Winter 2014 Legal Focus

Guiding you to lifelong prosperity

Becoming a self-employed member of an LLP - when is the best time?

New LLP SORP issued

Capital Allowances - reporting change

VAT - a reminder of why tax law is so lengthy

Residual Balances Rules have changed

SRA and Accountant’s Reports - the current position

Contents:

LMS 2014 Financial BenchmarkingReport - results out soon

New Team Members

BackgroundBy way of a reminder, the introduction of newrules prompted firms to decide what action totake for their fixed share members to be ableto remain self-employed for tax purposes.

“Of the three choices available(variable profit shares, increasedinfluence and injection of capital),in our experience by far themost popular route for remainingself-employed has been themaking of a capitalcontribution.”

Condition C of the new rules requires the fixedshare member to have made a capitalcontribution equating to 25% or more of theamount they reasonably expect to be paid bythe LLP during the tax year in question.

The position is relatively straightforward forexisting members at 6 April 2014 who hadmade the required contribution by that date (orby 5 July 2014 in certain cases). However, thereare some pitfalls to watch out for in othersituations.

Existing self-employed membersmaking additionalcontributionsWhere an existing member made the requiredcontribution at 6 April 2014 (or by 5 July, whereapplicable) based on their expectation on 6 Aprilof their profit share for the coming tax year, theycontinue to be taxed on a self-employed basis.If there should be an increase in their expectedprofit share part way through the tax year, whichwas not expected at 6 April, and therefore nottaken into account in the assessment made onthat date, it is necessary to reassess the level oftheir capital contribution, and additional capitalwill need to be contributed to remain self-employed for tax purposes. For example:

Robert, a long-standing LLP member, receivesan annual profit share of £80,000. At 6 April2014 there was no expectation that his profitshare would change during the year to 5 April2015, and so he made a capital contributionof £20,000 to remain self-employed. On 22December 2014, following a particularlylucrative client win, the board decide to rewardRobert with an increased profit share of£90,000, effective from 6 January 2015. Thischange in Robert’s circumstances means thathe now expects to receive £82,500

(£80,000 x 9/12 plus £90,000 x 3/12) in theyear to 5 April 2015, so his capital contributionneeds to be increased if he wishes to remainself-employed for the rest of the tax year.

Robert needs to increase his capitalcontribution to £20,625 (£82,500 x 25%) by 6January 2015, or he will be taxed as anemployee from that date. There is no graceperiod for introducing the additional capital.

In addition, as his capital contribution isreassessed on 6 April each year, in order toremain self-employed throughout the 2015/16tax year Robert will need to increase hiscontribution to £22,500 (£90,000 x 25%) by 6April 2015, assuming no change is expected to his£90,000 profit share. For simplicity, Robert maydecide to increase his contribution to £22,500from 6 January 2015, cash flow permitting.

Existing members taxed as employeesWhere existing LLP members have made nocapital contribution by the required date, orwhere the contribution is less than 25% of theirprofit share, they are taxed as an employeefrom 6 April 2014. If the member subsequentlyincreases their capital contribution in order tobecome self-employed, a special rule applies afraction to the individual’s contribution, therebypotentially reducing its value when applying the

In the past, becoming a self-employed LLP member has often meant complex calculations ofthe new member’s taxable profit share for the first few years, and dealing with the creation of“overlap profits”. The new rules that came into affect on 6 April 2014 for fixed share membersof LLPs have added more complexity, and all may not be as it seems.

25% test. The fraction is calculated as thenumber of days from the date of the additionalcontribution to the end of the tax year dividedby the number of days in the tax year. This isbest illustrated using an example:

Linda has been a member of an LLP formany years, receiving an annual profit shareof £100,000. At 6 April 2014 she had madea capital contribution to the LLP of just£5,000, so she was taxed as an employeefrom 6 April 2014. On 1 December 2014she contributes a further £20,000 to the LLPin an attempt to become self-employed, buther contribution is deemed to be £8,630(£25,000 total contributions x 126 days /365 days) for the purpose of the test. Asshe is deemed to have only contributed8.63% of her profit share for the tax year,she remains employed for tax purposes.

In order to become self-employed, Linda wouldneed to have contributed at least £67,421(£25,000 x 365 days / 126 days less the £5,000

already contributed). The later in the tax yearthe contribution is made, the greater it needs tobe. If Linda had made the contribution on 1January 2015 it would need to be £91,053 forher to become self-employed. The logic behindthis measure is pretty questionable, but it seemsHMRC require a 25% contribution to havebeen in place for the full tax year, and acontribution made part way through the yearmust be pro-rated.

The test is recalculated at the start of each taxyear, with no pro-rating of contributions, soLinda might prefer to wait until the start of thenew tax year before making the further£20,000 contribution. That is unless she canafford to make the exceptionally largecontribution and wait until the start of the newtax year to then withdraw the excess.

New membersAs explained above, the test to calculatewhether a member’s capital contribution is

sufficient is based on their profit share for thetax year. For a new member joining part waythrough a tax year it would, on first glance,appear that a reduced capital contribution canbe made initially, as a full year’s profit share willnot be received in the first tax year. However,the fraction calculated above is also applied tothe contribution in this situation. There is adetailed calculation involved, but the overalleffect of this is that the member must effectivelycontribute at least 25% of their annual profitshare, regardless of the date on which they jointhe LLP, which is arguably a reasonableoutcome.

SummaryApplying the 25% test at 6 April 2014 and atthe start of subsequent tax years should notpresent too many difficulties, but at all othertimes care needs to be taken to ensure thecorrect amount of capital is contributed tosecure self-employed status.

On 15 July 2014 the Consultative Committeeof Accountancy Bodies (CCAB) published anew version of its Statement of RecommendedPractice (SORP) on Accounting for LimitedLiability Partnerships (LLPs).

The new SORP, which is effective for accountingperiods commencing on or after 1 January2015, has been updated to remove allreferences to old UK Generally AcceptedAccounting Practice (UK GAAP) and takesaccount of the introduction of FinancialReporting Standard 102 – The FinancialReporting Standard applicable in the UK andRepublic of Ireland. It applies to all LLPsincorporated in the UK that prepare theiraccounts under either FRS102 or the FRSSE. Itdoes not apply to LLPs that have adoptedInternational Financial Reporting Standards(IFRS).

That’s a lot of acronyms - whatdoes this mean forLLPs?Well first of all, FRS102 is a brand newaccounting standard, which replaces all of thecurrent FRSs and SSAPs.

It is a single standard with 35 sections, coveringthe various different items previously dealt within separate standards, and is a mere 342 pageslong, compared to the 3,000 or so pages ofcurrent UK GAAP! Most large and medium-

sized UK entities will need toapply FRS102 when they preparetheir accounts in future.

FRS102 will introduce a number ofchanges to financial statements,including:

� Requiring more intangible assets to berecognised separately from goodwillwhen there is a business combination.These could include values on things likebrands and client lists.

� A presumption that the useful life ofgoodwill and intangible assets (the write offperiod) is no more than five years, unless areliable estimate can be made.

� Changes to the formats (and titles) of theProfit & Loss Account and Balance Sheet,such as introducing a Statement of FinancialPosition, a Statement of ComprehensiveIncome and a Statement of Changes inEquity.

� Changes to the accounting treatmentsavailable on reconstructions and mergers.

In short, the new SORP explains how FRS102will impact on an LLP’s accounts. As a result,there are changes to the presentation anddisclosures required for members’remuneration on the face of the P&L Account(or Statement of Comprehensive Income),considerable changes to the classification ofitems appearing on the LLP’s cash flow

statement, and changes to the treatment ofmembers’ retirement benefits.

The SORP also gives guidance on the use ofmerger accounting on conversion frompartnership to LLP and in the event of businesscombinations or group reconstruction, andrequires additional disclosures of remunerationto key management personnel, includingemployees.

New LLP SORP issued

All practices involved in commercial propertyconveyancing need to be aware of recentchanges in tax legislation relating to the claimingof capital allowances on fixtures, and itspotential impact on how they should adviseclients. Previously, capital allowances weregenerally the domain of accountants and taxadvisers.

Failure to ensure that the new form CPSE 1 isanswered correctly in respect of capitalallowances could have a significant impact onthe viability of commercial propertytransactions, and leave clients out of pocket,possibly leading to negligence claims.

“When advising on propertypurchases, solicitors should nowensure that the full capitalallowances history of the propertyis obtained prior to the purchaseagreement being signed.”

What are capital allowances?Capital allowances provide tax relief to theowner of a property, and can be claimed on‘integral features’, which include things likeelectrical and lighting systems, cold watersystems, ventilation systems, lifts and escalators.The amounts can often be significant.

For capital allowances purposes, integralfeatures fall within the definition of ‘fixtures’,which means ‘plant or machinery that is soinstalled or otherwise fixed in or to a building orother description of land as to become, in law,part of that building or other land’. Readersshould be aware that this is not the same as thelegal definition.

What has changed?The rationale behind the new rules is to ensurethat expenditure on fixtures is only written offonce against taxable profits over its economiclife. Therefore, when a commercial property issold, the purchaser’s position regarding thecapital allowances that are available needsdetailed consideration at the time of the

transaction, as the availability will be dependenton what (if any) allowances have previouslybeen claimed by the immediate, and alsoprevious, owners.

From April 2012, a ‘fixed value requirement’ hasbeen introduced. Therefore, a purchaser is onlyable to claim capital allowances on fixtureswithin the property if he and the seller havesigned a joint election to agree a value for suchfixtures on which the seller has previously madea claim. This is documented through somethingcalled a ‘Section 198 election’ (freehold) or‘Section 199 election’ (leasehold), which mustbe made within two years of the completiondate. Although there is a two year window, toensure this requirement is not missed, it wouldclearly be wise for the election to be made atthe time of the transaction. There is norequirement that the fixtures disposal valueused must be market value, but it cannotexceed the original cost.

Alternatively, an independent determination canbe obtained from a Tax Tribunal if the twoparties are unable to arrive at an agreed value.Any application to the tribunal must be withintwo years of the transaction.

Failure to do one of the above - either make ajoint election or make an application to a taxtribunal – not only impacts on the immediatepurchaser but also any subsequent purchasers,as the inability to claim capital allowances mayreduce the value of a property.

It is also worth noting that if the vendor hasnever claimed allowances on fixtures, and makesa statement to that effect, the purchaser can stillmake a capital allowances claim on the acquiredfixtures.

However, from April 2014, a ‘poolingrequirement’ has been introduced. Therefore, inaddition to the fixed value requirement,‘mandatory pooling’ will be required, whichmeans a buyer will only be permitted to claimcapital allowances if the seller has ‘pooled’ allqualifying expenditure that they have incurred,in their tax return.

To sum up the impact of the new rules, if theseller has claimed capital allowances on fixtures,the purchaser will need to confirm that theseller has allocated the expenditure to a pooland then agree a disposal value for theexpenditure by way of a Section 198/199election or by application to the Tax Tribunal. Ifthese steps are not taken, the purchaser isprevented from claiming capital allowances. It istherefore important that necessary proceduresare taken prior to signing, otherwise capitalallowances will be lost forever on the fixturesacquired as part of the building.

Consequently, when involved in the acquisitionor sale of a commercial property, carefulconsideration of the capital allowances positionshould be undertaken. Solicitors may thereforeneed to take a more proactive role in thecapital allowances process.

CapitalAllowances - reporting change

VAT - a reminder of why tax law is

so lengthy For VAT purposes, the supply of solicitor’sservices will be subject to the normal rules forcharging VAT at the time of supply of services.The time of supply is normally when the supplyis completed. This is called the “Basic Tax Point”.VAT has to be accounted for in the VAT quarterin which the tax point falls.

However, this tax point can be overridden by an“Actual Tax Point”, as per the following:

� The time when a payment is received or aVAT invoice issued, whichever is the earlier, ifit is before the Basic Tax Point.

� The time at which an invoice is issued if it iswithin 14 days of the date of the supply.However, if the invoice is issued 15 days ormore after the completion of the service,then the actual tax point will be the basictax point.

“ In the legal sector, we all knowthat sometimes it can be difficult,or even impossible, for solicitorsto decide on a fee before aservice is provided, because ofthe nature of their work.”

In those situations, the supply may be treated astaking place at the time when the solicitorissues a VAT invoice in respect of it, providedthat the invoice is issued no later than threemonths after the date of performance of theservices. However, if the invoice is issued morethan three months after the service wascompleted then the tax point will revert backto the basic tax point.

Single Supply?The majority of the supplies made by solicitorsare ‘single supplies’, i.e. a single service isdelivered. Here, each supply will have its ownbasic tax point. This will still be the case wherethe solicitor is making supplies to an individualon a regular basis or where the supplies willspan a number of years and billing occurs on aperiodic basis. The issue of a periodic invoicewill create an actual tax point and VAT will needto be accounted for in the VAT period in whichthe actual tax point falls.

Continuous supply?However, there are certain supplies of services(such as acting as trustees or where thesolicitor is retained and remunerated as a‘permanent legal adviser’ or acting as the client’s

legal office) that will be inherently continuous innature and as such, there will be no basic taxpoint. An actual tax point is created wheneveran invoice is issued or payment is received,whichever is the earlier. Firms that are involvedin making a continuous supply can issue what iscalled a ‘request for payment’ instead of aperiodic VAT invoice. A request for paymentdoes not create an actual tax point.

Money held on behalf of clients, and disbursementsAlthough solicitors are subject to the normaltax point rules as they apply for advancepayments, monies received from a client intothe firm’s client bank account do not create anactual tax point for VAT purposes. A tax pointis only created when monies are transferredfrom the client bank account to its office bankaccount.

Similarly, monies received from client thatrepresent reimbursement of expenses paid onthe client’s behalf (such as Stamp Duty andLand Registry fees) do not create a tax pointfor VAT purposes.

Place of supplyThe place of supply will determine where VATis accountable. Additionally, the place of supplyfor services will be determined by whether thesupply is a Business to Business supply (B2B) ora Business to Customer supply (B2C).

If the supply qualifies as a B2B supply then theplace of supply will be where the customer islocated, and VAT will be accountable in thatcountry. On the other hand, if the supplyqualifies as a B2C supply then the supply isdeemed to take place where the supplierbelongs. Hence, VAT will be accountable in thecountry where the supplier belongs.

It has to be mentioned that where the supply isa B2B supply and the client is VAT registered

and located in a different EC Member statethen VAT will have to be accounted for by theclient in its Member State via reverse charge.The supplier will need to zero rate theirsupplies and add the wording “reverse charge”on their sales invoice.

However, there are certain services where theplace of supply is not influenced by whether thesupply is B2B or B2C, but rather by specific VATrules. These are as follows.

Supply of services relating to LandIf the supply of services is related to land orproperty, the place of supply of those services iswhere the land itself is located, rather thanwhere the supplier or their customers belong.This will include services such as conveyancing,surveying or valuation of properties. However,the services must be directly related to land. Ifnot, then the supply would follow the normalplace of supply rules for services.

An example of a service that is not directlyrelated to land is services provided in drawingup a will that contains land as an asset.

Services provided to clients residentoutside the EUThere is a special VAT provision in regards tothe place of supply rules for ‘lawyer services’where the recipient of those services is a nonbusiness customer belonging outside the EU. Inthis case, the supply is deemed to be made inthe country where the recipient belongs andwill fall outside the scope of UK VAT.

Easy isn’t it?

Of course, if anybody has any questions, we arealways happy to help.

As expected, version 12 of the Handbookincludes confirmation of the increase in the limitfor donating residual client balances withoutprior SRA authorisation. The changes areeffective from 31 October 2014, and applyretrospectively, i.e. to existing and newbalances.

“For those of you who areunaware, prior to these changesthe limit for donating residualbalances to charity without firsthaving to obtain writtenpermission from the SRA was

£50. The new rules haveincreased this to £500.”

The limit applies to individual balances, notaggregate amounts, and any balances above£500 will still need to be approved by the SRA.

Other than the increase in the threshold, thereare no changes to the underlying rules aroundwhat practices should do to try and return thebalances to the clients, and the records thatneed to be kept when balances are donated.

Many readers will be aware that, following asomewhat unusual consultation, the SRA havenow backtracked on their planned intention toremove the need for Independent Accountantsto report on their compliance with the SRAAccounts Rules. The need for Accountant’sReports will remain in place for all practicesapart from those who:

a) receive all of their fee income from the LegalServices Commission; and/or b) can claimexemption as the amount of money passingthrough their client accounts is below the de-minimis limits.

Item b) above is the same exemption thatexisted previously, so the only change is a).

In addition, practices who receive an unqualifiedReport from their Accountants will no longerneed to file them with the SRA.

Whilst we understand that the SRA have adesire to reduce their own administrationburden, the move to only requiring qualifiedReports to be filed with them is somewhatsurprising, as the SRA are only too well awareof the fact that far more Reports ought to bequalified than presently are. In fact, out of the10,000 or so Reports filed with the SRA eachyear, only about half are qualified. If you ask anyReporting Accountant that does a lot of thiskind of work, non-qualified Reports are very

much the exception (only about 3% of oursare), so it could be said that many non-qualifiedReports are in some ways the ones the SRAshould be focusing on.

So what is coming next?First of all, the SRA are planning on issuing amodified form of the Accountant’s Report itselfduring the first quarter of 2015. This is going totake a risk based approach, with less in the wayof prescriptive tick boxes compared to thecurrent Report format. It also may require theReporting Accountant to sign an 'opinion' atthe end. There is going to be a consultationprocess shortly.

Secondly, the SRA are going to issuerevised SRA Accounts Rulesduring 2016, which again are likelyto be less prescriptive and more riskbased.

“The SRA have clearly taken themany responses to their initialconsultation seriously, and inparticular listened to commentsabout not only the strength andimportance of the independent

Residual Balances Rules have changed

SRA and Accountant’sReports - the current position

reporting process but also aboutmodernising the Accounts Rules, andtrying not to place yet more burdenon those filling the position of COFAin practices.”

LMS 2014 FinancialBenchmarking Report- results out soonMany readers will know that weproduce the Law Society's annualbenchmarking report. The 2014report has now closed, and we arealmost there in drafting it. It shouldbe available on line from earlyDecember, and the results make reallyinteresting reading.

New Team MembersOver the last few months we have been delightedto welcome several new members to our ever-expanding team.

Mathew Barlow and Emma Whittaker (far right)

have joined us as trainee accountants, AdeleBeadle (far left) specialises in performing SRAAccounts Rules audits, and Amanda Chamberlain(second left) helps to keep everything runningsmoothly on the admin front.

This now gives us over 25 dedicated membersin our Legal Team and about 130 retainedpractice clients.

� Audit under the SRA Accounts Rules� Accounting� Practice strategy planning� Partnership mergers/acquisitions� Taxation - compliance and planning� Practice structure planning, including LLPconversion, limited company incorporationand combinations

� Practice finance and performance reviews� Improving fee earner and non fee earnerefficiency

� Benchmarking against similar practices� VAT and Stamp Duty� Partnership changes� Remuneration planning� Goodwill valuations

� Expert witness work� Business plans (including financial forecasts)� New practice start-ups� Raising finance� Advice on practice administration software� Financial services� Trusts and estates

We are very happy to discuss matters arising from this newsletter, as well as any other issues relating to your business or personal financial affairs.

The services we provide include:

This newsletter has been prepared as a guide to topics of current financial business interests. We strongly recommend you take professional advice before making decisions on matters discussed here. No responsibility for any loss to any person acting as a result of the material can be accepted by us.

Hazlewoods LLP is a Limited Liability Partnership registered in England and Wales with number OC311817.

Registered office: Staverton Court, Staverton, Cheltenham, Glos, GL51 0UX. A list of LLP partners is available for inspection at each office.

Hazlewoods LLP is registered to carry on audit work in the UK and Ireland and regulated for a rangeof investment business activities by the institute of Chartered Accountants in England & Wales.Hazlewoods is a

member of International.

Windsor House, Bayshill Road, Cheltenham, GL50 3ATTel: 01242 237661 Fax: 01242 584263

www.hazlewoods.co.uk