BIM40230 - Receipts: unclaimed balances: receipts that become taxable by operation of law
The Limitation Act
Some receipts can become taxable by the operation of law. The most common reason for this is Section 5 of the Limitation Act 1980.
A trader who:
- receives an overpayment; or
- holds unclaimed balances for a customer or third party,
may have a liability to repay the amount overpaid or to pass on the unclaimed balance. Accounts prepared under generally accepted accounting practice have to recognise the potential liability. The time at which the liability should be recognised depends on the same general principles as those governing other trading receipts. These are summarised at BIM31000 onwards.
The contract between the customer and the trader may specify what happens to any repayment due and the time limits for action. Where the terms of trading do not specify what to do with receipts then the ordinary rules of law including the Statute of Limitations apply. In most circumstances the payer has six years in which to recover the payments (the limitation period) after which their right to recover the money is time-barred. The time limit for actions founded on a simple contract is governed by section 5 Limitation Act 1980 and is six years from the date the cause of action accrues. Other sections of the Limitation Act govern time limits in other circumstances. In Scotland the Prescription and Limitation (Scotland) Act 1973 gives the time limits.
Symons v Lord Llewelyn-Davies’ Personal Representative and Others [1982] 56TC630 shows that the timing of a receipt for tax purposes depends on the correct application of accountancy principles rather than on legal entitlement to money.
Where the Limitation Act applies the latest the receipt should be recognised in the accounts is 6 years after the limitation period starts. It may be recognised earlier if appropriate in the circumstances of the case. The tax treatment will follow the correct accountancy.
In Jay’s - The Jewellers Ltd v CIR [1947] 29TC274 the contract between the borrower and the pawnbroker was regulated by the Pawnbrokers Act 1872. No trust arose in relation to the sale of pledges and so the rule in the Limitation Act (see BIM40220, treatment of trustees) did not apply. A peculiarity of the Pawnbrokers Act meant that the timing of the payments becoming the property of the taxpayer partly followed time limits set down in the Pawnbrokers Act and partly the normal statutory limitation period.
Atkinson J regarded the effect of the Pawnbrokers Act as bringing into existence, 3 years after the sale, a new asset which had arisen out of a trade transaction. In other words statute made the unclaimed balances, arising from the sale of the pledges in question, taxable trading receipts at that time because it extinguished the borrower’s rights. Atkinson J considered that the unclaimed balances where the Limitation Act barred legal action after 6 years, even though that Act does not technically extinguish the debt, should be similarly treated.
The recognition of the receipt in computing trading profits followed the legal time limits for the money belonging to the taxpayer.
Atkinson J in the High Court distinguished Tattersall (see BIM40250) as a case where (29TC at page 286):
‘The Statute of Limitations had not commenced to run and the Court was dealing merely with the effect of a change in the method in which these sums [the unclaimed balances of sale proceeds] were dealt with in the firm’s books.’
In the case of a trader selling goods or services as a commission agent it is inappropriate to bring in the sale proceeds (of the goods or services) as a trading receipt of the trader in the period of receipt. The trader’s balance sheet for the period should show cash at bank including such proceeds as a debit and a matching credit to creditors save to the extent of commission earned, which should be taken to profit and loss account as a trading receipt of the period. The sale proceeds should however be treated as a trading receipt in any subsequent period when the limitation period expires. This is because the Limitation Act, on the authority of Jays, operates to bring into existence a new asset arising from the course of the agent’s trade. In such event the liability to creditors can be regarded as extinguished and the amount should be credited to profit and loss.
Where a trader sells goods or provides services, and receives an undue overpayment for them, the excess will be part of the trader’s receipts even if the purchaser may have a claim against him for the undue overpayment. Depending on the facts, the trader may be entitled to make a provision against the possibility of having to repay. Where accounts are subsequently prepared adding back to profit and loss account the amount of any debt or provision previously allowed, on the basis, say, that the trader does not accept that they are any longer liable or have no intention of meeting any claim, the sum written back is taxable.
Health warning
This page is part of the section of the Business Income Manual on unclaimed balances. You should read the whole section to understand this topic: see the contents page at BIM40200.
