Inland Revenue 29
17 March 1998
______________________________________________________________
WITHDRAWAL OF CASH BASIS PRACTICES FOR PROFESSIONS
After wide consultation the Chancellor has announced today
that the `cash basis' practices available to professional
businesses should be phased out in the interest of
establishing a fairer tax system. The proposals aim to end the
timing advantage that the practices offer certain
professionals. The consultation has enabled the Government to
develop and refine the proposed arrangements.
DETAILS
1. The Inland Revenue practices which permit those carrying on
a profession or vocation to compute their profits on a `cash'
or `conventional' basis are withdrawn.
2. Legislation will be included in this year's Finance Bill to
provide that profits must be computed for tax purposes on a
basis which shows a true and fair view of profits.
3. The first tax year affected will be 1999-2000. Professions
and vocations currently on a `cash' or `conventional' basis
will be required to change to a `true and fair view' basis in
that year and any amounts that might otherwise escape tax on
the change of basis will be subject to a one-off
`catching-up' charge.
4. The catching-up charge will be payable over ten years of
assessment starting with 1999-2000.
5. The catching-up charge for any year except the last will be
`capped' by charging tax on one tenth of the total amount
subject to the charge or 10 per cent of normal profits of the
business, whichever is the smaller.
6. In calculating the catching-up charge a deduction can be
made for any net double charge which can be shown to have
arisen when the firm originally moved from the earnings basis
to a cash or conventional basis.
7. New barristers (advocates in Scotland) can remain on the
cash basis for the first seven years of practice at which
point they must move to the earnings basis with the
catching-up charge outlined above.
8. The catching-up charge will be allocated to partners by
reference to their shares for each of the ten years over
which the catching-up charge is spread.
More detail is in the Annex.
NOTES FOR EDITORS
1. The consultation exercise produced more than 600
responses, over 350 of which were from barristers (or
Scottish advocates). A number of meetings with representative
bodies were held, and as a result of this helpful input a
number of modifications have been made to the original
proposals.
2. Businesses carrying on a `trade' are taxed under Case I
of Schedule D. Businesses carrying on a `profession or
vocation' are taxed under Case II of Schedule D. The major
difference in practice between the way taxable profits of
`trades' and those of `professions and vocations' are worked
out arises from Inland Revenue Statements of Practice A3 and
A27.
3. Statement of Practice A3, first issued in 1969, applies
only to barristers (advocates in Scotland). It states that
the normal basis for computing barristers' profits is the
cash basis, but that they may adopt another basis such as
bringing in receipts when a firm entry is made in a `fees
book' provided any such basis is applied consistently.
4. Statement of Practice A27, first published in its current
form in 1979 but of long standing, applies to all other
professions and vocations. It states that the profits of all
such businesses must be computed on the `earnings' basis for
the first three years of business, but that thereafter, with
the agreement of the Inspector and subject to certain
conditions, the business can change to a `cash' basis or to a
`conventional' basis such as bringing receipts when bills are
issued. The business is entitled to retain such a basis
indefinitely provided that the conditions continue to be
fulfilled.
5. The proposals do not mean that tax has been avoided under
the existing practices. The change is about the timing of
taxation. We estimate that about an extra 40 million pounds
of tax a year will be paid in the transitional period,
starting on 31 January 2001; but amounts thus collected
earlier will correspondingly reduce later bills.
6. Statements of Practice explain the Inland Revenue's
interpretation of legislation and the way the Department
applies the law in practice. They do not affect a taxpayer's
right to argue for a different interpretation, if necessary,
in an appeal to the General or Special Commissioners.
INLAND REVENUE PRESS OFFICE
Media enquiries to: 0171 438 6692/6706/7327
(Out of hours 0860 359544)
Non media enquiries to: 0171 438 6420/6425
(Office hours only)
Annex
Start deferred by one year
1. Many representations argued that the original proposals
gave little time to adapt accounting systems or, in the case
of partnerships, to sort out the sometimes complex
arrangements between partners. Accordingly, the revised
proposal defers the start by one year. The proposals will now
first affect the 1999-2000 tax year (instead of 1998-99). But
the legislation will be included in the Finance Bill so the
rules are clear as soon as possible.
2. Normally the catching-up charge will now be calculated at
the accounting date in 1999-2000 (instead of 1998-99). If
there is more than one accounting date in 1999-2000 the
earliest date will be used. If there is no accounting date in
that year then there will be a deemed accounting date on 6
April 1999. These possibilities can arise where accounts are
drawn up for shorter or longer periods than 12 months.
3. The first computation on the earnings basis will normally
be for the 12 months ending on the accounting date in
2000-01. The debtors, creditors and work in progress used to
calculate the catching-up charge at the end of the previous
period will form the opening earnings basis figures.
4. Professionals are no longer able to move to a cash or
conventional basis under Statement of Practice A27. New
barristers (advocates in Scotland) will still be able to use
a cash or conventional basis for the first seven years of
practice: see below.
Catching-up charge: spread and cap
5. Many commentators felt the period over which the
catching-up charge had to be paid was too short. Hence, the
proposal is now that the catching-up charge will be spread
over ten tax years. The amount chargeable each year except
the last will be the smaller of:
one tenth of the total charge; and
10 per cent of the `normal' profit.
6. For a sole practitioner the catching-up charge will be
taxable over the ten tax years 1999-2000 to 2008-09. The
catching-up charge for any of the first nine years will be
nil if the normal profit for that year is nil or there is a
loss. In the final year there will be no limit; so the charge
for that year will be the balance.
7. The charge will be made under Case VI of Schedule D and so
will not be liable to Class 4 NICs. Existing Case II losses
can be set against the charge. The charge will be `net
relevant earnings' and therefore pensionable (but there will
be no special treatment of any pensions cap). It will not be
possible to set `overlap relief' against the catching-up
charge.
8. The usual payment on account rules will operate, as under
the original proposal. The operation of the payment on
account rules will normally mean that the first payment will
be on 31 January 2001 and any final charge will be payable on
31 January 2010.
9. The ten year spread and 10 per cent cap will apply
automatically but the practitioner will be able to opt to pay
the whole catching-up charge at once or in such greater
amounts as he or she specifies (which may be beneficial in
certain loss situations).
10. The `normal' profit is the amount chargeable to tax as
professional income for the tax year of the practice to which
the catching-up charge relates. It is the profit apart from
the catching-up charge and before capital allowances
adjustments. It follows that the `normal' profit for the first
year will be the cash or conventional basis profit.
Subsequent `normal' profits will be on the earnings basis.
11. Where a sole practitioner ceases to practice the ten year
spread will continue but there will be no 10 per cent profits
cap (because there are no longer any profits).
12. For partnerships the one-tenth and 10 per cent limits will
operate at the partnership level. More details are under
`partnerships' below.
13. Existing rules will apply to any cessations or change of
basis before the new rules apply.
Relief for any initial double charge
14. At present a professional (apart from a barrister) cannot
use the cash or conventional basis for the first three tax
years. When the cash basis is adopted subsequently, receipts
or expenses may enter into the tax computation twice: once in
the earnings basis period and again in the cash or
conventional basis period. In some cases the opposite can
happen and receipts or expenses may drop out of any
assessment. Where this has happened any net aggregate amount
which can be shown to have been doubly taxed may be deducted
in arriving at the catching-up charge. Such a double charge
cannot arise in the case of barristers because they can use
the cash basis from the outset.
New barristers (advocates in Scotland)
15. New barristers face an especially difficult time because
they must practise on their own from the outset; they cannot
begin at the Bar as employees. In recognition of this, the
revised proposals will permit new barristers to remain on the
cash basis until the seventh anniversary of the start of
their practice. Then they will have to change to the earnings
basis and meet the catching-up charge in the way described
earlier; that is, with the charge spread over ten years and
limited to 10 per cent of the normal profits for the first
nine of those years.
16. The seven year period will start when the barrister begins
to be available for fee generating work.
Partnerships
17. The original proposals contemplated that the catching-up
charge would be allocated by reference to the partnership
shares on the date that charge is worked out (Method 1). Most
commentators prefer the charge for each year to be allocated
to partners by reference to the shares applicable for each
year there is a catching-up charge (Method 2). This spreads
the charge more evenly between partners. Under the revised
proposals Method 2 will be used.
18. The one tenth and 10 per cent limits for the first nine
years will apply at the partnership level and leave a net
Case VI charge for allocation to the partners.
19. The Case VI charge for the partnership as a whole for the
first year will be allocated to the persons who were members
of the partnership:
during the twelve months ending on the date the
catching-up charge is calculated; and
will use the profit sharing arrangements for that twelve
month period.
20. For later years the same approach will be used except that
the allocation will use the twelve months ending on the
anniversary of the catching-up date which falls into the tax
year. This will be so even if the accounting date for the
partnership changes.
21. Each partner will only remain liable for his or her share
of the catching-up charge for the period up to the date they
leave the partnership. Anyone joining the partnership in the
ten year spreading period will, equally, become liable for
the share of the charge allocated to them from then on.
22. If the partnership business ceases altogether, the persons
who were partners in the period immediately prior to the date
of cessation will continue to be liable for the charge over
the remainder of the ten year spreading period. The 10 per
cent profit cap will not apply because there are no longer
any partnership profits.
23. As in the sole practitioner case, the partnership could
opt to pay more than the capped and spread payment (see
heading on `catching-up charge' above). All partners would
have to give notice before this could happen. Use of `true
and fair view'
24. The aim of the proposals is to apply the earnings basis to
professionals on the cash and conventional basis. The earnings
basis is already the basis which applies under the existing
law to some professionals and to traders. We believe the use
of the accountancy concept of a `true and fair view' does the
job in a concise yet flexible way because:
1. accounting standards as they currently operate are
applied and so the tax treatment can adapt automatically
to changes in those standards; and
2. the accountancy concept of `materiality' is imported,
which means a practical view can be taken of the time
when immaterial amounts are recognised.
25. The materiality concept is particularly relevant in
arriving at work in progress. It permits a broad-brush
approach in small cases or for small amounts. Although there
may be occasions where accountancy practice is displaced by a
rule of tax law the Inland Revenue do not consider such an
approach to materiality in the valuation of work in progress,
if sanctioned by accountancy practice, to be inconsistent
with tax law.
26. The `true and fair view' approach is concerned only with
the computation of taxable profits or losses. For these
proposals it:
1. makes no difference to the law under which traders
compute business profits;
2. does not require accounts to be drawn up on any
particular basis; for example, cash basis accounts could
still be prepared provided adjustments are made to
convert the profit to an earnings basis profit in the
tax computations;
3. does not require accounts to be audited;
4. does not require additional disclosure or require a
true and fair view balance sheet to be prepared.
27. Some representative bodies are considering the accountancy
issues and the Inland Revenue would be glad to collaborate in
the production of detailed guidance for the benefit of
practitioners and Inland Revenue staff.