Use deferred income to save tax
Sales invoices need to be recognised in the correct accounting period.
An invoice can sometimes be deferred when preparing the annual accounts, thereby deferring corporation tax for another year also.
If an invoice has been raised prior to the year end it is imperative to analyse any supporting contract or sales order and to consider whether the sale has been made prior to the year end.
If the sale is found to occur after the year end, it should be included next year and would be deferred income.
Goods
In the case of goods, the key issue will be whether the significant risks and rewards of ownership have been transferred to the customer. For example, if goods have been shipped prior to the year end this would normally indicate that the risks and rewards of ownership have been delivered.
However, if the seller is responsible for insuring the goods during transit, they would still have the risks of ownership if the goods reach their destination post year end. The goods should be recorded in stock and sale occurs post year end, so there would be deferred income.
Services
With regards to services, the key issues are whether the contractual obligations have been fulfilled and the period to which the services relate. For example, annual services or subscriptions should be recognised over the whole year. eg an annual invoice raised on 30 Nov’12 by a company with a 31/12/12 year end should have 11/12 months deferred income until the following year.
If a business provides services over a length of time it is also important to consider if there are any contractual obligations which need to be fulfilled before the income can be fully recognised in the accounts, but are subject to critical events outside of their control. For example, a business may raise sales invoices on a stage by stage basis eg 40% upfront, 40% on hitting a milestone, 20% on completion.
Deferred income for entire contract? (eg Events)
If the entire contract is subject to final delivery or a critical event then it may not be correct to recognise the invoice beforehand. For example, a business organising/planning events wouldn’t have distinguished all its obligations until the event is successfully delivered.
In this case the income, and therefore tax, should only be recognised once the event occurs.
Further help
If this sounds complicated, MAH would be happy to help and we have lots of experience with dealing with issues around deferred income. Contact us now!
Background to tax/accounting rules:
HMRC guidance mentions:
BIM31019 – courts reluctant to override generally accepted accounting practice.
BIM40080 – case law generally supports the accruals concept.
BIM40075 – mentions no general standard for revenue recognition.
BIM40075 appears to be out of date as FRS 5 was amended in 2003 to cover Revenue Recognition and UITF 40 also gives the following guidance:
p(26) Where the substance of a contract is that the seller’s contractual obligations are performed gradually over time, revenue should be recognised as contract activity progresses to reflect the seller’s partial performance of its contractual obligations. The amount of revenue should reflect the accrual of the right to consideration as contract activity progresses by reference to value of the work performed.
p(27) Where the substance of a contract is that a right to consideration does not arise until the occurrence of a critical event, revenue is not recognised until that event occurs.
p(28) The amount of revenue recognised on any contract for services should reflect any uncertainties as to the amount that the customer will accept and pay. [p(19)… This only applies where the right to consideration is conditional or contingent on a specified future event or outcome, the occurrence of which is outside the control of the seller].