HMRC recently issued guidance on the current tax implications of FRS101/102, the new accounting standards applicable to UK companies who do not already account under IFRS or FRSSE.

Financial instruments

FRS102 classifies financial instruments as either 'basic' or 'non-basic' as follows:

  • Basic financial instruments (such as cash, trade debtors, trade creditors and simple loans) – recognised at transaction price/ amortised cost i.e. no change; and
  • Non-basic financial instruments (such derivatives, non-plain vanilla debt, investments in convertible debt) – recognised at fair value, leading to greater volatility in the profit and loss account.

Tax Impact

Tax treatment will follow the accounting treatment, and therefore for 'non-basic' financial instruments the requirement to recognise at fair value will result in greater movement in the financial statements (either in P&L or statement of other comprehensive income). As these adjustments will generally be taxed, then companies should expect greater volatility in their tax computations.

HMRC sets out specific tax rules for the following types of financial instrument.

  • Intercompany loans – treat as a 'basic' financial instrument, ie amortised cost basis.
  • Debt-equity swaps – any amount of profit recognised in P&L or reserves is taxable. However, there are exempt gains arising where a debt is released in consideration of shares (s322 CTA 2009 – see CFM 33200 onwards for more detail)
  • Hedging relationships – possible to disregard the accounting treatment on election (SI 2004 / 3256). See CFM 13270 for further details.

Investment Properties

Investment properties should be initially recognised at cost, and then subsequently at fair value, with movements recorded in the P&L.

Tax impact

The movements in fair value on properties let to third parties are not taxable unless the property is actually sold. However there is a requirement to reflect deferred tax on this movement (although this is not detailed in HMRC's guidance).

Intangibles including goodwill

Under FRS101/102 the useful economic life of an asset must be finite and cannot exceed 5 years where a reliable estimate cannot be made. Previously under UK GAAP the rebuttable presumption was a maximum life of 20 years, although an indefinite life could apply.

Tax impact

This could result in a material impact to the amortisation of intangible assets for both accounting and tax. Where tax relief is claimed on amortisation, then the rate of relief may increase under FRS102. However if the election to amortise the asset at 4% per annum for tax has been made, then this will not be impacted by the change in accounting treatment.

Leases

FRS 101 / 102 does not have the presumption that if the present value of minimum lease payments is greater than 90% of the fair value of the asset then this would be classified as a finance lease. This could impact the tax treatment of some leases previously seen as finance leases.

Another tax change is the change arising from the spreading of lease incentives (FRS102 requires the incentive be spread over the term of the lease unless there is a more appropriate method, while previous UK GAAP requires the spreading of an incentive over the period to the first rent review). This may create differences in the period over which lease incentives are recognised for tax purposes.

The assessment of finance leases for lessors changes under FRS102 from the 'net cash investment' method (under SSAP 21) to the 'net investment' method. This could create some differences in the timing of income recognition and therefore tax assessment.

This is only a brief summary of some of the issues highlighted in the recent HMRC guidance, as FRS101/102 could have a wide ranging impact for those companies affected. Please speak to your usual S&W contact to discuss the potential impact for you.

We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2014. NTD174 code exp: 30/6/2014