For the purposes of this note, transitional adjustments arise where a company adopts IAS for accounting purposes in a period of account beginning on or after 1 January 2005.
They also arise where a company changes its accounting basis within UK GAAP to adopt all of FRS 25 and 26 in such a period (but this change only affects the tax treatment of loan relationships and derivative contracts).
See CIRD 12300 & 12310 for guidance
Transitional adjustments on loan relationships can arise under two separate parts of Chapter 2 Part 4 FA 1996.
In cases where the change is to IAS, and the option in IFRS 1 paragraph 36A to show comparative figures using UK GAAP is not chosen, paragraph 19A Schedule 9 FA 1996 will apply. This calculates the transitional adjustment by comparing the opening accounting value under IAS with the closing accounting value under UK GAAP. Accounting value is defined to mean the carrying value of the asset or liability as shown in the balance sheet of the company subject to adjustments for specific tax provisions which have the effect of changing the carrying value for tax purposes.
The tax adjustment provisions are
In cases where the election not to restate comparatives is made, or where the change is within UK GAAP, the transitional adjustment will be reflected in a prior period adjustment ("PPA") in the first new period of account. Section 85B FA 1996 ensures that this amount is brought into account for tax purposes despite being taken to the statement of realised gains and losses (STRGL) in UK GAAP or the statement of changes in equity (SOCIE) in IAS.
A transitional adjustment which takes the form of a PPA will also be adjusted for tax purposes by any relevant provision. For example, if the company changes the accounting treatment of a loan to a connected person so that it is in future accounted for on a fair value basis, there will be a section 85B PPA amount reflecting the difference between carrying value under an accruals method and fair value. But section 87(2) FA 1996 requires that the profits and losses on the asset continue to be brought into account for tax purposes as if the change to fair value accounting had not been made.
Therefore the PPA is ignored.
The treatment of transitional adjustments under the post-2004 legislation depends on whether the transitional adjustment falls within the category of adjustments that are not brought into account at all or whether it represents
In the case of a loan relationship coming to an end in 2005, the transitional adjustment is brought into account in the first period of account to begin on or after 1 January 2005 – see regulation 4(3) of the Loan Relationships and Derivative Contracts (Change of Accounting Practice) Regulations 2004 (SI 2004/3271) ("CofAP regulations"). It is intended to amend the CofAP regulations in 2006 to provide that where a loan relationship comes to an end within the first period of change whenever the change took place the transitional adjustment is brought into account in the first change period.
An adjustment on a loan relationship described in the second bullet will never be brought into account. This is because regulations 11 and 12 of the Disregard regulations (SI 2004/3256 as amended by SI 2005/2012 and proposed to be amended in 2006) disregard both the transitional adjustment and the credits and debits that represent the unwinding of the transitional adjustment.
In the case of a liability described in the third bullet the transitional adjustment is deferred to 2007 pending further consideration - regulation 3B CofAP regulations.
In any other case, the adjustment is spread over 10 years. Where the first post-change period is later than the company’s first period to begin on or after 2006, the 10 years starts from the period of change. In other cases it starts from the first period beginning on or after 1 January 2006. See regulation 3A of the CofAP regulations.
As to transitional adjustments not brought into account at all, they consist of
where in the earlier period the loan relationship was brought into account at a contract rate, and in the later period the loan relationship is brought into account at a spot rate of exchange, but only to the extent that the transitional adjustment is attributable to the different rates of exchange. See regulation 3C(2)(d) and (3) CofAP regulations.
Transitional adjustments on derivative contracts
can arise under two separate parts
of Schedule 26 FA 2002.
In cases where the change is to IAS, and the option
in paragraph 36A of IFRS 1 to show comparative figures
using UK GAAP is not chosen, paragraph 50A
Schedule 26 FA 2002 will apply.
This calculates the transitional adjustment by comparing the opening accounting value under IAS with the closing accounting value under UK GAAP.
Accounting value is defined to mean the carrying value of the contract as shown in the balance sheet of the company subject to adjustments for specific tax provisions which have the effect of changing the carrying value for tax purposes.
The tax adjustment provisions are
In cases where the election not to restate comparatives is made, or where the change is within UK GAAP, the transitional adjustment will be reflected in a prior period adjustment in the first new period of account. Paragraph 17B Schedule 26 FA 2002 ensures that this amount is brought into account for tax purposes despite being taken to the STRGL or SOCIE.
The treatment of transitional adjustments under the post-2004 legislation depends on whether the transitional adjustment falls within the category of adjustments that are not brought into account at all, or whether it represents -
In the case of a derivative contract as described in the first two bulleted paragraphs above, the transitional adjustment is brought into account in the first period of account to begin on or after 1 January 2005 – see regulation 4(4) CofAP regulations. It is intended to amend the CofAP regulations in 2006 to provide that where the loan relationship being hedged etc comes to an end within the first period of change whenever the change took place the transitional adjustment is brought into account in the first change period.
In any other case, the adjustment is spread over 10 years. Where the first post-change period is later than the company’s first period to begin on or after 2006, the 10 years starts from the period of change. In other cases it starts from the first period beginning on or after 1 January 2006. See regulation 3A of the CofAP regulations.
As to transitional adjustments not brought into account at all, they consist of cases where regulation 3C so provides, namely -
It is the view of HMRC that paragraph 50A applies in such a case. Paragraph 50A requires the calculation of the "accounting value" of a derivative contract of the company at the end of the earlier period when the company as using "old" UK GAAP.
"Accounting value" means the carrying value of the contract recognised for accounting purposes, and in determining the profits, gains and losses to be recognised in determining the carrying value of the contract for the purposes of this paragraph, section 94A(2) of the Finance Act 1996 applies – paragraph 50A(3) to (3B).
The answer is found by simply asking what in the old GAAP accounts is the amount recognised in respect of the derivative contract that exists in the later period – and the answer to that question is nil. Support can be gained, if needed, for this proposition from the reference in sub-paragraph (3B) to section 94A(2). Obviously that reference is of application for the later period, but it can be read as applying to the earlier period as deeming there to be a derivative contract in that period. But in any case an interpretation of paragraph 50A that gives a sensible answer (that the amount is nil) is always to be preferable to one that prevents the paragraph operating at all.
Transitional adjustments on other assets and liabilities profits and losses on which fall within the CT Acts can arise in two cases.
In cases where the change is to IAS section 64(3)(b) FA 2002 will apply.
In cases where the change is within UK GAAP, the transitional adjustment will be reflected in a prior period adjustment in the first new period of account and section 64(3)(a) FA 2002 will apply.
Schedule 22 FA 2002 then has effect in both cases. In applicable cases the deferral or spreading rules in paragraphs 6 to 9 Schedule 22 will be applicable. For example where expenditure on an intangible asset was incurred before 1 April 2002 and written off to profit and loss account, and taken into account in computing Case I profits accordingly, and is then restated on the balance sheet as an asset under IAS, paragraph 6 Schedule 22 will apply, with the result that the previously allowed expenditure is not recaptured, but no relief is given for any amortisation of the intangible on the balance sheet.
