Cash accounting or accrual accounting?

Cash accounting and accrual accounting

The accounting method depends on the tax concerned and on the size of the business.

Two accounting systems exist

Under accrual accounting, income and expenses are recorded as soon as they are certain in principle and determined in amount, even if not yet paid.

Under cash accounting, income is recorded when received and expenses when paid.

The applicable rule differs for direct taxation and for value added tax (VAT).

Direct taxation

Commercial companies with legal personality (SARL, SA, SCA, SENC, SCS), economic interest groupings and special limited partnerships must keep double-entry accounts (articles 8 and 11 of the Commercial Code).

Sole traders and partnerships (SENC, SCS) whose turnover excluding VAT for the last financial year does not exceed EUR 100,000 may keep simplified accounts instead (article 13 of the Commercial Code).

Paragraph 161 of the General Tax Law (Abgabenordnung) requires any operator whose annual turnover exceeds EUR 100,000 to keep double-entry accrual accounts and to draw up a balance sheet each year. This applies to commercial, industrial and craft activities, to agricultural and forestry activities and to liberal professions.

Operators below the EUR 100,000 threshold may determine their taxable profit by simple comparison of operating receipts and expenses, under article 18 (3) of the Income Tax Law (LIR) and the Grand-Ducal Regulation of 3 December 1969. This is a cash basis.

Two categories of income follow the cash principle regardless of turnover:

• agricultural and forestry operators covered by the derogation of article 64bis LIR and its implementing regulation ;
• rental income from real estate, taxed on receipts under articles 104 and 108 LIR.

Value added tax

As a rule, VAT becomes chargeable when the supply is made, or when the invoice is issued where an invoice is required (articles 21 and 24 of the VAT Law). The tax is therefore due on sales, whether or not the customer has paid.

Article 25 of the VAT Law opens an option. A taxable person whose turnover excluding VAT for the previous calendar year did not exceed EUR 500,000 may ask to be taxed on receipts. VAT then becomes chargeable only when payment is collected, in whole or in part. Where the payment is partial, the tax is due only on the amount received.

The option is subject to the following conditions:

• it applies from the first day of the calendar year following the request ;
• it covers only supplies made within Luxembourg for which the taxable person is liable for invoiced VAT ;
• it must be kept for at least five consecutive calendar years, unless the turnover condition ceases to be met ;
• input VAT is deductible only once the supplier's invoice has been paid ;
• when the regime ends, VAT on invoices still unpaid becomes chargeable under the ordinary rules.

The regime is designed for small businesses selling mainly to final consumers.

Example

A Luxembourg SARL in the IT sector sells, in year N, EUR 165,000 of equipment and EUR 110,000 of installation services, both excluding VAT, to customers established in Luxembourg. By year end, customers have paid EUR 220,000 excluding VAT.

VAT deferred in year N: EUR 9,350 (46,750 – 37,400)

For direct taxation, the outcome is identical under both options. The SARL keeps double-entry accounts and its taxable profit includes the full turnover of EUR 275,000, whether collected or not.

The receipts basis only shifts the moment at which VAT is paid to the Treasury; it does not reduce the tax.

The company also loses the deduction of input VAT on any supplier invoice it has not yet paid.