The Treasury strikes back

The Chancellor of the Exchequer's Autumn Statement contained two nasty surprises for lawyers, reducing the tax benefits available to firms incorporating their practices. Mr Osborne clearly has an alternative view of the correct interpretation
of "season of goodwill". The changes, which are already in effect, seem to act against the general move by solicitors away from practising in partnership and towards incorporation.

Ten years ago, the chancellor's moves would have been viewed as being of minority interest only, due to the small number
of law firms which had then
been incorporated. However, incorporation is now the single most popular way of practising for solicitors. The latest SRA statistics (October 2014) show there are now some 3,509 incorporated practices - 34 per cent of all firms and over 300 more than a year previously.
At the same time, partnerships now number 2,419, a drop of over 250 from the previous year. Incidentally, the total number of firms practising in England and Wales is now down to 10,444, from a high point of 11,369 in May 2012. Meanwhile, the number of solicitors in private practice is at an all-time high of 133,327, up by 17,000 in five years. So, there is a very clear trend of more solicitors but fewer firms, and a greater chance of the newly qualified not finding jobs. Mergers are playing a big part in this transition, and the trend towards incorporation goes hand in hand with that.

There is one very big reason why incorporation has proved to be so popular, and that is the tax advantage. There are other reasons, such as making firms more saleable in commercial market terms and a desire to modernise, but the tax advantage is normally the
main one. The first prong of
Mr Osborne's assault attacks
the tax savings on the initial acquisition, which were derived from the limited company's acquiring the goodwill from
the individual owners of the practice. After entrepreneurs' relief was applied, the owners paid capital gains tax at 10 per cent on the disposal, which enabled them to withdraw the 90 per cent balance from their loan accounts tax-free.

This has now effectively been stopped for the vast majority of firms. The chancellor also stated that firms would no longer be able to claim corporation tax relief on the amortisation of internally generated goodwill and customer-related intangible assets acquired from a related business on or after 3 December 2014. The combined effect of the two measures is that the tax benefits of incorporation are significantly reduced, unless there is an actual change in ownership of the business in question, which in most cases there is not.

Just in case any solicitors
are inclined to mutter the word "Scrooge" under their breath, they will doubtless be comforted by the entirely separate announcement from HM Revenue & Customs that they have three months to
own up to any undeclared income or face tougher penalties when caught. The deadline is 9 March 2015.

It is unlikely that the tax changes will bring about an abrupt drop in the number of firms wishing to incorporate their practices (they do not eliminate all of the tax advantages associated with incorporation), but they will probably slow down the rush
to that end. However, there is external pressure to incorporate in the shape of non-lawyers wishing to become involved in alternative business structures.
A large number of potential buyers of law firms are put off
by the old partnership model
and want to both buy into and
be involved in incorporated entities.

It would be very interesting
to know what the Ministry of Justice (MoJ) and LSB have to
say about the chancellor's new strategy regarding law firms, which seems to run directly against their agenda. The LSB has stated many times that it is competition-driven and seeks to encourage new forms and types of practice. This hardly chimes with the chancellor's statement, although in political terms it is unlikely that the Treasury asked the MoJ for an opinion before the statement was made. The season of goodwill indeed. SJ

Stuart Bushell is managing director of SIFA