FORMS OF PUBLIC PRACTICE BUSINESS STRUCTURES

Transcription

1 FORMS OF PUBLIC PRACTICE BUSINESS STRUCTURES FOR PUBLIC PRACTITIONERS OPERATING IN NEW ZEALAND INTRODUCTION Members who satisfy the requirements under CPA Australia s By-Law 9 can apply for a Public Practice Certificate (PPC) to be issued. In doing so, they are required to identify the practice type they intend to practice under subject to the forms allowed under By-Law 9.3. A member who offers public accounting services may only do so: as a sole trader or as a partner or via a company or as a trust or as a practice structure which is approved by the Board. Deciding on the appropriate practice structure can be complex and requires a range of issues to be considered including personal liability, succession planning and taxation to name just a few. You need to determine what structure suits your current circumstances and business model and how this choice may affect future plans. This document takes a brief look at the above business structures and provides information that might assist you when considering the most appropriate practice structure. This document is not intended to provide any form of advice or recommendation but rather highlight some areas which may influence your decision on the practice structure. As a public practitioner, you will make a number of very important business decisions concerning your practice. Deciding under which structure you will establish your practice is one of these important decisions and we recommend you seek professional advice during this process. This document only considers legislation relevant to business structures in New Zealand. 1

2 CONTENTS General considerations that apply to all structures 3 Income from personal services 3 Converting structures 3 Goods and Services (GST) Act Accident Compensation Corporation (ACC) 3 Sole Practitioner 4 General 4 Professional / CPA Australia 4 Taxation 5 Analysis 5 General partnership 7 General 7 Professional / CPA Australia 7 Taxation 8 Analysis 9 Company 10 General 10 Professional / CPA Australia 10 Taxation 11 Analysis 12 Look-through company 14 General 14 Professional / CPA Australia 14 Taxation 15 Analysis 16 Trust 17 General 17 Professional / CPA Australia 17 Taxation 19 Analysis 20 2

3 GENERAL CONSIDERATIONS THAT APPLY TO ALL STRUCTURES Income from Personal Services When deciding on the most appropriate structure for your practice, you must consider New Zealand's tax laws dealing with: derivation of income from personal services the impact of attempting to divert income to other parties ( income splitting ). There are two ways such arrangements can be challenged by Inland Revenue. Firstly, the general anti avoidance rules under sections BG 1 and GA 1 of the Income Tax Act (2007) (the ITA 2007) can apply. In addition, there are specific rules in the ITA 2007 to disallow excessive remunerations being paid to relatives. The general anti-avoidance rules limit the ability of taxpayers to structure their affairs in a manner which would alter the incidence of tax. The Inland Revenue Department (IRD) has a strong focus on schemes which attempt to reallocate income from personal services. Following the Supreme Court decision, Penny and Hooper v Commissioner of Inland Revenue [2011], favouring Inland Revenue, the high degree of scrutiny into arrangements which seek to shift income to individuals or other structures on a lower marginal tax rate is likely to continue. Converting structures Where a practitioner decides to convert their business structure, careful consideration should be given to the possible tax implications of such a conversion (for example, depreciation recovered and tax avoidance). In addition, the transfer of work-in-progress may be separately taxable and the sale of the business may be subject to GST. Goods and Services (GST) Act 1985 Regardless of the business structure selected, an entity will have to register for GST if the projected annual turnover meets the registration threshold, which is currently $NZ60,000. Accident Compensation Corporation (ACC) The Accident Compensation Act 2001 provides financial compensation and support to citizens, residents, and temporary visitors who have suffered personal injuries. The ACC Scheme is administered on a no-fault basis providing compensation to an entitled party while removing a party's right to sue the 'at fault party' (unless the party is seeking exemplary damages). The ACC Scheme provides a range of entitlements to injured people, from contribution towards the cost of treatment, to weekly compensation for lost earnings, and to home or vehicle modifications for the seriously injured. The entitlements offered by the Scheme are subject to various eligibility criteria. 3

4 SOLE PRACTITIONER 1. General a) Brief outline A sole practitioner, also called a sole trader or sole proprietor, is an individual undertaking business and/or investment activities in his or her own name for their own benefit. The legal status of a sole practitioner is not separate from the individual. b) 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 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. c) Succession During the lifetime of the sole practitioner, transfer of business assets will result in potential tax liabilities in relation to income tax and goods and services tax. 2. Professional / CPA Australia a) Non-membership equity Not applicable. b) Membership To offer public accounting services a member must be of CPA or FCPA status. c) Public Practice Certificate ( PPC ) A member that represents to the public that he/she provides public accounting services must hold a Public Practice Certificate if they have a bona fide expectation that their gross annual income from the provision of public accounting services will exceed $45,000. Where a member earns less than $45,000 but more than $10,000 of gross fees per calendar year that member must apply for a Limited Public Practice Certificate. These requirements apply to any member providing public accounting services into New Zealand, no matter where in the world they are located. d) Audit/Trust Account APES 310: Dealing with Client Monies requires a member who holds or receives trust money to establish and maintain Trust Bank accounts and Trust accounts with adequate internal controls and to have them audited annually. e) Continuing Professional Development ( CPD ) The By-Laws require all members to complete 120 hours of structured CPD each triennium, with a minimum of 20 hours in any year. f) Quality Review Program ( QRP ) A member must agree to comply with the QRP throughout the period a PPC is held prior to the certificate being granted. g) Risk management Under APES 325: Risk Management for Firms, a member must establish and maintain a Risk Management Framework. 4

5 h) Insurance 3. Taxation Professional indemnity insurance must be held for the practice, the policy of which must indemnify the member and the practice. The minimum sum insured shall be as stipulated in CPA Australia's By-Laws or as prescribed by any legislative enactment. The member shall produce proof satisfactory to CPA Australia that such insurance is held. Other specific terms that the policy must include may be found in CPA Australia s By-Law 9.8 including, but not limited to, multiple automatic reinstatement and cover for all persons affiliated with the practice. a) Method of accounting i. Cash ii. The cash method of tax accounting may only be appropriate in a very limited number of circumstances. IRD have previously stated that the cash method of accounting may be appropriate where the earning of income is a direct result of the personal exertion of the taxpayer and the use of employees, assets does not contribute significantly to the generation of income (refer to Tax Information Bulletin: Volume 9, No. 6 (June 1997)). A large accounts receivable balance was identified as a potential indicator of cases where the cash method of account is not an appropriate method. Accruals b) Income splitting Where a sole trader fails to meet all of the factors required to utilise the cash method of accounting, the accruals method will have to be used instead. As a general rule, a full time sole practitioner would likely use the accrual method. The accruals method will consider amounts to be derived at balance date if there is an entitlement to bill, even if no actual invoice has been issued (Henderson v FC of T (1970) 1 ATR 133 (HCA)). Specific anti avoidance rules exist in respect of excessive remuneration paid to relatives or associated parties. The Commissioner will take into account all relevant matters in determining whether an amount is excessive or not in the particular circumstances of the case at hand. An exemption may be available under GB 24 ITA 2007 for genuine contracts provided that the outlined criteria are satisfied. c) Losses Tax losses are carried forward in the name of the sole practitioner and can be off-set against any other assessable income earned in the individual s name. d) Financing 4. Analysis Interest deductions are available where a nexus exists between incurring an interest expense and deriving assessable income. Sole practice meets all forms of registration simply and is therefore the most inexpensive of all forms of practice structure. However, there is the significant disadvantage of unlimited liability which many of the other structures are able to limit. If the sole practitioner structure is chosen, a family trust should be considered to protect critical personal assets from the unlimited liability of the practice. Four important facts to consider: 1. How are business risks managed? 5

6 2. How will future growth be managed? 3. How will successions be handled? 4. How are private/business accounts/borrowings segregated from private dealings? 6

7 GENERAL PARTNERSHIPS 1. General a) Brief outline A general law partnership is an association of two or more entities that carry on business in common with a view to profit or gain. A partnership agreement should be entered into which sets out the contractual relationship between the parties. It can be a verbal agreement, or it can be reduced to writing. While a verbal agreement may suffice at law, a written agreement is preferable. b) Liability Individual partners are exposed to the risk of joint and several liability for the debts of the partnership and their liability is unlimited. That is, a general partnership is not, at law, a separate legal entity, separate from the partners. In the event that the partnership is sued, the assets of the individual partners will be available to litigants and creditors. c) 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 must be relied upon to cost-effectively pass control to the next generation. Sections HG 2 10 of the ITA 2007 deal with the income tax treatment of disposals of partnership interests. The provisions provide for safe harbours and thresholds as to when a disposal of a partner s interest will result in tax liabilities. d) Limited partnerships A limited partnership exists as a separate legal entity, distinct from the underlying partners. The limited partnership is governed by the Limited Partnership Act 2008 and requires that the parties enter into a written partnership agreement. From an income tax perspective, a limited partnership is treated as a general partnership. Therefore, taxable gains and losses are attributed to the partners directly. The partnership itself is not subject to tax on those gains/losses. A limited partnership must have at least one limited partner and one general partner. A limited partner is prohibited from engaging in the management of the partnership which is left solely to the general partner(s). Given that only limited partners enjoy the protection of limited liability, the general partner is typically a shell company responsible for the management of the partnership and is liable for the underlying debts and obligations of the partnership. Such restrictions in relation to the management of the partnership may well restrict the ability of CPA Australia members to utilise such a structure. Legal advice should be sought in this regard. 2. Professional / CPA Australia a) Non-membership equity 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: 7

8 i. has a majority of capital in the partnership under the control of members with a CPA Australia Public Practice Certificate and abide with the By-Laws regulating the holding of a Public Practice Certificate ii. iii. iv. b) Membership 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. To offer public accounting services a member must be of CPA or FCPA status. c) Public Practice Certificate ( PPC ) A member that represents to the public that he/she provides public accounting services must hold a Public Practice Certificate if they have a bona fide expectation that their gross annual income from the provision of public accounting services will exceed $45,000. Where affiliated with a partnership the member must ensure that it is an approved practice entity under CPA Australia s By-Laws. Where a member earns less than $45,000 but more than $10,000 of gross fees per calendar year that member must apply for a Limited Public Practice Certificate. These requirements apply to any member providing public accounting services into New Zealand, no matter where in the world they are located. d) Audit/Trust Account APES 310: Dealing with Client Monies requires a member who holds or receives trust money to establish and maintain Trust Bank accounts and Trust accounts with adequate internal controls and to have them audited annually. e) Continuing Professional Development ( CPD ) The By-Laws require all members to complete 120 hours of structured CPD each triennium, with a minimum of 20 hours in any year. f) Quality Review Program ( QRP ) A member must agree to comply with the QRP throughout the period a PPC is held prior to the certificate being granted. g) Risk management Under APES 325: Risk Management for Firms, a member must establish and maintain a Risk Management Framework. h) Insurance 3. Taxation Professional indemnity insurance must be held for the practice, the policy of which must indemnify the member and the practice. The minimum sum insured shall be as stipulated in CPA Australia's By-Laws or as prescribed by any legislative enactment. The member shall produce proof satisfactory to CPA Australia that such insurance is held. Other specific terms that the policy must include may be found in CPA Australia s By-Law 9.8 including, but not limited to, multiple automatic reinstatement and cover for all persons affiliated with the practice. a) Method of accounting 8

9 i. Cash ii. The cash method of tax accounting is prima facie, inappropriate for professional service firms conducted through a general partnership. Accruals b) Income splitting As a rule of thumb, professional services firms should account for income on the accruals basis when an entitlement to bill arises. The accruals method will consider amounts to be derived at balance date if there is an entitlement to bill, even if no actual invoice has been issued (Henderson v FC of T (1970) 1 ATR 133 (HCA)). Income splitting typically involves a high income-earning taxpayer diverting some of his or her income to a family member or other related entity taxed at a lower marginal rate. CPA Australia By-Laws only permit partnerships with unqualified persons where the Board of CPA Australia approves the partnership arrangement. Therefore, income splitting may not be available through a partnership structure. Specific anti avoidance rules exist in respect of excessive remuneration paid to a relatives or associated parties under section GB 23 of the ITA The Commissioner will take into account all relevant matters in determining whether an amount is excessive or not in the particular circumstances of the case at hand. An exemption may be available under GB 24 for genuine contracts provided that the outlined criteria are satisfied. c) Losses Tax losses are distributed to the partners in the same proportions as partnership income is distributed. Section HG 2(2) of the ITA 2007 prohibits streaming of expenditure or loss when inconsistent with the partnership share in the partnership agreement. d) Financing 4. Analysis Interest deductions are available where a nexus exists between incurring an interest expense and deriving assessable income CPA Australia regulations restrict partnerships to suitably qualified Public Practice Certificate holding parties. Partnerships otherwise meet all form of regulatory requirements simply, individual income tax rates apply and there is unlimited liability of individual partners for the debts of the partnership. Five important facts to consider: 1. How are disputes resolved? 2. How is entry/exit price determined? 3. How is voting exercised? 4. What happens on death/disability of partner? 5. How are personal assets protected against the potential liability arising out of the partnership? 9

10 COMPANY 1. General a) Brief outline A company is a legal entity formed by registration under the Companies Act It is a separate legal entity and as such, acquires legal rights and liabilities (i.e. it can sue and be sued in its own 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. b) Liability If the business is sued, only the assets of the company are available to creditors. The shareholders will only be liable for the amount of their share capital (up to the face value of the shares held if the shares are not fully paid) while their other assets remain protected. In some circumstances, a director may be found to be personally liable for a tax debt, and/or if found liable for allowing the company to trade while insolvent, the director s personal assets may be used to pay those amounts. If the director has insufficient assets, that person may be made bankrupt. Accordingly, directors of companies should be careful in paying tax debts and, where possible, take care in owning assets in their own name. c) Succession Companies have perpetual succession (subject to complying with the law). Succession planning with a company structure can be 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. 2. Professional / CPA Australia a) Non-membership equity 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: i. a majority of voting shares are held by members holding a CPA Australia Public Practice Certificate or a member of Chartered Accountants Australia and New Zealand (Chartered Accountants ANZ) holding a practising certificate ii. iii. a majority of directors voting rights are held by members holding a CPA Australia Public Practice Certificate 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 nonmembers 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 or - be a family member as defined in the By-Laws. 10

11 b) Membership To offer public accounting services a member must be of CPA or FCPA status. c) Public Practice Certificate ( PPC ) A member that represents to the public that he/she provides public accounting services must hold a Public Practice Certificate if they have a bona fide expectation that their gross annual income from the provision of public accounting services will exceed $45,000. Where affiliated with a company the member must ensure that it is an approved practice entity under CPA Australia s By-Laws. Where a member earns less than $45,000 but more than $10,000 of gross fees per calendar year that member must apply for a Limited Public Practice Certificate. These requirements apply to any member providing public accounting services into New Zealand, no matter where in the world they are located. d) Audit/Trust Account APES 310: Dealing with Client Monies requires a member who holds or receives trust money to establish and maintain Trust Bank accounts and Trust accounts with adequate internal controls and to have them audited annually. e) Continuing Professional Development ( CPD ) The By-Laws require all members to complete 120 hours of structured CPD each triennium, with a minimum of 20 hours in any year. f) Quality Review Program ( QRP ) A member must agree to comply with the QRP throughout the period a PPC is held prior to the certificate being granted. g) Risk management Under APES 325: Risk Management for Firms, a member must establish and maintain a Risk Management Framework. h) Insurance 3. Taxation Professional indemnity insurance must be held for the practice, the policy of which must indemnify the member and the practice. The minimum sum insured shall be as stipulated in CPA Australia's By-Laws or as prescribed by any legislative enactment. The member shall produce proof satisfactory to CPA Australia that such insurance is held. Other specific terms that the policy must include may be found in CPA Australia s By-Law 9.8 including, but not limited to, multiple automatic reinstatement and cover for all persons affiliated with the practice. a) Method of accounting i. Cash ii. The cash method of tax accounting is prima facie, inappropriate for professional service firms conducted through a company structure. In accordance with the Tax Information Bulletin Volume 9, No. 6 (June 1997), the cash method may only be appropriate where a taxpayer s income is earned as a result of his/her personal exertions. The company is unable to exercise personal exertion and is therefore unlikely to be able to utilise the cash method of accounting. Accruals As a rule of thumb, professional services firms should account for income on the accruals basis when an entitlement to bill arises. 11

12 b) Income splitting The accruals method will consider amounts to be derived at balance date if there is an entitlement to bill, even if no actual invoice has been issued (Henderson v FC of T (1970) 1 ATR 133 (HCA)). Income splitting typically involves a high income-earning taxpayer diverting some of his or her income to a family member or other related entity taxed at a lower marginal rate. If a business is operated through a company, there should be no income splitting of personal services income. Specific anti avoidance rules exist in respect of excessive remuneration paid to relatives or associated parties under section GB 23 of the ITA The Commissioner will take into account all relevant matters in determining whether an amount is excessive or not in the particular circumstances of the case at hand. An exemption may be available under GB 24 for genuine contracts provided that the criteria outlined in the section are satisfied. The attribution rules contained under sections GB may apply, especially in the case of smaller practices, where 80% of a practice s income is derived from a single source (note that associated entities are considered to be a single source). The attribution rules apply when a taxpayer who earns income from personal services (the working person) inserts an associated entity between the working person and the party purchasing those services. The buyer of the services deals with the associated entity, which derives the income arising, but it is the working person who actually provides the services. If the criteria in section GB 27 are met, than the amount of income attributed to the working person will be calculated under GB 29. Broadly speaking, the rules will attribute any income derived from personal exertion to the working person after deduction of allowable expenditure. Where a company structure is used, CPA Australia s By-Laws require amongst other things th: i. CPA Australia members hold a majority of voting shares in the company ii. the majority of the directors be CPA members or members of the other two professional accounting bodies. Please refer to CPA Australia s By-Laws for further details. c) Losses Complex rules govern the way in which companies can use prior year and current year losses. Losses are quarantined, meaning they stay within the company and cannot be distributed to shareholders. The continuity of ownership test must be satisfied for a company to carry forward or offset losses. d) Financing 4. Analysis Section DB 7 of the ITA 2007 provides that a company has an automatic deduction for interest incurred. This rule does not apply to a qualifying company or look through company. The company structure provides a member with the protection of limited liability and is able to separate management and ownership of a practice. Provides for easy transfer of ownership but is administratively more difficult than some of the previous structures. Five important facts to consider: 1. Who are entitled to be directors? 2. How do the pre-emptive share transfer clauses work in the constitution? 12

13 3. Is there a shareholders agreement? If not, why not? 4. When does the chairperson have a casting vote? 5. How are audit and insolvency assignments handled? 13

14 LOOK THROUGH COMPANY 1. General a) Brief outline A look-through company is a company which has filed an election (IR 862) with IRD (after meeting certain criteria). It provides for a transparent entity which is a hybrid of a company and a sole trader or partnership. A look-through company cannot have more than five look-through counted owners (as defined). A lookthrough company acts through its management, directors and members. Directors and management of a company are its controllers. Further commentary on the look-through company regime may be found on the IRD s website. b) Liability If the business is sued, only the assets of the look-through company are available to creditors. The shareholders other assets are protected. That is, a look-through company provides limited liability protection against creditors. If a shareholder is sued that person will only be liable for the amount of their share capital (up to the face value of the shares held if the shares are not fully paid). In some circumstances, a director may be found to be personally liable for a tax debt, and/or if found liable for allowing the company to trade while insolvent, the director s personal assets may be used to pay those amounts. If the director has insufficient assets, that person may be made bankrupt. Accordingly, directors of companies should be careful in paying tax debts and, where possible, take care in owning assets in their own name. c) Succession A look-through company has perpetual succession (subject to complying with the law and in particular the requirements of the look-through company regime). Succession planning with a company structure can be well planned for 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 although tax consequences may arise. d) Recent changes Several amendments have been enacted to the look-through company regime in the Taxation (Annual Rates for , Closely Held Companies, and Remedial Matters) Bill. The changes include amendments to the look-through counted owner definition; restrictions on distributions from certain entities who own an LTC; and restrictions on amount of foreign income that a foreign LTC can earn. For further details, refer to the IRD s website. 2. Professional / CPA Australia a) Non-membership equity 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: i. a majority of voting shares are held by members holding a CPA Australia Public Practice Certificate or a member of Chartered Accountants Australia and New Zealand (Chartered Accountants ANZ) holding a practising certificate 14

15 ii. iii. b) Membership a majority of directors voting rights are held by members holding a CPA Australia Public Practice Certificate 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 nonmembers 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 or - be a family member as defined in the By-Laws. To offer public accounting services a member must be of CPA or FCPA status. c) Public Practice Certificate ( PPC ) A member that represents to the public that he/she provides public accounting services must hold a Public Practice Certificate if they have a bona fide expectation that their gross annual income from the provision of public accounting services will exceed $45,000. Where affiliated with a company the member must ensure that it is an approved practice entity under CPA Australia s By-Laws. Where a member earns less than $45,000 but more than $10,000 of gross fees per calendar year that member must apply for a Limited Public Practice Certificate. These requirements apply to any member providing public accounting services into New Zealand, no matter where in the world they are located. d) Audit/Trust Account APES 310: Dealing with Client Monies requires a member who holds or receives trust money to establish and maintain Trust Bank accounts and Trust accounts with adequate internal controls and to have them audited annually. e) Continuing Professional Development ( CPD ) The By-Laws require all members to complete 120 hours of structured CPD each triennium, with a minimum of 20 hours in any year. f) Quality Review Program ( QRP ) A member must agree to comply with the QRP throughout the period a PPC is held prior to the certificate being granted. g) Risk management Under APES 325: Risk Management for Firms, a member must establish and maintain a Risk Management Framework. h) Insurance Professional indemnity insurance must be held for the practice, the policy of which must indemnify the member and the practice. The minimum sum insured shall be as stipulated in CPA Australia's By-Laws or as prescribed by any legislative enactment. The member shall produce proof satisfactory to CPA Australia that such insurance is held. Other specific terms that the policy must include may be found in CPA Australia s By-Law 9.8 including, but not limited to, multiple automatic reinstatement and cover for all persons affiliated with the practice. 15

16 3. Taxation a) Method of accounting i. Cash ii. The cash method of tax accounting is prima facie, inappropriate for professional service firms conducted through a company structure. In accordance with the Tax Information Bulletin Volume 9, No. 6 (June 1997), the cash method may be appropriate where a taxpayer s income is earned as a result of his/her personal exertions. The company is unable to exercise personal exertion and is therefore unlikely to be able to utilise the cash method of accounting. Accruals b) Income splitting As a rule of thumb, professional services firms should account for income on the accruals basis when an entitlement to bill arises. The accruals method will consider amounts to be derived at balance date if there is an entitlement to bill, even if no actual invoice has been issued (Henderson v FC of T (1970) 1 ATR 133 (HCA)). Income splitting typically involves a high income-earning taxpayer diverting some of his or her income to a family member or other related entity taxed at a lower marginal rate. If a business is operated through a look-through company, there should be no income splitting of personal services income. Where a company structure is used, CPA Australia By-Laws require amongst other things that: i. CPA Australia members hold a majority of voting shares in the company ii. the majority of the directors be CPA members or members of the other two professional accounting bodies. Please refer to CPA Australia s By-Laws for further details. c) Losses The look-through company does not retain any losses (as a company would) and instead the losses are passed through to the look-through owners. A loss limitation rule under sections HB of the ITA 2007 limit the allowable deductions to the investment (also known as the owner s basis) of the look-through owner in the look-through company. Any amounts over the allowable limit are carried forward to future income years until the owner satisfies the loss limitation rule (for example by increasing their investment in the look through company). d) Financing 4. Analysis Interest deductions are available where a nexus exists between incurring an interest expense and deriving assessable income. The look through company offers the benefit of limited liability while remaining a tax transparent entity attributing all income and losses to the look through owners. Whilst tax or BAS services and financial advisory services can be conducted by a company, currently audit and insolvency services must be conducted by individuals either as sole practitioners or partnerships. Five important facts to consider: 1. Who are entitled to be directors? 16

17 2. How do the pre-emptive share transfer clauses work in the constitution? 3. Is there a shareholders agreement? If not, why not? 4. When does chairperson have a casting vote? 5. How are audit and insolvency assignments handled? 17

18 TRUSTS 1. General a) Brief outline A trust is a legal relationship whereby a trustee holds the legal interest or title in property for the benefit of others (beneficiaries). 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 essentially two basic forms of trusts: b) Liability i. discretionary trusts, where entitlements to income and assets of the trust are not fixed. The trustee has some discretion on how income and/or capital is distributed amongst a group of potential beneficiaries. The term "trading trust" is typically used to describe a discretionary trust that undertakes some form of business. The trustees of a trading trust are usually a shell corporate entity (which provides limited liability protection). ii. fixed trusts, where entitlements of the beneficiaries are fixed. The most common form of fixed trust is a unit trust, where beneficiaries entitlements to trust income and capital are fixed in proportion to the number of units they hold. A unit trust for New Zealand income tax purposes is deemed to be a company. If the business is sued, the trustees are exposed, hence many trusts use a corporate trustee. If a beneficiary of a trust is sued in their own name, only their personally owned assets are available to creditors and the business assets of the trust are protected. c) Succession Trusts offer many succession planning opportunities. The key advantage being that, depending on the type of trust utilised, control of a trust can generally pass to the next generation without triggering tax consequences. 2. Professional / CPA Australia a) Non-membership equity 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 providing: i. the trustee of the trust is either: ii. iii. - a member or members all of whom hold a Public Practice Certificate 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 Public Practice Certificate issued by CPA Australia or - if there is more than one trustee, a member or members who hold a Public Practice Certificate 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 18

19 iv. control of the practice and of any trust, its assets and income remains with the member, his or her partners or directors and shareholders holding a CPA Australia Public Practice Certificate v. the trust is not so arranged as to result in any creditors receiving less than they would have received if the member practiced in corporate form vi. vii. b) Membership 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 his or her 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. To offer public accounting services a member must be of CPA or FCPA status. c) Public Practice Certificate ( PPC ) A member that represents to the public that he/she provides public accounting services must hold a Public Practice Certificate if they have a bona fide expectation that their gross annual income from the provision of public accounting services will exceed $45,000. Where affiliated with a trust the member must ensure that it is an approved practice entity under CPA Australia s By-Laws. Where a member earns less than $45,000 but more than $10,000 of gross fees per calendar year that member must apply for a Limited Public Practice Certificate. These requirements apply to any member providing public accounting services into New Zealand, no matter where in the world they are located. d) Audit / Trust Account APES 310: Dealing with Client Monies requires a member who holds or receives trust money to establish and maintain Trust Bank accounts and Trust accounts with adequate internal controls and to have them audited annually. e) Continuing Professional Development ( CPD ) The By-Laws require all members to complete 120 hours of structured CPD each triennium, with a minimum of 20 hours in any year. f) Quality Review Program ( QRP ) A member must agree to comply with the QRP throughout the period a PPC is held prior to the certificate being granted. g) Risk management Under APES 325: Risk Management for Firms, a member must establish and maintain a Risk Management Framework. h) Insurance Professional indemnity insurance must be held for the practice, the policy of which must indemnify the member and the practice. The minimum sum insured shall be as stipulated in CPA Australia's By-Laws or as prescribed by any legislative enactment. The member shall produce proof satisfactory to CPA Australia that such insurance is held. Other specific terms that the policy must include may be found in CPA Australia s By-Law 9.8 including, but not limited to, multiple automatic reinstatement and cover for all persons affiliated with the practice. 19

20 3. Taxation a) Method of accounting i. Cash ii. The cash method of tax accounting is prima facie, inappropriate for professional service firms conducted through a trust structure. Accruals b) Income splitting As a rule of thumb, professional services firms should account for income on the accruals basis when an entitlement to bill arises. The accruals method will consider amounts to be derived at balance date if there is an entitlement to bill, even if no actual invoice has been issued (Henderson v FC of T (1970) 1 ATR 133 (HCA)). Income splitting typically involves a high income-earning taxpayer diverting some of his or her income to a family member or other related entity taxed at a lower marginal rate. As with any other arrangement, all the features of a trust arrangement must be examined to determine whether the arrangement attracts the operation of the general anti avoidance provisions of sections BG1 and GA 1 of the ITA (2007). Professionals and all other service providers should receive income from the trust that is commensurate with their duties and responsibilities, or they should be the sole beneficiaries to the trust in relation to that income. The payment of a below market salary will be deemed to be tax avoidance unless the trust lacks available funds to pay a market salary. The Supreme Court decision of Penny and Hooper v C of IR (2011) clarified that the fixing of artificially low salaries in a trading trust structure constitutes tax avoidance. Commentary on Inland Revenue s stance on this issue can be found on their website. Business income of the trust may be split by being distributed to non-qualified beneficiaries (family members) so long as the trust arrangement is explicable by reference to ordinary business or family dealings, and no income from personal services is split. Pursuant to CPA Australia s By-Laws, income from the trust can generally only be shared by: i. family members (which is defined) and/or ii. entities of which a member and/or his or her family are the sole owners. Non-members Where a professional practice is run through a trust structure, CPA Australia s By-Laws require, amongst other things, that the trustee must be either i. a CPA Australia member or ii. an incorporated entity that complies with certain control and ownership requirements or iii. a CPA Australia member and a member of his or her family (as defined). Please refer to CPA Australia s By-Laws for further details. c) Losses Trusts are not able to distribute losses to beneficiaries (unlike a Look-Through Company or Partnership) and there are also special rules relating to the carrying forward or utilisation of tax losses. d) Financing Interest deductions are available where a nexus exists between incurring an interest expense and deriving assessable income. 20

21 4. Analysis CPA Australia rules permit the use of trusts, and beneficiaries who are associated with family and entities. This allows some income tax planning opportunities assuming that all relevant income tax requirements are met. If the trust is appropriately structured utilising a corporate trustee, the substantial benefit of limited liability may be realised. There is a possibility of tax avoidance claims being raised especially where a firm is restructured to take advantage of the tax benefits of a trust structure. Four important facts to consider: 1. How does the trust deed deal with differences between accounting income and taxable income? 2. How are losses carried forward? 3. How is income and/or capital distributed to beneficiaries of the trust? 4. Will income splitting be a potential concern? 21

22 June 2018 CPA Australia Legal Notice Copyright Notice Copyright CPA Australia Ltd (ABN ), All rights reserved. Save and except for third party content, all content in these materials is owned or licensed by CPA Australia (ABN ). Other than for the purposes of and subject to the conditions prescribed under the Copyright Act 1968 (Cth) (or any other applicable legislation throughout the world), or as otherwise provided for in this copyright notice, no part of these materials may in any manner or any medium whether now existing or created in the future, (including but not limited to electronic, mechanical, microcopying, photocopying or recording) be reproduced, adapted, stored in a retrieval system or transmitted without the prior written permission of the copyright owner. Modification of the materials for any other purpose than provided under this notice is a violation of CPA Australia s copyright and other proprietary rights. All trademarks, service marks and trade names are proprietary to CPA Australia. For permission to reproduce any material, a request in writing is to be made to the Legal Business Unit, CPA Australia Ltd, GPO Box 2820, Melbourne, Victoria, Disclaimer CPA Australia has used reasonable care and skill in compiling the content of this material. However, CPA Australia and the editors make no warranty as to the accuracy or completeness of any information in these materials. This material is intended to be a guide only and no part of these materials is intended to be advice, whether legal or professional. You should not act solely on the basis of the information contained in these materials as parts may be generalised and may apply differently to different people and circumstances. Further, as laws change frequently, all practitioners, readers, viewers and users are advised to undertake their own research or to seek professional advice to keep abreast of any reforms and developments in the law. Limitation of Liability To the extent permitted by applicable law, CPA Australia, its employees, agents and consultants exclude all liability for any loss or damage claims and expenses including but not limited to legal costs, indirect special or consequential loss or damage (including but not limited to, negligence) arising out of the information in the materials. Where any law prohibits the exclusion of such liability, CPA Australia limits its liability to the resupply of the information. 22