By David Webster, Partner in the corporate team at Russell-Cooke
For some time the possibility of barristers practising through incorporated entities has existed, but only if that entity was regulated by an approved regulator such as the SRA, rather than the BSB. Although some barristers have forged ahead by innovating and adopting new methods of service provision, the general impression is that take up of these opportunities has been fairly limited.
The latest development, following Legal Services Board approval this November, is that the BSB now has the ability to regulate entities. Previously the BSB only regulated individual barristers, whether self-employed or in-house. The BSB has also imposed various requirements on Heads of Chambers to bring Chambers within the regulatory net. The BSB has confirmed that it will start accepting applications for incorporated practices from 5 January 2015, and expects to start authorising applications in April 2015.
Although the BSB has plans to expand its operations in this area, for the moment it will be limiting itself to entities managed and owned by barristers and other legal professionals. It will also focus primarily on entities specialising in advocacy, litigation and specialist legal advice. Indeed, the BSB is explicit that it is not looking to replicate other regulators’ entity regulation regimes. Accordingly, the BSB is not seeking to emulate the SRA and it seems likely that it will regulate entities owned and managed predominantly by barristers.
Anecdotal evidence suggests that these latest changes are likely to see a wider take up within the Bar than previous developments. However, the main attraction seems to be in establishing single person entities as vehicle for conducting self-employed practice, rather than the establishment of incorporated Chambers to rival solicitors’ firms. The BSB itself has commented that it expects to regulate between 900 and 1,400 single person entities in the first three years.
This article considers some of the key issues which barristers should consider as a result of these changes.
Personal Tax Position
There are many reasons why practising through an incorporated entity may be attractive. Indeed, the BSB has commented, perhaps optimistically, that by entering into the field of entity regulation in this manner, it will“significantly help broaden the public’s choice as to how they access legal services”. However, for many barristers one of the key driving forces will be their personal tax position.
It is not axiomatic that practising through an incorporated entity will reduce the aggregate tax burden of providing legal services as a barrister. Nevertheless, the differing tax rates which apply to companies and the flexibility which a corporate structure brings (in terms of when and how income is extracted) means the use of a company can generate significant tax savings. Key points to consider in this area include:
- There is a difference between practising through an LLP (which is tax transparent despite its separate legal personality), and a company.
- Currently, a UK tax resident barrister will pay income tax at the prevailing personal tax rates on their fee income (currently ranging from the basic rate of 20% to the additional tax rate of 45% for income over £150,000).
- Profits extracted from a company will be subject to double taxation. In the current tax year, company profits are subject to corporation tax at a rate of between 20% and 21.25%. This tax is due regardless of whether the profits are retained as working capital in the company, invested, or paid out to employees or shareholders. There will then be a separate tax charge when money is paid out to employees or shareholders, whether as dividend or employment income.
- The income tax rate applicable to dividends is lower than for employment income. By extracting profits from a company in the form of dividends, potential tax savings arise (particularly for those who are basic rate taxpayers).
General nature of a company or LLP
- Both companies and LLPs offer the protection of limited liability for the individuals involved. Whilst undoubtedly attractive as a matter of principle, in practice it may be of less relevance. For example:
- As regards relations with clients, one would expect risk to be borne by PI cover in the first instance, as with practising as an individual.
- An individual should not assume that no liabilities of the company can end up being attributed to a Director personally. Space prevents a more detailed explanation of the relevant law, and in many cases the rules on directors’ duties and other related matters (including wrongful trading risk) may be of academic interest only. However, individuals should be particularly cautious if their entity is in financial difficulty, and the possibility of those duties being owed to and/or enforced by creditors and insolvency practitioners arises.
- Operating through a limited liability entity means that certain information about your professional affairs will become a matter of public record. Both companies and LLPs will need to, for example, lodge annual accounts. Furthermore, there will be ongoing filing obligations and other administrative requirements which, whilst by no means insurmountable, need to be complied with.
- If acting through a company, it is almost inevitable that a barrister will be a Director and employee of that company. As suggested above, concerns about the application of directors duties and employment law are probably more academic than substantive for as long as the company remains solvent, but at a practical level it will require the operation of, for example, a payroll system to allow appropriate income tax and PAYE deductions .
- Practising through an entity will involve a fairly fundamental shift in presentation for barristers used to practising as individuals. In some respects the changes will be mundane, such as ensuring terms and conditions are amended appropriately and invoices are correctly issued. However, these details are important. If a barrister holds themselves out (particularly in correspondence) as acting on their own account rather than as a Director of a company, in the worst case scenario a barrister could end up taking on uninsured personal obligations (rather than these being liabilities of the company).
- It is important to maintain clear lines between personal and business expenditure. A common problem for small business owners is the commingling of personal and business funds. Generally this is resolved by a reconciliation at the end of the financial year, but this is an unnecessary headache (which may also lead to additional expenditure on professional advice), which can be avoided fairly easily. More serious complications can arise when a company is treated as having made a loan to a director, in terms of unwanted tax charges under the rules on loans to participators.
Individual or group entities?
Most of the attention on the recent change has focussed on the possibility of single member entities being used by the Bar. However, the extent to which there is an appetite to have the BSB regulate entities comprising groups of barristers (and other regulated legal professionals) is unclear.
The BSB’s own press release comments on the fact that “barristers and other advocacy focussed lawyers are now able to pool together resources and share the risks of investing in their own business”, but does not give any indication of anticipated take up.
Two particular scenarios which merit further consideration are:
The hybrid single member company
The possibility of an individual having a two member company in which their spouse or civil partner has a significant interest. This is a relatively common arrangement in general commerce, and allows the distribution of the company’s income to be spread across the two individuals concerned. However, this may not be an attractive or workable proposal for many barristers for numbers of reasons:
- Any entity regulated by the BSB has to be comprised of owners and managers who are all legally regulated professionals. Even where this does not operate as a block in itself, the fact that both individuals have to be legally regulated professionals means that, because of likely income levels, the chance of significant tax efficiencies arising is minimised.
- Chambers may be reluctant to allow individuals outside of Chambers to be involved in a company practising under the umbrella of Chambers.
(This approach may become more viable if the BSB is designated as an ABS licensing authority in the near future, as it eventually plans to be.)
One of the key constraints on barristers joining together in an entity where each effectively has an interest in the practice of the other has been the satisfactory management of conflicts. It is difficult to see how groups of barristers who want to maintain sufficient independence to be able to appear on opposite sides of the same case (as the current Chambers system permits) can incorporate together. Accordingly, we do not foresee a wave of, for example, entire Chambers looking to benefit from entity regulation.
However, for those who do not see conflict or confidentiality concerns as a real problem in practice, there are significant opportunities here. Although this has yet to be really tested, the ability to, for example, develop a brand, or raise external finance to expand a business, is likely to be facilitated through use of a corporate vehicle.
The latest news from the BSB is perhaps the first recent regulatory change likely to lead to widespread take up from the Bar. It may be however that for many of those involved in this process, the motivations are (entirely understandably) financial, rather than innovation in the provision of legal services. Certainly it will be interesting in the short term to see the extent to which the BSB regulates entities which reflect a genuine pooling of lawyers working together. It may be that this is a decisive factor in determining whether or not the BSB decides to pursue regulatory innovation any further.
David Webster is a Partner in the corporate team at Russell-Cooke