Professional Practices News: Summer 2013 - Causing A Bit Of A Stir; Change Afoot For Partnerships

FOREWORD - GROWING PAINS

By Giles Murphy

As the UK weather slowly starts to remember it is summer, there are signs that the UK economy has remembered that it is traditionally supposed to grow. While this edition of Professional practices news looks at the economic outlook, it also reminds us of the fragility of any professional practice firm and the warning signs that indicate your firm might be at risk.

Partners in professional firms will also be looking warily at the HMRC consultation into the taxation of partners and the potential impact any changes may have. One area where change is certain is pensions and the so-called auto-enrolment regime. Both taxation and pension changes may have a lasting impact on the net amount partners can withdraw from the business for the services they provide and, therefore, both receive attention in our newsletter.

On a more positive note, we look at how to bring out the best in your partners in relation to business development and at the Brazilian market as a location for expansion of professional practice firms.

If you have any queries on any of the matters covered, please do not hesitate to get in touch.

PROBLEM? WHAT PROBLEM? - SPOTTING FINANCIAL WARNING SIGNS EARLY IS ESSENTIAL FOR SURVIVAL

By Colin Hardman

Colin Hardman examines the warning signs that, if identified early, can greatly improve the recovery prospects of firms in financial difficulty.

An inevitable consequence of the recent economic turmoil is that some professional practices, large and small, are suffering from falling profits and liquidity issues. In extreme cases, this has led to the failure of some firms. For every high-profile failure, such as the administration of Cobbetts LLP earlier this year, there are numerous, less well-reported failures of smaller firms. There has also been a marked increase in professional practices and their lenders seeking restructuring and insolvency advice - a trend that is unlikely to reverse in the near future.

As a further indication of this problem, in our latest annual survey of the legal sector, the greatest concerns to firms were the fragility of the UK economy, pressure on fees and maintaining profitability. Cuts in legal aid, the Jackson reforms and increased competition from 'Tesco law' are also unwelcome contributory factors to a general lack of confidence within the sector.

Common warning signs

The first step to stability and recovery is to identify (and accept) there is a problem. Below are some of the more common warning signs that a firm may be heading for trouble.

Lack of clarity and agreement on the firm's strategic direction - The goals of senior/equity partners are often at odds with those of junior/salaried partners, leading to incongruent behaviour. Higher than expected rates of voluntary departure of partners and other key fee-earners - Dissatisfaction with the direction of the practice or perceived unfairness in the reward structure may well lead to the exit of better performing fee earners. Together with a failure to deal with weaker performing staff, this can result in dissatisfied clients and subsequently falling profits and lower billing recovery rates. Inadequate management information systems - Firms should prepare management accounts to assess their trading performance and current financial position (especially lock-up). They should produce an annual budget, apply key performance indicators (financial and non-financial) and short-term cash flow forecasts. These tools are essential when it comes to making the appropriate decisions to maximise profits and control cash. Level of drawings not realigned with lower profits - When profits start falling firms often fail to realign their outgoings, resulting in a depletion of cash reserves or increased reliance on overdraft facilities. A further consequence of this is an imbalance in levels of bank debt compared to partners' capital. One or more new initiatives requiring capital investment - This can include expansion into new territories or service lines - usually slow burners in terms of revenue and profit generation, while being a significant cash drain in the early stages. Passive billing and collection procedures - While lock-up is a contributory factor in many cash- stricken firms, accelerated billing and collection processes can have a dramatically beneficial effect on liquidity in a relatively short period of time, reducing the level of funding required from other sources (especially the bank and the partners themselves). Lack of professional advice and support - Denial and/ or unwillingness to seek professional advice is common among professional practices. While a natural reaction may be to try to resolve issues within the sanctum of the firm, the implications of wrongful trading, particularly when coupled with unlimited liability (if a general partnership), should be a sufficient wake-up call to being more proactive in getting external professional advice. Identifying and dealing with issues quickly and conveying the subsequent strategy (and progress towards delivering it) to key stakeholders, including the bank and your own staff, will greatly improve the chances of recovery and survival.

CURTAIN TO FALL ON PROFIT MANIPULATION? - STEPS TO PUT A STOP TO THE MISUSE OF PARTNERSHIPS

By Pamela Sayers

Pamela Sayers looks at measures announced in the Budget that affect many businesses involving LLPs and other partnerships.

The increasing use of a mix of corporate structures and LLPs by professional practices to take advantage of differing tax rates has prompted the Government to take action.

Disguised employment and manipulation of profits

Possibly prompted by the Legal Services Act coming into force, the Government has published a consultation on measures to:

remove the presumption of self- employment for partners of LLPs, to tackle the disguising of employment relationships through LLPs; and counter the manipulation of profits or losses by LLPs and other partnerships involving companies and/or trusts or other vehicles to achieve a tax advantage. The consultation process will lead to fresh legislation being enacted next year, likely to be effective from 6 April 2014.

The Government acknowledges that the current tax law deliberately makes all members of an LLP self-employed. It appears that it is not looking to stop this altogether, but rather to refine the circumstances when members will be regarded as self-employed. This would suggest that any change to the legislation is unlikely to be applied retrospectively.

The consultation document addresses the use of corporate partners for tax-avoidance purposes, which includes cases where individual partners benefit directly or indirectly from accessing the low rates of UK corporation tax, currently 23%, reducing to 21% from 1 April 2014 and to 20% from 1 April 2015.

Presumption of self-employment

Government scrutiny of the tax rules for LLPs may also stem from concerns that revenue from employer national insurance contributions (NICs) are being lost due to the difference in rates for self-employed individuals compared to those for employees and their employers. Individuals who have been given LLP member status may in all other respects be treated as an employee. Therefore, HMRC intends to remove the presumption...