Analysis - A welcome release from old attitudes
The Inland Revenue’s press release of 20 July did not sound exciting – ‘Tax provisions move closer to accounting practice’. But I thought it was one of the most interesting releases I’d seen all year: it reflects a shift in Revenue attitudes and may be a harbinger of further change.
It all started with two special commissioners’ decisions. The Jenners case concerned the well-known shop on Princes Street in Edinburgh, which made a provision in year one for repairs which the owners knew they would carry out in years two and three. The Revenue said no deduction was available until the costs were actually ‘expended’; the taxpayer won before the commissioners.
The Herbert Smith case was also about a provision, properly made for accounts purposes, which the Revenue argued was not deductible as it related to future losses. Herbert Smith (the London solicitors – unusually, the senior partner litigated in person) had vacated premises and only been able to sublet them for lower rent. For accounting purposes, the provision was correct and the commissioners agreed that it should be allowed for tax.
Meanwhile, along came FRS 12, which applies to the accounting treatment for provisions in accounting periods ending after 22 March 1999. The Revenue issued a bulletin article, broadly endorsing the principle that profit for tax purposes should follow the accounts results.
However, at that stage they took the view that FRS12 made no difference to principles established in Owen v Southern Railway of Peru Ltd (36 TC 602), which held that provisions were only deductible if they could be established with sufficient accuracy.
I was not alone in commenting that a provision satisfying the ‘reliable estimate’ criterion of FRS 12 ought to qualify for a tax deduction.
Last week’s press release confirms ‘provisions correctly made under FRS 12 are tax-deductible except where there remain specific tax rules to the contrary’.
The Jenners and Smith cases are not to be appealed, and the Revenue has accepted the Smith case establishes that there is no longer a tax rule denying provisions for ‘anticipated’ losses or expenses. The natural consequence of this, the Revenue has accepted, is that provisions properly made under SSAP9 for losses on long-term contracts will be accepted as deductible for tax purposes, and Statement of Practice SP 3/90 will be withdrawn.
I welcomed the release, and not just because all the points were ones which I had raised with the Revenue during meetings on behalf of the Chartered Institute of Taxation. It seems, where a company prepares accounts in accordance with proper accounting practice, its taxable profits should only differ from the profits shown when there is a clear political decision that they should do so. Successive governments have discouraged entertaining expenditure, and so that is disallowable for tax purposes: that is acceptable in my view. There are many other areas where taxable profits differ from accounting profits – those areas should now be identified, and re-examined to determine whether there is any reason for the differences. This would be continuing a trend which started some years ago, with the legislation on forex, financial instruments and loan relationships. I do not claim the legislation is perfect, but it does recognise a strong link between what companies put in their accounts and what they should pay tax on.
The current work on intellectual property is another example.
However, it’s not all plain sailing. Capital allowances versus depreciation is a very difficult area: the Revenue would be concerned that companies would suddenly become very prudent in their depreciation policies, while businesses would fear that a sudden switch to an accounting basis would cause vast amounts of deferred tax to crystallise.
But, we could make a start. We can look at major distortions which exist and ask what justification there is for continuing them. We should ask government to state clearly the policy behind any tax measures which move away from the principle that a company should pay tax on commercial profits it earns.
Heather Self is a partner with Ernst & Young and the chairman of the CIoT’s technical committee.