There are likely to be current and deferred tax implications of the UK’s withdrawal from the EU. Examples of three potential tax exposures and the resulting accounting implications are described below. This does not purport to be an exhaustive list.

If a business is transferred to a UK company from a company resident in another EU country, in exchange for shares issued by the UK company, no immediate tax charge on ‘hidden reserves’ or unrealised capital gains on the transfer arises in the company resident in the other EU country. This is as a result of the EU Merger Directive, which was required to be implemented into the domestic law of EU member states a number of years ago. However, the applicable national law normally only provides for a deferral of tax on the ‘hidden reserves’ or unrealised gains until the assets are transferred outside the EU/EEA. Therefore, depending on exactly how that Directive has been implemented into domestic law, the position in some countries (for example, Germany, Denmark, Italy, Netherlands) is that a tax charge in respect of ‘hidden reserves’ or unrealised capital gains on such historical transfers might crystallise after the end of the transitional period on 31 December 2020. We have been advised by some European tax colleagues that, in view of the way in which the laws are drafted and the nature of individual arrangements, whether such a tax charge does arise might need to be determined by the courts.

Consider the example of a group containing a UK company and a Dutch company, where a business has previously been transferred tax-free from the Netherlands to the UK in exchange for shares. Assuming there are no further changes in Dutch law, then Dutch tax law has the effect that a tax charge on the unrealised gains on the previous transfer will arise in the Dutch company in January 2021.

The EU Parent Subsidiary Directive provides that member states are not permitted to charge any withholding tax on dividend payments from a subsidiary in one member state to a parent company in another member state where the parent company holds at least 10% of the capital of the subsidiary.

After the end of the transitional period on 31 December 2020, dividends paid to a UK company from its EU subsidiaries will no longer benefit from the above Directive. Instead, withholding tax will be charged on any such dividends at the rate provided in the domestic law of the country in which the subsidiary is resident or, if lower, at the rate provided in the bilateral double tax treaty between the UK and that country. In the case of Germany and Italy, based on their current law, for example, withholding tax of 5% would be charged on dividends from a subsidiary in which the UK parent company holds at least 10% of the capital.

There are requirements in both IAS 12 and FRS 102 for tax that will fall due on undistributed earnings of subsidiaries to be provided. Even if an entity meets the conditions for not providing deferred tax (distribution is not probable in the foreseeable future, and the control condition is met), the tax which would be payable if the earnings in question were distributed should be disclosed (for IFRS/FRS 101 reporters).

Other examples of countries where withholding taxes would be levied on dividends paid to the UK include Portugal (where the withholding tax would be 10%), and Croatia (where the withholding tax would be 5%). The treaties of both of these countries with the UK require a company to have a 25% shareholding to get these reduced rates.

The withdrawal of various tax reliefs after the end of the transitional period on 31 December 2020  is likely to increase taxable profits in the future. Where the recognition of deferred tax assets for tax losses carried forward is dependent on the availability of future taxable profits against which to offset the losses, this could increase the amount of deferred tax assets recognised.

For example, the crystallisation of the tax deferred from previous reorganisations (see example 1 above) could increase future taxable profits. In addition, some EU territories with laws that tax the profits of ‘controlled foreign companies’ (CFCs) have reliefs to exempt charges for controlled companies which are resident in EU countries. After the end of the transitional period, such reliefs might not be available for controlled companies resident in the UK, and so might increase the taxable profits of an EU-resident (but non-UK-resident) company which controls the UK company.

By contrast, the withdrawal of relief for withholding taxes (not only for dividends, as described above, but also for interest and royalties) could actually decrease taxable profits under certain circumstances. For example, this could occur if a UK company receives interest which suffers withholding tax, and treats the withholding tax as a tax-deductible expense, rather than claiming credit for the withholding tax against its UK corporation tax liability. Where this situation is likely to decrease future taxable profits, it could decrease the amount of deferred tax assets recognised for surplus tax losses carried forward.

We believe that companies should perform an analysis of their positions (using the approach outlined in the Appendix to this paper, or something similar, to highlight where their main tax exposures arising are likely to be.

There are a number of potential tax exposures which could arise as a result of the UK leaving the EU. The current and deferred tax implications of those exposures should be considered.

IFRIC 23 clarifies how to apply the recognition and measurement requirements in IAS 12 when there is uncertainty over income tax treatments.  A liability is generally recognised at the amount that is expected to be paid. IAS 12 requires current and deferred tax balances to be measured based on tax rates and laws that have been enacted or substantively enacted by the end of the reporting period.

The standard appears to envisage a process where tax laws are enacted through national parliaments. Brexit is different because enactment of the UK's notice of withdrawal from the EU occurs before the replacement arrangements are known. In effect, giving notice under Article 50 represents the commencement and not the culmination of a legal process.

Our view of IAS 12’s accounting requirements is that giving notice under Article 50 substantively enacts the UK’s withdrawal from the EU, but the effects of that withdrawal on tax legislation are uncertain as they depend on what specific tax arrangements will apply after the end of the transitional period following agreement of the UK’s future trading relationship with the EU.  In other words, giving notice under Article 50 substantively enacts tax law in an agreement which is not yet known. This is, in itself, a tax uncertainty.

A key question is when entities should reflect the impact of Brexit in their accounting for income taxes. SIC 25 provides guidance on how an entity should account for the tax consequences of a change in tax status. Our view is that the UK ceasing to be subject to EU rules is the point at which the tax status of entities that are subject to EU law changes and the relevant date is the end of the transitional implementation period, 31 December 2020, rather than exit day 31 January 2020 or 29 March 2017, the day the UK invoked Article 50 .

Following the guidance in SIC 25, the impact of Brexit is recognised immediately after the end of the transitional period. This includes the deferred tax recognition impacts noted above. For accounting periods ending on or before the end of the transitional period the impacts of Brexit are potentially disclosable non-adjusting post balance sheet events

Entities should -assess the potential tax impact and the amount expected to be paid. It may be the case  that, even during the final stages of the negotiation process, entities might be aware that potential exposures exist, but the outcome remains  insufficiently clear to determine whether an outflow is probable or to make an estimate of the amounts involved. The position may not become clear until late in the negotiation process.

In this case, as in the case for all uncertain tax positions, good-quality disclosure of the judgements taken by management and of the potential exposures should be given. As noted above, IAS 1 requires disclosure of significant judgements made by management, as well as major sources of estimation uncertainty.

IAS 37’s disclosure requirements also apply to tax-related contingencies. These disclosures are potentially more onerous than the disclosures on sources of estimation uncertainty under IAS 1.

The UK’s Financial Reporting Council (“FRC”) gave some example disclosures, in these circumstances, in its thematic review of tax disclosures. The FRC also made clear that it expects better disclosure of tax uncertainties, and this could be a prime example of where Corporate Reporting Review Team (“CRRT”) of the FRC might challenge companies that are vague and boilerplate in their disclosure, especially given the FRC’s call for companies to make better disclosure generally of the risks and uncertainties associated with Brexit.

Yes, the impact of Brexit must be recognised within the 31 December 2020 financial statements. The transition period ends one hour before midnight in the UK on 31 December 2020 although in the EU it ends at midnight. Practically companies close their books at close of trading on 31 December 2020 which for the majority will be before 23.00 GMT. Some might argue that as withdrawal is after that, the impact of Brexit should be reflected in the books as at the opening of trading on 1 January 2021.

However, where there is a significant event after the books are closed but before the start of the next financial year it would be difficult to justify not accounting for that event within that year’s financial statements. Accounting for the event ensures that up to date relevant and reliable information is reported to users in the appropriate financial year.

The answer might be different for entities based in different time zones. For example, for a parent entity based in mainland Europe, the impact of the end of the transition period will only arise after midnight on 31 December 2020 and thus would be accounted for on 1 January 2021. If there is a material impact arising from the transition agreement ending, then appropriate disclosures should be considered in accordance with IAS10, Events after the Reporting Period.

Our tax colleagues have identified a series of steps to work through, to determine the impact for accounting and/or disclosure purposes. We believe that the approach and steps outlined below are sensible guidance for clients to apply, to help them to identify the potential tax issues when considering the accounting impact.

1. Identify the reliefs and exemptions in local tax law that rely on the UK being a member of the EU. This might be the case where EU directives or case law have been implemented into local tax law.

2. Is the relief or exemption relevant to taxes on undistributed earnings?

For outbound investments, consider:

For inbound investments, consider:

3. Would the relief or exemption be applicable to a transaction that has already occurred, and does the UK leaving the EU and the transitional period ending trigger a tax charge if the relief or exemption is annulled?

For reorganisations and cross-border asset transfers, consider:

4. Will the withdrawal of reliefs or exemptions increase or decrease future taxable profits? What impact will this have on the recognition of deferred tax assets for surplus tax losses carried forward?

For deferred tax assets, consider:

If future taxable income is to decrease, consider whether it remains probable that there will be sufficient future taxable profits to support the continued recognition of deferred tax assets.