Audit and Technical Partner Leavitt Walmsley Associates Ltd
Share this content

FRS 102: Deferred tax issues explained

14th May 2013
Audit and Technical Partner Leavitt Walmsley Associates Ltd
Share this content
deferred-tax-issues
Cecilie_Arcurs

In the current version of UK GAAP taxation is dealt with in two accounting standards: FRS 16 Current Tax and FRS 19 Deferred Tax, explains Steve Collings. 

Aspects concerning taxation are also found in FRS 17 Retirement Benefits (specifically paragraphs 71 and 72) which deal with tax relief on a company’s pension contributions and the attribution of the tax effects to the profit and loss account and statement of total recognised gains and losses. 

FRS 102 deals with taxation in Section 29 Income Tax. The scope paragraph of Section 29 confirms that income tax (for the purposes of FRS 102) includes all domestic and foreign taxes which are based on taxable profit. It then goes on to include taxes such as withholding taxes payable by a subsidiary, associate or joint venture within its scope.

Unlike FRS 16 and FRS 19 currently, Section 29 combines the requirements of both current and deferred taxes and the standard recognises that current tax is payable or refundable in respect of the taxable profit or taxable loss in respect of the current reporting period or past reporting periods.  The scope section of Section 29 takes the same stance as FRS 19 in respect of deferred tax in that it acknowledges that deferred tax represents the future tax consequences of transactions and events recognised in the entity’s financial statements of both the current and previous accounting periods. When a business combination takes place (business combinations are dealt with in Section 19 Business Combinations and Goodwill) the section also requires deferred tax to be recognised in respect of assets and liabilities recognised as a result of the business combination. In respect of assets, it is all assets other than goodwill.

Current tax

This is the simplest part of Section 29 and relates to the CT charge or credit and the associated liability or asset depending on whether the company has a liability to CT, or is due a refund from HMRC in respect of taxable losses that have, perhaps, been carried back and offset against the previous year’s taxable profit.

Paragraph 29.3 requires a reporting entity to recognise a current tax liability in respect of CT payable for the current and past periods. This will, in almost all cases, be based on the company’s taxable profit for the financial year. On the flip side if a company is due a refund of CT, then the company is required to recognise a current tax asset in respect of such. All tax amounts are required to be measured using the tax rates and laws that have been enacted or substantively enacted by the balance sheet date.

Deferred tax

Here cometh the problem child! At the outset I think it is important to acknowledge that the accounting for deferred tax could have been a whole lot worse in the previous exposure drafts. In the previous exposures which were based on IFRS for SMEs, the section that dealt with deferred tax looked at deferred tax from a temporary difference approach. In the UK, accountants have been used to dealing with deferred tax from a timing difference approach. The differences between the two are fairly significant. The temporary difference approach focuses on the balance sheet so, for example, a deferred tax liability would arise if the carrying value of an asset was greater than its tax base or if the carrying value of a liability is less than its tax base. 

Timing differences, on the other hand, focus on the P&L account and are differences between a company’s taxable profits and its results as stated in the financial statements that arise from the inclusion of gains and losses in tax assessments in periods different from those in which they are recognised in the financial statements. A typical scenario of a timing difference in the UK would be where an asset qualifies for 100% Annual Investment Allowance (AIA) in the year of acquisition, but is being depreciated over three years using the straight-line method of depreciation. In this scenario, a deferred tax liability would be recognised.

None of these concepts are new to accountants and paragraph 29.6 to Section 29 does require deferred tax to be recognised in respect of all timing differences at the balance sheet date. Paragraph 29.6 goes on to define a timing difference slightly differently than FRS 19 does as follows:

‘Timing differences are differences between taxable profits and total comprehensive income as stated in the financial statements that arise from the inclusion of income and expenses in tax assessments in periods different from those in which they are recognised in the financial statements.’

So, in a nutshell, what this definition is saying is that a timing difference will arise when an item is included in the tax computation in the current period but the same transaction has been recognised in the financial statements in a different period.

In respect of deferred tax recognition, there are some points that practitioners will need to note in Section 29:

  • Tax losses that are carried forward to the next accounting period that essentially give rise to a deferred tax asset must only be recognised to the extent that it is probable that they will be recovered against the reversal of deferred tax liabilities. Like its outgoing predecessor, FRS 19, the default presumption is that the mere existence of tax losses is taken as strong evidence that there may not be other future taxable profits against which the unutilised tax losses can be relieved. There should be evidence to the contrary that the company will be able to utilise deferred tax assets (such as the awarding of a lucrative contract in the next financial year)
  • Paragraph 29.8 says that deferred tax will be recognised in an entity’s financial statements in respect of tax allowances for the cost of a fixed asset when these are received before or after the depreciation of the fixed asset is recognised in profit or loss. If, and when, the client has met all the conditions imposed by HMRC for retaining the relevant capital allowances, deferred tax is then reversed 
  • When a client has a subsidiary, associate, branch or an interest in a joint venture, it must recognise deferred tax when income or expenses from these sources have been recognised in the financial statements but will subsequently be included in the tax computation in a future period. There are two exceptions to this rule:

o   Where the reporting entity has control over the reversal of the timing difference

o   There is probability that reversal of the timing difference will not take place in the foreseeable future 

Paragraph 29.9 gives an example of a situation where there are undistributed profits in a subsidiary, associate, branch or interest in a joint venture.

Timing difference ‘plus’

As mentioned earlier in the article, the previous FRED 44 required deferred tax to be computed using a temporary difference approach. There was an outcry about this approach and so the (now defunct) Accounting Standards Board (ASB) required this particular area to be redrafted, but to be as near to the international equivalent (IAS 12 Income Taxes) as possible. This resulted in the concept of the ‘timing difference PLUS’ approach being borne.

The ‘plus’ part builds on the existing ‘timing difference’ approach that many of us are already familiar with but the intention by the ASB in bringing in the ‘plus’ part was so that the calculation of deferred tax would be the same in many (but not all) cases as under IAS 12. It achieves this by extinguishing the fewer exceptions that are currently contained in FRS 19. A typical example of this is in respect of fixed assets that are subjected to the revaluation model as permitted in Section 17 Property, Plant and Equipment. Under FRS 19 at paragraph 14, no deferred tax is recognised on a revaluation gain in respect of a non-monetary asset that is subjected to the revaluation model unless the client has:

  • entered into a binding agreement to sell the revalued assets
  • recognised the gains and losses expected to arise on the sale

This exception contained in FRS 19 is now outlawed by paragraph 29.15 in FRS 102 which now requires deferred tax in respect of a non-depreciable property whose value is measured using the revaluation model to be measured using the tax rates and allowances that apply to the sale of the asset. 

Likewise with assets carried under the revaluation model, where a client has an investment property that is measured using fair value in accordance with Section 16 Investment Property, deferred tax is recognised using the tax rates and allowances that apply to the sale of the investment property. There is an exception to this rule in paragraph 29.16 which relates to investment property that has a limited useful life and where the client is going to use the economic benefits associated with the investment property over time.

There are a couple of other additional instances (due to the ‘plus’ approach) where deferred tax concepts will be triggered and one of these is in respect of a business combination (that used to be referred to in ‘old language’ as an ‘acquisition’). Paragraph 29.11 says that when the tax base of an asset acquired in a business combination (not goodwill, however) is less than the value at which it is recognised in the acquirer’s financial statements, then a deferred tax liability is recognised to represent the additional tax that will be paid in the future. On the flip side, when the tax base of an asset is more than the amount recognised for the asset in the financial statements, a deferred tax asset is recognised to represent the additional tax that will be avoided in respect of that difference. A deferred tax asset or liability is recognised for the additional tax the client will either avoid or pay due to the difference in value at which a liability is recognised and the amount that is assessed to be owed to HMRC. Amounts attributed to goodwill will be adjusted by the amount of deferred tax recognised. 

Measurement of deferred tax

The measurement of deferred tax is similar to the current FRS 19 requirements in that paragraph 29.12 requires a reporting entity to measure a deferred tax liability or asset using the tax rates and laws that have been enacted, or substantively enacted, at the balance sheet date and which are expected to apply to the reversal of the timing differences. There are some other requirements that practitioners need to consider:

  • If different tax rates apply to different levels of taxable profit, deferred tax is measured using an average rate(s) that have been enacted or substantively enacted at the balance sheet date and that will apply to the taxable profit or loss of the periods in which the company expects the deferred tax asset or liability to be realised or settled
  • Paragraph 29.14 recognises that in some jurisdictions, taxes are payable at higher or lower rates should all or part of the profit or profit and loss account reserves be paid out as a dividend to shareholders. Paragraph 29.14 also goes on to say that in other jurisdictions, taxes may be refundable or payable if all or part of the profit or P&L account reserves are paid out as a dividend to shareholders. This paragraph requires an entity to measure current and deferred taxes using the rates applicable to profits that are eligible to be distributed as a dividend until the entity recognises a liability to pay a dividend. When a liability to pay a dividend is recognised in the financial statements, the entity recognises a current or deferred tax liability/asset and the associated tax expense/income
  • Deferred tax recognised in respect of assets carried under the revaluation model are measured using the tax rates that apply when the asset is sold
  • For investment property measured at fair value, deferred tax is measured using the tax rates that apply when the asset is sold

One final point to note, which is going to go largely unnoticed (if not completely unnoticed), is that it will no longer be permissible to discount deferred tax balances to present day values. The reality is that hardly anyone discounts deferred tax balances for the time value of money so this new requirement in Section 29 is not going to be earth-shattering.

VAT

A quick point to mention where VAT is concerned is that this is dealt with in paragraph 29.20 to Section 29 and requires the turnover shown in the profit and loss account to exclude VAT. There is now reference to the flat rate scheme for VAT and any VAT imputed under the flat rate scheme is not to be included in the turnover figure. 

Presentation

Deferred tax liabilities will be shown within provisions for liabilities (as is the case currently) and deferred tax assets are shown within debtors. A company will not be able to offset current tax assets against current tax liabilities if there is no legally enforceable right to do so and there is the intention to settle on a net basis, or to realise the asset and then settle the deferred tax liability at the same time.

Where deferred tax is concerned and offsetting, a company can only offset deferred tax assets and liabilities in two situations:

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

Disclosures

FRS 102 requires disclosure of:

  • The current tax expense/income
  • The aggregate current and deferred tax relating to items recognised as items of other comprehensive income or equity
  • A reconciliation between the tax expense/income in the P&L account and the pre-tax profit or loss on ordinary activities multiplied by the applicable tax rate
  • The amount of net reversal of deferred tax assets and liabilities expected to occur during the year beginning after the reporting period together with a brief explanation for the expected reversal
  • An explanation of changes in the applicable rates of tax compared with the previous period
  • The amount of deferred tax liabilities/assets at the end of the reporting period for each type of timing difference and the amount of unused tax losses/tax credits
  • The expiry date (if any) of timing differences, unused tax losses and credits
  • An explanation of the nature of the potential tax consequences that would result from the payment of dividends to shareholders if part or all of the profit/P&L account reserves were paid out to them

Conclusion

While the vast majority of taxation issues contained in FRS 102 will be the same as what is currently done under FRS 16 and FRS 19, there are some additional considerations relating to deferred tax issues that practitioners need to bear in mind for their clients (particularly those concerning revaluations). 

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘Interpretation and Application of International Standards on Auditing’. He is also the author of ‘The AccountingWEB Guide to IFRS’ and ‘IFRS For Dummies’ and was named Accounting Technician of the Year at the 2011 British Accountancy Awards.

Replies (20)

Please login or register to join the discussion.

avatar
By carnmores
14th May 2013 13:52

I maintain that DT is wholy inappropriate

for small companies

Thanks (3)
Chris M
By mr. mischief
15th May 2013 08:04

Totally agree the last post

it is the only part of the accounts where I say "This is just accountancy drivel so just ignore it" to clients.

Thanks (3)
Man of Kent
By Kent accountant
15th May 2013 10:45

Yep

explaining DT is like explaining the tax credit on dividends - watch the eyes glaze over...

 

 

Thanks (3)
avatar
By Barkster
15th May 2013 11:56

My brain glazed over just reading it................

..not your fault Steve - it's just a mind-numbing subject !

But in words of one syllable or less, what do we have to do differently with the old CA/AIA -v- NBV-on-the-Balance-Sheet chestnut, and from when, as this is the only DT I ever come across really ??

Thanks (1)
7om
By Tom 7000
15th May 2013 12:19

Yep what Barkster said

can someone translate all that to  simple Geordie...

Do I need to do anything else except pull out advanced capital allowances?

Thanks (0)
avatar
By Ian Bee
15th May 2013 12:34

Old school

I agree with Barkster. For over 30 years I have always approached DT from the Balance sheet and deducted NBV from TWDV. You can then reconcile this to the depreciation and CAs in the tax comp. There may be an adjustment for non qualifying assets, but that is all DT is in most companies. 

Having worked for larger Plcs with global reach, I know that at that level DT can be more complicated but that affects relatively few companies. 

There seems to be a desire on the part of standard setters to over complicate this to distinguish between timing differences and temporary differences, though in all practical senses I cannot see what the difference really is. Not the fault of the author but it seems to be the standards themselves.

Thanks (2)
avatar
By musemma
15th May 2013 12:47

Deferred Tax.

I recall someone referring to deferred tax as a situation where 1+1 = 3. It is so difficult to explain and sometimes understand. Very complicated and prone to error/miscalculation when presenting and disclosing it on the balance sheet.

Thanks (1)
avatar
By adam.arca
15th May 2013 13:52

Disagree

I've got to say I disagree with the above comments.

I've always seen DT as (big company complications aside) a pretty easy issue and one that makes perfect sense in terms of matching and accruals (even though these now seemed to be dirty words for standard setters).

It's not even that complicated to explain: "CT is what you're paying; DT is the extra you should have been paying if nice Mr Taxman hadn't given you all that AIA." The difficulty comes when DT reverses.

So IMHO any accounts (for large or small company) which have a material DT liability would be incomplete unless that liability is recognised.

It's also my opinion, however, that sole trader accounts are incomplete because they do not include a provision for the tax bill arising from current year profits, and thereby overstate the "true" capital. I don't adjust for that, though, because no one else does and I don't want to disadvantage my clients. So that means I'm being inconsistent between my S/T clients and my ltd clients. The joys of accountancy...

Thanks (0)
avatar
By TC1
15th May 2013 16:05

Disagree with "Disagree"

I find DT extremely complicated to calculate, when there are new assets every year, constantly changing WDA and AIA rules and limits, some taxes brought forward and others deferred.

It's also a nightmare taking over the accounts from someone else, either fathoming what the deferred tax entries relate to (frequently, I find the same figure every year for years) or getting DT going if it hadn't been included.

I do agree with adam.arca when he says "any accounts which have a material DT liability would be incomplete unless that liability is recognised". But the magic word is "Material", and so often, the figures aren't.  And if the inclusion of DT makes the accounts less comprehensible to the main users, is that good accounting?

 

 

Thanks (1)
avatar
By DMGbus
16th May 2013 10:51

My over simplified take on DT?

Here's my interpretation on deferred tax (DT) as it applies to clients that I deal with:

Example figures:

£ 3,000  Book value of fixed assets per the Balance Sheet

£ 2,000  Tax written down value of Capital Allowances assets per tax comps

------------  ---------------------------  

£ 1,000  Difference - accounts value is higher than tax value ( 3000 minus 2000 )

   20%   Expected future Corporation Tax rate

£   200  Deferred tax provision ( 1000 times 20% )

====================== 

My explanation to client:  Deferred tax is how much tax you'd pay if you sold the fixed assets at their book value.

 

Now, I see nothing mysterious or complicated here.

Yes, it's not as easy as I outlined if there are assets not subject of capital allowances or if there are tax losses carried forward - but these two added facets don't take more than 60 seconds to factor into the calculations.

 

Now, if anyones still confused or having difficulties, then they need to think back to the days of Stock Relief where added calculations had to be made.

 

 

 

Thanks (1)
avatar
By TC1
16th May 2013 10:15

Simples

Thank you, DMGBus.  Even I can understand that.  Why did no-one explain it to me like that before?

Thanks (0)
7om
By Tom 7000
16th May 2013 13:26

@adam.arca

Why are you doing balance sheets for sole traders....and worrying about capital accounts

Quote em fixed fees, give em a P and L, smash it into the TAX return and off it pops with a bill for  £300 and a  thanks very much for a mornings work.

 

If its big enough to need a balance sheet, incorporate it charge em £400 for doing so and triple their fees ...but it will save you more in tax sir...routine

 

But then,,,,what do I know...

Thanks (1)
Replying to lionofludesch:
avatar
By adam.arca
16th May 2013 15:51

Tom

Tom 7000 wrote:

Why are you doing balance sheets for sole traders....and worrying about capital accounts

Quote em fixed fees, give em a P and L, smash it into the TAX return and off it pops with a bill for  £300 and a  thanks very much for a mornings work.

 

 

Erm, perhaps because I'm old school and like to do the job properly?

 

Tom 7000 wrote:

If its big enough to need a balance sheet, incorporate it charge em £400 for doing so and triple their fees ...but it will save you more in tax sir...routine

 

But then,,,,what do I know...

 

Erm, maybe because being a limited company isn't just about the tax? Plus, when I incorporate a sole trader business, it's usually for a lot more than £400 because there's usually a lot more to consider than what that fee level can bear.

Thanks (0)
avatar
By Nelly
10th Jun 2013 12:50

Help

Please can someone help me,

Just got my first limited company for two years 2012 and 2013 accounts

Please see below how I have presented the account for 2012

P&L account:

Sales:39794

Cost of sales:19375

Gross profit: 20419

Distribution costs:908

Administration costs:18053

Operating profit: 1458

Interest payable and similar charges: 208

Profit before taxation:1250

 

Balance sheet:

Office equipment:795

Depreciation:199

Net book: 596

Cash at bank and in hand: 2653

Creditors amounts falling due within one year:1999

Total net assets (Liabilities): 1250

 

Capital and Reserves

Profit and loss account:1250

Please can someone guide me for the adjustment I am suppose to do before filling the accounts on CT600.

 

The accounts for the year 2013

Sales:155161

Cost of sales:104217

Gross profit: 50944

Distribution costs:2274

Administration cots:38426

Operating profit:10244

Interest payable:297

Profit on ordinary activities: 9947

 

Balance sheet:

Office equipment up to 2013:1445

Accumulated depreciation: 560

Net book value: 885

cash at bank and in hand: 52107

Creditors amounts falling due within one year: 42704

Total net assets(liabilities): 10288

 

Capital and reserves 

Profit and loss: 10288

Please your input about the adjustments I am suppose to do before filling ct600 would be more appreciated!

How much I am going to put on Capital and reserves AC74,AC76 on CT600 2012 and 2013?

I have done it but I just need someone to double-check for me before I fill it.

Thank you

Thank you.

 

 

 

Thanks (0)
avatar
By andrew.mitchell
11th Jun 2013 12:48

Not wholly inappropriate for SMEs

People's eyes may glaze over when you try to explain deferred tax to them, but I recently had the other side of the coin.

Instead, I had to explain to a client why, despite making a loss of £11,000 in their 2013 accounts, the company still had to pay nearly £5,000 Corporation Tax. Having provided for deferred tax in 2012, it was much easier to show that they had saved £11,600 tax in 2012 by claiming Annual Investment Allowances but had to pay £6,800 extra in 2013 when they sold some of those assets and incurred a balancing charge. By accounting for the deferred tax, the total tax charge in the 2012 accounts and particularly the net credit in 2013 reflected much more accurately the results in the accounts. 

Thanks (0)
avatar
By carnmores
11th Jun 2013 14:45

while we are on pointless incomprensible
Accounting nonsense lets all hear it for current cost accounting OMG there went another month of my life on examining the absurd

Thanks (0)
avatar
By carnmores
11th Jun 2013 14:47

@andrew
What pissed[***] your client off was not the PL charge but the cash out lay one suspects

Thanks (0)
Replying to CWservices6064:
avatar
By andrew.mitchell
11th Jun 2013 15:15

Well yes, he was more interested in the cash flow than the technicalities of deferred tax, but my point was

a) It wasn't difficult to explain and he was happier when he understood that it was because he had saved tax the previous year, and

b) In the age of AIA's, Deferred Tax is very relevant to SMEs.

Thanks (1)
avatar
By carnmores
12th Jun 2013 12:37

no no no

its not , its all about informing them of possible liabilities rather than DT per se IMO. and what do you do if you have any sole traders do you DT them?

Thanks (0)
avatar
By aliamar152
04th Jul 2019 10:33

How is the IFRS 9 transition adjustment posted if a company does not recognise deferred tax (probably because they do not expect to make any profits in the near future). Remember we recognise the adjustment 100 percent to the asset, 70% to retained earnings and 30% to deferred tax.

Thanks (0)