BIM34070 - Change of basis of computing taxable profits: accounting policy changes: computational adjustment

Change of accounting policy taking effect before 6 April 1999

Following the principle established in Pearce v Woodall-Duckham Ltd [1978] 51TC271 ( BIM34005) a tax computation adjustment should bring in the prior period adjustment either as a taxable Case I/II receipt, or if negative, a deductible expense, of the first accounting period of the new policy.

Where the profits of the trade, profession or vocation have been computed on a conventional basis and there is a change in the conventional basis or a change to an earnings basis ICTA88/S104 subsections (4) and (5) apply to catch any amounts which would otherwise fall out of charge. This imposes a charge under Case VI on those amounts.

Change of accounting policy taking effect on or after 6 April 1999 and before 1 August 2001

FA98/S44 and FA98/SCH6 apply where there has been a change of accounting policy taking effect in a period of account ending on or after 6 April 1999.

FA98/SCH6/PARA3 gives the computational method to calculate the adjustment necessary in the tax computation, see BIM34125. When only one prior period adjustment is made in the accounts the tax adjustment will arithmetically equal the prior period adjustment in the accounts. In some circumstances the accounts may make several adjustments, and these may be to capital items as well as revenue items. In these cases the tax adjustment will have to be calculated separately.

What to do with the adjustment, FA98/SCH6/PARA2

A positive adjustment, instead of being a trading receipt chargeable under Case I, is chargeable to tax under Case VI of Schedule D on the first day of the first period of the new accounting policy.

But the income remains earned income (AP36) and:

• trading losses can be brought forward and set against it as if it were trading income,
• it is part of relevant earnings for personal pension purposes.

For individuals the income does not count for Class 4 NIC purposes.

Negative adjustments continue to be treated as deductible Case I or II expenditure and are brought into account in the first period of the new policy.

There are special provisions for an individual carrying on a profession or vocation who adopts a new basis to comply with FA98/S42, FA98/SCH6/PARA4 & PARA5. Detailed guidance is at BIM74000 onwards.

FA98/SCH6/PARA6 applies the rules to partnerships.

Change of accounting policy taking effect in a period of account ending on or after 1 August 2001

FA02/S64,Schedule 22, and ITTOIA2005/Part2/Ch17 apply where the change of accounting policy takes effect in a period of account (see BIM34135) ending on or after 1 August 2001.

FA02/SCH22/PARA2 and ITTOIA2005/S231 give the computational method to calculate the adjustment, (see BIM34130). It is based on the FA98 method. Again, when only one prior period adjustment is made in the accounts the tax adjustment will arithmetically equal the prior period adjustment in the accounts. In some circumstances the accounts may make several adjustments, and these may be to capital items as well as revenue items. In these cases the tax adjustment will have to be calculated separately.

What to do with the adjustment, FA02/SCH22/PARA4 - PARA5 and ITTOIA2005/Part2/Ch17

• where the change of accounting policy takes effect in a period of account ending on or after 1 August 2001 but before one ending after 5 April 2005 in relation to periods of account beginning on or after 1 January 2005 then a positive adjustment is chargeable as a receipt of the trade arising on the last day of the first period of account of the new accounting policy;
• where the change of accounting policy takes effect in a period of account ending after 5 April 2005 in relation to periods of account beginning on or after 1 January 2005 then a positive adjustment is chargeable as a receipt of the trade arising on the first day of the first period of account of the new accounting policy;
• where the change in accounting policy takes effect in a period of account ending on or after 1 August 2001 but before one beginning on or after 1 January 2005 then a negative adjustment is allowed as a deduction in computing profits as an expense arising on the last day of the first period of account of the new accounting policy;
• where the change in accounting policy takes effect in a period of account beginning on or after 1 January 2005 then a negative adjustment is allowed as a deduction in computing profits as an expense arising on the first day of the first period of account of the new accounting policy.

where the change of accounting policy takes effect in a period of account ending on or after 1 August 2001 but before one ending on or after 6 April 2005 then a positive adjustment is chargeable under Case VI of Schedule D on the last day of the first period of the new accounting policy;

where the change of accounting policy takes effect in a period of account ending on or after 6 April 2005 a positive adjustment is chargeable as trading income on the last day of the first period of the new accounting policy. This adjustment is not chargeable to class 4 NIC;

where the change of accounting policy takes effect in a period of account ending on or after 1 August 2001 then a negative adjustment is allowed as a deduction in computing profits as an expense arising on the last day of the first period of account of the new accounting policy.

ITTOIA2005/Part2/Ch17 gives earned income treatment for positive adjustments for individuals, and allows some loss relief.

The FA98 legislation continues to apply the spreading rules for individuals who changed their accounting policy in order to comply with FA98/S42. (The repeal of the FA98 legislation only applies where the change of accounting policy takes effect in a period of account ending on or after 1 August 2001.) This is explained in detail at BIM74000 onwards.

ITTOIA2005/S238/S239 contain spreading rules for barristers on the ending of the FA98/S43 exemption. These rules are the same as the rules for individuals complying with FA98/S42.

The FA02 legislation and ITTOIA2005/S234/S235 also contain spreading rules for expenses which have already been allowed under the old basis, see BIM34105, and for changes to stock valuations, BIM34110.

The FA02 legislation and ITTOIA2005/S236/S237 contain spreading rules for the change from realisation basis to mark to market, see BIM34105 onwards.

Where the change of basis was to recognise expenses in a later period then the special rules in FA02/SCH22/PARA6 and ITTOIA2005/S234 may apply, see BIM34105.

FA02/SCH22/PARA13 applies the rules to partnerships.

UITF 40 adjustment income

For guidance on Urgent Issues Task Force (UITF) 40 and the spreading of UITF 40 adjustment income for accounting periods ending on or after 22 June 2005 see BIM74200 onwards.