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Barristers: Cash vs Earnings Accounting Basis Debate

Introduction

Choosing the right accounting basis is a crucial decision that every barrister faces. It can affect your tax treatment, the ease of managing your accounts, and even your financial planning for the future. This article dissects the nuances between two primary accounting methods available to barristers: the Cash Basis and the Earnings Basis. We delve into the intricacies of each to help you make an informed decision that suits your professional needs.

Cash Basis – A Simplified Approach

Features and Eligibility

From the tax year 2013/14 onwards, barristers in England and Wales have had the option to adopt the Cash Basis for their accounting. If you are considering this method, it is important to assess your eligibility based on your level of professional receipts. You can join this scheme if your receipts for the accounting year of assessment do not exceed £150,000.

Entry and Exit Rules

Entry into this accounting basis requires an election to be made in your first tax return where it applies. If, however, your receipts exceed £300,000 in any accounting period, you must revert to the Earnings Basis for the subsequent period unless the receipts drop below the entry threshold of £150,000.

Expenditure and VAT

One of the key features of the Cash Basis is its treatment of expenditures and VAT. Expenses are recognised when they are actually paid. If you are VAT-registered, you have the flexibility to handle VAT in two ways: either by excluding it altogether or by including it on a VAT-inclusive basis in your gross receipts and payments.

Earnings Basis – The Traditional Approach

Earnings Basis – General Definition

In simple terms, the ‘earnings basis’ means your profits for the year are based on the money you have actually earned, not just the cash you have received. Additionally, any increase in your debtors counts as income and boosts your profits, while a decrease does the opposite. As for expenses, you can only deduct those you have incurred during the year, regardless of whether you have actually paid them or not.

Profits and Debtors

In the Earnings Basis, profits for a tax year are the earnings realised in that year. A net increase in debtors (i.e., amounts owed to you by clients) counts as income and must be included in your profits. Conversely, a net decrease in debtors will reduce your income and consequently your profits.

Capital Expenditure

Capital expenditures, like the purchase of a computer or office furniture, are not immediately deductible. Instead, they are accounted for through depreciation over the asset’s useful life. However, this type of accounting can offer more flexibility in tax planning, allowing barristers to better manage their tax charge over time.

Work in Progress

Under the Earnings Basis, barristers must also account for both complete and incomplete work at the end of the accounting period. This is crucial for calculating the adjustment to income and thereby the tax liability. For incomplete work, a reasonable estimate of the amount earned thus far must be made.

Special Cases: Contingent Fees and Legal Aid

In cases where payment is dependent on the outcome of a case, the Earnings Basis allows for the recognition of this income only when the contingency occurs. This means that if you are engaged in high-volume contingent fee work, a different approach to income recognition might be necessary, one based on past track records of similar outcomes.

Making the Choice – Cash Basis vs Earnings Basis

Factors to Consider

The decision between Cash and Earnings Basis accounting is pivotal, especially for a barrister. Here are some crucial factors to consider:

Level of Receipts: If your annual receipts do not exceed £150,000, you are eligible for the Cash Basis. But remember, crossing the £300,000 threshold will mandate a change to the Earnings Basis.
VAT Registration: If you are VAT-registered, the treatment of VAT varies significantly between the two bases, influencing your total income and expenditure for accounting purposes.
Interest Charges: The Cash Basis restricts interest charges on business borrowings to a £500 deduction, making it less suitable for those with significant interest expenses.
Tax Planning: The Earnings Basis allows for more nuanced tax planning, especially concerning capital expenditures and depreciation.
Special Cases: If you deal with a lot of contingent fees or legal aid work, the Earnings Basis may offer more flexibility in accounting for these income streams.

Changing Your Accounting Basis

Switching between the two accounting bases is not straightforward and comes with its set of challenges and tax adjustments. For instance, when moving from the Cash to the Earnings Basis, you may encounter ‘adjustment income’, a special form of relief to soften the tax impact. Likewise, shifting from the Earnings to the Cash Basis necessitates deductions to avoid double counting of income and expenses.

Expert Advice is Crucial

Given the complexity and the potential tax implications, it is often advisable to consult an accountant well-versed in the nuances of barrister accounting practices. They can help you calculate the adjustment income, manage bad debts, and ensure that your accounts are prepared in line with the current legal requirements in England and Wales.

Jack Ross Chartered Accountants has decades of experience dealing with the intricate tax systems that govern barristers’ finances. Use the contact form below and one of our specialist advisors will be in touch.

Special Accounting Scenarios for Barristers

Contingent Fee Agreements

For barristers dealing with conditional fee agreements, the Earnings Basis allows the flexibility of not recognising the fee until the case’s outcome is determined. This accounting treatment can be particularly useful in providing a more accurate picture of your business finances.

Legal Aid Cases

In legal aid cases, “work in progress” should be recognised as the work is done, not as payments are received. This level of granularity is more easily managed under the Earnings Basis, which allows for more detailed accounting records.

Bad Debts

The question of whether to use the direct write-off method or the allowance method for bad debts is another consideration. The Earnings Basis offers the flexibility to use the allowance method, providing a more nuanced approach to handling unpaid fees.

Final Thoughts: What is Best for Your Practice?

Choosing between the Cash and Earnings Basis impacts your tax treatment, cash flow, and even your practice’s valuation. Therefore, it is crucial to make an informed choice based on your specific circumstances and accounting needs.

Whether you are a seasoned barrister or just starting your practice, understanding the complexities of accounting is vital for managing your finances effectively. A change of accounting basis can have significant implications, from how you calculate your tax charge to how you recognise earnings and expenditure.

Seeking specialised accounting services for barristers? Complete the contact form below and a Jack Ross advisor will be in touch to discuss tailored solutions.

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What are the key differences between Cash and Earnings Basis accounting for barristers?

Cash Basis focuses on money received and paid, while Earnings Basis considers earned income and incurred expenses, offering a more nuanced financial picture.

How do accounting basis choices affect barristers' tax treatment?

Your choice of accounting basis influences how you calculate your tax charge, recognise earnings, and handle expenditure, making it vital to choose wisely.

When should a barrister consider changing their accounting basis?

A change in accounting basis can be triggered by exceeding certain receipt thresholds or a significant change in commercial circumstances, such as higher interest deductions or sustained losses.