As the personal tax deadline creeps ever closer, this article highlights some key tips which could be implemented so that the 31 January 2024 payment does not generate overwhelming panic, ensuring you have sufficient funds within your business, should you need to cover the amounts due in January.
This is increasingly relevant now with the tax basis period reforms in progress, with the 2023/24 tax year being the transitional year to the new basis period rules. From the 2024/25 tax year, all unincorporated businesses and LLP’s will be taxed on the profits generated between the start and end of the tax year, i.e. from 6 April to 5 April.
Whilst this change in regulation has already been enacted, there are still some tax planning strategies which can be utilised to minimise the cash flow implications of the tax payments from one year to the next.
Firstly, we will consider some reminders of best practice for your business’s cash position, to ensure you have the funds available to draw from, should you need to do so, when required at the end of January.
Ensuring all overheads are factored into fees
The profitability, and hopefully resultant positive cashflow of a business is achieved by ensuring that its billing levels are sufficient to more than cover the running costs incurred in achieving these, plus some profit too!
A great deal of useful information comes out of a business’s accounting system, including fees billed and amounts recovered, but there tends to be little detail on overheads, which are often treated as a central expense without being allocated to individual departments.
When setting billing expectations for a department, there should be a calculation of the estimated contribution of that department to the total overheads of the business, plus, once again, an addition for profit. Many firms used to apply a multiple of two times salary costs to get to a billing target. But times, and expenses, have moved on. Unless you build into a model how you will allocate overheads to each fee earning team, then you may be underestimating what that team needs to bill. This may then result in lower contribution levels and departmental losses.
If you know at the start of your business year, what your teams re aiming to bill then you can track the impact on cash flow projections so that there are no nasty surprises.
Please contact your local MHA office for assistance with how to use overhead absorption to set billing targets.
Billing periods
Check what your client care letters say about billing on account part way through a matter.
If you have work in progress building up then think about it rationally – this is time that you have paid your staff to work, and given them IT to use and an office to sit in. You have spent cashflow to generate this work in progress, so the quicker that you can bill it the better, as you are recouping some of that cash spent.
Credit terms and recovery of billed amounts
Once the above invoices have been raised, it is imperative that the funds in respect of those bills are received as soon as possible.
Where you have funds sat in client account that are not earmarked for other uses, then make sure that you are regularly reviewing and transferring monies from client to office account.
It is important that your invoice clearly states your business’s credit terms, and if these are not met that they are properly implemented. If you do not use a credit controller to chase overdue debts then you may be delaying cash collection quite significantly. Fee earners or the client relationship manager should be asked to get involved if Credit Control fail to collect the debts. Work for that client could be put on hold until debts are settled.
Payments on account
Many firms ask clients to make payments on account for the matter as they are instructed or as the matter is progressing. These monies sit in the client account, waiting for allocation to a bill having been generated with the transfer to office account. But it is so much easier collecting bill payments from client account that by chasing the client to make payment.
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2023/24 basis period transitional year
This tax year, ending on 5 April 2024, is the first that will see unincorporated businesses and LLP’s taxed on the profits for the actual tax year from 6 April to 5 April each year, irrespective of what their accounting year end is.
Going forward, if your business accounting year end is any date other than between 31 March and 5 April, this will mean apportioning elements of your taxable profit from two financial years that straddle the tax year.
This first period, called the transitional year, pulls into tax whatever profits have not yet been included on a tax return plus the actual profits earned up to 5 April 2024. If your business has a 30 April year end then this will mean that profits from 1 May 2022 to 30 April 2023 will need adding in, together with the profits earned from 1 May 2023 to 5 April 2024. This is almost 2 years worth of profits being taxed in one year!
There is some good news however, which allows relief to be given as a deduction off the extended profit period above for any overlap profits generated under the current basis period rules. This overlap profit was taxed twice in the period that a new partner joined an ongoing business or a new business was set up with a non-31 March year end.
Transitional profit spreading
In addition, there are rules that allow the payment of the tax liability generated from transitional period profits to be spread over 5 tax years beginning with the year of transition. This will ease the increase in cash outflows in Year 1, by ensuring the extra tax due on these profits is not paid entirely in 2023/24.
January 2024 personal tax liability
The tax payments falling due at the end of January 2024 will be the last of the old style balancing payment plus payment on account, before the full impact of the basis period reform takes centre stage.
Be careful if you are looking to make claims to reduce your payments on account, due to falling profits. Have you fully reviewed the impact of catch up of any untaxed profits, and the use of your overlap relief? Do you understand what the transitional profits look like and what will be the impact of spreading the additional liability over the next 5 years?
Do you have any plans to retire over the next 5 years? If so, then your retirement date will crystallise any unpaid transitional year tax.
If you would like to discuss the impact of the basis period review on your business please contact you local MHA office.
