IAS 12 paras 81(c), 81(g) tax reconciliation and deferred tax balances with detailed explanatory notes

Co-operative Group Limited – Annual report – 2 January 2021

Industry: retail, financial

8 Taxation

What does this show? Our tax charge is made up of current and deferred tax – this note explains how those items arise. Additional explanatory footnotes are included to explain the key items. We were re-accredited with the Fair Tax Mark during 2020 and the additional disclosures we provide are in line with best practice guidance.

The tax on the Group’s net profit before tax differs from the theoretical amount that would arise using the standard applicable rate of corporation tax of 19% (2019: 19%) as follows:

The net tax charge of £61m on a profit before tax of £138m gives an effective tax rate of 44%, which is higher than the standard rate of 19%. The main reasons for this difference is the adjustment to group relief payable following the rate change enacted in the 2020 Budget and deprecation on non-qualifying assets, being debits of £16m and £11m respectively, see footnotes ii) and vii) on the following page for more detail.

Tax expense on items taken directly to consolidated statement of comprehensive income or consolidated statement of changes in equity

Of the tax taken directly to the consolidated statement of comprehensive income, £15m credit (2019: £17m credit) arises on the actuarial movement on employee pension schemes. There is also a £15m charge being the impact of rate change on the deferred tax related to the employee pension schemes. Following the disposal of CISGIL, the fair value gains on insurance assets are transferred to discontinued operations shown as a movement through the income statement. Therefore, the cumulative deferred tax liability on these fair value gains at disposal had to be transferred from equity reserves to the income statement. The £3m charge in the income statement is shown within the tax charge attributable to discontinued operations (2019: £1m charge).

2019 figures have been restated to show a further £12m credit that was recognised in the consolidated statement of changes in equity. This arises from the impact of the changes in how the Co-op Group applies IFRS 15 on recognition of certain income and expenses, see Note 15 and footnote (vii) for more details.

*See general accounting policies section on page 197 for details of the restatement.

Following last year’s Budget, on 11 March 2020, the Chancellor revoked the enacted corporation tax rate reduction from 19% to 17%, thereby leaving it at 19%. Accordingly, each deferred tax balance has been re-measured individually based on the 19% enacted tax rate, (2019: 17.0%). This has contributed £1m to the deferred tax charge in the current year.

Following the 2021 Budget, on 3 March 2021, the Chancellor has announced that with effect from 1 April 2023 the corporation tax rate will increase by 6% to 25%. Under IFRS it is the rate(s) actually enacted at the balance sheet date that determine the amount of deferred tax to be recognised. Accordingly, this announcement does not effect how the deferred tax balance has been measured as at 02 January 2021. However, once the above rate change has been enacted later this year, for subsequent reporting periods the Co-op will take account of this increased rate for determining the amount of deferred tax to be recognised. If this 6% rate increase in 2023 had been applied instead of the current enacted rate of 19% the impact that would be expected to go through the income statement is a £9m charge.

Tax policy

We publish our tax policy on our website (https://www.co-operative.coop/ethics/tax-policy) and have complied with the commitments set out in that policy.

Footnotes to taxation Note 8:

i) The Group is not tax-paying in the UK in respect of 2020 due to the fact it has a number of brought forward capital allowances (£295m gross claimed in 2020) and tax losses (£5m gross utilised in 2020) that offset its taxable profit for the period. These allowances and losses are explained in more detail in Note 15. The current tax charge of £3m primarily relates to discontinued operations and will be met by CISGIL following its disposal from the Group. Outside of the UK, our Isle of Man resident subsidiary, Manx Co-operative Society, a convenience retailing business in the Isle of Man showed a small profit in 2020, giving rise to a small current tax liability of £0.3m (2019: £0.2m). This is the Group’s only non-UK resident entity for tax purposes, which employs 106 part-time and 144 full-time colleagues out of our total Group headcount figure. All other income in the consolidated income statement is generated by UK activities and all other colleagues are employed in the UK.

The unaudited 2020 revenue of Manx Co-operative Society is £37m and all other revenue reflected in the consolidated income statement is generated by UK trading activities. The unaudited net assets of Manx Co-operative Society at 2 January 2021 were £12m, compared to net assets of the consolidated Group of £2,669m. The Manx assets represent the only overseas assets within the Group. A full copy of the most recent accounts is available here https://www.co-operative.coop/investors/rules. The presence of this IOM resident subsidiary has not resulted in any additional tax charge in 2020 over and above that payable to the Isle of Man authorities stated above. If these activities had been carried out in the UK, these profits would have been included within the Group’s taxable profit prior to the availability of capital allowances and tax losses.

In addition the Group has one company registered in the Cayman Islands, Violet S Propco Limited. This is a legacy dormant company and is UK resident for tax purposes, as it is managed and controlled entirely within the UK. All tax obligations in respect of this company are therefore reported in the UK.

ii) The Group holds a creditor balance in relation to group relief claimed from The Co-operative Bank (‘the Bank’) (see Note 22). Group relief is the surrender of tax losses made by one group company to another which made taxable profits. In 2012 and 2013, the Bank had tax losses that it was able to surrender to a number of Group companies which had taxable profits during those two years. This group relief payable is linked to and held at prevailing tax rates. Due to the enacted rate changed from 17% to 19% the creditor balance has been remeasured increasing the total liability by £16m to £147m (2019: £131m). It should be noted that due to the settlement of this creditor in February 2021, the rate change announced in the 2021 Budget will have no impact on creditor. See additional Note 34 (Events after the reporting period) for more detail on the early settlement of this in 2021.

iii) There was minimal adjustment in the current year relating to prior years. The 2019 current tax credit of £1m represented tax recoverable from a loss carry-back in one of our entities in 2018.

iv) Deferred tax is an accounting concept that reflects how some income and expenses can affect the tax charge in different periods to when they are reflected for accounting purposes. These differences are a result of tax legislation. The current year charge primarily relates to deferred tax arising on movements on our pension assets and fixed assets. Note 15 explains how each deferred tax balance has moved in the year. As the Group is not taxpaying in respect of 2020, the reconciling items between the tax charge at the standard rate and the actual tax charge mostly affect the deferred tax we carry as they will result in us having more or less capital allowances or losses to offset against future profits.

v) There was minimal adjustment in the current year relating to prior years. In 2019 there was a £48m credit for adjustment to deferred tax in respect of previous periods, primarily due to a one-off review of the method used to determine the temporary differences arising in respect of accelerated tax depreciation on fixed assets which resulted in a revised estimation technique as noted in the 2019 financial statements.

It is common for relatively small adjustments to arise in respect of prior years, as the tax charge in the financial statements is an estimate that is prepared before the detailed tax calculations are required to be submitted to HMRC, which is 12 months after the year end. Also, HMRC may not agree with a tax return some time after the year end and a liability for a prior period may arise as a result. Where there this gives rise to uncertainties a provision is recognised. Our position on the level of uncertain tax positions has reduced due to increased certainty gained through correspondence with HMRC during 2020.

vi) Some expenses incurred by the Group may be entirely appropriate charges for inclusion in its financial statements but are not allowed as a deduction against taxable income when calculating the Group’s tax liability. Examples of this include some repairs, entertaining costs and legal costs.

vii) The accounting treatment of depreciation differs from the tax treatment. For accounting purposes an annual rate of depreciation is applied to capital assets. For tax purposes the Group is entitled to claim capital allowances, a relief provided by law. Some assets do not qualify for capital allowances and no relief is available for tax purposes on these assets. This value represents depreciation arising on such assets (primarily Land and Buildings).

viii) In 2020, further re-measurement adjustments and costs to sell have been recognised in arriving at the fair value of our insurance underwriting business (CISGIL) following the completion of the deal on 3 December 2020. We are not permitted to deduct the re-measurement adjustments when calculating our profits for tax purposes. Further information is provided about the re-measurement in Note 9 (Loss on discontinued operations, net of tax).

ix) During the year a number of properties were sold, where the taxable profit is in excess of the accounting profit.

x) It is a requirement to measure deferred tax balances at the substantively enacted corporation tax rate at which they are expected to unwind. The net impact of rate change on deferred tax balances recognised through the income statement is minimal this year.

Accounting policies

Income tax on the profit or loss for the period is made up of current and deferred tax. Income tax is recognised in the income statement except to the extent that it relates to items recognised directly in reserves, in which case it is recognised in other comprehensive income. Current tax is the expected tax payable on the taxable income for the period, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years.

15 Deferred taxation

What does this show? Our tax charge is made up of current and deferred tax as explained in Note 8. We show a net asset or net liability in the balance sheet to reflect our deferred tax. This note shows how those items are calculated and how they affect the income statement. Additional explanatory footnotes are included to explain the key items.

Deferred income taxes are calculated on all temporary differences under the liability method using an effective tax rate of 19.0% (2019: 17.0%). Temporary differences arise because sometimes accounting and tax requirements mean that transactions are treated as happening at a different time for accounting purposes than they are for tax purposes.

The movements in the net deferred tax liability during the period are set out below:

Following last year’s Budget, on 11 March 2020, the Chancellor revoked the enacted corporation tax rate reduction from 19% to 17%, thereby leaving it at 19%. Accordingly, each deferred tax balance has been re-measured individually based on the 19% enacted tax rate, (2019: 17.0%). The impact on the net deferred tax liability was an increase of £16m, but of this amount only £1m was charged to P&L within the £38m shown above. The remaining £15m was a charge directly to the consolidated statement of comprehensive income in respect of retirement benefit obligations. This charge was offset by a separate £15m credit (2019: £17m credit) that arises on the actuarial movement on the retirement benefit obligation.

Following the 2021 Budget, on 3 March 2021, the Chancellor has announced that with effect from 1 April 2023 the corporation tax rate will increase by 6% to 25%. Under IFRS it is the rate(s) actually enacted at the balance sheet date that determine the amount of deferred tax to be recognised. Accordingly, this announcement does not affect how the deferred tax balance has been measured as at 2 January 2021.

However, once the above rate change has been enacted later this year, for subsequent reporting periods the Co-op will take account of this increased rate for determining the amount of deferred tax to be recognised. If this 6% rate increase in 2023 had been applied instead of the current enacted rate of 19% the impact on the balance sheet would have been to increase the net deferred tax liability per Note 15 by £50m.

*See general accounting policies section on page 197 for details of the restatement.

Footnotes:

i) This amount includes deferred tax liabilities that arose on the acquisition of Nisa Retail Limited in 2018 and the adoption of IFRS 9, also in 2018. These are offset by a deferred tax asset in respect of provisions. Expenses that have not yet been incurred are able to be recorded in the accounts as provisions. However, of these certain expenses don’t receive tax relief until they have been paid for and so the related tax relief is delayed to a future period.

ii) This amount represents the theoretical future tax cost to the Group in respect of the current pension scheme surplus. The overall increase in 2020 was £35m. This is primarily the impact of the rate change going from 17% to 19%, being £37m charge and split between income statement and other comprehensive income as £22m and £15m respectively. In addition there is a £2m credit for movement in the total schemes’ surpluses which is split between income statement and other comprehensive income as £13m charge and £15m credit respectively. The split between other comprehensive income and the income statement reflects the movement in the overall pension scheme surplus.

iii) A deferred tax asset arises on capital allowances where the tax value of assets is higher than the accounts value of the same fixed assets. The reason the Group has a higher tax value for these fixed assets is due to the fact the Group has not made a full claim to its maximum entitlement to capital allowances since 2013 due to reduced levels of trading profits in the intervening years. However, impairment, disposals and depreciation have continued to reduce the accounts value for our assets. The Group expects to use these allowances to reduce future trading profits. The £15m increase in year is mainly due to the £29m impact of the rate change less partial unwind of the difference as trading profits are now higher than in past years. (See Note 8 footnotes (v) for more detail.)

A provision of £1m (2019: £2m) is included in this balance in respect of uncertain tax positions (see Note 8 footnote (v) for more detail). In the event of an adjustment arising from uncertain tax positions, offset would arise through increased capital allowance claims.

iv) This amount represents the theoretical amount of tax that would be payable by the Group on (a) the sale of all investment properties, (b) the sale of properties that have been restated at their fair value on historic mergers and transfers of engagements and (c) the sale of any property that has had an historic capital gain ‘rolled into’ its base cost (which is an election available by statute designed to encourage businesses to reinvest proceeds from the sale of trading properties into new trading properties and ventures).

v) Following the disposal of CISGIL the Group no longer has deferred tax in relation to claims equalisation reserve that belonged to CISGIL.

vi) The Group has incurred trading losses and interest losses that were in excess of taxable profits in the past. These losses can be used to reduce future trading profits and capital gains which are included in future tax forecasts for the Group. The restriction on the amount of losses that can be used in any one year post 1 April 2017, being £5m plus 50% of any surplus taxable profits above this amount, is not expected to limit the use of these losses other than extend the time over which they will be claimed.

The increase of £5m represents a £2m impact from the rate change plus £3m net additional tax allowable losses that have been identified as arising in prior years and agreed with HMRC.

vii) Due to the IFRS 15 restatement the 2019 opening reserves reduced by £25m and the 2019 income statement showed a net debit of £43m before tax. The tax impact of these adjustments are credits of £12m, being shown in the movement of deferred tax in the main Note 15 above, and £7m, being the reduction in tax charge following restatement in 2019, respectively. The total deferred tax asset of £12m shown on the restated balance sheet for 2019 is then released in 2020 as a charge to tax in the income statement for 2020, when the IFRS 15 restatements are allowed for tax.

viii) On the adoption of IFRS 16, with effect from 1 January 2019, the opening reserves were restated down by £286m. Tax relief is provided for this restatement by spreading a deduction over the combined weighted average length of leases. The current year unwind of £4m is broadly offset by the impact of the rate change leaving the balance unchanged overall.

ix) This movement is made up of current year movements as explained in footnotes (i) to (viii) above and a prior year adjustment. The net effect of the prior year adjustments in each of the above items is minimal, see Note 8 footnotes (v) for more detail.

Accounting policies

Deferred tax is provided for, with no discounting, using the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The following temporary differences are not provided for: the initial recognition of assets or liabilities that affect neither accounting nor taxable profits, and differences relating to investments in subsidiaries to the extent that they will probably not reverse in the foreseeable future. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantively enacted at the balance sheet date. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available to use the asset against. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised.