BIM74030 - Abolition of the cash basis: how to compute the catching up charge: FA98/SCH6/PARA3

The statutory formula

In what follows, the accounts for the period before the change are referred to as the 'old accounts' and the accounts for the period following the date of change are referred to as the 'new accounts'.

The amount of the catching up charge is calculated as follows:

First step

Aggregate any amounts by which the old basis understated profits (or overstated losses) by comparison with accounts on a true and fair view basis. That is to say, add together:

1. Receipts which have not been included in the old accounts but which would have been included in the true and fair view account, for example debtors at the date of change.
   
   
2. Expenses that were included in the old accounts but which on a true and fair view relate to the period after the change, for example an expense, such as rent, paid in advance.
   
   
3. The opening values for stock and work in progress for the new accounts to the extent that they were not included in the old accounts.

Second step

Deduct the aggregate of the amounts by which profits were overstated (or losses understated) on the old basis in the period before the change. That is to say, add together:

4. Receipts included in the old accounts which would not have been included on a true and fair view.
   
   
5. Expenses not included in the old accounts but which would have been included on a true and fair basis, for example creditors at the date of change.
   
   
6. The closing values of stock and work in progress for the old accounts to the extent that they have not been included in the opening values in the new accounts.

Any amount so deducted may not be deducted again in computing the profits for a period of account.

Third step

In the case of a profession or vocation adopting true and fair view to comply with FA98/S42 a further deduction may be made by way of adjustment in respect of any change of accounting basis before 6 April 1999. This covers the situation where before 6 April 1999 the taxpayer had changed from an earnings basis to another basis. Such a change normally involved including some receipts and expenses twice.

Any further adjustment is computed as follows:

1. Aggregate the amounts by which the profits were overstated (or losses understated) as a result of the earlier change of basis

1) Receipts that were brought into account in more than one period of account.
2) Expenses that were not brought into account in any period of account.
3) The closing values of stock and work in progress in the period of account before the earlier change to the extent that they exceeded the opening values in the next period of account.

2. Then deduct the amounts by which profits were understated (or losses overstated) as a result of that earlier change

1) Receipts not brought into any period of account.
2) Expenses deducted in more than one period of account.
3) Opening values of stock and work in progress in the first period of account following the earlier change to the extent that they exceed the closing values in the preceding period of account.

Any amount may not be deducted if it has previously been brought into account; and it may not be deducted again on a subsequent change of accounting basis.

If the final result is a positive figure it is the so-called 'catching up charge' and is chargeable to tax under Case VI of Schedule D as detailed in BIM74035.

If the final result is a negative figure, it is treated as an expense of the business for the first period for which the accounts are prepared on a true and fair basis.

See BIM74055 for an example of the calculation of the catching up charge.