Adviser: left exposed by UITF40

Few new rules can have had as much impact on practising accountants as
UITF40, dealing with revenue recognition in service contracts. In force since
June, some might say its greatest achievement has been to underline the fact
that the ASB is independent of the profession.

The guidance has the effect of changing the way in which businesses account
for their income from service contracts. Instead of accounting for the revenue
on the completion of the contract, UITF40 requires providers, in most cases, to
recognise revenue as contract activity progresses. In many cases, this will lead
to the bringing forward of material amounts of taxable profit.

UITF40 has sparked numerous challenges. CCAB has made a joint submission to
the Treasury pointing out the potentially damaging and in some cases
business-threatening effect of imposing substantial one-off tax charges on
service businesses.

Leaving aside an ongoing debate on the wider technical implications, ACCA has
carried out research into what the application of the changes could mean in
practice for firms’ bottom lines and tax liabilities. A survey of 20 practising
members, ranging from sole practitioners to large firms, set out to gauge the
likely level of the uplift in clients’ reported incomes and resulting tax
charges arising from UITF40.

The survey confirmed suspicions that the radical accounting change would have
material effects on the reporting of income and exposure to tax on the part of a
wide range of providers. It also appeared to confirm the existence of a major
ancillary problem for practising accountants, namely that the lack of awareness
of the implications among clients outside accountancy.

Practitioners taking part in the survey were first asked to estimate the
likely uplift in the amounts currently treated as work in progress in their
clients’ accounts and which in future will have to be included in turnover. In
the case of barrister clients, the uplift was put at 100%. In the case of
accountants, the uplift would be anything between ‘minimal’ and 400%, while for
solicitors it was as high as 500%.

On this basis, and assuming a current work in progress value of £50,000 and
tax at 40%, the increase in reported profit for barristers would be £50,000,
leading to an additional one-off tax charge of £20,000. In a firm where the
accounting uplift was 400%, this would lead to higher reported profits of
£150,000, causing an additional tax charge of £60,000.

The findings of the ACCA survey were presented to HMRC in late June during
the course of a meeting with a delegation from CCAB.

The profession’s argument is that some form of relief should be made
available to service businesses to enable the one-off tax charge arising from
the new accounting treatment to be spread over a fixed period rather than
imposed in one sweep.

Given the radical nature of the rule change and the suddenness of the
resulting charge, this would not be unreasonable.

John Davies is head of business law at ACCA