NewsAlert Tax Accounting Services

NewsAlert
Tax Accounting Services
Tax Management and Accounting Services
July 23, 2012
Key tax accounting considerations of the United Kingdom's Finance Act 2012
Summary
The UK Finance Act 2012 (FA 2012) was enacted on July 17, 2012 for US GAAP purposes and
substantively enacted on July 3, 2012 for IFRS purposes. It includes the following key provisions which
may have a tax accounting impact:
The main rate of corporation tax is reduced from 25% to 24% with effect from April 1, 2012. This
reduction is in addition to the decrease from 26% to 25% enacted in July 2011 by Finance Act 2011
(FA 2011).
The main rate of corporation tax will be reduced further from 24% to 23% from April 1, 2013.
A new regime for Controlled Foreign Companies (CFCs) is introduced from January 1, 2013.
Amendments are made to the branch exemption regime, under which the profits of a UK company‟s
overseas permanent establishments may be exempt from UK tax.
A new 'patent box' regime will be introduced from April 1, 2013, which effectively taxes profits
attributable to patents at 10%.
In the oil and gas sector, tax relief for decommissioning costs is capped at 50%, resulting in
increases to effective tax rates in that sector. Other changes are also announced.
Specific legislation has been introduced relating to corporate assets used to fund pension schemes,
known as 'asset backed contributions'.
Although the majority of these provisions were substantively enacted on July 3, 2012, the reduction in
the main corporation tax rate from 25% to 24% effective from April 1, 2012 was substantively enacted
on March 26, 2012 under the Provisional Collection of Taxes Act 1968 (PCTA68).
The Government has also announced various changes which will (subject to consultation) be included
in Finance Bill 2013 (FB 2013). The main changes which are likely to have a tax accounting impact are:
There is a proposed 1% further reduction in the main corporation tax rate to 22% applicable from
April 1, 2014.
A new 'above the line' research and development credit has been proposed for larger companies.
A rule may also be introduced to allow companies with a non-sterling functional currency to
compute capital gains and losses in that functional currency.
Multinational groups with UK entities are encouraged to assess the tax accounting implications of these
changes.
General rules on accounting for tax law changes
Under US GAAP, Accounting Standards Codification (ASC) 740 requires companies to use the tax law
in effect at the balance sheet date of the relevant reporting period. Companies therefore need to assess
the impact of any enacted tax law changes on existing deferred tax balances and include the impact as a
discrete item in the interim period in which the changes are enacted. The effects, both current and
deferred, are reported as part of the tax provision attributable to continuing operations, regardless of
the category of income in which the underlying pre-tax income or expense or deferred tax asset or
liability was or will be reported. In addition, the estimated annual effective tax rate (ETR) to be applied
to the results of any period should incorporate the impact of any enacted tax law changes, to the extent
that the changes apply during that period.
Under International Accounting Standard (IAS) 12, companies are also required to use the tax law in
effect at the balance sheet date of the relevant reporting period. However tax law changes only need to
have been substantively enacted by the balance sheet date for deferred tax balances to be adjusted, or
for the impact to be reflected in the annual ETR, if applicable. Unlike US GAAP, under IFRS, companies
should backwards trace the effects of a law change upon existing deferred tax balances in order to
determine the portion of the adjustment that is recognized as part of the tax provision attributable to
continuing operations or otherwise recognized as part of the tax provision that is allocable to other
comprehensive income or equity. (For example, a reduction due to the change in rate used to measure a
deferred tax asset related to accrued pension costs that was previously recorded in other comprehensive
income should likewise be recorded in other comprehensive income).
Both GAAPs may require a detailed analysis of the impact of the changes to assess when the temporary
differences existing at the date of substantive enactment or enactment are expected to reverse.
Reductions in the main corporation tax rate
FA 2012 was given Royal Assent on July 17, 2012, enacting both the reduction in the main corporation
tax rate from 25% to 24% effective from April 1, 2012 and the reduction from 24% to 23% effective from
April 1, 2013. Therefore, for reporting periods with a balance sheet date on or after July 17, 2012,
temporary differences expected to reverse before April 1, 2013 should be recognized at 24% and those
expected to reverse after April 1, 2013 should be recognized at 23%. However, no account should be
taken of the announced future reduction in the corporation tax rate expected to be included in FB 2013.
Under IFRS, the reduction in the main corporation tax rate to 24% was substantively enacted under
PCTA68 on March 26, 2012. (PCTA68 allows for certain legislative changes to have statutory effect for a
limited period pending inclusion in a full Finance Act if they are passed by House of Commons
resolution.) The reduction to 23%, however, was substantively enacted upon substantive enactment of
FA 2012 on July 3, 2012. Thus, for reporting periods with a balance sheet date on or after March 26,
2012 but before July 3, 2012, deferred tax should have been recognized in respect of taxable and
deductible temporary differences expected to be realized or settled from April 1, 2012 at 24%. Following
substantive enactment of FA 2012, for balance sheet dates on or after July 3, 2012, deferred tax assets
and liabilities expected to be realized or settled from April 1, 2013 should be recognized at 23%.
Amounts expected to reverse before this date should continue to be recognized at 24%. No account
should be taken of the announced future reduction in the rate expected to be included in FB 2013.
Under both US GAAP and IFRS, for periods with balance sheet dates after enactment/ substantive
enactment respectively, the estimated annual ETR used to calculate the current year charge or credit
will also need to reflect the new rates for the relevant proportion of the periods for which they apply, as
well as any other enacted or substantively enacted rates applicable during the relevant periods.
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New Controlled Foreign Company (CFC) rules
FA 2012 incorporates the new CFC regime which had previously been announced as part of the
Government‟s package on the reform of corporation tax. The new rules will incorporate a very different
approach to exempting income in overseas subsidiaries of UK companies.
The main changes are around the methods for exempting income. These include a 'gateway' test which
may take many companies out of the CFC rules altogether. Groups will therefore need to consider
which exemptions may apply to their overseas companies.
Although these exemption rules will be very different, the ultimate mechanism for taxing the CFC
profits will not change. As under the previous rules, a CFC apportionment will give rise to an additional
amount of tax payable. Therefore, there should be no change to the method of accounting for this
charge under US GAAP or IFRS; it will continue be included as part of the current tax charge in the
income statement in the period of apportionment.
One significant change under the new rules, however, is the introduction of a partial, or in some cases
full, exemption for finance income arising in an offshore company. Provided certain conditions are met,
this type of income may be 75% or fully exempt from a CFC apportionment. Where such companies
have items which give rise to deferred tax balances, such as losses, consideration will need to be given to
the tax rate at which these should be recognized. Where the 75% exemption applies, the appropriate
treatment would be to reduce the temporary difference by 75% and apply the relevant tax rate to the
reduced amount. Any local taxes payable and the impact of double tax relief on the CFC apportionment
would then need to be considered in measuring the overall deferred tax asset or liability.
Lastly, the functional currency of offshore finance companies and the impact on accounting for income
taxes will also need to be considered on a case by case basis, depending on a company‟s specific fact
pattern.
Foreign branch exemption
The foreign branch exemption regime provides for an exemption from UK corporation tax for profits
attributable to a UK resident company‟s foreign permanent establishments (PEs). The regime was
introduced by FA 2011 on July 19, 2011. From that date, a UK resident company has been able to elect
for the exemption to apply from the start of the company‟s next accounting period.
FA 2012 has made a number of changes to the regime, with effect from January 1, 2013. These
introduce additional conditions for investment businesses, make it easier for the exemption to apply to
newly formed companies and those migrating to the UK and amend the current anti-diversion rule so
that PEs fall within the scope of the reformed CFC rules.
Accounting for foreign branches has always been one of more complicated aspects of tax accounting.
However the approach is similar under US GAAP and IFRS and generally involves the following steps:
1. Compute current and deferred tax in respect of income taxes applicable in the foreign territory.
2. Compute current and deferred tax in respect of domestic corporation tax on the overseas income.
3. Adjust the domestic corporation tax figures for any double tax relief.
In addition, in some territories it may be necessary to provide for deferred tax which would be payable
if the profits of the branch were distributed to the head office.
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If the UK foreign branch exemption election is made, then steps two and three above will no longer
apply to the tax accounting numbers (current or deferred) in respect of periods when the exemption is
in force. This would leave only the non-UK income taxes for those periods to consider. As the situations
when the exemption applies may be different following the changes included in FA 2012, this should be
taken into account in current and deferred tax calculations in the relevant periods.
In addition, if an entity has incurred losses in the foreign branch in the six years prior to the first period
that the exemption is intended to apply, this defers the effect of the election until the branch has made
sufficient profits to utilize the losses. The tax accounting implications in such a situation would also
have to be considered on a facts specific basis.
Patent box
FA 2012 contains legislation to provide an effective 10% rate of corporation tax (through an additional
special deduction) on profits arising from patented technology. This new regime is to be phased in over
four years from April 1, 2013. The 10% rate applies to a company‟s worldwide profits attributable to the
patented invention. Qualifying profits include profits arising from licensing, disposals of patent rights
and the sales of products which include patented inventions. This is a significant tax saving compared
to the main rate of corporation tax and will benefit companies from a wide range of industry sectors.
There is a formulaic approach to the calculation of the patent box profit or loss. The formula generates a
corporation tax deduction which has the effect of reducing corporation tax on the profits attributable to
patents to 10%. The benefit of the deduction should be recognized under US GAAP and IFRS as part of
current tax in the year in which the special deduction is included on the company‟s tax return. As the
new regime is being phased in over four years from April 1, 2013, there will be a gradual reduction in
the effective tax rate over this period.
As the tax relief is being given in the form of a special deduction, it should not be factored into the
assessment of the tax rate that is expected to apply to profits. Deferred tax should therefore be
measured at the main corporation tax rate.
Decommissioning in the Oil & Gas Sector
Although the main rate of corporation tax is to be reduced from to 24% from April 1, 2012 and to 22%
by 2014, UK oil and gas production will not benefit. Budget 2012 made no change to the rate of
corporation tax or the supplementary corporation tax for UK ring-fenced activities in the oil and gas
sector. However, as announced in Budget 2011, FA 2012 introduced legislation to restrict the future
relief for end of life decommissioning costs to 20% rather than the 32% supplementary corporation tax
rate.
Under IFRS, companies with balance sheet dates on or after July 3, 2012 should reflect the impact of
this reduction in the overall effective rate when measuring their deferred tax assets and liabilities
relating to decommissioning temporary differences. The overall combined corporation tax and
supplementary rate will reduce from 62% to 50%. Depending on the precise approach companies have
adopted as their accounting policy for determining the tax bases of decommissioning assets and
liabilities, the impact in each affected period may vary. In particular, it will be important to ascertain
whether future tax deductions are allocated to the decommissioning asset or to the decommissioning
liability in the deferred tax calculations due to the impact of the initial recognition exception; it is also
important that the same approach is consistently followed. However, overall, deferred tax assets and
liabilities associated with decommissioning activities recognised prior to July 3, 2012 will reduce.
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US GAAP does not contain the same extent of detailed guidance in respect of decommissioning
activities as exists in IFRS. The usual principles of deferred tax accounting under US GAAP should be
followed. As the rate reduction was enacted for US GAAP on July 17, 2012, companies with net
decommissioning assets and liabilities should reflect the new combined 50% tax rate in deferred tax
calculations for reporting periods with a balance sheet date on or after July 17, 2012.
Other significant changes impacting the oil and gas sector
FA 2012 also introduced changes to extend field allowances. Field allowances reduce the amount of a
company‟s ring fence profits subject to the supplementary corporation tax charge. The changes
announced in Budget 2012 were to the small field allowances and West of Shetland allowances and
apply to fields with development authorization on, or after, 21 March 2012. In addition, an extension of
field allowances to include additionally-developed fields is to be introduced by future legislation.
For multinational groups with UK entities holding relevant interests, the impact of the additional
allowances could have a significant impact on their current tax rate and on effective rates used in
deferred tax calculations under both US GAAP and IFRS. The permanent benefit from additional
allowances could be a major component of the reconciliation between accounting profits at the
statutory tax rate and the actual tax charge.
Asset backed contributions to pension schemes
FA 2012 includes specific legislation relating to the use of corporate assets to fund pension schemes,
referred to as asset backed contributions. This legislation seeks to remove unintended and excessive tax
relief given to an employer in respect of certain contributions made to their pension schemes.
Previously, employers may have received a tax deduction up-front for a relevant contribution to a
pension scheme, with the pension scheme only receiving the cash payments over the term of the
arrangement. Where the arrangement involved an asset and this generated an income stream to the
pension scheme, it may have been possible for the employer to obtain both a deduction up-front and for
the income payments derived from the asset. This unintended relief has been removed. In addition,
legislation has been drafted to force a 'true up' at the end of the life of a scheme implemented before
February 22, 2012, such that the tax authority will reclaim any excess tax relief where the payments to
the pension scheme over the life of the scheme were less than the relief claimed by the employer.
It is important to give careful consideration to the calculation of the current and deferred tax position of
each scheme under US GAAP and IFRS, as the current tax relief and tax base used in deferred tax
calculations could be significantly different under the new rules.
Research and development
The Government is consulting on a potential new regime which will give credits for research and
development (R&D). Two models were proposed in the consultation: a fully payable credit model and a
discounted payable credit model. As part of the consultation, views from accountants were sought as to
whether the proposals could be accounted for „above the line‟ (i.e. as part of profit before tax). PwC
responded to the accounting questions raised in the consultation.
Under IFRS, the relevant requirements to consider for an „above the line‟ accounting treatment are set
out in IAS 12 on tax credits and IAS 20 on Government grants. As the fully payable credit model as
proposed appears to be more of the nature of a Government grant than a tax credit, IAS 20 would
require the credit to be recognised „above the line‟ in the period in which the R&D costs are recognised.
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The reduced payable credit model, however, limits the amount of credit to be received on the basis of
the relevant entity's tax liability. It would therefore not be within the scope of IAS 20 but within IAS 12
(income taxes), and so could not be accounted for „above the line‟. Under IAS 12 all of the credit would
be accounted for within the tax line.
As US GAAP contains similar rules to IFRS, the tax accounting result obtained under IFRS should be in
line with the US GAAP position.
Proposed addition to the designated currency election relevant to chargeable gains
FA 2011 included provisions to allow investment companies to elect to change their computational
currencies for tax purposes, subject to certain 'reasonableness tests' in respect of the currency. The new
proposal for FB 2013 is to allow certain companies with a non-sterling functional currency to elect to
calculate chargeable gains in that currency. Currently chargeable gains are still required to be calculated
in sterling.
Under IFRS, preparing a tax return in a different currency to the accounting functional currency of the
entity can result in foreign exchange impacting the measurement of temporary differences on nonmonetary assets and liabilities. Depending on the expected manner of recovery of the relevant asset,
where the accounting functional currency and the tax currency are now the same, this election may
result in foreign exchange impacting the temporary difference measurement in fewer situations.
Companies preparing accounts under IFRS should ensure that deferred taxes are appropriately
calculated using the correct methodology.
Under US GAAP, as the 'local' currency of the entity in which its books and records are maintained will
not alter, this would not result in any change to the method under which deferred tax is calculated.
However there may be fewer foreign exchange transaction gains and losses due to there being fewer
situations where the computed tax needs to be remeasured from the new computational currency to the
functional currency. Such gains or losses are recorded above the tax line.
Financial statement disclosures
Companies should consider disclosure in their financial statements of the impact of each of these
changes in tax law. Even if the items have only been proposed before a balance sheet date, the impact
needs to be disclosed under US GAAP and IFRS if it is material. This is also required once the changes
have been enacted (for US GAAP) or substantively enacted (for IFRS). IFRS also requires disclosure of
the allocation of the impact between the income statement, other comprehensive income and equity if
this is considered to have a material impact on the financial statements.
Once the changes have been enacted for US GAAP, the current year‟s reconciliation of the ETR should
also include a reconciling item for the effect of the enacted law changes if their effect is considered
'significant.' Significant is defined by Rule 4-08(h) of SEC Regulation S-X as an individual item that is
more than five percent of the amount computed by multiplying pre-tax income by the statutory tax rate.
There is a similar requirement for IFRS accounts once the changes are substantively enacted and if the
impact is considered to be a major component of the tax expense.
Companies should also consider whether enhanced disclosures over and above the required minimums
should be made to assist users of financial statements in understanding the implications of the changes.
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Contacts
PwC clients that have questions about this Tax Accounting Services NewsAlert should contact their
engagement partner or the primary authors of this NewsAlert who welcome any questions about this
topic:
Ken Kuykendall
Partner
Global & US Tax Accounting Services Leader
(312) 298-2546
[email protected]
Doug Berg
Managing Director
Global & US Tax Accounting Services
[email protected]
(313) 394-6217
Juliette Wynne-Jones
Director
Global & US Tax Accounting Services
(312) 298-4170
[email protected]
pwc.com/us/tas
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legal, or other competent advisors. Before making any decision or taking any action, you should consult a
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information is provided 'as is', with no assurance or guarantee of completeness, accuracy, or timeliness of the
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