CFM33140 - Loan relationships: core rules: other comprehensive income (OCI)

CTA09/S320A

Background

From 2016, the loan relationship rules are based on the amounts recognised in profit or loss in accordance with generally accepted accounting practice (GAAP).

Accounting standards, however, can recognise items in 'other comprehensive income'. Such amounts are generally of the type of item that should, at some point, be within the scope of the rules.

Often such amounts, to the extent they are not reversed, are 'recycled' to be items of profit or loss. In other words, amounts that were previously recognised in OCI are transferred to be recognised in profit or loss. Under the standard tax rules, such amounts will typically be brought into account under the regime when they are transferred to profit or loss.

However, in other cases, there is no 'recycling' for accounting purposes. In these cases, there is specific provision to bring such amounts into account under the regime.

Tax 'recycling' under s320A

S320A deals with special cases where the normal rule is overridden in cases where amounts taken to OCI are not expected to be recycled to profit or loss. This ensures that amounts taken directly to OCI are, at some point, taken into account for tax.

The special rule comes into effect if, in a company's period of account, an asset or liability representing a loan relationship of a company ceases in accordance with GAAP to be recognised in the company's accounts.

The rule can have effect in relation to amounts that:

  • are recognised in a company's accounts
  • have been treated, in accordance with GAAP, as items of other comprehensive income, and
  • have not been subsequently transferred to profit or loss (had they so been, they would then have become taxable, applying CTA09/S308(1A)).

Where one of two conditions are satisfied, such amounts can be taken into account. These conditions are:

  • at the time when the asset or liability ceases to be recognised, it is not expected that the amounts that have been recognised in OCI will in future be transferred to become items of profit or loss, or
  • at some later time, it is not expected that such amounts will in future be transferred to become items of profit or loss.

The amount is brought into account for tax in the period in which the condition is satisfied. If amounts are subsequently transferred to profit or loss in a company’s accounts they are not then taxed.

The combined effect of CTA09/S308(1A) and S320A is that all amounts recognised in OCI, to the extent that they are not reversed, will be brought into account for tax purposes. This ensures that amounts in OCI in respect of the loan relationships matters do not fall out of the scope of taxation altogether.

Example 1 - FVOCI loan receivable (recycling in accounts)

A company holds a loan receivable at fair value through OCI (FVOCI) in its accounts. Changes in the fair value of the loan receivable are initially recognised in OCI. At the point that the loan is derecognised, the company will transfer the amounts accumulated for the change in fair value in OCI to profit or loss.

These amounts would typically, therefore, be brought into account for tax when they are transferred to profit or loss. There is no need for S320A to be applied.

Example 2 - Changes in own credit risk (no recycling in accounts)

A company fair values one of its own debt instruments. In accordance with accounting rules, the element of the fair value movements that relates to the company's own credit risk is recognised in OCI. Where such a loan is derecognised, the amounts accumulated in OCI will not be transferred to profit or loss.

Even though there is no recycling in the accounts, the amounts recognised in OCI are brought into account for tax under S320A at the point the loan is derecognised.

What if a company applies FRS105?

Under UK GAAP, a company that is a micro entity is permitted, but not required, to draw up its financial statements under FRS105. This is a much simpler standard than FRS102 or IAS. No distinction is made between profit or loss and other comprehensive income; the company will simply take all items of income and expense in presenting its profit or loss. Accordingly, nothing can be recognised in OCI and subsequently fall with the scope of S320A. For more on the current UK financial reporting standards, see CFM20030.

Pre-2016 rules

F(2)A15 made a significant change to which amounts recognised in a company's accounts, in respect of the loan relationships (and derivative contracts) matters, fall to be taken into account for tax, absent the application of special rules.

The effect of the pre-2016 rules was, very broadly, that all amounts recognised in the company's accounts would be brought into account under the loan relationship rules. This would typically include amounts recognised both to profit or loss, and to OCI. However, this was subject to certain specific tax overrides.

The pre-2016 rules are explained at CFM33160.