Incorporation – is this a good idea for my law firm?

Incorporation – is this a good idea for my law firm?

 

Incorporation is one of those questions that is often kicked around in a Partners meeting or during the annual Partners Retreat.

But firstly, what do we mean by incorporation – in short this is taking an existing unincorporated business such as a sole trader or partnership and converting the firm into a corporate body i.e. a limited company.

Individual Partners can have wide ranging views as to whether this is right for the firm or not. These views can often be based on personal opinion, which are in turn based on that individual Partners’ own personal circumstances and history of Partnership at the firm and elsewhere in their professional careers.

Where law firms have a wide generational spread of Partners, you can end up with different “camps” being formed on this issue.  Without wishing to stereotype, experience and history tends to show that the more experienced and longstanding Partners may not feel the current Partnership model is a problem, whilst younger, newer Partners to the firm may be more passionate about the corporate model.

So who is right? 

Well as ever, the answer is “it depends…”

The first key issue that I always ask Partners in a law firm to consider is “How comfortable are you” with NOT being a company from a commercial risk perspective?”

The response is usually that they are relatively comfortable because that is what PI insurance is for.  I then ask “How would you feel if there was an administrative error and the insurance did not get renewed on time or if for the claim in question, a Partner had not followed appropriate procedures and therefore the insurance would not provide full cover?”

Whilst not meaning to scaremonger, you can see how the perceived risk has escalated for professional firms in the modern business world. By simply reading your news feeds, you can see how other firm’s practices are being called into question on almost a weekly basis.

Generally, the longer that people have been in Partnership, the more they tend to be able to sleep at night absorbing this level of risk into their day to day.  However, the opposite can be said for newer generations of Partners, particularly Gen Y or “millennials”.

Setting aside commercial risk, normally the next question I hear is: “There are lots of tax breaks by operating as a company aren’t there?” Again, the answer is “it depends…”

“It depends” because the previous tax advantage has been reduced since 2016 when Chancellor George Osborne increased the rate of tax applicable to dividends.  Prior to this, the tax differential was much clearer.

However, if firms are trying to re-invest profits back into the business for growth or refurbishment, then the Partners will not be drawing out all of the profits.  In this instance, the tax saving is still clear as under the Partnership model they are likely to be suffering a combined tax & NI rate of 42% on profits, even though they are being left in the firm whereas under the corporate model the tax rate  is currently 19% and reducing further to 17% from April 2020.

This is often a bugbear (for all generations) that they simply don’t know how much tax they will be due to pay each year under the Partnership model, and the fact that the tax has no correlation to the amount they actually draw!  The corporate model brings a much clearer tax model for Partners where they will be able to forecast to the penny how much their personal tax should be, based on their remuneration package.

But there are some other tax considerations to be borne in mind, often flagged by the longer standing Partners, which include considerations such as the “benefit in kind regime” which will come into play in the corporate model.  This probably means the days of driving around in the expensive gas-guzzling Mercedes or BMW completely funded by the firm may be over – due to the penal rate of tax with this regime for these types of cars.

However, many firms are adapting and now still able to offer this “perk” in the corporate model but replacing Partners cars with electric cars, which are due to have a 0% rate of tax from April 2020.

The corporate model itself can certainly be more “complex” in terms of bringing new Partners into the firm depending on your existing Partnership model of joining.  Nevertheless, with different share classes and loan account options, a suitable model can normally be created to suit.  Yet, to counter this if you don’t have a corporate model, you may not have a new generation of Partner keen to join the firm in the first place!

So, for firms looking to grow and reinvest in the business and to bring in the next generation of business leaders, the corporate model can make a lot of sense.

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