13 March 2019
Can Barristers change their accounting basis to become more tax efficient?
Depending on various factors, as a Barrister, you can choose how you would like your accounts and tax to be prepared. You are allowed to change between the basis of accounting relatively freely providing you notify HMRC accordingly and make all the necessary transitional adjustments where appropriate. It might be the case that changing the basis of accounting could make you more tax efficient. Read the latest in our series of Barrister FAQ articles to find out more.
Changing Basis
Moving from the ‘Old’ Cash Basis to the Earnings Basis
At the end of a barristers seventh year of practice, they can no longer use the ‘Old’ Cash Basis and must leave for either the ‘New’ Cash Basis or the Earnings Basis. When moving onto the Earnings Basis, a barrister must introduce their debtors and work-in progress as “adjusted income”. This adjustment income can then be spread over a ten-year period, the first nine years instalments are usually the lower of one-tenth of the catch-up charge with the tenth year as a balancing figure.
From year eight of practice onwards, barristers will need to include closing debtors and work in progress at the full value, with opening amounts as their prior years closing entries. Catch-up charges can be accelerated if preferred – for instance in years where income is lower than usual.
Example 1
Barrister A commenced trading in 2010/2011 and has completed their final year under the ‘Old’ Cash Basis in 2016/17 with a turnover of £260,000 and closing debtors for the period of £100,000.
In 2017/2018 their turnover increased to £300,000 and now with £125,000 in debtors, therefore their accounting turnover would be as follows:
|
|
2016/17 |
2017/18 |
|
Opening Debtors |
N/A |
£100,000 |
|
Cash Receipts |
£260,000 |
£320,000 |
|
Closing Debtors |
N/A |
£125,000 |
|
“Adjusted Income”/ Catch-up Charge |
£100,000 x 10% = £10,000 |
£10,000 |
|
Total |
£270,000 |
£355,000 |
Moving from the Earnings Basis to the 'New' Cash Basis
Where a barrister wishes to move from the Earnings Basis to the ‘New’ Cash Basis, they must first comply with the entry threshold of a total income. From 6th April 2017, eligibility has now risen for fees received from £83,000 (previously in line with the VAT registration threshold) to £150,000. Once in, barristers can stay in the ‘New’ Cash Basis so long as fees do not exceed £300,000.
When calculating the accounts using the Cash Basis, the closing debtors and work in progress (previously included under the Earnings Basis) are treated as deductions in the first accounts prepared under the New Cash Basis. The opening debtors for the year are deducted from the fees received to determine the fee’s received in the period, this is necessary to avoid double counting of income and expenses. This can give a very low figure for earned income.
If a barrister moves to the ‘New’ Cash Basis but is within their old catch-up period (under which debtors are being taxed over ten years after seven years in practice), then the annual catch up charge will still apply.
Example 2
Barrister B is entering year five of using the Earnings Basis where they have decided to change to the ‘New’ Cash Basis. At the end of year four, their closing debtors totalled £120,000 and has an £80,000 catch-up charge remaining to pay over a maximum of the next six years. In 2017/18 (being year five) their fees received for the year are £140,000, therefore their earned income would be as follows:
|
|
2016/17 |
2017/18 |
|
Opening Debtors |
£115,000 |
£120,000 |
|
Cash Receipts |
£150,000 |
£140,000 |
|
Closing Debtors |
£120,000 |
N/A |
|
“Adjusted Income”/ Catch-up Charge |
£ 13,000 |
£13,000 Min. £80,000 Max. |
|
Total |
£168,000 |
£33,000 Min. £100,000 Max. |
This example shows a dramatic drop in Barrister B’s earned income and could result in a loss in their accounts. Under the Cash Basis, this loss can only be offset against future profits of the same trade, it cannot be carried back or offset against any other income in year.
Example 3
Barrister C is entering year twelve of using the Earnings Basis and has paid off all if their catch-up charge. At the end of year eleven their closing debtors totalled £90,000. In 2017/18 (being year twelve) their turnover for the year is £135,000, therefore their accounting turnover would be as follows:
|
|
2016/17 |
2017/18 |
|
Opening Debtors |
£ 70,000 |
£ 90,000 |
|
Cash Receipts |
£130,000 |
£135,000 |
|
Closing Debtors |
£ 90,000 |
N/A |
|
“Adjusted Income”/ Catch-up Charge |
£ 0 |
£ 0 |
|
Total |
£150,000 |
£ 45,000 |
As a result of the change in basis, Barrister C has dropped below the additional rate threshold for tax and therefore will receive a ‘tax holiday’ for the year. It is important to note that in year thirteen (2018/19) Barrister C’s income will be back up to the £130,000- £140,000 figures as they no longer have the offset of opening balances, therefore would need to make a reserve for their tax bill as lower payments on account will have been made during the year.
Moving from the ‘New’ Cash Basis to the Earnings Basis
When a barrister exceeds the exit level for the Cash Basis (currently £300,000) they must move onto the Earnings Basis, during this they must introduce their debtors and any work in progress. In the first year’s accounts on this basis, the total figure for the debtors and work in progress will be introduced as ‘adjusted income’, which is brought into charge in equal instalments over six years, by way of catch-up charge, where the full amount would otherwise be fully chargeable to tax in the first year.
Example 4
Barrister D has been using the New Cash Basis since they commenced trading on 6th April 2013. In the year 2017/18 their income exceeded £300,000 at £310,000 and with closing debtors and work in progress standing at £135,000. These debtors will have to be included in the accounts over the next six years, As follows:
|
|
2016/17 |
2017/18 |
|
Opening Debtors |
N/A |
N/A |
|
Cash Receipts |
£290,000 |
£310,000 |
|
Closing Debtors |
N/A |
N/A |
|
“Adjusted Income”/ Catch-up Charge |
N/A |
£ 22,500 |
|
Total |
£290,000 |
£332,500 |
Barrister D will have a larger than anticipated tax bill for the year as payments on account for 2016/17 would not have taken into consideration the additional £22,500 taxable at 45%. If Barrister D’s income drops below the entry threshold of £150,000 in 2018/19, they do not have to move onto the Earnings Basis.
Moving from the ‘Old’ Cash Basis to the ‘New’ Cash Basis
Switching between these bases should not result in any adjustments. In the event of any unrealised capital allowances, other than a car, they may be deducted as an expense in the first year under the New Cash Basis, provided this has been fully paid for.
Our specialist barrister team has drawn on its 30+ years of experience to create our comprehensive guide to Barrister accounts and Taxation. Download it here.
Are you a Barrister looking for help with your accounts and financial planning?
RWB Director, Nick Bonnello, specialises in barrister accounts. Contact Nick on 0115 964 8860 or email nickb@rwbca.co.uk to understand how you can become more tax efficient.
The views provided in this article are for general information purposes only. Nothing in this article represents advice of any nature whatsoever. Accordingly, RWB CA Limited does not accept any liability or responsibility for the information contained in this article or any decision or other action that may be taken in reliance upon the information contained within it. RWB CA Limited accepts no responsibility for any errors of fact or opinion and assumes no obligation to provide you with any changes to its assumptions.