Deferred tax and known future changes in the rate of corporation tax



Introduction

On 22 June 2010, the Emergency Budget was announced. It introduced a reduction in the rate of corporation tax from 28% to 27% from 1 April 2011, with further annual reductions of 1% each year culminating in a rate of 24% on 1 April 2014.

This will impact the deferred tax calculations of companies reporting under International Financial

Reporting Standards (“IFRSs”) and UK Generally Accepted Accounting Principles (“UK GAAP”).

Both UK GAAP (IFRS 21 para 22) and IAS (IAS 10 para 22) require non-adjusting post balance sheet events to be disclosed if the effect is material. A non-adjusting post balance sheet event includes enacted or announced of changes in tax rates after the balance sheet date that will affect current and/or deferred tax.

As of 17 August 2010 the following are non-adjusting post balance sheet events include:

  • the 1% reduction in main rate of corporation tax each year from 1 April 2012 to 1 April 2014 (when the rate will become 24%),
  • the 20% small companies’ rate of tax from 1 April 2011,
  • the reduction in rates of capital allowances effective from 1 April 2012 (18% for the main pool at 8% for special rate pool).

However, to date, only the change for the tax year starting 1 April 2011 to 27% has been substantively enacted.

Interaction with the UK tax rules

In the UK, corporation tax is paid in relation to an accounting period. When the accounting period straddles tax years in which different rates of corporation tax will apply, the entity’s tax liability will be calculated by applying a single pro-rated effective tax rate to the entire accounting period. Therefore, when calculating deferred tax, consideration needs to be given to the effective tax rate that will apply to future accounting periods.

Impact on current and deferred tax during year-end reporting

Under both UK GAAP and IFRS, the following periods will be affected as listed below:

The period-end date is up to and including 19 July 2010 (years ending June 2010 or earlier)

Disclosure

Preparers will need to disclose the potential effect of the announced but not substantively enacted tax rates on deferred tax as a non-adjusting post balance sheet event if the effect is material. The requirement calls for disclosure of the nature of the event and an estimate of its financial effect.

In order to estimate the financial effect of the announced but not substantively enacted tax rates, an analysis of when the relevant temporary / timing differences are expected to reverse will be required.

The financial effect of the announced rates will then be determined by calculating the difference between:

a) the deferred tax currently provided in the financial statements and

b) the deferred tax balance that would have arisen if the deferred calculation had used the announced rate that will be applicable in the relevant period(s).

Where the entity’s accounting period straddles two different tax years it will be necessary to calculate a pro-rated effective tax rate for the accounting period and apply that rate to all reversals expected to occur in that accounting period.

If it is not possible to estimate the financial effect, this should be disclosed.

The balance sheet date is 20 July 2010 onwards (years ending July 2010 onwards)

Measurement

Current tax will be affected to the extent that the accounting period falls into a tax year where the new (substantively enacted) rates apply. Where this is the case current tax will need to be calculated using the pro-rated effective tax rate for the period.

Deferred tax will need to be computed on the basis of the substantively enacted tax rates that are expected to apply when the deferred tax is expected to reverse.

Where the entity’s accounting period straddles two separate tax years, it will be necessary to calculate and apply a pro-rated effective tax rate.

The announced future changes in tax rates will not affect the measurement of deferred tax in the financial statements until the relevant rates are substantively enacted.

Any adjustment to deferred tax balances arising from a change in tax rates that was substantively enacted during the accounting period being reported on, will need to charged or credited in that period. No portion of the adjustment should be considered to be a prior year adjustment.

Movements in deferred tax should be recognised in profit or loss except to the extent that the tax arises from a transaction or event recognised outside of profit or loss. Care will need to be given to identifying the period of reversal of temporary/timing differences that arise from transactions or events recognised outside of profit or loss, as the deferred tax effect of the rate change will need to be apportioned between profit or loss and other comprehensive income / equity at the appropriate rates.

Disclosure

Preparers will need to disclose the potential effect of the announced but not substantively enacted tax rates on deferred tax as a non-adjusting post balance sheet event if the effect is material.

The requirement calls for disclosure of the nature of the event and an estimate of its financial effect.

In order to estimate the financial effect of the announced but not substantively enacted tax rates, an analysis of when the relevant temporary / timing differences are expected to reverse will be required.

The financial effect of the announced rates will then be determined by calculating the difference between:

a) the deferred tax currently provided in the financial statements; and

b) the deferred tax balance that would have arisen if the tax deferred tax calculation had used the announced rate that will be applicable in the relevant period(s).

Where the entity’s accounting period straddles two different tax years it will be necessary to calculate a pro-rated effective tax rate for the accounting period and apply that rate to all reversals expected to occur in that accounting period. If it is not possible to estimate the financial effect, this should be disclosed.

Impact on interim reporting under IFRS

IAS 34 provides guidance when calculating tax rates for interim reporting. This guidance should be applied as best practice even for those companies who do not comply with IAS 34 in preparing their interim report.

The practical implications of the guidance in IAS 34 are as follows:

The current income tax expense should be recognised in each interim period based on the best estimate of the weighted average annual income tax rate expected for the full financial year based on the principles set out by IAS 12. The estimated effective tax rate should reflect all announced and substantively enacted tax rates applicable to the accounting period.

Deferred income tax balances at the interim period-end should however be prepared on the same basis as would be expected at the year end. Therefore, deferred tax balances will need to be adjusted for future changes to tax rates that have been substantively enacted by the end of the interim period. The resulting movement in deferred tax balances will need to be charged to profit or loss (or charged or credited directly to equity if appropriate) in the relevant interim period.

Writing Down Allowances

The budget also announced changes to Writing Down Allowances (WDAs). The capital allowance changes will apply to all businesses including companies, partnerships and sole traders.

Changes to Writing Down Allowances

The reduction in the WDAs for new and unrelieved expenditure on plant and machinery are as follows:

  • · from 20% to 18% for the main pool
  • · from 10% to 8% for the special rate pool

The new rules will take effect for the calculation of WDAs for chargeable periods ending on or after 1 April 2012 for corporation tax purposes and 6 April 2012 for income tax purposes.

Impact on Deferred Tax

The measurement of deferred tax balances disclosed and/or presented, will be affected by the changes in capital allowances to the extent that the new rates will result in temporary/timing differences reversing in different periods (and therefore potentially at different tax rates) than would otherwise be the case.

As a result, the changes in capital allowances may well affect the disclosure of deferred tax in the post balance sheet event note.

Disclaimer

We have taken great care to ensure the accuracy of this publication, which has been produced for the information of clients, staff and contacts of Smith & Williamson Limited. However, this publication is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Clients who would like more information are invited to contact the individual with whom they normally deal. © Smith & Williamson Limited 2010.