When a practice is in the middle of a lengthy project, how it is going to pay its tax might not be top of its list of priorities. However, there are tax-related considerations that have implications for both a practice's cash flow and its work flow.
These are not so much about saving money as avoiding paying too much at the wrong time, and are well worth discussing with an accountant.
John Hickey teaches a professional studies unit at Manchester School of Architecture entitled ‘Managing the Cash’, and keeping tax liability at the correct level is one of his key lessons.
He suggests that one valuable step that practices could take is to ensure that the profit levels they declare for early-stage design work do not have implications for later earnings in their tax accounts.
An architect’s fees are often front-loaded: the early design stages command proportionately higher fees than work carried out in later contract administration stages. Those later stages often make much lower profits, or perhaps even losses.
Small practices with projects that span tax years might well find that the ultimate profitability of their work on a project may fall back, perhaps dramatically. Therefore they should ensure that projected profits at early stages accurately reflect this, and avoid paying a disproportionate amount of tax too early.
A related issue is the evaluation and calculation of ‘work in progress’: the contracted work that has been carried out but not yet invoiced for. It is taxable as if it were income. Work in progress has to be declared, Hickey stresses, but may be kept to a minimum, depending on the context of the project.
Again, by valuing early-stage work in progress at a level that accurately acknowledges the end-profit of a project, a practice’s tax liability can be smoothed out, taking into account future years. This could avoid adverse effects on a practice’s cash flow.
Hickey suggests calculating work in progress on the basis of cost rate per hour, plus a modest aggregated profit rate. This would make a difference to a practice declaring earnings as it approached the point where a high proportion of fees are received for front-end work.
Another potentially heavy tax burden can arise from completing more work on projects than strictly needs to be done at that time.
"Have a work plan and don’t stock up on work in progress by increasing staff levels unless you are very confident," warns Hickey. "There is no point in having design work completed six months before it is needed if you cannot charge for it but still have to declare it. You would end up paying tax too soon."
The real horror to avoid is what Hickey refers to as the ‘Death Valley Curve’. This is where too many early-stage projects all arrive together and require operational cash at the same time. Without sufficient fee income coming in, any banking or loan facilities could be quickly overwhelmed. This scenario is unlikely to end well.
Hickey also has a few suggestions regarding VAT. Cash accounting for VAT is very well known. However, Hickey still encounters architects who are unaware of it. If you opt for cash accounting, then VAT is payable on money received, not on the value of VAT invoices issued (which is the default when registering for VAT).
Depending on the timing of invoicing and payment, this simple option can reduce quarterly outgoings by 20%. Architects can switch to cash accounting provided it is used on both input and output, but it must be applied consistently from then on.
Another VAT option to consider is the flat-rate VAT scheme, which used to be very attractive to businesses with low outgoings. Businesses on the flat rate pay a percentage of quarterly gross income (fees plus VAT) instead of claiming back VAT on individual purchases.
Managing a practice’s tax affairs, accounts and cash flow effectively is a complicated business - one which requires transparency, organization and specialist knowledge. Any practices considering acting upon the suggestions within this feature are advised to consult with a qualified professional accountant beforehand.
Thanks to John Hickey, Director, DV Architecture.
Text by Neal Morris. This is a Professional Feature edited by the RIBA Practice team. Send us your feedback and ideas
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Posted on 11 April 2019.
