. He is also a fellow of the Taxation Institute of Australia.

ANNA TANG is an associate at Ambry Legal, practising in taxation and commercial law. She is also a fellow of the Taxation Institute of Australia.

[1] Under s317(4) of the Current Act, the trust deed of the discretionary trust must restrict the beneficiaries of the trust to the family members of the principal and/or companies in which the beneficial interests are wholly owned by the principal and/or the principal’s family members. A family member is defined in s3 of the Current Act as a parent, spouse, domestic partner, child, grandchild, sibling or child of a sibling.

[2] [2003] SASC 409.

[3] Refer to the Parliamentary Secretary to the Treasurer’s media release No 017 (2 June 2005), available on

[4] Refer to s152-30 of the ITAA 1997 for the definition of “connected with”.

[5] Refer to s152-25 of the ITAA 1997 for the definition of a “small business CGT affiliate”.

[6] Refer to s152-10 and 152-15 of the ITAA 1997.

[7] Refer to ss152-110(1)(c) and 152-305(2)(b) of the ITAA 1997.

[8] Refer to s152-55 of the ITAA 1997.

[9] While beyond the scope of this paper, note that there are strategies that allow certain untaxed capital gains to be distributed out of a company in a tax effective manner – refer for example to s47(1A) of the ITAA 1936, Archer Bros Pty Ltd (in vol liq) v FCT (1952-53) 90 CLR 140 and Taxation Determination TD 2000/5.

[10] Refer to s2.7.4 of the New Act.

[11] Refer to s2.7.36 of the New Act.

[12] Refer to Felman v Law Institute of Victoria [1998] 4 VR 324 at 350.


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