Partial Incorporation
KPMG recently went ahead with partial incorporation, restricted to its audit practice with the help of incorporation kit. Opting for partial incorporation is a high risk strategy for KPMG that is sure to be tested in the courts at the first opportunity. The problem KPMG faces is that the courts may treat partial incorporation as a mere device, and make the whole of the firm liable, on the grounds that the underlying reality of the arrangement remains that of a partnership encompassing both the new company and all the members of the residual partnership.
KPMG's decision to go ahead with partial incorporation restricted to its audit practice must have sent the legal advisers to the other Big Six firms scurrying back to their law books. According to the press reports, they had all advised that partial incorporation would not work: only full incorporation of the whole of the practice would protect non-audit partners from joint and several liabilities for audit negligence verdicts. Have KPMG and their advisers found a way around the problem that no-one else thought of?
The problem KPMG faces is that the courts may treat partial incorporation as a mere device, and make the whole of the firm liable, on the grounds that the underlying reality of the arrangement remains that of a partnership encompassing both the new company and all the members of the residual partnership. This is because there is no simple checklist of requirements to establish when a partnership exists. The law governing whether or not any particular business arrangement constitutes a 'partnership' turns out to be quite difficult to apply in practice, and certainly does not depend on whether or not you choose to call your arrangement a partnership.
The starting point is the Partnership Act 1890, which codified the common law principles of partnership developed by the courts up to that time. Section 1 defines a partnership as 'the relation which subsists between persons carrying on a business in common with a view to profit'. A company is a 'person' for the purposes of this definition, so that it is possible to have a partnership between two or more companies, or between individuals and a company. This has obvious relevance to KPMG's plans. A great deal of law has grown up over the decades on the meaning and effect of the phrases 'carrying on a business', 'in common' and 'with a view to profit' in the statutory definition. For example, does a relationship formed for the avowed purpose of tax avoidance fall within the requirement 'with a view to profit'? The court pointed out that the arrangement had to make a profit before it was capable of avoiding tax on that profit, and it therefore still came within the definition.
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