Consider ten year tax spreading when accounting treatment changes

The issue

For periods commencing on or after 1 January 2015 UK medium and large companies were not permitted to prepare their accounts in accordance with Old UK GAAP. Instead such entities were required to transition from Old UK GAAP to one of the alternatives, often FRS 102. For periods commencing on or after 1 January 2016 this applied to small companies too.

This change can produce significant ‘transitional adjustments’ and the question arises of how these should be taxed. There are all sorts of occasions where tax rules depart from accounting rules but often the taxable profit will follow the accounting rules and this can include ‘transitional adjustments’. Often there is a requirement to spread the tax effect of accounting treatment changes over 10 years.

 

Change of Accounting Practice Regulations

In 2004 and 2005, the Government considered various representations about the impact of the transitional rules when a company moves from Old UK GAAP to either IAS or FRS 26. In view of the size of some of the known impacts, and the fact that many of the impacts could not be determined until companies made the calculations after the year end, the Government decided to defer the tax impact of all transitional adjustments. This deferral was given effect in Change of Accounting Practice (COAP) Regulations (SI 2004/3271).

The COAP Regulations apply to most transitional adjustments arising in respect of loan relationships or derivative contracts from change in accounting practice. As such, the Regulations are applicable to transitions to FRS 101 and FRS 102 in the same way as they applied to transitions to IAS or FRS 26. In most cases, the effect of the Regulations is to spread the transitional adjustment over 10 years, starting with the first period in which the new accounting policy applies.

 

Example

A small company with a 31 January 2017 year end has to restate a creditor that was previously shown as £2,000,000 to £1,000,000 under FRS 102. Without any relief this would give rise to a taxable credit of £1,000,000 for the year ended 31 January 2017. Because of the COAP regulations, on transition, the difference between the closing value for the previous period and opening value in the current period is to be brought into account, with the amount spread over a period of ten years. Therefore instead of £1000,000 being taxed in one go, £100,000 will be taxable for the year ended 31 January 2017 and each of the 9 subsequent periods.

 

Final word

This spreading treatment clearly has an advantageous effect when credits are being spread but it will slow down relief for debits. Often these transitional adjustments will ‘unwind’ in the accounts over time and the tax treatment will usually follow the accounting treatment for these ‘unwinds’.

 

 

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