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UITF Abstract 40
Prior to 2000, there were three bases to choose from when preparing accounts of professional firms. The first, and most popular among firms of Solicitors, was the Cash Basis whereby income and expenditure was only recognised when it was either received or paid.
The second basis was commonly referred to as the Conventional Basis which differed from the Cash Basis only to the extent that bills issued but not settled at the year end were taken into account. This basis found favour with many professional firms.
The third basis was the Accruals Basis which extended the Conventional Basis by recognising accrued and prepaid expenditure and also work in progress, ie incomplete work, at cost. This was not widely adopted by professional firms.
In 2000, the Inland Revenue via an earlier Finance Act, imposed the full accruals basis and everyone in business thereafter had to identify and account for work in progress at cost. In professional partnerships generally this meant staff costs inclusive of relevant overheads and excluding any element of partner cost. In limited companies directors take the place of partners and their time will be included, but any profit element will be excluded.
In 2003, by way of an interpretation of FRS5 issued in the 1990's, the Accounting Standards Board (ASB) issued Practice Note G on Revenue Recognition. This caused much debate and the widely held and publicised view was that little if anything had changed.
In March 2005 the ASB through its sub-committee known as the Urgent Issues Task Force issued UITF abstract 40 in which it spelled out quite clearly the basis of recognising income in respect of incomplete work for all service providers. The result is that for all accounting periods ending after 22nd June 2005 the accounts of all service providers have to recognise work in progress at full selling price. This applies to sole traders, partnerships, limited liability partnerships and limited companies.
There are some instances whereby pieces of incomplete work can be omitted from the year end valuation and the simplest to explain is where the outcome of the piece of work is 'at risk'. An example of this is a 'no win no fee' arrangement. If the work in question is incomplete at the year end and this case has not been won by that date then there is no right to any of the income.
Apart from these few instances, all incomplete work will require to be valued at full selling price. It is of no consequence if there is no contractual right to issue a bill for the incomplete work at the year end. It is sufficient that there is a right to expect to be paid for the work when it is completed. Therefore if a piece of work is, say, 50% complete at the year end then 50% of the expected final sales value has to be recognised regardless of whether or not a bill can be issued at that date for this amount.
Up until this time this incomplete work would have been valued at cost and in professional practices this would mostly exclude partner input. It would also exclude profit on the staff cost element. Therefore the change means a recognition of the previously excluded profit element as well as the partner input value. For many, this will represent a significant uplift in value.
The accounting rules state that in the year of change the whole year has to be measured on the same basis. The consequence of this is that the work in progress at the start of the year in which the change takes place has to be revalued on the new basis. The introduction of this revalued amount at the start of the accounting period creates an uplift adjustment of the difference between the new revalued amount and the previous value based on cost. This uplift adjustment is a one-off adjustment to move to the new basis and creates an exceptional one-off tax bill. Gordon Brown, in his pre-Budget Statement, has stated that legislation will be introduced to allow the tax cost arising from this uplift to be spread over at least three years.
What does this mean for you?
For many businesses there is the immediate consequence of the large tax charge arising out of this one-off uplift adjustment. Every year thereafter, because work in progress is now being valued at selling price, there is every likelihood that year on year profits will be greater thus giving rise to increased annual tax bills. All of this means pressure on cash flow and for many, there will be the need to arrange additional long term funding.
However, tax is only one concern arising out of this change. There are the strategic concerns for business continuity through succession. This increased value of work in progress will be added to the Balance Sheets thereby increasing the value of the capital in the business. The consequence is that on retiral the owners of the business, in the case of partnerships, will be seeking a full release of their investment that is now greater and in the case of limited companies a higher disposal price for their shares. This puts more pressure on future cash flows.
In addition, in the case of partnerships, incoming owners will be expected to introduce funds to match the existing owners and as this value is now greater then the incoming owners will require to find a greater amount of cash than previously. In the case of limited companies new management being brought into ownership will require to subscribe for shares that carry a higher acquisition value. All of this could act as a deterrent to the introduction of future owners.
If your business is that of a service provider, or if you have any questions in general, please contact us as soon as possible to discuss how this latest development might affect you.
The Construction Industry Scheme
The Contractor's Viewpoint
For many years there have been schemes to combat the black economy in the construction industry.
A new variant was originally scheduled to take effect from 6 April 2006, but the start has subsequently been delayed until 6 April 2007.
Under the new scheme CIS4, CIS5 or CIS6 cards and vouchers CIS23, CIS24 and CIS25 are all discontinued.
If you are a contractor and you want to engage somebody to work for you, you must first establish whether or not the type of work involved falls within the construction industry scheme. HM Revenue & Customs (HMRC) Factsheet CIS348 is a useful starting point for this.
Once you are satisfied about the status of the work, you need to obtain basic details from the subcontractor, such as name, unique taxpayer reference (UTR) and national insurance number.
If you use subcontractors who do not trade as limited companies, the first priority is to establish whether, in all the circumstances, they are entitled to be treated as self employed. This matter is discussed in our article Employed or Self Employed? All wages for employees must be paid under PAYE.
If you believe your worker should be categorised as self employed, you need to set up an appropriate contract. The next stage is Verification. You need to contact HMRC to verify the subcontractor, and to establish whether the subcontractor is to be paid gross or net. For net payments there are two rates of deduction - a standard rate (18%) for those who have registered with HMRC ("matched") and a higher rate (up to 40%) for those who have not ("unmatched").
You will be given a verification reference number for each set of subcontractors verified in the same telephone call or internet session. These will be in the format V0000543267 for matched subcontractors but will have one or two letters on the end that are unique to each unmatched subcontractor (eg V0000543267/B).
Please note that the verification process should be used only when a contract is in place, or a tender accepted. It cannot be used speculatively to establish payment status details of a subcontractor.
You can continue to pay a subcontractor without further verification so long as the previous payment was made in the current or two previous tax years. As part of the transition to the new scheme, you do not need to verify subcontractors if you have paid them since 6 April 2004 and when you last paid them you had seen a registration card, temporary registration card or tax certificate (these latter two with an expiry date later than 03/2006).
Contractors must issue a payment statement to each subcontractor for whom they have made a deduction from a payment. The statement may cover all payments in a tax month, or each individual payment. There are penalties if payment statements are not issued within 14 days of the end of the tax month. There is no prescribed format, but they must contain the following information:
- the contractor's name and reference
- subcontractor's name and UTR
- verification reference number
- total payment(s) in the tax month
- the cost of any materials supplied
- deduction(s) made from the payment(s)
Care should be taken when using standard payroll statements, as they often have inappropriate headings, such as "employee number". It is important that payment statements clearly identify the subcontractor as a self employed individual rather than an employee.
Contractors must also make monthly returns of all payments to subcontractors, showing for each subcontractor most of the details shown on the payment statements, together with declarations that:
- all subcontractors needing verification have been verified
- employment status has been considered, where appropriate
Returns and payments must reach HMRC within 14 days of the end of the relevant tax month. There will be penalties if these are late or incorrect.
Nil returns must be made if no subcontractors have been paid in the month. There are no annual returns.
Contractors who are also subcontractors must pass the compliance test to remain eligible for gross payments. The old compliance test focused on the contractor's compliance over a three year period. The new test looks at a 12 month period, but the rules are much stricter - for instance if you pay your PAYE/CIS deductions more than 14 days late even just once you will lose your gross payment status and future payments will be net of tax.
Use of Vehicle Mileage Rates for the Self Employed
The use of mileage rates is an optional alternative to keeping detailed records of actual expenditure. For either method, journeys must be made wholly and exclusively for business purposes.
Self employed taxpayers can compute their expenses using a fixed rate per business mile if the annual turnover of their business is less than the VAT registration threshold (£60,000 for 2005-06) when they first use the vehicle. The mileage rate basis must be applied consistently from year to year. It can be changed only when a vehicle is replaced.
If the turnover increases and exceeds the VAT registration threshold, or if the threshold is reduced, then the taxpayer should continue to use the mileage rate basis until the vehicle is replaced.
The mileage rate covers the cost of running and maintaining the vehicle, such as fuel, oil, servicing, repairs, insurance, vehicle excise duty and MOT and also an element to allow for depreciation/capital allowance.
It does not cover costs that are specific to a particular journey, such as tolls, congestion charges and parking fees. These will be allowable for tax purposes where they are incurred solely for business purposes. The taxpayer may also claim the business proportion of the interest on any loan used to purchase the vehicle.
The relevant mileage rates are as follows:
| Cars and vans: |
| On the first 10,000 miles in the tax year |
40p per mile |
| On each additional mile above this |
25p per mile |
| Motor cycles |
24p per mile |
| Bicycles |
20p per mile |
A Day - 6 April 2006
A-Day is the popular name given to 6 April 2006, the starting date for the unifying rules for all occupational and personal pension schemes that are registered as qualifying for tax relief. The eight existing tax regimes will be replaced by a single universal regime.
Non-registered pension schemes may continue, but without any tax advantages.
Contributions
Under the new rules there will be no limit to the number of schemes an individual may belong to. Most of the contribution restrictions will be replaced by two overall key controls:
Annual Allowance (AA)
Annual contributions up to the level of earnings (or £3,600 gross if greater) will attract tax relief. Contributions above these levels will not receive any relief and there will be a tax charge of 40% to the extent that the increase in pensions savings in a tax year exceeds the AA.
Lifetime Allowance (LTA)
This will be taken into account whenever benefits are withdrawn. At the first withdrawal, any funds used in excess of the LTA will be taxed at 25% to the extent that they are used to buy a pension or 55% in the case of lump sum payments.
LTA and AA controls will be reviewed every five years. The levels for the first five years have been set as follows:
| Tax Year |
Annual Allowance (£) |
Lifetime Allowance (£) |
| 2006-07 |
215,000 |
1,500,000 |
| 2007-08 |
225,000 |
1,600,000 |
| 2008-09 |
235,000 |
1,650,000 |
| 2009-10 |
245,000 |
1,750,000 |
| 2010-11 |
255,000 |
1,800,000 |
Scheme Investment
One of the features of the new system is the lifting of restrictions on types of investment, and it will be possible for registered pension schemes to invest in more or less anything.
However, it was announced in the Pre-Budget Report that the Government will remove the tax advantages where self-directed pension schemes invest in residential property or certain other assets such as fine wines, classic cars and art & antiques. This is to prevent people benefiting from tax relief in relation to contributions made for the purpose of funding purchases of holiday or second homes and other prohibited assets for their or their family's personal use. Borrowing by schemes to increase investments will be limited to 50% of the fund.
In certain circumstances the pre A-Day limit may be considerably higher, so there could be scope for timely tax planning.
Tax Free Lump Sums
All schemes will have the ability to offer members a tax free lump sum of up to 25% of their pension fund (limited by the LTA).
Benefits
The minimum age for drawing benefits will increase from 50 to 55 by April 2010, although people in schemes with early retirement dates will maintain their rights to draw benefits early. It will not be necessary to retire before benefits can be drawn.
Benefits must be crystallised by age 75. Someone in a money purchase scheme who does not wish to buy an annuity may instead withdraw income from the pension fund, with special provisions for passing on the fund following the death of the member. This new category of Alternatively Secured Pensions was originally intended for those with religious objections to risk pooling. The Government will monitor the situation to ensure that such pensions are not being used for tax avoidance.
Employers
Employers will be able to claim tax relief for contributions paid to a registered pension scheme. Exceptionally large contributions will be spread over 2 to 4 years.
Administration
The complex approval process for pension schemes will be replaced by a simplified regime requiring registration only. Schemes that were approved schemes before A-Day will automatically become registered schemes.
Transitional arrangements will protect pre A-Day pension rights (including rights to lump sum payments).
Changes to the payment of Working Tax Credit - November 2005
A major change in the way Working Tax Credit (WTC) is paid will reduce the burden on business from this November. With effect from 7 November, payment of WTC by employers will be phased out and claimants will receive their payments directly from HM Revenue and Customs (HMRC).
The Working Tax Credit and Child Tax Credit (CTC) were introduced in April 2003, as part of Government reforms aimed at 'making work pay' and ending child poverty. Currently, around 580,000 people are receiving WTC through their employer.
The Government has recognised that paying WTC through the payroll involved some costs for employers, and after detailed discussion with business leaders, the Chancellor announced in his last Budget that paying WTC via employers would be phased out between November 2005 and April 2006.
How the system will change
From 7 November, HMRC will pay all new WTC claims directly into employees' bank, building society or Post Office card accounts without involving their employer, reducing costs for business and improving privacy for claimants.
At this stage existing claimants will continue to get their WTC through the payroll, until they notify HMRC of a change in their circumstances that affects their award. When that happens, HMRC will send the employer a 'stop notice' for that employee, asking them to stop paying WTC through the payroll, and will switch the employee to direct payment.
Between December 2005 and February 2006, remaining claimants will be switched to direct payment. Again, HMRC will send 'stop notices' to employers in manageable batches by reference to employees' details.
The stop notices give employers the standard 42 days to stop WTC payments. HMRC expects all claimants to be switched to direct payment by 31 March 2006.
Your role as an employer
The 120,000 employers currently paying WTC through their payroll will need to write to affected employees before 7 November 2005 to let them know what is happening. During September employers are being sent a mailshot explaining the phasing-out process and including the text that employers must use when they write to their employees.
The mailshot is also available at www.hmrc.gov.uk/employers/pve-mailshot.rtf, so that employers can copy or download the appropriate text for their employees onto their own headed paper.
Writing to employees is obligatory. Any employer that fails to do so before 7 November could be charged a penalty of up to £300, plus a penalty of up to £60 a day.
Retaining records
With this change in payment method the only remaining tax credit obligations on employers will be to retain tax credit records after the end of the tax year to which they relate, and to answer earnings enquiries or requests for other information from HMRC. These requests will be limited to cases when HMRC cannot get information from other sources, or has reason to suspect that a claimant has mis-stated their true earnings or the number of hours they have worked.
Payroll and HR managers can reassure their employees that, as long as HMRC has their up to date bank account details, they will not need to do anything to be switched over to the new payment system. Employees can check that their bank details are up to date by calling the helpline number below.
Once they are switched to direct payment, most claimants will see their WTC clearly identified on their bank, building society or Post Office card account statements.
Claimants will not lose any money as a result of the switch to direct payments. If they do notice a difference in payments, it is likely to be because of their changed circumstances. There may also be a slight difference in the amount paid if the claimant's salary is paid by calendar month, as direct WTC payments are usually made every four weeks.
Timeline for the switch to direct payments
September 2005
- HMRC sends out targeted mailshot to employers, explaining how the switch to direct payment will work. Mailshot includes wording for the letter employers must send to affected employees
- Wording for employee letter available on HMRC website: www.hmrc.gov.uk
7 November 2005
- Deadline for employers to write to employees. Employers who fail to do so by this date may be fined
- Switch over process starts. From this date, stop notices will be issued in respect of all claimants reporting a change of circumstances that affects the amount they are paid. Employers have the usual 42 days to stop paying WTC. Employees will then be switched to direct payment
- All new claimants from this date will be paid directly
1 December 2005 - 18 February 2006
- Stop notices issued in respect of all claimants who haven't reported a change in circumstances, and they are switched to direct payment
31 March 2006
- Switch over completed: WTC will be paid directly to all claimants
Contact Information
Working Tax Credit Helpline:
If you or your employees have any questions about WTC before or after the switch, you can call HMRC's Tax Credit helpline on: 0845 300 3900 (textphone 0845 300 3909).
Lines are open every day (except Christmas Day, Boxing Day, New Year's Day and Easter Sunday), from 8.00 am to 8.00 pm.
National Minimum Wage: the new rates
The following National Minimum Wage rates apply with effect from 1 October 2005:
- The main adult rate increases from £4.85 an hour to £5.05 an hour
- The development rate for 18-21 year olds rises from £4.10 to £4.25 an hour
(The development rate can also apply to workers aged 22 and above who are embarking on their first six months in a new position with a new employer, and are receiving accredited training.)
16 and 17-year-olds will remain entitled to a minimum wage of £3.00 an hour.
Future changes
Following recommendations from the Low Pay Commission, the minimum wage allowances are set to rise again on 1 October 2006, as follows:
- The main adult rate will rise to £5.35 an hour
- The development rate will rise to £4.45 an hour
For further information on the National Minimum Wage, visit www.lowpay.gov.uk
The new rules on gender discrimination
Employers are being urged to make sure they are prepared for the new rules on sex discrimination, which take effect on 1 October.
Under the Amended Equal Treatment Directive (ETAD), employers have an obligation to ensure that the working environment is free of discrimination and harassment.
Employers must continue to ensure that they do not:
- discriminate in recruitment, employment or vocational training on the basis of gender
- treat women less favourably due to pregnancy or maternity leave
- allow harassment or sexual harassment by managers, colleagues, or vocational training providers
- discriminate in selecting employees for all further and higher education courses
Employers must also make it clear to staff that it could be unlawful to behave in a way that might offend others, violate their dignity, or create a hostile environment.
Discrimination and harassment in unpaid practical work experience will also be deemed unlawful, and partnerships will no longer be allowed to discriminate when providing death and retirement benefits.
Indirect sex discrimination can be difficult to spot, so employers are being advised to look closely at practices in the workplace.
Employers must also respond to any discrimination or harassment claims within eight weeks; any failure to do so could count against them in an employment tribunal.
The Hazardous Waste Regulations 2005
New regulations governing the production and disposal of hazardous waste products have now come into force, potentially affecting a far greater number of businesses.
Under the Hazardous Waste Regulations 2005, which became effective on 16 July, commonplace items such as televisions, lead-acid batteries and fluorescent light tubes, have joined the existing list of toxic, corrosive and irritant substances.
This means that an increasing number of businesses will for the first time be defined as hazardous waste producers, and will have to meet the new 'waste acceptance criteria' (WAC).
The majority of businesses producing hazardous waste will need to register with the Environment Agency, and could face substantial fines and possible prison sentences if they fail to comply with the regulations.
Further guidance on the regulations is available here.
The new rules on consulting employees
New regulations on consulting employees about developments in the workplace came into force on 6 April.
The EC Directive on Informing and Consulting Employees means that staff will have a right to be informed and consulted on a regular basis about issues in the organisation they work for.
The legislation initially applies to organisations with 150 or more employees, and will extend to firms with 100 or more employees in April 2007, and to firms with 50 or more employees in 2008.
In order for the regulations to apply, an employee request must be made by at least 10% of the employees in the organisation.
Experts have expressed concerns that some firms are not prepared for the regulations, and are urging employers to make sure they have sufficient measures in place to deal with an employee request.
Further information on the directive is also available.
The Pension Protection Fund
The new Pension Protection Fund (PPF) and Pensions Regulator came into effect on 6 April 2005, with the aim of protecting workers' interests in the event that their employer becomes insolvent.
Under the new measures, members of eligible defined benefit pension schemes can receive compensation if there are insufficient assets available in the pension scheme.
The Pensions Regulator will also have wider powers to ensure that work-based pension schemes are being well-run.
According to the Government, the measures will take the pressure off employers with well-run pensions schemes, by concentrating on those whose schemes are in difficulty.
Further information on the Pension Protection Fund is available on PPF website.
The new Small Business Rate Relief scheme
The new Small Business Rate Relief scheme became effective on 1 April 2005, with the aim of alleviating the impact of business rates on small firms.
The scheme offers 50% rate relief to business properties with a rateable value of under £5,000.
The relief then decreases on a sliding scale of 1% for every £100 of rateable value, reaching 0% at £10,000.
The scheme is available to ratepayers with more than one property, provided that the additional properties have rateable values of less than £2,200, and the combined rateable value of all of the properties is under the appropriate threshold.
There is also a 'buffer zone' for properties with rateable values of between £10,000 and £15,000 which meet the eligibility criteria.
To qualify for the relief, properties must be on the local rating list on 1 April of each year, and business owners must apply to their local billing authority within six months of the end of the chargeable year.
The new Chip and PIN regulations
With effect from 1 January 2005, under the so-called 'liability shift', retailers who do not use the new Chip and PIN payment system could now be held liable in the event of fraudulent transactions which take place at the point of sale.
The Chip and Pin system aims to ease the growing problem of credit card fraud, which costs the UK hundreds of millions of pounds every year.
Under the system, when cardholders purchase goods using a credit or debit card, they are required to type a four-digit pin number into a keypad, rather than signing a receipt.
Retailers who comply with their card issuers' instructions under the new system will be covered in the event of fraud.
However, those choosing not to adopt the Chip and PIN system could be held responsible for any ensuing losses.
The Forum of Private Business (FPB) has urged small firms to comply with the regulations, warning that those who choose not to use the technology could be targeted by fraudsters.
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