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This publication is available at https://www.gov.uk/government/publications/accounting-standards-the-uk-tax-implications-of-new-uk-gaap/frs-102-overview-paper-new
The purpose of this overview paper (hereafter ‘the paper’) is to assist companies who are thinking of choosing or have already chosen to apply FRS 102. In particular, it provides an overview of the key accounting changes and the key tax considerations that arise for those companies that transition from Old UK GAAP 1 to FRS 102.
The paper is equally relevant to small companies who elect to apply Section 1A of FRS 102. Section 1A provides for certain modifications to the full requirements for small companies, and in particular provides reduced disclosure and presentation requirements. For ease of reference commentary in this paper which refers to FRS 102 will also apply to those companies that apply Section 1A of FRS 102 unless otherwise stated within that section of the paper.
The main section of this paper is split into 2 parts:
- Part A of this paper provides a comparison of the accounting and tax differences that arise between Old UK GAAP and FRS 102
- Part B of this paper provides a summary of the key accounting and tax considerations that arise on transition from Old UK GAAP to FRS 102
The paper concentrates on the Corporation Tax position. It may also assist individuals (and other entities) that are within the charge to income tax as many of the accounting and tax issues will be similar. However, there are significant differences between the 2 tax regimes which aren’t reflected in this paper. In particular, there are specific rules for loan relationships, derivative contracts and intangible fixed assets which only apply for the purposes of Corporation Tax.
For companies that transition from Old UK GAAP to FRS 101 a separate paper providing an overview of the key accounting and tax considerations is available. This paper reflects the current thinking of HM Revenue and Customs (HMRC) and it’s based on the law as it stands as the date of publication. It’s intended that this paper will be updated as further information is available and as new accounting standards and tax law develop.
The commentary provided in the paper is of a general nature. Companies should not rely on the commentary in isolation and it’s not intended as a substitute for referring to the accounting standards and tax law. Changing the basis on which accounts are prepared is a complex area and companies may wish to consider discussing the implications of transition with its advisers and/or consult the detailed guidance in the HMRC manuals.
It remains the responsibility of the entity or individual to ensure that it prepares accounts in accordance with relevant GAAP and submits a self assessment in line with UK tax law. Note that where HMRC considers that there is, or may have been, avoidance of tax the analysis as presented won’t necessarily apply.
This paper is an update of a previous papers published in January 2014 and October 2015. The primary changes from the original paper are:
- additional commentary in relation to non-interest bearing loans
- updated commentary on the application of the Disregard Regulations and Change of Accounting Practice Regulations, reflecting the changes made to these statutory instruments in December 2014
- accounting commentary updated to reflect the amendments to FRS 102 issued in August 2014 and July 2015
- where applicable it has been updated for any commentary specific to section 1A of FRS 102
It doesn’t reflect:
- amendments to FRS 102 – Pension Obligations (February 2015)
- FRS 104 – Interim Financial Reporting
- proposed changes to the tax rules, for example changes to the loan relationship and derivative contract rules and changes to the intangibles legislation included in Finance (No.2) Act 2015
Summary of the changes to the accounting standards
There currently exists a suite of accounting standards in the UK. Subject to certain restrictions detailed in the respective standards themselves, companies may choose or may be required to prepare their accounts under one of the following:
- EU endorsed IFRS/IAS: those accounts prepared in accordance with International Accounting Standards within the meaning of s395 of the Companies Act - hereafter ‘IAS’ for the purposes of this paper
- new UK GAAP: FRS 100, FRS 101 and FRS 102. Entities applying New UK GAAP will, within the framework of FRS 100, apply one of the following:
- FRS 101 is effectively the recognition and measurement requirements of IAS subject to some adjustments to ensure alignment with UK Companies Act and also reduced disclosure requirements
- FRS 102 is a new suite of accounting requirements which are closely aligned to, but aren’t the same as, IFRS
- Section 1A of FRS 102, available to small companies, is aligned to FRS 102 but with reduced disclosures and presentation requirements
- FRS 105 is based on the recognition and measurement requirements of FRS102, with some accounting simplifications and reduced disclosures for eligible micro entities
Hereafter ‘New UK GAAP’ for the purposes of this paper:
- Old UK GAAP: substantively the FRS’s, SSAP’s, UITF’s and relevant accepted practice in existence and applied prior to the introduction of New UK GAAP - for purposes of this paper this is described as ‘Old UK GAAP’ - for the avoidance of doubt this paper includes FRS 26 (and related standards) within its meaning of Old UK GAAP unless otherwise stated
- FRSSE: the Financial Reporting Standard for Smaller Entities - companies that meet the eligibility criteria may prepare and file abbreviated accounts
- Micro-entities: companies that meet the eligibility criteria may prepare and file abridged accounts, with effect for periods commencing on or after 1 January 2016 these requirements are contained in FRS 105
For periods commencing on or after 1 January 2015 UK medium and large companies won’t be permitted to prepare their accounts in accordance with Old UK GAAP. Instead such entities which applied Old UK GAAP will need to transition from Old UK GAAP to one of the alternatives. It’s expected that for many companies currently applying Old UK GAAP they will transition to one of FRS 101 or FRS 102.
For periods commencing on or after 1 January 2016 small companies won’t be permitted to prepare their accounts in accordance with the FRSSE. Instead such companies will need to transition to one of the New UK GAAP alternatives. It’s expected that for many entities currently applying FRSSE they will transition to Section 1A of FRS 102.
Transition to New UK GAAP will impact on the accounts in 2 key ways:
- assets and liabilities at the accounting transition date will be identified, recognised and measured in line with the requirements of the new standards
- thereafter profits and losses will be recognised in accordance with the new standards - these may differ from those profits and losses that would have been reported had Old UK GAAP or the FRSSE been retained
Interaction of these changes with tax
Tax legislation for companies requires that the profits of a trade are calculated in accordance with generally accepted accountancy practice, subject to any adjustment required or authorised by law in calculating profits for Corporation Tax purposes (section 46 Corporation Tax Act 2009). Similar rules exist in other parts of the tax legislation.
Generally accepted accountancy practice for Corporation Tax purposes is defined at section 1127 Corporation Tax Act 2010 and is:
- UK Generally accepted accountancy practice – generally accepted accountancy practice in relation to accounts of UK companies (other than IAS accounts) that are intended to give a true and fair view
- In relation to a company that prepares IAS accounts means generally accepted accountancy practice in relation to IAS accounts
As noted above, the Corporation Tax treatment for companies relies heavily on the accounting treatment adopted in the company’s accounts. With the introduction of IAS in 2004 / 2005, a number of changes were made to the tax legislation to deal with certain issues that arose for companies that transitioned to IAS in their entity accounts. In many cases, the effect of these rules is to provide tax treatment which is broadly equivalent to companies that continued to use the previous UK GAAP.
The changes made to the tax statute aren’t generally restricted to companies that have IAS accounts. So the rules will also apply to companies that have, for example, adopted FRS 26 with the result that derivative contracts have been fair valued. The rules are also likely to be relevant for companies which adopt FRS 101, FRS 102 or Section 1A of FRS 102 where they face similar issues to those encountered by companies adopting IAS.
Non-UK incorporated companies
It’s possible for companies incorporated outside of the UK to be resident in the UK. In addition, the tax statute can require consideration of the application of generally accepted accounting practice to companies that aren’t resident in the UK (for example, Controlled Foreign Companies).
In most cases the same statutory definition of generally accepted accounting practice applies. As such, where the company prepares IAS accounts, these will be used to calculate profits; and in other cases the profits will be calculated on the basis of UK GAAP (as it would be applicable for such a company).
PART A – Comparison between Old UK GAAP and FRS 102
This part of the paper provides a comparison of the ongoing accounting and tax differences that arise between Old UK GAAP and FRS 102.
1. Reporting financial performance
Old UK GAAP
Accounts prepared in accordance with Old UK GAAP are required to present, amongst other things, a profit and loss account (P&L), balance sheet and where applicable a statement of total recognised gains and losses (STRGL). The format of the P&L and balance sheet are determined by company law, whilst the format of the STRGL is set by FRS 3.
FRS 102 (excluding Section 1A of FRS 102)
Accounts prepared under FRS 102 are also required to present a balance sheet (or ‘statement of financial position’). Section 5 of FRS 102 provides preparers with a policy choice of presenting its total comprehensive income for a period as either:
- a single statement of comprehensive income, in which case the statement presents all items of income and expense recognised in the period
- 2 statements; an income statement and a separate statement of comprehensive income
The single statement approach is akin to a combined P&L and STRGL while the 2 statement approach keeps them separate. While FRS 102 differs from Old UK GAAP in this regard it should be noted that for companies adopting FRS 102 the format requirements of the Companies Act still apply.
FRS 102 also requires that a statement of changes in equity is presented which captures an entity’s profit or loss for a reporting period, other comprehensive income for the period, the effects of changes in accounting policies and corrections of material errors recognised in the period, and the amounts of investments by, and dividends and other distributions to, equity investors during the period.
While format requirements of the Companies Act remain in many cases the terminology used in FRS 102 differs from Old UK GAAP. As a result, it’s possible that certain items will be described differently compared with previously and from one entity to another. FRS 102 does permit the use of titles/descriptions that differ to those used in the standard itself, and some companies may retain the Old UK GAAP descriptions.
|Old UK GAAP||FRS 102|
|Profit and loss account||Income statement|
|Statement of total recognised gains and losses||Statement of comprehensive income (sometimes referred to a statement of other comprehensive income)|
|Balance sheet||Statement of financial position|
|Cash flow statement||Statement of cash flows|
|Reconciliation of movements in shareholders funds||Statement of changes in equity|
- old UK GAAP includes a choice as to whether to present the reconciliation of movements in shareholders’ funds as a primary statement
- as previously stated, section 5 of FRS 102, permits an entity to prepare a single performance statement rather than a separate income statement and a separate statement of comprehensive income - this combined statement is typically called a statement of comprehensive income or a statement of profit or loss and other comprehensive income
- in some circumstances FRS 102 allows an entity to produce a ‘statement of income and retained earnings’ in place of the statement of comprehensive income and the statement of changes in equity
- Appendix 3 of FRS 102 provides a comparison table of Companies Act terminology and FRS 102 terminology
Section 1A of FRS 102
Those entities preparing their accounts using Section 1A of FRS 102 will only have to present a balance sheet, profit and loss account and limited notes. They won’t be required to present any other primary statements but are encouraged to present a statement of comprehensive income (sometimes referred to as the statement of total recognised gains and losses) and a statement showing changes in equity.
They will also have the option of presenting an abridged balance sheet and profit and loss account.
The abridged balance sheet includes the main headings only (intangible assets, tangible assets, investments, stocks, debtors, cash, prepayments, creditors, provisions, accruals, share capital, share premium, revaluation reserve, other reserves and P&L reserve). No further analysis of these headings is required.
The abridged profit and loss account starts with a single figure for ‘gross profit or loss and other operating income’. There is no separate disclosure of turnover, cost of sales and other operating income.
While the references and titles used in FRS 102 are aligned to those used in IAS the tax statute has been updated to cover both sets of terminology. A reference in statute to the ‘income statement’, for example, will take its normal accounting meaning. Furthermore, the reduced disclosure requirements permitted by Section 1A of FRS 102 would not typically have any effect on the company’s tax position.
2. Consolidated accounts/seperate financial statements, investments in associates and joint ventures
Whether prepared using Old UK GAAP or New UK GAAP the relevance of consolidated accounts and equity accounting is very limited in UK tax law, and it’s not thought that FRS 102 represents any significant change that would require revisiting those few areas of UK tax law that do have regard to consolidated accounts (such as aspects of the finance leasing arrangements (Chapter 2 Part 21 CTA 2010), intangible fixed assets rules (Part 8 CTA 2009) and the World Wide Debt Cap rules (Part 7 of TIOPA 2010)).
Nor typically does the treatment of associates, for example, joint ventures in separate financial statements have relevance for tax under current UK law.
However consolidated accounts can be informative and can provide useful information which doesn’t show up on the face of the individual accounts.
3. Accounting policies, estimates and errors
Accounting for a change in accounting policy
FRS 3, Reporting financial performance, requires that changes in accounting policy are applied retrospectively and that the cumulative effect of prior period adjustments are presented at the foot of the STRGL.
Section 10 of FRS 102 requires that a change in accounting policy resulting from a change in the requirements of an FRS or FRS abstract is accounted for in line with the requirements of that revised FRS or FRC abstract.
When the standard doesn’t contain specific requirements, the change in policy, in a manner comparable to Old UK GAAP, will be applied retrospectively to the earliest date which is practicable as if the new policy had always applied.
The requirement to apply the policy retrospectively is similar between Old UK GAAP and FRS 102, but there is a difference in how this is presented. As noted above, under Old UK GAAP, FRS 3 requires that the cumulative effects of prior period adjustments are presented at the foot of the STRGL. In contrast FRS 102 requires that the change is recognised in the statement of change in equity.
Accounting for change in estimate
Old UK GAAP requires that a change in estimate is applied prospectively. For example where an entity changes the useful estimated life of a tangible fixed asset it doesn’t adjust the depreciation brought forward. Instead the depreciation is adjusted prospectively to reflect the revised useful economic life.
FRS 102 is consistent with Old UK GAAP in this regard.
Accounting for errors
Where a fundamental error is identified FRS 3 requires that this is accounted for by restating the prior period comparative figures. Errors that aren’t considered fundamental are accounted for in the period they are identified.
Section 10 of FRS 102 requires that, to the extent practical, an entity shall correct material errors retrospectively in the first financial statements authorised for issue after the error is discovered, through restating the prior period comparative figures. Errors that aren’t considered to represent material errors are accounted for in the period they are identified.
For trading profit Chapter 14 Part 3 CTA 2009 provides that where there is a change from one valid basis on which the profits of a trade are calculated to another valid basis (for example on a change of accounting policy), an adjustment must be calculated to ensure that business receipts will be taxed once and once only and deductions will be given once and once only. For Corporation Tax purposes, adjustments are treated as receipts or deductions in computing the trade profits.
That approach will continue to apply for prior period adjustments arising in accordance with Section 10 of FRS 102.
The above applies to changes from one valid basis to another. Where the change is from an invalid basis (such as may occur when a material error is identified in the accounts), UK tax law requires the invalid basis to be corrected for tax purposes in the period it first occurred with subsequent periods also corrected for tax purposes. Whether tax can be collected or repayments claimed for earlier periods is dependent on the time limits for making or amending self-assessments.
Similar tax rules apply for changes in accounting policies or errors on non-trade items, such as loan relationships, derivative contracts and intangible fixed assets.
4. Financial instruments
In accounting terms, a financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another. Examples of common financial instruments include; cash, trade debtors, trade creditors, bonds, debt instruments and derivatives.
Companies applying Old UK GAAP fall into 2 main camps – those applying FRS 26 and those that don’t. Companies that haven’t adopted FRS 26 are likely to see the largest changes as a result of adopting FRS 102. Furthermore, under FRS 102 a company effectively has 3 options for the accounting of financial instruments: (i) Sections 11/12 of FRS 102; (ii) IAS 39; or (iii) IFRS 9. This means that there are 6 possibilities for transitioning from Old UK GAAP to FRS 102.
This chapter of the paper concentrates on those companies which don’t currently apply FRS 26 as it’s likely that these companies will see the biggest change. The paper covers both the Sections 11/12 and the IAS 39 options under FRS 102. This paper doesn’t consider the accounting and tax interaction where the third option, IFRS 9, is adopted.
This section of the paper is applicable for accounting periods commencing before 1 January 2016. For accounting periods commencing on or after 1 January 2016 there are changes to the loan relationship and derivative contract rules which may affect the tax treatment. In particular, the tax treatment now follows the amounts recognised in profit or loss. Given that many UK companies will be adopting FRS 102 for the first time in 2015, the paper has not been updated for these changes.
Note that this paper deals with borrowing costs in chapter 14, foreign currency translation in chapter 17 and liabilities and equity in chapter 18.
4.2 General requirements
Old UK GAAP
As noted above, for companies applying Old UK GAAP the accounting for financial instruments can be segregated into 2 camps – those that apply FRS 26 and those that don’t.
FRS 26 is aligned to IAS 39 and is mandatory for companies with listed debt or equity that aren’t using IAS. It’s optional for all other entities, and they can take advantage of the option to use fair value accounting that is part of UK company law.
For companies not applying FRS 26 there is no specific, comprehensive standard for financial instruments in Old UK GAAP. Instead accounting for financial instruments is primarily determined by the requirements of FRS 4 (issuer of capital instruments), SSAP 20 (foreign currency transactions), FRS 5 (substance over form, including some recognition / derecognition issues).
Otherwise, for companies not applying FRS 26, the accounting for financial instruments is based largely on the general principles in FRS 18, particularly the accruals concept, and relevant provisions of company law. The Companies Act provides that current assets (such as cash and trade debtors) are recognised at purchase price/cost while the accruals concept is applied in determining, for example, the recognition and measurement of interest income in lenders.
In contrast to Old UK GAAP (where FRS 26 isn’t adopted) FRS 102 provides a company with specific guidance on accounting for all financial instruments. In Section 11 it provides three accounting options:
- application of Section 11 and Section 12 of FRS 102
- application of the recognition and measurement criteria of IAS 39
- application of the recognition and measurement criteria of IFRS 9 (and IAS 39 as amended for IFRS 9)
Section 11 and Section 12 option
Sections 11 and 12 within FRS 102 provide specific guidance on accounting for financial instruments. Section 11 addresses ‘Basic’ financial instruments while Section 12 considers all ‘other’ financial instruments. While Sections 11 and 12 address accounting for financial instruments, there are certain exceptions to their scope including insurance contracts, investments in subsidiaries, associates and joint ventures and leases 2 . Section 12 does however apply, for example, to all derivative financial instruments.
‘Basic’ financial instruments are those considered to have straightforward terms - examples provided in Section 11 include cash, trade debtors, trade creditors and simple bank loans with standard repayment conditions. Such instruments are typically recognised at transaction price and measured on an amortised cost basis. This is largely consistent with Old UK GAAP.
‘Other’ or ‘non-basic’ financial instruments refer to all other financial instruments. In contrast to basic financial instruments ‘other’ financial instruments are typically recognised and subsequently measured at fair value in the P&L. In particular the following are examples of instruments which will now be held at fair value in accordance with Section 12 of FRS 102:
- all derivatives (including interest rate swaps, a forward commitment to purchase a commodity that is capable of being cash-settled, and options and forward contracts)
- loans that aren’t plain vanilla debt – where, for example, the amount repayable can vary or where non-standard interest rates are used
- investments in convertible debt where the return to the holder can vary with the price of the issuer’s equity shares rather than just with market interest rates 3
The requirements of Section 12 of FRS 102 represent a significant change from Old UK GAAP (both where FRS 26 has and has not been adopted). It’s likely that many more financial instruments will be required to be fair valued under FRS 102 than is currently the case under Old UK GAAP.
IAS 39 option
As noted above FRS 102 also permits a user to make the policy decision to apply the recognition and measurement criteria of IAS 39. Although IAS 39 doesn’t distinguish between ‘basic’ and ‘other’ financial instruments in the same way it does share some similarities with Section 12 of FRS 102; for example in both cases, a company will typically be required to account for all financial instruments separately whereas synthetic or composite instruments are relatively common under old GAAP (where FRS 26 isn’t adopted). Below are the characteristics that would result in a financial instrument being measured at fair value under IAS 39:
- assets and liabilities held for trading purposes or speculatively
- assets and liabilities designated at the outset by the company as at fair value through profit and loss
- all derivative financial instruments
Note that under the IAS 39 option, debt instruments designated as ‘Available for Sale’ (AFS) will be measured at fair value with fair value gains and losses recognised directly in Other Comprehensive Income (OCI) while interest income, foreign exchange and impairment losses will continue to be recognised in profit or loss.
Again this represents a significant change from Old UK GAAP (where FRS 26 isn’t adopted).
For companies most financial instruments will fall to be loan relationships (under Part 5 CTA 2009), non-lending money debts (treated as loan relationships under Chapter 2 of Part 6 CTA 2009) or derivative contracts (under Part 7 CTA 2009). UK tax law provides in general that the accounting treatment of these types of instruments is followed for tax purposes. This paper doesn’t cover those financial instruments that fall outside of these categories – for example, equity instruments in the form of shares and guarantees.
A particular aspect of the taxation of loan relationships and derivative contracts is that it departs from the normal principle of looking only at the profit and loss account (or income statement). The legislation ensures that most items taken to ‘reserves’ are brought into account. This would include amounts recognised in the STRGL under Old UK GAAP and amounts recognised as items of OCI under FRS102 or IAS. A further rule ensures that where a profit or a loss from a loan relationship or derivative contract is recognised directly to equity, then this would be brought into account in the same way as if it was recognised to profit or loss or through reserves.
As a result, where the accounts measure the instrument at fair value, either with profits going to profit or loss, or as items of other comprehensive income, these fair value movements will typically be brought into account for tax. There are, however, certain exceptions where the tax statute specifies a particular accounting treatment. The most common example is where there is a loan relationship between connected companies. In this case, section 349 CTA 2009 requires the profits to be calculated for tax purposes on the basis of an amortised cost basis. Also, there are specific rules dealing with derivative contracts which form part of a hedging relationship (these are explained in more detail below).
In addition where, under the IAS 39 option, financial assets are treated as ‘held-to-maturity’ (HTM) there is an expectation that such assets are held to maturity. These are measured at amortised cost. However, a sale of a small number of such assets prior to maturity can result in all the HTM assets becoming ‘tainted’, such that the assets would be required to be accounted for as being AFS. Specific tax rules apply in this scenario - see CFM 33150 for further details.
Where a financial instrument is measured on a different basis under FRS 102 compared with Old UK GAAP it’s likely that transitional adjustments on adoption of FRS 102 will arise. For further guidance on the transitional provisions applying to financial instruments see Part B of this paper.
Further detail on specific transactions involving financial instruments where the requirements of FRS 102 differ from the requirements of Old UK GAAP are set out below.
4.3 Debt-equity swap
Where debt is extinguished through the issue of an entity’s own equity the accounting applied in accordance with Old UK GAAP may differ from that required by FRS 102.
Old UK GAAP, where FRS 26 has not been adopted, permits an accounting policy choice as regards the recognition of a gain or loss. In certain situations it may be appropriate to adopt a no gain/no loss policy, so that the value of the equity issued is treated as being equal to the carrying value of the debt given up. However, companies are permitted to adopt a policy of recognising a gain or loss on such transactions. Under both approaches, it’s necessary to consider the interaction with the requirements of company law as regards the amount of share premium to be recorded and the requirements as regards realised profits4.
FRS 102 doesn’t provide specific guidance on debt-equity swaps. Section 11 of FRS 1025 requires that any difference between the carrying amount of the financial liability extinguished and the consideration paid is recognised in profit or loss. In addition Section 22 requires that equity instruments are recognised on issue at the fair value of the cash or other resources received. However, companies will need to consider the specific facts and nature of the transaction undertaken. For example, company law considerations regarding realised profits and share premium accounts will need to be considered and may impact on the accounting treatment.
Under general principles of the loan relationship regime, an amount of profit recognised to the profit and loss account, or to reserves, would be brought into account. However, section 322 CTA 2009 will typically exempt gains arising where a debt is released in consideration of ordinary shares. See CFM 33200 onwards for further details of this exemption.
4.4 Debt restructuring / derecognition
Debt may be restructured or have its terms modified such that, in accordance with FRS 5 and Old UK GAAP (where FRS 26 isn’t adopted), no gain or loss would be recognised in the accounts.
In contrast, FRS 102 requires that, where the modification or restructuring to the debt is considered substantial, the original debt instrument will be derecognised and the ‘new’ debt instrument recognised at its fair value. To the extent that the fair value of the new instrument differs from the carrying value of the original debt instrument a gain or loss will typically be recognised as an item of profit or loss. This gain or loss should reverse over the remaining life of the instrument.
The loan relationship would normally be taxed in line with the amount recognised in the accounts. As such, the profit or loss on derecognition / rerecognition will typically be brought into account.
Note that the government has included within Finance (No.2) Act 2015 an exemption to cover distressed debt, which would apply in certain cases where the loan is modified or replaced. The proposal is that the exclusion would apply to modifications and releases from 1 January 2015.
On transition Section 35 of FRS 102 provides that financial assets and liabilities derecognised under the previous accounting framework shall not be recognised on adoption of FRS 102. Section 35 also provides that where a financial asset or liability would have been derecognised under FRS 102 but under the company’s previous accounting framework hadn’t been derecognised a company may, on transition, either (i) derecognise the financial asset or liability on adoption of FRS 102; or (ii) continue to recognise until disposed of or settled.
However, no exclusions apply where the derecognition occurs after the accounting transition date – for example, after the start of the prior period comparatives. As a result, the company may be required to derecognise / recognise the debt.
The Change of Accounting Practice Regulations were amended in December 2014 to address this issue in certain instances of distressed debt. For further guidance on the transitional provisions applying to financial instruments see Part B.
4.5 Initial recognition - non-market instruments
Old UK GAAP, where FRS 26 isn’t applied, typically requires that financial instruments are initially recognised at cost. This cost may or may not equate to the fair value of the financial instrument.
In contrast under FRS 102, whether through the application of Section 11 and 12 or through the IAS 39 option, financial instruments are typically measured on initial recognition at (i) transaction price (ii) present value (of there is a financing element) or (iii) at fair value. The transaction price (or ‘cost’) will typically, but may not always, equate to the present value / fair value of the instrument. Where the transaction cost differs from the present value / fair value of the instrument it’s possible that a day-one gain or loss could arise. For example, this can be an issue with non-interest bearing debts which aren’t repayable on demand.
The loan relationship would normally be taxed in line with the accounts. As such, any day-one gain or loss will typically be brought into account. However, consideration should be given to the facts which led to the transaction price differing from fair value.
In particular, there are 2 sets of provisions which may alter this position.
Where the loan arises between connected companies, the amounts to be brought into account on the basis of an ‘amortised cost basis of accounting’ as required by sections 313 and 349 CTA 2009 - in particular this requires the tax treatment to be based on the loan shown in the accounts at ‘cost’ and adjusted for amortisation and impairments
What constitutes ‘cost’ will depend on the particular facts in question. HMRC would normally accept that this equates to the cost of the loan under Old UK GAAP (where FRS 26 has not been applied), such that in this case the tax treatment under FRS 102 will largely follow the Old UK GAAP position (where FRS 26 has not been applied).
See CFM35190 for further details of the rules for taxing loan between connected companies.
Secondly, if the loan did not arise as a result of a transaction between persons acting at arm’s length it may be necessary to apply the transfer pricing rules in Part 4 of TIOPA 2010. Where any tax advantage is already negated by the connected companies then the transfer pricing rules are unlikely to apply
See the International Manual for further details of the transfer pricing rules.
HMRC has published draft guidance on this issue.
Potentially this could result in a transitional adjustment. For further guidance on the transitional provisions applying to financial instruments see Part B of this paper.
4.6 Hedging relationships/synthetic instuments
Old GAAP, where FRS 26 has not been adopted, requires derivatives that are entered into as part of a company’s hedging strategy to be accounted for on an historic cost basis equivalent to that used for the underlying asset, liability, position or cash flow.
In contrast, both Section 12 of FRS 102 and the IAS 39 option typically require all derivatives to be accounted for separately and to be measured at fair value. Section 12 of FRS 102 and IAS 39 both then provide certain ‘hedge accounting’ rules.
Under both Section 12 of FRS 102 and the IAS 39 option, hedge accounting is only permitted where certain criterion are met. However as part of the amendments made to FRS 102 in July 2014 the criteria was changed making hedge accounting more readily available to entities where it’s consistent with their risk management processes. The mechanics of hedge accounting, whether applying Section 12 of FRS 102 or under the IAS 39 option are thereafter comparable.
Whether applying Section 12 of FRS 102 or under the IAS 39 option, the mechanics for hedge accounting are significantly different to the accounting for synthetic instruments under Old UK GAAP (where FRS 26 isn’t applied).
Without special rules, hedge relationships would not typically be effective for tax purposes, whether or not they were designated as a hedge for accounting purposes. The ‘Disregard Regulations’ (SI 2004 / 3256) were introduced to address this issue.
Broadly speaking, where a derivative is part of a hedging relationship the rules operate to restore the Old UK GAAP position (for example, where FRS 26 isn’t applied). In particular, there are specific regulations for derivatives dealing with currency, commodities, debt and interest rates. The rules apply in a number of different circumstances and they also contain particular elections that may be made.
For periods of account commencing on or after 1 January 2015, the default setting is for the tax treatment of derivative contracts to follow the profit and loss account. Companies have the option of electing into computational provisions in the Disregard Regulations. Previously, companies had the ability to elect out from the Regulations.
For companies that already apply fair value accounting in respect of derivatives which potentially fall within the scope of the Disregard Regulations, they will continue with their existing treatment. These company can, if they so wish, change their status in the future on a prospective basis.
Companies that will be applying fair value accounting for the first time in a period of account commencing on or after 1 January 2015 will need to decide whether to elect-in to regulations 7, 8 and 9. There are strict deadlines for making these elections.
It’s also likely that transitional issues could arise in such cases. For further guidance on the transitional provisions applying to financial instruments and the interaction with the Disregard Regulations see Part B of this paper.
HMRC has published additional guidance to help companies with hedging instruments making the transition to new accounting standards. This is available at: Corporation Tax: Disregard Regulations for derivative contracts.
Further information is available in the Corporate Finance Manual (CFM) as follows:
- derivative contracts are explained at CFM13010 onwards
- hedge accounting is explained at CFM27000 onwards
- the tax treatment of derivatives is explained at CFM57000 onwards
4.7 Hybrid instruments/embedded derivatives
This paper doesn’t address in detail the position of hybrid instruments and the embedded derivatives. This is a complex area and affected companies will need to consider the accounting and tax treatment carefully.
In overview, FRS 26 and IAS 39 require companies to separate out (‘bifurcate’) embedded derivatives from host contracts. However, bifurcation isn’t typically permitted under Old UK GAAP (where FRS 26 isn’t applied) or under Sections 11 / 12 of FRS 102 (although in both cases the issuer of compound instruments will still separate out the equity component in accordance with FRS 25 or Section 22 respectively). Links to the relevant guidance is set out in chapter 18 (liabilities and equity) of this paper.
4.8 Companies that currently apply FRS 26
The above commentary focuses on companies that don’t currently apply FRS 26. Companies that have adopted FRS 26 and choose to apply the IAS 39 option under FRS 102 are likely to see no change in the accounting of financial instruments. For those that choose to apply the Section 11 /12 option certain elements won’t change but the basic/other distinction has the potential to result in significant changes. For example, such companies could see the following differences:
- as noted above, financial instruments are required to be fair valued under Section 12 for all but ‘basic’ instruments - loans previously recognised on an amortised cost basis may therefore be measured at fair value in accordance with Section 12
- as noted above, Sections 11 and 12 don’t permit the bifurcation of embedded derivatives (although the issuer of compound instruments will still separate out the equity component under Section 22) - for example the holder of a hybrid financial instrument is required under FRS 26 to bifurcate the instrument into its host debt and embedded derivative - the host debt is then measured on an amortised cost basis and the embedded derivative at fair value - in contrast FRS 102 Section 12 there is no equivalent requirement to split the instrument for accounting purposes, and the whole instrument would typically be fair valued
As such, transition adjustment may arise - see Part B of this paper.
Section 13 of FRS 102 differs from SSAP 9 insofar as it specifically excludes from its scope WIP in the course of construction contracts (covered in section 23 of FRS 102), agricultural produce and biological assets (covered in section 34 of FRS 102) and financial instruments (section 11 and 12 of FRS 102).
For many entities these differences will have no impact on the recognition or measurement of stock.
However entities operating in the agriculture sector, for example, may, in accordance with FRS 102, apply either a cost model or a fair value model. The use of the fair value model is likely to represent a significant change in the measurement basis of stock and hence the timing of profits/losses on such stock.
For tax purposes there are 2 acceptable valuation bases for stock, either the lower of cost and net realisable value, or mark to market (fair value). If either of these methods are used no ongoing adjustment is required for tax purposes.
Where mark to market is used there is no tax law that requires the profits or losses disclosed by the accounts to be adjusted for tax purposes. Note there are particular tax rules, the ‘herd basis,’ that can be applied to particular farm animals. Guidance on this and the valuation of farming stock is in the Business Income Manual.
6. Investment property
Old UK GAAP (SSAP 19) requires an entity to carry investment property at their open market value with movements in value recognised each period in the STRGL unless they represent a permanent diminution in value in which case they are recognised in the P&L. Where investment properties are let to and occupied by another group entity for its own purpose, SSAP 19 contains an exemption which excludes such properties from its scope (hence they would be included as part of fixed assets).
FRS 102 requires that investment property is initially recognised at cost6 and subsequently measured at fair value. However in contrast to SSAP 19, FRS 102 section 16 requires those fair value movements to be recognised in the P&L. In addition FRS 102 section 16 doesn’t contain an exemption comparable to that present in SSAP 19 for property let to and occupied by group entities. Hence certain properties treated as fixed assets under Old UK GAAP may now be classified as investment property under Section 16 of FRS 102.
Note that FRS 102 section 16 does permit the use of the cost model where the fair value cannot be reliably measured without undue cost or effort.
The accounting treatment of investment properties doesn’t determine, for tax purposes, whether the property is held as an investment property (giving a capital receipt on disposal) or whether it’s part of a trading transaction (and so is on revenue account and forms part of the company’s trading profits).
Assuming the property is held, for tax purposes, as an investment, the income arising on the property is bought into tax as it’s recognised in the accounts (for example rental income would be bought into tax as recognised in profit or loss). In this case, movements in fair value of investment properties aren’t taxable. The disposal of the investment properties will typically give rise to a chargeable gain.
In certain circumstances a company holding investment property as a lessee under an operating lease may, under section 16 for FRS 102, account for it as an investment property. Where it does so, the property is initially recognised at the lower of its fair value and the present value of the minimum lease payments. The corresponding creditor is accounted for as a finance lease (see Section 20 of FRS 102). Where this happens the tax rules applying to finance leases will apply.
7. Property, plant and equipment
Section 17 of FRS 102 and FRS 15 are primarily about Property, plant and equipment (‘PPE’) or ‘fixed assets’ to use the Companies Act and FRS 15 terminology. Both standards are broadly consistent in principle. However differences are present in particular;
- Section 17 of FRS 102 requires that major spare parts are included in PPE
- Section 17 of FRS 102 requires that cost is measured by reference to the present value of all future payments where the asset is acquired under terms beyond normal credit terms
- Section 17 of FRS 102 doesn’t permit the use of Renewals Accounting
- Section 17 requires that residual values are based on current prices rather than historic prices
While such differences for accounting purposes are present, UK tax law departs from the accounting standards by disallowing depreciation and revaluations in respect of capital assets, and instead granting capital allowances (on some assets). Hence accounting changes aren’t expected to have a significant tax impact.
In some cases where ‘revenue’ expenditure is added to the cost of an asset, tax law follows the accounts by recognising for tax purposes amounts reflected in profit and loss account by way of depreciation charge to the extent that they are a write off of revenue expenditure. In those cases where depreciation under Section 17 of FRS 102 differs from that under FRS 15 (for example, because of revaluation of residual values) tax will follow the amount as per Section 17 of FRS 102.
As noted above there is no equivalent to ‘Renewals’ accounting (FRS 15 paragraph 97-99) under Section 17 of FRS 102 so there may be an adjustment for tax purposes made under the change of basis legislation – see part B of this paper.
8. Intangible assets including goodwill
Intangible assets and goodwill arising on business combinations
The definition of an intangible asset in Old UK GAAP (FRS 10) states that intangible asset are “Non-financial fixed assets that don’t have physical substance but are identifiable and are controlled by the entity through custody or legal rights.’’
FRS 102 defines an intangible asset (other than goodwill) as an “identifiable non-monetary asset without physical substance’’ where “identifiable’’ is an asset that is separable or arises from a legal contract or other legal right. This definition is different from that present in Old UK GAAP in so far as the intangible asset need not be separable from the business. Consequently either on transition (where the exemption to retain previous GAAP figures isn’t used) or on subsequent business combinations, more intangible assets may be recognised under FRS 102 than would have been recognised under Old UK GAAP.
For tax purposes Sections 871-879 of Part 8 CTA 2009 provide a comprehensive set of rules for changes in accounting for intangibles and especially for cases where what is included entirely as goodwill under Old UK GAAP is disaggregated into different types of intangible property with different amortisation rates or impairment factors under FRS 102.
Intangible assets and goodwill - Useful Economic Life (UEL)
FRS 10 states that goodwill and intangibles should be amortised over their UEL. It also states that there is a rebuttable presumption that the UEL won’t exceed 20 years. FRS 10 does permit the use of an indefinite UEL in which case it’s not amortised but is instead subject to annual impairment reviews.
FRS 102 differs from Old UK GAAP in respect of UEL. Firstly FRS 102 doesn’t permit an indefinite life. All intangibles and goodwill are presumed to have a finite life and the period over which they are subject to amortisation should reflect this. Where the useful life of the intangible asset can be reliably estimated this life is used as the UEL. Where a reliable estimate of the UEL cannot be made, FRS 102 states that the UEL must not exceed 5 years (note however, that effective periods commencing on or after 1 January 2016 this is changed to 10 years).
In general tax relief is provided on either the amortisation/impairment of goodwill and intangibles recognised in the accounts. Sections 871 to 873 of CTA 2009 ensure that any write up on the transition from Old UK GAAP to FRS 102 will be a taxable credit for Part 8, and section 872 ensures that any such credit is limited to the net amount of relief already given. Any impairment from written up cost will be deductible.
Tax relief is unlikely to be affected if an entity has elected for a fixed rate of 4%. Note that a fixed rate election must be made within 2 years of the end of the accounting period in which the expenditure was incurred and cannot be reversed.
FRS 10 requires that software costs which are directly attributable to bringing an item of IT into use within the business are recognised as part of tangible fixed assets. Where such costs did not relate to bringing an item of IT into use they would typically have been written off direct to the P&L. In addition UITF 29 provides that, where certain criteria are met, website development costs are recognised as part of tangible fixed assets.
FRS 102 doesn’t specify how such costs should be treated. Hence the nature of the item should be considered in determining its treatment. It’s possible that having considered the nature of the software that it’s recognised as an intangible asset.
For companies where costs on expenditure such as software have been previously written off to profit and loss account and claimed as a deduction in a Case I computation in respect of expenditure on a tangible asset, the following tax consequences will apply in respect of the change of accounting policy. First the adjustment in respect of the change of accounting basis will be taxed under Chapter 14 Part 3 CTA 2009. For example, a positive adjustment is brought into account as a taxable receipt. Second, capitalised expenditure in respect of an intangible asset will be relieved under the rules in Part 8 CTA 2009 as it’s written down in the accounts (subject to the normal exclusions, including the pre-FA 2002 rule).
Guidance on many of these issues is in HMRC’s CIRD Manual (in particular see CIRD12300 which address changes in accounting policies for intangible assets within Part 8 CTA 2009).
9. Business combinations
Section 19 of FRS 102 is broadly comparable to FRS 6 and FRS 7. However particular differences are present:
- because of the difference in the definition of an intangible asset an acquisition under FRS 102 may result in a different balancing figure being assigned to goodwill on a business combination
- there is a change in the measurement of the consideration given where that consideration is contingent
- the look back period in which provisional fair values can be amended is different (FRS 102 look back period is 12 months since acquisition date)
- a change in step acquisitions in some circumstances
FRS 6 and 7 of Old UK GAAP are relevant in UK tax law only where the carrying value of an asset or liability acquired in a business combination is relevant for tax purposes, for example, for loan relationships. This also applies where a company is applying FRS 102. Tax law determines the value of trading stock for the business ceasing and its value for the successor business – see Chapter 11 Part 3 CTA 2009. In respect of goodwill on business combinations please see chapter 8 of this paper.
Entities that apply Old UK GAAP will use SSAP 21, UITF 28 and FRS 5 in determining the accounting treatment of leases. Entities that adopt FRS 102 will apply the recognition and measurement requirements of Section 20.
Both Old UK GAAP and FRS 102 consider whether a lease transfers substantively the risks and rewards of the leased asset. However it should be noted that SSAP 21 includes a presumption that if the present value of the minimum lease payments is 90% or more of the fair value of the leased asset that it would typically be classified as a finance lease. Section 20 of FRS 102 doesn’t contain this presumption.
Nevertheless the emphasis on the transfer of risk and rewards is such that in most cases the classification of leases will be consistent between Old UK GAAP and FRS 102. Once the lease has been classified the accounting treatment thereafter is also, generally, comparable. However differences, even where the classification is the same, do exist and the interaction with tax is noted below.
UITF 28 requires that operating lease incentives in the lessee are spread over the period ending on the date from which it’s expected that the prevailing market rent will be payable (if this period is shorter than the lease term, otherwise over the lease term).
Section 20 of FRS 102 requires that lease incentives are spread over the term of the lease unless another way would better reflect the reality. Consequently there may be differences in respect of the period over which such incentives are recognised.
Since the accounting is followed where the incentive isn’t capital (for example, a rent free period) the difference may alter the timing of income recognition for tax purposes.
UK tax law isn’t entirely consistent with SSAP 21 (see Statement of Practice 3/91). But accounts figures (including where appropriate consolidated accounts) are recognised for the purposes of Chapter 2 Part 9 CTA 2010 and Chapter 2 Part 21 CTA 2010 which deal with leasing and finance leases with return in a capital form.
For lessors, FRS 102 Section 20 requires use of the ‘net investment’ method for finance leases, whilst SSAP 21 requires the ‘net cash investment method’. There may be differences in the timing of income recognition under the 2 bases. In some cases these affect the timing of income for tax purposes, for example, where Schedule 12 Finance Act 1997 applies.
Legislation in sections 228B to 228F Capital Allowances Act 2001, and Chapter 5A Part 12 ICTA (inserted by FA 2006) brings the tax treatment of both lessors and lessees of finance leases of plant & machinery into line with the accounting basis in FRS 102 Section 20 or SSAP 21 as appropriate.
Note that it’s not envisaged that s.53 FA11 will apply to entities on transition to Section 20 of FRS 102 by virtue of subsection 3 of s.53 FA11.
There are no significant differences between Section 21 of FRS 102 and FRS 12. For tax purposes the recognition and measurement of provisions in the accounts forms the basis for the quantum and timing of tax relief (subject to adjustment where the expenditure is capital for tax purposes or otherwise disallowable). Consequently, for most companies it’s not expected that FRS 102 will have a significant tax impact in this area.
12. Revenue recognition
In general, reporting of revenue in accounts is followed for tax purposes. There is no specific standard for revenue recognition in Old UK GAAP. However, Application note G of FRS 5 provides revenue recognition guidance in respect of the sale of goods and services as well as other specific revenue recognition scenarios, SSAP 9 provides guidance in respect of long term contracts and UITF 40 addresses service contracts.
The general principles of revenue recognition within FRS 5 Application note G are that revenue is recognised when the seller obtains the right to consideration in exchange for the goods, services, or work performed. The right to consideration typically derives from the performance of its obligations under the terms of the exchange with the customer. FRS 5 application note G requires that, on recognition, revenue is measured at the fair value of the consideration received or receivable.
Revenue recognition under FRS 102 will primarily be determined by Section 23 of FRS 102. The recognition criteria within Section 23 are broadly aligned with Old UK GAAP. In addition, where the respective recognition criteria are met, Section 23 also requires that revenue is recognised at the fair value of the consideration received or receivable.
Hence while there are a few differences between Old UK GAAP and FRS 102 (for example the latter expressively addresses and defines construction contracts in Section 23), for many entities there will be no change following adoption of FRS 102.
Consequently for many companies there will be no accounting or tax impact.
13. Government grants
SSAP 4 requires that grants are recognised when there is reasonable assurance that related conditions, if any, will be met. Where reasonable assurance is present grants are then recognised in the accounts based on the relationship between the grant and the related expenditure.
FRS 102 Section 24 states that the grant won’t be recognised until the entity has reasonable assurance that it will or has complied with the grant conditions and that the grants will be received. It requires that an entity adopts either the accruals or performance model to determine the subsequent accounting for the grant. Under the accruals model grants relating to revenue are recognised in income on a systematic basis over the periods in which the entity recognises the relevant grant costs. Under the performance model Section 24 of FRS 102 states:
- a grant that doesn’t impose specified future performance-related conditions on the recipient is recognised in income when the grant proceeds are received or receivable
- a grant that imposes specified future performance-related conditions on the recipient is recognised in income only when the performance-related conditions are met
- grants received before the revenue recognition criteria are satisfied are recognised as a liability
Whether the accruals model or the performance model is adopted in overall terms the differences, if there are any, are limited to timing differences on recognition.
For tax purposes grants which meet revenue expenditure, such as interest payable, are normally trading receipts, and this will continue where Section 24 of FRS 102 applies.
14. Borrowing costs
FRS 102 Section 25 and FRS 15 on capitalising borrowing costs are similar – both permit such treatment where relevant criteria are met.
For companies section 320 CTA 2009 provides specific rules which allow relief for capitalised borrowing costs but only where they relate to a fixed capital asset or project. However, relief isn’t available where the costs are capitalised in the carrying value of an intangible fixed asset which falls within Part 8 CTA 2009. The same approach will continue where Section 25 of FRS 102 is applied. See CFM 33160 for further details.
15. Share based payments
Accounting for share based payments under Old UK GAAP (FRS 20) and FRS 102 (Section 26) are aligned with few differences.
Tax deductions in respect of share based payments are governed by specific legislation in Part 12 CTA 2009.
16. Employee benefits
In respect of accounting for pension schemes Section 28 of FRS 102 differs to FRS 17 in particular:
- it removes the multi employer exemption on defined benefit schemes such that the scheme position is reported in the solus accounts of the entity contractually or legally responsible for the plan
- the calculation of the net interest on defined benefit schemes is different. Under Section 28 of FRS 102 the net interest comprises the expected interest income on plan assets excluding the effect of any surplus that isn’t recoverable and the interest cost on the scheme obligation.
These changes, and others, aren’t expected to have an impact for tax. Under current UK tax law, sections 196, and 246 FA 2004 and sections 1290-6 CTA 2009 provide relief on a contributions paid basis.
Holiday pay accural
Under Old UK GAAP many entities did not accrue or provide for holiday pay. FRS 102 requires that when an employee has rendered services to an entity during a period any related holiday pay or similar is accrued for.
For tax purposes this accrual would be treated in line with the treatment of unpaid remuneration which is dealt with at Part 20 Chapter 1 CTA 2009.
Employee benefit trusts
Under Old UK GAAP, UITF 32 provides guidance on how to account for Employee benefit trusts.
The requirements of FRS 102 (Section 9) are comparable. FRS 102 states that there is a rebuttable presumption that contributions to an intermediate payment arrangement where the employer is a sponsoring entity are made in exchange for another asset and don’t represent an immediate expense.
In addition the assets and liabilities of the intermediary will be accounted for by the sponsoring entity as an extension of its own business.
The above treatment doesn’t apply where it can be demonstrated that the sponsoring entity won’t obtain future economic benefit from the amounts transferred or it doesn’t have control of the right or other access to the future economic benefit.
For tax purposes the treatment of employee benefit contributions is dealt with at Part 20 Chapter 1 CTA 2010.
17. Foreign currency translation
Under Old UK GAAP a company accounts for its currency exchange transactions in line with either SSAP 20 (where FRS 26 isn’t applied) or FRS 23 (where FRS 26 is applied). For companies which have adopted FRS 23 (and FRS 26) the transition to FRS 102 and Section 30 isn’t expected to result in any significant changes. For companies that applied SSAP 20 many won’t encounter differences but when they do they may be significant. 5 main areas of difference are set out below.
17.1 Functional/presentational currency
Determination of functional currency under FRS 102 requires consideration of the currency of the primary economic environment in which the entity operates. Key factors in determining this are the currency that mainly influences the sales prices for goods and services and the currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services.
Consideration is also given to the currency in which funds from financing activities are generated and the currency in which receipts from operating activities are usually retained. This is in line with the accounting adopted by companies which currently apply SSAP 20.
However, in contrast to SSAP 20, FRS 102 also specifically requires consideration of the influence of the parent on the company’s operations and activities.
It may be that when these factors are taken into account this will result in a different assessment of the company’s functional currency. This could have a significant impact on the calculation of the profits recognised in the company’s accounts. In particular, this can create exchange rate volatility where the company’s assets and liabilities are denominated in a different currency to that of its functional currency.
In addition, FRS 102 allows an entity to have a ‘presentation currency’ which isn’t necessarily the same as the functional currency. This typically has less impact on the calculation of the company’s profit for a period (just that it’s expressed / presented in a different currency).
Chapter 4 of Part 2 CTA 2010 provides detailed rules as to how the company’s profits are to be calculated for tax. CFM64000 explains the operation of these rules. It should be noted, though, that where an investment company changes its functional currency, exchange gains and losses arising on loan relationships and derivative contracts are excluded from tax if they arise as a result of a change in functional currency in the period of account in which the gains or losses arise and a period of account ending in the 12 months preceding that period. See CFM64120 for details.
Where a company is a UK investment company it may be eligible to make a ‘designated currency election’. This must be made in advance of the date it’s to take effective. See CFM64500 onwards for further details.
17.2 Foreign operations (including branches)
Income and expenditure of foreign operations (including branches) are translated from the functional currency of the foreign operation into the company’s functional currency at actual or average rates not at closing. Exchange movements arising on retranslating the company’s net investment in the foreign operation recognised in other comprehensive income.
Note that where the company disposes of the foreign operation, the exchange movements previously recognised to other comprehensive income aren’t recycled to profit or loss.
For tax purposes, the calculation of the company’s profits from a trade or business undertaken through a foreign operation will typically be based on the amounts of profit or loss translated into the company’s function currency in accordance with GAAP. Exchange differences arising from the retranslation of the net investment aren’t typically brought into account for Corporation Tax purposes.
17.3 Contract rate accounting
Where a company enters into a contract to settle a transaction at a particular rate of exchange, SSAP 20 stated that the exchange rate fixed by the contract may be used to record the transaction.
The position is different under FRS 102. The use of a contracted rate of exchange to translate monetary items isn’t permitted. The closing rate as at the balance sheet date should be used instead. The contract would typically represent a derivative financial instrument which would then be separately recognised and measured at fair value in the accounts.
This is a further example of a hedging relationship where under FRS 102 the hedged item and the hedging instrument need to be recognised separately in the accounts. The accountancy and tax treatment of hedging relationships is discussed above (see chapter 4.6).
The Disregard Regulations (regulations 7 and 10) may apply to restore the Old UK GAAP position (where FRS 26 has not been adopted). Guidance on the application of this is available at CFM 57000 onwards.
Note that where the forward contract is taken out as a hedge of qualifying expenditure, the amount of capital allowances is based on the amount of actual qualifying expenditure incurred (for example, translated at the spot rate at the date of that the expenditure is incurred) - see CA11750
Transitional adjustments may also arise - see Part B of this paper for commentary on this.
17.4 Net investment hedging (also known as the ‘Cover method’ or ‘SSAP 20 matching’)
Where an equity investment denominated in a foreign currency is hedged by a loan, SSAP 20 allows a company to re-translate the investment at the balance sheet date as if it were a monetary item. Exchange differences on the shares are taken to reserves. Exchange differences on the hedging loan are also taken to reserves, and offset against the gain or loss on the shares. Any excess on the loan that cannot be offset is taken to profit and loss account. This method of accounting is sometimes called the ‘cover method’ or ‘net investment hedging’.
S328 and S606 CTA 2009 ensure that exchange movements taken to reserves aren’t immediately brought into account. Potentially an adjustment would be made to any chargeable gain calculation where the shares are subsequently disposed of.
There is no equivalent in Section 30 of FRS 102 for the ‘cover method’ of hedging non-monetary assets. Hedge accounting is instead dealt with by Section 12 of FRS 102 (or IAS 39 where this option is taken) – see chapter 4.6 above. However, under either Section 12 of FRS 102 or IAS 39, net investment hedging in respect of a shareholding in a subsidiary company is only permitted at consolidation.
Where a company has a loan liability or a derivative to act as a hedge of the exchange risk from holding an investment in shares, regulations 3 and 4 of the Disregard Regulations (SI 2004/3256) would typically mean that the exchange gain or loss on the loan or derivative would be ‘disregarded’ for tax. Potentially an adjustment would be made to any chargeable gain calculation where the shares are subsequently disposed of.
For further details of net investment hedging see CFM 62000 onwards.
17.5 Permenent-as-equity debt
The following commentary concerns ‘permanent-as-equity’ loans, for example made by a parent to a subsidiary undertaking, which represent an arm’s length provision. Where the loan isn’t undertaken on at arms length terms, then special rules apply for calculating the amount of exchange gains and losses to be taxed. See CFM38500 for further details.
For companies that apply SSAP 20 it’s possible for ‘permanent as equity’ loans to be treated as non-monetary items and be carried at historic rates on the balance sheet rather than be retranslated as at each period end. In such cases, the cumulative exchange movement would be reflected in any gain or loss on eventual disposal of the instrument. Tax would typically follow the accounting in this case.
Alternatively, it’s possible that the ‘permanent as equity’ loan is retranslated at the year end, but with exchange movements recognised through reserves. This might arise in respect of a standalone loan investment, or it may arise where the company has applied the cover method in respect of borrowings or a currency contract matching the loan investment. S328 and S606 CTA 2009 ensure that exchange movements taken to reserves aren’t immediately brought into account. The cumulative exchange gain or loss would typically be brought into account when the loan investment is subsequently disposed of.
In both cases, accounting for such exchange differences is only possible where companies have adopted SSAP 20 (and not FRS 23) and isn’t permitted for companies applying FRS 102. As a result, under FRS 102 such instruments will need to be retranslated at the year end, with exchange movements being recognised in profit or loss.
In most cases such amounts will be brought into account for tax. There is a specific rule to deal with cases where a loan asset or derivative contract ‘matches’ the company’s own share capital – see CFM62850 for further details. In addition, in December 2014 the Disregard Regulations were extended so to exclude exchange movements on certain instruments that were previously accounted for as permanent as equity debt under SSAP20. These exchange amounts are disregarded and brought back into account on disposal of the loan instrument (in line with the treatment under the old accounting).
Transitional adjustments may arise where the debt was not previously retranslated at the year end, although the amendment to the Disregard Regulations may also apply to this transitional amount. See Part B of this paper for commentary on this.
18. Liabilities and Equity
Accounts prepared in accordance with Old UK GAAP will apply the presentation and disclosure requirements of FRS 25 in respect of financial instruments and in particular liabilities and equity.
FRS 102 contains comparable requirements in Section 22, Liabilities and Equity. Consequently on transition from Old UK GAAP to FRS 102 no changes are expected in respect of the classification or presentation of liabilities and equity that currently fall within the scope of FRS 25.
However, while the classification and presentation may not change the subsequent measurement of such items may change on adoption of FRS 102. For example the accounting on issue of a compound financial instrument is comparable across Old UK GAAP (FRS 25) and FRS 102 (section 22). In all cases the issuer will be required to account for the debt and the equity components separately (see CFM21260). However, the issuer of such an instrument will need to consider the measurement requirements of Section 11 and 12 (or IAS 39) in respect of subsequent measurement of the debt component.
Guidance on the taxation of hybrid and compound instruments in both issuer and holder is available in the HMRC Corporate Finance Manual. In particular, see:
- CFM37600 (Bifurcated instruments under the loan relationship rules)
- CFM50410, CFM50420, CFM50430 and CFM52500 (Bifurcated instruments under the derivative contract rules)
- CFM55200 (Holder of convertible or share-linked securities)
- CFM55400 (Issuer of convertible or share-linked securities)
For further guidance on the transitional provisions applying to hybrid instruments see Part B of this paper.
19. Specialised activities
FRS 102 section 34 includes specific guidance on a number of specialised activities such as service concession arrangements, agriculture and extractive industries. Such specialised activities aren’t addressed within this paper.
PART B - Transitional adjustments (Old UK GAAP to FRS 102)
This part of the paper provides a summary of the key accounting and tax considerations that arise on transition from Old UK GAAP to FRS 102.
In accounting terms transition to FRS 102 is addressed in Section 35 of FRS 102.
On transition FRS 102 section 35 requires that the balance sheet presented in respect of the accounting transition date:
- recognises all assets and liabilities whose recognition is required by FRS 102
- doesn’t recognise assets and liabilities if FRS 102 doesn’t permit such recognition
- reclassifies assets, liabilities and components of equity to ensure presentation is consistent with FRS 102
- measures all recognised assets and liabilities in accordance with FRS 102
The transition date, for accounting purposes, is the first day of the earliest accounting period presented in the accounts. For example for entities preparing their accounts at 31 December 2015 the transition date will be 1 January 2014.
FRS 102 contains certain transitional exceptions and exemptions to the above requirements. These aren’t repeated here in detail but cover areas such as business combinations, estimates, intangibles, investment property and service concession arrangements.
However, even with such exceptions and exemptions it’s expected that on transition there may be a significant number of adjustments both to the carrying value of assets and liabilities recognised previously under Old UK GAAP and in terms of newly recognised assets and liabilities. For accounting purposes these adjustments will be made to the assets and liabilities as at the accounting transition date with a corresponding adjustment made directly to the opening P&L reserves.
For trading profit Chapter 14 Part 3 CTA 2009 provide that where there is a change from one valid basis on which the profits of a trade are calculated to another valid basis (for example on a change of accounting policy), an adjustment must be calculated to ensure that business receipts will be taxed once and once only and deductions will be given once and once only. For Corporation Tax purposes, adjustments are treated as receipts or deductions in computing the trade profits. Details of the calculation are set out at BIM 34130.
21. General trading
The relevant legislation for companies is in CTA 2009 Chapter 14 Part 3. Section 180(4) reads:
(4) A “change of accounting policy” includes, in particular —
(a) a change from using UK generally accepted accounting practice to using generally accepted accounting practice with respect to accounts prepared in accordance with international accounting standards, and
(b) a change from using generally accepted accounting practice with respect to accounts prepared in accordance with international accounting standards to using UK generally accepted accounting practice.
So while it details UK GAAP to IAS and vice versa, the key phrase is that a ‘change of accounting policy includes in particular’ those 2 cases. While the change from Old UK GAAP to FRS 102 isn’t listed it’s still included within the scope of this provision.
For companies with property income sections 261-2 CTA 2009 deal with adjustment income or expenditure where the basis on which the profits are calculated changes.
The relevant legislation is in CTA 2009 at Part 8, Chapter 15.
Where there is a change of accounting policy in drawing up a company’s accounts from one period of account to the next, and both those accounts are drawn up in accordance with GAAP in relation to those periods then the provisions of Chapter 15 will apply.
No taxable credit or allowable debit is to be brought into account under Chapter 15 to the extent that it’s already brought into account by section 723 (revaluations), section 725 (reversal of accounting loss) or section 732 (reversal of accounting gain). See section 878 CTA 2009
Change in accounting value
When there is a change of accounting policy it’s possible that there will be a difference between the accounting values recognised at the end of the earlier period and the opening balance in the later period for certain intangible fixed assets. Where such a difference arises and no section 730 election has been made section 872 treats an increase as a taxable credit, and a decrease as an allowable debit, arising at the start of the later accounting period.
The amount of the debit or credit is the difference multiplied by the fraction tax written-down value/accounting value, where both these values are those at the end of the earlier period. Section 872(5) caps the amount of any credit to the net amount of previous debits on the asset less previous credits on the asset.
Chapter 15 also contains different rules to deal with a change of policy involving disaggregation or where the asset is subject to a fixed-rate writing down election under section 730.
Primacy of other parts of Part 8
Section 878 contains provisions to ensure that where all or part of the difference is brought into account under other sections of Part 8 that part isn’t brought into account again. The relevant other paragraphs are section 723 (gain on revaluation CIRD 13050), section 725 (reversal of accounting loss CIRD 13090) and section 732 (reversal of accounting gain CIRD 12560).
Section 872 doesn’t apply to a chargeable intangible asset in respect of which a fixed rate election has been made under section 720 (see CIRD 12905).
23. Financial instruments
Transitional adjustments - general
Adjustments on loan relationships as a result of changes in accounting policy can arise under 2 separate parts of the regime.
Prior period adjustments
In cases where a company stays within the same accounting framework, or otherwise doesn’t restate its opening figures, the accounts will normally show a prior period adjustment (PPA) either in reserves or in equity. For loan relationships section 308 ensures that this amount is brought into account for tax purposes where it’s taken to the statement on total recognised gains and losses (in Old UK GAAP) or statement of changes in equity (in FRS 101, FRS 102 or IAS).
A transitional adjustment which takes the form of a PPA will also be adjusted for tax purposes by any relevant provision. For example, if the company changes the accounting treatment of a loan to a connected company so that it’s in future accounted in its accounts on a fair value basis, there will be a PPA reflecting the difference between the carrying value under an accrual method and fair value. However, s349 CTA 2009 requires the profits and losses on the asset continue to be brought into account for tax purposes as if the change to fair value accounting has not been made. Therefore the PPA is in this example ignored.
No prior period adjustment
In some cases there may be no PPA even though there is a change in accounting measurement for a particular instrument. For example, no PPA will be recognised where there is a change to the overall accounting framework and the opening figures have been restated. This will often be the case where a company adopts IAS, FRS 101 or FRS 102 for the first time.
In these cases sections 315 to 319 CTA 2009 will apply. These calculate the transitional adjustment by comparing the opening accounting value in the current accounting period with the closing accounting value for the previous accounting period. Accounting carrying value is defined to mean the carrying value of the asset or liability as shown in the balance sheet of the company subject to adjustments for specific tax provisions which have the effect of changing the carrying value for tax purposes (for example, s349 CTA 2009 for connect party debt).
The derivative contract regime has equivalent rules in sections 597 and 613 to 615 CTA 2009. The overall effect in either case is to ensure that no amount should fall out of account as a result of a change in accounting policy.
Change of Accounting Practice Regulations
In 2004 and 2005, the Government considered various representations about the impact of the transitional rules when a company moves from Old UK GAAP to either IAS or FRS 26. In view of the size of some of the known impacts, and the fact that many of the impacts could not be determined until companies made the calculations after the year end, the Government decided to defer the tax impact of all transitional adjustments. This deferral was given effect in Change of Accounting Practice (COAP) Regulations (SI 2004/3271), which have been the subject of subsequent amendments.
The COAP Regulations apply to most transitional adjustments arising in respect of loan relationships or derivative contracts from change in accounting practice. As such, the Regulations are applicable to transitions to FRS 101 and FRS 102 in the same way as they applied to transitions to IAS or FRS 26. In most cases, the effect of the Regulations is to spread the transitional adjustment over 10 years, starting with the first period in which the new accounting policy applies.
A company has a loan with non-vanilla terms in an unconnected company which is due to be repaid in 5 years. Under Old UK GAAP it measures the loan on a historic cost basis. Under FRS 102 it’s required to measure the loan at fair value. On transition, the difference between the closing value for the previous period and opening value in the current period is to be brought into account, with the amount spread over a period of ten years.
There are certain exclusions from the COAP Regulations. In these cases the COAP Regulations don’t apply at all. This is likely to mean that the transitional adjustment will be brought into account in full on transition (ie subject to the normal rules). The main exclusions are for transitional adjustments in respect of:
- a loan relationship which comes to a natural end in the accounting period that the transition takes place because it’s repaid or redeemed on the date which is the latest date on which, under its terms, it falls to be repaid or redeemed
- an embedded derivative that is bifurcated out of a loan asset or liability described in the first bullet
- a derivative contract which hedges a loan asset or liability described in the first bullet
A company has a designated a financial instrument as AFS with maturity in 6 months. Under Old UK GAAP it measures the loan and derivative on an historic cost basis. Under FRS 101 it’s required to measure the derivative at fair value. On transition, the difference between the closing value for the previous period and opening value in the current period is to be brought into account in full in the current period.
The COAP Regulations also include provision for some further cases where transitional adjustments will never be brought into account. These specific issues are explained below, but are intended to ensure that the correct amounts are brought into account overall for loan relationships and derivative contracts.
Transitional adjustment - specific issues
(1) Convertible loans and asset-linked instruments (pre-2005)
There are rules which grandfather the previous tax treatment for most convertible debt and asset-linked instruments issued before the company’s first period of account beginning on or after 1 January 2005 (see CFM 37680 to 37710 for further details).
The COAP Regulations (reg 3C(2)(a), reg 3C(2)(aa) and reg 3C(2)(f)) require that amounts that arise on transition in respect of such contracts are never brought into account. This ensures that there is continuity of treatment.
(2) Embedded derivatives where the host instrument isn’t a loan relationship
Going forwards under FRS 102 (with the IAS 39 option) embedded derivatives in a contract are typically required to be bifurcated in the accounts. However, where section 616 CTA 2009 applies, the embedded derivative is treated as if it were closely related to the host contract and therefore not separated out. The COAP Regulations (reg 3C(2)(b)) requires that amounts that arise on the transition to FRS 102 on such contracts are never brought into account. This ensures that there is continuity of treatment.
(3) Interest rate contracts in a hedging relationship (Reg 9 contracts)
Under IAS, FRS 101 and FRS 102, derivative contracts will typically be measured at fair value in the company’s accounts. Regulation 9 of the Disregard Regulations deals with interest rate contracts used for hedging. Amounts on such contracts are brought into account on an ‘appropriate accruals basis’. In effect, the tax treatment of such contracts under ‘Old UK GAAP’ continues where regulation 9 of the Disregard Regulations applies.
The COAP Regulations (reg 3C(2)(c)) means that no transitional adjustments arising on such contracts are to be brought into account under these Regulations. This ensures that there is continuity of treatment. The amounts will be brought into account under the Disregard Regulations in priority to the COAP Regulations.
(4) Currency, commodity and debt contracts in a hedging relationship (Regs 7 or 8 contracts)
Under IAS, FRS 101 and FRS 102, derivative contracts will typically be measured at fair value in the company’s accounts. Regulations 7 and 8 of the Disregard Regulations deals with currency, commodity and debt contracts used to hedge a forecast transaction or firm commitment. Amounts on such contracts are brought into account under regulation 10. Generally, the effect of these regulations is that the tax treatment of such contracts follows the ‘Old UK GAAP’ accounting treatment.
The Disregard Regulations (regs 7(1) and 8(1)) provide that no transitional adjustments arising on such contracts are to be brought into account – these amounts are disregarded. This ensures that there is continuity of treatment – the amounts will subsequently be brought into account under the Disregard Regulations in priority to the COAP Regulations.
(5) Designated cashflow hedges (Reg 9A contracts)
Under IAS, FRS 101 and FRS 102, derivative contracts will typically be measured at fair value in the company’s accounts. Under a designated cash flow hedge, the company will recognise certain movements in the fair value through other comprehensive income, and maintained as part of a cash flow hedging reserve.
Regulation 9A will apply in respect of designated cash flow hedges, unless the instrument is within regulation 7, 8 or 9 of the Disregard Regulations. The effect of this regulation is to disregard for tax purposes the amounts recognised in the statement of equity (as items of other comprehensive income) until they are recycled to the income statement.
The COAP Regulations (reg 3C(2)(e)) exempts the spreading on transition amounts to the extent that they hedge future cashflows. It’s aimed at the opening adjustments to the cashflow hedge element of shareholders’ equity reserves. These amounts will subsequently be recycled through the income statement and so ensures continuity of treatment.
(6) Contract rate accounting
Under Old UK GAAP where FRS 23 (and FRS 26) doesn’t apply, a company can translate a foreign currency amount on a monetary item (typically a money debt or a loan relationship) using the rate implicit in a contract (typically a derivative contract). This isn’t permitted under IAS, FRS 101 or FRS 102 which all require the foreign currency amount to be translated using the spot exchange rate. Typically the derivative contract will be required to be recognised separately and measured at fair value. Potentially the company may apply hedge accounting in respect of the hedging relationship in its accounts.
Where regulation 9 of the Disregard Regulations applies, any adjustment to the derivative contract is effectively ignored – see (3) above. Where this happens, the COAP Regulations (reg 3C(2)(d)) disregards any loan relationship adjustment as well.
(7) Reversal of previous exchange gains and losses
Very occasionally an issue can arise where transitional adjustments represent the reversal of previous exchange gains and losses, typically where the company treats the loan as an equity instrument. The COAP Regulations (reg 3C(2)(ca) and reg 3C(2)(da)) provide that such transitional adjustments aren’t to be brought into account to the extent that those previous exchange gains or losses had been disregarded for tax.
(8) Permanent as equity debt
Under Old UK GAAP where FRS 23 (and FRS 26) doesn’t apply, a company can translate permanent as equity debt at its historic cost. This isn’t permitted under IAS, FRS 101 or FRS 102 which all require the foreign currency amount to be translated using the spot exchange rate.
In certain cases, regulation 12A of the Disregard Regulation can apply to exclude the transitional adjustments on permanent as equity debt.
(9) Modification and replacement of distress debt
Under Old UK GAAP where FRS 26 doesn’t apply, where debt is restructured or have its terms modified, no gain or loss would be recognised in the accounts. In contrast, FRS 102 requires that where modification is considered substantial the original debt instrument will be derecognised and the ‘new’ instrument recognised at its fair value.
In certain cases where the company is in financial distress, the COAP Regulations (reg 3C(2)(g)) exempts the credits arising on transition, together with any debits representing the reversal of these amounts.
For further details of the treatment of transitional adjustments for loan relationships and derivative contracts see CFM76000 onwards.
Defined, for purposes of this paper only, on page 3 ↩
See FRS102 11.7 and 12.3 for comprehensive list ↩
Note that where the convertible debt is a compound financial instrument the accounting in the issuer will also be determined by reference to Section 22 of FRS 102 ↩
The appendix to UITF Abstract 47 provides some further explanation of these points ↩
IAS 39 has a similar requirement for companies that have chosen the IAS 39 option ↩
If payment terms are deferred beyond normal credit terms, the cost is determined by reference to the present value of the future payments ↩