Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

FRS 102: Investment property issues clarified

by
24th Dec 2014
Save content
Have you found this content useful? Use the button above to save it to your profile.

The Financial Reporting Standard applicable in the UK and Republic of Ireland (FRS 102) is to become mandatorily effective for accounting periods commencing on or after 1 January 2015 (with earlier adoption permissible), says Steve Collings.

Over the last few months there have been some relatively common questions asked about FRS 102 – the main ones being the issue concerning investment properties and the significantly different accounting treatments under FRS 102 when compared to SSAP 19 Accounting for Investment Properties.

The main area of concern surrounds the treatment of deferred tax on investment properties and the treatment of such properties for group accounts purposes.  This article aims to clear up some of the confusion surrounding investment properties.

What is an investment property under FRS 102?

FRS 102 distinguishes investment property from owned property by defining what an investment property is as follows:

“Property (land or a building, or part of a building, or both) held by the owner or by the lessee under a finance lease to earn rentals or for capital appreciation or both, rather than for:

(a) use in the production or supply of goods or services or for administrative purposes, or

(b) sale in the ordinary course of business.”

Note that the above definition includes land or a building or both.

Group accounts

Paragraph 8(b) of SSAP 19 prohibits property let to and occupied by another group company (for example a subsidiary) to be treated as investment property in either the individual accounts or the group financial statements. FRS 102 is silent on the treatment of investment properties let to and occupied by group companies. However, Staff Education Note 4 Investment Properties confirms that FRS 102 does not exclude from investment properties those properties that are let to and occupied by group companies. This is one of the issues which is being frequently questioned by accountants.

In a group situation, investment properties would be recognised as such in the individual financial statements of a lessor. When it comes to preparing the group financial statements, investment properties would form part of property, plant and equipment.

Deferred tax implications

Deferred tax under FRS 102 is wider in its scope and as such deferred tax will need to be provided on virtually all timing differences. When fair value for investment property can be obtained without undue cost or effort, paragraph 16.7 of FRS 102 requires fluctuations in this fair value to be taken to profit or loss (as opposed to a revaluation reserve as is currently the case in SSAP 19). This is clearly going to involve a significant change in presentation for those companies who are going to be applying the requirements in FRS 102 to their investment properties in 2015. 

Paragraph 29.16 of FRS 102 has a direct link to investment properties and requires deferred tax to be accounted for in respect of investment property that is measured at fair value in accordance with Section 16 requirements and therefore any increase or decrease in the fair value of the investment property must be matched with a corresponding provision for deferred tax. In contrast, current UK GAAP only requires deferred tax to be provided for where there is a binding agreement to sell the property at the balance sheet date. 

Under FRS 102 the impact on profit or loss can (in some situations) be significant. This is because fair value gains and losses will hit the profit and loss account together with the deferred tax implications. Clients who are going to be affected by this need to be advised sooner rather than later bearing in mind the requirement to apply FRS 102 retrospectively to the date of transition and hence there will be changes to previously reported profit/loss and equity.

Fair value gains

Under the provisions in Section 16 of FRS 102, gains on the fair value of investment property are taken directly to profit or loss (and reported within operating profit). Such gains would not be taxable income for the purposes of corporation tax and hence would be treated in much the same way as, say, a gain on disposal of a fixed asset. 

Another point worth noting is that the fair value gain is not distributable as a dividend to shareholders – this also includes any transfers to profit and loss reserves of brought forward revaluation surpluses for investment property at the date of transition. Some commentators are suggesting the use of an ‘undistributable reserves’ account within the equity section of the balance sheet in order to distinguish distributable reserves from undistributable reserves although there is nothing in companies’ legislation which requires this, but it would be a way of keeping a track of those reserves which are not distributable for dividend purposes.

Conclusion

The treatment of investment properties under FRS 102 is seemingly controversial but it is crucial that such property is correctly distinguished and correctly accounted for to avoid embarrassment.  Important points to note under FRS 102 are:

  • The definition of what constitutes investment property under FRS 102 is outlined in paragraph 16.2 to 16.4 of FRS 102
  • Fair value gains and losses (for investment property only) are taken to profit or loss and not to a revaluation reserve account
  • FRS 102 requires an entity to match any increase in value with an appropriate deferred tax provision
  • Fair value gains in the valuation of investment property are not distributable as a dividend to shareholders
  • For group accounts purposes, investment properties are classified as such in the individual financial statements of the lessor. They form part of property, plant and equipment in the consolidated financial statements

Replies (13)

Please login or register to join the discussion.

avatar
By shoshana
07th Jan 2015 13:27

Calculation of deferred tax

Excellent summary as always, Steve. The point about distributable profits is an important one - many accountants still seem to think that the balance on the profit and loss account is the amount distributable.

It might be worth saying that generally the deferred tax amount is based on a notional sale of the property at the reporting date.

For companies this will involve comparing the fair value to the indexed cost at that date - because of indexation (which rises inexorably over time) the effective tax rate it produces is going to be less than for other items.

If material, this may need to form part of the tax reconciliation note required by FRS102.29.27(b).

Malcolm

Malcolm Greenbaum

Director, Greenbaum Training and Consultancy Limited

IFRS, US GAAP, UK GAAP, UK tax and VAT

 

Thanks (0)
avatar
By bhimal
07th Jan 2015 16:28

Is the deferred tax taken against the distributable profit and loss reserves?

Thanks (0)
Replying to johnhemming:
avatar
By shoshana
07th Jan 2015 16:40

Deferred tax is unrealised

bhimal wrote:

Is the deferred tax taken against the distributable profit and loss reserves?

The deferred tax is an unrealised gain or loss as it relates to an item which is unrealised so does not affect distributable reserves.

Malcolm

Thanks (0)
avatar
By TerryD
07th Jan 2015 16:38

Thoughts

It seems that the only get out for the individual accounts of group companies which hold properties used by other group companies is not to charge rent as it will then fail the definition of an investment property.

As an aside, I don't think that creating a separate reserve for these non-distributable revaluation surpluses is an option - FR102 specifically states that revaluation gains go to Profit & Loss Account. I think the answer is simply to include a narrative beneath the Profit & Loss Account Note to state the amount of undistributable reserves included therein.

Thanks (0)
Replying to Mr J Andrews:
avatar
By shoshana
07th Jan 2015 16:44

Still an investment property

TerryD wrote:

It seems that the only get out for the individual accounts of group companies which hold properties used by other group companies is not to charge rent as it will then fail the definition of an investment property.

As an aside, I don't think that creating a separate reserve for these non-distributable revaluation surpluses is an option - FR102 specifically states that revaluation gains go to Profit & Loss Account. I think the answer is simply to include a narrative beneath the Profit & Loss Account Note to state the amount of undistributable reserves included therein.

Terry, I still think it would be an investment property - the definition in FRS 102.16.2 is

"property (land or a building, or part of a building, or both) held by the owner.....to earn rentals or for capital appreciation or both, rather than for:

(a) use in the production or supply of goods or services or for administrative purposes; or

(b) sale in the ordinary course of business."

It is not held for a) or b) above so would still be an investment property.

Malcolm

Thanks (0)
avatar
By TerryD
08th Jan 2015 17:23

Not sure

The property is not held for rental income or capital appreciation so fails the first part of the definition. If, as you say, it also fails the second part of the definition, then I think that takes it out of the realm of Section 16 altogether.

The property does, however, meet the definition of property, plant and equipment as it is held "for use in the production of supply of goods or services, for rental to others, or for administrative purposes". It is rented out in the sense that is used by another entity, but not for the purpose of earning rental income (because no rent is actually charged).

I hope that we can reach a consensus on this as there must be thousands of groups, large and small, where the property is held by a different company from the one using it and no rent is charged. If all these companies have to start paying to have valuations done, there will be many unhappy directors!

Thanks (0)
avatar
By shoshana
12th Jan 2015 11:49

I see what you mean

Terry, I think you make a very valid point. If no rent is being charged and it cannot be shown that the owner is holding the property for its capital appreciation then it does seem to fail the definition.

One unrelated issue is the possibility of tax transfer pricing issues if no rent is charged, subject to the exemption for small companies.

Malcolm

Thanks (0)
avatar
By TerryD
12th Jan 2015 15:55

I take your point about transfer pricing. I am no expert in that field, but I would expect that if a supportable management charge were raised and use of the building were included in its computation, there would not be a problem with transfer pricing. Then the question would be does that invalidate the assertion that no rent is charged? I think not, so long as there is no lease or other similar agreement.

Thanks (0)
avatar
By FATEMA Q
28th Jan 2015 17:26

Business Set up cost
Hi,

I work for a co. that sells furniture online and have recently rented an empty space to open up a showroom. We have incurred a hefty sum for the set up cost including the following:

# Property agent fees
# Cost of contract negotiation
# Decoration of the warehouse
# other various

The tentative time of completion of the warehouse is in March'15, that is when we hope to start operating from there.

I have gone through the FRS 102, but it only mentions about investments in properties but does not say anything about set up cost on rented properties.

Would appreciate if we could have a feedback on the above costs, should we capitalize the set up cost or treat them as an operating expense?  

Thanks (0)
avatar
By TerryD
28th Jan 2015 17:32

Revenue

I'd put all those through as revenue costs.

Thanks (0)
avatar
By juliedwatts2
18th Feb 2015 12:54

Revaluation frequency

Great article - thank you.

I am also wondering though - I have read Section 16 on investment properties and note that the investment property has to be valued at fair value each reporting date.  My question is - does it need to be valued by an independent valuer every reporting period.  Previously you would have done it every three years.  I note in the disclosure section that if the valuation has not been done by an independent valuer you must state so.  If the directors considered the market and felt there was a potential impairment or large movement upwards they should probably get a professional value done but if the market is stable I wonder if that is necessary every year. Would there be scope therefore to still only have the valuation done every couple of years with the directors reviewing the position between valuations for the year end and referring back to the professional valuation having been undertaken in the prior year?

 

Thanks (0)
avatar
By shoshana
18th Feb 2015 17:28

No
An Independent valuation is not required by FRS 102.

Thanks (0)
avatar
By MMU001
01st Feb 2018 01:11

Hello All,
i have a question i shall be thankful if anyone helps me.
Mr A buy a house for investment purpose on 01 January 2001 and sold the house on 31 December 2010.
1) He never lives in that house
2) Always rented
My question is on disposal can we treat this house as investment property or residential property when calculating Capital gain tax?
Thank you in advance for your reply

Thanks (0)