1.1 Allocation of tax income and expense between periods

The most significant accounting question which arises in relation to taxation is how to allocate tax expense (income) between accounting periods. The particular period in which transactions are recognised in the financial statements is determined by FRS 102. However, the timing of the recognition of transactions for the purposes of measuring the taxable profit is governed by tax law, which sometimes prescribes an accounting treatment different from that used in the financial statements. The generally accepted view is that it is necessary for the financial statements to seek some reconciliation between these different treatments.

Broadly speaking, those tax consequences that are legal assets or liabilities at the reporting date are referred to as current tax. The other tax consequences, which are expected to become, or (more strictly) form part of, legal assets or liabilities in a future period, are referred to as deferred tax.

This is illustrated by Example 26.1, and the further discussion at 1.1.1 to 1.1.2 below.

1.2 Permanent differences

Some differences between an entity's taxable profit and accounting profit arise not because the same items are recognised in taxable profit and accounting profit in different periods (i.e. timing differences), but because an item recognised in accounting profit is never recognised in taxable profit and vice-versa. For example:

• An item of PP&E is depreciated but its cost is not deductible for tax purposes other than on sale. An example in the UK would be an industrial building. Any depreciation of such an asset recognised for accounting purposes is a permanent difference.
• In the UK a company may obtain a tax deduction for a share-based payment transaction based on its value at vesting or exercise, which is typically higher than its value at grant, on which the expense in the financial statements is based. Any excess of the tax deduction over the expense recognised in the financial statements is a permanent difference.

As discussed further at 6.5 below, Section 29 requires that deferred tax is not recognised on permanent differences, except for differences arising on first accounting for a business combination accounted for by applying the purchase method. [FRS 102.29.10].

2.1 Withholding taxes on dividends and VAT and other sales taxes

The requirements of Section 29 in relation to withholding taxes on dividends (see 3.3 below) are not reflected in IAS 12 – Income Taxes, which refers only to withholding taxes payable by a subsidiary, associate or joint arrangement on distributions to the reporting entity. Accordingly, entities moving from IFRS to FRS 102 may find themselves grossing up withholding taxes on dividend income for the first time.²

IAS 12 does not include VAT and other similar sales taxes in its scope, whereas Section 29 does (see 4 below). Taxes outside the scope of IAS 12 fall under the general requirements of IAS 37 – Provisions, Contingent Liabilities and Contingent Assets. [IFRIC 21.BC4]. Specific provisions of other standards, notably in IFRS 15 – Revenue from Contracts with Customers, IAS 2 – Inventories, IAS 38 – Intangible Assets, and IAS 16 – Property, Plant and Equipment, result in an accounting treatment for VAT and some other sales taxes that is essentially the same as that required in FRS 102.³

2.2 Current tax and deferred tax

The requirements of Section 29 and IAS 12 in respect of the recognition and measurement of current tax are essentially the same.

As regards deferred tax, Section 29 adopts a ‘timing difference’ approach, except when the entity first recognises assets and liabilities acquired in a business combination accounted for by applying the purchase method (where the treatment is largely the same as IFRS). Timing differences are differences between taxable profits and total comprehensive income as stated in the financial statements that arise from the inclusion of income and expenses in tax assessments in periods different from those in which they are recognised in financial statements. [FRS 102.29.6].

IAS 12 applies a ‘temporary difference’ approach, whereby deferred tax is recognised on the difference between the carrying amount of an asset or liability and the amount at which that asset or liability is assessed for tax purposes (referred to as its ‘tax base’). However, there are some exceptions to this, most notably the initial recognition exception, whereby no deferred tax is recorded on a difference between the carrying amount of an asset or liability and its tax base where that difference arose on the initial recognition of the asset or liability in a transaction which gave rise to no accounting profit or loss and no tax effect and was not a business combination. No such exemption is necessary under a ‘timing differences’ approach as no timing differences arise on the initial recognition of an asset. [FRS 102.BC.B29.5].

Whilst it had been determined that FRS 102 should be based on a ‘timing differences’ approach in most circumstances, it was considered important to maintain consistency with IFRS on the recognition of deferred tax arising from a business combination. Accordingly, Section 29 departs from a pure ‘timing differences’ approach in this respect alone. [FRS 102.BC.B29.6].

Having supplemented the ‘timing differences’ approach with a requirement to recognise deferred tax on business combinations, the main distinction between Section 29 and IFRS is that IAS 12 requires deferred tax to be recognised on any difference between the carrying amount of an asset or liability and its tax base that arises after the initial recognition of the asset or liability. Section 29 would prohibit the recognition of such differences that are not the result of timing differences. For example, no deferred tax is recognised under Section 29 when: [FRS 102.BC.B29.7]

• the tax basis (the tax-deductible amount) of an asset is amended, such as when the legislation changes the amount of future tax relief relating to the asset (see 6.5 below); and
• the tax deduction (or estimated future deduction) for share-based payment exceeds the cumulative amount of the related remuneration expense (see 7.7 below).

3.1 Terms used in Section 29

The following terms are used in Section 29 with the meanings specified. [FRS 102 Appendix I].

3.2 What is an ‘income tax’?

Section 29 applies to income tax. [FRS 102.29.2(a)]. Income tax as defined in FRS 102 Appendix I includes:

• all domestic and foreign taxes that are based on taxable profit; and
• taxes, such as withholding taxes, that are payable by a subsidiary, associate or joint arrangement on distributions to the reporting entity.

This definition is somewhat circular, since ‘taxable profit’ is, in turn, defined in terms of profits ‘upon which income taxes are payable’. [FRS 102 Appendix I].

UK corporation tax is an ‘income tax’ as defined, since it takes as its starting point the totality of a reporting entity's accounting profits. However, both the UK and overseas jurisdictions raise ‘taxes’ on sub-components of net profit. These include:

• sales taxes;
• goods and services taxes;
• value added taxes;
• levies on the sale or extraction of minerals and other natural resources;
• taxes on certain goods as they reach a given state of production or are moved from one location to another; or
• taxes on gross production margins.

Taxes that are simply collected by the entity from one third party (generally a customer or employee) on behalf of another third party (generally local or national government) are not ‘income taxes’ for the purposes of Section 29. This view is supported by the requirement of Section 23 – Revenue – that taxes which are collected from customers by the entity on behalf of third parties do not form part of the entity's revenue [FRS 102.23.4] (and therefore, by implication, are not an expense of the entity either).

In cases where such taxes are a liability of the entity, they may often have some characteristics both of production or sales taxes (in that they are payable at a particular stage in the production or extraction process and may well be allowed as an expense in arriving at the tax on net profits) and of income taxes (in that they may be determined after deduction of certain allowable expenditure). This can make the classification of such taxes (as income taxes or not) difficult.

Further discussion of factors that are considered in determining whether a particular tax meets the definition of an income tax under IFRS may be found in Chapter 29 at 4.1 of EY International GAAP 2019.

3.3 Withholding and similar taxes

As discussed at 3.2 above, Section 29 includes in its scope those taxes, such as withholding taxes, which are payable by a subsidiary, associate or joint arrangement on distributions to the reporting entity. [FRS 102 Appendix I]. FRS 102 also sets specific requirements in relation to withholding taxes on income from entities other than a subsidiary, associate or joint venture. This gives rise to further questions of interpretation which are not addressed by the standard.

When an entity pays dividends to its shareholders, it may be required to pay a portion of the dividends to taxation authorities on behalf of shareholders. Outgoing dividends and similar amounts payable shall be recognised at an amount that includes any withholding tax but excludes other taxes, such as attributable tax credits. [FRS 102.29.18].

Incoming dividends and similar income receivable shall be recognised at an amount that includes any withholding tax but excludes other taxes, such as attributable tax credits. Any withholding tax suffered shall be shown as part of the tax charge. [FRS 102.29.19].

The rationale for the treatment as income taxes of taxes payable by a subsidiary, associate or joint arrangement on distributions to the investor is discussed further at 6.4 below. Essentially, however, the reason for considering withholding taxes within the scope of income tax accounting derives from the accounting treatment of the investments themselves. The accounting treatment for such investments – whether by consolidation or the equity method – results in the investor recognising profit that may be taxed twice: once as it is earned by the investee entity concerned, and again as that entity distributes the profit as dividends to the investor. Section 29 ensures that the financial statements reflect both tax consequences.

3.4 Investment tax credits

Investment tax credits are not defined in FRS 102 and can take different forms and be subject to different terms. Sometimes a tax credit is given as a deductible expense in computing the entity's tax liability, and sometimes as a deduction from the tax liability, rather than as a deductible expense. In other cases, the value of the credit is chargeable to corporation tax and in others it is not. Entitlement to investment tax credits can be determined in a variety of ways. Some investment tax credits may relate to direct investment in property, plant and equipment. Other entities may receive investment tax credits relating to research and development or other specific activities. Some credits may be realisable only through a reduction in current or future corporation tax payable, while others may be settled directly in cash if the entity is loss-making or otherwise does not have sufficient corporation tax payable to offset the credit within a certain period. Access to the credit may be limited according to total of all taxes paid, including employment taxes (such as PAYE and NIC) and VAT, in addition to corporation tax. There may be other conditions associated with receiving the investment tax credit, for example with respect to the conduct and continuing activities of the entity, and the credit may become repayable if ongoing conditions are not met.

Section 24 of FRS 102 – Government Grants – excludes from its scope government assistance that is either provided by way of a reduction in taxable income, or determined or limited according to an entity's income tax liability, citing investment tax credits as an example and then stating that taxes based on income are required to be accounted under Section 29. [FRS 102.24.3]. This implies that those investment tax credits that are excluded from the scope of Section 24 should be accounted for as income tax. However, if government assistance is described as an investment tax credit, but it is neither determined or limited by the entity's income tax liability nor provided in the form of an income tax deduction, such assistance should be accounted for as a government grant under Section 24 (see Chapter 21 at 3.2.1).

This raises the question as to how an entity should assess whether a particular investment tax credit gives rise to assistance in the form of benefits that are available in determining taxable profit or loss or are determined or limited on the basis of income tax liability [FRS 102.24.3] and, therefore, whether Section 24 or Section 29 should be applied. In our view, such a judgment would be informed by reference to the following factors as applied to the specific facts and circumstances relating to the incentive:

In group accounts, in which entities from different jurisdictions may be consolidated, it may be desirable that all ‘investment tax credits’ should be consistently accounted for, either as a government grant under Section 24 or as an income tax under Section 29. However, the judgment as to which section applies is made by reference to the nature of each type of investment tax credit and the conditions attached to it. This may mean that the predominant treatment by FRS 102 reporters for a specific type of tax credit differs from the consensus by FRS 102 reporters in another jurisdiction for what could appear to be a substantially similar credit. We believe that, in determining whether the arrangement is of a type that falls within Section 24 or Section 29, an entity should consider the following factors in the order listed below:

• the predominant local determination by FRS 102 reporters as to whether a specific credit in the relevant tax jurisdiction falls within the scope of Section 24 or Section 29;
• if there is no predominant local consensus, the group-wide approach to determining the section that applies to such a credit should be applied; and
• in the absence of a predominant local treatment or a group-wide approach to making the determination, the indicators listed in the table above should provide guidance.

This may occasionally mean that an entity operating in a number of territories adopts different accounting treatments for apparently similar arrangements in different countries, but it at least ensures a measure of comparability between different FRS 102 reporters operating in the same tax jurisdiction.

Where a tax credit is determined to be in the nature of an income tax, an entity will need to determine whether the related benefit is more appropriately accounted for as a discrete tax asset akin to a tax loss, or as a deduction in respect of a specific asset and therefore akin to accelerated capital allowances. In most cases, we believe that it will generally be more appropriate to treat a tax credit that is accounted for as income tax as a discrete tax asset akin to a tax loss. As a result, the recoverability of any amounts that are unused and available for carry forward to future years would be assessed in accordance with the criteria discussed at 6.2 below.

Analysis of these features by reference to the criteria set out above leads us to conclude that the RDEC credit is more appropriately regarded as a government grant. In particular, the benefits of the tax credit are capable of being realised in cash where there is insufficient corporation tax capacity; the tax credit relates to specific qualifying expenditure; and the grant income is determined on a pre-tax basis and is itself taxable.

Such an analysis requires a thorough understanding of the rules applying to the particular relief. Other seemingly similar reliefs should be treated as income taxes under Section 29 if, for example, the relief is not itself taxable; the relief could only be recovered by offset against other liabilities to corporation tax; or, where there is a cash payment alternative, the expected cash inflow approximates more closely to the value of the tax benefit rather than to the value of the expenditure incurred.

3.5 Interest and penalties

UK tax law (and that of other jurisdictions) provide for interest and/or penalties to be paid on late payments of tax. This raises the question of whether or not such penalties fall within the scope of Section 29. The answer can have consequences not only for the presentation of interest and penalties in the income statement; but also for the timing of recognition and on the measurement of amounts recognised. If such penalties and interest fall within the scope of Section 29, they are presented as part of tax expense and measured in accordance with the requirements of that section. Where uncertainty exists as to whether interest and penalties will be applied by the tax authorities, an entity must consider the effect of uncertain tax positions as discussed at 5.2 below. If interest and penalties do not fall within the scope of Section 29, they should be included in profit before tax, with recognition and measurement determined in accordance with other accounting requirements, most likely to be Section 21.

In our view, in the absence of specific guidance in FRS 102 on recognition and measurement of interest and penalties, an entity may apply the hierarchy provided in Section 10 – Accounting Policies, Estimates and Errors – and accordingly, consider the guidance in EU-adopted IFRS, [FRS 102.10.6], as described below:

1. the determination of whether Section 29 or Section 21 should be applied is not a simple accounting policy choice. Instead, the nature of the particular amount payable or receivable for interest and penalties, how it is calculated and whether this meets the definition of an income tax are relevant to making an appropriate judgement. If Section 29 is determined to apply, then the entity recognises and measures any current tax and deferred tax on that basis. If an entity does not apply Section 29 to interest and penalties, then it applies Section 21 to those amounts;
2. paragraph 26 of Section 29 requires an entity to disclose the major components of tax expense (income) and paragraph 14 of Section 21 require a reconciliation of the carrying amount at the beginning and end of the reporting period as well as various other pieces of information. Accordingly, regardless of whether an entity applies Section 29 or Section 21 when accounting for interest and penalties related to income taxes, the entity would disclose information about that interest and those penalties if it is material; and
3. paragraph 6 of Section 8 – Notes to the Financial Statements – requires disclosure of the judgements that management has made in the process of applying the entity's accounting policies and that have the most significant effect on the amounts recognised in the financial statements.

Factors that are relevant in determining whether an item is accounted as income tax are more fully discussed in Chapter 29 at 4.4 of EY International GAAP 2019.

3.6 State-aid

In the European Union, member states are prohibited from providing ‘State Aid’, whereby government intervention results in an advantage being conferred on a selective basis to undertakings in a manner that may distort competition. State intervention includes the transfer of resources, for example by grants, guarantees, equity investment or by the provision of tax incentives and tax reliefs. Where the European Commission confirms that State Aid has been provided, it has powers to require the member state to seek recovery of the funds determined to have been transferred.

Where such incentives have been provided under local tax law, the related tax reliefs will have been accounted for under Section 29 on the basis of substantively enacted legislation as at the relevant reporting date. In situations where the European Commission has confirmed the provision of State Aid, recovery may be made either by a revision to local tax legislation or by a direct demand for repayment under EU Regulations, including competition law. The question therefore arises whether the recovery of incentives and reliefs that are now determined to be State Aid should be accounted for as a repayment of income tax under Section 29 or as the payment of a fine or levy in accordance with Section 21.

If recovery of the State Aid is achieved by changes to tax legislation, it follows that Section 29 would apply. However, where recovery does not involve any changes to tax legislation, the answer is not clear. On the one hand the economic substance is that previously claimed tax reliefs are being returned; whereas the legal form of the repayment is a fine or a levy. In our opinion, in these circumstances entities face considerations that are similar to the judgement as to whether interest and penalties should fall in the scope of Section 29 or Section 21 (see 3.5 above).

3.7 Effectively tax-free entities

Certain classes of entity (for example, in the UK, pension funds and certain partnerships) are exempt from income tax, and accordingly are not within the scope of Section 29.

However, a more typical, and more complex, situation is that tax legislation has the effect that certain classes of entities, whilst not formally designated as ‘tax-free’ in law, are nevertheless exempt from tax provided that they meet certain conditions that, in practice, they are almost certain to meet. Examples in the UK are certain investment vehicles that pay no tax, provided that they distribute all, or a minimum percentage, of their earnings to investors.

Accounting for the tax affairs of such entities raises a number of challenges, as discussed further at 7.6 below.

3.8 Discontinued operations – interaction with Section 5

Section 5 – Statement of Comprehensive Income and Income Statement – requires the post-tax results of discontinued operations to be shown separately on the face of the statement of comprehensive income (and any separate income statement presenting the components of profit or loss). This is discussed further in Chapter 6.

The definitions of income tax, tax expense and taxable profit in Section 29 (see 3.1 above) do not distinguish between the results of continuing and discontinued operations, or the tax on those results. Thus, Section 29 applies not only to the tax income or expense on continuing operations, but also to any tax income or expense relating to the results of discontinued operations.

5.1 Enacted or substantively enacted tax legislation

5.2 Uncertain tax positions

In recording the amounts of current tax expected to be paid or recovered, [FRS 102.29.5], the entity will sometimes have to deal with uncertainty. For example, tax legislation may allow the deduction of research and development expenditure, but there may be uncertainty as to whether a specific item of expenditure falls within the definition of eligible research and development costs in the legislation. In some cases, it may not be clear how tax law applies to a particular transaction, if at all. In other situations, a tax return might have been submitted to the tax authorities, who are yet to opine on the treatment of certain transactions, or even have indicated that they disagree with the entity's interpretation of tax law.

These situations are commonly referred to as ‘uncertain tax positions’ or ‘uncertain tax treatments’ and estimating the outcome of these uncertainties is often one of the most complex and subjective areas in accounting for tax. However, FRS 102 does not specifically address the measurement of uncertain tax positions, beyond the general requirement of the standard to measure current tax at the amount expected to be paid or recovered. [FRS 102.29.5].

When a Standard does not specifically address a transaction other event or condition, FRS 102 requires an entity's management to use its judgment in developing and applying an appropriate accounting policy. [FRS 102.10.4]. It would be appropriate to refer to other sections of FRS 102, [FRS 102.10.5], for example to the guidance in Section 21 on the determination of a ‘best estimate of the amount required to settle the obligation at the reporting date’ [FRS 102.21.7] (see Chapter 19 at 3.7.1). An entity may also consider the approaches applied by IFRS reporters dealing with uncertain tax treatments under IFRIC 23 – Uncertainty over Income Tax Treatments. [FRS 102.10.6]. These approaches are discussed in Chapter 29 at 9 of EY International GAAP 2019.

One of the judgments required to be made by management is to determine the unit of account. This might be an entire tax computation, individual uncertain positions, or a group of related uncertain positions (e.g. all positions in a particular tax jurisdiction, or all positions of a similar nature or relating to the same interpretation of tax legislation). The estimated outcome could be different depending on whether the probability of outcomes is considered on an item by item basis or across the population of uncertainties as a whole.

Another consideration required in estimating an uncertain tax position is the question of ‘detection risk’, which refers to the likelihood that the tax authority examines every single amount reported to it by the entity and the extent to which the tax authority has full knowledge of all relevant information. In our view, it is normally not appropriate to assume that the tax authority would not exercise its right to examine amounts reported to it nor to assume that it has less than full knowledge of all relevant information. Accordingly, such ‘detection risk’ should not feature in the recognition and measurement of uncertain tax positions.

In many jurisdictions, including the UK, the tax law imposes a legal obligation on an entity operating in that jurisdiction to disclose its full liability to tax, or to assess its own liability to tax, and to make all relevant information available to the tax authorities. In such a tax jurisdiction it would be difficult, as a matter of corporate governance, for an entity to record a tax provision calculated on the basis that the tax authority will not become aware of a particular position which the entity has a legal obligation to disclose to that authority.

5.3 ‘Prior year adjustments’ of previously presented tax balances and expense (income)

The determination of the tax liability for all but the most straightforward entities is a complex process. It may be several years after the end of a reporting period before the tax liability for that period is finally agreed with the tax authorities and settled. Therefore, the tax liability initially recorded at the end of the reporting period to which it relates is no more than a best estimate at that time, which will typically require revision in subsequent periods until the liability is finally settled.

Tax practitioners often refer to such revisions as ‘prior year adjustments’ and regard them as part of the overall tax charge or credit for the current reporting period whatever their nature. However, for financial reporting purposes, the normal provisions of Section 10 (see Chapter 9) apply to tax balances and the related expense (income). Therefore, the nature of any revision to a previously stated tax balance should be considered to determine whether the revision represents:

• a correction of a material prior period error (in which case it should be accounted for retrospectively, with a restatement of comparative amounts and, where applicable, the opening balance of assets, liabilities and equity at the start of the earliest period presented); [FRS 102.10.21] or
• a refinement in the current period of an estimate made in a previous period (in which case it should be accounted for in the current period). [FRS 102.10.17].

In some cases the distinction is clear. If, for example, the entity used an incorrect substantively enacted tax rate (see 5.1 above) to calculate the liability in a previous period, the correction of that rate would – subject to materiality – be a prior year adjustment. A more difficult area is the treatment of accounting changes to reflect the resolution of uncertain tax positions (see 5.2 above). These are in practice almost always treated as measurement adjustments in the current period. However, a view could be taken that the eventual denial, or acceptance, by the tax authorities of a position taken by the taxpayer indicates that one or other party (or both of them) were previously taking an erroneous view of the tax law. As with other aspects of accounting for uncertain tax positions, this is an area where considerable judgment may be required.

5.4 Intra-period allocation, presentation and disclosure

The allocation of current tax income and expense to components of total comprehensive income and equity is discussed at 8 below. The presentation and disclosure of current tax income expense and assets and liabilities are discussed at 10 and 11 below.

6.1 Recognition of deferred tax on timing differences

Timing differences are differences between taxable profits and total comprehensive income as stated in the financial statements that arise from the inclusion of income and expenses in tax assessments in periods different from those in which they are recognised in financial statements. [FRS 102.29.6]. Timing differences are said to originate in the accounting period in which they first arise or increase and to reverse in subsequent periods when they decrease, eventually to zero.

6.2 Restrictions on the recognition of deferred tax assets

Embodied in the definition of an asset in FRS 102 is the expectation of an inflow of future economic benefits. [FRS 102 Appendix I]. Accordingly, Section 29 restricts the recognition of unrelieved tax losses and other deferred tax assets to the extent that it is probable that they will be recovered against the reversal of deferred tax liabilities or other future taxable profits. Section 29 observes that the very existence of unrelieved tax losses is strong evidence that there may not be other future taxable profits against which the losses will be relieved. [FRS 102.29.7].

By contrast to IAS 12, FRS 102 provides no additional guidance on the interpretation of this general requirement. However, in applying the hierarchy set out in Section 10, we believe that the guidance in IAS 12 is relevant in forming a view as to whether to recognise a deferred tax asset under Section 29. Accordingly, in our opinion, the entity needs to consider:

• recovery against the reversal of recognised deferred tax liabilities; and
• the availability of future taxable profits.

6.3 Capital allowances – when all conditions for their retention have been met

Section 29 requires deferred tax to be recognised on timing differences arising when the tax allowances for the cost of a fixed asset are accelerated (i.e. received before the depreciation of the asset is recognised in profit or loss) or decelerated (i.e. received after the depreciation of the asset is recognised in profit or loss). However, any recorded deferred tax should be reversed if and when all conditions for retaining the allowances have been met. [FRS 102.29.8].

A past example of a situation giving rise to such a reversal in the UK related to entities that had previously claimed industrial buildings allowances (IBAs) which ceased to be subject to clawback (or a balancing charge) if the asset had been held for 25 years. However, IBAs were phased out in the UK by 2012.

6.4 Income or expenses from a subsidiary, associate, branch or joint venture

Entities are required to recognise deferred tax on timing differences that arise when income or expenses from a subsidiary, branch, associate or joint venture have been recognised in the financial statements and will be assessed to or allowed for tax in a future period, except where: [FRS 102.29.9]

• the reporting entity is able to control the reversal of the timing difference; and
• it is probable that the timing difference will not reverse in the foreseeable future.

Section 29 notes that such timing differences may arise where there are undistributed profits in a subsidiary, branch, associate or joint venture. [FRS 102.29.9]. For example, an entity may have recognised in its consolidated financial statements the profits of its subsidiaries or recognised in its consolidated income statement an amount in respect of its share of the earnings of its equity-accounted associates and joint ventures. In cases where the investee is required to deduct withholding tax on any distribution of those profits to its parent, there will be future tax consequences relating to those earnings that have been recognised in the entity's financial statements. Subject to the exception above, deferred tax should be recognised for such timing differences.

6.5 Permanent differences

Permanent differences are differences between an entity's taxable profits and its total comprehensive income as stated in the financial statements, other than timing differences. [FRS 102 Appendix I]. Permanent differences arise because certain types of income or expenses are non-taxable or disallowable, or because certain tax charges or allowances are greater than or smaller than the corresponding income or expense in the financial statements. [FRS 102.29.10]. These latter items are sometimes referred to as ‘super-deductible’ or ‘partially-deductible’ assets and liabilities. Under Section 29, deferred tax is not recognised on permanent differences, except when an entity is accounting for assets and liabilities acquired in a business combination accounted for by applying the purchase method (see 6.6 below). [FRS 102.29.10].

A permanent difference generally arises from the tax status of an asset (or liability) at the time of its initial recognition. For example, in the UK certain categories of building attract no tax deduction in respect of their use within the business, but only on a subsequent sale. Conversely, the tax deductions made available may exceed the actual expenditure incurred, such as in the case of certain companies engaged in North Sea exploration activities. Another example of a permanent difference arises where an asset is transferred at book value from one member of a group to another, together with its tax history. In this case, the selling subsidiary derecognises the asset and any related deferred tax; but the buying subsidiary recognises only the asset, despite the fact that the cost may only be partially deductible for tax purposes.

In other cases, a permanent difference can be created as a result of changes in tax law subsequent to the original recognition of the asset, for example when the cost of an asset becomes deductible for tax purposes having previously been disallowed. Such changes can give rise to the recognition of deferred tax assets or liabilities under IFRS, but do not under Section 29, where the effect is recognised prospectively as timing differences arise.

In most cases, the application of this requirement for permanent differences is straightforward – either an item is deductible or assessable for tax, or it is not. However, certain items give rise to accounting income and expenditure of which some is assessable or deductible for tax, and some is not. Accounting for the deferred tax effects of such items can raise some issues of interpretation which particularly affect:

• non-deductible assets subject to revaluation (see 6.5.1 below); and
• partially deductible and super-deductible assets (see 6.5.2. below).

6.6 Business combinations

As an exception to the general ‘timing differences’ approach to the recognition of deferred tax in Section 29, an entity is required to recognise deferred tax on the differences between the values recognised for assets (other than goodwill) and liabilities acquired in a business combination accounted for applying the purchase method and the amounts at which those assets and liabilities will be assessed for tax. [FRS 102.29.11]. Any such differences are permanent differences to the acquiring entity as defined in FRS 102, because they arise from:

• gains or losses recognised by (and/or tax charged to or credited by) the acquiree before its acquisition;
• fair value adjustments made by the reporting entity on acquisition (which are effectively recognised in goodwill or negative goodwill, not in total comprehensive income); and
• the effect of permanent differences that were not recognised in the financial statements of the acquired entity.

Accordingly, the amount of deferred tax required to be recognised in a business combination may be greater than just the differences between the fair values of assets and liabilities acquired and their previous carrying amounts in the financial statements of the acquired entity.

This exception to the general ‘timing differences’ approach of Section 29 requires entities to account for deferred tax arising in a business combination accounted for applying the purchase method using the ‘temporary differences’ approach of IAS 12. The accounting for deferred taxes in such business combinations is largely consistent with the guidance in IAS 12 except that whilst IAS 12 explicitly prohibits only the recognition of a deferred tax liability relating to the initial recognition of goodwill, [IAS 12.15(a)], Section 29 prohibits the recognition of both a deferred tax liability and a deferred tax asset on goodwill arising in a business combination. [FRS 102.29.11]. Accordingly, in the (albeit rare) situation where goodwill is tax deductible and the deductible amount exceeds the value recognised in the financial statements, no asset would be recognised under FRS 102 whereas a deductible temporary difference may qualify for recognition as a deferred tax asset under IAS 12. The recognition and measurement of deferred tax in the context of a business combination is discussed more fully in Chapter 29 at 12 of EY International GAAP 2019.

Deferred tax recognised in a business combination is reflected in the measurement of goodwill, and not taken to total comprehensive income or equity. [FRS 102.29.11]. This requirement may lead to the creation of goodwill which, on a literal reading of Section 27 – Impairment of Assets, would be required to be immediately impaired, as illustrated by Example 26.7 below.

This will give rise to the following consolidation journal:

¹ 20% of (£[60m + 20m] – £15m)

The fair value of the consolidated assets of the subsidiary (excluding deferred tax) and goodwill as presented in the financial statements is now £113m, but the cost of the subsidiary is only £100m. Clearly £13m of the goodwill arises solely from the recognition of deferred tax. However, Section 27, paragraph 18(b), explicitly requires tax to be excluded from the estimate of future cash flows used to calculate any impairment. This raises the question of whether there should not be an immediate impairment write-down of the assets to £100m. In our view, this cannot have been the intention of Section 27, as discussed in Chapter 24.

7.1 Revalued non-depreciable assets and investment property measured at fair value

Section 29 specifies the manner of recovery that should be applied by entities in two situations as follows:

• deferred tax relating to a non-depreciable asset that is measured using the revaluation model in Section 17 – Property, Plant and Equipment – should be measured using the tax rates and allowances that apply to the sale of the asset; [FRS 102.29.15] and
• deferred tax relating to investment property that is measured at fair value in accordance with Section 16 – Investment Property – should be measured using the tax rates and allowances that apply to the sale of the asset, except for investment property that has a limited useful life and is held within a business model whose objective is to consume substantially all of the economic benefits embodied in the property over time. [FRS 102.29.16].

These provisions of Section 29 are derived from IAS 12, where they appear as an exception to a more general principle that measurement of deferred tax should have regard to the manner in which an entity expects to recover the asset, or settle the liability, to which the deferred tax relates. [IAS 12.51, 51B, 51C]. However, there is no such equivalent general principle expressed in Section 29, although it could be implied from the requirement that deferred tax is measured using the tax rates ‘that are expected to apply to the reversal of the timing difference’. [FRS 102.29.12]. In measuring deferred tax arising on a business combination accounted for by applying the purchase method, an entity should consider the manner in which it expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities (see 6.6.1 above). [FRS 102.29.11A]. Whilst this requirement applies only to the measurement of deferred tax arising on a business combination accounted for by applying the purchase method, we believe that its underlying principle should be applied more generally. The concept of the ‘manner of recovery’ is discussed in more detail at 7.4 below.

7.2 Uncertain tax positions

‘Uncertain tax positions’ are not discussed in FRS 102, but are generally understood to arise when the tax treatment of an item is unclear or is a matter subject to an unresolved dispute between the reporting entity and the relevant tax authority. An uncertain tax position generally occurs where there is an uncertainty as to the meaning of the tax law, or to the applicability of the law to a particular transaction, or both.

As discussed at 5.2 above, uncertain tax positions generally relate to the estimate of current tax payable or receivable. However, in some situations an uncertain tax position affects the measurement of timing differences as at the reporting date, or to the tax base of an asset or liability acquired in a business combination. For example, there might be doubt as to the amount of tax depreciation that can be deducted in respect of a particular asset, which in turn would lead to doubt as to any related deferred tax arising in a business combination, or to the cumulative difference between depreciation charged to date and amounts recognised in the tax returns. In these circumstances the discussion at 5.2 above will also be relevant to the measurement of deferred tax assets and liabilities.

7.3 ‘Prior year adjustments’ of previously presented tax balances and expense (income)

The requirement to revise estimates of amounts recognised as deferred tax assets and liabilities at successive reporting dates is an inevitable consequence of the Standard and, in that respect, the normal requirements of Section 10 apply (see Chapter 9). As discussed in the context of current tax at 5.3 above, the nature of any revision to a previously stated deferred tax balance should be considered to determine whether the revision represents:

• a correction of a material prior period error (in which case it should be accounted for retrospectively, with a restatement of comparative amounts and, where applicable, the opening balance of assets, liabilities and equity at the start of the earliest period presented); [FRS 102.10.21] or
• a refinement in the current period of an estimate made in a previous period (in which case it should be accounted for in the current period). [FRS 102.10.17].

7.4 Expected manner of recovery of assets or settlement of liabilities

As noted at 7.1 above, Section 29 requires that in measuring deferred tax arising on a business combination accounted for by applying the purchase method, an entity should consider the manner in which it expects to recover or settle the carrying amount of its assets and liabilities. [FRS 102.29.11A]. We believe that this principle should be applied in measuring all deferred tax, in order to meet the requirement of Section 29 to measure deferred tax using the tax rates and laws that are ‘expected’ to apply to the reversal of the timing difference. [FRS 102.29.12]. If a different rate or law would apply to the reversal of the difference depending on the manner of reversal (e.g. depreciation or sale), the expected manner of reversal is an essential input to the assessment of the expected applicable tax rate or law.

7.5 UK indexation allowance

A UK company, in computing the taxable gain on the sale of an asset, is allowed to increase the cost of the asset by an indexation allowance, the broad intention of which is to exclude purely inflationary gains from taxation. As noted at 6.5.3 above, on a strict interpretation of the definition of ‘permanent difference’, an indexation allowance is a permanent difference since it is effectively an item of expenditure that appears in taxable profit, but not in total comprehensive income. However, in our view, supported by long-standing practice under FRS 19 (under which the same issue of interpretation would have arisen), it is more appropriate to take account of the indexation allowance in measuring any deferred tax that would be expected to arise on the sale of an asset.

In our view, deferred tax at the reporting date should be computed based on the indexation that would be available if disposal were to occur at the balance sheet date. Possible increases in the allowance due to future inflation should not be assumed.

The benefit of an indexation allowance can be taken only to the extent that it reduces a tax liability. It cannot be used to create or increase a tax loss. Therefore, a deferred tax asset should not be recognised in respect of an asset whose indexed cost for tax purposes is greater than its carrying amount.

7.6 Effectively tax-free entities

In the UK, and elsewhere, certain types of entity, typically investment vehicles, are exempt from corporate income tax provided that they fulfil certain criteria, which generally include a requirement to distribute all, or a minimum percentage, of their annual income as a dividend to investors. Examples in the UK include investment trusts and real estate investment trusts ‘REITs’. This raises the question of how such entities should measure income taxes.

One view would be that such an entity has a liability to tax at the normal rate until the dividend for a year becomes a liability. The liability for a dividend for an accounting period typically arises after the end of that period. Under this analysis, therefore, such an entity would be required, at each period end, to record a liability for current tax at the standard corporate rate. That liability would be released in full when the dividend is recognised as a liability in the following period. This would mean that, on an ongoing basis, the income statement would show a current tax charge or credit comprising:

• a charge for a full liability for the current period; and
• a credit for the reversal of the corresponding liability for the prior period.

In addition, deferred tax would be recognised at the standard tax rate on all timing differences.

A second view would be that the provisions of Section 29 regarding different tax rates for distributed and undistributed tax rates are intended to apply where the only significant factor determining the differential tax rate is the retention or distribution of profit. By contrast, the tax status of an investment fund typically depends on many more factors than whether or not profits are distributed, such as restrictions on its activities, the nature of its investments and other regulatory or listing requirements. On this view, the analysis would be that such an entity can choose to operate within one of two tax regimes (a ‘full tax’ regime or a ‘no tax’ regime), rather than that it operates in a single tax regime with a dual tax rate depending on whether profits are retained or distributed.

7.7 Share-based payment transactions

The accounting treatment of share-based payment transactions, some knowledge of which is required to understand the discussion below, is dealt with in Chapter 23.

In the UK, and many other jurisdictions, an entity receives a tax deduction in respect of remuneration paid in shares, share options or other equity instruments of the entity. The amount of any tax deduction may differ from the related remuneration expense, and may arise in a later accounting period. For example, in the UK, an entity recognises an expense for employee services in accordance with Section 26 (based on the fair value of the award at the date of grant), but does not receive a tax deduction until the award is exercised (in the case of options) or vests (in the case of free shares). The tax deduction is for the fair value of the award at the date of vesting or exercise (as the case may be), which will be equal to the intrinsic value at that date.

Under Section 29, any tax deduction received in excess of the amount recognised as an expense under Section 26 gives rise to a permanent difference which is recognised as current tax when it is received. However, recognition of the Section 26 expense in advance of the tax deduction being received to the extent of that expense gives rise to timing differences, on which a deferred tax asset should be recognised (subject to the general restrictions discussed at 6.2 above).

Section 29 does not prescribe how these timing differences should be calculated. As the tax relief will ultimately be given for the intrinsic value of the award, this forms a reasonable basis for computing the timing difference, which has generally been followed in practice under UK GAAP. However, practice varies as to whether the timing difference is computed as:

• the lower of (a) the total expected tax deduction based on the intrinsic value at the reporting date and (b) the cumulative share-based payment expense (Approach 1); or
• the lower of (a) the cumulative share-based payment expense and (b) the total expected tax deduction based on the intrinsic value at the reporting date, multiplied by the expired portion of the vesting period at that date (Approach 2).

Where the intrinsic value of the award is equal to, or more than, the grant date fair value used in applying Section 26, the two approaches have the same effect. However, where the intrinsic value falls below the grant date fair value, the two approaches give rise to a different result, as illustrated by Example 26.10 below.

The intrinsic value of the award at each reporting date is as follows:

Under Approach 1 above, the timing difference would be calculated as the lower of (a) the total intrinsic value at the reporting date and (b) the cumulative share-based payment expense.

¹ The award vests at this point so that any tax relief is recognised as current tax.

Under Approach 2 above, the timing difference would be calculated as the lower of (a) the cumulative share-based payment expense and (b) the total intrinsic value, multiplied by the expired portion of the vesting period at that date.

¹ The award vests at this point so that any tax relief is recognised as current tax.

In our view, either approach is acceptable, but should be adopted consistently.

Under Section 29 all tax on share-based payment transactions is accounted for in profit or loss (in contrast to the allocation between profit or loss and equity required under IFRS).

7.8 Legislation at the end of the reporting period

Deferred tax should be measured by reference to the tax rates and laws, as enacted or substantively enacted by the reporting date, that are expected to apply to the reversal of the timing differences. [FRS 102.29.12].

When different tax rates apply to different levels of taxable profit, deferred tax expense (income) and related deferred tax liabilities (assets) are measured using the average rates that are expected to apply to the taxable profit (tax loss) of the periods in which the deferred tax asset is expected to be realised or the deferred tax liability is expected to be settled. [FRS 102.29.13].

As discussed at 5.1.3 above, FRS 102 does not provide further guidance on actual enactment in other jurisdictions. However, IAS 12 provides some further guidance that is discussed more fully in Chapter 29 at 5.1 of EY International GAAP 2019.

8.1 Dividends and transaction costs of equity instruments

8.2 Gain/loss in profit or loss and loss/gain outside profit or loss offset for tax purposes

It often happens that a gain or loss accounted for in profit or loss can be offset for tax purposes against a gain or loss accounted for in other comprehensive income (or an increase or decrease in equity). This raises the question of how the tax effects of such transactions should be accounted for, as illustrated by Example 26.12 below.

Similar issues may arise where a transaction accounted for outside profit or loss generates a suitable taxable profit that allows recognition of a previously unrecognised tax asset relating to a transaction previously accounted for in profit or loss, as illustrated by Example 26.13 below.

Movements in value would be accounted for in other comprehensive income (‘OCI’). Taken in isolation, the valuation gains in 2019 to 2022 would give rise to current tax liabilities (at 20%) of £2,000 (2019), £1,000 (2020) and £1,000 (2021). However, these liabilities can be offset against the losses brought forward. This raises the question as to whether there should be either:

1. no tax charge or credit in either profit or loss or other comprehensive income in any of the periods affected; or
2. in each period, a current tax charge in other comprehensive income (in respect of the taxable income arising from valuation gains on the bonds) and current tax income in profit or loss (representing the recognition of the previously unrecognised deferred tax asset).

In our view, the treatment in (b) should be followed. Although the previously unrecognised deferred tax asset can only be recovered as the result of the recognition of a current tax liability arising from a transaction accounted for in other comprehensive income, the previously unrecognised asset relates to a trading loss previously recorded in profit or loss. Accordingly, the current tax credit arising from the recognition of the asset is properly accounted for in profit or loss.

8.3 Discontinued operations

As noted above, Section 29 requires tax income and tax expense to be allocated between continuing and discontinued operations. Some of the practical issues raised by this requirement are illustrated by Examples 26.14 to 26.16 below.

¹ Continuing operations profit £10m @ 25% = £2.5m

² Discontinued operations loss £2m @ 25% = £0.5m.

³ Net taxable profit £8m @ 25% = £2.0m

The tax allocated to the discontinued operation represents the difference between the tax that would have been paid absent the loss accounted for in discontinued operations and the amount actually payable.

This allocation reflects that fact that, although the transaction that allows recognition of the brought forward tax losses is accounted for as a discontinued operation, the losses themselves arose from continuing operations. This is essentially the same analysis as is used in Example 26.13 above (where a current tax liability recognised in other comprehensive income gives rise to an equal deferred tax asset recognised in profit or loss).

This allocation reflects that fact that, although the transaction that allows recognition of the brought forward tax losses is accounted for as a discontinued operation, the losses themselves arose from continuing operations. This is essentially the same analysis as is used in Example 26.14 above.

8.4 Defined benefit pension plans

Section 28 requires an entity, in accounting for a defined benefit post-employment benefit plan, to recognise actuarial gains and losses relating to the plan in full in other comprehensive income (‘OCI’). At the same time, a calculated current (and, where applicable, past) service cost and finance income and expense relating to the plan assets and liabilities are recognised in profit or loss – see Chapter 25.

In the UK, and many other jurisdictions, tax deductions for post-employment benefits are given on the basis of cash contributions paid to the plan fund (or benefits paid when a plan is unfunded).

This significant difference between the way in which defined benefit plans are treated for tax and financial reporting purposes can make the allocation of tax deductions for them between profit or loss and OCI somewhat arbitrary, as illustrated by Example 26.17 below.

When the funding payment is made in January 2020, the accounting deficit on the fund is reduced by £400,000. This gives rise to a current tax deduction of £80,000 (£400,000 @ 20%), in relation to the contribution paid to the pension scheme, and a deferred tax expense of £80,000 in respect of the reversal of the temporary difference arising as some of the deferred tax asset as at 31 December 2019 is released. The difficulty is how to allocate this movement in the deferred tax asset between profit or loss and OCI, as it is ultimately a matter of arbitrary allocation as to whether the funding payment is regarded as making good (for example):

• £400,000 of the £800,000 deficit previously accounted for in profit or loss;
• the whole of the £200,000 of the deficit previously accounted for in OCI and £200,000 of the £800,000 deficit previously accounted for in profit or loss; or
• a pro-rata share of those parts of the total deficit accounted for in profit or loss and OCI.

In the example above, the split is of relatively minor significance, since the entity was able to recognise 100% of the potential deferred tax asset associated with the pension liability. This means that, as the scheme is funded, there will be an equal and opposite amount of current tax income and deferred tax expense. The only real issue is therefore one of presentation, namely whether the gross items comprising this net nil charge are disclosed within the tax charge in profit or loss or in OCI.

In other cases, however, there might be an amount of net tax income or expense that needs to be allocated. Suppose that, as above, the entity recorded a pension cost of £1 million in 2019 but determined that the related deferred tax asset did not meet the criteria for recognition under Section 29. In 2020, the entity determines that an asset of £50,000 can be recognised in view of the funding payments and taxable profits anticipated in 2020 and later years. This results in a total tax credit of £130,000 (£80,000 current tax, £50,000 deferred tax) in 2020, raising the question of whether it should be allocated to profit or loss, to OCI, or allocated on a pro-rata basis. This question might also arise if, as the result of newly enacted tax rates, the existing deferred tax balance were required to be remeasured. In our view, any reasonable method of allocation may be used, provided that it is applied on a consistent basis.

One approach might be to compare the funding payments made to the scheme in the previous few years with the charges made to profit or loss under Section 28 in those periods. If, for example, it is found that the payments were equal to or greater than the charges to profit or loss, it might reasonably be concluded that the funding payments have ‘covered’ the charge recognised in profit or loss, so that any surplus or deficit on the statement of financial position is broadly represented by items that have been accounted for in OCI.

However, a surplus may also arise from funding the scheme to an amount greater than the liability recognised under Section 28 (for example under a minimum funding requirement imposed by local legislation or agreed with the pension fund trustees). In this case, the asset does not result from previously recognised income but from a reduction in another asset (i.e. cash). The entity should assess the expected manner of recovery of any asset implied by the accounting treatment of the surplus – i.e. whether it has been recognised on the basis that it will be ‘consumed’ (resulting in an accounting expense) or refunded to the entity in due course.

Where it is concluded that the asset will be ‘consumed’ (resulting in accounting expense), the entity will need to determine whether such an expense is likely to be recognised in profit or loss or in OCI in a future period.

9.1 Payments for intragroup transfer of tax losses

Where one member of a group transfers tax losses to another member of the group, the entity whose tax liability is reduced may be required, as matter of group policy, to pay an amount of compensation to the member of the group that transfers the losses to it. Such payments are known by different terms in different jurisdictions, but are referred to in the discussion below as ‘group relief payments’.

Group relief payments are generally made in an amount equal to the tax saved by the paying company. In some cases, however, payment may be made in an amount equal to the nominal amount of the tax loss, which will be greater than the amount of tax saved. This raises the question of how such payments should be accounted for.

The first issue is whether such payments should be recognised:

• in total comprehensive income; or
• as a distribution (in the case of a payment from a subsidiary to a parent) or a capital contribution (in the case of a payment from a parent to a subsidiary).

The second issue is, to the extent that the payments are accounted for in total comprehensive income, whether they should be classified as:

• income tax, allocated between profit or loss, other comprehensive income or equity (see 9 above). The argument for this treatment is that the payments made or received are amounts that would otherwise be paid to or received from (or offset against an amount paid to) a tax authority; or
• operating income or expense in profit or loss (on the grounds that, as a matter of fact, the payments are not made to or received from any tax authority).

There is a long-standing practice in the UK that such payments are treated as if they were income taxes. We believe that this practice is appropriate to the extent that the intragroup payment is for an amount up to the amount of tax that would otherwise have been paid by the paying company. Where a tax loss payment is made in excess of this amount, we consider that it is more appropriate to account for the excess not as an income tax but as either:

• a distribution or capital contribution (as applicable); or
• operating income or expense (as applicable).

In considering the applicable treatment, the legal and regulatory requirements in the entity's jurisdiction would also be relevant, for example if those local requirements stipulate whether the excess payment is, in law, a distribution. This is the case in the UK, where payments for group relief in excess of the tax relief are regarded in law as distributions of profit. [TECH 02/17BL.9.69]. The chosen treatment should be applied consistently.

10.1 Statement of financial position

Section 29 requires deferred tax liabilities to be included within provisions for liabilities and deferred tax assets to be included within debtors when an entity applies statutory formats to present its statement of financial position. Where an entity applies the ‘adapted formats’ permitted under the UK Companies Act (see Chapter 6 at 5.1). [FRS 102.29.23], deferred tax assets and liabilities must be shown as separate line items on the face of the statement of financial position, but classified as non-current. [FRS 102.4.2A(p)].

When the ‘statutory formats’ are applied, deferred tax assets are included within current assets, even if due after more than one year. However, where the amount of debtors due after more than one year is so material in the context of net current assets that in the absence of disclosure of the debtors due after more than one year on the face of the statement of financial position readers may misinterpret the financial statements, FRS 102 requires the amount to be disclosed on the face of the statement of financial position, but still within current assets. [FRS 102.4.4A].

As noted in Chapter 6 at 5.1.11, certain of the statutory disclosures in the Regulations may cause particular complexity when deferred tax is included as a line item within provisions. In particular, UK companies preparing Companies Act accounts must state the provision for deferred tax separately from any other tax provisions and reconcile movements in deferred tax (as it is a line item under provisions). [1 Sch 59-60]. In our view, the reconciliation of movements in deferred tax is also required where ‘adapted formats’ (as well as statutory formats) are used, even though deferred tax is not shown as a provision in the balance sheet.

Section 29 does not explicitly require separate disclosure of the current tax creditor on the face of the statement of financial position and, as discussed in Chapter 6 at 5.3.8.G, note (9) to the balance sheet statutory formats in Schedule 1 to the Regulations would require current tax to be disclosed within the line item for ‘Other creditors, including taxation and social security’. However, where an entity applies the ‘adapted formats’ permitted under the UK Companies Act, current tax assets and current tax liabilities must be shown as separate line items on the face of the statement of financial position, and classified appropriately as current and/or non-current. [FRS 102.4.2A(o)].

10.2 Statement of comprehensive income

As discussed at 8 above, except for tax relating to distributions to owners that are accounted in profit or loss, the tax expense (or income) should be accounted in the same component of comprehensive income to which it relates.

The results of discontinued operations should be presented on a post-tax basis. [FRS 102.5.7E].

The results of equity-accounted entities should be presented on a post-tax basis. [FRS 102.14.8].

10.3 Statement of cash flows

Cash flows arising from taxes on income are separately disclosed and classified as cash flows from operating activities, unless they can be specifically identified with financing and investing activities. Where tax cash flows are allocated over more than one class of activity, the total amount of taxes paid should be disclosed. [FRS 102.7.17].

11.1 Components of tax expense

The major components of tax expense (or income) should be disclosed separately. These may include: [FRS 102.29.26]

1. current tax expense (or income);
2. any adjustments recognised in the period for current tax of prior periods;
3. the amount of deferred tax expense (or income) relating to the origination and reversal of timing differences;
4. the amount of deferred tax expense (or income) relating to changes in tax rates or the imposition of new taxes;
5. adjustments to deferred tax expense (or income) arising from a change in the tax status of the entity or its shareholders; and
6. the amount of tax expense (or income) relating to changes in accounting policies and errors (see Chapter 9 at 3.7).

11.2 Other disclosures required by FRS 102

The following should also be disclosed separately: [FRS 102.29.27]

1. the aggregate current and deferred tax relating to items that are recognised as items of other comprehensive income or equity; and
2. a reconciliation between the tax expense (income) included in profit or loss and the profit or loss on ordinary activities multiplied by the applicable tax rate;
3. the amount of the net reversal of deferred tax assets and deferred tax liabilities expected to occur during the year beginning after the reporting period together with a brief explanation for the expected reversal;
4. an explanation of changes in the applicable tax rate(s) compared with the previous reporting period;
5. the amount of deferred tax liabilities and deferred tax assets at the end of the reporting period for each type of timing difference;
6. the amount of unused tax losses and tax credits;
7. the expiry date, if any, of timing differences, unused tax losses and unused tax credits; and
8. where different tax rates apply to retained and distributed profits (see 7 above), an explanation of the nature of the potential income tax consequences that would result from the payment of dividends to shareholders.

The requirement at (c) above is noteworthy in that it is not required by IAS 12 nor the IFRS for SMEs. The disclosure should be given on a net basis, which takes account of both the reversal of existing timing differences and the origination of new ones. [FRS 102.BC.B29.9]. For example, for timing differences related to property, plant and equipment, an entity needs to compare next year's depreciation charge and next year's tax writing down allowances to see if it reverses or increases the timing difference.

The Basis for Conclusions notes that the net basis provides information that is relevant to the entity's future cash flows, and hence is more relevant than disclosure on a gross basis. The Basis for Conclusions also noted that the additional benefit of disclosure on a net basis outweighed the cost to preparers of forecasting future new timing differences. [FRS 102.BC.B29.9]. Given that, unlike the requirement at (e) above, the disclosure does not ask for an analysis for each type of timing difference, it would appear that the disclosure of a single net figure would be sufficient.

In addition, Section 32 requires entities to provide information about the nature of any changes in tax rates or tax laws enacted or announced after the reporting period that have a significant effect on current and deferred tax assets and liabilities. [FRS 102.32.11(h)]. An estimate of the financial effect of these changes should also be disclosed, or a statement given that such an estimate cannot be made. [FRS 102.32.10]. The requirements of Section 32 are discussed in Chapter 29.

11.3 Disclosures required by entities subject to UK and Irish legislation

Under previous UK and Irish GAAP, accounting standards in many cases included the disclosure requirements for entities established under UK and Irish legislation. This is not the case in FRS 102. Entities should therefore consider any additional requirements arising from legal and regulatory requirements. For example, UK incorporated entities must also comply with the requirements of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008, which are discussed further in Chapter 6.