FRS 105: Micro-entities and tax

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On 21 July 2017, HMRC issued ‘FRS 105 overview paper – tax implications’ which provides guidance to micro-entities that are thinking of applying, or have chosen to apply, FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime. The overview paper itself is split into two sections:

Part A: compares the accounting and tax differences arising between old UK GAAP and FRS 105.

Part B: provides a summary of the key accounting and tax considerations that arise on transition from old UK GAAP (i.e. the FRSSE) to FRS 105.

Paragraph 19 of the Accounting Council’s Advice to the FRC to issue FRS 105 notes that it is not possible for the Financial Reporting Council (FRC) to explicitly permit or prohibit the use of FRS 105 in the financial statements of an unincorporated business.

HMRC has acknowledged in their FRS 105 overview paper that they will generally accept calculations of profit of unincorporated entities that have been prepared using the principles in FRS 105.

This article will consider some of the main areas that may affect micro-entities transitioning and applying FRS 105.

Transition to FRS 105

The rules for transition to FRS 105 are outlined in Section 28 Transition to this FRS. Paragraph 28.7 of FRS 105 requires a four-step approach to be carried out:

  1. Recognise all assets and liabilities that are required to be recognised under FRS 105.
  2. Derecognise assets and liabilities where FRS 105 does not permit recognition.
  3. Reclassify items as one type of asset, liability or component of equity but are a different type of asset, liability or component of equity under FRS 105.
  4. Measure all recognised assets and liabilities under the provisions of FRS 105 going forward.

Practitioners should note that FRS 105 does not allow the use of revaluation amounts (arising through the application of the alternative accounting rules) or use of fair values. As such, any assets that have been previously revalued, as permitted under, say, the FRSSE, must be restated to the carrying value that would be reported under the historical cost accounting rules.

It is not possible for a micro-entity to use a previous revaluation, or fair value, as deemed cost on transition and then apply the cost model to this amount, as the micro-entities’ legislation prohibits the use of any revaluation or fair value amounts. This is an issue which must be carefully considered on transition because any restatement of previously revalued assets to historic cost values is likely to have an adverse effect on the balance sheet.


The FRSSE required the correction of an error by way of a prior period adjustment if the error was ‘fundamental’. The term ‘fundamental’ was taken to mean that the error essentially destroys the true and fair view and validity of the accounts.

Paragraph 8.16 of FRS 105 requires the correction of an error by way of a prior period adjustment if the error is material. It is expected that more prior period errors will be corrected by way of a prior period adjustment under FRS 105.

Tax treatment: errors

Where the error is a change from an invalid basis to a valid basis, tax legislation requires the invalid basis to be corrected for tax purposes in the period it first occurs. Subsequent periods should also be corrected for tax purposes. Tax payable or refundable will depend on the time limits for making, or amending, self-assessments.

Financial instruments

The requirements in Section 9 Financial Instruments in FRS 105 are simpler than in FRS 102 as micro-entities are unable to apply fair value accounting. It should be noted that HMRC’s FRS 105 overview paper does not cover those financial instruments which fall outside the scope of:

  • loan relationship rules (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).

Examples of instruments not covered by those rules include equity instruments in the form of shares and guarantees. For those instruments that fall under the scope of the above, the tax treatment will follow the accounting treatment.

The FRS 105 overview paper does acknowledge that for businesses within the charge to income tax, there is no equivalent legislation which may lead to significant differences from corporation tax in tax treatment.

For income tax purposes, HMRC requires the profits of a trade to be calculated under GAAP principles, and these are then adjusted as authorised or required by tax law.

For income tax purposes, the distinction of financial instruments between capital and revenue is important. Certain borrowing, such as a bank overdraft would be regarded by HMRC as revenue. Indicators that borrowing is of a capital nature would normally be where the borrowing is:

  • not temporary;
  • fixed in amount; and
  • available for use in any of the trader’s activities and not merely the day-to-day trading activities.

Indicators that borrowing is of a revenue nature will be where the borrowing is:

  • temporary;
  • fluctuating; and
  • incurred as an incident of carrying on the day-to-day activities of the business.

With regards to financial instruments, a micro-entity transitioning from the FRSSE to FRS 105 is more than likely not going to experience any transitional or prior year adjustments. A transitional adjustment would be needed, for example, where the micro-entity measured a financial instrument on a different basis under the FRSSE (e.g. an investment at revaluation) than what is required under FRS 105, which would be historic cost. Where a change of basis is required under FRS 105, Part B of the overview paper provides further guidance on the tax treatment of this change.

Investment property

Under the FRSSE, investment property was accounted for at open market value at each balance sheet date, with changes in open market value being taken to the revaluation reserve. This was done as SSAP 19 Accounting for investment properties and the FRSSE applied the alternative accounting rules in the Companies Act 2006 which required gains and losses to go to a revaluation reserve and be reported via the statement of total recognised gains and losses.

FRS 105 does not allow the use of revaluations or fair value amounts. Investment properties must, therefore, be restated to historic cost values on transition and in the prior year and subsequently accounted for under the historic cost model in Section 12 Property, Plant and Equipment and Investment Property. This will require the property to be depreciated and tested for impairment at each balance sheet date. It must also be noted that a previous GAAP revaluation cannot be used.

Where FRS 105 is being used and the client has got investment property on the balance sheet, restating to historic cost values may prove difficult for some entities. Paragraph 28.10(c) of FRS 105 provides a transitional exemption that may prove easier to apply when restating such investment property on transition.

Tax treatment: investment property

The accounting treatment does not determine, for tax purposes, whether a property is held as a property for investment or whether it is part of a trading transaction. For tax purposes, if the property is being held as an investment, the income will be brought into tax as it is recognised in the micro-entity's accounts (i.e. through rental income). On disposal, a chargeable gain will typically arise.

Tangible fixed assets (property, plant and equipment)

FRS 105 deals with property, plant and equipment (PPE) in Section 12 Property, Plant and Equipment and Investment Property. This section is broadly consistent with previous UK GAAP, although Section 12:

  • requires major spare parts be brought in as PPE (paragraph 12.4)
  • does not allow renewals accounting; and
  • requires that residual values are based on current rather than historic prices (this will affect the depreciation charge).

Tax treatment: PPE

Depreciation is still ignored for the purposes of tax, and capital allowances on some assets are granted instead. Revaluations are irrelevant because FRS 105 prohibits them (and tax law would ignore them as well). Accounting treatments in FRS 105 are unlikely to have significant tax impacts.

As renewals accounting is no longer permitted, it might be that a micro-entity has to make an adjustment for tax purposes under the change of basis legislation which is outlined in part B of the overview paper.


All goodwill under FRS 105 must be amortised; there is no option for goodwill to have an indefinite useful economic life. Where the micro-entity is unable to make a reliable estimate of the useful life of goodwill, the maximum period for amortisation is ten years.

Tax treatment: goodwill

The overview paper acknowledges that tax relief is unlikely to be affected if an entity has elected for a fixed rate of 4%, which should have been made within two years of the end of the accounting period in which the expenditure was incurred and cannot be reversed.

Generally, relief for corporation tax purposes is provided on either the amortisation or impairment of goodwill. Sections 871 to 873 of CTA 2009 ensure that any write-up on transition to FRS 105 becomes a taxable credit and section 872 ensures that such credit is limited to the net amount of relief already given. Impairment from written-up cost will also be deductible.

The overview paper reflects the changes to tax law that took place in 2015. The upshot of those changes was that any goodwill from a business combination which took place after 7 July 2015 will not be eligible for tax deductions and hence the 4% fixed rate will not be available.

For income tax purposes, there are no equivalent sections 871 to 879 of Part 8 CTA 2009 and hence any amortisation of goodwill would not be an allowable deduction for income tax purposes.


The concept of finance versus operating leases is still present in FRS 105 and the accounting treatment for both types of lease is similar as that under the FRSSE.

However, the definition of a finance lease in the glossary to the FRSSE (effective January 2015) referred to the 90% test whereby if the present value of the minimum lease payments equated to 90% or more of the fair value of the leased asset, a lease is a finance lease.

FRS 105 at paragraph 15.6(d) says that if, at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset, then this is an indicator the lease is a finance lease. The 90% test has been substituted for the phrase ‘substantially all’.  

Notwithstanding this difference, the emphasis is on the transfer of risks and rewards and where risks and rewards are transferred from the lessor to the lessee, the treatment is that of a finance lease.

Paragraph 15.15 refers to lease incentives and requires these to be expensed on a straight-line basis over the lease term unless another systematic basis is more appropriate. This is different to previous UK GAAP, which required lease incentives to be recognised in profit or loss on a straight-line basis up to the point at which lease rentals revert to market rate.

As a consequence, FRS 105 may require lease incentives to be written off over a longer period, which may alter the timing of income recognition where the incentive is not capital (e.g. a rent-free period).

Tax treatment: leases

FRS 105 requires lessors use the ‘net investment method’ for finance leases, whereas SSAP 21 Accounting for leases and hire purchase contracts required the use of the net cash investment method which may result in differences in the timing of income recognition.

Legislation (sections 228B to 228F Capital Allowances Act 2001, Chapter 2 Part 9 CTA 2010 (Corporation Tax) and Chapter 10A Part 2 ITTOIA (Income Tax)) brings the tax treatment of finance leases in respect of both lessors and lessees for finance leases of plant and machinery in line with the accounting requirements of FRS 105, Section 15 Leases.

Holiday pay accruals

Under previous UK GAAP, many entities did not bring unpaid holiday pay into the accounts as an accrual. Such accruals would normally arise when the holiday year is not sequential to the financial year, or where staff can carry forward holidays to the next financial year.

In practice, it is not expected that the vast majority of micro-entities will require holiday pay accruals. However, FRS 105 does require such holiday pay to be accrued where it is earned but not paid by the balance sheet date.

Tax treatment: holiday pay

As mentioned above, in practice it is not expected that a significant number of micro-entities will have to make holiday pay accruals. Where they do, the accrual would be treated in line with the treatment of unpaid remuneration (Part 20 Chapter 1 CTA 2009 and sections 36 to 37 ITTOIA). Essentially to gain the tax relief, the holiday pay must be paid within nine months’ of the year-end.


While FRS 105 is less complex than FRS 102, there are some notable differences between FRS 105 and the FRSSE which should be understood to ensure correct accounting and tax treatment. Copies of the overview papers issued in July 2017 can be downloaded here.

About Steven Collings


Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.


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14th Aug 2017 08:16

Extract above

The FRSSE required the correction of an error by way of a prior period adjustment if the error was ‘fundamental’. The term ‘fundamental’ was taken to mean that the error essentially destroys the true and fair view and validity of the accounts'.

I have never made a period period adjustment, I think people are worried to make them, they may fear open up a can of worms.

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14th Aug 2017 10:50

Thank you for this Steve

I have a company client that has investments in unit trusts historically held in the balance sheet at cost. Under FRS 102 (it is slightly too large to be a micro entity) it has to value these at market value in the balance sheet for the first time. My tax advice line says that because these are not a loan instrument the valuation of the assets can remain at cost for tax purposes and my client won't therefore have to pay tax on historical (unrealised) gains. Do you agree?

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