REV BN 13: International Accounting Standards (IAS): The Tax Implications

Who is likely to be affected?

1. Large companies.

General description of the measure

2. A number of technical amendments are being made to the legislation included in the 2004 Finance Act and in regulations made in December 2004. They reflect recent developments in both IAS and UK Generally Accepted Accounting Practice (GAAP) and correct some errors and omissions in the 2004 legislation.

3. The Government also proposes to extend and widen the moratorium allowing securitisation special purpose companies to be taxed as if they had continued to use UK GAAP as it stands at 31 December 2004. A power to make regulations setting out a permanent scheme of taxation for these companies will also be included in the Finance Bill.

4. An anti-avoidance measure will also be introduced to prevent companies frustrating the announcement made by the Government at Pre-Budget report that transitional adjustments would be deferred until 2006 at the earliest.

Operative date

5. These changes will generally have effect for periods beginning on or after 1 January 2005, the earliest date from which companies are permitted to use IAS to draw up their accounts. The anti-avoidance measure will apply from 14 December 2004.

Proposed revisions

6. Securitisation companies are special purpose vehicles (SPVs) involved in structures under which at least one such company is used to issue securities or commercial paper into the market which are backed by charged assets, the cash flows from which are used to meet liabilities under the securities. Such SPVs are usually 'bankruptcy remote' so that they are insulated from any insolvency risks within the group (the 'sponsoring group') that transferred the assets into the structure. Often there is more than one SPV in a chain of companies ending with an issuer SPV, or an SPV may be used to 'warehouse' assets prior to transfer into a structure involving an issuer SPV.

7. The effect of IAS and revised UK GAAP (especially IAS 39 and FRS 26) on the profits and hence the tax of SPVs is still the subject of debate among accountants. But SPVs are peculiarly dependent on an appropriate rating of the debt, in particular one that is higher than the rating of the sponsoring group, because the higher rating means a lower cost of finance. But if rating agencies are unsure of the potential tax liabilities of an SPV they may be unwilling to grant a rating or may wish to downgrade ratings previously granted to SPVs that were set up before the recent accounting changes came into effect.

8. In order to avoid disruption to the markets, at PBR draft legislation was published containing a provision (the 'moratorium') that allows SPVs in a defined category to continue to use UK GAAP as it stood on 31 December 2004 for another year for the purpose of computing their taxable profits, even where they make the transition to preparing accounts under IAS or revised UK GAAP. Following
subsequent discussions between the Inland Revenue and representatives of the securitisation industry, the Finance Bill will contain legislation that modifies the moratorium so that it:

• applies for all accounting periods beginning in 2005; and
• widens the class of SPVs to which it applies.

9. In addition the Finance Bill will contain a power to make regulations to establish a permanent regime for securitisation SPVs.

10. A number of other amendments and additions are being made to the legislation enacted in Finance Act 2004 on IAS. Many were included in draft legislation published at the Pre-Budget Report 2004, but there have been some changes to that legislation as a result of consultation. The changes include:

• removing releases of debt as part of a debt/equity swap from a charge to tax;
• restoring the rule formerly in section 85(3)(c) Finance Act 1996 that applies where a company acquires debt owed by a connected company from a third party. But the new rule will charge tax on the debtor company as if it had been released from repaying more than the amount paid by the acquiring company, unless the acquiring company had brought credits into account. In that case the credits will reduce the amount treated as released;
• ensuring that a debit for a valuation change not related to impairment is still allowed where the debit represents an exchange loss;
• ensuring that the exemption for reversal of unallowed debits for valuation changes applies to debits disallowed under the pre-2005 rules or bad debt deductions in the case of money debts which are not loan relationships, and that these rules apply to general provisions for bad debt;
• limiting debits and credits in relation to impairment of money debts which are not loan relationships to trading debts;
• repealing paragraph 6B and 6C(2) Schedule 9 FA 1996 which are redundant;
• amending the definition of exchange gains and losses in the loan relationships and derivative contracts legislation to make it clear how it operates where fair value accounting is used;
• applying section 94A FA 1996 (bifurcation of embedded derivatives) only where it is required for accounting purposes. This means it is not used where a company accounts for an asset 'at fair value through profit and loss', and where a company continues to use UK GAAP as it stood before FRS 25 and FRS 26 apply. But those companies will be allowed to elect into the bifurcation rules;
• amending the changes of accounting basis rules in the Intangible Fixed Assets regime in Schedule 29 FA 2002 so that any credit is capped at the level of net debits previously given. This rule will apply to capacity at Lloyd's as well as to other assets; and
• introducing new rules into the Intangibles regime to clarify what happens where an asset such as goodwill is disaggregated into several assets on a change of accounting basis, and where separate assets are aggregated.

11. In addition regulations will be made amending Part 9 Schedule 26 FA 2002 (derivative contracts) to continue the process of providing a comprehensive tax code for, in particular, embedded derivatives. The Order will:

• restore paragraph 45H Schedule 26 which deals with the adjustments to base cost of shares where debt is converted into shares;
• modify paragraph 45J so that it applies with suitable adaptations where an exchangeable security was issued before the issuing company was required to bifurcate the security; and
• allow companies to elect to follow for tax purposes the accounting treatment of derivatives embedded in a contract that is not a loan relationship.

12. Regulations will also be made when the Finance Act receives Royal Assent to amend the Disregard regulations. In particular:

• The closing date for elections out of regulations 7, 8 and 9 will be extended to 1 July 2005.
• transitional amounts in relation to derivative contracts to which regulations 7, 8 or 9 apply will be included in the Disregard regulations and not in the Change of Accounting Basis regulations;
• the definition of 'exchange gains and losses' will mirror the changes to paragraph 54(2) Schedule 26 FA 2002 mentioned above.

13. Regulations will also be made when the Finance Act receives Royal Assent to amend the Change of Accounting Basis regulations. In particular:

• an error in the regulations about 'held-to-maturity' assets will be corrected. The 'greater than 10%' rule will become 'less than 10%' as always intended;
• the reference to regulation 4 derivative contracts will be removed; and
• the exception for securities falling within section 94A will be removed, and modifications to the way credits and debits on such securities are brought into account will be included in the Disregard regulations.

14. The Government announced at the 2004 PBR that IAS transitional adjustments would be deferred until 2006 at the earliest. An anti-avoidance measure will be introduced to prevent companies crystallising losses in advance of transition to IAS. It will provide that where:

• a company takes steps on or after 14 December to realise a loss which results in a debit in a period ending before transition;
• those steps were not carried out in the normal course of the company's business but with the sole or main purpose of bringing the debit into account;
• had those steps not been taken and the asset still been held at the transition date; and
• the asset had the same value as at the date the loss arose;

then a debit would have arisen on transition which would have been deferred under the Loan Relationship and Derivative Contracts (Change of Accounting Practice) Regulations, then the debit in respect of the loss realised will be deferred under those regulations.

15. The measure will contain a rule to prevent groups of companies getting round it by fragmenting steps between different companies.

Further advice

16. If you have any questions about these changes, please contact Richard Thomas on 020 7147 2558 or Sue Davies on 020 7147 2565.

Information about Budget measures is available on the Inland Revenue website Inland Revenue website.