FRS 102 Tax Consequences
For accounting periods commencing on or after 1 January 2015, current UK Generally Accepted Accounting Principles (UK GAAP) has been replaced by a single standard. The transition requires many UK companies’ financial information to be prepared in accordance with Financial Reporting Standard 102 (FRS 102). This change could have a major impact on tax-related cash flows.
For some companies, FRS 102 will see little change in their financial statements but for others there could be significant differences. The only exceptions will be those applying International Financial Reporting Standards (IFRS) or Financial Reporting Standard for Smaller Entities (FRSSE). FRSSE entities will only defer these changes for a year until the FRSSE is withdrawn for accounting periods commencing on or after 1 January 2016. It is important that companies understand the differences in the new standard, and how it might impact their taxable profits.
Financial instruments
Basic financial instruments will continue to be accounted for at amortised cost or cost less impairment. More complex ones such as interest rate swaps or forward foreign currency contracts will be recognised at fair value, with movements recognised through the profit and loss account.
The default rule for tax, is that tax treatment will follow the accounts so fair value movements will give rise to a tax allowable deduction or tax income. However, a tax election can be made to set aside its fair value movements, therefore, reducing the volatility of the tax charge.
Furthermore the entity may be able to hedge the financial instrument, so any movement covered by hedge avoids the profit and loss account altogether, therefore not affecting the tax charge and protecting distributable reserves.
Action:
Understand if any complex financial instruments could pass through the profit and loss account. They could of course change expected tax cash flows.
Decide whether to elect to set aside the tax charge on profit and loss movements on financial instrument.
Decide whether, in certain circumstances, hedge accounting is appropriate for the financial instruments to protect the volatility of the profit and loss account and therefore the tax charge.
Intangible assets
A greater range of intangible assets will be recognised, especially on business combinations. These include intellectual property, customer lists and brand names.
Following the Summer Budget 2015, a tax deduction is no longer available for newly acquired goodwill, customer relationships and unregistered trademarks. If acquired before 8 July 2015, you will still qualify for tax deduction. Changes to accounting policies will impact the timing of tax deductions for allowable IP. The deferred tax implications of non-allowable IP will need to be considered carefully, as tax relief will be available when these assets are sold.
The default amortisation period for goodwill under FRS 102 has been increased to 10 years. Existing accounting policies around goodwill may need reviewing.
Action:Look hard at what you have already acquired and its useful economic life to maximise tax deductions.
Investment property
Investment property revaluations will be taken directly to profit and loss, along with any associated deferred tax charge. Under current UK GAAP, deferred tax is only provided where there is an imminent sale proposed. As these are capital gains transactions, they do not give rise to an actual tax charge until the sale of the property. No cash flow tax differences to the current treatment will arise, but the greater volatility of results will cause the effective tax rate in the accounts to fluctuate.
Action:Check bank covenants to ensure the impact of unrealised property revaluations is excluded.
FRS 102 requires holiday pay provisions. These are, in principle, tax deductible provided amounts are paid out within nine months of year end. Where staff have large accrued holiday balances which are carried forward in the long term, tax dis allowances could arise, resulting in taxable profits in excess of accounting profits.
Action:Consider how best to track unused holiday pay entitlement.
Incentives to enter into a lease will be recognised as a reduction to the expense passing through the profit and loss account over the lease term.
This differs from existing UK GAAP which recognises the reduction to the date when full market rental is payable, which is normally considered to be to the first break clause
Action:As tax treatment follows the accounting treatment, a tax deferral can be obtained under the new standard to the extent revenue incentives are spread over a longer time period.
As the examples above demonstrate, deferred tax is likely to be provided on a greater range of assets. This will impact the profits available for distribution. Businesses that typically pay out a high proportion of their profits by way of dividend should ensure they understand the impact.
As accounting profit is the key driver of the calculation of taxable profits, any changes to accounting treatment will alter the quarterly instalment payments.
What you should do
- Consider whether tax systems and processes for both tax and financial reporting will capture the relevant information or need updating.
- Update cash flow forecasts to take into account the impact of the new accounting standards.
- Consider the impact of restating the prior years and whether any adjustments create a one-off tax charge or credit.