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HMRC internal manual

Business Income Manual

Tax and accountancy: when to recognise profits: source is important

In Tapemaze Ltd v Melluish [2000], 73TC167 the company carried on a business of hiring assets and received payments in advance. In its accounts the payments in advance which related to the following period were shown on the balance sheet as deferred income. They would then be released to the profit & loss account as turnover in the following period, and matched with the related costs.

It sold its business, including the majority of the assets but retained the cash in hand and its bank account. It therefore retained payments in advance which related to the period after the date of sale. This sum then formed part of an exceptional item in the profit & loss account for the accounting period of sale.

The report from the Board of Inland Revenue’s Advisory Accountant explained the accountancy. The sum was not income arising from the sale, it was a recognition that income which had been carried forward as deferred income would no longer need to be carried forward as it no longer had a liability to perform under the hire contracts. The appropriate accounting treatment was to recognise the profits at that point.

Hart J concluded: ’In my judgment, both the beginning and the end of the inquiry should be to consider the source of the profit which has been properly recognised as income in these accounts.’ He considered that the relevant question in the context of accruals accounting was whether the trade was the source of the profit shown in the accounts, and not whether the cash, when received, was a trade receipt.

In this case the correct accountancy was clearly explained and the question of law was whether the income was trading income which arose in that year. There was a profit of a revenue nature, shown in accounts which complied with generally accepted accounting practice, and the source of those profits was the trade. It was therefore appropriate to include those profits within the amount of profits or gains which had arisen from the trade for the year.