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How To Change From Old Cash Basis to Earnings Basis for Barristers: A Transitional Adjustment

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Cash Basis to Earnings Basis: A Jack Ross Guide

Introduction: A Critical Decision for Barristers

In the legal profession, particularly among self-employed barristers, the choice of accounting basis can profoundly impact tax liability and financial management. Since the tax year 2013/14, barristers in the UK have had the option to adopt the cash basis for tax accounting. While this was a welcome development, it also brought about the question: when in their career and by what means should a barrister transition from a cash basis to an earnings basis?

What Is the Cash Basis?

The cash basis is a simplified accounting method where you only declare the money you have received and the expenses you have paid within the tax year. This method is particularly popular among self-employed individuals and small businesses, including barristers.

What Is the Earnings Basis?

Contrastingly, the earnings basis, or accruals basis, records income and expenses as they are earned or incurred, not necessarily when the money changes hands. This method adheres more closely to Generally Accepted Accounting Principles (GAAP).

Why This Matters

The decision to switch from the cash basis to the earnings basis is not one to be taken lightly. It involves considerations related to turnover, debtors, VAT registration, and even the types of cases a barrister takes on. Furthermore, HMRC imposes certain transitional rules and adjustments that must be meticulously followed.

In this article, we will walk you through the process, the eligibility criteria, and the transitional adjustments you need to be aware of when considering such a change. Whether you are new to the profession or looking to optimise your tax position, this guide is for you.

Understanding the Mechanics: Cash Basis vs Earnings Basis

Cash Basis: The Simplicity Factor

In the cash basis, the tax treatment is straightforward. Income is only recognised when it is received, and expenses are deductible when they are paid. For barristers, this could mean that professional fees are only considered as income when they are actually received from clients or solicitors. On the expenditure side, costs like chamber fees or legal research expenses become deductible when they are actually paid.

Limitations of the Cash Basis

However, the cash basis has limitations. For instance, if your turnover exceeds £300,000, you must leave the cash basis and switch to the earnings basis. Additionally, the cash basis does not allow for a detailed view of debtors and creditors, which could be crucial for barristers dealing with complex cases that span multiple accounting periods.

Earnings Basis: The Comprehensive View

The earnings basis provides a more holistic view of a barrister’s financial position. Under this method, income is recorded as it is earned. So, if you have provided legal services but have not been paid yet, this would still be recognised as income. Similarly, if you have incurred expenses but have not paid them, they are still deductible.

When Should Barristers Consider the Earnings Basis?

The earnings basis is generally more suitable for barristers with a high volume of work in progress or those dealing with complex financial transactions. It is especially beneficial if you are working on cases that are likely to extend over a long period or if you often have significant amounts of income that are yet to be received.

Transitional Adjustment: Cash Basis to Earnings Basis

When you switch from the cash basis to the earnings basis, a transitional adjustment will occur to account for income and expenditure that may be double-counted or omitted. This adjustment income is usually spread over six years to ease the tax burden. Understanding how to calculate this adjustment is crucial for barristers to avoid any tax complications.

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Legal and Regulatory Considerations: What Barristers Need to Know

HMRC Guidelines 

When it comes to tax and accounting, it is crucial to stay compliant with the guidelines set forth by HMRC. HMRC provides extensive guidance on eligibility criteria for using the cash basis, which barristers should carefully review.

When is it Mandatory to Leave the Cash Basis?

For barristers, if your turnover exceeds £300,000 in an accounting period, you must leave the cash basis for the earnings basis when preparing the next set of accounts. Failing to do so could result in penalties and additional tax charges.

VAT Registration and Council Tax

VAT registration also plays a role in your accounting decisions. If you are VAT registered, you will need to account for it on a VAT-inclusive basis if you choose the cash basis. Similarly, barristers need to consider the impact of council tax on their overall taxable profits, as it can be deducted as an expense under certain conditions.

Legal Aid and Special Cases

In cases involving Legal Aid, barristers must be particularly cautious. Legal Aid payments fall under special taxation rules, and the accounting basis you choose can have implications on how you report this income. Always consult with an accountancy expert like Jack Ross familiar with the legal sector to ensure compliance.

Navigating Transitional Adjustments: A Guide for Barristers

What is Transitional Adjustment?

When you switch from the cash basis to the earnings basis or vice versa, there may be transitional adjustments to consider. This adjustment income is essentially the difference between the amounts recognised under the old and new bases. Transitional adjustment is crucial for avoiding double-counting or omission of any income or expenditure.

How to Calculate Adjustment Income

Adjustment income would typically involve several accounting entries and could spread over six years or more, depending on the specific circumstances. Barristers can elect to accelerate the charge if they prefer, which would require expert consultation to ensure it aligns with your tax planning strategy.

Debtors and Creditors

One of the most significant parts of transitional adjustment involves reconciling debtors and creditors. Amounts owed to the business, or amounts that customers owe, must be accurately reflected to avoid any tax discrepancies.

The Role of Capital Allowances

Capital allowances play a crucial part in transitional adjustments. Apart from cars, any residual unrelieved capital allowances pools may be deducted as an expense in the first year under the new basis. This requires careful calculation to ensure that you are not missing out on any tax relief.

This concludes the article on how to change from the old cash basis to the earnings basis for barristers. Transitioning between accounting bases is a complex process that requires a thorough understanding of tax law, HMRC guidelines, and accounting principles.

Consult An Accountant – Get in Touch with Jack Ross

Jack Ross Chartered Accountants has decades of experience in dealing with the finances of barristers. If you are thinking of changing from the cash basis to the earnings basis, or just need professional advice on your finances, get in touch. 

Seeking specialised accounting services for barristers? Complete the contact form below; a Jack Ross advisor will promptly contact you to discuss tailored solutions.

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Cash basis accounting recognises income and expenses only when money changes hands. Earnings basis, on the other hand, records them as they are earned or incurred. The choice between the two can significantly affect a barrister’s tax liability and financial management.

Barristers should consider switching to the earnings basis if their turnover exceeds £300,000 or if they deal with complex financial transactions and cases that span multiple accounting periods. The earnings basis offers a more comprehensive view of your financial position.

Transitional adjustments occur when you switch from the cash basis to the earnings basis. These adjustments account for any income and expenditure that may be double-counted or omitted. Understanding how to calculate these adjustments is crucial for tax compliance.

Professional Testimony

Charles Eastwood, Barrister,  St Johns Buildings Chambers

I would recommend Jack Ross Chartered Accountants as great leaders in the field of providing barrister accounting services.

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