Client pays upfront for a six-month retainer — when is that income taxed?

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Client pays upfront for a six-month retainer — when is that income taxed?

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I run a small business in London, and one of my regular clients has just offered to pay £3,000 upfront for a six-month retainer. The retainer would cover ongoing advice and support from November through to April, with no separate monthly invoices. The money is already in my business bank account, and I have not spent it yet, but I am not sure how to treat it for tax. My first instinct was to count the whole £3,000 as income straight away, because I have received it, but that does not feel quite right when I still have six months of work to do.

Does the timing depend on whether I use the cash basis or the traditional accruals basis? I currently prepare my accounts on the cash basis, but I am not sure whether that changes anything here, or whether the money still needs to be spread across the months when I actually do the work. I also want to understand what happens if the retainer period crosses my tax year end. If some of the work falls into the next tax year, is part of the income taxed in that later year, even though I received all the cash earlier?

I am also wondering about VAT, although I am not VAT-registered at the moment. If I were registered, would the VAT point be when I receive the payment, or when I provide the services? And what should I do if the client cancels part-way through and I have to refund some of the retainer? Would I need to adjust my income for the refund, and in which year?

Finally, how should I record this in my books so that I can see clearly what has been earned and what is still owed in work? I want a simple approach that will not cause problems at year end. Any examples, especially for a sole trader on the cash basis, would be really helpful.

Tagsself assessment cash basis retainer income tax year

Answer 1

AAmelia Jack

Yes, the timing depends on your basis, and that is the key point in your question. On the cash basis, which you use, income is generally taxed in the tax year you receive it. If you receive the whole £3,000 in November, it will count as income for that tax year, even though the work runs through to April and crosses the 5 April year end. You do not spread it month by month for tax purposes on the cash basis.

On the traditional accruals basis, the answer would be different. Income would be recognised as you earn it, so a £3,000 retainer for November to April would normally be spread at £500 a month. That would put £2,500 in the first tax year, for November to March, and £500 in the next tax year for April. That is why the same retainer can be taxed in one year or split across two years, depending on the basis you use. Changing basis is not something to do casually, because it affects all your income and expenses, so take advice before switching just for one client.

For your books, keep the tax treatment and the management picture separate. Record the £3,000 receipt, then track earned and unearned amounts each month, so you can see that £500 is earned in November, £1,000 by December, and so on, with the balance shown as deferred income until the work is done. That record will also help if the client cancels part-way through. If you refund part of the retainer, the refund should reduce the income in the year you make it, and you should keep the cancellation agreement and proof of repayment with the original retainer agreement.

VAT is a separate question. As you are not VAT-registered, there is no VAT to charge on this retainer, but keep an eye on your rolling taxable turnover, because the retainer counts towards it. If you were VAT-registered, the tax point would normally be when you receive the payment or issue an invoice, whichever is earlier, so VAT would not simply follow the monthly earning pattern either. In short, do not assume that receiving money and earning income are the same thing for tax, and plan for the full £3,000 to be taxed in the year of receipt while you are on the cash basis.

Client pays upfront for a six-month retainer — when is that income taxed?

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