CFM76110 - Other tax rules on corporate finance: change of accounting basis: examples: AFS and FVTOCI assets

This example applies in respect of the tax rules which apply for accounting periods beginning on or after 1 January 2016 onwards.

Under IAS 39 a company would recognise certain financial assets as being ‘available-for-sale’ (AFS). These assets would be measured at fair value in the balance sheet. However, the movements in the fair value would be recognised in other comprehensive income (OCI). Amounts of interest income, exchange movements and impairment losses would be recognised in profit and loss.

Under IFRS 9, there is a category called ‘fair value through OCI’ (FVTOCI) which has a similar accounting treatment to AFS assets. The requirements for classifying assets as AFS (under IAS 39) and as fair value through OCI (under IFRS 9) are, however, different.

On a change of accounting policy, transitional adjustments are made for tax based on the change in the tax-adjusted carrying value (TACV) of the loan.

Particular care needs to be given to loans and derivatives where amounts are recognised through OCI, as this results in differences between the accounting carrying value and TACV of the instruments in question. As such, tax adjustments may be required even when there is no change in the accounting carrying value of the relevant financial instrument on transition. In other cases, no tax adjustments may be needed even though there is a change in the accounting carrying value.

Tax-adjusted carrying value

The tax treatment of loan relationships and derivative contracts is based on the amounts recognised in profit or loss. Amounts recognised through OCI are not immediately brought into account for tax. Instead, the tax rules provide for the amounts that have been recognised in OCI to be brought into account in the future either:

• when the amounts in question are recycled to profit or loss, or
• on the derecognition of the loan or liability if no recycling is expected.

As a result, the cumulative amounts treated as within OCI will need to be reversed for the purposes of calculating the TACV.

Example 1: Fair value through profit or loss (FVTPL) to FVTOCI

A company has a loan asset which under IAS 39 was classified as FVTPL and will be classified as fair value through OCI under IFRS 9. The fair value of the asset as at 31 December 2017 under IAS 39 is £250,000, while the amortised cost value of the asset would be £200,000 at that date.

On adoption of IFRS 9, the company continues to measure the loan at its fair value of £250,000. However, the cumulative fair value gains on the loan will now be recognised in OCI. Typically the company will establish a separate reserve for these movements in equity. The balance of the amounts that are treated as having been recognised in OCI as at 1 January 2018 under the new accounting treatment is a credit of £50,000 (being the difference between the fair value of the asset and the amortised cost value of the asset).

Under the old accounting treatment, the company would have been taxed on the fair value movements in the loan as they are recognised in profit or loss. As such, there are no adjustments needed to determining the TACV of the loan at 31 December 2017. The TACV at 31 December 2017 under the old accounting treatment will therefore be £250,000.

Under the new accounting treatment, however, the company will not be immediately taxed on the fair value movements that are recognised in OCI. Instead these amounts will be brought into account when they are recycled to profit or loss, or on derecognition of the loan. As such, the amounts that are treated as being recognised in OCI need to be removed from the carrying value of the loan in calculating the TACV. The TACV at 1 January 2018 under the new accounting treatment will therefore be £200,000.

A transitional debit adjustment of £50,000 must be brought into account on adoption of IFRS 9 (typically spread over ten years). This represents the reduction in the TACV of the asset from £250,000 to £200,000. It can also be seen as reversing the cumulative fair value gains of £50,000 that have previously been recognised in profit or loss (and already taxed), which for future periods will be treated as having been recognised in OCI and may be taxable on release to profit or loss or on derecognition.

Example 2: AFS to FVTPL

A company has a loan asset which under IAS 39 was classified as AFS and will be classified as fair value through profit or loss under IFRS 9. The fair value of the asset as at 31 December 2017 under IAS 39 is £12,000. The amortised cost value of the asset was £10,000 at that date, such that £2,000 of fair value movements in respect of the loan asset have been recognised in OCI. Typically the company will have established a separate reserve for these movements in equity.

On adoption of IFRS 9, the company continues to measure the loan at its fair value of £12,000. However, the cumulative fair value gains on the loan will now be recognised in profit or loss.

Under the old accounting treatment, the company was not being immediately taxed on the fair value movements that were recognised in OCI. Instead these amounts were to be brought into account when they are recycled to profit or loss, or on derecognition of the loan. As such, the amounts that have been recognised in OCI need to be removed from the carrying value of the loan in calculating the TACV. The TACV at 31 December 2017 under the old accounting treatment will be £10,000.

Under the new accounting treatment, however, the company will be taxed on the fair value movements in the loan as they are recognised to profit or loss. As such, there are no adjustments needed to determining the tax-adjusted carrying value (TACV) of the loan at 1 January 2018. The TACV at 1 January 2018 under the new accounting treatment will be £12,000.

A transitional credit adjustment of £2,000 must be brought into account on adoption of IFRS 9 (typically spread over ten years). This represents the increase in the TACV of the asset from £10,000 to £12,000. It can also be seen as bringing into account the cumulative fair value gains of £2,000 that have previously been recognised in OCI, and which have not therefore been brought into account previously.

Example 3: Amortised Cost to FVTOCI

A company has a loan asset which under IAS 39 was classified as amortised cost and will be classified as FVTOCI under IFRS 9. The amortised cost of the asset as at 31 December 2017 under IAS 39 is £50,000, while the fair value of the asset would be £60,000 at that date.

On adoption of IFRS 9, the company changes the carrying value of the loan so that it is now measured at its fair value of £60,000.The cumulative fair value gains on the loan will be recognised in OCI. Typically the company will establish a separate reserve for these movements in equity. The balance of the amounts that are treated as having been recognised in OCI as at 1 January 2018 under the new accounting treatment is a credit of £10,000 (being the difference between the fair value of the asset and the amortised cost value of the asset).

Under the old accounting treatment, the company would have been taxed on the amounts on the loan as they are recognised to profit or loss; no amounts were recognised in OCI. As such, there are no adjustments needed to determine the TACV of the loan at 31 December 2017. The TACV at 31 December 2017 under the old accounting treatment will be £50,000.

Under the new accounting treatment, however, the company will not be immediately taxed on the fair value movements that are recognised in OCI. Instead these amounts will be brought into account when they are recycled to profit or loss, or on derecognition of the loan. As such, the amounts that are treated as being recognised in OCI need to be removed from the carrying value of the loan in calculating the TACV. The TACV at 1 January 2018 under the new accounting treatment will also be £50,000 (being the £60,000 carrying value with the £10,000 of amounts recognised in OCI being removed).

In effect, the asset will continue to be taxed on an amortised cost basis. As a result, no transitional adjustments are needed in respect of this asset on adoption of IFRS 9.

Example 4: AFS to Amortised Cost

A company has a loan asset which under IAS 39 was classified as AFS and will be classified as being measured at amortised cost under IFRS 9. The fair value of the asset as at 31 December 2017 under IAS 39 is £675,000. The amortised cost value of the asset would be £600,000 at that date, such that £75,000 of fair value movements in respect of the loan asset have been recognised in OCI. Typically the company will have established a separate reserve for these movements in equity.

On adoption of IFRS 9, the company changes the carrying value of the asset so that it measure the loan at amortised cost (effectively eliminating the fair value movements that had been recognised in OCI).

Under the old accounting treatment, the company was not being immediately taxed on the fair value movements that were recognised in OCI. Instead these amounts were to be brought into account when they are recycled to profit or loss, or on derecognition of the loan. As such, the amounts that have been recognised in OCI need to be removed from the carrying value of the loan in calculating the TACV. The TACV at 31 December 2017 under the old accounting treatment will be £600,000.

Under the new accounting treatment, the company will be taxed on the amounts from the loan as they are recognised in profit or loss. As such, there are no adjustments needed to determining the tax-adjusted carrying value (TACV) of the loan at 1 January 2018. The TACV at 1 January 2018 under the new accounting treatment will also be £600,000.

In effect, the asset will continue to be taxed on an amortised cost basis. As a result, no transitional adjustments are needed in respect of this asset on adoption of IFRS 9.