Valuation of Work in Progress – Background

On 10 March 2005 the Accounting Standards Board (ASB) issued UITF (Urgent Issues Task Force) Abstract 40 (UITF 40) which is effective for accounting periods ending on or after 22 June 2005. UITF 40 is an element of Generally Accepted Accounting Practice.

Existing Revenue Approach regarding the preparation of accounts

Revenue Statement of Practice SP-IT 02/92 deals with the position of individuals and partnerships. It is not a requirement for tax purposes to prepare accounts to GAAP standards, and individual non-corporate businesses may elect not to do so. SP-IT 02/92 does not apply to companies.

For CT purposes, TCA97 s76A (1) requires that the profits or gains of a company are computed in accordance with GAAP.

Finance Act 2006; UITF 40 and Tax Changes

The legislative changes which were introduced to take on board issues arising from UITF 40 have been included in TCA97 Ch 7 Pt 4. That chapter deals with matters such as discontinuance of, and change of basis for computation of profits of a trade or profession.

Where a change in the basis of valuing work in progress could result in a one-off uplift in profits, a new section TCA97 s95A, introduced by FA06 s56, confirms that the uplift is taxable but provides an element of tax relief in certain circumstances.

The tax charge will be relieved by spreading it over five years, but only if the uplift referred to above:

• Arises from a change in the basis of valuing work in progress in computing profits taxable under Case I or II;
• The change arises by virtue only of the guidance issued on 10 March 2005 by the Urgent Issues Task Force of Accounting Standards board on Application Note G of Financial Reporting Standard 5 (known as “UITF Abstract 40”); and
• The change is for a chargeable period ending in the period of two years from 22 June 2005.

The spreading may apply to companies, partnerships and individuals and so covers income tax and corporation tax.

If one of the years of spread is the year of discontinuance of the trade or profession, then any remaining untaxed part of the uplift is brought to account for tax purposes in the year of discontinuance.

In illustration, assume that the year ending 31 March 2006 gives rise to the following;

	31 March 2006	31 March 2005
Fees earned	15,000	12,000
Opening WIP	4,000	2,500
Costs	7,500	6,000
Closing WIP	(5,500)	(3,000)
Net profit	9,000	6,500
2006 WIP	4,000
Counter balancing credit*	3,000
Uplift	1,000**
* The closing balance of work in progress at 31 March 2005 i.e. €3,000, also described in Finance Act 2006 as “counter balancing credit,” would normally be brought forward as the opening balance for year ended 31 March 2006. In this case the work in progress has been re-valued and the resulting uplift may need to be recognised under the new provisions.
** If the figure of €1,000 arises by virtue of UITF Abstract 40, it may be spread over five years commencing in this case with €200 being taxed under Case I or II as appropriate in the year ending 31 March 2006.

The remaining €800 is taxed equally over the next four years but is apportioned for CT where a chargeable period is less than twelve months.

If the business ceased say on 31 December 2006, the entire balance would be taxed under Case I or II as appropriate in that final period.

The Finance Act 2006 applies the relief by spreading a tax charge. It does not re-define income.

Other provisions on change in Basis of Accounting

The new Finance Act 2006 provision as described above restates a tax charge and creates a new relief alongside existing provisions which may continue to apply and which are to found within TCA97 s94(3). It is important to be aware of the differences between the situations.

Section 94(3) can impose a Case IV tax charge where there is:

• A change in the accounting basis from a conventional to an earnings basis; or
• A change of conventional basis, and
• As a consequence, work in progress is brought into the accounts for the first time, or,
• There is a change in the basis of valuing work in progress which is not a consequence of UITF 40.

Section 94(3) continues to impose a Case IV charge so that the Case I or II charge and spreading relief set out in Finance Act 2006 would not apply in the above circumstances.

Assume that in the year to 31 December 2005, a business changed its accounts from a cash basis to an earnings basis recognising work in progress but not applying UITF 40. The profits after adjusting for opening work in progress of €10,000 amount to €30,000.

The amount of €10,000 which represents profits otherwise falling out of assessment is taxed within Case IV by virtue of section 94(3) for the year 2005. There is no spreading provided for in section 94(3).

To re-state the position, a change of basis which results in the recognition of work in progress by virtue of UITF 40 is within the scope of new section 95A, thus giving rise to a Case I or II charge and spreading.