The Tax Faculty of the Institute of Chartered Accountants in England and Wales (ICAEW) has published a series of Frequently Asked Questions on the tax implications of changes in the way providers of services are required to recognise revenue in their accounts.
The changes arise from 'Urgent Issues Task Force Abstract 40', issued recently by the Accounting Standards Board.
The faculty confirmed that talks are to be held with HM Revenue and Customs in an effort to soften the blow for firms facing an increase in their taxable profits for 2005/06 as a result of the changes, with additional tax payable on 31 January 2007.
A ten-year "spreading relief" applied on the withdrawal of the cash basis for professional firms in 1998. But the faculty said Ministers will need to be convinced that a relief is justified on this occasion, given that the 1998 change "was brought about by the Revenue rather than the result of a change in UK GAAP".
"We need practical examples of likely financial problems so that we can present a robust case," it said.
The Accounting Standards Board issued Urgent Issues Tax Force (UITF) Abstract 40 on 10 March 2005.
The Abstract said (at paragraph 30): "The accounting treatment required by this Abstract should be adopted in financial statements relating to accounting periods ending on or after 22 June 2005 but earlier adoption is encouraged."
The ASB said the Abstract explains that "as a matter of principle there is no difference between the accounting required for long-term contracts and other contracts for services.
"The overriding consideration is whether the seller has performed, or partially performed, its contractual obligations. A principal conclusion of the Abstract is that where the substance of a contract is that the seller's contractual obligations are performed gradually over time, revenue should be recognised as contract activity progresses to reflect the seller's partial performance of its contractual obligations.
"In these circumstances it is inappropriate to defer recognition of revenue until contract completion."
The Tax Faculty published, on 9 April, answers to Frequently Asked Questions prepared by the Institute.
The faculty indicated that further guidance would follow. The Institute's FAQs included the observation that the publication of Abstract 40 "marked the culmination of a controversy that split the accountancy profession over the previous 18 months".
Where revenue is recognised earlier than hitherto, the Institute said, the related tax liability "may be correspondingly earlier". For some members there would be a one-off increase in taxable profits in the first year of application of the change.
[HM Revenue and Customs] has the power to defer collection of tax where this causes genuine hardship, the Institute added. Discussions with HMRC to "try and ameliorate the tax effects" of Abstract 40 were still at an early stage.
The Tax Faculty's FAQs published yesterday, 5 May, explain that Abstract 40 provides, for the first time in the UK, detailed provisions on how a service provider should recognise revenue.
It will supersede the faculty's earlier guidance , contained in TAX 30/98, which was issued following the withdrawal of the "cash basis" for professional firms.
That earlier guidance said: "Profit cannot be deferred by leaving jobs in work-in-progress after they have reached a billable stage. Once a job has been completed the billable amount should normally be recognised as a debtor rather than work-in-progress."
The new tax FAQs, which are for general guidance only and carry a disclaimer, set out the differences between the income tax and corporation tax treatments of the adjustments required on a change of accounting basis.
They go on to consider the income tax position for unincorporated service providers, ie. those paying income tax. The "adjustment income" will be treated as "arising on the last day of the first accounting period that the new accounting basis was adopted".
The faculty said service providers will have "some time to prepare" for any one-off tax charge.
However, some will face financial hardship and the faculty will be discussing with HM Revenue and Customs "whether some form of relief is necessary".
Andrew Goodall
Editor, TaxZone
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