OVERVIEW OF FRS 39
Classifications of financial instruments
(a) FRS 39 has 4 clearly defined categories of financial assets:
(a) Financial assets at fair value through profit or loss;
– Held for trading;
– Designated as at fair value through profit or loss;
(b) Held-to-maturity assets;
(c) Loan and receivables;
(d) Available-for sale assets.
(b) FRS 39 has 2 defined categories of financial liabilities:
(a) Financial liabilities ‘at fair value through profit or loss’;
– Held for trading;
– Designated as fair value through profit or loss;
(b) Others financial liabilities (measured at amortised cost).
Valuation of financial instruments
(c) All the financial instruments should be measured at fair value, except for:
(a) loans and receivables and held-to-maturity investments are carried at amortised cost. The amortisation is calculated using the effective interest method;
(b) investment in equity instrument which do not have a quoted market price in an active market and whose fair value cannot be reliably measured and derivatives that are linked to and must be settled by delivery of such unquoted equity instruments, which shall be measured at cost (see paragraph 46 of FRS 39).
Fair value is defined in terms of a price agreed by a willing buyer and seller in an arm’s length transaction. Where there is no active market, valuation techniques will be used. Factors influencing the fair value of a financial instrument includes:
– time value of money
– credit risk
– foreign currency exchange prices
– commodity prices
– equity prices
– volatility
– prepayment risk and surrender risk
– servicing costs for a financial instrument
The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments of receipts through the expected life of the financial instruments. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts (see paragraph 9 of FRS 39).
Gains or losses
(d) The changes in the value of financial assets and liabilities at each year-end will be dealt with under each category of the assets or liabilities (see paragraph 55-56 of FRS 39).
(i) For financial assets and liabilities classified as at fair value through profit or loss (category 1), the unrealised gains or losses are recognised in the profit and loss account.
(ii) For available-for–sale financial assets (category 2), the unrealised gains and losses are recognised directly in equity, through the statement of changes in equity, except for impairment losses and foreign exchange gains or losses which are recognised in the profit or loss account, until the financial asset is derecognised, at which time the cumulative gain or loss previously recognised in equity shall be recognised in the profit and loss account.
(iii) For financial assets (i.e. held-to-maturity assets, loans and receivables (categories 3 and 4)) and financial liabilities carried at amortised cost, a gain or loss is recognised in the profit and loss account when the financial asset or financial liability is derecognised or impaired, or through the amortisation process. The changes in the amortised cost calculated using the effective interest method are recognised either as “interest income” or “interest expense” in the profit or loss.
“Interest income” – relate to an accounting concept which includes the interest based on the coupon/contractual rate, amortised discount/premium and transaction cost of the debt instrument/loan.
SECTION 34A TAX TREATMENT – Determination of profit or loss in respect of financial instruments
(a) Section 34A (in operation from 1 January 2005), states that for tax purposes the amount of any profit or loss or expense in respect of any financial instrument for a qualifying person is determined in accordance with:
– FRS 39, or
– SFRS for Small Entities from 1 January 2011 (as the case may be).
(b) Therefore, the income tax treatment of financial assets and liabilities is aligned with the accounting treatment.
Election to be subject to section 34A tax treatment
(a) An entity who is not required to prepare or maintain financial accounts in accordance with the FRS 39 or SFRS for Small Entities may apply to the CIT for approval to be subject to section tax treatment.
(b) If approval is granted, that entity shall be treated as a qualifying person from the YA for which approval is granted or such later YA that the Comptroller may approve.
TAX TREATMENT ARISING FROM THE ADOPTION OF FRS 39
(a) IRAS has issued a revised e-Tax Guide — Income Tax Implications Arising from the Adoption of FRS 39 – Financial Instruments: Recognition & Measurement, which explains the changes to the treatment of financial assets and liabilities for income tax purposes arising from the adoption of FRS 39.
(b) The e-Tax Guide deals with the minimisation of tax adjustments arising from the section 34A treatment of financial assets and liabilities.
Financial assets
Financial assets on revenue account
(a) For financial assets on revenue account the tax treatment is as follows:
(i) For financial assets at fair value through profit or loss (FVTPL), all gains or losses recognised will be taxed or allowed as deduction whether realised or unrealised.
(ii) For available-for-sale financial assets, all gains or losses which are recognised in the balance sheet (as a separate item in the equity) will not be taxed or allowed as a deduction.
At the time of de-recognised, the cumulative gain or loss recognised in equity that are transferred to the profit or loss will be taxed or allowed as a deduction.
(iii) For held-to-maturity assets and loans, the “interest income” which are calculated using the effective interest method, will be subject to tax.
(b) Arising from this alignment with the accounting treatment, entities need not make any adjustment for income tax purposes.
Financial assets on capital account
(a) For financial assets on capital account, the entity will need to submit a list of the assets to the Comptroller of Income Tax (CIT) for his determination that the assets qualify as capital assets.
Where CIT has agreed that they are assets on capital account, the gains or losses will not be taxed or allowed as a deduction.
This treatment will continue until such time that circumstances have changed and the entity requests for a review to treat the assets as being on revenue account, in which case, the change of tax treatment will be prospective.
However, the CIT reserves the right to tax the gains that have been previously agreed on capital account if at the time of realisation, there is evidence to show that the gains are revenue gains.
(b) Except for debt securities and negotiable certificates of deposit, gains or losses on financial assets on capital account reflected in the profit or loss are to be adjusted since they are not taxable or deductible for income tax purposes.
(c) For debt securities and negotiable certificates of deposit that are on capital account, the interest income reflected in the profit or loss under FRS 39 will be adjusted to that based on the coupon or contractual rate and that based on the provisions of section 10(12) of the Income Tax Act respectively.
In the case of discount /premium derived from debt securities that are on capital account, adjustment will have to be made to assess such discount/premium to tax upon maturity or redemption of the debt securities in accordance with the provisions of section 10(8A).
Impairment losses incurred on financial assets on revenue account
(a) Under FRS 39, impairment losses are incurred under certain circumstances described in the paragraphs 58 to 62 of FRS 39. General and specific provisions for bad and doubtful debts would no longer be made.
(b) Impairment losses incurred on financial assets on revenue account will be allowed as a deduction and any reversal taxed.
(c) Impairment losses, reversal amount of impairment losses and foreign exchange gains or losses for available-for-sale financial assets, that are recognised in the profit or loss will be taxed or allowed as a deduction;
Special rules for impairment of financial assets on revenue account for banks and finance companies in certain circumstances
(a) Under the MAS’s Notice 612 (MAS Notice 1005 for merchant banks and MAS Notice 811 for finance companies) “Credit Files, Grading and Provisioning”, any bank, merchant bank or finance company which does not have a robust loss estimation process or sufficient quality historical loan loss data and are unable to provide for collective impairment under FRS 39 are required to continue to maintain a level of collective impairment provisions that is not less than 1% of the gross loans and receivables after deducting any individual impairment provisions that have been made.
As a concession, subject to the conditions stipulated in section 14I of the ITA, the amount determined under the provisions of section 14I will be deducted for income tax purposes for a period of 5 years from the first year of assessment (hereinafter referred to as the “YA”) that such bank, merchant bank or finance company is required to comply with FRS 39 for accounting purposes.
Such banks, merchant banks and finance companies are expected to be able to comply with the requirements of FRS 39 for provision of impairment losses by the end of the fifth year.
The tax concession to claim the tax deductions referred to in this paragraph was extended in Budgets 2009, 2012 and 2015.
With the latest extension in Budget 2015, banks, merchant banks and finance companies will be able to claim the tax deductions till YA 2019 or YA 2020, depending on their financial year end; all other existing terms and conditions of the scheme apply.
(b) For any annual period where the banks, merchant banks and finance companies are able to provide for impairment losses under FRS 39, the entire impairment amount for financial assets on revenue account computed under FRS 39 will be allowed. Should there be any additional collective impairment amount required under MAS Notice 612 (MAS Notice 1005 for merchant banks and MAS Notice 811 for finance companies) on prudence grounds, it will also be allowed as a deduction.
(c) Any reversal amount of the impairment losses previously allowed is taxable and no indexation of the reversal amount of impairment losses is required, including any write-back of specific provision for doubtful debts made prior to FRS 39 tax treatment.
Indexation is the adjustment to compensate for the reduction of tax rate between the time the deduction for doubtful debts was allowed to the time the same amount is brought back to tax.
Interest-free and Non-Arm’s Length Loans
Interest-free loans
(a) For any interest-free loan, the “discount” of the loan (deemed interest income) and the “interest income” recognised in the profit or loss will not be allowed as a deduction or taxed because these are merely book entries.
This treatment is only applicable to genuine cases of interest-free loans where there is no payment for these book entries. Tax adjustments will be required.
Non-arm’s length loans
(a) Similarly, under FRS 39, non-arm’s length loans are measured at amortised cost using the effective interest method.
This means that at initial recognition of the loan, there will also be a “discount” of the loan recognised in the profit or loss.
In addition, apart from the interest received based on the contractual rate of say 2% when the market interest rate is say 5%, there will also be “income” recognised over the life of the loan which adds up to the “discount” written off to the profit or loss at the initial recognition.
(b) Notwithstanding the accounting treatment, only the actual interest income based on the contractual rate is subject to tax and the deemed interest income is to be disregarded.
Financial liabilities
(a) For the financial liabilities, the income tax treatment will also be aligned with that of the accounting treatment under FRS 39, except for financial liabilities that constitute accretion to capital or where the financial liabilities are in the form of convertible debt securities. This would mean that –
(i) For financial liabilities at FVTPL, all gains or losses (realised or unrealised) will be taxed or allowed as a deduction.
(ii) For liabilities measured at amortised cost using the effective interest method, the interest expense will be allowed as a deduction.
(b) For any borrowing that constitutes accretion to capital, tax adjustment is required.
Up to and including YA 2007, only interest expense incurred based on the contractual rate is allowed under section 14(1)(a).
From YA 2008, borrowing costs (other than interest expense) which are incurred as a substitute for interest expense or to reduce interest cost, are also allowable under section 14(1)(a).
Where such borrowing costs are in the form of a discount or premium on redemption of debt securities (including the redemption of convertible debt securities), the deduction under section 14(1)(a) is allowed only at the time the discount or premium is incurred by the issuer (i.e. at maturity or redemption of debt securities), and the deduction is given in respect of the difference between the redemption price and issue price of the debt securities.
The above tax treatment will also apply to an issuer that issues debt securities that are convertible to another company’s shares (commonly known as exchangeable debt securities).
For withholding tax purposes, the IRAS has confirmed that the amount of interest expense that is subject to withholding tax is the actual amount of interest paid or payable, i.e. based on the contractual rate stated in the loan agreement, and not the amount that is computed based on the effective interest method.
(c) Under paragraphs 28 to 32 of FRS 32, an issuer of convertible debt securities (which provide an option to the holder of debt securities to convert its debt securities to the issuer’s own shares) is required to reflect the liability and equity components of such debt securities separately on the issuer’s balance sheet.
At initial recognition, the issuer is required to fair value the liability component (as if there was no equity component) and the equity component will be the difference between the fair value of the convertible debt securities as a whole, and the fair value of the liability component.
Subsequent to the initial recognition, the issuer is required to amortise the discount/premium to the profit and loss account, where the discount/premium is the difference between the redemption price and the liability component initially recognised in the accounts.
For income tax purposes, the discount/premium attributable to the equity component or the embedded derivative (which is the option to convert the debt securities into equity) is not allowable as there is no actual cash outlay and such discount/premium is capital in nature (being related to the issuer’s share capital).
This is notwithstanding that the discount/premium attributable to liability component is deductible under section 14(1). Tax adjustment will have to be made.
Hedging instruments
(a) For hedging instruments where the underlying asset or liability is:
(i) On revenue account, the unrealised gains will be taxed and unrealised losses will be allowed as a deduction
(ii) On capital account, unrealised gains and losses will not be taxed or allowed as a deduction.
Valuation of assets in the computation of interest adjustment
(a) Interest expenses and borrowing costs incurred in lieu of interest relating to non-income producing assets are not deductible for tax purposes.
Interest adjustments would have to be made in the tax computation if there are such expenses applicable to non-income producing assets.
Direct identification method can be used if entities can directly identify the interest-bearing funds used to acquire the non-income producing assets.
However, interest adjustments are normally made using the total asset method (“TAM”):
Interest adjustment (disallowable interest expense) =
Cost of non-income producing assets
———————————————– x Interest expense
Cost of total assets
(b) Before the introduction of FRS 39, historical cost is used for the numerator and denominator of the TAM without taking into account any provisions made (e.g. provision for depreciation and bad debts) and valuation surplus/deficit.
(c) With the adoption of the FRS 39:
(i) For accounting purposes, the financial assets and financial liabilities are shown at:
– fair value,
– cost, or
– amortised cost.
(ii) For tax purposes, the treatment of financial instruments on revenue accounts aligned with that of the accounting treatment of FRS 39.
Therefore, in computing the interest adjustment on non-income producing assets, the value of these assets is the value reported in the balance sheet without any adjustment for any provisions made and valuation surplus or deficit.
If entities have opted to remain on the pre-FRS 39 tax treatment, the historical cost will be used to compute the value of the assets.
(d) However, entities that wish to use historical cost to value the assets can make an election in writing, at the time of submitting their tax return.
They must be able to track the historical cost of all the assets separately and keep proper records on the cost of the assets.
Once the election is made, it will be applied consistently. Taxpayers can opt to use the value of the financial assets shown in the balance sheet under the FRS 39 treatment at any time after that.
Such a move to the FRS 39 valuation is irrevocable once it is exercised.
(e) If taxpayers have opted to remain on the pre-FRS 39 tax treatment described in paragraph 30, the historical cost will be used to compute the value of the assets.
Small entities using SFRS-Small Entities
(a) An entity that has already moved to the section 34A tax treatment has to continue to align the tax treatment with the accounting treatment for financial instruments on revenue account when it adopts the SFRS-Small Entities for accounting purposes.
(b) For newly incorporated eligible small entities that have prepared their first set of accounts in accordance with SFRS for Small Entities, the default tax treatment will be the section 34A tax treatment (i.e. the alignment of tax treatment with the accounting treatment for financial instruments on revenue account), refer to IRAS Guidelines – Income Tax Implications Arising from the Adoption of the SFRS for Small Entities.
Transitional rules
(a) Under FRS 39, at the beginning of the financial year in which FRS 39 is initially adopted, the entity is required to identify those financial assets and financial liabilities that should be measured at fair value and those that should be measured at amortised cost based on the criteria in FRS 39.
The entity will then have to re-measure these items at fair value or amortised cost, as the case may be.
Any difference between the re-measured amount and the previous carrying amount, excluding assets available for sale, is recognised as an adjustment to the balance of retained earnings at the beginning of the financial year in which the FRS 39 is initially applied (“opening balance of retained earnings”).
(b) The tax treatment if the entity adopted the FRS 39 for accounting purposes will be:
(i) For available for sale assets, the difference between the re-measured amount and the previous carrying amount together with subsequent cumulative changes in fair value is recognised in a separate component of equity until subsequent derecognition or impairment, when the cumulative gain or loss is transferred to the profit or loss.
For tax purposes, as the gains or losses for the available-for-sale assets are recognised in equity, they will not be taxed or allowed as a deduction in the said first YA.
(i) For financial assets and financial liabilities that are on revenue account, the adjustments recognised in the opening balance of retained earnings will be taxed or allowed as a deduction in the first YA that the section 34A tax treatment is applicable after the entity is required to adopt the FRS 39 for accounting purposes.
The transitional adjustments for tax purposes also include the difference between the book value of the financial assets and financial liabilities (i.e. the previous carrying amount) and the amount recognised for tax purposes as at the last day of the basis period of the YA just before the adoption of the section 34A tax treatment. Examples are trade receivables, bond premium or discount, upfront fees and deferred income.
(c) As a concession, a 5-year instalment plan will be granted for the additional tax payable arising from the transitional tax adjustments for the first YA in which the section 34A tax treatment is applicable.
To enjoy this concession, the entity has to move to the section 34A tax treatment no later than the 5th year after it has first adopted the FRS 39 for accounting purposes.
Exceptions to computation of profit, loss or expense
The following financial instruments listed in section 34A(2) are the exceptions to the section 34A treatment:
(a) Negotiable certificate of deposit – where a qualifying person to whom section 10(12)(b) applies derives interest from a negotiable certificate of deposit or derives a gain or profit from the sale thereof, his income therefrom shall be treated in the manner set out in section 10(12).
(b) Debt securities – where a qualifying person derives interest from debt securities and the interest is chargeable to tax under section 10(1)(d), such interest shall be computed based on the contractual interest rate and not the effective interest rate.
(c) Interest-free loan – any amount of profit or expense in respect of an interest-free loan is to be disregarded.
(d) Non-arm’s length loans – only the interest income or expense of non-arm’s length loans based on the contractual rate will be chargeable to tax or allowed as a deduction.
(e) Interest expense – in a case where section 14(1)(a) applies, only the interest expense incurred based on the contractual rate is allowed as a deduction.
On 14 August 2009, the IRAS updated its e-Tax Guide — Income Tax Implications Arising from the Adoption of FRS 39 — Financial Instruments: Recognition & Measurement to clarify that with effect from YA 2008 and subsequent YAs,
(i) The borrowing costs (other than interest expense) which are incurred:
– as a substitute for interest expense, or
– to reduce existing interest cost
are also allowable under s 14(1)(a).
(ii) Where the borrowing costs are in the form of a discount or premium on redemption of debt securities, the deduction under section 14(1)(a) will be allowed only at the time the discount or premium is incurred by the issuer at the time of maturity or redemption of such debt securities.
Such a deduction will be allowed in respect of the difference between the redemption price and issue price of the debt securities.
(iii) Similar tax treatment will also apply to an issuer that issues debt securities that are convertible to another company’s shares.
(iv) Where convertible bonds that give the bond-holder an option to convert the bonds into the issuing company’s shares, the discount or premium attributable to the equity component (i.e. the embedded derivative which is the option to convert the bonds into equity) amortised to the profit or loss, it will not be allowed as there is no actual cash outlay and such a discount/premium is capital in nature.
(vi) Hedging instrument – where the underlying asset or liability is on capital account will be disregarded, i.e. the profit or loss (whether realised or unrealised) will not be taxed or allowed as a deduction.
Where the underlying asset or liability is on revenue account, the profit or loss (whether realised or unrealised) will be taxed or allowed as a deduction.
(vii) Banks and finance companies – where a bank or qualifying finance company within the meaning of section 14I is unable to make a provision for the impairment losses in respect of a group of financial assets in accordance with FRS 39, but is required to make such provision by the MAS, section 14I shall apply for a period of 5 years, or such further period as the Minister may allow, beginning from the YA in which the bank or qualifying finance company is first required to prepare financial accounts in respect of its trade or business in accordance with FRS 39.
Last reviewed: 3 January 2018