Solicitors NewsletterAutumn 2015
Benchmarking
Tax matters
Complaints information for
clients of solicitors’
You and your reporting accountant
Changes to financial statements arising from
FRS 102
specialist accountants and advisors to the legal profession
Contents
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bennettbrooks.co.uk
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You and Your Reporting Accountant…all change…again!
Benchmarking
Tax Matters - Closing the gap and purchasingcommercial property
Complaints information for clients ofSolicitors’
Changes to financial information statementsarising from FRS 102
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Page 13
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Benchmarking
I am an avid reader of both the Law Society (LMS) and Natwest benchmark reports, not just because clients like to know how their results compare to everyone else, but also because they reveal pointers as to how some practices achieve exceptional financial results. We also discover similar indicators and trends when comparing figures from our own client base; some partners share in very average profits whereas others can achieve stunning rewards for their efforts.
The LMS survey shows a range of profits per partner from £72,000 to £264,000, but Natwest has an even wider distribution from £41,000 to £538,000 and this study is more in line with our own findings. Whilst location certainly has some bearing on these figures, it is not just larger practices and the London based firms that show the best results.
So what are these common indicators?
Factors evidenced by best performing practices
Fee to Equity Partner Ratio - there is a high ratio of fee-earners to equity partners and the ratio exceeds 4 fee-earners to each partner. Where work is more complex it is likely that the gearing ratio will be smaller as more supervision and experience is needed. It is also relevant that clients are not willing to pay for partners to complete routine tasks and would expect this to be done at a lower charge out rate. However, gearing ratios take time to change as recruitment should not take place until everyone in the team is fully utilised. Where there are likely to be partners approaching retirement, consideration should be made about whether a new partner is required or whether gearing can be improved by recruiting a less experienced fee-earner.
Yvonne Wood, Managing [email protected]
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Chargeable Time - fee-earners charge at least 1,100 hours per annum to clients. Where staff work a 7.5 hour day and have 28 days holiday including bank holidays there are 1,740 available hours, so 1,100 only represents 63%, leaving plenty of time for personal development, winning new work and managing people. Fees will only be maximised if staff fully record all their time regardless of whether this can ultimately be charged on to the client. By not charging all the time spent on an assignment in the first instance double discounting takes place – once at the point of recording and again at the point of billing.
Specialisms – high-profit fee-earners tend to be specialists not generalists.
Fee Earner to total head ratio - fee-earner headcount as a percentage of total headcount is over 50% - the best ratio seen was 75%. So in a firm of 12 fee-earners and 3 partners in the most profitable practices there would be 3 non fee-earners to cover reception, cashiering, IT and secretarial work etc.
Lock-up – best firms achieve less than 90 days. This is the combination of debtors and work in progress and represents cash that
is tied up. Figures of less than 90 days are achieved by the best firms, however this is bound to vary widely depending on the mix of client work undertaken. Typically this is split, 60 days work in progress and 30 days debtors. The firms with the tightest control have great client communication about their billing process, good credit control, they take money on account at the start of the case to cover disbursements, and have a great awareness (by fee-earners) of WIP and debtors on each matter that is under their control.
Understanding the key ratios that are being achieved by the more profitable firms is one thing, delivering these results for your business is not always as easy. We work with many of our clients to improve business processes and deliver routine reports on these (and other) key indicators. We find that firms that take this information seriously make significant progress, and it is about making progress. These kinds of results don’t appear overnight, management needs to fine tune its approach and continuously feedback results, in order to continue to get the best out of its people.
If you would like a free benchmark report please email your financial data to [email protected]
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You and Your Reporting Accountant - all change…again!
For those of you who read our last newsletter (Spring 2015) you may recall from my article “Accountants Report – ‘To be or not to be…’ that the SRA finally confirmed it was to retain the Report for those holding client money (unless of course the money the firm holds is entirely from the Legal Aid Agency). Since then further consultations have taken place and finally in October they announced additional changes are to take effect and apply to firms with accounting periods ending after 1st November 2015 (effectively for firms with a 30 November 2015 year end and onwards). These changes not only widen the number of firms that will be exempt from reporting, but they
also include substantial changes to the work that the reporting accountant needs to undertake in completing their report.
In summary these changes are:
1. For firms where client money balances do not exceed an average of £10,000 and where the maximum balance is not in excess of £250,000, there will now be no report required.
2. Historically the reporting accountant has had to carry out detailed tests (as stipulated in Rule 39) when completing their report. This is replaced by Rule 38
Stuart Littler, [email protected]
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requiring the accountant instead to use their professional judgement and adopt a suitable work programme, and from this determine whether or not a report needs to be qualified. This brings in line the requirements for the accountants’ assessment of breaches with those of the COFA, in so far as only material breaches should be reported to the SRA. As COFA’s are only too well aware, there is no set definition as to what deems a breach as “material”. Guidance available from the SRA states that “material breaches are likely to arise:
a. As a result of an intention to break the rules; and/or
As a result of a significant weakness in the firm’s systems and controls such that there has been a systematic break down of controls designed to prevent breaches;Breaches arising from administrative errors are less likely to be material, but could still be if they are persistent, derive from a lack of control or breakdown of controls and have put client money at risk”.
We should not forget that the overarching objective is to ensure that client money is kept safe, (in accordance with Rule 1.1 of the SRA Accounts Rules).
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A new Accountants Report has been issued to incorporate these changes, and this can be found on their ‘ethics guidance’ page of the SRA website (issued on 22 October 2015).
What do these changes mean in practical terms?
Firstly, there has been a significant shift in the scope of work that accountants will have to undertake.
Previously the emphasis of audit work was on both prescriptive and transactional testing but there was no specific requirement to assess the firm’s underlying controls and procedures. The introduction of materiality changes the emphasis towards the assessment of both the strength and appropriateness of a firm’s controls, and in terms of the audit work, that it is ‘proportionate and targeted to the nature of the work the firm undertakes’. This not only impacts on the work of the reporting accountant but also reinforces the responsibilities of law firms (and their COFA’s) to ensure appropriate systems and controls are in place and facilitating their continual assessment for compliance. Our experience in the sector tells us that often firms either have no, or certainly insufficient, documentation describing their procedures.
This outline would enable them to better understand and internally communicate these processes, particularly for those high risk client money procedures. In an age where technologies and business processes inevitably change over time having documented procedures also better enables a firm in their assessment of their continued compliance. Accountants, more than ever, need to understand the detailed procedures that are in operation and have greater dialogue with COFAs in order to obtain and understand this information is vital. Without such understanding the accountant is restricted in their ability to form an opinion on the adequacy of systems and less able to determine compliance with these new rules.
There will now be greater assessment on the risk to client monies and this risk profile will be specific to each firm. Reporting accountants must identify the areas that present greater risk and so they can plan sufficient coverage in the audit work they carry out. The impact of this also manifests itself in the need for greater interaction between the accountant and the COFA,
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such as the communications ahead of annual visits to confirm procedures and obtain sufficient information for identification of high risk areas.
Key risk assessment factors are likely to include the following:
• Types of work (higher risk areas being Probate, enduring power of attorney, residential conveyancing, personal injury, trust - sole trust/all trustees within the firm);
• Financial position of firm;• Historic problems, especially
recurring ones;• Number of offices and
geographical spread of these offices;
• Dominant individual within firm;• Dominant client;• Knowledge of firm (first year
of acting compared with long standing client);
• Quality of staff and overall attitude to rules;
• Poor controls and systems and firms understanding of these within the firm;
• Changes within the firm in the year (new areas of work, new offices, personnel etc);
Also in order to help the COFA (as well as the accountant) in their understanding as to what might constitute a material breach (and would “likely” lead to a qualified report being submitted), the SRA have identified the following factors, this list is for guidance and not intended to be exhaustive:
• A significant and/or unreplaced shortfall on client account (either client debit balance or office credit balance)
• Wilful disregard for safety of client funds by action or deliberately overriding the Accounts Rules
• Actual or suspected fraud or dishonesty by managers or employees
• Material breaches not already reported to the SRA by the COFA
• Inadequate accounting records or records not retained
• Significant failure to provide documentation to the accountant
• Three way -client account reconciliations not carried out (I highlight three way as quite often firms only carry out a ‘standard’ bank reconciliation and do not include
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specifically on the reconciliation that this is agreed to the total of the client ledgers)
• Client account used as a bank facility
It is interesting to see that the SRA deems long standing residual balances due to clients, and improper use of suspense ledgers, as significant (and “may” lead to a qualified report). I would say that these are two of the most common rules that are breached and currently result in qualified reports. Those firms who struggle with dealing with these aspects, need to ensure action is taken on these issues otherwise they may well continue to result in qualified reports and draw their attention to the SRA.
So in essence what should a COFA be doing ahead of the next visit from their accountant…
1. Ensure systems and procedures are sufficiently documented, not only to assist your accountant but to help fulfil the COFA’s own obligations in ensuring compliance with the rules;
Ensure you are familiar with the SRA’s published Guidelines – Accounting Procedures and Systems (found in appendix 3 of the SRA Accounts Rules);
Identify those areas of high risk specific to your firm and within individual departments/offices/personnel;
Expect a call from your accountant ahead of their visit to go through these new requirements and this will be ongoing in future years as they look to identify and understand year on year procedural and process changes;
As reporting accountants we will of course be contacting our clients over the forthcoming months to discuss these changes. As experts in the sector we are always happy to advise legal firms on these matters, so if you are uncertain or just require further information or assistance on the points raised, please email [email protected].
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Complaints information for clients of solicitors’ firms
The Law Society, Solicitors Regulation Authority and Legal Ombudsman have been issuing statements/articles in recent months on the subject of the use of alternative dispute resolution (ADR), and (as a consequence) the suggested complaints information wording. Originally the Legal Ombudsman intended to become an ADR body, and (because of the provisions of the EU Directive on Consumer Alternative Dispute Resolution) that would have impacted on the timescale for a client to make a complaint to that office. That Directive came into effect on 1st October 2015. The Legal Ombudsman then withdrew its application to become an ADR body, thus leaving solicitors (and the Law Society) in a state of confusion.
Many solicitors have been unaware of two aspects relating to complaints to the Legal Ombudsman:
• Persons/organisations entitled to complain to the Legal Ombudsman - pursuant to section 2.1 of the Legal Ombudsman Scheme Rules (January 2015) this right to complain is limited to consumers – namely an individual, a personal representative of a deceased person, a “micro-enterprise” (having fewer than 10 employees and annual turnover or assets not exceeding 2,000,000 Euros), a charity or club/association with annual income of less than £1 million, or a trustee of a trust with assets of less than£1 million.
• Timescale for a complaint to the Legal Ombudsman - pursuant to sections 4.4 and 4.5 of the Legal Ombudsman Scheme Rules the Legal Ombudsman can investigate complaints up to six years from the date of the problem happening or within three
Peter Lane, [email protected]
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years of when someone should have found out about the problem (assuming the act/omission complained of occurred after 10th October 2010). However, if a solicitors’ firm sends a final written response to a complaint within eight weeks of receiving it (such response including information of the entitlement to complain to the Legal Ombudsman, their contact details, and that such complaint must be made within six months), the time limit for the complainant to refer the matter to the Legal Ombudsman is six months from the date of that final response.
At the stage when the Legal Ombudsman was considering becoming an ADR body, it was intended that the six months timescale for a complaint should be extended to one year, to comply with the EU Directive on Consumer Alternative Dispute Resolution. However, they have now back-tracked and stated that the timescale should be notified as six months.
The Legal Ombudsman’s office has confirmed the following points:
1. The ADR option be available only to a “consumer”,
namely an individual acting for purposes which are wholly or mainly outside that individual’s trade, business, craft or profession. Both parties must agree to use a non-statutory body (i.e. ADR) to resolve a dispute.
The Legal Ombudsman’s office have stated that they are reconsidering seeking ADR status. A decision is to be made in early January 2016, and if they do so decide, they would apply for ADR status soon thereafter. When and if the Legal Ombudsman attains ADR status, the wordings mentioned below would have to be changed again to reflect a one year time frame for escalating a complaint to that office, and (if so wished) naming that office only as a suggested ADR body.
However, that leaves the question of what a complaints procedure should contain, from now until any change.
The two places where information about the Legal Ombudsman and ADR would normally appear, namely in the client care/terms of business information sent to a client at the outset of a matter, and in a Complaints Procedure document
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(sent to someone who does complain). The full information (including the categories of person/organisation entitled to complain to the Legal Ombudsman) certainly needs to be included in the Complaints Procedure. However, the initial client information could be limited to how and to whom to complain, the existence of an internal complaints procedure and the potential entitlement to complain to the Legal Ombudsman.
Set out below are suggested wordings for (1) the terms of business/client care documentation, and (2) the Complaints Procedure document.
If a complaint is received and dealt with, and a final response sent; that final response must also include information of the entitlement to complain to the Legal Ombudsman, their contact details,and that such complaint must be made within six months.
Terms of Business - complaints section wording:
In the unlikely event that you are not satisfied with the service the firm is providing or the amount of your bill, please contact the lawyer who is dealing with the matter, or their supervisor. If you are still not satisfied, please contact our client care partner [or manager] _________, either by letter at____________, or by e-mail at _________, or by telephone on __________. Our client care partner [or manager] would provide you with a copy of our full complaints procedure. If at the end of our investigation you are still not satisfied, then you could contact the Legal Ombudsman - PO Box 6806, Wolverhampton, WV1 9WJ, or by telephone on 0300 555 0333, or by e-mail to [email protected] . Our complaints procedure gives details of the categories of person/organisation that are entitled to complain to the Legal Ombudsman, relevant timescales, and the possibility of the complaint being concluded by way of Alternative Dispute Resolution (ADR).
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Relevant section of Complaints Procedure document:
If you remain dissatisfied at the end of our complaints process, you would then be at liberty to contact the Legal Ombudsman, provided you are an individual, a personal representative of a deceased person, a “micro-enterprise” (having fewer than 10 employees and annual turnover or assets not exceeding 2 million Euros), a charity or club/association with annual income of less than £1 million, or a trustee of a trust with assets of less than £1 million. The Legal Ombudsman can investigate complaints up to six years from the date of the problem happening or within three years of when someone should have found out about the problem. However, if we send a final written response to your complaint within eight weeks of receiving it, the time limit for you to refer the matter to the Legal Ombudsman would be six months from the date of that final response.
If you would like more information about the Legal Ombudsman, their contact details are as follows:-
Website www.legalombudsman.org.uk
E-mail [email protected]
Telephone - 0300 555 0333
Postal address - Legal Ombudsman, PO Box 6806, Wolverhampton, WV1 9WJ.
Alternative complaints resolution bodies also exist and are competent to deal with complaints about legal services, should both you and our firm wish to use such a scheme at the end of our internal complaints process. They provide Alternative Dispute Resolution (ADR) services. Small Claims Mediation is one such body, details of which can be found at www.small-claims-mediation.co.uk ; and another is Ombudsman Services, details of which can be found at www.ombudsman-services.org . Under the provisions of the EU Directive on Consumer Alternative Dispute Resolution, to pursue this process you would have to be a “consumer”, namely an individual acting for purposes which are wholly or mainly outside your trade, business, craft or profession.
For more information on legal compliance please email [email protected]
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Many practices will be aware that changes to the way financial statements are prepared are imminent. The changes will affect financial statements for accounting periods commencing on or after 1 January 2015, so those practices with December year ends are likely to be the first to experience the new look accounts. In addition to these changes the small company size thresholds are also being increased, which also affect the audit threshold.
With effect from 1 January 2016 small company thresholds will be Before After
Turnover £6.5m £10.2mTotal assets £3.26m £5.1mStaff 50 50
The key differences for most law firms will be as follows:
• Reduced number of mandatory disclosures in the accounts
• The same set of accounts sent to shareholders/members are filed at Companies House – no abbreviated accounts possible and all shareholders must agree
to the preparation of abridged accounts, if those are to be used.
• New methods of accounting for Goodwill, Deferred Tax, Holiday Pay, Rent free periods on leases etc., may affect profits and therefore staff/partner bonuses, bank covenants and the ability to pay dividends.
• Changes in terminology
Review of those matters that may affect profits
Goodwill – Under the current regime (UK GAAP), Goodwill can be written off over a period that does not exceed 20 years. Under FRS102 this is reduced to 10 years. Therefore the consequence for those practices that either have Goodwill arising from incorporation or from acquiring practices could be a suppression of profits.
Deferred tax – for those practices who have property on their balance sheet that has been revalued over the years, under FRS102 there is a requirement to make a provision for the future tax arising as a result of the revaluation. The tax will not be
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Changes to financial statementarising from FRS102
Yvonne Wood, Managing [email protected]
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due for payment until the assett is sold therefore the provision in the accounts will be as deferred tax, but this will result in the reduction in distributable reserves.
Holiday Pay – Under FRS102 there is a requirement to account for the cost of holiday pay due but that has not been taken at the end of any financial year. Where the holiday year is coterminous with the financial year, and there is no ability to carry forward unused holiday entitlement, a charge in the accounts will not arise. In all other cases, this accrual will result in reduced profits in the first accounts that it is accounted for.
Rent free periods on leases – where a lease permits a rent free period, under the current regime, this is written off over the period to the date of the next rent review.
Under FRS102 this is to be written off over the whole lease term. The effect of this will also be reduced profits as this rent free benefit is written off over a longer period.
The inevitable consequence of the changes outlined are that reported profits and retained profits are likely to be lower than under the previous UK GAAP regime. It is also important to point out that these will also impact any bank covenant calculations that are related to profits, it could also affect staff and “partner” bonuses and more importantly it could affect the company’s ability to pay dividends if distributable profits are eliminated as a result of the above changes.
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It was clear from the Chancellor’s announcement at the Summer Budget 2015 that the taxation of small businesses is back on
the top of the agenda. Despite the welcome future reductions
in corporation tax rates, the proposed changes in dividend
taxation from 6 April 2016 mean less of those pounds earned will be retained by the shareholders.
Whilst we still do not have absolute certainty until
publication of the Finance Bill 2016 the expected changes are:
• The dividend tax credit will be repealed
• A new dividend allowance of £5,000 per year will be introduced (this does not reduce total income, but essentially taxes the first
£5,000 at a 0% rate), and
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Tax Matters
Closing the gap
Mary Tierney, Tax [email protected]
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• The rates of tax on dividend income will increase to 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
For many years now, when comparing drawing remuneration as salary to dividend, we have generally found that dividends are best from a tax perspective. Notably this is because no national insurance liability accrues on dividends.
However the new rules now mean that the tax gap between extraction of profits by way of salary or dividends has narrowed. Where-as in 2015/16 approximately £28k of dividend income could potentially be received without an income tax charge, the same dividend in 2016/17 will result in a tax bill of £1,725.
There is still a small tax benefit in operating as a limited company as opposed to a sole trader, although this disappears from profits of around £140,000. On average, up to £200,000 of profits, the effective marginal tax rate on extracting profits from a company as compared to operating as a sole trade will now only be around 1.4%. This compares with a benefit of around 5.1% in 2015/16.
What next?
It is clear that this will be of keen interest to owner/managers, and we await draft legislation to fully confirm the implications. It will certainly be high on our agenda in early 2016 during year-end planning meetings, where we will be looking at options such as:
• Bringing forward the payment of dividends into 2015/16. This will require careful consideration of company law procedures to ensure the date of payment arises in 2015/16 and evaluating the benefit of a lower liability versus earlier tax payment
• Postponing dividends to ensure that sufficient reserves are maintained in anticipation of any possible future transactions, for instance a share buyback
• Utilising the proposed £5,000 annual dividend allowance each year
• Extracting profits by way of the director’s loan account (25% corporation tax charge and a beneficial loan (3% interest rate since April 2015))
• Maximising tax efficient profit extraction, e.g. pension contributions and other tax free benefits
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It is fairly well known by now that since April 2014, on the sale of a commercial property, to ensure that the purchaser can claim capital allowances on fixtures in the building it is important that both:
1. The vendor has identified plant and machinery that he has claimed (or could have claimed) capital allowance on and
2. That the vendor and purchase agree a value for these assets, preferably in the sales contract, or if not within 2 years of the transaction.
There will, of course, be many permutations and individual considerations will be required.
Will it have the desired effect of preventing tax motivated incorporations? This is as yet unclear, but given that there are many commercial reasons that result in a limited company being more effective, than an unincorporated structure, the marginal benefits may still be worthwhile. What is more certain is that until the UK’s deficit is under control, the tax burden for virtually everyone is likely to go up.
Failure to meet these complex provisions correctly can result in additional tax charges for the vendor and no possible capital allowance claim reducing the tax payable by the purchaser.
The purpose of this note is not however to discuss these rules, which whilst complicated are now I believe fairly well understood, but to outline important tweaks in the way these new rules work which I suspect is very often overlooked.
Take a pretty typical scenario.
A property is bought in 2000 (or any date prior to April 2008).
For qualifying plant and machinery that the vendor could have made a claim on, if the vendor has not pooled these assets prior to sale, the allowances on these are lost and there is nothing we can do about it. If however the timescales set out above apply, regardless of the vendors actions, we as purchaser can however make a capital allowances claim for the value of a particular class of assets known as “integral assets” in the property that the seller was unable to claim for while they held the property.
The way in which we would calculate the amount we can claim is not simply the value of these
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Commercial Property Purchases
assets now (that might be quite small) but an apportionment of the overall purchase price based on the valuation of these integral assets. Every case is different, but for a typical office building this could amount to some 15% of the overall price as well as making the property more marketable when you come to sell it, as you have now identified and pooled assets so the potential to claim capital allowances on them is not lost to future owners. To put this in context, for a purchase of £500k the tax benefit to a company could be worth in the region of a £15k
reduction in corporation tax due.
Making this claim is relatively easy working with a chartered surveyor who understands the rules and can value the property and the integral fixtures appropriately.
bennettbrooks are familiar with identifying these claims, and we work with the appropriate professionals to reduce our client’s tax position.
For more information on this or other Tax Matters please [email protected]
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We hope we have given you a flavour of our services for Solicitors.
We know that providing full and comprehensive industry focused services means our clients get the specialist expert advice they need from people they trust at the time they need it. Our wider service range is outlined below:
Core Services
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If you would like to find out more about the outstanding service and style that is bennettbrooks just give us a call on 0845 330 3200 or visit our website
www.bennettbrooks.co.uk
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