End of the cash basis
The cash basis of preparing barristers’ accounts came to an end when section 42, FA 1998 was enacted, requiring accounts to be prepared ‘on a true and fair basis’. Reference to this basis was replaced by section 101(5), FA 2002 which required accounts to be prepared ‘in accordance with generally accepted accounting practice (GAAP)’. See also the HMRC Business Income Manual at BIM 74000- BIM 74015.
The effect, as far as barristers are concerned, is that accounts must be prepared taking into account accruals, debtors and work in progress, and the GAAP requirement is now enshrined in section 25, ITTOIA 2005.
Work in progress at full value
It was originally considered that Statement of Standard Accounting Practice 9 (SSAP 9) meant that work in progress could be valued at the lower of cost or net realisable value. However Financial Reporting Standard 5 (FRS 5) was amended in June 2003. This led to doubts as to whether the time of individual barristers should be reflected in work in progress. After some controversy an abstract from Urgent Issues Task Force (UITF 40) highlighted a provision in SSAP 9 dealing with long term contracts. The effect of this was that the work in progress of professionals such as barristers had, in effect, to be valued at full value. This applies for all periods of account ending on or after 22 June 2005.
There are further complications as some barristers operate fee arrangements outside ‘the norm’. Advice has been received from the Consultative Committee of Accountancy Bodies in this respect, to the following effect:
- When a no win, no fee arrangement is entered into, fees can only be recognised when the case has been won.
- Where the arrangement is for the client to pay at the end, a reasonable assessment of the fee earned at the end of the accounts year should be made. In some instances this is not possible.
- In the case of a fixed fee it should be possible to quantify the work in progress at year end, depending on the progress of the case.
- In Legal Aid cases work in progress should be recognised depending on the progress of the case, not payments on account received. In some instances account must be taken of the fact that some parts of payments on account will have to be repaid.
The legislators and HMRC accepted that recognition of debtors and work in progress in one tax year would place an impossible burden on professionals, particularly newly enrolled barristers. Similarly, valuation of work in practice at full value inclusive of principal’s time in one tax year was prohibitive. Accordingly transitional provisions were introduced.
Newly enrolled barristers
Section 160, ITTOIA 2005 permits the cash basis to continue for the first seven years of a barrister’s practice. This commences usually, but not always, from the second six months of a barrister’s pupillage. See also HMRC Business Income Manual at BIM 51101, BIM 74020 and BIM 74110. Accounts may be prepared on a fees received basis immediately on commencement of practice, but once a basis has been chosen it must be used consistently. GAAP must be adopted for any accounting period that ends more than seven years after the barrister commences practice, and where this is after 22 June 2005 the earnings basis effectively incorporates UITF 40. This means that the full adjustment may be spread over the next ten years, in accordance with section 238, ITTOIA 2005, but may be accelerated as discussed below.
In some instance fees may be earned during the first six months of pupillage from writing articles, and in the case of some sets, the pupil may earn a fee for ‘devilling’ for a senior barrister within the chambers. This may then effect the commencement of the seven year cash basis period.
Spreading the catch-up charge
Sections 226-240, ITTOIA brings income not taxed under the cash basis into account. The catch-up charge is not subject to NIC, but it qualifies for earnings for UK pension purposes (see also BIM 74025 – BIM 74065).
Section 239, ITTOIA 2005 provides that a qualified barrister’s catch-up charge on cessation of the cash basis is spread over a ten year period (see BIM 74035 – BIM 74040). Instalments for the first nine years are the lower of one tenth of the catch up-charge or 10% of the barrister’s pre-capital allowances profits, and form the basis of a catch-up assessment. In the tenth year the balance is brought into account (see BIM 74045). It was possible to accelerate the taxation of the catch-up charge in a particular tax year by making an election. The residual catch-up charge would then be spread evenly over the remaining period. This legislation applies for the first period of account commencing after 6 April 1999. Both opening and closing debtors and work in progress are valued at full value, and in effect the opening debtors and work in progress form the catch-up charge.
This relieving provision meant that in each of the nine years of assessment commencing with the year of assessment when the adjustment would otherwise be taxed, the catch up-charge would be the lower of:
- One tenth of the catch up charge; or
- Ten per cent of the pre-capital allowances profits for the year.
Any balance of the catch up charge would be assessed in the tenth year. It was possible to accelerate the taxation of the catch up charge by making an election. A figure of more than one tenth would then be taxed in an earlier year, and the balance of the catch up charge would then be taxed evenly over the remainder of the ten year period. This could be beneficial depending on the barrister’s individual tax affairs. Section 239 regarding the catch up charge remains current.
Spreading the UITF 40 adjustment
A further transitional provision is that barristers who recognise SSAP9 and UITF 40 in their accounts for the first time may benefit from spreading the catch up charge over six years commencing with accounts years ending on or after 22 June 2005. This was on the basis that the accounting policy pre and post change was GAAP compliant. Income reflected in the first three adjustment years would be the lower of:
- One third of the adjustment income; or
- One sixth of the pre-capital allowances profits for the tax year concerned.
In the fourth and fifth adjustment years, the adjustment would be the lower of;
- The amount remaining untaxed;
- One third of the adjustment income; or
- One sixth of the pre-capital allowance profits for the tax year concerned.
Any balance is taxed in the sixth year. The adjustment could therefore be made over three years or possibly six, depending on the profit profile of the barrister.
In some instance barristers may have adopted an earnings basis prior to 22 June 2005, but before the adoption of UITF 40. On the subsequent adoption of UITF 40 a further adjustment would arise. Adjustments should qualify for both the ten year and six year spreading provisions. However, when calculating the amount of the six year spreading charge arising from the adoption of UITF 40, the profits used in the calculation are those pre-capital allowances and the application of the ten year adjustment under section 238.
In instances where a barrister either deliberately or inadvertently failed to adopt an earnings basis at the end of the seven year period after commencing practice, they would not be complying with GAAP. The result of this would be that on adoption of UITF 40 they would not qualify for the six year spreading provision.
The author acknowledges helpful comments made by Keith Gordon of Atlas Chambers, which have been incorporated into this article. This is an abridged version of an article that was first published in Taxation magazine; the second and concluding part of this feature will be published in July’s issue of Counsel.
John Newth FCA FTII FIIT ATT
Example 1 – newly qualified barrister
Horace was taken on as a pupil by Dickens Chambers on 1 October 2004. Subsequently he completed his pupillage at the set and was offered a tenancy. He is regarded as commencing practice on 1 April 2005, at the beginning of his second six months of the pupillage.
Horace adopts the cash basis for the first seven years of practice, and prepares his accounts up to 31 March each year. This terminates at 31 March 2012, at which point he must adopt GAAP, including the valuation of work in progress according to UITF 40. His debtors and work in progress at full value at 31 March 2012 total £70,000.
The catch up charge of the lower of £7,000 or 10% of his pre-capital allowances profits each year will be added to his assessable profits from practice for the ten years 2012/2013 to 2021/2022. The first catch up charge might be assessable in 2011/2012 if, for example, Horace prepared accounts to 5 April. This is because the change in basis falls in the year to which the 2011/2012 accounting period relates.
Horace could have adopted GAAP from the moment he commenced practice. However, he would then be prevented from changing back to the cash basis during his first seven year of practice.
Example 2 – acceleration of catch up charge
Assuming the same facts as in Example 1, supposing that, in the year 2015/2016, Horace decides to accelerate the catch up charge by electing to add £13,000 to his profits for that year. He has already paid tax on a catch up charge of £7,000 a year for the three tax years 2012/2013 to 2014/2015, totalling £21,000. Taking into account the £13,000 this leaves a figure of £70,000 minus £34,000 equalling £36,000 to be taxed in the six years 2016/2017 to 2021/2022. Horace will be assessed on £6,000 for the six years 2016/2017 to 2021/2022.
Example 3 – reduced profits
Assuming again the facts as in Example 1, Horace has pre-capital allowances profits of £50,000 in 2013/2014 and £60,000 in 2014/2015. The catch up charge will then be assessed as follows:
2012/2013 - £7,000
2013/2014 - £5,000
2014/2015 - £6,000
2015/2016 to 2020/2021 - £7,000 a year for 6 years, totalling £42,000
2021/2022 - £10,000
Example 4 – barrister adopting GAAP
Bernadette had been in practice for some years and her accounts year end is 30 April. She was required to adopt the full earnings basis for her accounts from 1 May 1999, at which point her debtors and work in progress were £120,000. The catch up charge for the years 1999/2000 to 2008/2009 would therefore be the lower of £12,000 or 10% of the pre-capital allowances profit each year.
Her profits exceed £120,000 for each of the years except 2005/2006, when her profits totalled £60,000. The catch up charge assessable in addition to practice profits would therefore have been:
1999/2000 to 2004/2005 six years at £12,000 = £72,000
2005/2006 - £6,000
2006/2007 and 2007/2008 - £12,000 for each year totalling £24,000.
2008/2009 - £18,000
Example 5 – barrister electing to accelerate catch up charge
Assuming the same facts as in Example 4, except that Bernadette elects to accelerate the catch up charge. She elects for £15,000 of the catch up charge to be assessed in 2006/2007 and £18,000 in 2007/2008. The charge assessable then becomes:
1999/2000 to 2005/2006 seven years at £12,000 = £84,000
2006/2007 - £15,000
2007/2008 - £18,000
2008/2009 – the balance of £3,000
Example 6 – barrister recognising UITF 40
Edwin’s accounts year end is 31 March, and on recognition of work in progress at full value there is an adjustment of £60,000. He has previously adopted GAAP. The pre-capital allowances profits of his practice were:
Year ended Profits
As the adjustment income has been fully recognised by 2009/2010, there is no addition to the profits for the year to 31 March 2011.
Tax year One-third of adjustment income One sixth of profits Taxable adjustment
2005/2006 £20,000 £13,333 £13,333
2006/2007 £20,000 £7,500 £7,500
2007/2008 £20,000 £16,667 £16,667
2008/2009 £20,000 £10,000 £10,000
2009/2010 £20,000 £20,000 £12,500
2010/2011 £20,000 £12,500 Nil