What a changing tax framework means for your business

Changes to National Insurance rates and basis periods are set to impact individuals and businesses alike – MHA’s SRA specialist director, Robert Blech, goes into the details.

Following the huge impact of the pandemic, it is clear that monies need to be recouped, and inevitably some of it will unfortunately fall on the taxpayer.

With some tax changes already in place, some proposed, and a new Spring Statement announced for this coming March, what do law firms need to be mindful of? And, what will the impact be on the practice and its owners?

National Insurance changes

There will be a 1.25% increase in all National Insurance (NI) rates from 5 April 2022. From 5 April 2023, NI rates will return to previous levels and this extra tax will be collected as a new Health and Social Care Levy. This levy, unlike NI, will also be paid by state pensioners who are still working. In line with this, there will also be a 1.25% increase in dividend tax from 5 April 2022, taking rates to 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. The £2,000 dividend allowance will still be in place.

A rise in NI means that the cost of employing staff goes up, which affects cash flow – especially for law firms where this is already tight. The result of such an increase may lead to employees asking for a rise to offset the fall in pay.

If a law firm is a sole trader/partnership or LLP, personal tax will also increase due to the NI change. If trading as a limited company, income tax on dividends will detrimentally impact dividends received.  For example, a dividend of £10,000 will attract £125 in extra tax.  Taking into consideration payments on account, where tax is paid in advance based on the previous year’s liability, this amount will likely be higher.

For further information on this, as well as other tax planning tips, please see MHA’s Year End Tax Planning Guide. The publication is for individuals and businesses and summarises some key tax and financial planning tips which must be actioned prior to 5 April 2022.

Basis period reforms

Additionally, there are proposed changes to the tax basis period from 2024-25 with a transition year from 2023-24 for sole practitioners, partnerships and LLPs. Under this reform a business’s profit or loss for a tax year will be that which occurs in the actual tax year itself, irrespective of the accounting year end date. Under the current regime, the tax is based on the profit attributable for the accounts period end, which falls in the relevant tax year. For this reason, many law firms have year ends of 30 April, which in effect defers most of the profits until the next tax period. To illustrate this, an LLP’s profits with a year end of 30 April 2022 will fall into the 2022-23 tax year. However, under the proposals (if applicable now) in the 2022-23 tax year, all profits from 6 April 2022 to 5 April 2023 would be taxable. The reason for the transition year is to catch up with periods that have not yet been taxed. Therefore, in 2023-24, there will be a catch up if a law firm has a year end not in line with the tax year, which if 30 April can be significant.

The impact of this on cash flows may be material and, therefore, planning should begin on mitigating the potential impact of this now. Professional advice should be sought, and discussions had at management level.

Conclusion

It is important that law firms are aware of the proposed changes to the basis periods, and the impact this will have on the practice and the owners.  If you would like assistance with any of the points raised above, or other tax planning issues, then please contact our national team.