What constitutes a true and fair view for accounts contains an element of judgement. Finance directors are often torn between showing rosy results, for the benefit of investors and banks, and showing less favourable results for basing their tax on. Not only can provisions have an effect on results, but it is vital to know if they will be tax-deductible. There are many differences between the tax and accounting treatment of provisions. Two recent court cases, involving the solicitors Herbert Smith and the Edinburgh retailers Jenners have led to a change in practice. The rules for deciding when a provision is tax-deductible in the eyes of the Inland Revenue were summarised in the December 1999 issue of their Tax Bulletin. The criteria are as follows: – The provision is for allowable revenue expenditure. A provision is not tax-deductible if it relates to non-deductible expenditure. For example, neither a provision for capital expenditure nor a provision for business entertainment is tax-deductible. – The provision is required by UK GAAP. In theory, any provision in statutory accounts should be in accordance with UK GAAP. However, the Revenue will not necessarily accept that provisions in statutory accounts are in accordance with UK GAAP. If the matter is disputed it may be necessary to call for expert evidence. This is what happened in the case of Johnson v Britannia Airways, which ended up in the High Court in 1994. With the introduction of FRS 12 (provisions, contingent liabilities and contingent assets), the rules under UK GAAP for the recognition of provisions have become much tighter. Companies may find the Revenue inquiring into whether provisions are in accordance with FRS 12. If the Revenue discovers a provision is not in accordance with FRS 12, then a tax deduction could be disallowed. The fact that auditors have signed the accounts will not stop the Revenue from challenging. Companies which qualify as small under the Companies Act 1985 have the option to apply the Financial Reporting Standard for Smaller Entities instead of normal standards. Most differences relate to less onerous disclosure requirements. But, one important difference is that a company producing accounts under the FRSSE does not have to comply with FRS 12. If a small company produces accounts in accordance with the FRSSE, then it might be able to obtain a tax deduction for a provision which does not comply with FRS 12. An example could be a provision for future maintenance costs which might be included in accounts under the FRSSE, but not under FRS 12. However, the Revenue has not stated whether they consider provisions to be tax-deductible in such cases. The provision does not conflict with any specific tax rule governing the timing of the deduction. There are various statutory restrictions on the timing of tax deductions. For example, provisions for companies’ pension contributions are not allowable; tax deductions are only available when amounts are actually paid. There has been a change in practice in this area following the Herbert Smith and Jenners cases. After the Herbert Smith case, the Revenue accepted the principle that a loss can be anticipated. This means a provision that relates to a future loss can be tax-deductible. After the Jenners case, the Revenue accepted that a provision for repairs to premises can be tax-deductible. Previously, it was only thought allowable when the money was spent. The provision has been estimated with accuracy. This requirement is reflected in the rule of thumb that specific provisions are tax-deductible, while general provisions are not. This is a main difference between the tax and accounting treatment of provisions. There are three points that FDs should take away from this. First, not all provisions are tax-deductible. Second, opting to use FRSSE might increase the chance of provisions being allowable. And third, even if auditors sign a company’s accounts, the Revenue may still challenge.
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