What is happening to UK GAAP?
Statutory financial reporting of UK subsidiaries of US MNCs will soon be affected by forthcoming changes to UK GAAP. These changes will not only impact UK accounting but will also have a knock-on effect on tax reporting and the timing of cash tax payments. As part of the change there are accounting choices to be made which could also impact cash taxes.
UK GAAP will be abolished in its current form and by 2015 at the latest, all UK companies currently using UK GAAP will have to change either to a form of GAAP which uses the IFRS methodology, or adopt a completely new UK GAAP standard (FRS 102).
Companies need to start considering the choices available to them now. By making smart decisions about which companies adopt which GAAP, and the timing of adoption, it is often possible to prevent any adverse tax consequences and/or to improve a company's tax position.
As this will take time, the work should start soon, and must be considered in conjunction with the other effects of GAAP changes on companies' financial statements, distributable reserves and accounting system.
A new UK GAAP standard (FRS 102) is to be introduced, and will replace all the current UK GAAP standards (FRSs, SSAPs, etc.). Companies currently using UK GAAP must either change to FRS 102 or to IFRS. Companies that are subsidiaries have additional options open to them – they can adopt FRS 102 with reduced disclosures, or FRS 101 (which is based on IFRS, with reduced disclosures).
All companies currently using UK GAAP must change to FRS 102, IFRS or FRS 101 for accounting periods beginning on or after 1 January 2015. However, early adoption is permitted.
Yes, both FRS 101 (IFRS with reduced disclosures) and FRS 102 (new UK GAAP) are within the Companies Act framework. So it will be possible for a group to meet the consistency requirement in the Companies Act where some subsidiaries apply FRS 101 and others apply FRS 102.
In UK tax law there are several types of taxable profit which are based on the accounting result. Examples include trading profits, property income, loans, intangibles and derivatives.
If a company changes GAAP then this could impact its cash tax liabilities in two ways – via transitional adjustments, and from the different method of calculating accounting profit going forward.
Some of the key areas affected are considered below.
This is already a complex area, and a change of GAAP adds to the complexity.
Companies will need to review their hedging arrangements to ensure they will still be hedged for tax (and accounting) purposes, where required. This may require some restructuring, or for documentation to be put in place in advance as evidence of the hedging intention.
Transitional adjustments for loans and derivatives are spread over 10 years. There may be opportunities to crystallise losses early to accelerate tax relief.
Companies which currently have off balance sheet derivatives, quasi equity loans, convertible debts and other complex financial instruments need to consider what the tax treatment of these will be on transition and going forward. Making the correct GAAP choice could reduce tax costs and avoid unwanted complexities.
Companies using the older UK GAAP standard for foreign currency (SSAP 20) may be forced to reassess what the appropriate accounting currency (functional currency) should be on adoption of IFRS or FRS 102. This could lead to a change of the currency in which taxable profits must be computed, giving rise to tax exposures on foreign exchange movements. Intermediate holding companies with loans are particularly vulnerable to this, but there are various ways of managing the situation.
Tax relief for goodwill is usually based on the amortisation charge in the accounts. Under current UK GAAP goodwill is typically amortised over 20 years; whereas under FRS 102, it could be as low as 5 years; and under IFRS there is no amortisation. Choice of GAAP could therefore have a significant impact on the timing and amount of tax relief for goodwill, and on the amount of any taxable amount (which could be a charge or a deduction) arising on transition from one GAAP to another.
Recognition of separate intangible assets is more common under IFRS and FRS 102 than under UK GAAP. This can trigger taxable amounts (either charges or deductions) on transition unless specific exemptions are taken. These may need to be managed, if significant.
The rules that determine when certain revenues and costs are recognised (and over what periods) can differ between current UK GAAP, IFRS and FRS 102. A change of GAAP can therefore lead to a taxable transitional adjustment and a change in taxable profits going forward. Examples of items affected include holiday pay accruals and lease incentive payments.
Specifically for UK subsidiaries of US MNCs, Earnings and Profits (E&P) calculations may need to be considered on a change in GAAP, as well as the potential need for any accounting method changes for US returns.
The method of computing deferred tax under IFRS differs significantly from that used under current UK GAAP (FRS 19). A company adopting IFRS or FRS 101 could therefore see significant changes in the amount of deferred tax provided.
Deferred tax under FRS 102 is recognised based the timing differences approach in FRS 19. However, there are some differences from FRS 19, such as the requirement to recognise deferred tax on asset revaluations and on fair value adjustments to assets (except goodwill) and liabilities in a business combination. Deferred tax cannot be discounted under FRS 102.
Management should start to consider the effects of GAAP change as soon as possible. As described above, there could be significant tax consequences arising from the choice of GAAP selected.
There will also be other issues which management will need to consider, such as:
Access a PDF copy of the article on PwC.com.
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Ken Kuykendall Andrew Wiggins Doug Berg |