The adoption of FRS 102 is fast approaching – do you know what the tax implications of the changes are and how this could affect you and your company?
Tax law currently uses the accounting profit as the starting point for calculating the tax-adjusted profit of a business. Where FRS 102 causes the accounting profit to be different than under current UK GAAP it follows that this can have an impact on the taxable profit.
Over the life of a business the total profit will be the same, so adoption of FRS 102 will principally be a timing issue. On a year by year basis short-term changes to taxable profit could have a real impact on the business in terms of the amount of tax in cash terms that may need to be paid.
The prior period will need to be re-stated on the first adoption of FRS 102. This is best illustrated with an example:
A company adopts FRS 102 for its year ending 31 December 2015. It will need to restate its 2014 profits and balance sheet at 1 January 2014 and 31 December 2014 to reflect the applicable changes under FRS 102. Where adjustments to the 2014 profits or the retained earnings at 1 January 2014 are required, which would have affected taxable profits, any additional profit will be taxed or any additional expenditure will be given tax relief in the tax computation for the year ending 31 December 2015.
This would be a one-off adjustment but one that may have a significant impact in the transitional year. It could for example result in a company being required to pay its corporation tax under the quarterly instalment payment regime where otherwise this may not have been the case.
Property, Plant and Equipment (PPE)
Fair value accounting and the use of different valuation methods to recognise these assets at a value other than original cost will have limited tax impact. These adjustments will not be recognised for tax purposes and instead qualifying assets will continue to attract capital allowances in the normal way.
Intangible assets and goodwill
For post 2002 intangible assets tax relief is generally given based on the amortisation charge passing through the financial statements. If an election for the fixed rate writing down deduction (4% per annum) has been made, the deduction will remain as before, as it is an irrevocable election. In all other cases, if the amortisation period is shortened to become capped at 5 years, tax relief could be obtained over a much shorter period than previously.
Where fair value adjustments are made through the income statement these will be disregarded for tax purposes. An income statement deduction arising from a downward fair value adjustment will be added back for tax purposes and not result in tax relief. Similarly a credit to the income statement will not be taxable.
An actual disposal of property will result in a taxable profit or loss in the normal way.
Recognising all identifiable assets on acquisition could result in additional intangible assets being recognised which previously may have been combined with goodwill, for example, customer contracts, intellectual property and so on. Where these have a different amortisation period to goodwill it may be possible to accelerate tax relief on those assets.
The revenue section within FRS 102 is briefer than existing UK GAAP. The tax treatment of revenue follows the accounting treatment, therefore if there were to be a change in accounting treatment of a certain type of revenue as a result of the briefer standard the tax treatment would follow that change.
The complex loan relationship rules apply to companies in respect of financial instruments. In general terms the tax treatment will follow the accounting treatment. Accounting for financial instruments, including loans, on a fair value basis will therefore result in upward and downward fair value adjustments having a direct impact on the tax position of a company in a given year. This is an area that is likely to give rise to an adjustment on first time adoption of the standard.
Initial recognition of a term loan could give rise to a taxable credit for the borrower on initial recognition.
Company A and Company B are in the same group of companies. Company A lends Company B £10 million at a zero rate of interest repayable in 5 years time. The market rate of interest is 3%. Under FRS 102 the position for the borrower (Company B) on initial recognition is as follows:
Initially recorded at present value = £10m/1.035 = £8,626,088
Dr cash – £10,000,000
Cr loan – £8,626,088
Cr finance income (P&L) £1,373,912
A taxable credit of £1,373,912 arises in year 1. Taxable debits will arise annually over the term of the loan as the position unwinds. (The opposite treatment would be seen for Company A.)
A lease will be required to recognise the benefit of a lease incentive over the term of the lease. This is a change from current UK GAAP which requires the incentive to be recognised over the shorter of the lease term or the date from which a market rate rent will apply.
For tax purposes, the income representing the incentive may be recognised over a longer period of time under FRS 102, therefore having a positive tax cash flow impact on the company by spreading the income.
Holiday pay accruals will now be treated in same way as other accrued remuneration (that is, accrued bonuses) for tax purposes. Where there is a holiday pay accrual at the accounting period end tax relief will only be available in that period if it is paid within 9 months of the accounting period end. If the accrual is paid later than 9 months after the accounting period end tax relief will be available in the period in which the payment takes place. In most cases holiday pay accruals are paid shortly after the accounting period end meaning the changes should have limited impact for tax purposes.
Whilst not strictly related to the tax position of the business, fair value adjustments for a range of assets and liabilities will potentially have a significant impact on available distributable reserves. Deferred tax will also need to be recognised on a greater range of assets, for example investment properties and will consequently impact reserves.
This may impact the ability to pay a dividend between group companies or out to individual shareholders of the ultimate parent company. This could impact the income and consequently the income tax position of a shareholder in an owner-managed business.