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Special rules for barristers and advocates
Barristers are not permitted to provide their services through a limited company. All barristers have to register as self-employed and submit business accounts as a sole trader to HMRC. There are special provisions relating to cash accounting and the rules have changed in recent years meaning there are three different regimes that can apply. There are time limits for the cash accounting schemes so if you are in your first few years of practising you will need to make sure that you are reporting the correct figures to HMRC. Guidance is available from the Bar Council here.
The Finance Act 2013 introduced the possibility of cash accounting for most unincorporated business including sole traders from 6th April 2013. Barristers already had a cash scheme available when they started their practice with permission to continue the same cash accounting principles for up to 7 years under the Finance Act 1998. This old cash scheme is no longer available to new barristers, but anyone who started preparing accounts under the old cash basis by 5th April 2013 can continue to do so until their seven years is up or they transfer voluntarily to another scheme. Once you have left the old cash scheme there is no turning back.
Barristers can join the new cash scheme where fee receipts do not exceed the VAT registration threshold (currently £79,000 per year). If receipts are more than twice the VAT registration threshold (currently £158,000) the barrister must leave the scheme.
The advantages of the cash schemes are that they are easier to administer so there is less need to engage an accountant to prepare your accounts. You only pay tax on fees received and you do not have make calculations at the year-end for work that is incomplete or invoiced and not yet paid by your clients. This means that your tax payments are delayed compared to the earnings basis below and will improve your cash flow. There are other aspects of the cash schemes which are explained in more detail here.
A barrister on the old cash scheme can elect to leave the scheme early, but the new cash scheme does not allow exit unless there is a “change in commercial circumstances”.
Earnings based accounting
UITF 40 requires that long term contracts are recognised in the year-end accounts to the extent that partly performed work is recognised as taxable income. This requires barristers to calculate the value of any Work In Progress (WIP) at the end of their financial year and include this in their total income.
Materiality is a key concept in accounting, but the materiality of the total WIP must be considered not just the materiality of each individual contract. It is not permitted to disregard a number of immaterial amounts if when considered together they are material to the accounts. In practice this means that almost all WIP is chargeable to tax under the earnings method. One of the few clear cut exceptions is a no fee no win case, where no WIP is to be recognised.
When changing from either cash accounting scheme to the earnings based scheme a calculation of the WIP must be made which will increase the taxable income for the year. The old cash method allows the closing WIP at the time of the change to the earnings method to be recognised over a period of up to 10 years. The provisions under the new cash scheme have a reduced timeframe of 6 years. It is normally the case that anyone transferring from the old cash scheme to the new cash scheme would not need any adjustment to the annual accounts. There are corresponding adjustments for barristers transferring from the earnings scheme to the new cash scheme – explained in more detail here.
For more information on an accountancy firm that can set you up with online accounting and deal with all your business accounts and VAT – contact Alterledger or visit the website alterledger.com.
|Bar Council Guidance||practice-updates-and-guidance/remuneration-guidance/|
|Faculty of Advocates||http://www.advocates.org.uk/|
|HMRC crackdown on barristers||http://www.bbc.co.uk/news/business-19635051|
BIM74150 sets out HMRC’s guidance:
Unfortunately, there is no special treatment of cases where a client is legally aided. Work in progress, and anticipated profit costs in completed cases, have to be brought into account notwithstanding that there might be substantial delay in the receipt of fees. However, the solicitor is entitled to exercise a prudent approach where he or she knows that costs are going to be taxed, as to what the realisable value of work in progress, and anticipated profit costs, might be.
But the law society guidance provides more detail:
- The Tax Point is normally payment
- Prudent judgement is required of the value of work done to date
- Payments should not be recognised if it is likely that they may have to be refunded
Other interesting points from the Law Society:
- No Win No Fee – Revenue recognised when the case is won
- Pay at End – either estimate the fees or if uncertain revenue should be recognised when a reliable estimate can be made
- Fixed Fee – use appropriate judgement
Perhaps one of the most important things an individual can do when self-employed is to keep meticulous accounts. This means not only keeping a record of income and expenditure, but also work in progress at the end of the tax year. The case of Mark Smith v HMRC  TC02321, which was an appeal heard in the First Tier Tribunal of the Tax Chamber illustrates the potential ramifications of failing to keep one’s accounts in sufficient order.
The appellant in this case was trading as a builder. He sought to appeal against assessments to tax and amendments to self-assessments in respect of the years ending 5 April 2001 to 5 April 2007 inclusive.
The central issue before the tribunal related to the appellant’s computation of profits. It was admitted that his accounts understated the profits gained in a particular tax year. However, it was his contention that this was a “one-off”. Nevertheless, in following years, his assessments were raised in an effort to make good the profits previously understated. The question was whether these assessments were justified.
In the construction industry, building projects can last for several months or years, generally, each month the contractor will submit an application for payment to the client based on their assessment of the work. When and if the client agrees they will certify the work and make payment, if they disagree a lower amount will be certified. The certification process can often take up to 3 weeks.
The Contractors Quantity Surveyor will prepare a report known as a Cost Value Reconciliation (CVR) or Cost Value Comparison (CVC). These will show the value of the work completed to a set date (whether certified or not) and the profit, here is an example
Often a CVR will list every sub-contract package and the materials ordered in great detail compared to the tender and stage of completion.
The underlying principle is that of ‘matching’ costs and revenue to allow the accountant to accrue for costs and adjust revenue (accruing Income).
The tribunal held that HMRC’s assessments were in fact justified. In relation to quantum, the tribunal confirmed that the burden of proving the amount assessed lay with the taxpayer. In this case, the appellant failed to adduce evidence sufficient to displace the assessments made by HMRC. Accordingly, the assessments were confirmed and the appeal was dismissed. The appellant therefore remained liable in the amount as assessed by HMRC.
The reason why HMRC were successful was that in the case of Mark Smith he based his income on certified revenue, this meant that the profit was understated, within Construction “UK GAAP” requires revenue to be reported on application based on the CVR matching approach.
The details of the additional profits and tax for each year are as follows:
(1)2000/01: additional profits of £43,189 giving rise to tax of £17,275.60
(2)2001/02: additional profits of £65,205 giving rise to tax of £24,972.02
(3)2002/03: additional profits of £73,889 giving rise to tax of £27,737.86
(4)2003/04:additional profits of £70,023 giving rise to tax of £27,503.41
(5)2004/05: additional profits of £70,000 giving rise to tax of 27,704.18
(6)2005/06: additional profits of £65,240 giving rise to tax of £26,735.44
(7)2006/07: additional profits of £45,541 giving rise to tax of £18,671.81
Who bears the burden of proving excessive assessments?
In establishing discovery assessments, HMRC bears the burden of demonstrating that they are valid. However, if an individual taxpayer believes the assessment to be excessive, the burden then shifts to that individual to prove that is the case.
Section 50(6) of the Taxes Management Act 1970 provides that:
“If, on an appeal notified to the tribunal, the tribunal decides—
(c) that the appellant is overcharged by an assessment other than a self- assessment, the assessment shall be reduced accordingly, but otherwise the assessment shall stand good.”
In other words, once HMRC makes an assessment, the amount of that assessment stands unless the individual taxpayer can prove on the balance of probabilities (through the production of evidence) that the assessment should be different.
In this instance, HMRC had substantially underestimated the appellant’s profits for the year 2004/05. The appellant submitted that his underestimation for profits in 2004/05 was a ‘one-off’, and therefore did not warrant any adjustment for other years. It was for him to prove this. He was unable to do so and failed to adduce any evidence. HMRC concluded that the appellant had been gravely negligent in the conduct of his tax affairs and that further assessments were therefore justified.
Additionally, the appellant seemed to provide no explanation to the Tribunal to account for the under-declaration. There may have been a legitimate reason for this, and had his accounts been kept consistently throughout the period in question, he would have perhaps had evidence capable of proving to the tribunal that the error was in fact a sole incident.
This is a joint blog between Rebecca Broadbent (Practice Manager, Chambers of Jason Elliott [Barristers]) and Steve Bicknell
It’s a common issue and area of confusion and it has tax implications. WIP is valued at the lower of cost or net realisable value but Debtors whether invoiced or not are valued at Sales Value, uninvoiced Sales are shown as Amounts Recoverable on Contracts within Debtors.
Here is an example from HMRC
A joiner contracts to create fitted bookcases in an office for a total price of £15,000. He purchases the timber (materials cost £6,000) and builds the doors in his workshop. He also prepares the timber for the rest of the structure in his workshop. He then builds the skeleton of the bookcases on the customer’s premises and attaches thereto the timber that he has already prepared in his workshop. What is the accounts treatment if his year end occurs after he has prepared the timber and the doors but before he has gone to the customer’s premises to build the skeleton and fit them?
The contract is a single contract and the joiner should recognise revenue according to the stage of completion of the work. It is not relevant whether the work is done at his workshop or at the client’s premises. Neither is it relevant that part of the contract can be regarded as ‘goods’ and part as ‘services’: both are treated in the same way for accounting purposes.
Let us assume the joiner assesses that he has done 1/3 of the work by the year end and he has used half of the timber and other materials. The calculation would be: total price £15,000 less materials at cost (£6,000) leaves £9,000. Assuming the profit attaches only to the labour, accrued income is £3,000 (1/3 complete) plus materials at cost of £3,000 ( a half used), a total of £6,000. The remaining half of the total cost of the materials (£3,000) is work in progress. These figures should then be adjusted to reflect any likely losses, discounts, delay in payment or cost of difficulties expected to arise in completing the contract. Any progress payments received should be treated as creditors in accordance with SSAP 9.
Also further guidance at
So do you have Work in Progress or Amounts Recoverable on Contracts?