A wider scope for work in progress

If you run a business providing any kind of services you could face a tax enquiry unless you adopt some important new rules on recognising income.

A change in accounting practice means that where you have a service contract in progress at the end of your accounting period, your accounts must include a proportion of the contract income – including your profits – corresponding to the stage of completion of the contract. For example, if the contract is 60% complete, then 60% of the income must normally be included in your accounts, even if you cannot bill it yet.

The change was imposed by the Accounting Standards Board rather than through a change in tax legislation. But HM Revenue and Customs (HMRC) has said that it expects all businesses to adopt the new practice, which goes by the title UITF 40, for periods ending after 22 June 2005. This will generally result in a one-off ‘catching-up’ tax charge in the tax year in which that accounting period ends – 2005/06 or 2006/07. For some businesses, this extra tax could be 50% or more of their normal tax bill, but most businesses will be able to pay it over three to six years.

When UITF 40 was first announced, many people thought it only really covered accountants and solicitors. It has since become clear that many other business sectors will be affected if they perform service contracts over a period of time. For example doctors, dentists, architects, builders, letting agents, independent financial advisers, IT consultants, even farmers may have to recognise some of their income at an earlier stage. What is more, the new practice applies to limited companies as well as partnerships and sole traders.

You cannot ignore the new accounting practice – HMRC will see to that – but you can lessen its financial impact. For example, regular billing and progress payments will ensure that you will have the cash to pay the additional tax. Good accounting systems should prevent you overvaluing the income you bring into account. Please contact us to discuss the implications for your business and how we can help.