New UK GAAP - a reminder on deferred tax on business combinations
06 June 2016
Under new UK GAAP, businesses are required to recognise deferred tax on temporary differences that have arisen as a result of business combinations (with the usual requirements to consider recoverability before recognising deferred tax assets).
Section 29, which covers income tax under FRS 102, contains no grandfathering provisions. This means that while business combinations themselves may not be restated (due to grandfathering in the relevant business combination provisions), there may be deferred tax adjustments on transition to New UK GAAP.
As there may be no transitional adjustment in respect of the business combination itself, there is no obvious trigger to act as a reminder to consider the deferred tax position. Given that the transaction may have taken place some time ago, this is an area that can easily be overlooked unless it is specifically on the radar
A common example of where deferred tax may arise is as follows:
- A company acquires shares in a trading business with leasehold property
- The leasehold property is going to be recovered entirely through use (ie it is expected to that the cost of the assets will be offset by profits from the company’s trade and that the assets will be scrapped at the end of the lease)
- 70% of the leasehold property qualifies for capital allowances
- The base cost of the assets will waste to nil over the life of the lease.
In this example it is necessary to:
- Estimate the net book value of the assets on consolidation that were acquired as part of the business combination that didn’t qualify for capital allowances as at the date of transition
- Compare this to the tax base (ie nil)
- Recognise deferred tax at the appropriate rate on consolidation (with the debit being recognised in reserves rather than adjusting goodwill)
- Unwind the deferred tax through the consolidated income statement as the assets are depreciated.
A similar issue would arise if the company acquired trade and assets rather than shares.
Even where an asset was acquired in a past business combination that does have a tax base, if fair value adjustments were made to the asset (eg say the acquiree owned land whose fair value is greater than the carrying amount in the acquiree’s books), deferred tax will arise in relation to that fair value adjustment if the tax base of the land remains unchanged (which it will in a share deal).
There can be practical difficulties in identifying areas where temporary differences have arisen and in estimating the quantum of those differences - especially where the business combination took place a long time ago. The position may also be more complex where depreciable assets are expected to be recovered partially through use and partially through sale. This is undoubtedly a complex area, however the deferred tax may well be material and cannot be ignored.