The vast majority of law firms will face a significant one-off tax hit within the next two to three years after the Accounting Standards Board last week published its long-awaited definitive guidance on accounting for contracts to provide services, including legal work.

The guidance to application note G to financial reporting standard 5 - issued by the board's urgent issues task force - clarifies how different types of contracts for services should be treated.


For example, the task force said that where there are distinguishable phases of a single contract, it may be appropriate to account for and pay tax on the contract as two or more separate transactions, provided the value of each phase can be reliably estimated.


Compliance with the new accounting rules is expected to require a considerable acceleration in the way law firms recognise revenue and profit.


However, in a move welcomed by the Law Society, conditional fees will not be covered by the new arrangements as revenue will not need to be recognised where the right to consideration is contingent on the occurrence of a critical event.


Fears that the new rules would be applied retrospectively have also receded, after the task force ruled that they should only apply for accounting periods ending on or after 22 June 2005. It is nevertheless encouraging early adoption where possible.


David Furst, chairman of accountancy firm Horwath Clark Whitehill, said: 'There will be a one-off tax hit [when the change occurs]. At least it is in the future and not in the past but it is going to have a significant effect on a good number of firms, particularly those with a high level of work in progress.'


Mr Furst warned that many small and medium-sized firms in particular would need to bill more quickly in the wake of the guidance.


He said: 'People may also wish to strengthen their cash collection - some firms are very good at that but others are pretty hopeless.'


George Bull, partner at accountancy firm Baker Tilly, agreed. 'Firms are going to have to consider whether and how the guidance is going to affect them. It willaffect different firms in different ways,' he said.


The timing of the one-off tax hit will depend on a firm's year-end, Mr Bull added, with some practices likely to have to deal with the issue by 31 January 2007, while those with a 30 April year-end will not have to find the necessary cash to pay the uplift until January 2008.


Law Society President Edward Nally said: 'We are pleased that the task force has finally published its guidance which will provide some clarity for the profession.'


He said the Law Society will be publishing advice in the near future.