Government proposal for taxing clients through interest charge

Those waiting for the SRA’s consultation on handling interest on client account, promised for later this year, may have been surprised to see the Government announce last week its proposals for a new Interest on Lawyers Client Account (ILCA) scheme.

The ILCA scheme would see a proportion of interest earned on client accounts (75% of interest from pooled accounts and 50% from individual accounts) used to fund the justice sector. The scheme would be administered by the MoJ and law firms would be required to hold client money in accounts that meet specified requirements.

This is not a new concept – similar schemes operate in other jurisdictions, such as Canada, France and Australia, and the proposal was first mooted here in 2010 however was dropped and picked up again in a series of roundtables last summer.

The rationale given is for the legal sector to contribute this unearned income to strengthening justice.

Whilst there can be no doubt that the justice system is in critical need of funding and support, the consultation doesn’t address the core fact that interest monies belong not to law firms but to their clients. It suggests that clients may be unaware that interest is earned and do not expect to receive this, however this is perhaps missing the point.

The SRA’s rules currently require firms to pay over a “fair sum” of interest to their client unless they reach alternative agreement. Its planned consultation aims to address precisely the concern that firms are relying on the income generated - and the lack of transparency for clients and their understanding of what they are entitled to.

The new Government proposals leave questions surrounding how firms should handle the remaining interest, which it has suggested may be required in order for firms to cover their administrative costs: It can be presumed that the SRA will proceed with proposals in order to address its concerns.

There are a number of other practical issues to be bottomed out, including how to establish arrangements that do not create a disproportionate cost/burden and can apply in a consistent and appropriate way across all regulated professions and all types of account (including Third Party Managed Accounts)

However, above all, consideration needs to be given to the likely unintended consequences of the scheme.

Many of the firms that have been relying on interest to remain financially sustainable will either put up their costs or go out of business – either way, this will reduce the availability of affordable services and exacerbating the access to justice crisis.

Alternatively, firms that are in a position to do so might sensibly restructure to move their unreserved services outside of SRA regulation, and outside of the reach of the Government’s current proposals. Bearing in mind the narrow scope of the reserved activities under the Legal Services Act 2007, this has the potential to radically reshape and deregulate the legal services market.  And firms with international clients and offices may seek to move business outside of the jurisdiction, defeating the aims of the proposals and the Government’s aims to boost economic growth in the UK.