Taxation – Fairness and tax make an odd couple

I am intrigued by the number of letters I have had from accountants Maas Fairness and tax are an odd couple. explaining why the cash basis is not an anomaly, as the Inland Revenue thinks, but is the proper way to prepare accounts for a professional practice.

Intrigued because, when I started to study accountancy in 1959 the accruals basis was regarded as a fundamental principle of accountancy! Now that we have SSAP2 and FRSSE (which confirms SSAPs apply to all business entities) I find it hard to understand how any accountant can still seek to justify the cash basis conceptually.

I understand the withdrawal of the cash basis will hurt those affected – as large numbers of professional firms already use the accruals basis it is hard to guess how widespread the problem is – but doubt that the withdrawal as such will cause major difficulties.

Obviously, for a growing business the proprietor will have to pay tax on the increase in debtors and work-in-progress earlier than he had hoped, but having a hoped-for relief snatched away before it arises cannot easily be described as foul play on the government’s part.

Be alert to the catch-up charge

A lot of people are worrying needlessly about computing work-in-progress.

A sole trader does not have work-in-progress. A partnership has work-in-progress only if it has productive staff. Work-in-progress in accounting terms derives from the concept of matching; it aims to carry forward expenditure of year one which generates income of year two. As no expenditure in relation to proprietor’s time is deducted in calculating profits of year one there is nothing to be carried forward.

Work-in-progress can obviously be substantial for businesses that employ a large staff. However, it is valued at cost, not selling price, and it is perfectly proper to exclude time which is likely to be irrecoverable or will be recovered only in the event of a contingency – the occurrence of which cannot be assessed with reasonable accuracy.

For the smaller business with few staff it is unlikely to be a major figure. If it is, the firm ought to reconsider its policy on billing.

The cries of anguish against the withdrawal of the cash basis are in danger of masking the real problem, namely, the catching-up charge. In particular, the proposal on partnerships – that the charge should fall wholly on those who happen to be partners on the last day of the firm’s 1998/1999 accounting year and in many cases will never receive the amount that is being taxed – is so clearly unjust that Parliament ought to reject it. It will not, of course.

Lobby your MP

Accordingly, what those affected ought to be doing is looking for a fairer way of taxing the work-in-progress and debtors at the date of the change.

I would like to hear from anyone with any ideas on how to do it, as I think the government might well look again at this change if a better solution can be found.

Personally, though, I don’t think they will say those privileged few who have in the past prepared their accounts on an unconventional basis would have had to be paid at some stage under the post-cessation receipt rules.

Although fairness and tax are often strange bedfellows, most governments try to maintain fairness between different groups of taxpayers. Nor do I think they will agree to carry forward the charge indefinitely, as politicians do not like long-tail transitional rules – and those of us who continually call for the tax system to be simplified can hardly favour such provisions either.

Those who do not have any bright ideas should consider writing to their MP (House of Commons, London SW1 1AA) pointing out the injustice of the charge and explaining how it will impact on them personally. Most MPs have a sense of fairness and if enough can be convinced about the inequity of the catch-up charge as presently proposed, the government may be forced to think again.

I think the inequity for partnerships is so great it is preferable to drop the proposals entirely if a fairer way cannot be found. But governments do not normally drop proposals because accountants think them unfair.

It is only political pressure that is likely to achieve that.

Robert Maas is a partner with Blackstone Franks.

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