IR 42 29 November 1994 PROFIT RELATED PAY: EXTRAORDINARY ITEMS The Chancellor proposes in his Budget to change the rules relating to the treatment of certain items in accounts drawn up for the purpose of the income tax relief for Profit-Related Pay (PRP). Under the proposed changes - profits or losses on the sale or termination of an operation; - costs of a fundamental reorganisation or restructuring having a material effect on the nature and focus of the reporting entity's operations; - profits or losses on the disposal of fixed assets; - and the tax effects of any of these items, will be capable of being taken into account or left out of account in drawing up profit and loss accounts for the purpose of PRP. The Chancellor's proposed changes will replace the current treatment of "extraordinary items" for PRP purposes. His intention is to ensure - following a recent change in accounting practice - that the tax relief for PRP can continue to be linked as closely as possible to profits which genuinely reflect the efforts of the employees in the scheme. This change will apply to profit and loss accounts in respect of profit periods beginning on or after the date of Royal Assent to the Finance Bill. DETAILS 1. The income tax relief for PRP is intended to encourage employee motivation and pay flexibility. The Government's objective has always been that the relief should be linked as closely as possible to pay linked to profits which genuinely reflect the efforts of the employees in the PRP scheme. 2. The PRP legislation provides that "extraordinary items" may be left out of account, or taken into account, in drawing up profit and loss accounts for registered PRP schemes, notwithstanding the accounting requirements imposed by the Companies Acts. At the time the legislation was introduced, the term "extraordinary items" was defined, in Statement of Standard Accounting Practice 6 (SSAP 6), to include a range of items which could not be said to reflect the efforts of the workforce - for example, material profits or losses arising from the disposal of fixed assets. 3. The recent replacement of SSAP 6 by Financial Reporting Standard 3 (FRS 3) has altered the definition of "extraordinary items". Consequently, many items which might previously have been treated as "extraordinary" for accountancy purposes may no longer be so treated. That change of practice makes it more difficult for businesses to draw up PRP schemes under which PRP is closely linked to profits which genuinely reflect employees' efforts. 4. An Inland Revenue Press Release issued on 20 July 1994 announced that the Government considered that this change in practice would require an amendment to the tax legislation, that any revised legislation should take as its starting point definitions of accountancy terms appearing in FRS 3, and that they proposed to consider the possibilities further in the light of any relevant findings resulting from an on-going survey of the operation of PRP. The Chancellor's proposal represents the outcome of that consideration. He proposes to replace the reference to "extraordinary items" in the PRP legislation with a reference to the following three categories of "exceptional items", which FRS 3 requires to be shown separately on the face of the profit and loss account after operating profit - profits or losses on the sale or termination of an operation; - costs of a fundamental reorganisation or restructuring having a material effect on the nature and focus of the reporting entity's operations; - profits or losses on the disposal of fixed assets; - and the tax effects of any of these items. Extra-statutory Concession (ESC) 5. The Press Release of 20 July also announced that the Inland Revenue would be prepared to accept - as an interim measure and by concession - that items which might properly have been accounted for as "extraordinary" within the definition provided by SSAP 6 might continue to be taken into account or left out of account for PRP purposes in profit and loss accounts for accounting periods ending on or after 22 June 1993, provided that the rules of the scheme specifically permit the items to be treated in that way. ESC to be withdrawn next year 6. If Parliament approves the Chancellor's proposal, this concession will cease to apply from the start date of the new legislation - ie it will not apply to profit periods beginning on or after the date of Royal Assent to the Finance Bill 1995. ESC to be amended 7. The concession applies, as formulated at present, only if "the rules of the scheme specifically permit the items to be treated in that way". Following representations that that requirement is unreasonably restrictive, the Inland Revenue are now prepared to apply the concession whether or not there is a specific provision in the rules of the scheme about the treatment of extraordinary items. NOTES FOR EDITORS 1. PRP is that part of pay which varies with changes in the profits of the business in which the employee works. PRP paid to employees under a scheme which has been registered by the Inland Revenue is eligible for tax relief, subject to certain limits. 2. All PRP paid in respect of profit periods beginning on or after 1 April 1991 can be tax-free up to a limit of the lower of 20 per cent of pay or Pounds 4,000. Model Rules to help employers to set up PRP schemes were published by the Inland Revenue in September 1991. 3. To qualify for tax relief, PRP must be paid under a scheme registered by the Inland Revenue before the date on which the scheme is due to start. Application for registration must be made on a prescribed form accompanied by a report from an independent accountant that the scheme complies with the legislation. A profit and loss account must be drawn up for each 12 month period for which the scheme runs, and an independent accountant must sign a report saying that the account gives a true and fair view of the profit or loss for the period. 4. The attached table gives the latest figures of take- up of PRP schemes. It shows that the number of employees covered by registered schemes in the quarter to 30 September 1994 increased by 1 per cent to 1,875,700 and that the number of live schemes rose by almost 4 per cent to 7,773. 5. The legislation governing the provision of tax relief for PRP is contained in Sections 169 to 184 of, and Schedule 8 to, the Income and Corporation Taxes Act 1988, as amended by the Finance Acts 1989, 1991, and 1994. TABLE PROFIT-RELATED PAY - QUARTERLY FIGURES FOR LIVE REGISTRATIONS Number of Number of schemes employee participants end October 1987 145 26,411 end December 1987 430 71,827 end March 1988 616 89,952 end June 1988 729 103,800 end September 1988 784 107,300 end December 1988 830 122,400 end March 1989 869 122,100 end June 1989 902 129,000 end September 1989 947 135,400 end December 1989 1,112 226,500 end March 1990 1,175 232,000 end June 1990 1,172 233,200 end September 1990 1,179 229,100 end December 1990 1,233 263,400 end March 1991 1,277 350,100 end June 1991 1,329 353,900 end September 1991 1,423 370,700 end December 1991 2,049 581,000 end March 1992 2,597 718,100 end June 1992 3,066 765,800 end September 1992 3,268 780,600 end December 1992 4,149 973,600 end March 1993 4,615 1,167,400 end June 1993 4,904 1,179,700 end September 1993 5,405 1,228,200 end December 1993 6,443 1,570,100 end March 1994 7,039 1,794,100 end June 1994 7,486 1,856,600 end September 1994 7,773 1,875,700