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How much of the cash you receive should you save to pay to HMRC? There are many considerations when making this decision. Sole traders have three different taxes to calculate and pay: VAT, personal tax and National Insurance. Then there is the current year’s tax payable with two payments on account due by 31 January and 31 July every year based on the previous year’s tax. There is also the repayment of any student loans. If you prepare your accounts under the earnings basis, you will be paying tax on your debtors too – fees billed that you haven’t received yet! So, it’s safe to say things were complicated even before the impact of COVID.
If you have, then we would recommend reviewing the basis on which your accounts are prepared to see if you can move from the earnings (accrual) basis to the ‘new’ cash basis.
As a barrister, profits could be calculated in one of three ways: the ‘old’ cash basis, the earnings basis, or the ‘new’ cash basis. The ‘old’ cash basis was withdrawn in the Finance Act 2013. This is therefore now only used by barristers who operated on this basis for the accounting tax year 2012/13. This granted barristers, during their first seven years of trading, the opportunity to calculate their income and expenditure as it was received and paid, regardless of their turnover figure. Debtors (and creditors) were then released into the accounts over the following ten years through the ‘catch-up charge’.
Tip: If you used the ‘old’ cash basis you can choose to accelerate your catch-up charge so that tax is paid on it at a lower rate of tax.
The earnings (accruals) basis taxes barristers on the billable value of their work, whether paid or not. This results in including debtors and work in progress to their accounts. Expenditure is relieved when incurred, whether settled or not by the end of the accounting period.
Tip: If your taxable profits are below £150,000 and you are using the earnings basis, consider moving to the ‘new’ cash basis which results in a one-off tax reduction on your debtors.
The ‘new’ cash basis – available to barristers from tax year 2013/14 – became more attractive when the limits were uplifted in 2017/18. Unlike the ‘old’ cash basis, there is no seven-year time limit on its use, but there are entry and exit thresholds based on the level of fees received. The entry threshold is for receipts to be below £150,000 (or the pro-rated equivalent where the accounting period is less than 12 months; however, this is not pro-rated where the accounting period exceeds 12 months). The exit threshold for fees received is £300,000; if you exceed this amount you will have to move onto the earnings basis, unless fees received in the subsequent accounting period fall back below the entry threshold.
The most important point to make here is communication. Speak to your accountant to seek their professional advice. Let HMRC know you can’t pay. Make sure you still file all returns with HMRC even if you can’t pay the tax due on them. This avoids any penalties and ensures that HMRC has the figures to hand, should you need to arrange/be offered a ‘time to pay’ agreement. In the past, your accountant could arrange the whole ‘time to pay’ agreement process with HMRC but nowadays the agreement must be from the actual person wanting the payment extension (although the accountant can make the initial call to negotiate the agreement in principle). HMRC has been very understanding due to COVID and up to 24-month payment terms have been agreed in certain circumstances. While interest is still charged, penalties are waived if the time to pay agreement is fully honoured.
If you are struggling to pay your payment on account, have you ensured that it will be due? If your taxable profits are going to be lower, your payment on account can be reduced. Talk to your accountant if this is the case because HMRC must be informed.
The tax impact of having a 31 March or a 30 April year-end can be significant. The main advantage of a 30 April year-end is when your income is significantly increasing in your first few years at the Bar, and you are being taxed 11 months in arrears. However, this can leave you with a significant final tax bill on retirement (see our Barristers’ Guide for a worked exampl). Therefore, you might want to look at moving your year-end towards 31 March as you approach retirement.
Another advantage of a 30 April accounting year-end is that your accounts can be prepared within plenty of time before the following 5 April tax year-end. This means planning, such as paying in pension contributions which can be made in plenty of time. For example, if you are aware that you will have a taxable income of just over £100,000 and will be losing your personal allowance (and therefore paying an effective rate of 60% tax) you can make a pension contribution to keep your taxable income below £100,000. It is a lot trickier to plan for this if you have a 31 March year-end.
There are lots of differences between trading as a limited company and as a sole trader, but perhaps the most important question is whether you spend all the money you earn? If you do, then one of the key benefits of trading through a limited company, ie the ability to manage your taxable profits, is lost.
There are various thresholds where the amounts of tax you pay increase: moving from a basic rate tax-payer (20%) to a higher rate (40%) as your taxable income goes above £50,270; when your taxable income goes above £100,000 you lose your personal allowance (£1 lost for every £2 over) and pay an effective rate of 60% tax between £100,001 and £125,140; once you pass £150,000 of taxable income you become an additional rate tax payer at 45%.
Trading through a limited company means the amount of taxable income an individual withdraws from the company can be limited to ensure these various thresholds are not breached. For example, a sole trader with taxable earnings of £250,000 pays tax on this amount regardless of whether they have drawn all those funds from the business or not. However, if only £100,000 of income is withdrawn then a limited company allows you to minimise your tax bill by only paying personal tax on this amount withdrawn. The standard approach in a limited company is to take a low salary of £8,844 and then top up with dividends. The first £2,000 of dividends are tax-free, then a basic rate dividend tax rate of 7.5% to £50,270 and the remainder to £100,000 is taxed at higher rate dividend tax of 32.5%. Please note that a limited company also pays corporation tax (currently 19% but set to rise).
If you are spending all the money you have earned, then it depends on the amount of taxable profits you have as to whether it is more cost-effective being a limited company or a sole trader. At lower rates of taxable profits (less than £180,000) it is slightly more advantageous trading as a limited company in that there is less overall tax to pay. But there are other things that need to be considered in addition to this.
There are different treatments of capital assets, such as cars and phones, between a sole trader and a limited company. A phone is fully allowable and without any benefit in kind if supplied through a limited company, whereas an apportionment between personal and business use is required for a sole trader. Brand new electric (0% emission) cars have 100% first-year allowance for capital gains purposes and very low benefit in kind charge if a car is provided through a limited company – making this very attractive. A sole trader in the same circumstance would also get this allowance but would be restricted by having to apportion between personal and business use. However, a high CO2 emission car provided by a company to an employee would be significantly taxed (most taxpayers would be better advised to buy the car personally and claim mileage to the company) whereas the impact would not be as severe if purchased as a sole trader.
Limited companies cannot use the cash basis to prepare their accounts. A sole trader can use the cash basis so long as they meet the requirements. Put simply, cash basis accounting is a straightforward way of working out the tax payable, based solely on income received and expenses paid. There is no need to calculate debtors and creditors at the year end, nor estimate accruals and prepayments. Careful consideration needs to be given to this as barristers’ debtors can be extremely large. Added to this, there can be misunderstanding when calculating bad debts and contingency fees meaning more potential for the tax figures to be wrong if investigated by HMRC. It is important to seek professional advice from an accountant if you are looking to incorporate.
Nick Bonnello is the Managing Director of RWB Chartered Accountants and heads up the specialist Barrister Tax and Accounts team. For further details please go to: www.rwbca.co.uk/our-services/barristers
How much of the cash you receive should you save to pay to HMRC? There are many considerations when making this decision. Sole traders have three different taxes to calculate and pay: VAT, personal tax and National Insurance. Then there is the current year’s tax payable with two payments on account due by 31 January and 31 July every year based on the previous year’s tax. There is also the repayment of any student loans. If you prepare your accounts under the earnings basis, you will be paying tax on your debtors too – fees billed that you haven’t received yet! So, it’s safe to say things were complicated even before the impact of COVID.
If you have, then we would recommend reviewing the basis on which your accounts are prepared to see if you can move from the earnings (accrual) basis to the ‘new’ cash basis.
As a barrister, profits could be calculated in one of three ways: the ‘old’ cash basis, the earnings basis, or the ‘new’ cash basis. The ‘old’ cash basis was withdrawn in the Finance Act 2013. This is therefore now only used by barristers who operated on this basis for the accounting tax year 2012/13. This granted barristers, during their first seven years of trading, the opportunity to calculate their income and expenditure as it was received and paid, regardless of their turnover figure. Debtors (and creditors) were then released into the accounts over the following ten years through the ‘catch-up charge’.
Tip: If you used the ‘old’ cash basis you can choose to accelerate your catch-up charge so that tax is paid on it at a lower rate of tax.
The earnings (accruals) basis taxes barristers on the billable value of their work, whether paid or not. This results in including debtors and work in progress to their accounts. Expenditure is relieved when incurred, whether settled or not by the end of the accounting period.
Tip: If your taxable profits are below £150,000 and you are using the earnings basis, consider moving to the ‘new’ cash basis which results in a one-off tax reduction on your debtors.
The ‘new’ cash basis – available to barristers from tax year 2013/14 – became more attractive when the limits were uplifted in 2017/18. Unlike the ‘old’ cash basis, there is no seven-year time limit on its use, but there are entry and exit thresholds based on the level of fees received. The entry threshold is for receipts to be below £150,000 (or the pro-rated equivalent where the accounting period is less than 12 months; however, this is not pro-rated where the accounting period exceeds 12 months). The exit threshold for fees received is £300,000; if you exceed this amount you will have to move onto the earnings basis, unless fees received in the subsequent accounting period fall back below the entry threshold.
The most important point to make here is communication. Speak to your accountant to seek their professional advice. Let HMRC know you can’t pay. Make sure you still file all returns with HMRC even if you can’t pay the tax due on them. This avoids any penalties and ensures that HMRC has the figures to hand, should you need to arrange/be offered a ‘time to pay’ agreement. In the past, your accountant could arrange the whole ‘time to pay’ agreement process with HMRC but nowadays the agreement must be from the actual person wanting the payment extension (although the accountant can make the initial call to negotiate the agreement in principle). HMRC has been very understanding due to COVID and up to 24-month payment terms have been agreed in certain circumstances. While interest is still charged, penalties are waived if the time to pay agreement is fully honoured.
If you are struggling to pay your payment on account, have you ensured that it will be due? If your taxable profits are going to be lower, your payment on account can be reduced. Talk to your accountant if this is the case because HMRC must be informed.
The tax impact of having a 31 March or a 30 April year-end can be significant. The main advantage of a 30 April year-end is when your income is significantly increasing in your first few years at the Bar, and you are being taxed 11 months in arrears. However, this can leave you with a significant final tax bill on retirement (see our Barristers’ Guide for a worked exampl). Therefore, you might want to look at moving your year-end towards 31 March as you approach retirement.
Another advantage of a 30 April accounting year-end is that your accounts can be prepared within plenty of time before the following 5 April tax year-end. This means planning, such as paying in pension contributions which can be made in plenty of time. For example, if you are aware that you will have a taxable income of just over £100,000 and will be losing your personal allowance (and therefore paying an effective rate of 60% tax) you can make a pension contribution to keep your taxable income below £100,000. It is a lot trickier to plan for this if you have a 31 March year-end.
There are lots of differences between trading as a limited company and as a sole trader, but perhaps the most important question is whether you spend all the money you earn? If you do, then one of the key benefits of trading through a limited company, ie the ability to manage your taxable profits, is lost.
There are various thresholds where the amounts of tax you pay increase: moving from a basic rate tax-payer (20%) to a higher rate (40%) as your taxable income goes above £50,270; when your taxable income goes above £100,000 you lose your personal allowance (£1 lost for every £2 over) and pay an effective rate of 60% tax between £100,001 and £125,140; once you pass £150,000 of taxable income you become an additional rate tax payer at 45%.
Trading through a limited company means the amount of taxable income an individual withdraws from the company can be limited to ensure these various thresholds are not breached. For example, a sole trader with taxable earnings of £250,000 pays tax on this amount regardless of whether they have drawn all those funds from the business or not. However, if only £100,000 of income is withdrawn then a limited company allows you to minimise your tax bill by only paying personal tax on this amount withdrawn. The standard approach in a limited company is to take a low salary of £8,844 and then top up with dividends. The first £2,000 of dividends are tax-free, then a basic rate dividend tax rate of 7.5% to £50,270 and the remainder to £100,000 is taxed at higher rate dividend tax of 32.5%. Please note that a limited company also pays corporation tax (currently 19% but set to rise).
If you are spending all the money you have earned, then it depends on the amount of taxable profits you have as to whether it is more cost-effective being a limited company or a sole trader. At lower rates of taxable profits (less than £180,000) it is slightly more advantageous trading as a limited company in that there is less overall tax to pay. But there are other things that need to be considered in addition to this.
There are different treatments of capital assets, such as cars and phones, between a sole trader and a limited company. A phone is fully allowable and without any benefit in kind if supplied through a limited company, whereas an apportionment between personal and business use is required for a sole trader. Brand new electric (0% emission) cars have 100% first-year allowance for capital gains purposes and very low benefit in kind charge if a car is provided through a limited company – making this very attractive. A sole trader in the same circumstance would also get this allowance but would be restricted by having to apportion between personal and business use. However, a high CO2 emission car provided by a company to an employee would be significantly taxed (most taxpayers would be better advised to buy the car personally and claim mileage to the company) whereas the impact would not be as severe if purchased as a sole trader.
Limited companies cannot use the cash basis to prepare their accounts. A sole trader can use the cash basis so long as they meet the requirements. Put simply, cash basis accounting is a straightforward way of working out the tax payable, based solely on income received and expenses paid. There is no need to calculate debtors and creditors at the year end, nor estimate accruals and prepayments. Careful consideration needs to be given to this as barristers’ debtors can be extremely large. Added to this, there can be misunderstanding when calculating bad debts and contingency fees meaning more potential for the tax figures to be wrong if investigated by HMRC. It is important to seek professional advice from an accountant if you are looking to incorporate.
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