Deferred tax under FRS 102

This helpsheet has been issued by ICAEW’s Technical Advisory Service to help members understand how to account for deferred tax under FRS 102.

Members may also wish to refer to the following related helpsheet:

• Accounting for investment property under FRS 102

Section 29 requires that deferred tax is recognised in respect of ‘timing differences’, which arise when gains and losses are recognised in profit or loss in a different period than when they are recognised in the tax computation.

Section 29 also adds a requirement to recognise deferred tax arising in connection with business combinations (such as fair value adjustments and newly recognised assets and liabilities - discussed in more detail below), which is not strictly a timing difference.

FRS 102 paragraph 29.12 states that deferred tax should be measured using ‘the tax rates and laws that have been enacted or substantively enacted by the reporting date that are expected to apply to the reversal of the timing difference’.

While paragraph 29.12 talks about the rate we expect to apply at the time of the reversal, we are still limited to those rates that have been substantially enacted at the reporting date.

Example

Company A has a year end of 31 December 20X2.

At 31 December 20X2 the substantively enacted rates are 19%, increasing to 25% from April 20X3.

Company A has timing differences that are expected to reverse in the year to 31 December 20X4.

Company A therefore calculates their deferred tax using the 25% rate.

Prior to the 20X2 accounts being signed off there is an announcement that the increase to 25% will not go ahead.

This would not change the figures presented in the December 20X2 financial statements. This is because the rates substantially enacted at the year end have not changed.

The announcement is a non-adjusting post balance sheet event, so if the impact is material this should be disclosed in a note in line with paragraph 32.11 of FRS 102.

As defined in the glossary to FRS 102, a tax rate is regarded as ‘substantively enacted’ if it is included in either:

• a Bill that has been passed by the House of Commons and is awaiting only passage through the House of Lords and Royal Assent; or
• a resolution having statutory effect that has been passed under the Provisional Collection of Taxes Act 1968. (Such a resolution could be used to collect taxes at a new rate before that rate has been enacted. In practice, corporation tax rates are now set a year ahead to avoid having to invoke the Provisional Collection of Taxes Act for the quarterly payment system).

Paragraphs 29.15 and 29.16 of FRS 102 specify that deferred tax relating to non-depreciable assets (such as land) and investment property should be measured using the rates and allowances that apply to the sale of the asset (other than investment property with a limited useful life and is held within a business model whose objective is to consume substantially all of the economic benefits embodied in the property over time). This is because the expectation is that the value will be recovered through sale rather than through use and the tax rate used should reflect this expectation.

Under FRS 102, Section 17 permits the use of the revaluation model for property, plant and equipment, with revaluation gains and losses being recognised within other comprehensive income and accumulating in a revaluation reserve.

Deferred tax will usually need to be provided on revaluation movements on property, plant and equipment, even if rollover relief is expected to be available (since rollover relief merely delays the tax effect; it does not eliminate it).

Example

Company A owns a freehold building from which it operates and is accounted for using the revaluation model. The applicable tax rate is assumed to be 20%.

During the year the building appreciates in value from £200k to £250k, accounted for as follows:

Dr Freehold buildings £50k
Cr Other comprehensive income  £50k (accumulating in the revaluation reserve)

The resulting deferred tax effect of £10k (£50k x 20%) is also recorded as follows:

Dr Other comprehensive income £10k
Cr Deferred tax liability  £10k

For assets held under the revaluation model in line with Section 17 an assessment will need to be made regarding how the value of that asset is expected to be recovered by the entity – either through use or sale. This assessment will information the appropriate tax rate to use for the calculations of deferred tax.

Under FRS 102, Section 16 requires most investment property to be carried at fair value through profit or loss (see Accounting for investment property under FRS 102). As such, a timing difference usually arises on the remeasurement of the investment property at each year end which would therefore require deferred tax to be recognised. As the fair value movement is recognised in the profit or loss account, the deferred tax on the remeasurement of the investment property is also recognised in the profit or loss account.

In most cases, deferred tax in relation to investment properties carried at fair value is measured using the tax rates and allowances that apply to the sale of the asset in line with FRS 102 paragraph 29.16.

When accounting for a business combination using the purchase method set out in Section 19 of FRS 102, the identifiable assets, liabilities and contingent liabilities of the acquiree are recognised in the consolidated financial statements at their fair values at the acquisition date. These fair values may be different from the amount which is deductible for (or liable to) corporation tax. In such cases, paragraph 29.11 of FRS 102 requires deferred tax to be recognised in respect of these differences. Any deferred tax recorded in this manner is adjusted against the goodwill figure. For this reason, FRS 102 prohibits the recognition of deferred tax in respect of goodwill itself.

FRS 102 paragraph 29.7 states that ‘unrelieved tax losses and any other deferred tax assets shall be recognised only to the extent that it is probable that they will be recovered against the reversal of deferred tax liabilities or other future taxable profits (the very existence of unrelieved tax losses is strong evidence that there may not be other future taxable profits against which the losses will be relieved)’. Probable is defined in the glossary to FRS 102 as more likely than not.

This does not mean that there is an all or nothing approach to the recognition of deferred tax assets. It may be the case that it is probable that part of a deferred tax asset will be recovered but not probable that the remainder will be.

In assessing whether a deferred tax asset should be recognised an entity needs to assess the expected performance, and the likelihood of improved results leading to the realisation of the deferred tax benefit.

Where a financial instrument is measured at fair value through profit or loss (e.g. derivatives, or investments in publicly traded shares), the resulting gains or losses may be taxed when they are recognised in the financial statements, or they may be taxed on settlement (or sale) of the financial instrument.

If the gains or losses are taxed in the same period as they are recognised, there are no deferred tax implications, since there is no timing difference. However, if they are only taxed on sale or settlement of the financial instrument, a timing difference will arise and deferred tax will need to be recorded as a result.

The tax treatment of financial instruments is a complex area and specialist advice may be required in determining whether and when such items are taxable.

Statement of comprehensive income

In the statement of comprehensive income, broadly speaking, the presentation of deferred tax follows the item to which it is attributable. For example, deferred tax arising on the remeasurement of investment property would appear in the tax expense line of the profit and loss account, because the fair value gain or loss on the investment property will also appear in the profit and loss account. However, deferred tax arising on the revaluation of an item of property, plant and equipment will appear in other comprehensive income (OCI), consistent with the treatment of the revaluation movement to which it relates.

Balance sheet

In the balance sheet, paragraph 29.23 of FRS 102 requires that deferred tax liabilities are presented ‘within provisions for liabilities’ and deferred tax assets are presented ’within debtors’, unless the balance sheet formats have been adapted.

FRS 102 paragraph 29.24A requires deferred tax assets and liabilities to be offset (i.e. presented net in the balance sheet) if, and only if:

• the entity has a legally enforceable right to set off current tax assets against current tax liabilities; and
• the deferred tax assets and deferred tax liabilities relate to income taxes levied by the same taxation authority on either the same taxable entity or different taxable entities which intend either to settle current tax liabilities and assets on a net basis, or to realise the assets and settle the liabilities simultaneously, in each future period in which significant amounts of deferred tax liabilities or assets are expected to be settled or recovered.

ICAEW members, affiliates, ICAEW students and staff in eligible firms with member firm access can discuss their specific situation with the Technical Advisory Service on +44 (0)1908 248 250 or via webchat.