There are many advantages of incorporation, with the main ones being an ease of succession, asset protection, taxation and cash flow management.
Companies are also limited in liability and have greater access to leading capabilities provided the business is profitable and cash flow positive.
A company can retain business profits and be taxed at 30% (lower for SBEs), the company tax rate and can be paid out in future years to control the businesses cash flow and taxation consequences.
Some incorporate facts when incorporating
- You only need to transfer Goodwill and Fixtures & Fittings to the Incorporated Practice (IP), not WIP and debtors. This keeps the stamp duty cost down;
- The IP provides a layer of asset protection;
- IP simplifies partner entry and exit as it is only shares that are bought and sold, not partnership assets;
- If you are eligible for the small business CGT concessions, which most partners in partnerships or sole practitioners are, depending on the value of your net assets, CGT can either be completely eliminated or significantly deferred to ultimately exit from the business. Even better, with correct shareholding structured, you can maintain your access to the small business CGT concessions into the future;
- With appropriate asset structuring and funding in place, debt can be restructured into the IP to provide personal debt relief and repaid from after tax profits of 70% with interest being tax deductible, lower if the business is an SBE;
- By utilising correct shareholding structures, you can spread your share of business profits over your family members, including non-working spouse, children over 18 and even cap your tax at 30% in a corporate beneficiary, lower if the business is an SBE;
- You will receive fully franked income as dividends. If the ultimate recipient has a tax rate higher than 30%, you only pay the top up. If the tax rate is less than 30%, you get the difference back from the ATO
Other considerations when incorporating
One other issue that some firms don’t consider when they incorporate is the shift for cash to accrual in terms of the timing of when income is assessable.
For firms that were previously on a cash basis for bringing to account their income, when they incorporate, they usually move to an accrual’s basis. This means that the company (or principal if the company cannot retain profits) will pay tax on the income that has been invoiced, not received.
If when you sell your practice to a company, you do not sell the WIP and debtors, and you were on a cash basis, then during the next year the WIP and debtors will be collected on a cash basis in your name, but the company will be taxed on all invoices issued. This can cause some cash flow issues if it is not adequately planned for.
If you’re considering setting up and Incorporated Practice, make sure you seek advice to address all the issues that will impact on your decision. Also be mindful of the significant advantages that incorporation provides and take a balanced view.