Mind The GAAP New Irish and UK GAAP What it means for tax Focus on FRS 102. Alan Bromell

Transcription

1 Mind The GAAP New Irish and UK GAAP What it means for tax Focus on FRS 102 Alan Bromell

2 Agenda 1 Overview - New Irish and UK GAAP 2 Why it matters for tax 3 Irish tax impact Seven key issues 4 Other issues 2

3 Why are we here? Accounting periods commencing on or after 1 January 2015 financial statements will look different. Irish GAAP as we know it ceases to exist and companies will convert to IFRS or new accounting standards based on IFRS accounting standards New Irish GAAP Irish tax law is not changing as a result of this but The financial statements are often the starting point in determining taxable profits and that starting point is moving.. Today we will cover: o The choice of GAAPs o 7 key areas affecting tax o Change in how tax is presented in Financial Statements o Deferred tax o Transition matters Focus on Irish businesses 3

4 Irish tax implications - type of taxpayer Type of taxpayer Tax rules Trading entity Taxable profit follows P&L timing and measure Investment company (or Trading entity s non-trading income) General tax principles (income arising/gain etc.). Accounting profit may not be taxed now but consider if a timing difference requiring deferred tax 4

5 Trading entity - why the financial statements matter General rule: Section 76A - The profits or gains of a trade carried on by a company shall be computed in accordance with generally accepted accounting practice subject to any adjustment required or authorised by law in computing such profits or gains Likely GAAP impact for trading companies: Functional currency unlikely to change (possible exception for special purpose companies engaged in trade) May be transitional valuation adjustments impacting accounts (e.g. derivatives brought on Balance Sheet) Transition from GAAP to New GAAP Schedule 17A (updated by Finance Act 2014): Transitional adjustments are spread over a 5 year period for tax purposes (net income and expense) More on this later 5

6 Company Law Rules Financial Reporting Framework 1. Generally (unless listed or otherwise required to adopt EU IFRS) companies have a free choice to adopt either: 2. IFRS Accounts 3. OR Companies Act Accounts FRS 101 FRS 102 FRS 105 6

7 Timeline for adoption FRS 102 The mandatory timeframe for 31 December year ends: March December 2013 Transition date 31 December 2014 Comparative balance sheet date 31 December 2015 First reporting date Applies for accounting periods commencing on or after 1 January 2015 Prior year comparatives will be impacted 7

8 FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland Generally applicable to entities except those required by law or other regulation to use EU IFRS 1. Likely to comprise the vast majority of companies 2. Based on IFRS for SMEs but elements of existing Irish GAAP incorporated 3. Less guidance hierarchy of guidance 4. Precedent expected to emerge over time 5. May be acceptable to have diversity in practice 6. Will be updated and interpretation committee has been established 8

9 Seven key areas where accounting treatment will affect tax Concepts and Formats Transition Investment Property Deferred Tax Intra-group Lending Derivatives Intangible Assets 9

10 Financial Statements Presentation Old GAAP Balance sheet Profit and loss account Statement of total recognised gains & losses Cash flow statement Notes Statement of financial position Statement of comprehensive income and income statement Statement of cash flows Statement of changes in equity Notes FRS 101 (IFRS) Statement of financial position Statement of comprehensive income and income statement Statement of cash flows Statement of changes in equity Notes FRS 102 (New GAAP) 10

11 Total Tax Reconciliation Note under FRS 102 Reconciliation of effective tax rate 201X 201Y Profit for the year Total tax expense Profit excluding taxation Tax based on Irish corporation tax rate of 12.5%: Effect of higher tax rates in foreign jurisdictions Difference in tax rate on gain on sale of discontinued operation Non-deductible expenses Tax exempt revenues Recognition of previously unrecognised tax losses Current year losses for which no deferred tax asset was recognised Under/(over) provision in prior years Total tax expense included in profit or loss Items NOT included in the Tax Reconciliation: Differences between capital allowances and depreciation Payments deductible on a paid basis, etc. 11

12 Transition Schedule 17A par. 2 - identify any income falling out of the accounts or expense being recognised twice spread net impact over 5 years If the company ceases to trade within the 5 year period, the balance of any transitional adjustment not taxed/deducted is taxed/deducted in the final accounting period of the trade Finance Act 2014 updated Schedule 17A to apply to the transition to new GAAP Schedule 17A par. 4 - Identify any portion of unrealised gain on financial instruments (e.g. derivative) which arose before transition and was previously taxed/deducted with result that it will be doubly taxed/deducted when recognised in P&L in future - part of the overall tax transition net income/net expense to be taxed/deducted over 5 years (provided the financial instrument relates to the trade) 12

13 Trading Entity - Example Facts: Transitional gain on raw material derivative (not hedged) Transitional adjustment gain of 250 recognised in retained earnings, no future P&L recognition Fee of 300 for 3 year contract, taxed up front under old GAAP, but spread over 3 years under new GAAP (assume) Move to new GAAP at end of year 1 so that 200 to be taxed as income in contract years 2 and 3 Outcome Derivative: (1) Profits post transaction taxed as normal (follow P&L) (2) Annual transitional income for 5 years of 50 related to derivative gain Fees: (1) If do nothing, total of 500 will get taxed ( 300 upfront and 200 spread) (2) Deduct 200 over 5 years so that not doubly taxed 13

14 Investment property - overview Old GAAP FRS 101 (IFRS) FRS 102 (New GAAP) Exemption from investment property for internal group leases Investment property revaluation through reserves (STRGL) Group leases are investment property Revaluation movements in Income Statement Group leases are investment property Revaluation movements in Income Statement Consolidated accounts: If internal group lease exists, there will be a requirement for a consolidation adjustment to reflect the assets in Property Plant and Equipment at historical cost 14

15 Irish tax implications revaluation through Income Statement Type of taxpayer Impact Property trader Should be no impact on cash tax not earned Will impact deferred tax Investor No impact on cash tax CGT rules Will impact deferred tax 15

16 Investment Property Revaluation through profit and loss account No accounting exemption for group companies so the requirement to measure at fair value will apply also to properties rented to group members Challenge of recognition of deferred tax assets where timing differences give rise to losses especially capital losses 16

17 Investment Property example 1 Year ended 31 December 2016 Property held as investment for tax purposes and rented to 3 rd party Base cost : 100 Carrying value : /12/2016 : 150 Revaluation of 50 through income statement Current tax position: o o Section 76A only applies for Case I purposes Not relevant to Case V income /CGT gain o Adjust (i.e. do not tax) the revaluation of 50 Will have deferred tax impact (Deferred tax liability on timing difference) 17

18 Investment Property example 2 Year ended 31 December 2016 Trading stock for tax purposes but rented intra group so categorised as Investment Property in F/S Base cost : 100 Carrying value : /12/2016 : 150 Revaluation of 50 through income statement. Section 76A follow the accounts for Case I purposes. But general principles not earned and not a fair value adjustment on a financial asset which follows accounting timing under section 76B Revenue confirmed the 50 does not get taxed. Deferred tax on timing difference 18

19 Calculation of deferred tax/tax disclosure Old GAAP Calculation: Timing difference approach Disclosure: P&L reconciliation to current tax No detailed balance sheet analysis of deferred tax No requirement to detail key judgement areas FRS 101 (IFRS) Calculation: Balance sheet approach (temporary differences) Disclosure: P&L reconciliation to total tax Detailed balance sheet analysis of deferred tax Requirement to detail key judgement areas FRS 102 (New GAAP) Calculation: Timing differences plus approach Disclosure: P&L reconciliation to total tax Summary balance sheet analysis of deferred tax Requirement to detail key judgement areas Impact: In practice, expected that deferred tax calculated under FRS 101 and FRS 102 are likely to be materially similar 19

20 Deferred Tax Recognise deferred tax on intragroup transfers where CGT relief claimed Recognise deferred tax on transfers on which rollover relief claimed Recognise deferred tax on revalued property regardless of any intention to sell the asset old GAAP provided an exemption in this respect Close Company Surcharge requirement to recognise, even if plan is to distribute profits within 18 months or make election to ignore dividend, because tax rate is the rate applicable to undistributed profits Will need to collect information on base cost for assets which have been revalued or had gains rolled over in order to estimate amount of timing difference for deferred tax purposes Derivatives on balance sheet with fair value movement in P&L deferred tax impact if not taxed in current period e.g. as part of profits of trade Business combinations need to identify tax base cost of assets and recognise deferred tax if different to their fair values See Appendix for summary 20

21 Financial Instruments - derivatives/loans/hedges etc. Existing GAAP FRS 101 (IFRS) FRS 102 (New GAAP) Not separately identified Historical cost accounting Limited volatility of profits (and automatic recognition of certain movements in STRGL) Complex rules Initially fair valued Four different categories: Fair value through profit or loss Held-to-maturity Loans and Receivables Available-for-sale Certain movements can be reflected in SORIE. Requires documentation Basic instruments: Initial measurement is at transaction price, except financings which are measured at the NPV of future cash flows Other instruments: Fair value through income statement However: Option to choose FRS 101/IFRS approach Certain movements can be reflected in SORIE. Requires documentation 21

22 Intra- group debts and receivables Under FRS 102, if the financial asset is a basic instrument and the arrangement constitutes in effect a financing transaction then net present value should be used for initial measurement and discount for effective interest rate element. In most other cases, a fair value initial measurement should be used. Carefully review long standing intercompany receivables to assess if they are in effect a financing transaction Practical matters to consider when reviewing intra-group financing arrangements: Unusual terms in loan agreements (are they basic instruments)? Repayable on demand (in practice)? Carrying value at face value subject to impairment Ability for borrower to repay? Long term balance to company with deficit? Impact on transfer pricing (e.g. if decide to change terms and conditions of current intra group financing arrangements). Are they currently not in scope of transfer pricing because of grandfathering? Impact on interest as a charge borrowings (e.g. if decide to change intra group funding flows) 22

23 Example Intra- group debt Facts: Interest free loan of 100 with fixed term of 3 years Day 1 Old GAAP Balance Sheet 100 FRS 102 (basic) Balance sheet 85 Year 1 Year 2 P&L 0 Balance Sheet: Loan 100 P&L 0 Balance Sheet: Loan 100 Income Statement 5 Balance Sheet: Loan 90 Income Statement 5 Balance Sheet: Loan 95 Year 3 P&L 0 Income Statement 5 Balance Sheet: Balance Sheet: Loan 100 Loan Tax impact interest is taxed on an arising basis. Notional accounting entry should not be taxed

24 Derivatives Hedge accounting applies for most normal hedges used in practice BUT must document to secure hedging treatment before the first set of financial statements prepared in accordance with FR 102 are approved Derivatives not regarded as hedge related recognised on balance sheet at fair value where either cost or off-balance sheet treatment may have been previously applied Could be an impact on Income Statement (i.e. in or out of the money element of the derivative) Taxable/deductible if a fair value movement on a financial asset/liability and trade related (see section 76B) Could mean volatility in measure taxable profits and affect future ability to predict with certainty cash tax payable If losses in later periods but gains in earlier periods, 1 year restriction on trading loss carry back 24

25 Derivative Raw material commodity Facts: 1 Jan Y1 Acquire right to buy flour in Year 2 at Dec Y1 Market value of flour is now Jan Y2 Flour acquired from market for 100 Year Old GAAP Y1 P&L - STRGL - Balance Sheet Assets - Balance Sheet Reserves - Y2 P&L - STRGL - Balance Sheet Assets 100 Balance Sheet Reserves - FRS 101/102 (no hedging) Income Statement 10 SORIE - Balance Sheet Assets 10 Balance Sheet Reserves 10 Income statement - SORIE - Balance Sheet Assets 110 Balance Sheet Reserves 10 New GAAP (with hedging) Income Statement - SORIE 10 Balance Sheet Assets 10 Balance Sheet Reserves 10 Income statement 10 SORIE (10) Balance Sheet Assets 110 Balance Sheet Reserves 10 25

26 Intangible Assets other than Goodwill Recognise assets such as customer lists and certain customer relationships/brands/licences, etc. All intangibles must have a finite life, the default period for amortisation is 5 years unless can justify longer period Section 291A amortise over 15 years or follow accounts o Consider period of tax deduction 26

27 Other Changes/Issues Functional currency Impact on distributable reserves UK tax - more complex 27

28 Summary From 2015, financial statements will change Ultimately, likely to have minimal impact on quantum or timing of cash tax payments, but Tax notes will change Deferred tax will change Will need to make adjustments in tax computation for nontaxable/non-deductible items Consider practical impact: New format of tax reconciliation and likely more movements in scope of deferred tax Educate client team where different information required 28

29 Appendix Deferred tax summary of key differences (1) Difference FRS 19 FRS 102 IAS 12 Revaluations No provision to be made unless binding agreement to sell Deferred tax provided Deferred tax provided Rolled over gains No provision to be made until the assets into which the gains have been rolled over are sold. Deferred tax provided Deferred tax provided 29

30 Deferred tax summary of key differences (2) Difference FRS 19 FRS 102 IAS 12 Retained earnings of subsidiaries, JVs and associates No provision unless dividends have been accrued or there is a binding agreement to distribute Provide unless can control timing of reversal and no reversal probable in the foreseeable future Provide unless can control timing of reversal and no reversal probable in the foreseeable future Business combinations Deferred tax should only be provided where it would be recognised if the fair value adjustments were timing differences arising in the acquired entity s financial statements Where the amount attributable for tax purposes to assets and liabilities other than goodwill acquired in a business combination are different to their fair values deferred tax shall be recognised Deferred tax should always be provided on the difference between fair value and tax base of identifiable assets and liabilities acquired in a business combination (subject to non tax deductible goodwill) 30

31 Deferred tax summary of key differences (3) Difference FRS 19 FRS 102 IAS 12 Differences arising from remeasurement of non monetary assets from local currency to functional currency No deferred tax as this is not a timing difference No deferred tax as this is not a timing difference This results in a temporary difference on which deferred tax should be recognised Profit or losses arising on intra group transactions that are eliminated on consolidation Deferred tax should be provided based on the selling company tax rate Deferred tax should be provided based on the selling company tax rate Deferred tax should be provided based on the buying company tax rate 31

32 Deferred tax summary of key differences (4) Difference FRS 19 FRS 102 IAS 12 Tax base of goodwill greater than book basis of goodwill at the date of acquisition No deferred tax as this is not a timing difference No deferred tax for goodwill on business combinations provided the goodwill is not tax deductible Deferred tax asset is recognised 32

33 Deferred tax summary of key differences (5) Difference FRS 19 FRS 102 IAS 12 Measurement of deferred tax No specific comment Deferred tax on a non depreciable asset using the revaluation model or an investment property that is not a depreciable investment property shall provide deferred tax based on tax rates that apply to the sale of the asset rate can apply if can demonstrate other manner of recovery e.g. through rent Tax reconciliation Reconcile to current tax Reconcile to total tax Disclosure of expected net reversals of deferred tax balances in the next year Deferred tax assets and liabilities are measured based on the expected manner of recovery (asset) or settlement Reconcile to total tax 33