Tutorial: UITF 40

There has been widespread concern over the effect of the new method of accounting for WIP, UITF 40. The following tutorial gives a practical guide to working with the new regulations. There is also a worksheet to download in which you can enter your own figures.

By Rebecca Benneyworth

Data assembled by member bodies of the CCAB indicates that a significant number of firms of accountants are going to suffer a significant tax increase for the year in which the new basis of accounting for income is adopted.

Continued...

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Comments

Can I postpone for a year please

Anonymous | | Permalink

I have a legal partnership client with a normal year end of 31st July. Two partners left before 31/03/05. If I changed their accounts year end to after 5th April 2005 but before 22nd June 2005, have I:
(1) Successfuly put back the (tax on the) adjustment income by one year as the Accounts to 31/05/05 will not have to include UITF40 adjustment, the adjustment will come into the year to 31/05/06 (2006/2007 tax year), but relate to the opening adjustment at 31/05/05;
(2) Avoided the need to revisit the commercially agreed split at the date of the two retiring partners leaving (before 31/03/05);
(3)Avoided the tax charge arising at all on the partners who left prior to 31/03/05!
(4)Although increasing the overlap period by two months, this may compare favourably with the additional tax charge arising under UITF40 (albeit I've only put it of by 12 months)and may be viewed favourably by the ongoing partners.

I am missing something. (I do hope that the commercial reality aspects sufficiently support this as being sensible tax planning and not - heaven forbid - unnacceptable tax avoidance)

RebeccaBenneyworth's picture

It sounds good, but it won't work

RebeccaBenneyworth | | Permalink

Unless the law changes about partnership shares.
The scenario you present will be taxed as follows :
Year of change - as you say year ended 31 May 2006, which is 2006/07. The adjustment income is therefore calculated as at 31 May 2005 as you stated - uplift from WIP at cost to the UITF 40 sales provision.
BUT this is shared between the partners in the profit sharing basis applying to the 12 months ended immediately before the period of change - this is the period 1 June 2004 to 31 May 3005, which unfortunately probably includes your retiring partners.
The CCAB have asked the Treasury to change this rule, and as far as I know this is still "on the table" - more sensible would be to have it shared in the PSA in the year of change. So, of your four outcomes, it is YES to nos 1 and 4 - delay tax charge by a year and increase overlap by 2 months in exchange, but NO to number 3 - the outgoing partners will still pay tax on the adjustment income. As to whether it affects the commercial exit (outcome 2) - did the exit agreement factor in unbilled work at date of exit? It may well have, in which case there is no need to revisit. You may argue that that is a "done deal" in any event, and the remaining partners agree to indemnify the former partners for the additional tax liability, without reopening the negotiations for the exit package - i.e. without allocating them any additional share of profits. The remaining partners are then in the position of retaining 60% of the uplift, rather than nil.

RebeccaBenneyworth's picture

No problem Paul

RebeccaBenneyworth | | Permalink

We agree that the period of change - the new basis applies first in - year ended 30 September 2005. To comply with GAAP, you must prepare this fully on the new basis, which requires you to put through a prior year adjustment for accounting purposes, amending opening balances to the new basis.
Tax law says the following : (all references are to ITTOIA 2005)
S227 (1) (a) This Chapter applies if a person changes accounting basis from one period to another; (paras (b) and (c) also relate but not relevant here)
S227 (3) and (4) This means that a prior year adjustment would be necessary under GAAP.
Thus, this Chapter applies.
S228 - The adjustment will be called "adjustment income"
S 231 - Calculating the adjustment
Calculate the amount of profit understated on the old basis : "Amounts
1 Receipts which on the new basis would have been brought into account in calculating the profits of a period of account BEFORE (my caps) the change, so far as they were not so brought into account."
(other items not quoted as this covers it!)
This means that you have to calculate the amount that would have been brought into year ended 30 September 2004, had that been stated on the new basis. However, this is NOT taxed in 2004/05, but arises in the year of change, that is 2005/06. The adjustment income is calculated from the preceding year, but taxed in the year of change. So you won't be paying tax on it until 31 January 2007.
Finally, turning to Section 860 (4)"Each partner’s share of any amount of adjustment income is determined according to the firm’s profit-sharing arrangements for the 12 months ending immediately before the date on which the new basis was adopted." The new basis is adopted for the whole of the accounting period ended 30 September 2005, that is, with effect from 1 October 2004, so the adjustment income is spread in the PSA applying to year ended 30 September 2004, but is still taxed in 2005/06 with tax payable on 31 January 2007.
I have reviewed the guidance on the link you have provided, and I do think it could be a little clearer. I will pass this comment on!
Do come back for more clarification if you wish!

Stephen A Taylor's picture

Perplexed!

Stephen A Taylor | | Permalink

I am sinking into a deeper state of confusion (and depresssion!) about when and who is affected by the initial application of UITF 40. Our year end is 30 April and at 30 April 2004 we had two partners who retired. We also converted into an LLP on 1 May 2004 so presuambly my two former partners will not be caught by an unexpected tax charge as they have no connection or involvement with the LLP which is a completely seperate entity? Anyone care to comment or depress me further?

Partnerships again

Anonymous | | Permalink

Hi Rebecca

My firm is in a similar postion to that of Richard Jones. Our research did not lead us to a conclusive answer, but the guidance from the ICAEW seems to contradict what you say. the following link seems to indicate that, in Richard's example, the adjustment income would arise on 30 September 2005 and therefore be taxable on the partners who share the profits to 30 September 2005, and not the partners sharing the profits to 30 September 2004.
http://www.icaew.co.uk/viewer/index.cfm?AUB=TB2I_80993

Section 232 (1) ITTOIA 2005 also seems to indicate this treatment.

Is your view the commonly held view in the tax profession? Sorry to doubt your opinion but there seem to be so many conflicting views in this area, and I have some tax to pay in January!!!

RebeccaBenneyworth's picture

New partners

RebeccaBenneyworth | | Permalink

Hi Richard
First, the normal profit share is arrived at for the new partners. They are taxable from 1 October 2004 to 5 April 2005, which will be a time apportioned result from the 30 September 2005 accounts. These have been prepared on a new basis, stating both opening and closing uncompleted work at expected selling price.

The "uplift" or adjustment income is the increase in closing work in progress at 30 September 2004 (ie selling price less cost already included in 2004 accounts). This is taxed on the partners in the profit sharing ratio applying to the 12 months ended 30 September 2004 so your new partners will not share in the uplift at all for tax purposes - only in the possibly slightly higher profit reported for y/e 30 Sept 2005. The adjustment income will merely be taxed on the partners prior to the date of admission of the new ones.
Hope this helps!

New partners

AnonymousUser | | Permalink

We have a year end of 30 September 2005, so the provisions of UITF 40 will apply to this set of accounts. We have new partners introduced on 1 October 2004 to the partnership, so for 2004/05 they will be assessed on profits to 5 April 2005. The new charge applies on 30 September 2005 - so if the accounts are apportioned to calculate the assessable profits in the 2004/05 tax year, does the UITF 40 charge have to be included? I.e. do new partners have to suffer the charge twice? Any help will be gratefully received!

FRSSE 2005 and UITF 40

Mike Wood | | Permalink

Thanks to Rebecca and Sarah for their thoughts. It seems a pity that the introduction of UITF 40 principles by smaller entities could not somehow have been made to coincide with the date on which FRSSE 2005 becomes effective (ie accounting periods beginning on or after 1st January 2005).

It is still, I think, worth noting that, whereas FRSSE 2002 encouraged earlier adoption, FRSSE 2005 does not permit earlier application.

Although UITF 40 is not itself a part of FRSSE 2005, the principles underlying it are in the body text of FRSSE 2005 (paragraphs 4.1 to 4.4); and practically all of the 'consensus' text of UITF 40 can be found in paragraphs 29 to 34 (under the heading 'Revenue recognition and service contracts') of Appendix III to FRSSE 2005, 'Illustrative examples and practical considerations'. The Appendix is for general guidance and does not form part of the FRSSE, but its content must be regarded as persuasive at least.

RebeccaBenneyworth's picture

FRSSE commencement dates

RebeccaBenneyworth | | Permalink

Thnaks for your comments.
Although I still hold my view about the commencement dates, that is that the FRSSE delays the implementation of the UITF for some businesses, it was pointed out to me that this is a minority view. I spoke at length to the technical people at the Tax Faculty of the ICAEW, who relayed on to me the strong views of senior technical staff at the ICAEW on the accounting side, borne out by the FAQ's on the ICAEW website. I was also advised that the general view of the CCAB was that the commencement date was 22 June for all, and that informally it was expected that HMRC would also hold this view.

In view of this, I considered that it would mislead readers not to amend the article to reflect this - after all if I am in a small minority it would be helpful to make that clear! I therefore amended my tutorial to reflect the majority view, even though it is not my personal view.

I now see that accounting web has managed to get official comment from HMRC that they take the view expressed by the ICAEW, so the tutorial now has officail HMRC backing over commencement dates. I am horrified that the technical helpline could still be giving out advice to the contrary, as my change was made as a result of very strongly expressed views from the professional body.

I agree that this whole episode has been a disaster from start to finish - including the debate about the FRSSE. I also agree that if I have found this less than transparent, then so would the average practitioner, but that was my reason for dealing with the topic - to provoke debate and shed light on it, if possible.

Michael, as I agree with your view, it is difficult for me to debate this, and perhaps someone else might like to comment? However, I would sign off by saying, in reality it doesn't matter what you or I think, it is the view of HMRC that is important, and if we challenge them in court they would bring senior technical people from the profession as witnesses - who would agree with them!

FRSSE-UITF 40

AnonymousUser | | Permalink

It should be noted that until a few weeks ago, perhaps Oct 11, the ICAEW site suggested that the FRSSE could be used to postpone UITF 40 for such entities for up to 6 months. This probably explains answers received from technical helplines.

It is the ACCA's view though that UITF 40 need not be applied when FRSSE 2002 OR 2005 is used. This can be found in their technical factsheet on the topic.

The tax faculty of the ICAEW may be telling people that their suggested treatment is agreed by the CCAB bodies, but reading the ACCA technical factshet, this is clearly not the case.

The way that this has been handled has been a disaster, and not entirely the fault of the ASB.

In answer to Michael Wood, no early adoption of the provisions of UITF 40 for a FRSSE entity would not cause a problem as UITF 40 is deemed by some to be best practice, and therefore can be used immeadiately. UITF 40 is not actually part of the FRSSE, 2002 or 2005.

Date from which FRSSE 2005 effective

Mike Wood | | Permalink

I note that no-one has replied to my posting on 28th October and it would be helpful if Rebecca or one of the authorities to whom she has spoken can say why the following interpretation is incorrect.

The principles underlying FRS5 AN G and UITF 40 are embodied in the new FRSSE at paragraphs 4.1 to 4.4. These are in the body text of the new FRSSE, not within the guidance notes in Appendix III.

At paragraph 19.1, the FRSSE states that the accounting practices set out therein are to be regarded as standard in respect of financial statements relating to accounting periods beginning on or after 1st January 2005. It expressly forbids earlier application.

If an entity adopting the FRSSE uses the AN G/UITF 40 principles for an accounting period commencing before 1st January 2005, isn't it breaching paragraph 19.1 of the new FRSSE?

RebeccaBenneyworth's picture

Responding to your comments

RebeccaBenneyworth | | Permalink

Partnerships
The legislation dealing with adjustment income and partnerships is in Section 860 of ITTOIA 2005 rather than Section 230. Section 860(4) repeats the previous legislation found in Finance Act 1998 Schedule 6 para 5, and then Finance Act 2002 Schedule 22 para 13. It states "(4) Each partner’s share of any amount of adjustment income is determined according to the firm’s profit-sharing arrangements for the 12 months ending immediately before the date on which the new basis was adopted." So the new basis is adopted from 1 April 2005 (period ending 31 March 2006) and the partners bearing the tax liability are those sharing in the profits in the 12 months before the change was implemented - that is the 12 months ended 31 March 2005. How the partners agree to share this income between them is entirely for them to agree among themselves - I have outlined how they will be taxed. This is one aspect of this legislation which the CCAB have asked HMRC to look at again as it seems unfair. I would agree!

The FRSSE
I accept that my view is not that held by the ICAEW, and that I could have made this clearer. This is an area which has provoked much disagreement, and in fact for practitioners the only important view is that of HMRC. My comments were based on the normal practice adopted when the FRSSE has been updated. The Inland Revenue (as was) would accept that for entities consistently applying the FRSSE, changes would be reflected when the FRSSE was updated and not in advance, in other words the Revenue would not require smaller entities to implement changes before the new FRSSE required it. This was most recently the case when the Revenue went on record to this effect when FRS 12 was implemented, which is probably the last major profit impact of a change of accounting treatment. FRSSE 2005 reflects the requirements of UITF 40, and entities are required to follow it for accounting periods starting 1 January 2005. I did study the ICAEW FAQ's when writing this tutorial, and came to the conclusion that the view that I was expressing was in line with the guidance. In view of the comments posted, I have re- read question 19 and am now of the view that my view is not that held by the ICAEW. Readers wishing to adopt a prudent view will follow the new treatment for all periods ending after 22 June 2005. Those delaying implementation under the FRSSE could be at risk of challenge by HMRC. It would be useful for HMRC to now provide guidance - maybe through a Tax Bulletin article - on their view of the effective date of the change, and in particular whether they accept that entities applying the FRSSE will experience a delayed effect.

Date from which new FRSSE effective

Mike Wood | | Permalink

I wonder if Rebecca could comment on the effect of paragraph 19.1 of the new FRSSE on the time of implementation of the UITF40 principles for entities applying the FRSSE.

Paragraph 19.1 says that the accounting practices set out in the FRSSE shall be regarded as standard in respect of financial statements relating to accounting periods beginning on or after 1 January 2005. It also says that earlier application is not permitted.

The UITF40 principles are embodied in the new FRSSE. If an entity applying the FRSSE decides to use the UITF40 principles for an accounting period commencing before 1 January 2005, isn't it applying part of the new FRSSE early, which the new FRSSE specifically prohibits?

Partnerships

cem.fletchpart | | Permalink

Rebecca Benneyworth's statement in her first paragraph under the above heading is directly contrary to Section 230 ITTOIA 2005, which actually is written in plain English! I cannot believe that she is correct.

Partnership complications

colinwain | | Permalink

It is still not clear how the uplift in profits and associated tax charge is allocated between partners. In Rebecca Benneyworth's article she says that partners leaving in the previous year will take a share of the tax charge, even though they do not share in the profits for the year. ITTOIA 2005 states that the person liable for any tax charged on adjustment income is the person receiving or entitled to this income.

Does this mean that partnerships will have to amend their previous year's accounts and profit shares to take account of the uplift, so that a partner who left in the previous year will have a further tax charge as Rebecca suggests, but will also have an additional profit share that is due to them which may not be popular with the remaining partners?

RebeccaBenneyworth's picture

Commencement dates

RebeccaBenneyworth | | Permalink

I have discussed commencement dates at length with various authorities this week, and in particular the application of the FRSSE. In view of the advice I have taken at the highest level, I have amended my tutorial to reflect the majority view, and that is that the UITF applies from 22 June 2005 whether an entity follows the FRSSE or not.
However, I continue to hold my personal view that this is a matter of debate. This is therefore a matter which HMRC need to inform us on urgently - see my comments below.

UITF 40 and partnership changes

AnonymousUser | | Permalink

A few days after Rebecca Bennyworth's article was posted, I was surprised the Broadband connections weren't red hot about the impact on partners who, for instance, retired on 31/3/05.
Not many partnership agreements anticipate the possibility of the tax charge being skewed in this way and the opportunities for huge inequity and consequent dispute appear legion - or have I misunderstood?

Thanks

Anonymous | | Permalink

Rebecca,
Thank you. I appreciate you taking the time to consider this scenario and for your clear answer.