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Essential financial update for law firms - key points to take away

Read the latest tax and SRA rule updates, discussed during our recent law roundtable.

Changes to IR35

Initially announced in the Autumn Budget of 2018, for introduction from 1 April 2020, this affects individuals supplying their services through an intermediary Personal Service Company (PSC) who would be employed if engaged directly. It will affect medium and large organisations in the private sector – smaller organisations are exempt (generally where turnover is below £10.2m). The new legislation will shift the responsibility from the PSC to the business that the individual is supplying services to and includes the responsibility for deciding whether the rules should apply and deduct the associated employment taxes and National insurance contributions (NICs). We encourage you to review contracts and make changes, where necessary, 31 March 2020.

Changes to capital allowances

The Annual Investment Allowance (AIA), which provides 100% tax relief on the purchase of plant and machinery, increased to £1m with effect from 1 January 2019 until 31 December 2020. It reduces to £200,000 after this date. Consider the timing of your capital expenditure.

LLPs: a refresher on the salaried member rules

Introduced in Finance Act 2014, there are three tests to consider whether a member of a Limited Liability Partnership (LLP) is self- employed. The tests concern disguised salary, significant influence and capital contribution. At least one condition must be failed for the member to be treated as self-employed for tax purposes. Where significant influence is relied upon, make sure your LLP agreement supports this and doesn’t say, for example, that fixed share partners “have no decision-making power”. It is also important to review capital contributions at the start of each tax year to ensure capital is at least 25% of fixed profit shares.

Potential changes to Entrepreneurs’ Relief (ER)

On 6 April 2019, further qualifying conditions were introduced for ER to apply which considered ordinary share capital and increased the qualifying holding period from 12 months to 24 months. This capital gains tax relief was mentioned by both political parties in their manifestos. Currently the rate is 10% on qualifying business disposals up to a lifetime limit of £10m. Consider timing disposals to take advantage of relief in its current form before changes are legislated.

Review the financial clauses in your LLP agreement

We encourage firms to adopt wording that allocates the profits “at” the year end as opposed to “upon signing of the accounts” because “at” affirms that the profits, in aggregate, belong to the partners even though the precise split might not be made until much later. We notice that the LLP agreements of some large law firms even go so far as to allocate profits quarterly. This wording started to creep in post-2008 when so many firms were struggling and it was important to protect partners’ undrawn profits from the grasp of creditors.

Keep your structure under review

Around 48% of law firms are limited companies (“companies”), although most of these will be very small firms. LLP is not the only structure available and it’s worth considering whether a company (Ltd) would suit you better. Decision-making factors can include paying less tax on working capital retained in the business and accessing share based ownership models such as employee ownership trusts. Be wary of empty promises, though. If the majority of profits are withdrawn by partners, there is not likely to be much (or any) tax saving from converting to a company.

Have a succession plan!

Succession continues to be a problem for a great many law firms. Consider opening up discussions very early on with the next tier of partners and associates, encouraging them to participate in decision-making and training them to become future business leaders. Succession from within the business is usually more beneficial than trying to find a merger partner at the 11th hour. We see many cases where firms turned down reasonable offers (from acquirers or from within) only to have to go cap in hand to the same purchasers a decade later when the offer is less attractive.

Changes to make to comply with the SRA Accounts Rules 2019

As a general rule, assuming you’re compliant with the 2011 rules, very little will actually change. However, the key is to define your firm’s policies and procedures. This includes the definition of “promptly” in the context of your own practice. We will issue more guidance on this shortly, in terms of the categories of written policies we would expect firms to have.

Be aware of the SRA’s hot topics

Remind your fee earners to consider the underlying legal transaction and to be aware that, once the transaction has concluded, they must not then go on to provide a banking facility to clients. Be alert to money laundering when acting on instructions from clients and making payments from client account.

About the author

Claire Watkins

+44 (0)20 7556 1482
watkinsc@buzzacott.co.uk

Changes to IR35

Initially announced in the Autumn Budget of 2018, for introduction from 1 April 2020, this affects individuals supplying their services through an intermediary Personal Service Company (PSC) who would be employed if engaged directly. It will affect medium and large organisations in the private sector – smaller organisations are exempt (generally where turnover is below £10.2m). The new legislation will shift the responsibility from the PSC to the business that the individual is supplying services to and includes the responsibility for deciding whether the rules should apply and deduct the associated employment taxes and National insurance contributions (NICs). We encourage you to review contracts and make changes, where necessary, 31 March 2020.

Changes to capital allowances

The Annual Investment Allowance (AIA), which provides 100% tax relief on the purchase of plant and machinery, increased to £1m with effect from 1 January 2019 until 31 December 2020. It reduces to £200,000 after this date. Consider the timing of your capital expenditure.

LLPs: a refresher on the salaried member rules

Introduced in Finance Act 2014, there are three tests to consider whether a member of a Limited Liability Partnership (LLP) is self- employed. The tests concern disguised salary, significant influence and capital contribution. At least one condition must be failed for the member to be treated as self-employed for tax purposes. Where significant influence is relied upon, make sure your LLP agreement supports this and doesn’t say, for example, that fixed share partners “have no decision-making power”. It is also important to review capital contributions at the start of each tax year to ensure capital is at least 25% of fixed profit shares.

Potential changes to Entrepreneurs’ Relief (ER)

On 6 April 2019, further qualifying conditions were introduced for ER to apply which considered ordinary share capital and increased the qualifying holding period from 12 months to 24 months. This capital gains tax relief was mentioned by both political parties in their manifestos. Currently the rate is 10% on qualifying business disposals up to a lifetime limit of £10m. Consider timing disposals to take advantage of relief in its current form before changes are legislated.

Review the financial clauses in your LLP agreement

We encourage firms to adopt wording that allocates the profits “at” the year end as opposed to “upon signing of the accounts” because “at” affirms that the profits, in aggregate, belong to the partners even though the precise split might not be made until much later. We notice that the LLP agreements of some large law firms even go so far as to allocate profits quarterly. This wording started to creep in post-2008 when so many firms were struggling and it was important to protect partners’ undrawn profits from the grasp of creditors.

Keep your structure under review

Around 48% of law firms are limited companies (“companies”), although most of these will be very small firms. LLP is not the only structure available and it’s worth considering whether a company (Ltd) would suit you better. Decision-making factors can include paying less tax on working capital retained in the business and accessing share based ownership models such as employee ownership trusts. Be wary of empty promises, though. If the majority of profits are withdrawn by partners, there is not likely to be much (or any) tax saving from converting to a company.

Have a succession plan!

Succession continues to be a problem for a great many law firms. Consider opening up discussions very early on with the next tier of partners and associates, encouraging them to participate in decision-making and training them to become future business leaders. Succession from within the business is usually more beneficial than trying to find a merger partner at the 11th hour. We see many cases where firms turned down reasonable offers (from acquirers or from within) only to have to go cap in hand to the same purchasers a decade later when the offer is less attractive.

Changes to make to comply with the SRA Accounts Rules 2019

As a general rule, assuming you’re compliant with the 2011 rules, very little will actually change. However, the key is to define your firm’s policies and procedures. This includes the definition of “promptly” in the context of your own practice. We will issue more guidance on this shortly, in terms of the categories of written policies we would expect firms to have.

Be aware of the SRA’s hot topics

Remind your fee earners to consider the underlying legal transaction and to be aware that, once the transaction has concluded, they must not then go on to provide a banking facility to clients. Be alert to money laundering when acting on instructions from clients and making payments from client account.

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