Herbert Smith has ditched plans to overhaul its financial reporting system after a gloomy profit outlook made it likely that partners would be left out of pocket.
While most firms have an April year-end, Herbert Smith’s financial year runs from April to March. The firm had intended to shift its year-end forward a month, which would have allowed partners to defer tax payments by a year.
The plan, which had not been fully communicated to partners, would have been beneficial to Herbert Smith in a climate of rising profit. It would have enabled the firm to pay its £50m tax bill for the 2007-08 financial year, due on a net profit of £147m, a year later. Similarly the tax bill for 2008-09 would be paid in 2010.
Although the firm has altered its systems so that its accounting year now ends in April, it abandoned plans to change the year for tax purposes, given the bleak outlook for profitability.
Herbert Smith’s U-turn comes as firms across the market prepare to pay the final instalment of their 2007-08 tax bills in January.
Nick Carter-Pegg, head of professional services at BDO Stoy Hayward, explained how the tax deferral would have worked. “The tax year runs from 6 April to the following 5 April. When you do a tax assessment you look at the [accounting] year that has ended in that period. The year ending March 2008 would be in the 2007-08 tax year.
“By changing it to April the profits for the year ending 2009 would not get assessed until the end of April 2010.”
Although the firm saw revenue rise by around 11 per cent over the first six months of the current financial year – two percentage points behind budget – predictions for the full year remain uncertain.
The firm will not go ahead with the change because a drop in profit would create a cashflow disadvantage, with the deferral meaning that tax on a high amount of profit would be paid out of a smaller pool.
A source at the firm said: “The cashflow advantage only works when profits are rising. This year we didn’t know if profits would rise sufficiently to make it worth making that change.
“If we got it wrong, we would end up paying tax twice, so we have put the decision to change on hold.”
Read this week’s leader on Herbert Smith here.