The FRS 105 paper provides an overview of the key accounting changes and the tax considerations that arise for businesses that transition from old UK GAAP to FRS 105, covering topics from financial instruments and loans, investments in associates and joint ventures, to investment property.

As with the earlier FRS 102 guidance issued by HMRC, there are still a number of areas that have not been resolved, for example, how the tax treatment of equity instruments in the form of shares and guarantees.

FRSSE transition to New UK GAAP, particularly FRS 105, will impact on the accounts in two ways:

• assets and liabilities at the accounting transition date will be identified, recognised and measured in line with the requirements of the new standard; and
• 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.

Loans and derivatives

For companies within the charge to Corporation Tax, 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.

Despite producing a 25-page paper on FRS 105 tax treatment, HMRC has not decided the exact tax approach for financial instruments such as equity instruments in the form of shares and guarantees.

In the guidance note HMRC states: ‘There’s no equivalent legislation for businesses within the charge to income tax. This may lead to significant differences from corporation tax in tax treatment. In particular, items which are capital in nature will generally not be taken into account for income tax purposes.’

The distinction between capital and revenue items is an important one for financial instruments as this will to a large extent determine the tax treatment. An example of capital borrowing would be a long term loan of fixed amount which is used to enlarge the capital employed in the trade, while revenue borrowing is typically a bank overdraft facility.

It is important to note that what constitutes a capital item is not defined by statute and there is no single test that will determine the issue in all circumstances. HMRC Manual BIM35000 onwards has more guidance about the principles and criteria which need to be considered.

It is important to note that where a financial instrument is measured on a different basis under FRS 105 compared with Old UK GAAP or the FRSSE, transitional adjustments on adoption of FRS 105 will arise.

Loan relationships

On loan relationships, the tax treatment now typically follows the amounts recognised in profit or loss. For corporation tax, the loan relationship would normally be taxed in line with the amount recognised in the accounts. As such, the profit or loss on derecognition or re-recognition will typically be brought into account.

For income tax, whether or not the gain or loss arising is taken into account for tax purposes will depend on whether the gain or loss relates to borrowing of a capital nature or borrowing of a revenue nature.

Balance sheet

Accounts prepared under FRS 105 are also required to present a balance sheet (or ‘statement of financial position’). Section 5 of FRS 105 requires the profit or loss for the period to be presented in an income statement. There’s no requirement in FRS105 for a STRGL or any similar statement.

The HMRC guidance states: ‘Whether prepared using Old UK GAAP (or the FRSSE) or New UK GAAP the relevance of consolidated accounts and equity accounting is very limited in UK tax law.’

An entity cannot apply FRS 105 if it is required to or chooses to present consolidated financial statements (because it’s excluded from the micro-entities regime).

The FRS 102 overview papers show the consolidated accounts requirements for FRS 102 entities.

Typically, things like the accounting treatment of associates, joint ventures in individual financial statements has no relevance for tax under current UK law.

Accounting policy

FRS 105 requires that an adjustment is made to the opening balance of each affected component of equity (corresponding to the changes in the opening balances of assets and liabilities).

Accounting for change in estimate

There is no change to accounting for a change in estimate under FRS 105 in the sense that it reflects old UK GAAP/FRSSE treatment. This means that where an entity changes the useful estimated life of a tangible fixed asset, it does not adjust the depreciation brought forward. Instead the depreciation is adjusted prospectively to reflect the revised useful economic life.

Accounting for errors

Section 8 of FRS 105 requires that, to the extent practical, a business shall correct material errors retrospectively in the first financial statements authorised for issue after the error is discovered. This is achieved through restating the prior period comparative figures. Errors that are not considered to represent material errors are accounted for in the period they are identified.

Tax treatment

For trading profit, 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 only once and deductions will be given once and once only.

This is reflected in Chapter 14 Part 3 Corporation Tax Act 2009 (CTA 2009) (for corporation tax) and Chapter 17 Part 2 Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005) (for income tax).

For companies within the charge to corporation tax, 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.

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.

Loans and financial instruments

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, including new rules that apply from 1 April 2016. In particular, the tax treatment now typically follows the amounts recognised in profit or loss.

Non-UK incorporated companies

It is 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 are not resident in the UK (for example, controlled foreign companies).

In most cases the same statutory definition of GAAP 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).

Tax legislation for businesses 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 (section 46 Corporation Tax Act (CTA) 2009) or income tax (section 25 of Income Tax (Trading and Other Income Act 2005 (ITTOIA)) purposes. Similar rules exist in other parts of the tax legislation.

GAAP for corporation tax purposes is defined at section 1127 CTA 2010 and is:

• UK GAAP – 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; or
• in relation to a company that prepares IAS accounts means generally accepted accountancy practice in relation to IAS accounts.

HMRC links

FRS 105 overview paper - tax implications - updated 21 July 2017

The HMRC landing page, Accounting standards: the UK tax implications of new UK GAAP, is available here