3.2.1 Investment tax credits

As discussed at 3.2 above, investment tax credits are cited as an example of government assistance excluded from the scope of Section 24. Taxes based on income are required to be accounted under Section 29 – Income Tax. [FRS 102.24.3]. This implies that those investment tax credits that are excluded from the scope of Section 24 would be accounted for under Section 29 (see Chapter 26). However, if government assistance is described as an investment tax credit, but it is neither determined nor 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.

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 some cases, the assistance is chargeable to corporation tax and in others it is not. Entitlement to assistance can be determined in a variety of ways. Investment tax credits may relate to direct investment in property, plant and equipment, 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 the total of all taxes paid to the government providing the assistance, 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.

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 a number of different jurisdictions may be consolidated, it may be desirable that all investment tax credits should be consistently accounted for, either as a government grant or as an element of income tax. However, the fact that judgement is required in making this determination may mean that predominant practice by FRS 102 reporters relating to a specific type of tax credit has evolved differently from predominant practice by FRS 102 reporters in accounting for a substantially similar credit in another tax jurisdiction. We believe that, in determining whether the arrangement is of a type that falls within the scope of 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 whether Section 24 or Section 29 applies to such a credit; and
• in the absence of a predominant local consensus or a group wide approach to making the determination, the indicators listed in the table above should provide guidance.

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

The treatment of investment tax credits accounted under Section 29 is discussed in Chapter 26 at 3.4.

Analysis of these features by reference to the criteria suggested above leads us to the view that the RDEC credit is more appropriately regarded as a government grant, and therefore reflected in profit before tax. 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.

As noted above, an RDEC credit is treated as taxable income and so will affect the current tax liability in two ways as illustrated in the following example.

3.3.1 General conditions for recognition

Section 24 requires that government grants should be recognised only when there is reasonable assurance that:

1. the entity will comply with the conditions attaching to them; and
2. the grants will be received. [FRS 102.24.3A].

The standard does not define ‘reasonable assurance’. However, we would not expect an entity to recognise government grants before it was at least probable (or ‘more likely than not’) [FRS 102 Appendix I] that the entity would comply with the conditions attached to the grants (even though these conditions may relate to future performance and other future events) and that the grants would be received.

3.3.2 Measurement

All government grants are measured on initial recognition at the fair value of the asset received or receivable. [FRS 102.24.5]. The asset will normally be cash but could be a non-monetary asset such as land or other resources.

In this context, fair value is the amount for which an asset could be exchanged, between knowledgeable, willing parties in an arm's length transaction. Where guidance on determining the fair value of a specific asset is not available in the relevant section of FRS 102, the guidance in the Appendix to Section 2 – Concepts and Pervasive Principles – should be used (see Chapter 4). [FRS 102 Appendix I].

3.3.3 Basis of recognition in income

Section 24 provides entities with an accounting policy choice over the method of recognition of government grants in the income statement:

• the performance model (see 3.4 below); or
• the accrual model (see 3.5 below).

The policy choice must be applied on a class-by-class basis. [FRS 102.24.4].

A class of assets is defined in FRS 102 as a grouping of assets of a similar nature and use in an entity's operations. [FRS 102 Appendix I]. A class of financial assets is a grouping that is appropriate to the nature of the information disclosed and that takes into account the characteristics of the financial assets. [FRS 102.11.48(c)]. Therefore, it would appear that government grants of a similar nature and subject to similar conditions should be recognised in income in a similar way.

Any accounting policy choice should be made according to the requirements of Section 10 – Accounting Policies, Estimates and Errors. This requires that the chosen accounting policy results in information that is relevant to the decision-making needs of users of the financial statements and reflects the economic substance of transactions, other events and conditions, and not merely their legal form. [FRS 102.10.4]. In that regard, an understanding of the purpose for which the grant was awarded is a relevant consideration.

3.5.1 Grants relating to revenue

Grants relating to revenue should be recognised in the income statement on a systematic basis that matches them with the related costs that they are intended to compensate. [FRS 102.24.5D].

Grants that become receivable as compensation for costs or losses already incurred or to give immediate financial support to the entity with no future related costs should be recognised in income when they become receivable. [FRS 102.24.5E].

Most problems accounting for grants relate to implementing the requirement to match the grant against the costs that it is intended to compensate. This apparently simple principle can be difficult to apply in practice. This is because it is sometimes unclear what the essence of the grant was and, therefore, what costs are being subsidised. Moreover, grants are sometimes given for a particular kind of expenditure that forms part of a larger project, making the allocation a more subjective matter. For example, government assistance that is in the form of a training grant could be recognised in income in any of the following ways:

1. matched against direct training costs;
2. recognised over a period of time against the salary costs of the employees being trained, for example over the estimated duration of the project;
3. recognised over the estimated period for which the company or the employees are expected to benefit from the training;
4. matched against total project costs together with other project grants receivable;
5. recognised in income systematically over the life of the project, for example, the total grant receivable may be allocated to revenue on a straight-line basis;
6. allocated against project costs or income over the period over which the grant is paid (instead of over the project life); or
7. recognised in income when received in cash.

Depending on the circumstances, any of these approaches might produce an acceptable result. However, our observations on these alternative methods are as follows:

• method (a) could lead to recognition of the grant as income in advance of its receipt, since the major part of the direct training costs will often be incurred at the beginning of a project and payment of the grant is usually made retrospectively to the related expenditure. As the total grant receivable may be subject to adjustment, this may not be prudent or may lead to a mismatch of costs and revenues;
• methods (b) to (e) all rely on different interpretations of the expenditure to which the grant is expected to contribute, and could all represent an appropriate form of matching;
• method (f) might not appear to relate to the actual expenditure profile, but, in the absence of better evidence, the period of payment of the grant might in fact give an indication of the duration of the project for which the expenditure is to be subsidised; and
• method (g) is unlikely to be an appropriate method per se, as the cash receipt profile may be influenced by factors other than the expenditure profile. However, it may approximate to one of the other methods, or may, in the absence of any conclusive indication as to the expenditure intended to be subsidised by the grant, be the only practicable method that can be adopted.

In the face of the problems described above of attributing a grant to related costs, it is difficult to offer definitive guidance. Entities will have to exercise judgement in determining how the matching principle should be applied. The only overriding considerations are that the method should be systematically and consistently applied, and that, for material grants, the policy adopted should be adequately disclosed.

3.5.2 Grants relating to assets

Grants relating to assets should be recognised in the income statement on a systematic basis over the expected useful life of the asset. [FRS 102.24.5F].

For grants relating to depreciable assets, this means they are usually recognised as income over the periods, and in the proportions, in which depreciation on those assets is charged. Grants relating to non-depreciable assets may also require the fulfilment of certain obligations, in which case they would be recognised as income over the periods in which the costs of meeting the obligations are incurred. For example, a grant of land may be conditional upon the erection of a building on the site and it may be appropriate to recognise it as income over the life of the building.

The Regulations prohibit the offset of items that represent assets against items that represent liabilities. [1 Sch 8]. FRS 102 does not therefore permit grants relating to an asset to be deducted from the carrying amount of the asset. The grant should instead be recognised as deferred income. [FRS 102.24.5G].