A taxing time ahead for the self-employed
All architectural practices, unless they operate as limited-liability companies, should note major changes which will affect the basis upon which tax is assessed, albeit that the Chancellor's recent budget has delayed their introduction for one year.
When I started in practice in 1978 tax was paid on a preceding-year basis; that is, the liability for any given tax year was based on the profits earned during the previous accounting year. While advantageous to growing firms, this system was punitive if profits fell against previous years, especially where no adequate provisions for tax had been made. But in years of high inflation, self-employed professionals (solicitors, barristers, accountants, surveyors and some medical practitioners) all did very nicely, thank you! Think what 27 per cent inflation (which is where it peaked in the early 1980s) did to tax bills calculated on a preceding-year basis compared with paye.
Changes for the 1996/97 year now require tax assessments on the accounting year within the tax year concerned (ie, on a current-year basis). Furthermore, payments are now due twice during the year - with stiff interest penalties for late submissions.
However, and despite these changes which have generally brought Inland Revenue payments forward, the taxpayer has to date always had the option of being assessed on a cash basis. The new rules set to come in next year will convert most professionals who are currently on a cash basis to an earnings basis for tax assessment.
This effectively eliminates all cash-flow advantages previously enjoyed, as tax will be payable on profits as the work is done - and before invoices are issued or payments received. However, some points need noting:
Firstly, in order to prevent tax loss to the Revenue through the process of change from a cash basis (where revenue payment is delayed) to an earnings basis, special arrangements will be introduced. Businesses will be provided with a ten-year period over which the 'catch-up' amounts needed to convert to the earning basis can be paid in parallel with the new earnings-based arrangements - that is, at 10 per cent of the amount due per year or 10 per cent of the profit on any current year if that is lower, with any accumulated outstanding balance payable in year 10 . . .Got it?
The earnings-based tax system does not require any profit element to be included in calculations of work in progress, but this is pretty difficult territory and you will need a patient accountant.
One ray of light for those very small practices among you: there is no requirement under the new system to include the work in progress of proprietors - so you can, provided that you employ no staff, partially avoid the earnings- based system if you prefer. But be careful: there are complex rules for including appropriate allowances for non-fee earners such as secretarial staff.
It's all very complicated so whatever you do, make time to understand and plan for these changes - if they affect you, the implications could be very serious.
I had Andrew White, who is the senior partner of accountant Gordon Leighton, explain it all in words of one syllable, but as we've just incorporated, I've got a whole new set of problems to think about . . .