It is tempting to think that the tax practitioner comes to FRS 102 later than his or her accounting and audit colleagues. They prepare the accounts – maybe with a rough and ready tax provision – and then the tax computation is honed and finalised. In my view, the tax practitioner needs to understand the implications of FRS 102 well before that. The recent tentative decision by the Financial Reporting Council to withdraw FRSSE and bring small and micro-companies into FRS 102 increases the scope of entities to whom the considerations in this article apply.
There are three direct issues for the tax practitioner arising from the transition from old UK GAAP to FRS 102. The first, and perhaps most obvious is the change to taxable profit arising from changes to accounting profit. The general principle is that the tax treatment follows the accounting treatment, unless there is a specific tax rule which overrides the accounting treatment. Therefore changes to accounting profit arising from the revised treatment of, say, lease incentives and fair valuing derivative financial instruments will affect taxable profit, the requirement to accrue holiday pay might affect taxable profit – if it is payable within nine months after the end of the year and changes in depreciation will not affect taxable profit as depreciation is not allowed for tax but replaced by capital allowances. The changes in intangible assets – changes to the useful life and the fact that more intangibles will be recognised separately from goodwill – will affect corporation tax profits but not those for income tax.
In addition to the general principle, the tax practitioner needs to understand that FRS 102 is a standard of choices, and that these choices are likely to impact on tax. The tax practitioner may want to have a say in the choices the client should make. These choices fall into two groups – those accounting policy changes, which are permanent and those related to transition which are one-off but have a lasting effect. These choices may need to be made well before the actual tax computation is prepared, and often before the date of transition.
Consider the accounting for lease incentives referred to above. Under UITF 28 these incentives were credited to profit and loss over the shorter of the lease life and the period to the date of the next rent review, whereas under FRS 102 they are, generally, credited over the lease life. The net effect is that the taxable profit they represent is spread over a longer period under FRS 102 than under UITF 28. For most people this is likely to be attractive. There is a transition exemption in FRS 103 35.10(p) which allows an entity transitioning to FRS 102 to retain the treatment under UITF 28 where the lease commenced before the date of transition, rather than full restatement. Clearly this exemption is to make it easier for entities to make the transition without having to trawl through lease agreements and redo calculations. But easiest is not always best. To restate the lease incentive will always be more tax effective, unless of course the original treatment was over the life of the lease! There is even the possibility that the existence of very large lease incentives may justify recommending a client to early adopt FRS 102 so that the tax benefits are received earlier. Indeed they could have been obtained for periods ending as early as 31 December 2012.
There are similar transition issues in the treatment of goodwill and intangibles acquired during business combinations. If by restating the intangibles at the date of acquisition there is a quicker write off for tax, this may be considered a better option than retaining the old FRS 7 and 10 values.
The second reason the tax practitioner needs to get to grips with FRS 102 early is the need to recognise new adjustments in the tax computation. Under FRS 102 revaluation surpluses will be recognised in the profit and loss account and therefore be included in profit before tax. Under FRS 3 they were recognised in the STRGL. They will not be taxable until sold and therefore this profit will need to be added back in the tax computation. Listed investments will be included at fair value under FRS 102 with gains being recognised in profit and loss. They are currently carried at cost less impairment. These profits will not be taxable either and need to be added back. Blindly following last year’s tax computation may miss these important adjustments.
Last, but by no means least, in these direct impacts is the taxation computation in the year of transition. Tax law has always had an approach to taxing changes in accounting policy. These are reflected in sections 227 – 240 ITTOIA 2005 and S 180 – S 187 CTA 2009 and require the computation of adjustment income or expense, which is added to or deducted from the taxable profit for the year computed in the normal way i.e. taxable profit under FRS 102 adjusted under tax law at the time. There are special situations for areas such as mark to market. These general principles are applied at the date of transition. Practitioners need to understand the mechanics of this computation, together with the options available.
Finally in this article it is important to note that FRS 102 brings significant changes in the calculation and treatment of deferred tax, and the tax practitioner may be involved in doing – or checking - the calculation. The basic principle is the same as FRS 19 – tax on timing differences computed at the rate excepted to apply when the difference reverses. However the old exemptions do not apply and deferred tax is required on revaluation surpluses for investment and freehold properties. Under FRS 18 deferred tax would only be applied if there was a binding sales agreement and the entity recognised the profit or loss on sale. In addition, there are new timing differences on which deferred tax is required, such as the revaluation gain on listed investments referred to above.
The recent tentative decision by the Financial Reporting Council to withdraw FRSSE and bring small and micro-companies into FRS 102 increases the scope of entities to whom the above considerations apply.
Bill Telford is a freelance lecturer and training consultant specialising in financial reporting and auditing.
He is also the co-author of Accounting Principles for Tax Purposes, Fifth Edition which is available online here.