Pre-budget updateTax burden eased for small firms

Partners’ fears that additional tax bills, caused by a change in the way work in progress (WIP) is calculated, would have to be paid in a single year appeared to ease last week when Chancellor Gordon Brown trailed a relaxation of the rules relating to FRS5 in his pre-Budget statement.

However, the statement also added further confusion to a saga that has already rumbled on since December 2003. The position of partners at firms that have already made an adjustment in their accounts based on the new accounting standards remains unclear. The statement also outlines how next year’s changes will enable “most businesses” to spread any tax charge over three years, without explaining fully what it means by ‘most’.

Law Society president Kevin Martin welcomed the news. In a prepared statement, he said: “This is very good news for solicitors and will be a huge relief for many practitioners who simply didn’t know how they would be able to pay their tax next year. We have worked very closely with the Consultative Committee of Accountancy Bodies and the Treasury to resolve this problem.”

However, according to other practitioners, the issue is still far from resolved. One accountant familiar with the legal market admitted that the Chancellor’s decision to allow the tax burden to be spread was “excellent” news.

However, he added that the relief appeared to be targeted at smaller firms. “While the Law Society says this concludes the tax position, this may not be the case for the majority of the top 100 firms, which have already changed their accounting policies to reflect the original announcement in December 2003,” he said. “It appears that HM Revenue & Customs is taking the line that these firms do not fall within the new spreading provisions, as their adjustment predates the revised guidance issued in March 2005. These firms therefore appear to still have a potentially big ‘one-off’ tax hit, probably due for payment in January 2006.”

The additional tax liability had been created by changes to the way professional partnerships account for revenue and WIP. It was first highlighted in a note from the Accounting Standards Board in December 2003, known as Application Note G to FRS5. The changes created an uplift in tax because firms were obliged to recognise revenues from certain types of work earlier than before, increasing revenues and therefore the level of tax.

It remains unclear what the statement means by “most businesses”. As Baker Tilly’s George Bull pointed out: “There’s no promise here of spreading for the larger firms, but equally there’s no guidance as to what ‘big’ means. The change shows the Revenue has listened to the pleadings made by the legal community and it’s good news for smaller firms, but it appears to be bad news for larger firms.”