FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland deals with deferred tax in Section 29 Income Tax. For micro-entities choosing to prepare financial statements under FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime, deferred tax is irrelevant.
FRS 102 requires deferred tax to be recognised on all timing differences that have originated, but not reversed, at the balance sheet date (with certain limited exceptions). FRS 102, para 29.6 confirms that ‘timing differences’ are differences between taxable profits and total comprehensive income as stated in the financial statements that have arisen from the inclusion of income and expenses that have been assessed for tax in different periods to which they are recognised in the financial statements. One of the most common types of timing difference is the difference between the net book value of a fixed asset versus its tax written down value where accelerated capital allowances (eg Annual Investment Allowance) have been claimed.
Deferred tax is not recognised on permanent differences (except in limited circumstances where a business combination is concerned). FRS 102, para 29.10 confirms that a permanent difference arises because certain types of income and expense are non-taxable or disallowable, or because certain tax charges or allowances are greater or smaller than the corresponding income or expense in the accounts.
There is an added complexity at the present time for preparers of financial statements under UK GAAP because of the increase in corporation tax rate from 19% to 25% from 1 April 2023 and the resurrection of marginal rates of tax. This article examines the provisions in Finance Act 2021 which affect the calculation of deferred tax under FRS 102.
It should be noted that this article is also relevant to small companies which choose to apply the presentation and disclosure requirements of FRS 102, Section 1A Small Entities. This is because the same recognition and principles in FRS 102, Section 29 also apply to small companies.
Rate of tax used in the calculation of deferred tax
FRS 102, para 29.12 requires an entity to measure deferred tax using the tax rates and laws that have been enacted or substantively enacted by the balance sheet date and which are expected to apply to the reversal of the timing difference.
The term ‘substantively enacted’ is defined in the Glossary to FRS 102 as follows:
Tax rates shall be regarded as substantively enacted when the remaining stages of the enactment process historically have not affected the outcome and are unlikely to do so.A UK tax rate shall be regarded as having been 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.)
A Republic of Ireland tax rate can be regarded as having been substantively enacted if it is included in a Bill that has been passed by the Dail. |
Finance Act 2021 makes provision for the rate of corporation tax in the UK to increase (from 1 April 2023) from 19% to 25% where a company has profits in excess of £250,000. In addition, there is also a small profits rate of tax of 19% where profits are £50,000 or less. Marginal relief is brought back to provide a gradual increase in the tax rate of companies where profits fall between £50,000 and £250,000. These limits are effectively pro-rated where a company is associated with other companies. Therefore, for example, if a company had two ‘associated companies’, the upper limit would be £83,333 (£250,000 / 3 – [number of associated companies + 1]).
Finance (No. 2) Bill became substantively enacted on 24 May 2021. As a consequence, there are impacts on deferred tax accounting depending on whether the accounting period ends before or after 24 May 2021.
Accounting period ends prior to 24 May 2021
For accounting periods which end before 24 May 2021 (i.e. 30 April 2021 year ends and prior) but where the financial statements are approved post 3 March 2021 (the date of the Chancellor’s spring Budget), deferred tax would continue to be calculated at a rate of 19% because this was the rate that was enacted or substantively enacted by this date.
The entity may need to make additional disclosure as to the effect of the increased tax rate on current and deferred taxes, particularly where the effect of the increased tax rate may be material.
Accounting period ends on or after 24 May 2021
For accounting periods ending on or after 24 May 2021, deferred taxes in respect of timing differences which are expected to reverse on or after 1 April 2023 will need to be remeasured at 25% where profits are expected to exceed £250,000; or at the marginal rate if profits are expected to fall between £50,000 and £250,000.
Example – Deferred tax with marginal rate calculationsA company acquires a machine on 1 April 2022 at a cost of £75,000. The company’s depreciation policy for this machine is to depreciate it on a five-year straight-line basis. The directors anticipate a £nil residual value at the end of this five-year useful life. The company has taken advantage of HMRC’s Annual Investment Allowance and has claimed 100% relief on the cost of this machine.
The company’s taxable profit for the year ended 31 March 2023 is £50,000. It has no associated companies.
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£ |
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Corporation tax provision for the year |
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£50,000 x 19% |
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9,500 |
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Net book value of new machine |
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Cost |
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75,000 |
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Less depreciation (£75k / 5 years) |
(15,000) |
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Net book value at 31 March 2023 |
60,000 |
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Deferred tax calculation |
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Net book value of machine |
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60,000 |
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Tax written down value |
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- |
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Timing difference |
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60,000 |
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Tax rate enacted at balance sheet date |
19% |
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Deferred tax liability |
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11,400 |
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For the year ended 31 March 2024, taxable profit is £150,000. The calculations are as follows:
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£ |
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Corporation tax provision for the year |
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£150,000 x 25% |
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37,500 |
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Less marginal relief: |
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3/200 x (£250K - £150K) |
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(1,500) |
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Tax provision |
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36,000 |
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Effective tax rate |
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£36,000 / £150,000 |
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24% |
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Net book value of machine |
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Net book value b/f |
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60,000 |
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Depreciation charge 31 March 2024 |
(15,000) |
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Net book value c/f |
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45,000 |
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Deferred tax |
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Net book value of machine |
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45,000 |
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Tax written down value |
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- |
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Timing difference at 31 March 2024 |
45,000 |
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Tax rate (use the marginal rate above) |
24% |
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Deferred tax liability at 31 March 2024 |
10,800 |
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Deferred tax liability b/f |
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11,400 |
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Deferred tax liability c/f |
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10,800 |
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Unwinding of timing difference |
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600 |
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Journal: |
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Dr Deferred tax provision |
£600 |
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Cr Deferred tax in profit or loss |
£600 |
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It is important to keep in mind that the requirements of FRS 102 are to measure deferred tax 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 differences. This requirement means that in some cases the rate of tax used in the year end tax computation will be different than the rates used in the calculation of deferred tax because you are using the future rate for deferred tax purposes.
Presenting and offsetting deferred tax in financial statements
FRS 102, para 29.23 requires an entity to present deferred tax liabilities within provisions for liabilities (not within current or non-current liabilities). Deferred tax assets (where these meet the strict recognition criteria) are presented within debtors unless the entity has chosen to adapt its balance sheet. In practice, it does not appear to be common to adapt the format of the balance sheet.
FRS 102 also prohibits an entity from offsetting deferred tax assets and deferred tax liabilities. However, FRS 102, para 29.24A states:
An entity shall offset deferred tax assets and deferred tax liabilities 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.
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Conclusion
In practice deferred tax can be a challenging issue, particularly when complexities such as marginal rates are added to the mix. The key points to remember are to use the rate(s) that have been enacted or substantively enacted at the reporting date (which may be different than the rate of tax used in the tax computation) and to understand the differences between a timing difference and a permanent difference.
