How you structure your law firm in Australia is an important decision. It has both legal and financial implications for you as a legal practitioner. It can also affect the extent and type of legal services that you can provide.
The most common ways to structure your legal practice
The most typical ways of structuring a private legal practice in Australia include trading as:
1) a sole practitioner,
2) a partnership, and
3) an incorporated legal practices (a company structure).
For many years, sole practitioner and partnership law firm structures were the most common in Australia. However, in recent years, more and more Australian law firms are choosing to establish company structures.
We’ll now take a look at each of the three private law firm structures in more detail, including their respective advantage and disadvantages.
1. Sole practitioner
As the name suggests, a sole practitioner in the legal context practises law on their own. All barristers, for example, are sole practitioners.
The advantages of a sole practitioner structure
- A sole practitioner fully owns and controls their own legal practice.
- There are lower set-up costs than other types of law firm structures (such as partnerships and incorporated structures).
- A sole practitioner’s tax affairs are likely to be less complex than those of other types of law firm structures (this will also depend on additional assets and investments).
The disadvantages of a sole practitioner structure
- A sole practitioner is fully liable for any of their law firm’s debts and this form of legal practice may not achieve asset and income protection, particularly from outside claims.
- Sole practitioners have to pay income tax at their marginal rate, which may be higher than the tax rate that can be achieved by using an incorporated (company) structure.
- If an equity partner is introduced, a new tax structure will need to be formed. This may incur additional cost for professional tax advice.
A partnership law firm structure consists of two or more people legal professionals owning and running a legal practice. A partnership agreement is drawn up to reflect each partner’s responsibilities, capital contributions, and the distribution of the law firm’s profits and losses. The Partnership can consist of individuals or what is more common, a partnership of discretionary trusts.
The advantages of a partnership law firm structure
- Law firm profits can be split among partners to accurately reflect their contribution or to minimise overall taxation obligations.
- A partnership arrangement allows you to bring specialist expertise and knowledge to your law firm, which you can’t do under a sole practitioner structure.
- A partnership structure may enable you to raise more capital for your law firm in terms of partner’s contributions.
- Partnerships are generally less expensive (and easier) to set up than incorporated (company) structures (depending on the nature of legal documents required).
- Employees can be incentivised with opportunities to be promoted to become partners in the law firm based on their performance.
- It’s a relatively easy structure to change if necessary.
The disadvantages of a partnership law firm structure
- The potential for disputes between partners.
- Partnerships generally require consensus for decision-making, which can slow the process down (this will also depend on what was agreed in the Partnership Agreement).
- Each of the partners are personally liable for the law firm’s debts.
- Each of the partners can potentially be liable for the actions of other law firm partners.
3. Incorporated legal practice
An incorporated legal practice is a law firm that is set up as a company. The company must be registered with the Australian Securities and Investments Commission (ASIC) and it is subject to all the legal provisions of the Corporations Act in Australia. This is becoming an increasingly popular form of structuring a legal practice in Australia.
The advantages of an incorporated legal practice structure
- A company is a separate legal entity in its own right. This means that its employees are not legally liable for any company debts, unlike sole practitioners and partners in law firms.
- There is less disruption to the firm if an employee leaves, unlike when partner leaves a law firm.
- The company tax rate in Australia is lower than most individual marginal tax rates (which are the rates that sole practitioners and partners are charged). The company tax rate in Australia is currently 27.5% for any business (including law firms) that have an annual turnover less than $25 million.
- There can be a greater capacity for an incorporated legal practice to raise both debt and equity funding.
The disadvantages of an incorporated legal practice structure
- Setting up a company in Australia is more costly and time-consuming than setting up a sole practitioner or partnership law firm structure.
- Companies in Australia generally have more complex tax reporting obligations than sole practitioner and partnership structures.
- Company directors may be held personally responsible for the company’s debts if they breach their duties as a company director.
The bottom line
If you’re just about to set up a private law firm, it’s important to consider all of the advantages and disadvantages offered by each of the major types of structures. The most appropriate structure for your law firm will depend on both your current and future needs. Achieving the best structure for your circumstances will ensure you have the right balance of:
- Income and asset protection
- Distribution flexibility
- Effective tax planning
- The ability to introduce new stakeholders as your practice grows
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This article contains general advice only. It does not take into account your or your family’s individual objectives, financial situation or needs. You should seek advice from a financial planner or other professional adviser before making any financial decision based on this information.