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Our client, a writer, is receiving advances for works to be published in approximately two years' time. There is a condition attaching to the advance, in that should the publications not achieve a specified level of sales then part of the advance would have to be returned. If the specified level of sales is achieved, then the advance is retained by our client, who then commences to receive royalties.
Our client, a writer, is receiving advances for works to be published in approximately two years' time. There is a condition attaching to the advance, in that should the publications not achieve a specified level of sales then part of the advance would have to be returned. If the specified level of sales is achieved, then the advance is retained by our client, who then commences to receive royalties.
We, as her accountants, are well acquainted with the spreading provisions of literary and artistic works. The question arises — at what point does the advance become income and assessable? Would it be when the advance is made to the writer, or on the grounds the income may have to be refunded to the publisher, only when the specified level of sales has been achieved?
(Query T15,673 Howards End.
Answers:
Since the introduction of section 42, Finance Act 1998, all trades, professions and vocations have been required to calculate profits on a true and fair basis except where tax law specifically provides otherwise. A true and fair basis imports, inter alia, the fundamental accounting principle of prudence from Statement of Standard Accounting Practice 2. Under this concept, income should not be recognised in the profit or loss account until it is properly realised.
The Inland Revenue Inspector's Manual (at paragraph IM 358) suggests that a subsequent requirement to repay an amount does not necessarily preclude its treatment as income in the chargeable period in which it is received and cites the case of Smart v Lincolnshire Sugar Co Ltd 20 TC 643 to support this. However, the facts of that case were unusual and are unlikely to be relevant to an author. A more pertinent case would be Morley v Tattersall 22 TC 51. Furthermore, as many cases have confirmed, accounting principles are of increased importance since the Lincolnshire Sugar case was heard in the 1930s. As a result, 'Howards End's' client should have little difficulty in deferring income recognition until the sales target is reached.
This treatment is implicitly followed by the spreading provisions in section 534, Taxes Act 1988. In subsection (4), it is stated that the spreading rules apply to 'a lump sum payment, including an advance on account of royalties which is not returnable'. So once the sales level has been reached, the advance becomes non-returnable and the spreading provisions may be applied to it. — Kalonymous.
Apart from the few scribes who work for fixed fees, e.g. ghost writers penning autobiographies for those without the time or skill to write their own, or translators of books in foreign tongues, practically all authors are remunerated in ratio of sales of their work, i.e. by royalties.
The standard advance consists in fact of royalties paid in advance, but not refundable, and usually based on sales of just enough to make the contemplated first issue break even. If sales rise above that point, further royalties accrue commensurately.
The client in this case must have a respectable track record, as the advance is estimated on the basis of sales moving some way into profit. But although optimistic, the publisher is not foolhardy, and the top slice is reclaimable if the hopes prove unjustified. The (royalties paid in) advance should be included in turnover of the year of receipt. If any part of it has to be repaid, the refund (negative royalties) will be deductible from turnover in the year of repayment. Turnover is not affected by the spreading provisions. As in the case of averaging for farmers, these serve merely to allocate profit between years. — Man of Kent.
Editorial note. Accounting principles have assumed more and more relevance to taxation matters in recent years. Apart from the cases quoted by 'Kalonymous', other important recent cases are Johnston v Britannia Airways Ltd [1994] STC 763, Gallagher v Jones [1993] STC 537 and Herbert Smith and Co v Honour. 'Kalonymous's' reply is preferred, but begs the question of what should be declared on the self-assessment return pro tem.
We, as her accountants, are well acquainted with the spreading provisions of literary and artistic works. The question arises — at what point does the advance become income and assessable? Would it be when the advance is made to the writer, or on the grounds the income may have to be refunded to the publisher, only when the specified level of sales has been achieved?
(Query T15,673 Howards End.
Answers:
Since the introduction of section 42, Finance Act 1998, all trades, professions and vocations have been required to calculate profits on a true and fair basis except where tax law specifically provides otherwise. A true and fair basis imports, inter alia, the fundamental accounting principle of prudence from Statement of Standard Accounting Practice 2. Under this concept, income should not be recognised in the profit or loss account until it is properly realised.
The Inland Revenue Inspector's Manual (at paragraph IM 358) suggests that a subsequent requirement to repay an amount does not necessarily preclude its treatment as income in the chargeable period in which it is received and cites the case of Smart v Lincolnshire Sugar Co Ltd 20 TC 643 to support this. However, the facts of that case were unusual and are unlikely to be relevant to an author. A more pertinent case would be Morley v Tattersall 22 TC 51. Furthermore, as many cases have confirmed, accounting principles are of increased importance since the Lincolnshire Sugar case was heard in the 1930s. As a result, 'Howards End's' client should have little difficulty in deferring income recognition until the sales target is reached.
This treatment is implicitly followed by the spreading provisions in section 534, Taxes Act 1988. In subsection (4), it is stated that the spreading rules apply to 'a lump sum payment, including an advance on account of royalties which is not returnable'. So once the sales level has been reached, the advance becomes non-returnable and the spreading provisions may be applied to it. — Kalonymous.
Apart from the few scribes who work for fixed fees, e.g. ghost writers penning autobiographies for those without the time or skill to write their own, or translators of books in foreign tongues, practically all authors are remunerated in ratio of sales of their work, i.e. by royalties.
The standard advance consists in fact of royalties paid in advance, but not refundable, and usually based on sales of just enough to make the contemplated first issue break even. If sales rise above that point, further royalties accrue commensurately.
The client in this case must have a respectable track record, as the advance is estimated on the basis of sales moving some way into profit. But although optimistic, the publisher is not foolhardy, and the top slice is reclaimable if the hopes prove unjustified. The (royalties paid in) advance should be included in turnover of the year of receipt. If any part of it has to be repaid, the refund (negative royalties) will be deductible from turnover in the year of repayment. Turnover is not affected by the spreading provisions. As in the case of averaging for farmers, these serve merely to allocate profit between years. — Man of Kent.
Editorial note. Accounting principles have assumed more and more relevance to taxation matters in recent years. Apart from the cases quoted by 'Kalonymous', other important recent cases are Johnston v Britannia Airways Ltd [1994] STC 763, Gallagher v Jones [1993] STC 537 and Herbert Smith and Co v Honour. 'Kalonymous's' reply is preferred, but begs the question of what should be declared on the self-assessment return pro tem.
