Part two: financial management – maximising your tax efficiency
Some analysts are signalling the end of the recession, but most remain cautious in their outlook. 2010 is anticipated to be another difficult year. Recovery is still fragile, staff and partners are still concerned about their jobs, budgets are tight and cashflow remains a serious concern.
Unfortunately, as we start looking forward to recovering profits, there is the prospect of higher taxes to come. The 50% rate for those earning over £150,000 a year starts on 6 April.
Management currently still face difficult decisions, and ones they would rather not have to take. For those who have put off cost-cutting measures, it does not appear likely that turnover will recover in 2010 to the hoped-for levels. Although partners generally will have wanted to minimise staff redundancies, they also want firm and decisive leadership, and may thus be critical when end-of-year results are disappointing.
As usual there are many factors to take into account in taking financial action. Tax is only one and should rarely be the main driver. However, once an objective is set it is worth taking the trouble to ensure the steps taken are as tax-effective as possible. Added to that one needs to consider the rate at which tax relief will be available. Will expenditure get relief at 40% or 50%?
For most firms, staff costs are seen as the most significant variable cost. We have already seen firms losing staff recently and more may still follow. It is often assumed that one can pay up to £30,000 as a tax-free ex-gratia payment to departing staff. This is not necessarily so. The legislation is specific in only covering genuine (and properly followed through) redundancy or compensation for loss of office. It does not cover lump sums paid when long-serving staff retire early, or a settlement is offered to an employee after a period of extended sick leave.
Over the next year we are also likely to see yet more partners retire early or ‘move on to develop their career elsewhere’. In many cases an additional sum is paid to such individuals to assist in their decision-making. It is important that both sides are clear as to the nature of the payment. Is it an additional prior share of profit (tax-efficient for the firm) or either the purchase of goodwill or a compensation payment (tax-efficient for the retiree)? In the difficult discussions over a partner’s retirement this point is often not considered and agreed on at the time. HM Revenue & Customs do not like to have to get involved subsequently when the parties disagree on this point.
The other significant cost a firm bears is that of its office space.
Some firms may now be reviewing their space levels. Shrinking space commitments is not easy outside of break clauses. The current economic situation may be such that a landlord will accept a sum to agree to the surrender of a lease; but beware this will usually be in the form of a tax-inefficient capital payment. Instead, look at whether the same outcome can be engineered in a tax-deductible manner.
In instances where firms have surplus space they are unable to offload, they should consider whether they should mothball the surplus space to claim tax relief on the onerous lease cost going forward under accounting standard FRS12. The alternative of spreading out (giving everyone more space to rattle about in) may defer the accounting pain of a FRS12 provision, but it will also defer the tax relief.
Some firms may see themselves as being fortunate over the next year or so if their lease is about to expire. This may provide the opportunity to reduce their total space occupancy or enable them to move to better accommodation at a lower rental cost. However, the stalled commercial property market may have a sting in its tail in these situations. In the recent boom times a landlord would look to redevelop vacant office blocks such that dilapidations claims would not be levied on departing tenants. Landlords are now less likely to be redeveloping sites and so will be looking to maximise dilapidations claims. Settlements are therefore more likely over the next few years and the departing tenant needs to be aware that full tax relief will only be available on the ‘revenue’ element of the dilapidations settlement, not the ‘capital’ part. They should thus ensure they have documentary evidence (eg a surveyors report) of the revenue element, as HM Revenue & Customs are looking at these settlements in increasing detail.
In these difficult times ‘cash is king’ will be a mantra often stated. Firm’s management will be paying close attention to cashflow and will recognise 31 January and 31 July annually as being dates of big cash outflows, when partners’ tax bills are paid.
Management should be seeking advice as to when changing profit levels will feed through to changed tax payments, particularly in conjunction with the forthcoming increases in tax and national insurance rates.
For many, recovering profits will coincide with increased tax rates in 2010/11. With relatively low tax liabilities for 2009/10, partners’ 2010/11 interim tax payments will also automatically be low. This means that the increased 2010/11 tax liabilities will lead to significantly higher tax payments being due on 31 January 2012. At present not that many firms plan their cashflow through to that date yet.
In conclusion, if the economy is in for a prolonged recession, almost all professional firms will be adversely affected. To date, only those directly impacted by the credit crunch and collapsed property market have had to face draconian financial action. In planning for difficult economic circumstances, management should remember to consider the tax impact of any actions they are proposing, and whether a more favourable tax outcome can be achieved with some care and attention together with a few tweaks to their overall plans.
Louis Baker is head of the professional practices group at Horwath Clark Whitehill
