CFM76120 - Other tax rules on corporate finance: change of accounting basis: examples: own credit risk

This example applies in respect of the tax rules which apply for accounting periods beginning on or after 1 January 2016 onwards.

Under IFRS 9, companies may designate certain financial liabilities as fair value through profit or loss (FVTPL). For these liabilities, the element of the fair value gains and losses attributable to changes in their own credit risk are recognised in other comprehensive income (OCI) rather than profit or loss, except where this would create or increase an accounting mismatch.

Transition to IFRS 9 - accounting position

Under IAS 39 all of the fair value movements would have been recognised in profit or loss, where they would have typically have been brought into account for tax purposes.

Under IFRS 9, however, the fair value movements relating to the company’s own credit risk will normally be recognised in OCI. This will apply to the recognition of amounts for future periods. In addition, on adoption of the new accounting requirements the company would typically create a separate reserve within equity to reflect the amounts that, under the new accounting treatment, would have been recognised in OCI.

There will be no change in the carrying value of the liability - it is still measured at fair value. As such, there is no change in the company’s net assets in respect of this accountancy change.

Transition to IFRS 9 - tax position

Although there is no change in the accounting carrying value of the liability, there is a change in the tax-adjusted carrying value (TACV). This is because the tax rules provide for the amounts that have been recognised in OCI to be brought into account in the future - either when the amounts in question are recycled to profit or loss, or on the derecognition of the loan or liability if no recycling is expected.

As a result, the cumulative amounts previously taken to profit or loss and which are now recognised in OCI will need to be reversed for tax purposes on transition to the new accounting standard.

A separate spreading rule applies to this transitional adjustment so that it is spread over five years on a reducing basis of 40%, 25%, 15%, 10%, 10% rather than the standard ten year spreading [COAP regulation 3A(2A)].

Example

A company has issued a loan with face value of £100m which is measured at FVTPL under IAS 39. As at 31 December 2017 the fair value of the loan is £85m. The cumulative fair value movements of £15m have been recognised in profit of loss. Of these, credits of £10m are in respect of the company’s own credit risk.

In 2018 the company adopts IFRS 9 and continues to measure the loan at FVTPL. It therefore takes the fair value movements on the instrument that relate to the company’s own credit risk to OCI prospectively. In addition, it assumes for these purposes that it has always adopted this accounting treatment. As a result, it restates its accounts to reflect that the fair value movements relating to the company’s own credit risk are taken to OCI. In particular, it would typically create a reserve within equity for these amounts, which will have a credit balance of £10m as at 1 January 2018.

Under the old accounting treatment, the company would have been taxed on the fair value movements in the loan as they are recognised in profit or loss. As such, there are no adjustments needed to determining the TACV of the loan at 31 December 2017. The TACV at 31 December 2017 will be £85m.

Under the new accounting treatment, however, the company will not be immediately taxed on the fair value movements that are recognised in OCI. Instead these amounts will be brought into account when they are recycled to profit or loss, or on derecognition of the loan. As such, the amounts that are treated as being recognised in OCI need to be removed from the carrying value of the loan in calculating the TACV. The TACV at 1 January 2018 will be £95m.

A transitional debit adjustment of £10m must therefore be brought into account on adoption of IFRS 9. This represents the increase in the TACV of the liability from £85m to £95m. It can also be seen as reversing the cumulative fair value gains of £10m that have previously been recognised in profit or loss (and already taxed), and which for future periods will be treated as taxable by having been recognised in OCI. There is a separate spreading rule under the COAP Regulations which applies in respect of the amounts relating to own credit risk on adoption of IFRS 9. As a result, the transitional debit of £10m is relieved over five years £4m in 2018, £2.5m in 2019, £1.5m in 2020, £1m in 2020 and £1m in 2020.