FRS 102 amendments: What does this mean for tax?

Following a periodic review of UK GAAP, the final amendments to FRS 102 were issued by the Financial Reporting Council (FRC) in March 2024.  These changes to the UK financial reporting standard will take effect for accounting periods beginning on or after 1 January 2026.  

The two major amendments arising from the periodic review are to: 

• Section 23 - Revenue from contracts with customers 
• Section 20 - Leases  

A number of clarifications and changes have also been made to other areas, including: 

• Section 1A – Small entities 
• Section 2A – Fair value measurement 
• Section 26 – Share-based payments 
• Section 29 – Income tax 

For more resources and detail on the changes themselves, visit our Financial Reporting Standards hub. In this article, we specifically explore the tax and financial reporting implications businesses need to consider. 

Businesses must ensure that revenue recognition follows the relevant accounting standards. For some, this could be an opportunity to review and revise the terms of specific contracts to ensure they remain appropriate and fit for purpose.  

Under either accounting policy choice, there will be a change in opening retained earnings and this will be taxable/deductible in the year. Any such change will need to be included in the tax computation. The current tax credit or debit will be charged directly to retained earnings, so any increase or decrease in retained earnings will be shown net of the tax impact. Accounts preparers will need to ensure that the tax reconciliation appropriately reconciles to the current and deferred tax movements only, and that the opening and closing corporation tax debtor/creditor is correct. 

The changes to revenue recognition may also impact the amount recognised as revenue for future years. This will mean that the timing of tax liabilities may change from previous expectations. Consequently, careful cashflow planning to prepare for tax payments will be important. 

For companies, recognising revenue earlier, or later, than previously may also impact quarterly instalment payments (QIPs). There would then be further cashflow implications to consider at a time when late payment interest rates are significantly higher than historically. 

Previously, when operating lease rental expenses were deducted in the income statement, this constituted an allowable tax expense.  The changes result in an interest expense, arising from the lease liability and depreciation of the RoU asset being charged to the income statement, instead of a rental expense. Careful differentiation between RoU asset depreciation and other fixed asset deprecation will be required to ensure the correct amount is deducted for tax purposes. 

Businesses must also ensure that disallowable and capital costs are identified and the depreciation relating to these amounts disallowed in the tax computation. Examples may include: 

• Lease premiums 
• Stamp duty land tax 
• Legal costs relating to acquiring/substantially modifying the lease 
• Capital improvements/fit-out 
• Capital dilapidations provisions and similar decommissioning costs 
• 15% disallowance for leases on cars with high emissions 

Although these changes may simplify the tax treatment of basic leases, businesses with complex leasing arrangements will need to ensure that finance and reporting systems are able to capture the relevant tax information.  

Similarly, an impairment of the RoU asset may also be deductible for tax purposes. There could be significant tax consequences if the impairment reverses and results in a taxable credit, particularly if losses generated by the impairment have already been utilised, or if a surrender premium/termination payment is not tax-deductible. Depending on the quantum, the interaction with the £5m deductions allowance rules may also be relevant and is a complex area. 

If there is an adjustment to the opening balance of retained earnings at the date of initial application, the tax treatment of this adjustment would need to be considered in further detail. 

Finally, while the interest recognised on the lease liability may broadly be tax deductible on an accounting basis, it could also be subject to the corporate interest restriction (CIR) rules. 

The CIR rules must generally be considered when a UK net tax interest expense for a group exceeds £2m per annum. When reviewing a company or group’s CIR position, the tax-EBITDA is compared to the net tax interest expense (NTIE). 

Both revenue recognition and lease interest expense are likely to change as a result of the accounting standard amendments, which will need to be fully assessed for tax purposes. In some cases, the lease classification under previous accounting standards may need to be considered to determine the correct CIR treatment. Any transitional adjustments will also need to be dealt with. Interest restrictions could lead to a potential deferred tax asset, subject to recognition requirements.    

At the time of writing, tax legislation has not changed to deal with the amendments to FRS 102. The CIR rules are complex and modelling the impact may be required, particularly if interest expenses in aggregate are expected to exceed £2m.   

New sections have been added to FRS 102 requiring disclosures in relation to uncertain tax treatments. An uncertain tax treatment is defined as a tax treatment for which there is uncertainty over whether, or not, the relevant taxation authority will accept the tax treatment under tax law. This will require consideration of the probability of acceptance, on the assumption that a “taxation authority will examine amounts it has a right to examine and have full knowledge of all related information when making those examinations.”, as per the FCA.

Preparers of financial statements and disclosures will need to liaise with tax colleagues and advisers to ensure they have the appropriate information. Businesses should also ensure that tax governance is appropriate, including the maintenance of tax risk registers and ensuring a strong tax control framework is in place. Auditors may require more evidence than previously, in relation to uncertain tax treatments. 

Small companies will need to produce more detailed tax disclosures than previously. This will include, for example, a tax reconciliation, disclosure of current and deferred tax, and adjustments in respect of prior periods. Deferred tax balances will also need to be broken down into categories, and movements by cause. In addition, tax amounts recognised in other comprehensive income will also need to be disclosed. This is a significant change for preparers of small entity accounts. 

Depending on the chosen approach, comparatives may need to be restated which could include the tax disclosures, for example if the profit before tax changes. Additionally, as the tax credit or debit will be applied directly to retained earnings, any change in retained earnings should reflect the net amount after accounting for tax effects.

Unlike the transition to IFRS 16 for IFRS preparers, which permits retrospective application, comparatives are not restated on initial application of the revised section. If any adjustments to opening retained earnings are identified, these will need to be considered from a tax and reporting perspective.

As the amendments may impact key financial metrics, there are other areas that should also be considered and where careful tax planning may be required.

The changes discussed above may impact the size of a business when considering company size limits and audit thresholds, which have increased by approximately 50% for periods (beginning on or after 6 April 2025). Some businesses may no longer qualify for an audit exemption, resulting in increased reporting requirements. 

The change may also affect whether or not a corporate group is ‘not small’, which could lead to tax return enquiry window periods being extended. 

Similarly, some businesses may no longer be considered a small and medium sized enterprise (SME) for transfer pricing, and thus no longer eligible for an exemption. This could have serious tax implications and businesses could be unexpectedly caught out. Transfer pricing is an evolving area and must be considered regularly.  

Businesses and their owners should be mindful of how the timing of revenue recognition, interest and depreciation may impact the profit/EBITDA linked to calculation of earn-out payments. While this could impact the future payments under the earn-out itself, the taxation of the subsequent earn-out payments could be linked to the initial and subsequent valuations of the earn out. 

As a result of these changes, the terms of the earn-out may require adjusting, to deal with changes to accounting standards and the resulting tax effects. 

In addition, businesses considering M&A transactions, on both the buy and sell side, may also find their valuations changed based on a revised EBITDA, which could impact transaction prices. 

As part of pre or post-transaction restructuring, companies will need to consider whether any changes in distributable reserves positions will alter the envisaged steps. Depending on the nature of changes, this could lead to re-requesting tax clearance from HMRC. 

The amendments to FRS 102 will impact many businesses from financial reporting, cash flows, tax and commercial perspectives. To discuss these changes further, please contact your usual contact at S&W or the contact listed.