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Changing the accounts Back  
FRS12 is an accounting standard which has codified the basis upon which provisions, contingent liabilities and contingent assets are recognised and disclosed in accounts. The Revenue Commissioners have set out their policy on the application of tax rules to accounts prepared in accordance with FRS12.
FRS12 applies to company accounts for periods ending on or after 23 March 1999. Some sets of accounts are likely to contain prior year adjustments, restating the opening balance sheet for the accounting period as they would have been had the standard applied to previous years.

Although corporation tax is not computed directly on the profit disclosed in company accounts, that profit figure is the starting point for a series of adjustments, consisting of add-backs and of reliefs, which produce the taxable profit figure. Not surprisingly, the Revenue Commissioners keep an eye on accounting standards.

U turn
Generally speaking, the Revenue in the past would not agree to allow relief in a current period for a loss the trader expected to crystallise in a future period. That treatment was not absolute in all cases. Traders were permitted to write stock down to market value, where that was lower than cost, and claim a deduction for the write-down. Similarly, they were permitted to write down bad debts that were individually known to be doubtful as to recovery.

But beyond these instances, the rule that future losses could not be anticipated was applied fairly strictly.
In the construction industry, it would be normal to provide for the full amount of an anticipated loss on a long term contract, once loss was anticipated. Such anticipated future losses were not allowed as a deduction by the Revenue in computing current taxable profits.

The Revenue have now reversed their position on this specific matter. In the future they have said that they will permit a provision for a loss on a contract to be a deductible expense, notwithstanding that the loss will not crystallise until the contract is completed in future periods.

Court case
The Revenue statement is probably driven in part by UK case law, and not only by FRS12. In a recent case the UK courts allowed a firm a deduction for a provision made by them in respect of the losses they expected in future periods on the renting out of certain premises. The premises had been occupied for the purpose of the profession carried on by the firm, but had been vacated by them. They were sub-let at a lower rent than that to which the firm was committed to their head landlords. The rule against the anticipation of future losses would have required that no deduction be granted for these losses until they actually crystallised in each successive accounting period.

The UK courts rejected this and held that as the provision was made in accordance with generally accepted accounting principles, there was no rule of law that prohibited a deduction in respect of it.

Timing of expense
The Revenue statement makes it clear that they will accept FRS12 as determining the question of the timing of recognition of an expense. If an expense is recognised as arising in a particular accounting period by the application of FRS12, the Revenue will recognise that the expense arises in that period also, for taxation purposes. However FRS12 cannot determine whether a particular expense is of a capital nature (non deductible for tax purposes generally) or a revenue nature (generally but not always deductible for tax purposes).

Prior year adjustment
Generally the Revenue will allow a deduction in the current period for any prior year adjustment which involves the recognition of an expense of a tax deductible nature, where the expense was not allowed for tax purposes in the prior periods. This is not particularly generous since for many companies the applicable tax rate in the relevant prior periods will have been higher than that in the current period.

The Revenue also say that they would seek to tax any prior year adjustment which involves a write back of a provision for which tax relief has already been given, or which involves the recognition of income as having arisen in a prior period, where it was not recognised in that period for tax purposes. This statement by the Revenue is controversial. The law relating to the taxation of prior year adjustments is far from clear.

Notwithstanding the Revenue statement, which has introduced a welcome degree of clarity into the area, the application of FRS12 is likely to throw up quite a number of disputes between taxpayers and the Revenue authorities.

Eric Wallace is a Partner in KPMG.

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