Making Tax Digital for the Legal Sector

Major changes are being made to the way in which all taxpayers interact with HM Revenue and Customs (HMRC). The government is referring to these changes as Making Tax Digital (MTD), and they are proposing a staged introduction to the new rules, starting for many in April 2018.

We have prepared and submitted a comprehensive response to HMRC’s consultations on Making Tax Digital with regard to how it impacts our clients and have suggested matters to improve implementation for businesses. We are expecting further announcements to be made over the coming months.

The proposals are wide-ranging, but one of the biggest changes planned is an electronic quarterly report to HMRC of income and expenditure. Where the business is a partnership, the proposal is that one ‘nominated partner’ will take responsibility for the submissions, which then feed into each partner’s digital tax account.

As many legal practices are partnerships, we believe more consideration needs to be given to the practicalities of this. There is a need to maintain and protect the confidentiality of each member.

For legal practices it is a requirement of the Solicitors Regulation Authority that the nominated partner should have an understanding of the business financials, and this will need to be reflected in the Making Tax Digital proposals.

Software providers will play a big part in the changes. HMRC’s current proposals suggest that invoices must be electronically scanned into software, with this software automatically uploading summarised data (not the invoices themselves). It is not currently clear whether bespoke legal software packages are capable of submitting information directly to HMRC, and so it is vital that these software providers collaborate with HMRC, the legal profession and their accountants.

Any legal practices still using manual cash books or spreadsheets are likely to have to upgrade to meet the requirements. We also envisage that many partnership agreements will need updating.

Broadband is still a major issue in many rural areas. Whilst HMRC have suggested an exemption for those with no internet or computer access, it is not yet known how far these exemptions will stretch.

Watch this space for further information and feel free to speak to us about the accounting implications. Contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with a member of our Professional Practices team.

This article originally appeared on the blog of our member firm, Larking Gowen.

SRA Accounts Rules: Making Progress!

A recent consultation by the Solicitors Regulation Authority (SRA) proposes a complete revamp of the Rules. The current Accounts Rules have not notably changed for many years and can be difficult to fully understand. The SRA have recognised this and have reported that ‘of the approximately 9000 firms that hold client money, in the period June 2012 to December 2013, over 50% received a qualified accountant’s report but only 179 were referred to consideration for further regulatory action’.

This would suggest that many of the breaches reported on in the past have been technical in nature, rather than breaches which signified a risk to client money.

Since 1 November 2015 (Phase 2 of the SRA’s revamp), for accounting periods ending on or after that date, Reporting Accountants should only qualify Accountants Reports to the SRA if they identify ‘material’ breaches as a result of their work. The SRA provided a summary of Rules which they deemed to be ‘material’ when they released Phase 2 and these were specifically focused on the risks surrounding the misuse of client money.

It is therefore not a surprise that these Rules are the ones which remain within the main body of the Draft Accounts Rules proposed by the SRA in Phase 3 of their consultation. They are keeping client money separate from firm money, ensuring client money is returned promptly at the end of a matter, and using client money only for its intended purpose.

It is the SRA’s vision to reduce the number of Rules whilst increasing compliance. For many years they have been pushing self-regulation and monitoring (via OFR), and it appears that this is coming to fruition. The role of your firm’s COFA/ COLP has been for some time to identify risks to client money and to self-report should they identify any material procedural issues with regards to these risks. It is now the role of your Reporting Accountant to review procedures implemented as a result of your risk review and identify any systematic weaknesses with regards to safeguarding client money. These Draft Rules will mirror what your Accountant is now expected to look at, and remove the prescriptive, complex Rules we currently are expected to follow.

The proposals are expected to not only improve the provisions made by law firms to safeguard client money effectively, but also to reduce compliance costs for some firms. The SRA have proposed a change to the definition of client money, to enable some firms to reduce their client balances and in turn be exempt from obtaining an Accountants Report. They have also proposed the introduction of third party managed bank accounts, whereby client funds are held externally to the solicitors firm itself. These funds would not be subject to the Rules.

We are expecting the SRA to go live with Phase 3 in April 2017, but in the meantime, if you have any queries regarding the new Rules, risk or compliance, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with a member of our Agriculture team.

This article originally appeared on the blog of our member firm, Moore & Smalley.

Solicitors: how your billing procedures can improve cash flow

Strong and sustainable cash flow is essential for any successful business regardless of size. Poor cash flow management continues to be one of the most common reasons for business failure, regardless of how productive the business is. Strong billing procedures can be a major contributing factor to maintaining financial stability. Here are some changes you could make to your firm’s systems and behaviours to help improve cash flow and keep control of your finances.

Prompt Billing

Bill your client as soon as a matter is completed or agree an interim bill with your client if a matter is expected to continue for a longer period of time. Having a weak/ infrequent billing procedure will:

  • Give the impression that you are in no rush for payment, and leave money in your clients pockets which could be in your bank account.
  • Prevent a client to office transfer for monies already collected.

It could also result in more bill disputes as the client’s perception of the value of the work carried out may diminish over time.

How do you Bill?

Changing how you bill your clients could have a positive impact on your cash flow. The following options are available for you to implement:

  • Time-served Fees – Where matters are billed on a time-served basis, you may wish to discuss this with your clients and agree to bill more frequently.
  • Fixed Fees – Where a fixed fee has been agreed with a client you could arrange a payment plan which breaks the fee into smaller monthly payments to be made as the matter progresses. This should also reduce the risk of the client querying the bill on completion.
  • Payments on Account – Ask for payments on account before you start any work. This could help with payments of disbursements until the matter is completed and a final bill is raised.
  • Bills to Trusts requiring authorisations in advance from Trustees – consider sending a draft bill detailing your charges before issuing the actual fee note. This gives the Trustees time to review the draft before the ‘bill’ becomes due for payment or, where you are holding monies on client accounts but have not transferred the funds to office, the 14 day period runs out.
  • E-Billing – Consider sending bills via email. This will reduce the time it takes for the bill to reach the client and may speed up payment times.

Client Care and Fees

It is important that your billing procedure is agreed with your client at the outset of the matter, and included in your client care letter. This should help prevent fee disputes once final bills have been delivered and also achieve the outcomes outlined within the Solicitor Regulation Authority (SRA) Handbook.

Review Your Payment Terms

Your bills should clearly state the payment due dates and you should send regular statements once fees have been issued distinguishing between amounts that are due and overdue.

Managing the credit extended to your clients is a critical part of cash flow management. Tools such as putting an account on hold for a period of time or putting a payment plan in place should be considered for those clients who have a history of slow payment and requesting payments in advance from clients with a history of not paying their bills is essential. Chasing clients for outstanding bills costs your firm time and money and can be highly unprofitable.

If you are the COFA for your firm, you may wish to consider including ‘billing’ in your staff handbook to ensure all employees and managers comply with your firm’s policy. This is important in your monitoring of financial stability and compliance with SRA regulations.

By taking the above into consideration and implementing tighter procedures, your firm will be able to plan for a more financially stable approach to billing and ensure that it does not hinder the firm’s cash flow.

For further information or advice on managing your cash flow, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with a member of our Professional Practices team.

This article originally appeared on the blog of our member firm, Moore & Smalley.

Legal Benchmarking Report reveals the cost of premises is increasing yet firms are still not investing in IT and remote working

Benchmarking ThumbnailOur Legal Benchmarking report 2016  points to encouraging signs of growth for a second year, most notably through an upturn in the Property and Construction Sector.

The review, undertaken by our Professional Practices Group, indicates a much more positive outlook across most firms, helping to ease the considerable financial pressures experienced in recent years.

MHA Report highlights:

  • A year of growth in fee income across all size firms, with growth of between 13% and 27% for firms with more than five equity partners.
  • A direct increase in business in the Property and Construction Sector. We have actually seen a shortage of lawyers in the Property Sector, as the demand for their services took off so rapidly.
  • A lack of investment in IT accompanied by an increase in premises costs.
  • Across our different sized firms, the comparative lock up days this year to last has ranged from 5 days worse to 13 days better, with the more than 25 partner firms making the 13 day improvement.
  • In 2015 equity investment ranged from £91,000 to £146,000 dependent on the number of partners involved in the business.
  • External finance makes up between 20% to 38% of the overall finance invested in practices with the remaining amount being equity partner investment.
  • All firms have been under pressure to make higher pay awards to retain current staff. Also, the impact of automatic enrolment pension schemes is now showing in the increased spend on staff.
  • We expect 2016 to continue to be difficult for this sector.
  • We expect further pressure on staff pay scales into 2016.

The full Legal Benchmarking report 2016 is now available.

Karen Hain, Head of the Professional Practices sector explains: “A significant downward pressure on net profits is the high costs of keeping premises. It is clear from our review that firms have not downsized their premises, with the larger practices actually expanding. To make any significant inroads into premises cost savings, firms will need to make substantial changes to their way of working, such as hot desking, home working or paper free working. The lack of change in working procedures is echoed by the lack of real investment in IT spend.”

Indeed, productivity and time management are also key to a profitable business and a number of efficiencies can be gained through the use of technology and improved processes.

Karen went on to say: “As we look ahead, we expect 2016 to continue to see succession planning as a key risk for law firms. Difficult questions need to be considered about future strategy, so that changes can begin to be made. Firms also need to review their funding structures to understand their cash requirements, which usually fall under pressure during periods of growth. They must have plans if additional funding becomes necessary, as traditional banking routes may be restricted. ”

If you would like to discuss any issues raised in the report in more detail or you would like to speak with a member of our team, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with your local representative.

Winners and losers in the new dividend tax regime

In the recent Budget, the tax landscape changed in a way that many of us who deal with owner-managed limited companies were not expecting. The result of this is that the mantra of dividends are always beneficial over salaries is more marginal than it was before. You will be forgiven for not hearing about this at the time and indeed since as it has been some time before HMRC were able to publish their guidance.

In essence, dividends will now be taxed at your highest marginal tax rate, once you have exceeded a nil rate band of £5,000. The tax credit that used to be applicable has been withdrawn.

As ever, there are some winners and losers from the new regime.

An example of a winner is a higher rate taxpayer who has dividend income of £5,000. In the current tax year he will have a tax liability of £1,250 (25% of £5,000). Next year he will have no tax liability.

An example of a loser under the regime will be the sole shareholder of a company who takes a small salary and then dividends up to the threshold at which higher rate tax is payable. In the current tax year he has no income tax on the salary (as the salary is below the personal allowance) and no tax on the dividend. Next year only £5,000 of the dividend will be exempt from tax.

So should dividends be paid before 6 April 2016? This is an option, but of course you may accelerate tax due and there are implications as your total net income increases, especially if it exceeds £100,000 with the loss of the personal allowance.

For many law firms, incorporation is a serious option, but the withdrawal of entrepreneurs’ relief on the goodwill introduced, the restriction on the tax allowability of the write-off of goodwill and now the dividend changes make the tax advantage much smaller. However, in our view, there is still a benefit in tax terms for most individuals to continue to trade as a limited company. The tax saved by incorporation compared to being unincorporated will be reduced next year but there is still an annual tax saving. For a personal illustration of the savings, please contact us as we will need to illustrate it on a case-by-case basis.

Please note that our comments are based on the brief details of the new regime supplied by the Government. We expect this to be legislated for in Finance Bill 2016 but meanwhile we are still awaiting draft legislation, which may well not be released until after the Autumn Statement, which is usually at the beginning of December.

That is not an excuse not to plan; we fully expect clients who get to grips with the new regime will want to do something soon and lawyers will need to get the corporate paperwork right to ensure the desired timetable is adhered to.

If you would like to discuss this issue in more detail or you would like to speak with a member of our team, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with your local representative.

New UK GAAP: FRS102

A new Reporting Standard – FRS 102 has taken effect for accounting periods beginning on or after 1 January 2015. The new Standard contains a few key areas the professional services sector will need to consider as they represent a change in how certain transactions will be accounted for in the future.

Revenue recognition – earlier?

The requirements of FRS 102 are for the most part very similar to those in current UK GAAP, other than the accounting treatment of contingent revenue. In accordance with UITF 40 (old UK GAAP) revenue is recognised on conditional fee arrangements only once the critical event has occurred or specific future outcome has been realised, for example at the point the case is won.

The accounting requirements of UITF 40 are however not repeated in FRS 102. Instead revenue from the rendering of services is recognised when:

  • the amount can be reliably measured; and
  • it is probable that the economic benefits associated with the transaction will flow to the entity.

As such, revenue that is contingent on events outside the control of the entity may be able to be recognised earlier under  FRS102 than under the old UK GAAP.

Although we do not expect significant changes in revenue recognition, adoption of FRS 102 represents a golden opportunity to review current practice for recognition of contingent matters and work in progress.

Members’ capital balances

Under FRS 102 members’ capital balances with the Limited Liability Partnership (LLP) which do not attract interest and are repayable after more than one year will have to be discounted by an effective interest rate. This could mean the Capital balance reducing and an interest liability increasing on the LLP’s balance sheet.

In practice a simple solution may be to amend the LLP agreement to pay interest on capital balances as a first share of profits.
Holiday pay FRS 102 formalises the requirement for a holiday pay provision. Under old UK GAAP, the inclusion of a holiday  provision in the accounts was best practice, however there was no specific requirement. This requirement may represent a significant change to firms with high staffing levels.

Remuneration

There is a requirement under FRS 102 to disclose remuneration in respect of key management personnel. Key management personnel are those individuals who have authority and responsibility for planning, directing and controlling the activities of the
firm, directly or indirectly. This definition extends beyond designated members and may include operational management, made up of both members and non-members.

Lease incentives

For lease incentives such as rent free periods there is a slight change in that they will now be recognised over the whole lease term ignoring any breaks. Under old UK GAAP the benefit was recognised over the period to the first rent review.

Business combinations and goodwill

Under FRS 102 all business combinations will be accounted for under the purchase method (with the exception of group  re-organisations). The purchase method requires an acquirer to be identified, which is the entity that obtains control of the  other combining entities. The cost of the business combination shall be measured at fair value and allocated to the identifiable assets acquired and liabilities assumed at the acquisition date, including intangible assets acquired as part of the business combination. Any excess is recognised as goodwill. Where no reliable estimate of the useful economic life of goodwill can be made, under FRS 102 there will be a rebuttable presumption that goodwill is amortised over five years, compared to the existing presumption of 20 years. The FRC has however published FRED 59 (effective for accounting periods commencing 1 January 2016, with early adoption permitted) which proposes increasing the useful economic life where exceptionally a reliable estimate is not possible from five to ten years. This could be a key area for firms that are looking to acquire any new goodwill, or who have goodwill on their balance sheet currently being amortised over 20 years. The impact of the change is most likely to reduce reported profits and balance sheet strength in the short term.

Partnerships converting to an LLP can continue to use merger accounting, providing relevant criteria for a group reconstruction are met.

Conclusion

In summary, we do not believe the new Standard will produce a fundamental change to professional service firm’s accounts. However, members should consider whether any of the changes will effect the level of reported profits, related distributions and banking covenants in the first instance.

If you would like to discuss this issue in more detail or you would like to speak with a member of our team, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with your local representative.

SRA Accounts Rules to be relaxed

The Solicitor Regulation Authority (SRA) have announced a relaxation in the existing rigid requirements for submitting accountant’s reports. The proposed changes will mean that accountants can use their professional judgement to asses if the reports they prepare for solicitors’ practices comply with SRA account rules.

According to the SRA these changes should further improve the value of the reports, whilst reducing the burden on firms. It will also allow accountants more scope to use their expertise and advise clients on any potential risks.

Additionally the SRA have reduced the regulation for smaller firms who will not have to obtain an accountant’s report if they hold less than £25,000 of client money.

If approved by the Legal Services Board the amendments would form part of the SRA Handbook which goes live on 1st November 2015. This means the changes will only be applicable for accounting year ends on or after 30th November 2015.

This is the second phase of the regulatory reform programme launched in May 2014. The third phase will begin in the autumn and will look to simplify the Accounts Rules themselves.

If you would like to discuss this issue in more detail or you would like to speak with a member of our team, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with your local representative.