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For startups, especially technology-based companies, sales through service provision are often the main source of income. Accurately accounting for such service sales and properly managing related tax issues are essential elements for securing financial soundness and enhancing trust when attracting investment. However, early startups often have difficulties with this because they lack accounting and tax professionals or systems, and often rely on external accounting books for corporate tax and value-added tax reporting. In this column, we will look at the accounting standards that startups must know in relation to service sales and tax processing methods related to corporate tax and value-added tax.
1. Accounting treatment by type of service provided
The 'General Corporate Accounting Principles', which are the accounting standards applied by most early-stage startups, recognize revenue from the provision of services on a progress basis when 1) the amount of the entire transaction can be reliably measured, 2) there is a high possibility of economic benefits flowing in, 3) costs already incurred and costs to be incurred can be reliably estimated, and 4) the rate of progress can be reliably estimated.
Below, we will learn how to recognize progress criteria based on service type.
(1) Subscription-based services (e.g. SaaS, content platforms)
The subscription model is a method in which users pay a fixed amount on a regular basis and have the right to access a service or content for a certain period of time. This is because the company is seen as providing continuous services for the period in which the customer has access to the service, so revenue is generally recognized by allocating it over the subscription period.
Therefore, if an annual subscription fee is received, it should not be recognized as revenue at that time, but as an advance payment and then recognized as revenue monthly or quarterly depending on the service provision period. In addition, revenue is not recognized during the free trial period because no economic benefits are received, and in the case of initial installation fees or setup fees, if they are services that are distinct from subscription services to be provided in the future under non-refundable conditions, revenue is recognized at the time the service is provided.
(2) Project-based services (e.g., custom software development)
Project-based services are a form of software development that customers order. If the project performance can be reliably estimated, it is common to recognize revenue based on progress.
There is one more thing to consider for this type of service sales, which is the 'special accounting treatment for small and medium-sized enterprises'. If you are a small and medium-sized enterprise as defined by this accounting standard, you can recognize revenue on the date of completion of service sales for services that are completed within a period of one year.
This is a special case applied to ease the burden of accounting for early-stage startups that have difficulty in calculating the percentage of progress, but there is something to be careful about. If this special case is applied, all sales must be carried forward to the next fiscal year for short-term projects that have not completed the provision of services in the current fiscal year. Startups that recognize sales at the time of issuing simple tax invoices often experience confusion when sales fluctuate significantly during financial audits or accounting audits. Therefore, it is necessary to give sufficient consideration to whether to focus on reducing the burden of accounting or increasing the reliability of financial information through percentage-of-progress revenue recognition, depending on the growth stage of the company.
And if the project takes more than one year, the special exception does not apply and the progress criterion must be applied. If the progress cannot be reasonably estimated, the recoverable amount within the range of possible costs must be recorded as revenue. The progress can be calculated using the amount of work, work hours, input costs, etc. depending on the characteristics of the transaction, and the progress calculated based on the down payment or advance payment received from the customer is not appropriate because it does not reflect the progress of the work. If the company manages the progress by setting the total expected input hours, outputs for each input stage, and inspection conditions even for important projects exceeding a certain scale, it will not only increase the reliability of the accounting treatment but also help the company manage its revenue from a long-term perspective.
2. Other considerations in accounting
There are cases where a company enters into a service contract solely on its own but outsources most of the services. In this case, it is important to determine whether the company is acting as a principal or an agent in the transaction structure. If the company 1) assumes primary responsibility for providing the services, 2) sets the price of the service contract regardless of the outsourced labor supplier, 3) performs some additional services itself, 4) can select a supplier when there are multiple outsourced labor suppliers, and 5) pays the outsourced labor suppliers regardless of whether it receives payment for the service contract, the company is acting as a principal. If the company is acting as a principal, it should recognize revenue for the entire amount of the service contract, and if the company is acting as an agent, it should recognize revenue for only the commission.
3. Timing of attribution of corporate tax income
According to Article 69 of the Enforcement Decree of the Corporate Tax Act, the revenue calculated based on the rate of progress from the fiscal year in which the commencement date of the service provision falls to the fiscal year in which the provision of the object is completed is included in the income of the relevant fiscal year. Here, the rate of progress is recognized not only as input cost, but also as an objective indicator of the rate of progress such as work hours and work days, so if the sales are recognized based on the appropriate rate of progress according to accounting standards, no separate tax adjustment occurs.
However, the Corporate Tax Act allows small and medium-sized enterprises to include services performed for less than one year in the income of the fiscal year in which the delivery date of the object falls. Accordingly, small and medium-sized enterprises can recognize income based on completion criteria for services performed for less than one year, regardless of the accounting method.
Meanwhile, if sales are accounted for on a completion basis in accordance with corporate accounting standards regardless of whether the business is a small or medium-sized enterprise, the Corporate Tax Act also recognizes this and no separate tax adjustment occurs.
4. Time of supply of value added tax
Startups that provide services are liable for VAT. VAT is calculated by deducting purchase tax from sales tax, and the exact time of supply and tax base calculation are important. The VAT Act generally considers the time of supply as the time of completion of the service provision, but for payment based on completion, interim payment, long-term installment (over 1 year), and continuous service supply where the supply unit cannot be divided, the time of supply is determined to be the time of receipt of each portion of the consideration.
This “when each portion of the consideration is to be received” rule is different from the accounting practice of recognizing revenue over the year, so care must be taken when managing cash flow for VAT payment.
So far, we have looked at accounting and tax issues related to startup service sales. Service sales are a key driver of growth for startups, but behind them, there are complex accounting standards and tax regulations. Startups should recognize that accounting and tax management are not just about compliance with regulations, but are key strategic elements for attracting investment, expanding business, and sustainable growth. They should build a systematic system from the early stages, and if necessary, consider utilizing the advice of accounting and tax experts with a deep understanding of startups and the relevant industry. Through this, startups will be able to build a stable financial foundation and create a successful future even in an uncertain business environment.
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