This part of GOV.UK is being rebuilt – find out what beta means

HMRC internal manual

Business Income Manual

Change of basis of computing taxable profits: invalid to valid basis: computational adjustment

Enquiries into a return may lead to the conclusion that the particular treatment adopted in the accounts and tax computations does not, as required by tax law, result in the ‘full amount of profits’. An invalid basis of computing profits will have been used. In these circumstances a change of accounting policy or tax adjustment may be required. This is perhaps because the treatment conflicts with GAAP, or because, for example, a bad debt policy does not arrive at a sufficiently accurate result.

The Ahmedabad (Bombay Commissioners of Income Tax v Ahmedabad New Cotton Mills Company Ltd [1929] 8ATC574) principle requires that the opening and closing adjustment for the year of change should be on the same basis. Although that case concerned stock valuation our view is that the rule is of general application and covers a change of policy of accounting for any receipts and any adjustment to the timing of receipts and expenditure. This is because the Ahmedabad decision was that income tax is assessed and charged annually on the profits of the year, and not on the profits of any other year.

The application of the Ahmedabad principle may result in either profit falling out of account or being included twice. For example an enquiry was opened into a return with accounts for the year-end 31 December 2012. The bad debt provision was overstated. The opening provision in the accounts was £92,000 whereas the enquiries had shown that a more realistic provision would have been £18,000. The closing provision in the accounts was £108,000, when the facts supported a provision of £30,000. The adjustment to the taxable profit for that year has to be recomputed with the corrected opening provision, even though the accounts for the previous year had closed with a provision of £92,000. The adjustment is to increase the profits in 2012 by £4,000. A profit of £74,000 (£92,000 - £18,000) has fallen out of account, unless previous years’ profit figures can be adjusted (see BIM34035). (The accounts showed an increase in the provision of £16,000 (£108,000 - £92,000) whereas the correct amount should have been £12,000 (£30,000 - £18,000). The profit that has fallen out of account is the difference between the incorrect closing provision of £92,000 in the 2011 accounts and the corrected opening provision of £18,000 in the 2012 accounts).

Tax law does not permit adjustments made to one year to take account of the fact that profits may not have been taxed in earlier years. An invalid basis may bring income into account later than is correct, it may allow expenditure earlier than is permissible, or it may undervalue stock. In these situations, a change of basis will usually result in some profits dropping out of charge in the year of change because of the necessity to adjust the opening figure for the year of change to be on the same basis as the closing figure but by how much will depend on the precise facts in each case.

There may be cases where there is a change to a valid basis from an invalid basis, which has led to profit being recognised earlier than it should have been. For instance the old basis may have overvalued stock, and, as a result of a revaluation of the opening figure for the year of change some profits may be brought into charge twice. Any element of double counting in the year of change should be avoided, if necessary by making an adjustment to the tax computation of that year. However, where substantial amounts are involved and there is evidence that the old basis was adopted for tax avoidance purposes, guidance may be obtained from Business Profits.


A warranty provision of 30% of turnover was allowed in years prior to 31/12/2011. This is agreed to be invalid for tax purposes. It bore no relation to the actual amount of work required to be done under warranty.

The correct provision is agreed to be 4% of turnover.

At 31/12/2012 the closing provision is £40,000 on turnover of £1million.

In the accounting period to 31/12/2011 the turnover was also £1million - so the closing provision (£300,000 on the old basis) should also have been £40,000.

In computing the profits for the accounting period to 31/12/2012

  • the closing provision is £40,000.
  • the opening provision is restated as £40,000 (as the old basis was wrong/invalid).
  • so the reduction in the provision for the year is nil.

The ability to correct the tax treatment of the excessive provisions allowed in previous years depends on discovery and time limits, see BIM34035.