Lawyer Monthly Magazine - August 2019 Edition

• Timing differences (e.g. depreciation in the accounts is disallowed and instead capital allowances are claimed). Invariably, the taxable profits are higher than the accounting profits and partners will be paying tax on amounts more than those they have actually received. On what basis is a partner taxed? For a continuing partner, they are taxed on their share of taxable profits in respect of the accounting year ending in the tax year. New partners are taxed on their taxable profit share from the date of commencement to the following 5 April and, in future years, they are taxed as a continuing partner. If there is no 12 month accounting period ending in the second tax year, then it is the first 12 months. If a firm has a year-end other then 31 March, then overlap relief profits will be generated. Overlap profits are taxed twice initially, but when a partner retires or leaves the firm, they deduct their overlap profits from their taxable profit share in the year of their retirement or exit. Tax reserving policies The majority of law firms (generally excluding US law firms) will have tax reserving policies in place to deal with partners’ future tax liabilities. If a firm reserves on behalf of its partners, then it removes the hassle for partners of having to place money to one side and arranging for their tax liabilities to be paid personally. The firm benefits as the tax reserves will help finance working capital. The firm may reserve for tax tax and NI are paid in three instalments: • The first payment on account, due 31 January in the tax year, and is based on 50% of their previous year’s tax liability • Second payment on account, due 31 July after the end of the tax year, and is based on 50% of their previous year’s tax liability • Balancing payment, due 31 January after the end of the tax year, and is the actual tax and NI due to fewer payments on account. Therefore, for a new partner who was previously an employee, it is unlikely that in their first year they would have to pay the first and second payments on account, as these are based on the previous year’s self assessment tax liability. Therefore the amount due 31 January after the end of the first tax year, will be the tax liability for the tax year plus a further 50% in respect of the following tax year’s first payment on account. What is a partner’s profit share? How is it paid? There is likely tobean agreement solely on partnership income, or it may reserve tax on personal income as well. For a firm with a 31 March year- end, the tax charge will be the tax liability arising on the corresponding taxable profits, the provision in the accounts will be the second payment on account, due 31 July after year-end, plus the balancing payment due the following 31 January. For a firm with a year-end other than 31 March, the key question is on what basis will tax be reserved? There are effectively three choices. If a firm has a year-end of, say, 30 April 2020, the choices are: 1.Provide for the 2019/20 tax liability only (under reserving) 2.Provide for the 2019/20 tax liability plus the retirement fund (prudent) 3.Provide for the 2019/20 and 2020/21 tax liabilities (excessive, overly conservative). The second option is the most favourable, as it is prudent, is not excessive and there will be no hidden tax liability surprises that will come into play at a later date. The tax charge in the example will be the 2019/20 tax liability, plus the additional tax on the retirement fund (e.g. the tax on the taxable profits for the year ended 30 April 2020 less overlap relief brought forward). This poses the question of what rate of tax will be used in calculating the tax on the retirement fund? The rate used is up to the firm, but it is likely to be 42% or 47%. However, if profits are just over the £100,000 mark and the possibility of a 60% tax charge, then neither of these rates may work. to the level of drawings that are paid out on a monthly basis but the level of profit share may not be fixed and there may be a variable element dependent on a number of factors which could cover performance of the individual partner, their team, their office and the firm as a whole. How are partners assessed for tax? A partner is assessed for tax on their share of taxable profits, not on their share of accounting profit. Accounting profits are not necessarily the same as taxable profits because there are a number of adjustments which may be made. The nature of the adjustments that apply include, for example: • Personal partner expenses (e.g. private commuting costs, lunches, private medical insurance, life assurance) • Capital expenses (e.g. costs in relation to changes in relation to the partnership agreement) • expenses which are specifically disallowable (e.g. entertaining clients and contacts) 22 WWW.LAWYER-MONTHLY.COM | AUG 2019 Special Feature By Nicky Owen, Ryan Ketteringham & Phil Smithyes, Crowe