Tax Office ruling on partnerships sparks warning for professional services firms

Accountants say principals should review their business structures following a Tax Office ruling they say could hurt people leaving and entering partnerships common in the professional services world.

The accounting firm Grant Thornton says principals need to review their business structures to ensure they haven’t been hurt by the recently released final determination and two draft determinations from the ATO, which looked into entities that accountants, architects, consultants, engineers and lawyers use in their business structures.

The rulings cover professional services firms that move from a partnership structure to an incorporated structure.

In many of these partnerships, the goodwill of the business (that is, its main asset) has no value.

This means that when the partnership incorporates and the partners are given equity stakes, the granting of these equity stakes does not attract capital gains tax.

But according to Grant Thornton, although the determinations are targeted at a “no goodwill” practice – where principals at a professional practice agree when buying and selling equity that the value of the equity will not reflect the value of underlying goodwill – there are “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 professional practice cannot be owned, even in part, by family companies or trusts,” Grant Thornton says.

“If these conditions are not met, incoming principals will be subject to tax on the market value of their shares. Similarly, on exit, such principals will be subject to tax on the market value of their shares despite receiving only a nominal payment on exit.”

It recommends reviews for professional practices where:

• They operate through a company or trust.
• The full value of goodwill is not taken into account when principals enter and exit.
• Goodwill is valued at $0.
• Equity in the practice is owned by family trusts or companies.
• A family trust or company is a partner in the partnership.
• They are considering incorporation.