Tax overhaul leaves law firm futures under threat

A “bombshell” that is about to radically change the way professional services firms account for work in progress (WIP) could put a significant number of firms out of business and will certainly provide all with a significant hike in their tax bill.

Changes in the way all businesses account for revenue were introduced last November by the Accounting Standards Board (ASB) in an application note to FRS5, an official ASB ruling applying to accounting periods ending on or after 23 December 2003.

The key change for law firms and barristers is that the profit on equity partner time will be recognised – and therefore eligible for tax – while the work is in progress and not, as is currently the case, when the bill has been delivered. The charge is believed to represent up to 50 per cent of an annual tax bill.

The changes will take effect in the current accounting year. Firms with a year end on 31 March will face a larger tax bill on 31 January 2005. Those with a year end of 30 April will have until January 2006 to find the extra cash.

At the very least, all firms will face a substantial one-off uplift in their tax bills this or next year.

Simon Mabey, chairman of Smith & Williamson’s professional practices group, said: “It’ll be a really nasty shock to everybody, a bombshell. If anything is to change there needs to be a substantial lobbying campaign put in place fairly quickly.”

A meeting is to be held tonight (26 January) by the Association of Partnership Practitioners (APP). Nigel Davey, Deloitte & Touche partner and chairman of the APP’s taxation working party, said that the meeting had two objectives: “To put people on notice of what the new accounting standards means, and to galvanise representations to the Inland Revenue for some kind of concession or softening of the blow, by enabling the liability to be spread over a period of up to 10 years.”

The last time there was a major overhaul of the tax arrangements for professional services firms was in 1999, when the ‘catch-up charge’ was introduced to account for WIP at cost. Then the Inland Revenue allowed the cost to be spread over 10 years. Firms have until 13 February to convince the Inland Revenue of the urgency for a similar allowance this time.