A provision is set aside for future liabilities, the extent and timing of which are often not fully known. Setting aside a provision results in a tax saving in the current year. A provision that may remain on the balance sheet yields an even greater saving!
Conditions
In accordance with the principle of prudence, a provision may be recognised at an early stage; the starting point here is the principle of prudent business practice. The provisions encountered in tax practice are:
1. A so-called cost-smoothing reserve. This is a reserve or provision intended to spread costs evenly over several years. The following conditions apply:
– the costs lead to a spike in expenditure;
– the costs are disproportionately high (Supreme Court, 20 August 1980).
2. The most common is the general provision. A number of requirements apply to this:
– origin requirement: the costs must arise from facts and circumstances relating to this year;
– allocation requirement: the costs can be allocated to this period;
– requirement of certainty: there must be a reasonable degree of certainty that payment is due (Supreme Court, 5 March 1975).
Examples of facilities
Some examples of measures to reduce the tax burden are:
1. Provision for guarantee obligations: where guarantees are granted, this provision may be utilised. To this end, it is necessary to maintain proper records underpinning this provision.
2. Provisions for guarantee obligations: if a guarantee commission is received, a provisional liability may be recognised on the liabilities side of the balance sheet. If the guarantee expires, the provision recognised must be released.
3. Service provision: this is calculated on the basis of an estimate of the costs associated with the service.
4. Provision for maintenance costs: costs incurred every few years for periodic maintenance are allocated evenly across the years in which they are economically incurred by means of a provision.
5. Provisions for anniversary costs: care should be taken here in light of case law, as such provisions are not permitted under the law. The view taken in the literature, however, differs.
6. Provision for outstanding annual leave: at the end of the year, a proportionate share of the annual leave allowance is often set aside; this is considered standard practice. A provision may also be set aside for the backlog of holiday entitlement yet to be taken. It is in line with sound business practice to set aside a provision for outstanding holiday entitlement that will be taken or paid out in the future.
7. Provisions for legal costs: if legal proceedings against the company are imminent, a provision may be recognised in the balance sheet to reflect the estimated internal costs and the costs of legal assistance relating to these proceedings. Furthermore, the amount of any damages that may be payable may be included in the provision.
8. Provision for reorganisation: as soon as a decision to reorganise has been taken or it becomes apparent that this is necessary, a provision may be set aside for the estimated costs associated with this, such as costs relating to the termination of leases, the dismantling of installations and staff redundancies.
From a tax perspective, it is certainly worth taking a critical look at whether the correct provisions have been set aside – or can be set aside – in your particular case. After all, carefully determined provisions will give you a clearer picture of your company’s assets.