Every law firm partner knows the rhythm. January brings the balancing payment and the first payment on account, July brings the second, and the VAT quarter comes round four times a year whether or not clients have paid their bills. In a good year the firm's cash copes. In a year when fees are tied up in work in progress, or a large matter settles later than planned, the same dates can push partners into their savings or push the firm further into its overdraft than anyone would like.
Borrowing to smooth these payments is common and perfectly sensible. What matters is choosing the right route and arranging it well before the deadline, not the week after.
Why the bills land when cash is tight
Partners in an LLP or a traditional partnership are taxed as self employed on their share of the profit, whether or not they have drawn it. Under HMRC's self assessment timetable, the balancing payment for the previous tax year and the first payment on account for the current year are both due by 31 January, and the second payment on account is due by 31 July. Each payment on account is normally half of the previous year's bill, so a strong year pushes up the next year's payments before all of that year's fees have necessarily been collected.
The move to the tax year basis has added to this for many firms. Partners whose firm's accounting year does not end between 31 March and 5 April were taxed on transition profit in the 2023 to 2024 tax year, and by default that profit is spread over five years up to 2027 to 2028. For some partners it means a January bill noticeably larger than their drawings would suggest.
VAT has its own timing problem. Under standard VAT accounting, the firm owes the VAT on a bill once the invoice has gone out, even if the client takes three months to pay. Quarterly returns and payments are normally due one calendar month and seven days after the end of the quarter. A firm that bills heavily in the last few weeks of a quarter can find itself handing HMRC VAT on fees it has not collected yet.
A worked example
Picture a four partner firm with an April year end. Between them, the partners face personal tax bills of £180,000 at the end of January. The firm has been holding back a tax reserve from drawings, but a slow autumn means the reserve stands at £110,000. A week later, the VAT for the quarter to 31 December falls due at £65,000, much of it on bills that are still unpaid.
The firm could clear all of it from the overdraft, but that would leave very little headroom through February and March. Instead, the £70,000 tax shortfall can be spread over the months up to the July payment, and the VAT over the following quarter as debtors pay. The partners pay HMRC on time, the overdraft stays available for the day to day, and the cost becomes a known monthly figure that can be weighed against the overdraft or HMRC's own late payment interest.
The main routes
Tax and VAT funding is usually a short term loan arranged for the specific bill and repaid in monthly instalments, often over a period that ends before the next payment is due. Some lenders pay HMRC directly. It can be arranged at firm level for VAT or corporation tax, or for partners individually to cover their own self assessment.
Partner loans sit with the individual rather than the firm. They suit firms where partners' positions differ and not everyone wants to borrow.
HMRC's Time to Pay arrangements are worth knowing about too. They are agreed directly with HMRC, interest is still charged, and HMRC will want to understand why the bill cannot be paid in full. They can work as a fallback, but they are not something to rely on as a plan.
What lenders will ask for
Expect requests for the last two years of accounts, recent management accounts, aged debtors and work in progress, the tax calculation or HMRC statement showing what is owed, and the latest VAT return. For partner borrowing, lenders often want to see the partnership or members' agreement. Client account money can never be used for the firm's own liabilities, so lenders look only at office account cash and will want to see how the facility will be repaid from it. Applying four to six weeks before the deadline gives time for questions to be answered without anyone panicking.
Planning ahead
A few habits make a real difference. Review the tax reserve in October or November rather than in January. If profits are expected to fall, ask the firm's accountant whether a claim to reduce payments on account makes sense, as HMRC allows this. Ask too whether the VAT cash accounting scheme, available to businesses with taxable turnover up to £1.35 million, would let the firm pay VAT when clients pay rather than when bills go out.
Tax and VAT dates never move. Treating them as part of the firm's cash planning, rather than a surprise twice a year, keeps partners and the firm in control.
Simon Palmer is director of Smart Funding Solutions, a whole of market commercial finance broker in Chester that arranges VAT and tax funding for law firms and partners. He also runs Professional Practice Loans, which helps solicitors and other professional firms fund partner capital, tax bills and practice purchases.
Smart Funding Solutions is a trading style of Smart Funding Solutions Limited (FRN: 972740) who are Appointed Representatives of White Rose Finance Group Ltd (FRN: 630772) who are directly authorised by the Financial Conduct Authority.