Posted by Andrew Harris, director at Legal Futures Associate Hazlewoods
Harris: potential VAT complication
The Solicitors Regulation Authority’s latest consultation on the accounts rules, issued on 1 June 2016, proposes a significant reduction in the length, detail and complexity of the rules, with practices to be given more freedom and flexibility to decide how they should look after client money.
This is the third and final phase of the SRA’s review of the accounts rules. The first phase, in October 2014, saw some fairly minor changes to the format of the accountant’s report, and introduction of exemptions from the need to obtain a report at all for a small number of legal aid practices.
The second, in November 2015, involved more significant changes to the role of the reporting accountant and an increase in the number of firms able to obtain an exemption.
The new consultation document notes that “our accounts rules are too complicated and are not focused on the key risks to client money”. It goes on to say that the proposals have “the potential to remove a barrier for new entrants who at the moment may be so intimidated by the detail, length and complexity of the current rules they are put off from SRA regulation altogether”.
The SRA has produced a draft of its proposed accounts rules, which runs to six pages, and many will be delighted to hear that all of the old deadlines (next working day, two days, 14 days, etc) have gone. For example, the current rule 29 (Account records for client accounts, etc) has been reduced from 25 sections and 11 guidance notes to just five short paragraphs.
The lengthy guidance is not being thrown away, but moved to a new online toolkit, comprising guidance and case studies to aid compliance. Topics to be covered include ‘What is client money?’, ‘Who can make withdrawals from client account?’ and ‘Requirements to pay interest’. The toolkit will not be part of the SRA Handbook, and presumably won’t be mandatory either.
On the whole, most of the proposed changes seem sensible, although an unexpected proposal is a change to the definition of client money, so that money received in advance for the payment of the firm’s fees and disbursements for which the solicitor is liable (for example counsel fees and expert fees) will in future be office money. Currently, for the majority of practices, money in advance for fees must be held in client account until an invoice is raised.
It is difficult to understand why the SRA is looking to make a change here. Yes, the current rules on office and client money are a little complicated, but in my experience, most practices get them right the vast majority of the time, mainly because any client money held in office account in error usually results in an office ledger credit balance, and is therefore very easy to spot. That won’t be the case under the new proposals.
In response to concerns that this change might make it more difficult to reimburse clients of firms in financial difficulty (as there may not be any money in the bank to refund clients), the SRA suggests that clients should make payment by credit card, so that they can seek a refund under the Consumer Credit Act 1974, i.e. making it someone else’s problem! Failing that, clients can contact the Legal Ombudsman or claim on the SRA’s Compensation Fund. Not very helpful.
A potential complication, and one that the SRA does not mention in the consultation document, is that, in theory, firms may need to account for VAT on the funds when they are first paid into office account, rather than when their fees are billed, as this will represent an actual tax point for VAT.
Currently, most firms only account for VAT when they raise an invoice, as money held in client account is irrelevant for VAT purposes. Paying the VAT should not be a problem, as the money will now be in the office account, but accounting for it, and for any subsequent adjustments when the fees are eventually billed, will be.
Finally, the consultation document seeks to cement the SRA’s introduction of alternatives to the holding of client money, through the use of third-party managed accounts. I have yet to meet someone that thinks that these are a good idea, or might actually consider using one.
The consultation closes on 21 September. More details are on the SRA website here.
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