Supporting you and your business

LEGAL SECTOR Spring 2017

Welcome to our Spring Newsletter focusing on topical issues affecting the legal sector.

In this edition we cover a range of matters including the increasing use of annuities and profit retention in law firms, the implications of FRS 102 on the valuation of contingent work in progress in law firm accounts and focus on the impact of changes to the SRA Accountants rules and related issues.

Within our own firm, I am delighted to report that the PKF Francis Clark’s specialist legal team has continued to grow over the last year. We advise over 100 law firms across the UK from sole practitioners to some of the UK’s largest law firms.

In this last year we have in particular seen an increasing amount of project work being undertaken by our team in helping law firms develop innovative structures and business models for delivering services to their clients. Naturally, the issues surrounding sector succession, working capital funding and tax planning all form an important part of these considerations.

In late 2016 we published the second annual LawNet Financial Benchmarking Survey for the LawNet group, having been appointed to this role in 2015. We are now in the process of collating the South West Law Management Section Benchmark Report for the Law Society and look forward to reporting on this shortly.

Our own experience with clients and those emerging from these surveys, support the view that 2016 was a further successful financial year for most law firms with strong top line growth; typically in the range of 5% to 15% year on year and with most firms converting that growth to at least a 5% increase in average PEP. Our initial view of the 2016/17 financial year is more mixed at this point; greater volatility is perhaps the main observation to note.

We hope you find the newsletter helpful and informative. If you have any queries or want further details on any aspect then please get in touch with us.

Andrew Allen,Partner, Head of legal sector andrew.allen@pkf-francisclark.co.uk

Return of law firm annuities?Background

The changes in pension contribution allowances which took effect from April 2016, significantly affect the ability for higher earning professionals in law firms to make significant pension contributions.

From 6 April 2016 the maximum annual personal contribution is tapered to potentially a maximum of £10,000. The tapering takes effect for earnings over £150,000; such that at £210,000 the maximum annual contribution is £10,000; ignoring any unused brought forward allowances from the previous three tax years.

These changes, combined with earlier restrictions on pension allowances over recent years, means that for most law firm partners and owners the traditional approach of making large contributions in their later working life is not a feasible strategy for retirement planning.

Past and future retirement planning in law firms

Traditionally, partners in law firms have tended to substantially plan financially for their retirement in the last ten years of their working lives; when children are less dependent and household debt is lower. For many this can be the highest earning point in their careers and at this point they would start to make regular large lump sum pension contributions.

Under the new regime, this approach to lifetime pension planning is less effective and has gradually been eroded with the various pension changes in recent years.

For most partners/owners of law firms, making pension contributions will most likely continue to be a core and crucial part of their retirement planning – taking into account average PEP levels, many partners will still be able to make a significant £40,000 contribution each year.

However for those higher earning partners who are regularly earning significantly in excess of £150,000, an alternative plan for retirement may be needed alongside traditional pension routes.

An important point for all partners (or potential partners) to consider is that they need to start looking at pension contributions earlier in their working lives rather than leaving it to the last ten years; the traditional approach mentioned above.

Some points for partners and potential partners to consider in this respect will therefore include:

• Taking advantage of larger unused allowances pre- 5 April 2017 to make lump sum contributions.

• Potentially deferring reduction of some personal debt in favour of making pension contributions.

• Increasing regular personal pension contributions earlier in their working life.

The future – annuities from your law firm?

It is worth pondering why partners take cash out from law firms. The obvious comments here include monthly living needs, paying income tax bills and exceptional draws for key life expenditure such as houses, cars and holidays etc. After these items are considered, the next most common cash draw is for pension contributions!

With the ability to make pension contributions being restricted and with the longer term ability to build up a substantial personal pension fund being questionable, we have seen a number of law firms implementing structures to enable their partners to retain additional funds in the firm as a pension scheme alternative; in effect a ‘pension fund’ with the firm instead.

In the cases we have been involved with, the law firms look to retain those profits within a limited company to benefit from the lower rates of corporation tax in the interim.

These profits can then be paid out to the partner in their retirement, often in the form of an annuity, when they are paying lower rates of income tax personally.

The trading structure of the law firm and the amounts of the potential annuity involved will have an impact on the precise retirement arrangements – it may, for example, be necessary for a member of an LLP to remain as a ‘limited member’ of the LLP during the period of their annuity payment period.

Key benefits of annuities for the individual partner:

• An appropriate trading structure can defer significant levels of income tax into the future.

• Save income tax by extracting income in retirement when personal income tax rates are lower.

• Tax efficient retirement planning not fully possible through private pension contributions.

Benefits of annuities for the law firm:

• Easier access to finance compared to third party debt.

• Increased overall availability of finance to the business for long term investment.

• Lower effective borrowing costs.

• The law firm benefits from larger levels of working capital to reduce its external debt exposure.

• Greater investment flexibility.

• Short term cash flow benefits from deferred taxation position of partners.

Other considerations

a) Risk and asset charging – a key aspect for the individual partner is that they are putting a substantial amount of risk in their ‘pension fund’ by, in effect, investing in just a single business – their law firm. This point is perhaps best mitigated by a mixed investment approach by having some other pension provisions and pension planning in place. At the same time the partner may (if they trade through a limited liability vehicle) consider a charge to the balance sheet to give them some further assurance in this respect.

b) Independent financial advice – following on from point a) it is important that law firms ensure their members, shareholders and partners obtain independent advice on their pension approach more generally as part of any approach by the law firm to formally retain profits for annuity provisions.

c) Tax relief on annuity provisions – tax relief for income tax purposes is obtained when an annuity is paid rather than when it is provided. The recipient, of course, is subject to income tax in the year of receipt.

d) Limitations on annuity levels – tax legislation in place currently sets upper levels of annuities that can be paid to retiring partners based on their average profit in the years running up to retirement. Careful consideration of this issue is required when implementing such arrangements.

e) Discretionary versus compulsory elements – the general comments in this article are focused on the option for partners to forgo profits today for an annuity in the future. In some cases of course, firms may stray towards offering more complex arrangements involving payments of amounts above those retained from profits i.e. in effect, a pseudo goodwill payment into retirement.

f) Provisioning basis – the impact of reserving for annuities on the balance sheet should be considered. Depending on the terms of the annuity these can be straightforward or complex. It is important for firms to consider and model the long term impact that annuities will have on the firm’s balance sheet and cash flow.

g) Partnership/Members agreement – in most firms the arrangements of annuities will require amendments to be made to the core partnership governance and constitutional agreements in place.

If you would like to discuss retirement planning for your law firm owners and how this might interact with the funding of your law firm more generally, please get in touch and we would be pleased to discuss the options with you.

Many partners in law firms will have the terms FRS 5 and UITF40 etched in their memories and will immediately recollect the cash flow horrors and transitional accounting complications of moving from a cash basis of accounting to a full accruals basis in respect of income.

Whilst we all thought this issue was closed, unfortunately more recent interpretations of a new accounting standard have called a specific, but important, part of income recognition in law firms into question again.

Briefly, in terms of background, FRS 102 is an accounting standard that has now replaced FRS 5, UITF 40 and other accounting standards. So FRS 102 becomes the relevant basis on which most law firms will prepare their accounts – certainly for tax purposes and, where relevant, for statutory reporting purposes.

The area where FRS 102 changes the position compared to FRS 5/UITF 40 is in respect of conditional fee agreements.

Position under FRS 5/UITF 40

• At the balance sheet date, if the matter contingency was met e.g. liability was admitted, then the best estimate of the matter value at that time would be included in the accounts.

• For the purposes of valuing such matters, post balance sheet events up to the point of signing off the accounts remained relevant.

• If the matter contingency was not met at the balance sheet date law firms had the option to include the unbilled time at either nil or cost.

• Post balance sheet events for matters where liability is not admitted at the balance sheet date were not relevant.

Interpretation of position under FRS 102

Sector interpretation here has been evolving over the last year; the following summarises current common thinking:

• The significance of the balance sheet date has been removed. The relevant point for assessing contingent fees is now the date the accounts are signed off.

• At this date, if the contingency is met, then the best estimate of the matter value at that time would be included in the accounts.

• If, however, at this date the contingency is not met then firms will need to either value the matters at nil or full value (estimated recoverable value).

• In order to support the option of valuing at full value, firms will need to demonstrate that:

o the value of the revenue can be measured reliably;

o it’s probable that the economic benefits associated with the transaction will arise;

o the stage of completion of the transaction at the year-end can be measured reliably; and

o costs incurred and cost to complete the matter can be reliably measured.

• Crucially, the option to include such matters at ‘cost’ has been removed under FRS 102 – it’s either valued at nil or recoverable (full) value.

Impact for law firms

Firms undertaking substantial amounts of contingency and conditional fee agreement based work are the firms who are potentially affected by this interpretation. So areas such as personal injury, medical negligence, commercial property and general commercial transaction work, are the most obvious cases that come to mind.

Comparing the differing treatments above, under FRS 102 there is a challenge for law firms to demonstrate that, where the contingency is not met on a matter, it can meet the requirements to support the recognition of any revenue. Exceptions to this, perhaps, are firms where they undertake large volumes of homogenous matter types, here it would seem viable to support a revenue value for such matters.

Firms who, under FRS 5, valued non-liability admitted matters at cost, in many cases will now face the decision as to whether they value such cases at nil or substantiate why the cases meet the revenue recognition requirements outlined above.

In our view, firms in this position will need to be looking at their process for supporting the revenue in such matters but also reasons to keep the valuation of such revenue at a controlled level, appropriately taking into account any remaining risks and timeframes over which such income will ultimately be received.

Overall, having been closely involved over the last ten years in valuing these types of legal matters, it seems likely that for many firms, where they relied on the ‘cost’ approach to valuation that moving forward under FRS 102, those same matters may now be either be recognised at either:

1) nil; or

2) full value but with appropriate commercial reductions.

However our expectation is that for the majority of law firms, tFRS 102 - Rhis may not result in a materially different figure for income recognised in any individual reporting period.

There remains a good deal of subjectivity in the interpretation of FRS 102 in this area. Invariably, that means that the accounting treatment between law firms acting in the same areas of law could be quite different and may also change over time.

Arguably, this is no different to the current position where law firms have the option of cost or nil valuations on matters where the contingency is not met, but the guidance under the previous UITF 40 did enforce a consistency of approach. Under FRS 102, the whole subject appears more subjective.

Readers of law firm accounts will need to consider this point moving forward and the explanation of approach under the accounting policies notes in law firms will become an increasingly important point.

Action points for firms

• Consider the impact of post balance sheet events - do you want to get your accounts signed off earlier or later than you currently do as a result of FRS 102?

• If your firm relied on the cost valuation approach under FRS 5, consider the impact on your year-end procedures, recognition approach and what impact this might have on your reported income and profits.

We have significant experience in all aspects of the valuation of unbilled time for law firms. If you would like to speak to us about any specific issue here please get in touch.

FRS 102 - Recognising income in law firms; is your firm doing it right?

FRS 102 - Recognising income in law firms; is your firm doing it right?

The Separated Business Rule (SBR) changes

The SRA made a positive contribution to levelling the playing field between the legal sector and other professionals in late 2015, and within our legal team at PKF Francis Clark we have seen an increasing number of law firms embracing the opportunities this has presented to them at a commercial level.

The key change to the SBR means that solicitors can now establish separate unregulated businesses within their law firm, providing unreserved legal services if client/consumers are sufficiently and reliably informed.

Previously, this was not possible and any separate businesses operated by solicitors, even if they were delivering unreserved legal services, needed to be regulated by the SRA. This provided a competitive disadvantage to solicitors looking to compete in the wider open market place with other providers of unreserved legal services.

Typical protections that would not be available to clients of non-SRA regulated businesses include recourse to the Legal Ombudsman or the SRA’s Compensation Fund and their provider may not have professional indemnity cover.

Continued protections in place

Under the SBR changes, whilst a solicitor can now be an owner, manager or employee of a separate business, the following conditions now apply:

1. the solicitor cannot practice as a solicitor in the separate business;

2. the business must ensure safeguards exist, which means that clients are clear about the extent to which the services that the regulated law firm and the separate business offers, are regulated;

3. the separate business must not represent itself or any of its services as being regulated by the SRA;

4. the separate business cannot carry on any reserved legal activities or some immigration work; and

5. the law firm can only refer, connect or divide client matters with the separate business where the client has given informed consent to do so.

Commercial benefits from the SBR changes

We have seen a number of law firms looking to separate off non-reserved legal services from their main law firm practice. The firms doing this have, amongst other things, been seeking:

• Easier access to non-lawyer ownership and external investment options.

• An ability to brand such services in a different way to the main law firm.

• Lower operating costs to compete with other providers.

Looking to the future, a recent SRA Consultation made proposals to further relax the SBR, seen by many as detrimental to the legal sector, whereby it could be possible for an individual to represent themselves as a solicitor in a separate business which is not delivering regulated services and therefore not regulated – i.e. contrary to condition 1 listed above. This consultation is ongoing but could mark another significant development in this area during 2017.

The SBR changes, combined with a number of recent changes in tax legislation more generally, have resulted in a number of law firms reviewing their trading structure arrangements. If you would like to discuss the opportunities arising from the SBR changes, do get in touch with us.

Levelling the playing field -SBR changes

2016 saw the first year of the Accountants’ Report being prepared under the new regime implemented by the SRA following phase 2 of its review of the Accounts Rules.

PKF Francis Clark, through our involvement with the ICAEW Solicitors Special Interest Group, have been closely involved with the SRA during this evolutionary time and consequently, we have been central to the preparation of more detailed advice issued by the ICAEW in December 2015 to Reporting Accountants.

In this article we reflect on some of the key changes and the impact law firms should be seeing in terms of their annual ‘experience’ under the new regime.

Overview of changesThe primary changes introduced and the thrust of the SRA guidance issued centred on the following aspects:

Risk based approach

The SRA Accounts Rules previously prescribed, within the rules themselves, the broad nature of work that a Reporting Accountant (RA) was required to undertake when completing the Accountant’s Report. This largely dictated what work the RA undertook regardless of whether it was particularly relevant to an individual firm or whether existing control systems or previous experience indicated any specific risk to client funds in an individual area.

This rule has been removed and the RA is now able to report on the degree of compliance with the SRA Accounts Rules and perceived risk to client funds adopting a risk based approach and in order to do so, is able to formulate their own test procedures.

This change in approach has led to the removal of the requirement to prepare a RAs’ Checklist, as this largely reported on the prescriptive testing set out in the rules; and of course the Accountant’s Report itself has been changed –

significantly condensed and adapted to meet the new approach.

Disclosure of information

In keeping with the risk based approach the SRA has introduced a new rule which requires law firms to provide documentation to the RA as required enabling them to complete their work.

Along with these key regime changes the SRA also announced further exemptions for firms holding small levels of client funds.

What changes should law firms be seeing?For law firms the changes should mean that the experience you have in your annual SRA Accounts Rules review will change. Examples here may include:

Risk assessment

A significant element of this will be the RA assessing the relative risk of your firm. This may range from factors such as the size of the firm, type of work it undertakes, degree of breaches identified in the past, results of SRA reviews or any other information that might help them form a view.

There is unlikely to be any material impact on the law firm from this process in itself but the RA may ask for information not previously requested in the process; for example the RA may request details of:

• The internal breaches register to look at the nature and volume of current year breaches.

• Client complaints and PII claims received in the year to check their nature and volume.

• Details of the firm’s finance team including their qualifications, level of experience and training.

• The current financial performance of the law firm and funding available.

• Details of any regulatory matters in recent years included SDT cases/findings against the fee earners/managers.

• Correspondence with the SRA.

• The results of any internal reviews of internal controls and processes.

The above is only illustrative but it points towards the types of questions and information an RA could reasonably now consider when forming their view of risk assessment.

The results of this process will then largely guide the scope and nature of detailed testing the RA undertakes.

Controls and the operation of control systems

Historically, RAs needed to undertake an assessment of controls and systems to meet the requirements of the prescribed work areas. With the new risk based approach this element of the RAs’ work will become more important. In particular it will be important as part of assessing overall risk at the start of the RAs’ work and we have found in a range of law firms that the testing of control systems is being used as an alternative to some areas of detailed testing for compliance with the Accounts Rules which most law firms are more familiar with.

Law firms can expect more questions about their control systems and the control environment in which they operate. We have found that for many law firms it is sensible for them to ensure formal documentation of control systems are in place; many COFAs will of course have already undertaken this in discharging their own responsibilities.

So, in our experience, the RA is now spending more time looking at control systems and then annually reviewing any changes to them and their ongoing operation. We have also found that we have been able to help our law firm clients by commenting on the effectiveness of their control systems and have been able to make recommendations for improvements.

ACCOUNTANTS’ REPORTS

What changed in 2016

Variation in work

This is possibly the biggest culture shift! Law firms will need to become more comfortable with the concept that the type, volume and nature of work an RA undertakes may now change from year to year. This is normal in an ‘audit’ environment and of course the work should, and needs, to change if the risk assessment of the business is also changing.

This is nothing for the law firm to be concerned about but invariably it will mean some practical issues in dealing with requests for different types of information from time to time.

The qualification issue…..

Following previous changes by the SRA, only qualified audit reports are now required to be submitted to the SRA. There has, and to some extent will always be, some lack of clarity over exactly what constitutes a qualified report.

However, the SRA guidance notes issued on the new Accountant’s Report regime provides more specific details on areas and provides examples which might lead to a qualified report.

The ICAEW technical release also supports the qualification guidance and provides further specific examples of matters identified by the RA which could

lead to a qualified Accountant’s Report. These examples should be of interest to the COFA, both in terms of their own internal reporting requirements and in understanding the basis of a qualified Accountant’s Report, should this occur.

Accountants’ Reports are for the owners not just the SRA…..It is worth remembering in all this that the Accountants’ Report serves the purpose of protecting partners as individual owners of your law firm as well as the clients and the SRA.

Whilst the RAs are being encouraged to exercise greater professional judgement in this process, the SRA have been keen to remind them of their underlying responsibilities at the same time including the whistleblowing regime where, for example, undue pressure is exerted by the law firm.

With the SRA promoting greater reliance on professional judgement of the RA it becomes even more important that your RA is experienced at understanding the issues presented from holding client money and the purpose of the SRA Accounts Rules.

The future?The final Phase 3 review of the SRA Accounts Rules is currently in progress following a consultation in the summer of

2016. The proposals in this consultation were radical; they present a re-definition of client money, permit the use of Third Party Managed Client accounts and fundamentally reduce down the level of prescriptive detail in the rules.

Latest expectations are that the SRA will be reporting on the outcome of this consultation during the spring or summer of 2017 with potential changes not taking effect until 2018 or later.

For all law firms the biggest expense is people and more specifically payroll costs. There are a large number of rules and regulations that surround the management of a payroll system and we have seen an increasing number of law firms experiencing challenges with keeping up to date with the requirements in this area.

Is your law firm exposed to a PAYE compliance risk?

Nationally, we have also seen an increasing number of inspections being undertaken by HMRC to carry out a review of the PAYE and National Insurance Contribution (NIC) records.

What happens during a HMRC inspection?

During such inspections HMRC look to assess whether the records and systems maintained support the operation of PAYE/NIC, that business expenses have been appropriately incurred and accounted for and that any tax and NI liabilities have been correctly addressed. In addition, the compliance check will often review the employment status position of workers engaged by the business to ensure that the correct tax and NIC position is being adhered to.

Many employers believe that these HMRC checks cover only the operation of PAYE/NIC and that they only have to provide details of the payroll records. This is not true. Any records relating to the payment of expenses and benefits will also need to be made available. This for example, could include expense claim forms and receipts, company credit card receipts and statements, petty cash records and company car information.

If errors are identified by HMRC, additional tax and NI liabilities can arise on which both interest and penalties may also be due. Information provided by the employer as to how and why the errors occurred will have a direct influence on how the penalties are viewed and calculated.

Where are the common risk areas for law firms?

• Subsistence payments to employees during training and other work activities.

• Motor expense arrangements.

• Place of work and travel between home and work arrangements.

• Entertaining benefits.

• Access to legal services of their firm at below cost.

• Rewards and bonuses paid outside the payroll.

• Self employed consultancy contracts.

2016 changes to reporting benefits for employees

Up until April 2016, employers who pay/reimburse allowable expenses to employees had two options in terms of their treatment. These were to report the expenses on form P11D and the employee then had to claim their tax relief from HMRC or the employer held a dispensation, which is an agreement with HMRC that let them pay those allowable expenses without reporting them. In law firms it was common for expenses such as professional subscriptions to be covered by these dispensations.

From 6 April 2016 HMRC has replaced dispensations by introducing an exemption from paying tax and NIC on qualifying paid or reimbursed expense payments.

One of the major changes with the introduction of this new legislation is that it will now be a statutory requirement for employers to operate a system for checking employees’ expenses claims. The system has to check that the employees are actually incurring expenses; and that those expenses are allowable.

Are you ready for these changes and the impact this may have on your record keeping requirements?

Compliance health check

PKF Francis Clark has an internal PAYE/NIC and Expenses/Benefit compliance expert who can provide our law firm clients with health checks on employer compliance matters, reviewing their systems and record keeping processes ensuring that those systems are robust enough to meet the expectations of HMRC.

If you feel this is something that you may benefit from, please get in touch.

SECRET PROFITS – AVOIDING THE PITFALLS

Under the code of conduct principles law firms must ensure they remain transparent with their clients concerning their fees and must not be seen to be generating secret profits.

If secret profits are identified as being generated within a law firm by the regulators this can have significant consequences in terms of financial, reputational and operational risk.

In some instances firms are not always aware that they are potentially exposed in this area. This article examines the common areas where law firms can fall foul of generating secret profits and how the firm’s COFA can assist in maintaining compliance.

Telegraphic transfer fees ‘TT fees’TT fees are one of the most common areas where firms can be exposed to creating secret profits.

In a typical scenario a bank will make a charge of say £10 to a law firm for processing a TT fee; the practice may then charge say £25 plus VAT to the client. The additional uplift of £15 representing the firm’s own administration fee for processing the payment.

This additional fee element is not unreasonable to apply, however, the method in which this is communicated to the client is essential.

If the firm simply explains in their engagement letter to the client that a disbursement for a TT fee will be charged of the £25 plus VAT and then issue a bill of cost to the client that just shows a disbursement of the £25 plus VAT, then the firm will potentially have been deemed to have created a secret profit.

To remind ourselves at this point, under the glossary of definitions within the code of conduct (which can be found on the SRA website), a disbursement is defined as any sum spent or to be spent on behalf of the client or the trust.

If in the above example, a practice simply passed on the bank charges of £10 to the client; this can be classified as a disbursement when onward charging this to the client.

However, once this charge is increased to allow for the firm’s own administration fee, even the £10 element would not meet the definition as a disbursement. Therefore, by classifying the firm’s own administration element of this charge to the client as a disbursement would not technically be correct, creating a lack of transparency in the position presented to the client.

There are a number of disciplinary cases by the SDT covering the above scenario. Such outcomes include firm’s being required to return the full value of TT fees charged to clients, fines to cover the investigation costs and solicitors being struck off. It is therefore imperative that firms comply with the requirements in this area.

How can firms ensure they remain transparent in the above circumstances?

As mentioned above, the starting point on accepting instructions from the client will involve the issue of a client engagement letter which, for example in the case of a conveyancing matter, will include an indication of the costs and disbursements to be incurred.

Where firms only intend to pass the bank charge for TTs incurred to their client this can reasonably be included within the expected anticipated disbursements that will be incurred.

However, where the TT Fee charged to the client will also include the firm’s own administration fee, the whole charge (the bank charge plus the firm’s own mark-up) should be clearly shown as a separate part of the firm’s own costs and include a reference such as ‘our administration fee’.

In addition, the same principles apply when presenting the bill of costs to the client, i.e. where a firm charges an administration fee, it should be shown within the fee costs section as opposed to disbursements and clearly marked as the firm’s own fee.

The COFA together with the firm’s COLP should put systems and monitoring processes in place to ensure that everyone in the firm responsible for engaging and billing clients is aware of these requirements.

Commissions receivedCommissions received on behalf of clients for reserved activities are a further area that can create potential issues relating to secret profits.

There are some specific requirements where commissions are received by firms on behalf of clients which include:

• informing the client of their right to the commission and returning the full commission received to the client concerned; or

• offsetting the commission received against costs billed to the client; or

• agreeing with the client that such commission can be retained by the practice.

In terms of the last two points above, an agreement must be in place with client in advance for such treatment to be applied with a record retained to evidence the agreement. As part of this agreement, the client must be made aware of the amount of commission being received or an estimate where the amount is not known at the time.

It is important to highlight that historically a practice was permitted to retain any commission received without agreement with the client where the amount received was less than £20. This however, is no longer permitted.

Again, where law firms do not follow the above requirements they will fail to be seen as being transparent with their client and will be deemed to be receiving an unjust financial benefit.

In this area, the firm’s COLP should have a system of identifying commissions received within the financial records and ensuring such commissions are treated in accordance with the above. All fee earners and legal cashiers should be reminded of the above requirements where applicable. The terms of business should also communicate to the client their rights to receive the commissions received.

Online land registry feesFinally, a more recent issue that has come to our attention is that firms can now obtain a discount in relation to Land Registry fees for registration of title where an application is processed online.

Where such instances arise, it is important that the reduced cost is passed on to clients to meet the definition of a disbursement. As with the TT fee scenario, if the standard Land Registry fee is then charged to the client the firm will be making a profit which, if not appropriately communicated to clients, will be seen to be a secret profit.

The above points are clearly important for consideration and if your COLP or COFA has any concerns on the points above, please get in touch with us.

SECRET PROFITS – AVOIDING THE PITFALLS

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It has been confirmed that a scheme will be introduced which requires legal fees to be fixed for all claims with a value by claimant for damages of up to £25,000; in line with the level currently applied to other groups of personal injury claims but a significantly lower threshold than that originally mooted of £250,000.

A consultation has been issued to discuss how such fixed fees will be set and proposals at this point include:

a) Fees based on a percentage of damages with a cap at higher levels where damages are up to £25,000.

b) Fixed amounts of £3,000 for claims at pre- issue which increases to around £7,000 for post- listing claims. Additional amounts for trial fees and a 10% reduction for early admissions of liability by the defendant.

For law firms operating in this area,

whilst relieved that the £250,000 proposal has been dropped, they still face a number of challenges when the new fixed fees take effect including:

• Reviewing their case selection procedures.

• Monitoring and controlling work flow in teams.

• Managing profit margins by properly costing work involved in cases.

• Changes in the composition (mix of skills) of their teams to fit with fixed fee environment.

• Reviewing how they service their clients and what can be delivered within a fixed fee.

• Managing the transition from old to new cases over a number of years.

• Reviewing the structural delivery of services – is it still part of the main law firm?

• Reviewing the impact on projected cash and profit management over future years.

• Revisiting tax planning around management of profits from a timing viewpoint.

• Reconsidering income recognition policies.

As we saw with the impact of the Jackson Reforms in 2013 and fixed fees for Personal Injury there is likely to be a good deal of change in the management of this work area once the new regime is in place.

For some firms the advent of fixed fees here may mean that they cease to operate in this area of law which in itself will bring a number of financial and tax considerations including:a) Practical issues of winding down the

team.b) Selling the WIP/business book and

team.c) Managing the reduction in costs

(employees and overheads) over time.d) Looking at replacement areas of work

to replace lost profits.

If your firm is delivering clinical negligence services and would like to discuss your plans from a taxation, accounting and strategic angle please get in touch with our team.

Managing fixed fees in medical negligenceLast month the Department of Health finally announced more specific plans in respect of fixed fees in medical negligence matters following a long period of consultation.