Income Tax (Trading and Other Income) Act 2005 (c. 5)

Part 2 Trading income

Chapter 17 Adjustment income

Introduction

226 Professions and vocations

The provisions of this Chapter apply to professions and vocations as they apply to trades.

Adjustment on change of basis

227 Application of Chapter

(1) This Chapter applies if—

(a) a person carrying on a trade changes, from one period of account to the next, the basis on which profits of the trade are calculated for income tax purposes,

(b) the old basis accorded with the law or practice applicable in relation to the period of account before the change, and

(c) the new basis accords with the law and practice applicable in relation to the period of account after the change,

but does not apply to income which is charged in accordance with section 832 (relevant foreign income charged on the remittance basis).

(2) The practice applicable in any case means the accepted practice in cases of that description as to how profits of a trade should be calculated for income tax purposes.

(3) A person changes the basis on which profits of a trade are calculated for income tax purposes if the person makes—

(a) a relevant change of accounting approach (see subsection (4)), or

(b) a change in the tax adjustments applied (see subsections (5) and (6)).

(4) A “relevant change of accounting approach” means a change of accounting principle or practice that, in accordance with generally accepted accounting practice, gives rise to a prior period adjustment.

(5) A “tax adjustment” means any adjustment required or authorised by law in calculating profits of a trade for income tax purposes.

(6) A “change in the tax adjustments applied”—

(a) does not include a change made in order to comply with amending legislation not applicable to the previous period of account, but

(b) includes a change resulting from a change of view as to what is required or authorised by law or as to whether any adjustment is so required or authorised.

228 Adjustment income and adjustment expense

(1) An amount by way of adjustment must be calculated in accordance with section 231.

(2) If the amount produced by the calculation is positive, it is treated as income and charged to income tax under this Chapter.

It is referred to in this Chapter as “adjustment income”.

(3) If the amount produced by the calculation is negative, a deduction is allowed for it in calculating the profits of the trade.

It is referred to in this Chapter as an “adjustment expense”.

(4) This section is subject to section 234 (no adjustment for certain expenses previously brought into account).

229 Income charged

(1) Tax is charged under this Chapter on the full amount of any adjustment income arising in the tax year.

(2) This is subject to—

(a) sections 237 to 239 (which provide for spreading of adjustment income), and

(b) Part 8 (foreign income: special rules).

230 Person liable

The person liable for any tax charged under this Chapter is the person receiving or entitled to the adjustment income.

231 Calculation of the adjustment

The amount of the adjustment is calculated as follows.

• Step 1

  Add together any amounts representing the extent to which, comparing the two bases, profits were understated (or losses overstated) on the old basis.

  The amounts are—

  	Amounts
  1	Receipts which on the new basis would have been brought into account in calculating the profits of a period of account before the change, so far as they were not so brought into account.
  2	Expenses which on the new basis fall to be brought into account in calculating the profits of a period of account after the change, so far as they were brought into account in calculating the profits of a period of account before the change.
  3	Deductions in respect of opening trading stock or opening work in progress in the first period of account on the new basis, so far as they— (a)   are not matched by credits in respect of closing trading stock or closing work in progress in the last period of account before the change, or (b)   are calculated on a different basis that if used to calculate those credits would have given a higher figure.
  4	Amounts recognised for accounting purposes in respect of depreciation in the last period of account before the change, so far as they were not the subject of an adjustment for income tax purposes, where such an adjustment would be required on the new basis.

• Step 2

  Then deduct any amounts representing the extent to which, comparing the two bases, profits were overstated (or losses understated) on the old basis.

  The amounts are—

  	Amounts
  1	Receipts which were brought into account in a period of account before the change, so far as they would not have been so brought into account if the profits had been calculated on the new basis.
  2	Expenses which were not brought into account in calculating the profits of a period of account before the change, so far as they— (a)   would have been brought into account for a period of account before the change if the profits had been calculated on the new basis, and (b)   would have been brought into account for a period of account after the change if the profits had continued to be calculated on the old basis.
  3	Credits in respect of closing trading stock or closing work in progress in the last period of account before the change, so far as they— (a)   are not matched by deductions in respect of opening trading stock or opening work in progress in the first period of account on the new basis, or (b)   are calculated on a different basis that if used to calculate those deductions would have given a lower figure.

  An amount so deducted may not be deducted again in calculating the profits of a period of account.

Treatment of adjustment income and adjustment expense

232 Treatment of adjustment income

(1) Adjustment income is treated as arising on the last day of the first period of account for which the new basis is adopted.

(2) But this is subject to sections 235 (cases where adjustment not required until assets realised or written off) and 236 (change from realisation basis to mark to market).

(3) Adjustment income is treated for the purposes of Chapter 1 of Part 10 of ICTA (loss relief) as profits of the trade for the tax year in which tax is charged on it.

(4) In the case of an individual whose income from the trade is—

(a) earned income within section 833(4)(c) of ICTA, or

(b) relevant UK earnings within section 189(2)(b) of FA 2004,

adjustment income is similarly earned income or relevant UK earnings.

233 Treatment of adjustment expense

(1) An adjustment expense is treated as an expense of the trade arising on the last day of the first period of account for which the new basis is adopted.

(2) But this is subject to sections 235 (cases where adjustment not required until assets realised or written off) and 236 (change from realisation basis to mark to market).

Expenses previously brought into account

234 No adjustment for certain expenses previously brought into account

(1) This section applies if, as a result of a change of basis, expenses brought into account before the change on the old basis would on the new basis be brought into account over more than one period of account after the change.

(2) In such a case—

(a) no adjustment is made under this Chapter, and

(b) in calculating the profits of the trade no deduction is allowed for the expenses for any period of account after the change.

Realising or writing off assets

235 Cases where adjustment not required until assets realised or written off

(1) This section applies if there is a change of basis resulting from a tax adjustment affecting the calculation of any of the following amounts.

(2) The amounts are—

(a) any amount brought into account in respect of closing trading stock or closing work in progress in the last period of account before the change of basis,

(b) any amount brought into account in respect of opening trading stock or opening work in progress in the first period of account on the new basis, and

(c) any amount brought into account in respect of depreciation.

(3) Adjustment income or (as the case may be) an adjustment expense is treated as arising only when the asset to which it relates is realised or written off.

Mark to market

236 Change from realisation basis to mark to market

(1) This section applies if there is a change of basis from—

(a) not recognising a profit or loss on an asset until the asset is realised, to

(b) bringing assets into account in each period of account at a fair value.

(2) So far as—

(a) a receipt within item 1 of step 1 in section 231 represents the fair value of an asset that is trading stock, or

(b) an expense within item 2 of that step relates to such an asset,

adjustment income or (as the case may be) an adjustment expense is treated as not arising until the period of account in which the value of the asset is realised.

(3) In the case of adjustment income, this is subject to any election under section 237 (election for spreading).

(4) In this section “trading stock” has the same meaning as in section 174.

237 Election for spreading if section 236 applies

(1) If section 236 applies, the person who is liable to tax on any adjustment income may elect for the adjustment income to be spread over 6 periods of account.

(2) The election must be made on or before the first anniversary of the normal self-assessment filing date for the tax year in which the change of basis occurs.

(3) If an election is made, an amount equal to one-sixth of the amount of the adjustment income—

(a) is treated as arising, and

(b) is charged to tax,

in each of the 6 periods of account beginning with the first period to which the new basis applies.

(4) But if, before the whole of the adjustment income has been charged to tax, the person permanently ceases to carry on the trade, the whole of the amount so far as not previously brought into charge to tax—

(a) is treated as arising, and

(b) is charged to tax,

immediately before the cessation.

Spreading of adjustment income: barristers and advocates

238 Spreading on ending of exemption for barristers and advocates

(1) If an individual makes a change of basis—

(a) on ceasing to take advantage of the exemption given by section 160 (barristers and advocates in early years of practice), or

(b) on that exemption coming to an end,

any adjustment income is spread over 10 tax years as follows.

(2) In each of the 9 tax years beginning with that in which the whole amount of the adjustment income would otherwise be chargeable to tax, an amount equal to—

(a) one tenth of the amount of the adjustment income, or

(b) if less, 10% of the profits of the profession of the tax year,

is treated as arising and is charged to tax.

(3) For this purpose “the profits of the profession” means the profits as calculated for the purposes of this Part leaving out of account any allowances or charges under CAA 2001.

(4) In the tenth tax year the balance of the adjustment income is treated as arising and is charged to tax.

(5) If, before the whole of the adjustment income has been charged to tax, the individual permanently ceases to carry on the profession, this section continues to apply but with the omission of the alternative limit in subsection (2)(b).

(6) This section is subject to any election under section 239 (election to accelerate charge).

239 Election to accelerate charge under section 238

(1) An individual who under section 238 is liable to tax for a tax year on an amount of adjustment income may elect for an additional amount to be treated as arising in the tax year.

(2) The election must be made on or before the first anniversary of the normal self-assessment filing date for the tax year.

(3) The election must specify the amount to be treated as income arising in the tax year (which may be any amount of the adjustment income not previously charged to tax).

(4) If an election is made, section 238 applies in relation to any subsequent tax year as if the amount of adjustment income (as reduced by any previous application of this section) were reduced by the amount given by the following formula—

where—

• A is the additional amount treated as arising in the tax year for which the election is made, and

• T is the number of tax years remaining after that tax year in the period of 10 tax years referred to in section 238.

Supplementary

240 Liability of personal representatives if person liable dies

(1) This section applies in the case of the death of a person who would otherwise have been liable to tax under this Chapter on adjustment income.

(2) The tax under this Chapter for which the person would otherwise have been liable—

(a) is to be assessed and charged on the personal representatives, and

(b) is to be a debt due from and payable out of the deceased’s estate.

(3) The personal representatives may make any election under this Chapter that the deceased might have made.