HMRC have published outline guidance for individuals and partnerships on the one-off tax adjustment that arises from the accountancy changes brought about by Urgent Issues Task Force Abstract 40 (UITF 40).
The new legislation, which was contained in Finance Act 2006, applies to trades, professions and vocations and to UK property and overseas property businesses.
Broadly, the tax adjustment, which is called adjustment income, that can be spread arises on a change of accounting policy where:
- in the first period of account ending on or after 22 June 2005 the trader follows generally accepted accounting practice (GAAP) and adopts the principles for revenue recognition of service contracts contained in UITF 40; and
- in the period before the trader followed GAAP but not UITF 40.
This means that spreading is only available for the adjustment income arising from following UITF 40 for the first time in the first period of account ending on or after 22 June 2005. If the trader adopted the accounting policy contained in UITF 40 in a period of account ending before 22 June 2005, they will not be able to spread any adjustment income arising from the earlier change in accounting policy.
No claim is necessary for spreading, but an election may be made for the adjustment to be taxed more quickly (see below).
Once the adjustment income attributable to UITF 40 has been calculated it is spread according to the following rules.
In each of the first three tax years the lower of:
- one third of the adjustment income; and
- one sixth of the profits of the business is taxed.
“Profits” means the profits of the business calculated for income tax purposes leaving out any adjustment expenses (arising from any other change in accounting policy) or any capital allowances or balancing charges.
In the fourth and fifth years if there is any adjustment income not yet taxed, the amount remaining untaxed will be taxed if it is the lowest amount.
In the sixth year any remaining adjustment income is taxed.
Where the business has ceased, in the year of cessation the lower limit of one sixth still applies. In subsequent years only the one-third alternative applies until the full adjustment has been charged.
Accelerating payment
Traders can make an election to pay the tax arising on the adjustment income more quickly. The election will mean that an extra amount of adjustment income is treated as arising in a particular tax year. The election must be made before the first anniversary of the normal self assessment filing date for a tax year and must show how much extra adjustment income the traders wants to have taxed in that tax year. In future years, if there has been an election, the original adjustment income is treated as being reduced by the amount charged early.
Example
If there is adjustment income of £6,000 and an election has been made to charge an extra £1,000 in year one, when comparing one third of the adjustment income with one sixth of the profits, in the following year the amount of adjustment income for comparison is £5,000 not £6,000.
Partnerships
The new legislation covers continuing, new and departing partners. It mirrors the legislation for partnerships on the withdrawal of the cash basis.
For partnerships the adjustment is calculated from the figures in the partnership accounts in exactly the same way as a person who carries on business on their own account. It is charged each year on the individual partners.
For the first year each instalment is apportioned among the partners in accordance with their profit-sharing entitlement in the twelve months ending immediately before the date on which UITF 40 was adopted.
For subsequent years each instalment is allocated or apportioned according to the profit sharing arrangements for the twelve months immediately before the relevant anniversary of the date when UITF 40 was adopted (the date on which UITF 40 was adopted is the first day of the period of account when UITF 40 first applied). So the period of apportionment for any tax year is the twelve month period following the period of apportionment for the previous tax year.
This means that, as partners come and go, the individuals who are charged to tax will change, as will the amount on which they are charged as profit-sharing entitlements change. This also means that any election to pay more than the normal instalment for any year must be made by all the partners who are charged for that year.
There is nothing to prevent departing or joining partners from seeking an indemnity from the other partners to cover any charge.
Sarah Laing
Editor, TaxationWeb News
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