The below is a guide to accounting for income taxes under International Financial Reporting Standards (IFRS). The guide is chapter 13 of PwC UK's 'Manual of accounting – IFRS 2014' (IFRS Manual) - a comprehensive practical guide to IFRS. Written by PwC's Global Accounting Consulting Services team, the IFRS Manual is full of insights based on PwC's IFRS experience around the world.

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13 - Taxation (IAS 12)

Introduction

13.1 Tax in financial statements comprises current tax and deferred tax. Current tax is based on the taxable and deductible amounts that are included in the income tax return for the current year. Management recognises unpaid current tax expense for the current and prior periods as a liability in the balance sheet. It recognises any overpayment of current tax as an asset.

13.2 The amount of tax payable on taxable profits of a particular period maybear little relationship to the income and expenditure amounts in the financial statements. Tax laws and financial accounting standards recognise and measure income, expenditure, assets and liabilities in different ways. For example, some items of income or expenditure in the financial statements might be taxable or tax deductible in a period other than the one in which they were recognised (timing differences). The amount of an asset or liability for tax purposes (tax basis) might be different from the amount recognised in the financial statements; this could result in taxable or deductible amounts in the future when the amount of the asset is recovered or the liability is settled (temporary differences).

13.3 Deferred tax aims to address this mismatch. It is inherent in recognising an asset or liability that a reporting entity expects to recover or settle the carrying amount of the asset or liability. If that carrying amount is recovered or settled, future tax payments will be larger (or smaller) than if this recovery or settlement had no tax consequences. So, if the tax effects of temporary differences resulting from the difference between tax and accounting rules are recognised, the appropriate tax expense will be recognised in the financial statements. The tax charge in the financial statements comprises deferred tax as well as current tax.

13.3.1 This chapter covers the accounting for taxation at a period end. There are separate requirements in IAS 34 for determining the tax charge for an interim period (see Manual of Accounting – Interim financial reporting).

13.4 This chapter contains a number of worked examples, using illustrative tax rates.

IAS 12 - Income taxes

Objective

13.5 IAS 12 sets out the accounting treatment for income taxes. It deals with the accounting for the current and future tax consequences of:

Transactions and other events of the current period recognised in the financial statements.

The future recovery (settlement) of the carrying amount of assets (liabilities) recognised in an entity's balance sheet.

13.6 An entity accounts for the tax consequences of transactions and other events in the same way that it accounts for the transactions and other events themselves. The tax effects of transactions and other events recognised in profit or loss are also recognised in profit or loss. The tax effects of transactions and other events recognised outside profit or loss (either in other comprehensive income or directly in equity) are also recognised in the same place. See paragraph 13.288 onwards.

13.7 The standard also addresses how to recognise deferred tax assets arising from unused tax losses or unused tax credits, the presentation of income taxes in financial statements, and the disclosure of income tax-related information.

Scope

13.8 IAS 12 applies to accounting for income taxes; that is, taxes based on taxable profit. Income taxes include domestic and foreign income taxes and withholding taxes payable by a subsidiary, associate or joint venture on distributions to the reporting entity. [IAS 12 para 2].

13.9 The standard applies to taxes based on taxable profit. This implies that not all taxes are within IAS 12's scope; but, as taxable profit is not the same as accounting profit, taxes based on a figure that is not exactly accounting profit might be within the standard's scope. This is also implied by the IAS 12 requirement to explain the relationship between tax expense and accounting profit. 'Taxable profit' implies a net rather than gross taxable amount, management might need to exercise judgement to determine whether some taxes are income taxes.

13.10 In some jurisdictions, tax might be assessed using a measure not directly linked to accounting income. Tax might be assessed using a 'taxable margin', which is calculated as revenue less specified costs. Such 'margin taxes' apply a tax rate to income less expenses (an income tax structure); so they differ from systems that assess tax based on sales or gross receipts (a non-income tax structure). In this case, the tax is an income tax in nature, and IAS 12 applies.

13.11 Where a tax is assessed based on the lower of a percentage of revenue and a percentage of revenue less expenses (that is, a 'taxable margin'), it generally has the features of income tax and is within IAS 12's scope. The tax attributes should be assessed based on the overall tax system, not on the basis of the individual tax payers. The tax classification in an individual entity does not change just because the basis of assessment differs from year to year.

13.12 As well as assessing whether a specific tax payment is based on a measure of net income, management should consider the interaction with overall income tax. If an initial tax payment is not based on net income but represents a payment in advance that is subsequently trued-up to give a tax based on net income, the initial payment forms part of the income tax and falls within IAS 12's scope.

13.13 In some jurisdictions, shipping entities can choose to be taxed on the basis of tonnage transported, tonnage capacity or a notional income, instead of the standard corporate income tax. Taxes on tonnage transported or tonnage capacity are based on gross rather than net amounts; taxes on a notional income derived from tonnage capacity are not based on the entity's actual income and expenses. Such tonnage taxes are not therefore considered income taxes under IAS 12 and are not presented as part of tax expense in the statement of comprehensive income.

13.14 In some jurisdictions, certain items of income are received net of taxes deducted at source. Examples include dividend and royalty income. Because the tax is deducted at source the cash flows of the paying entity are affected. But the tax amount is still payable by (or paid on behalf of) the recipients and hence a tax on income to the receiving entity instead of a tax on income to the paying entity. See further paragraph 13.48.

13.15 Entities may receive government grants or tax credits. The standard does not address how to account for government grants (see chapter 9) or investment tax credits. But the standard does deal with accounting for temporary differences that arise from such grants or investment tax credits. [IAS 12 para 4]. Investment tax credits are considered in more detail in paragraph 13.275.2.

13.16 An entity does not generally recognise income taxes payable by an entity's shareholders. Shareholders or other group entities might pay income taxes on the entity's behalf in some circumstances – for example, if there is a consolidated tax return, or if relief for one entity's losses is transferred to another group entity. In such circumstances, the appropriate accounting is determined by examining the arrangement's details and considering relevant tax legislation.

13.17 A third party can indemnify an entity for income tax liabilities. Such an indemnity is typically given by a vendor in a business combination, but they can arise in other situations. An indemnity does not remove the entity's tax charge in profit or loss. In addition to the income relating to the indemnification asset receivable from the third party, there might be subsequent changes in the asset's value. The asset usually changes in line with changes in the indemnified liability, depending on the terms of the arrangement. Income taxes are taxes based on taxable profit (see para 13.8). An indemnification asset receivable from a third party in respect of a tax uncertainty is not within IAS 12's scope. So, movements in a third-party indemnification asset are not included in the income tax line item in the statement of comprehensive income; they are reported as part of pre-tax profits.

13.18 Any taxes not within IAS 12's scope are within the scope of IAS 37. That standard is dealt with in chapter 21.

Accounting for current tax

Introduction

13.42 A number of issues arise in respect of current tax. The following matters are dealt with in this section:

Recognition of current tax liabilities and current tax assets on the balance sheet.

 

Presentation of current tax in the performance statements and in equity.

 

The treatment of withholding and underlying taxes in the context of dividends and other interest payable and receivable.

 

The treatment of income and expense subject to non-standard rates of tax.

 

Measurement of current tax liabilities and assets.

Uncertain tax positions.

 

Presentation and disclosure of current tax.

Apart from the last item (considered in para 13.276 onwards), these matters are discussed below.

Recognition of current tax liabilities and current tax assets

13.43 Management recognises unpaid current tax expense for the current and prior periods as a liability in the balance sheet. Uncertain tax positions are considered further in paragraph 13.74 onwards. The amount payable in respect of the current tax expense is based on the taxable and deductible amounts that are expected to be reported on the tax return for the current year. The actual tax payable might differ from the tax liability recognised because a tax rule has been applied or interpreted incorrectly or there is a dispute with the tax authorities. Except where the adjustment is caused by a material error (which should be treated under IAS 8), it is treated as a change in accounting estimate and included in tax expense of the period when the adjustment arises. Management should normally disclose a material adjustment resulting from a change in accounting estimate. If the amount paid for current and prior periods exceeds the amount due for those periods, the excess is recognised as an asset. [IAS 12 para 12].

13.44 An entity may incur a tax loss for the current period that can be carried back to set against the profits of an earlier accounting period. Management should recognise the benefit of the tax loss as an asset in the period in which the tax loss occurs, because the asset is reliably measurable and recovery is probable. If the entity cannot carry back the tax loss, it might be able to carry it forward to set against income in a future period. For recognition of a deferred tax asset for carry-forward of unused tax losses, see paragraph 13.144. [IAS 12 paras 13, 14].

Recognition of current tax

Items recognised in profit or loss

13.45 Current tax is generally recognised as income or an expense and is included in profit or loss unless it arises from a transaction or event that is recognised (in the same or a different period), either in other comprehensive income or directly in equity. [IAS 12 para 58].

Items recognised outside profit or loss

13.46 Tax follows the item; so, current tax on items recognised, in the same or a different period in other comprehensive income is recognised in other comprehensive income; and current tax on items recognised, in the same or a different period directly in equity is recognised directly in equity. [IAS 12 para 61A]. The standard gives examples of items recognised in other comprehensive income or credited or charged directly to equity; these are shown in paragraphs 13.288.1 and 13.288.2. [IAS 12 paras 62, 62A].

13.47 Where an entity pays tax on all its profits, including elements recognised outside profit or loss, it can be difficult to determine the amount of current tax attributable to the amounts recognised outside profit or loss, either in other comprehensive income or directly in equity. In those circumstances, the attributable tax is calculated on a reasonable pro rata basis, or other basis that is more appropriate in the circumstances. [IAS 12 para 63].

Example – Allocation of tax on exchange loss

A parent entity made a trading profit of C1,500,000 during the year. The parent has a foreign currency loan receivable from a foreign subsidiary on which a tax deductible exchange loss of C500,000 arose. The loan is regarded by the parent as part of its net investment in the foreign subsidiary; so the exchange loss is reported in the parent's income statement under IAS 21. The tax rate for the year is 30%. Therefore the parent's tax charge for the year is C300,000 (profit before tax of C1,000,000 @ 30%).

On consolidation, the exchange loss of C500,000 is transferred to a separate component in equity under IAS 21 and is recognised in other comprehensive income. The total tax charge of C300,000 to be allocated between the income statement and other comprehensive income is as follows:

C'000

Tax on trading profit (C1.5m @ 30%)

450

Tax relief on exchange loss (C500,000 @ 30%)

(150)

Total tax charge

300

The income statement would bear a tax charge of C450,000, with C150,000 of tax relief being recognised in other comprehensive income in the consolidated financial statements. (The subsidiary's results have been ignored to keep the example simple.)

Withholding and underlying taxes

13.48 In some jurisdictions, the recipient of a dividend receives a tax credit to acknowledge that the income from which the dividend is paid has been subject to tax in the entity paying the dividend (an imputed credit for underlying tax). This situation differs from one where a withholding tax is deducted at source and paid to the tax authorities on behalf of the recipient by the entity paying the dividend.

13.49 Withholding tax generally means tax on dividends and other income that has been deducted by the payer of the income and paid to the tax authorities on behalf of the recipient. IAS 12 contains no specific definition of withholding tax but includes as an example the portion of a dividend that is paid to the tax authorities on behalf of the shareholders. [IAS 12 para 65A]. This situation is distinct from one where the entity's tax rate depends on the level of profits that are distributed to shareholders (see para 13.175).

13.49.1 Withholding taxes can vary in their characteristics. Some indicators are given below:

The recipient of the dividend receives a net amount of income (that is, the amount of dividend received is lower than the amount declared in the paying entity's documentation), instead of the recipient being paid the full amount of the dividend declared and an additional amount being payable to the taxation authorities.

The correspondence with the tax authorities concerning the tax payment notes that the tax is being paid on the recipient's behalf, rather than being an additional tax on the entity paying the dividend.

For a dividend received with an imputed tax credit not to be subject to further tax in the recipient, it will have to be subject to specific tax relief. But, where a withholding tax has been charged, this might discharge the liability to the tax authority, so the item is not subject to further tax in the recipient.

13.50 The tax treatment of dividends and other income subject to withholding tax is often different from dividends and other income received with an imputed tax credit.

13.51 The different tax treatments are considered to be sufficiently significant to require different accounting treatments for dividends and other income subject to imputed or underlying tax credits (these are notional and should not be taken into account as income tax of the recipient entity) from those that are subject to withholding tax (these are real and should be taken into account as income tax of the recipient entity).

Outgoing dividends and other interest payable

13.52 Outgoing dividends, interest and similar amounts should be recognised at an amount that includes withholding taxes (that is, gross including the amount of the withholding tax) and excludes any other taxes (such as attributable tax credits) not payable wholly on behalf of the recipient. As distributions to owners are charged to equity any withholding tax should also be charged to equity as part of the dividend. [IAS 1 para 107; IAS 12 para 65A].

 

Incoming dividends and other interest receivable

13.54 IAS 12 is silent on the treatment of withholding taxes in the recipient's financial statements. Withholding tax is tax actually suffered by the recipient entity; so management should recognise incoming dividends, interest and other income receivable in the income statement at an amount including (that is, gross of) any withholding taxes, but excluding other taxes, such as attributable tax credits, not payable wholly on behalf of the recipient. This treatment mirrors the treatment for outgoing dividends.

13.55 Where tax has been deducted at source on interest income and has been paid by the payer of the interest to the tax authorities on behalf of the recipient, the interest income should be recorded gross of the tax deducted at source. The tax should be shown as part of the tax charge.

 

Underlying tax

13.61 In some situations, relief is also available for foreign 'underlying tax' (that is, tax on the entity's profits out of which the dividends are paid).

13.62 An entity can claim double tax relief for both withholding and underlying tax, but dividends or other income received should not be grossed up for the underlying rate of tax. This is because the underlying tax is the liability of another entity (the payer of the dividend) and is not tax that has been suffered by the recipient. The underlying tax rate is simply used by the entity's tax authority to calculate the tax due on the dividend income and to work out the total relief that should be given for the double tax suffered. The only tax that the recipient suffers is the withholding tax, which is a 'real tax', as opposed to the underlying tax that, from the perspective of the recipient, is a 'notional tax'.

13.63 Consider the following example:

Example – Unrelieved overseas tax

 

A parent entity has a foreign subsidiary. The foreign subsidiary generated taxable profits equivalent to C100,000, on which it paid tax @ 35% amounting to C35,000. It distributed the remaining after-tax profit of C65,000 to the parent after deducting 5% withholding tax amounting to C3,250. The parent received a cash dividend of C61,750. The parent's rate of tax is 30%. The tax rules in the parent's jurisdiction require it to pay tax on the grossed-up dividend, as illustrated below:

 

 

 

Parent's tax computation

C

C

 

 

Cash dividend of C61,750 grossed up for overseas taxes (both underlying and withholding)

 

100,000

 


Tax @ 30%

 

30,000

Less double tax relief:

 

 

Total overseas tax paid (C35,000 + C3,250)

38,250

 

Relief restricted to parent's tax payable

(30,000)

(30,000)

 


 

Unrelieved overseas tax *

8,250

 

 



Parent's tax liability

 

nil


* It is assumed that no deferred tax asset can be recognised for the excess foreign tax paid.

 

 

Parent's separate income statement

C

C

 

 

Dividend received (grossed up for withholding tax)

 

65,000

Tax charge:

 

 

Parent's tax

 

Overseas tax paid (withholding tax)

3,250

 

 


 

Total tax charge

 

3,250

 


Profit after tax

 

61,750

 


 

Parent's consolidated income statement

C

C

 

 

Profit before tax

 

100,000

Tax charge:

 

 

Tax

30,000

 

Less: double tax relief

30,000

 


 

 Overseas tax paid†

38,250

 


Total tax charge

 

38,250

 


Profit after tax

 

61,750

 


† Total tax charge is effectively tax of C30,000 plus unrelieved overseas tax of C8,250 = C38,250

Income and expenses subject to non-standard rates of tax

13.64 Income received after tax has been deducted is distinguished from income taxable at non-standard rates. Entities often enter into transactions that give rise to income or expense that is not subject to the standard rate of tax. Examples include some leasing transactions, and advances and investments made by financial institutions. In some situations, after taking account of the financing cost, the transaction might result in a pre-tax loss and a post-tax profit. Consider the following example:

Example – Income taxed at non-standard rate

 

A financial institution borrows C10 million that bears interest at 9% per annum. The proceeds are immediately invested in an instrument that yields 8% per annum, but the income is taxable at 20%. The standard rate of tax is 33%. The entity makes a pre-tax loss of C100,000, but the transaction is profitable, after tax effects are taken into account, as shown below:

 

 

 

Income statement

C'000

C'000

Investment income @ 8%

800

Less: interest expense

(900)

 


Pre-tax loss

(100)

Taxation:

On income @ 20%

(160)

Tax relief on interest @ 33%

297

 


 

Tax credit

137

 


Post-tax profit

37

 


13.65 Banks and other institutions enter into such transactions precisely because they are profitable after tax. But they might argue that the presentation above makes it difficult to interpret the income statement and inhibits comparison between different entities, especially since pre-tax profits are an important measure of performance. They might prefer that income subject to the non-standard rate of tax should be presented on a grossed-up basis (as shown below). This would eliminate the distortion between pre- and post-tax profits, by reporting tax at the standard rate.

Income statement (grossed-up)

C'000

Investment income (grossed up): 640/(100% − 33%)*

955

Less: interest expense

(900)

 


Pre-tax profit *

55

Tax charge @ 33% †

(18)

 


Post-tax profit

37

 


* Includes notional income of C155

† Includes notional tax charge of C155

13.66 However, we believe that grossing up, because it is notional, fails to report the transaction's true nature. In our view, if a transaction results in a pre-tax loss and a tax benefit, it is reported as such, to achieve a faithful representation. Grossing up reports a false amount, both as pre-tax profits and as the tax charge for the year. The tax treatment of the transaction should have no bearing on the way it is reported for financial reporting purposes. If grossing up were allowed as a general rule, non-deductible expenditure could be presented on a grossed-up basis. This treatment would be inconsistent with generally accepted practice in accounting for such items, where no adjustments are usually made.

13.67 So, in our view, no adjustment should be made to reflect a notional amount of tax that would have been paid or relieved in respect of the transaction if it had been taxable, or allowable for tax purposes, on a different basis.

13.68 Entities whose results are significantly affected by transactions not at a standard rate of tax should disclose the full effects of such transactions in their financial statements.

Measurement of current tax liabilities and assets

Enacted and substantively enacted tax rates and laws

13.69 Current tax liabilities and assets are measured at the amounts expected to be paid or recovered using the tax rates and laws that have been enacted or substantively enacted by the balance sheet date. [IAS 12 para 46].

13.70 Where the government has announced changes in tax rates and laws at or before the balance sheet date, but the formalities of the enactment process are not yet finalised, management should consider whether the announcement has the effect of substantive enactment. In some tax jurisdictions, such announcements have the effect of substantive enactment; so the announcement of new tax rates and laws should be taken into account in the measurement process. [IAS 12 para 48].

13.71 Substantive enactment occurs when any future steps in the enactment process will not change the outcome. This underlying principle should be used to determine if a rate is substantively enacted in a particular territory.

Discounting of current tax assets and liabilities

13.72 Entities might have tax refunds due from or tax liabilities due to the tax authorities that are receivable or payable more than 12 months from the balance sheet date, but are not interest bearing. Deferred tax assets and liabilities cannot be discounted; but the standard is silent on discounting current tax balances. [IAS 12 para 53].

13.73 Current tax assets and liabilities are measured at the amounts expected to be recovered from or paid to the tax authorities. [IAS 12 para 46]. Management does not need to discount long-term current tax balances; but entities can measure these balances at a discounted value as a matter of accounting policy choice. The impact of unwinding any discount would be presented as finance income or expense.

Uncertain tax positions

13.74 An entity's tax position might be uncertain; for example, where the tax treatment of an item of expense or structured transaction may be challenged by the tax authorities. Uncertainties in income taxes are not addressed specifically in IAS 12. IAS 37 excludes income taxes from its scope and is not used to measure uncertain tax positions. The general measurement principles in IAS 12 should be applied: "Current tax liabilities (assets) for the current and prior periods shall be measured at the amount expected to be paid to (recovered from) the taxation authorities using the tax rates (and tax laws) that have been enacted or substantively enacted at the balance sheet date". [IAS 12 para 46]. The standard does not specify the unit of account and measurement method, several methods are observed in practice.

13.75 We believe the unit of account is an accounting policy choice under IFRS. Management might consider uncertain tax positions individually or grouped together for related uncertainties. Or it might consider tax uncertainties in relation to each taxing authority.

13.76 When management considers uncertain tax positions individually, it should first consider whether each position taken in the tax return is probable of being sustained on examination by the taxing authority. It should recognise a liability for each item that is not probable of being sustained. The liability is measured using either an expected value (weighted average probability) approach or a single best estimate of the most likely outcome. The current tax liability includes the total liability for uncertain tax positions.

13.77 When management considers uncertain tax positions in relation to each taxing authority, the key issue is the measurement of the tax liability. It is usually probable that an entity will pay tax, so the recognition threshold has been met. Management should calculate the total amount of current tax it expects to pay, taking into account all the tax uncertainties, using either an expected value (weighted average probability) approach or a single best estimate of the most likely outcome.

13.78 The examples below assume that management considers tax uncertainties individually. They show that the measurement methods referred to in paragraph 13.76 can give rise to different amounts of liability. All the examples assume that it is probable (more likely than not) that tax is payable.

Example 1 – Measuring an uncertain tax position

 

Entity K has included deductions in a tax return that might be challenged by the tax authorities. Entity K and its tax consultants estimate the probability of additional tax payable as follows:

 

 

 

 

Potential tax payable

Individual probability

Cumulative probability

Probability weighted calculation

C

 

 

C

800

15%

15%

120

600

30%

45%

180

400

20%

65%

80

200

20%

85%

40

0

15%

100%

– 

 

 

 

 


 

 

 

420

 

 

 

 


 

Most likely outcome C600.

Probability weighted outcome C420.

Example 2 – Uncertain tax position with two possible outcomes

 

Entity K takes a deduction in a tax return that might be challenged by the tax authorities. It estimates a 40% probability that additional tax of C120 will be payable and a 60% probability that additional tax of C80 will be payable.

 

 

Most likely outcome C80.

Probability weighted outcome C96 (C120 × 40% + C80 × 60%).

Example 3 – Use of probability weighted average method

 

A deduction of C300 might be challenged. Entity K and its tax consultants estimate the probability of additional tax payable as follows:

 

 

 

 

Potential tax payable

Individual probability

Cumulative probability

Probability weighted calculation

C

 

 

C

100

45%

45%

45.00

80

10%

55%

8.00

50

25%

80%

12.50

– 

20%

100%

 

 

 

 


 

 

 

65.50

 

 

 

 


 

Probability weighted outcome C65.5.

It would not make sense to use C100 as the most likely outcome in this case, as some of the deductions will probably be accepted by the tax authorities. Although there is a 45% chance that the full amount of C100 will be payable, there is a 55% chance of reduced tax being payable. Here, the probability weighted average would be the appropriate measurement method.

13.79 Where an entity has paid more than the amount payable under the relevant tax legislation, it will estimate the recovery of a tax asset. On the other hand, where an entity has not remitted taxes related to an uncertain tax position, it will evaluate the uncertainty surrounding the potential liability. We believe that the same considerations apply where this evaluation relates to the recovery or payment of taxes (as opposed to interest and penalties, dealt with in para 13.81). Under IAS 12, uncertain tax positions (whether assets or liabilities) are reflected at the amount expected to be recovered from or paid to the taxation authorities. Consistent accounting policies should be applied to uncertain tax assets and liabilities.

13.79.1 An entity discloses tax-related contingent liabilities and contingent assets in accordance with IAS 37 (see para 13.308). [IAS 12 para 88]. So, if IAS 12's recognition threshold is not met, IAS 37's disclosure requirements for contingent liabilities and contingent assets apply to uncertain tax positions. These disclosure requirements are dealt with in chapter 21.

13.80 Once an uncertain tax position is determined, in later periods management need to decide whether a change in the tax estimate is justified. We expect that a change in recognition and measurement is justified where circumstances change or where new facts clarify the probability of estimates previously made. Such changes might be: further judicial developments related to a specific case or to a similar case; substantive communications from the tax authorities; or a change in status of a tax year (for example, moving from open to closed in a particular jurisdiction).

Interest and penalties on uncertain tax positions

13.81 An entity might incur interest or penalties in relation to taxation; for example, where uncertain tax positions have been successfully challenged by the tax authorities. IAS 12 does not specifically address the treatment of uncertain tax positions or associated interest and penalties. The liability for the uncertain tax position is for a tax based on taxable profits, and is therefore an income tax liability. This liability is recognised and measured under IAS 12 (see further para 13.74).

13.82 There is a strong argument that interest and penalties differ from income tax liabilities, because they are not measured and settled by the tax authorities on the basis of taxable profits. This suggests that interest and penalties should be recognised, measured and presented as provisions under IAS 37, and classified as finance or other operating expense, respectively, in the income statement. This is because:

such obligations are not based on taxable profits and so they fall outside IAS 12's scope; and

the economic substance of reducing or delaying a tax payment is no different from other financing arrangements. Interest that increases with time and is in substance a financing cost of the liability is interest expense; other penalties represent operating costs.  

13.83 Practice varies with regard to these items. In some cases, interest and penalties are accounted for as if they are within IAS 12's scope, either because they are rolled up into a lump sum settlement and cannot be separated from the taxes, or as a matter of accounting policy. Any associated charge is normally included within the tax line in the income statement; and the liability is included within the income tax liability on the balance sheet.

13.84 The accounting policy for interest and penalties applies to both interest payable (and any related penalties) and to interest recoverable (and any related damages). For interest and damages recoverable, a contingent asset cannot be recognised under IAS 37 until it is 'virtually certain'; but uncertain tax assets are recorded under IAS 12 on the basis of the amount expected to be recovered. IAS 37 establishes a higher threshold for recognition than IAS 12; so an entity's accounting policy will determine when interest and damages recoverable will be recognised.

13.84.1 The accounting policy used to recognise, measure and classify interest and tax-related penalties or damages should be disclosed clearly in the financial statements and applied consistently.

Other expenses associated with taxation

Professional fees linked to tax expense

13.85 An entity might incur expenses that are indirectly linked to the income tax expense, such as fees payable to tax consultants that are based on a percentage of savings made under a specific tax scheme. These fees are not 'tax expense' under IAS 1.

Accounting for deferred tax

Introduction

13.86 Most transactions and events recorded in the financial statements have a tax consequence, which can be immediate or deferred. Often, income is taxable and expenses are deductible for tax purposes when incurred. However, the taxation or deduction for tax purposes might be delayed to a later period (for example, when cash flows occur under the transaction). Also, the recovery or settlement of an asset or liability might have tax consequences.  

13.87 Where transactions and events have occurred by the balance sheet date, future tax consequences cannot be avoided; the entity might have to pay less or more tax than if those transactions and events had not happened. Therefore, management recognises the tax effects of all income and expenditure, gains and losses, assets and liabilities in the same period in which they are recognised themselves and not in the period in which they form part of taxable profit. This matching of transactions and events with their tax effects gives rise to current tax; it also gives rise to deferred tax assets and liabilities.

13.88 An asset recorded in the financial statements is realised, at least for its carrying amount, in the form of future economic benefits that flow to the entity in future periods; this is the basis for the balance sheet liability method used by IAS 12. When such benefits flow to the entity, they give rise to amounts that may form a part of taxable profits. The asset's tax base (see para 13.111 onwards) can be deducted in determining taxable profits in either the same or a different period. When the asset's carrying amount is greater than its tax base, the amount of the future taxable economic benefits is greater than the amount allowed as a deduction for tax purposes; as a result, it gives rise to a deferred tax liability in respect of taxes payable in future periods. For assets and liabilities within subsidiaries, branches, associates and joint ventures, the principle extends to the tax consequences of recovering the reporting group's investments in those entities, when the reporting group has control over that recovery and expects such recovery to occur in the foreseeable future.

13.89 The balance sheet liability method can instead be viewed as a valuation adjustment approach; under this approach, management needs to provide for deferred tax to ensure that other assets are not valued at more than their economic (that is, post-tax) values to the business. Management should provide for deferred tax to reflect the fact that the economic value to the business of an asset is not the market value of, say, C150. Rather it is the market value of C150 less the present value of the tax that would be payable on selling the asset for C150. In theory, the appropriate method for recognising deferred tax provided for as a valuation adjustment rather than as a liability might be to net the tax provision against the asset's carrying amount. However an entity's results and position are more clearly communicated if tax effects are shown separately from the items or transactions to which they relate.

General principles

13.90 A deferred tax liability or asset is recognised if the recovery of the carrying amount of an asset or the settlement of a liability will result in higher (or lower) tax payments in the future than if that recovery or settlement had no tax consequences. [IAS 12 para 10]. A deferred tax liability or asset is recognised for all such tax consequences that have originated but have not reversed by the balance sheet date. Exceptions to this general principle are discussed later in this chapter.

13.91 The word 'recovery' in italics above is particularly relevant for measuring deferred tax liabilities that arise on assets. An entity generally expects to recover the carrying amount of an asset through use, through sale, or through use and subsequent sale. Tax authorities might levy different rates of tax depending on whether the asset is recovered through use (income tax) or through sale (capital gains tax). Also, some assets are revalued for tax purposes (increase due to indexation to eliminate the effects of inflation) only if the asset is sold. Therefore, the manner in which the entity expects, at the balance sheet date, to recover the asset directly affects the amount of tax that is payable in future; and this should be reflected in the measurement of deferred tax at the balance sheet date (see further para 13.170 onwards). Other measurement issues are considered in paragraph 13.165 onwards.

13.92 Deferred tax income or expense should be reported in profit or loss if it relates to items that are themselves reported in profit or loss. For transactions and other events recognised outside profit or loss, any related tax effects are also recognised outside profit or loss. Presentation of deferred tax in performance statements or equity is considered in paragraph 13.286 onwards.

13.92.1 The approach to determining deferred tax can be summarised as follows:

 

 

Consider the entity's structure (for example, a company/corporation or a partnership; a parent or a subsidiary) and the tax jurisdictions that apply to the entity.

 

 

 

Calculate current income tax.

 

Current tax payable to the taxation authorities is calculated based on the tax legislation in the relevant territory. Accounting for current tax is addressed in paragraph 13.42 onwards.

 

 

 

Determine the tax base.

 

The tax base reflects the tax consequences arising from the manner in which management expects, at the balance sheet date, to recover or settle the carrying amount of an asset or liability.

 

 

 

In simple situations, an asset's tax base equals the future deductible amounts when the asset's carrying amount is recovered. A liability's tax base equals its carrying amount less future deductible amounts. If there are no tax consequences of recovery, there is no deferred tax. Tax bases for assets are addressed in paragraph 13.111 onwards, and for liabilities in paragraph 13.120 onwards.

 

 

 

Calculate temporary differences.

 

Temporary difference is defined as the difference between an asset or liability's carrying amount and its tax base. Temporary differences are addressed in paragraph 13.93 onwards and summarised in paragraph 13.106.

 

 

 

Consider the exceptions to recognising deferred tax on temporary differences.

 

Three exceptions relating to temporary differences arise in the following situations:

 

 

Initial recognition of goodwill arising in a business combination (for deferred tax liabilities only) (see para 13.158 onwards).

 

 

Initial recognition of an asset or liability in a transaction that is not a business combination and does not affect accounting profit or taxable profit (see para 13.162 onwards).

 

 

Investments in subsidiaries, branches, associates and joint ventures, but only where certain criteria apply (see para 13.233 onwards for individual financial statements and para 13.253 onwards for consolidated financial statements).

 

 

 

 

Assess deductible temporary differences, tax losses and tax credits for recoverability.

 

A deferred tax asset is recognised to the extent that it is probable that taxable profit will be available against which a deductible temporary difference or unused tax losses or tax credits can be utilised (see para 13.128 onwards).

 

 

 

Determine the tax rate that is expected to apply when the temporary differences reverse; and calculate deferred tax.

 

Deferred tax is measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date (see para 13.165 onwards).

 

 

 

Measurement of deferred tax reflects the tax consequences that follow from the manner that management expects, at the balance sheet date, to recover or settle the carrying amount of an asset or liability (see para 13.170 onwards).

 

 

 

Recognise deferred tax.

 

Deferred tax is calculated by multiplying the temporary difference by the tax rate.

 

 

 

Consider the presentation and offsetting of current and deferred tax.

 

The requirements for presenting current and deferred tax are addressed in paragraph 13.278 onwards. The rules for offsetting current and deferred tax assets and liabilities are addressed in paragraph 13.281 onwards.

 

 

 

Disclose details of current and deferred tax.

 

Disclosure requirements relating to current and deferred tax are addressed in paragraph 13.290 onwards.

Temporary differences

13.93 The concept of temporary differences is central to the calculation of deferred taxes under IAS 12. Temporary differences are defined as differences between the carrying amount of an asset or liability and its tax base (see para 13.107 onwards). [IAS 12 para 5]. The term 'temporary difference' is used because ultimately all differences between the carrying amounts of assets and liabilities and their tax bases will reverse. An entity might delay the reversal of temporary differences by delaying the events that give rise to those reversals; for example, it might defer indefinitely the sale of a revalued asset. The carrying amount of assets and liabilities will always be recovered or settled. So the key questions are when and not whether temporary differences will reverse; and to what extent, on reversal, this will result in taxable or tax deductible amounts in future years.All such tax consequences will crystallise at some point. If the recovery of an asset has no tax consequences, the tax base is equal to the carrying amount and there is no temporary difference (see further para 13.111).

13.94 The following are examples of temporary differences:

An item of income or expenditure is included in accounting profit of the period, but recognised in taxable profit in later periods. For example, income receivable might be accrued in the financial statements in one year, but it is taxed in the next year when received. Similarly, management might make provisions for restructuring costs in the financial statements in one period, but those costs would qualify for tax deduction in a later period when the expenditure is incurred.

An item of income or expenditure is included in taxable profit of the period, but recognised in accounting profit in later years. For example, development expenditure might be tax deductible in the year in which it is incurred, but it is capitalised and amortised over a period for financial reporting purposes. Similarly, income received in advance might be taxed in the period of receipt, but treated in the financial statements as earned in a later period.

Where assets are acquired and liabilities assumed in a business combination, these are generally recognised at their fair values; but no equivalent adjustment is made for tax purposes (see para 13.238).

Assets are revalued and no equivalent adjustment is made for tax purposes (see para 13.208).

Goodwill arises in a business combination (see para 13.158).

An asset or liability's tax base on initial recognition differs from its initial carrying amount; for example, when an entity benefits from non-taxable government grants related to assets (see para 13.162).

The carrying amount of investments in subsidiaries, branches and associates or interests in joint ventures differs from the tax base of the investment or interest (see para 13.253).

An entity's non-monetary assets and liabilities are measured in its functional currency, but the taxable profit or tax loss (and so the tax base of its non-monetary assets and liabilities) is determined in a different currency (see para 13.274).

[IAS 12 paras IN2, 18].

 

13.96 Not all of the temporary differences listed above give rise to deferred tax assets or liabilities. Some are specifically exempted from recognition in the standard (see further para 13.157 onwards).

13.97 The carrying amounts of assets and liabilities used to calculate the temporary differences are determined from the entity's balance sheet. The applicable carrying amount is generally a question of fact; but judgement might be needed to determine the appropriate carrying amounts for use in deferred tax calculations that are based on the dual manner of recovery (see further para 13.172.2). Where applicable, the carrying amounts of assets are included in the computation of temporary differences net of any provision for doubtful debts or impairment losses. Similarly, the carrying amounts of liabilities, such as debts recorded at amortised cost, are included net of any issue costs. The carrying amounts of assets and liabilities in consolidated financial statements are obtained from the consolidated balance sheet. The tax base is determined by reference to a consolidated tax return in jurisdictions that require such a return; and by reference to the tax returns of each individual group entity in other jurisdictions. [IAS 12 para 11].

13.98 The tax base of assets and liabilities is defined so that it equals the carrying amount of the item if reversal will not give rise to taxable or tax deductible amounts. So, temporary differences are either taxable temporary differences or deductible temporary differences. Taxable temporary differences give rise to future taxable amounts, and so to deferred tax liabilities. Deductible temporary differences give rise to future tax deductible amounts, and so to potential deferred tax assets.

Taxable temporary differences

13.99 Taxable temporary differences are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. [IAS 12 para 5].

13.100 The recognition of an asset implies that its carrying amount will be recovered in the form of economic benefits that flow to the entity in future periods. The recovery of the carrying amount of many assets gives rise to taxable and deductible amounts; for example, machinery that produces goods that are in turn sold to generate revenue that enters into the determination of taxable profits and that gives rise to depreciation that is deductible for tax purposes against those taxable profits. When the carrying amount of an asset (the minimum expected future economic benefits) exceeds its tax base (the amount that can be deducted for tax purposes from those future economic benefits – see further para 13.111 onwards), the amount of taxable economic benefits will exceed the amount that is allowed as a deduction for tax purposes. This difference is a taxable temporary difference; and the obligation to settle the resulting income taxes in future periods is a deferred tax liability. The following example shows how a deferred tax liability can arise.

Example – Deferred tax liability relating to an asset

 

An asset that cost C150 has a carrying amount of C100. Cumulative depreciation for tax purposes is C90 and the tax rate is 30%.

 

 

 

Carrying amount
C

Tax base
C

Temporary difference
C

At acquisition

150

150

Accumulated depreciation

50

90

 


Net amount

100

60

40

 


Tax rate

30%

Deferred tax liability

12

 

 

 


The tax base of the asset is C60 (cost of C150 less cumulative tax depreciation of C90). In recovering the carrying amount of C100, the entity will earn taxable income of C100, but will only be able to deduct tax depreciation of C60. The entity will pay income tax on the excess. The difference between the carrying amount of C100 and the tax base of C60 is a taxable temporary difference of C40. So the entity recognises a deferred tax liability of C12 (C40 × 30%) representing the income tax that it will pay when it recovers the asset's carrying amount.

13.101 When the asset's carrying amount and its tax base are the same, the amount included in taxable profit on the asset's recovery is offset by the amount allowed as a deduction in determining taxable profit. So the recovery of the carrying amount has no net effect on the entity's taxable profit. Hence, no deferred tax arises.

13.102 A taxable temporary difference arises when the carrying amount of a liability is less than its tax base (see further para 13.120 onwards).

Example – Deferred tax liability relating to a liability

 

An entity has taken out a foreign currency loan of FC1,000 that is recorded at C625. At the reporting date, the carrying amount of the loan is C575. The unrealised exchange gain of C50 is included in profit or loss, but will be taxable when the gain is realised on repayment of the loan.

 

 

 

 

 

Carrying amount
C

Tax base
C

Temporary difference
C

At inception

625

625

Exchange gain

50

 


Net amount

575

625

50

 


Tax rate

30%

 

 

 

 

Deferred tax liability

15

 

 

 


 

The tax base of the loan is C625 (carrying amount of C575 plus the C50 of gain that will be taxable in future periods). In settling the liability at its carrying amount of C575, the entity will make a gain of C50; but it will not be able to deduct any amount for tax purposes. The entity will pay income tax of C15 (C50 × 30%) as a result of settling the carrying amount of the liability. The difference between the carrying amount of C575 and the tax base of C625 is a taxable temporary difference of C50. Therefore, the entity recognises a deferred tax liability of C15 (C50 × 30%) representing the income tax to be paid when the carrying amount of the loan is settled at an amount below the original proceeds.

Deductible temporary differences

13.103 Deductible temporary differences are temporary differences that will result in deductible amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. [IAS 12 para 5].

13.104 The recognition of a liability implies that its carrying amount will be settled through an outflow of economic benefits from the entity in future periods. When such economic benefits flow from the entity, they give rise to amounts that might be deductible when the taxable profits of a later reporting period (that is, after the period when the liability is recognised) are determined. In such situations, there is a difference between the carrying amount of the liability and its tax base (see further para 13.120 onwards). So a deferred tax asset arises in respect of the income taxes that will be reduced or recoverable in the future periods when the settlement amounts are allowed as a deduction in determining taxable profit.

Example – Deferred tax asset relating to a liability

 

An entity recognises a liability of C1,000 for product warranty costs. For tax purposes, the warranty costs are deductible only when claims are made.

 

 

 

 

 

Carrying
amount
C

Tax base
C

Temporary difference
C

Accrued warranty cost

1,000

1,000

Tax rate

 

 

30%

 

 

 

 

Deferred tax asset

 

 

300

 

 

 


 

The tax base of the warranty is nil (carrying amount of C1,000 less the amount of C1,000 that will be deductible in future periods when the claim is made – see further para 13.120). When a claim is made and the liability is settled at its carrying amount of C1,000, the entity obtains a deduction against taxable profits of the period in which the claim is made. So the entity will pay less income tax of C300 (C1,000 × 30%) as a result of settling the carrying amount of the liability. The difference between the carrying amount of C1,000 and the nil tax base is a deductible temporary difference of C1,000. Therefore, the entity recognises a deferred tax asset of C300 (C1,000 × 30%) representing the income tax that will be recoverable (reduced) in the future.

13.105 In the context of assets, a deductible temporary difference arises when an asset's carrying amount is less than its tax base (see further para 13.111 onwards). The difference gives rise to a deferred tax asset to the extent that income taxes will be reduced or recoverable in future periods.

Example – Deferred tax asset relating to an asset

 

An asset was acquired at a cost of C1,500. It has a carrying amount of C700 after an impairment write-down of C300 was recognised in the year. Cumulative depreciation for tax and accounting purposes amounted to C500 and the tax rate is 30%.

 

 

 

 

 

Carrying Amount

Tax Base

Temporary Difference

 

C

C

C

At acquisition

1,500

1,500

Accumulated depreciation

500

500

Impairment loss in year

300

 


Net amount

700

1,000

300

 


Tax rate

30%

Deferred tax asset

90

 

 

 


The tax base of the asset is C1,000 (cost of C1,500 less cumulative tax depreciation of C500). In recovering the carrying amount of C700, the entity will earn taxable income of C700, but will be able to deduct tax depreciation of C1,000. The entity will recover income tax. The difference between the carrying amount of C700 and the tax base of C1,000 is a deductible temporary difference of C300. So the entity recognises a deferred tax asset of C90 (C300 × 30%) representing the income tax that will be recovered (reduced) when it recovers the asset's carrying amount.

Summary of temporary differences

13.106 The relationship between the carrying amount and tax bases of assets and liabilities on the one hand, and the resulting deferred tax assets and liabilities that arise on the other, can be summarised as follows:

Relationship

For assets

For liabilities

Carrying amount is more than the tax base

Taxable temporary difference

Deductible temporary difference

Deferred tax liability (DTL)

Deferred tax asset (DTA)

 

 

 

Carrying amount is less than the tax base

Deductible temporary difference

Taxable temporary difference

Deferred tax asset (DTA)

Deferred tax liability (DTL)

 

 

 

Carrying amount = tax base

None

None

Tax bases

General

13.107 The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. [IAS 12 para 5]. The concept of tax base of an asset or liability is fundamentally important in applying the standard's provisions. The calculation of temporary difference depends on correctly identifying the tax base of each asset and liability in the entity's balance sheet. There is also a specific definition of 'tax base' for assets and liabilities (see paras 13.111 and 13.120 respectively). These definitions modify the general definition so that tax base equals the carrying amount in some circumstances. The standard provides a number of examples for determining the tax bases of assets and liabilities in particular situations.

13.107.1 An asset or liability might have more than one tax base; this depends on how the entity intends to recover or settle the asset or liability. See further paragraph 13.170 onwards.

13.108 The tax base as defined in the standard is generally the amount shown as an asset or liability in a tax balance sheet (that is, using tax laws as a basis for accounting). Example 2 of appendix B of the standard shows the preparation of a tax balance sheet. There may be that there is no requirement or custom to prepare or file a tax balance sheet with the tax authorities. In such cases, the tax bases can be obtained from the tax return or from the working papers for the taxable profit calculation.

13.108.1 The tax base might be different from the amount shown as an asset or liability in a tax balance sheet if there is uncertainty about the tax position. The entity might declare amounts in the tax return that could be subject to challenge by the tax authorities. In this case, management considers what it expects the outcome of any uncertainty will be; and it determines the appropriate tax base on this basis. If it is more likely than not that the uncertain item included in the tax return will be accepted by the tax authorities, the tax base used in the deferred tax calculation will be equal to the amount in the tax return. Otherwise, management calculates the tax base for use in the deferred tax calculation based on its expectations of the future tax consequences.

13.109 The definitions of tax base can be difficult to apply. A number of formulae exist for calculating tax bases; these are shown in the following paragraphs. These formulae can help to determine the tax base and apply the fundamental principle in paragraph 10 of IAS 12; this principle states that, with limited exceptions, an entity recognises a deferred tax liability (asset) whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (smaller) than if such recovery or settlement had no tax consequences (see para 13.125).

 

 

Tax base of an asset

13.111 The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits flowing to an entity when it recovers the asset's carrying amount. If those economic benefits will not be taxable, the asset's tax base is equal to its carrying amount. [IAS 12 para 7]. The words in italics are included in the formula below; so their meaning needs to be understood.

13.112 An amount is 'deductible for tax purposes' if the deduction is allowed under the tax laws in determining taxable profits. For example, deductible amounts might include depreciation (or capital allowances) as an allowable deduction for tax purposes, and any indexation benefits for assets subject to tax on disposal. The deduction might be for the full amount, a portion or none of the asset's cost. The deduction might be allowed in the period when the asset is acquired or over a number of periods. If the tax laws allow an asset's full cost on acquisition to be deductible, the asset's tax base on initial acquisition is its cost. But if the asset's cost cannot be deducted in determining taxable profit, either over a number of periods or on disposal, the asset's tax base is nil.

13.113 'Taxable economic benefits' that flow to the entity in future periods are income earned from the asset's use or proceeds arising from its disposal that are included in determining taxable profits. Although an entity often generates economic benefits in excess of an asset's carrying amount through use or sale, the standard does not require an entity to estimate the excess economic benefits that will be generated by the asset. Rather, the standard focuses on the future tax consequences of recovering an asset only to the extent of the asset's carrying amount at the balance sheet date.

13.114 In some circumstances, the economic benefits might not be taxable. Where this is so, the recovery of the asset's carrying amount has no future tax consequences; and so no deferred tax arises. It follows that the temporary difference is zero and the asset's tax base is equal to its carrying amount. This is consistent with the definition in paragraph 13.111. In other circumstances, only a proportion of the asset's carrying amount might be taxable (see example 2 in para 13.163).

 

13.117 The formula to determine an assets tax base can be used at the end of any reporting period; it is as follows:

Tax base of asset = Carrying amount − Future taxable amounts1 + Future deductible amounts

 

1 As noted in paragraph 13.113, IAS 12 focuses on the future tax consequences of recovering an asset only to the extent of the asset's carrying amount at the balance sheet date. So the taxable amount arising from recovery of the asset is limited to the asset's carrying amount.

13.117.1 The temporary difference on an asset is the difference between the asset's carrying amount and tax base. The formula for the temporary difference on an asset is as follows:

Temporary difference = Future taxable amounts − Future deductible amounts

13.118 The future taxable amounts at the end of a reporting period will often be the same as the asset's carrying amount; so the first two terms in the formula will net to zero, leaving the future deductible amounts equal to the tax base at the end of the reporting period; this is also the asset's tax written down value. If the income generated by the asset is non-taxable, both the future taxable amounts and the future deductible amounts are nil; so the tax base is equal to the carrying amount (as stated in para 13.114) and there is a nil temporary difference.

13.119 The above formula depends on taxable amounts and deductible amounts for the recovery of an asset's carrying amount, so a number of different scenarios are possible; each scenario below has examples that apply the formula.

 

Scenario A − Recovery of asset gives rise to both taxable and deductible amounts

Example 1 – Tax base of a machine

A machine cost C1,000. For tax purposes, depreciation of C300 has been deducted in the current and prior periods; and the remaining cost will be deductible in future periods, either as depreciation or through a deduction on disposal. Revenue generated by using the machine is taxable; and any gain or loss on disposal of the machine will be taxable or deductible for tax purposes through a balancing adjustment (such as claw back of capital allowances claimed). For accounting purposes, the machine has been depreciated by C200.

The tax written down value of the asset is C700 (cost of C1,000 less tax depreciation claimed to date of C300), which is also the tax base.

Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C800

C800

+

C700

=

C700

 

 

There is a taxable temporary difference of C100 (C800 − C700).

Example 2 – Tax base of inventory

Inventory at the balance sheet date has a carrying amount of C1,000. The inventory will be deductible for tax purposes when sold.

The amount that will be deductible for tax purposes if the inventory is sold is C1,000, which is its tax base.

Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C1,000

C1,000

+

C1,000

=

C1,000

 

 

The temporary difference is C1,000 – C1,000 = Cnil.

Example 3 – Tax base of revalued land

Land was acquired for C1,000 at the beginning of the financial year. It is revalued to C1,500 at the balance sheet date. The indexed cost of the land at the balance sheet date for tax purposes is C1,100.

If the land is sold at its carrying amount of C1,500, the amount deductible for tax purposes is the indexed cost of C1,100, which is the tax base.

Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C1,500

C1,500

+

C1,100

=

C1,100

 

 

There is a taxable temporary difference of C400 (C1,500 – C1,100).

 

 

The deferred tax consequences of the revaluation of land are considered further in paragraph 13.213 onwards.

Example 4 – Tax base of land carried at cost

Land was acquired for C1,000 at the start of the financial year. It is not revalued. The indexed cost of the land at the balance sheet date for tax purposes is C1,100. Under the tax rules applicable to the entity, indexation adjustments cannot create or increase a loss.

If the land is sold for the carrying amount of C1,000, the amount that will be deductible for tax purposes is C1,000 and not the indexed cost of C1,100.

Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C1,000

C1,000

+

C1,000

=

C1,000

 

 

The temporary difference is C1,000 – C1,000 = Cnil. 

Example 5 – Tax base of asset held for disposal

An asset costing C500 is carried in the balance sheet at a revalued amount of C700. The asset is held for disposal. For tax purposes, depreciation of C100 has been deducted in the current and prior periods. The gain on disposal will be taxed but limited to the tax allowance previously claimed.

The definition of tax base would suggest that the tax base is the amount that would be deductible in the future; that is, cost of C500 less tax depreciation claimed to date of C100 = C400, which is also the asset's tax written down value. But this is not the case, because not all of the asset's carrying amount of C700 at the balance sheet date would be taxable. The taxable gain is limited to tax allowances previously claimed, so the revaluation surplus of C200 is not taxable. Because the recovery of part of the asset is not taxable, this is equivalent to a tax deduction being available for that same amount. Applying the formula, the tax base becomes:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C700

C500

+

C400

=

C600

 

 

The temporary difference is C700 − C600 = C100 on which deferred tax should be provided. This amount matches the tax that would be payable if the asset was sold at its carrying amount at the balance sheet date (that is, revaluation surplus of C200, but restricted to tax depreciation of C100 previously claimed = C100).

 

The non-taxable element of the carrying amount (C200) forms part of the tax base (that is, the carrying amount of C700 less the future taxable amount of C500). There is also a deductible amount for the remaining C400 of tax depreciation to be received.

Example 6 – Tax base of asset held for disposal

Facts are the same as in example 5, except that the gain on disposal will be taxed and past tax allowances will be claimed back if the asset is sold at above cost.

The tax base is the amount that would be deductible in the future (that is, cost of C500 less tax depreciation claimed to date of C100 = C400), which is also the asset's tax written down value. Applying the formula, the tax base becomes:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C700

C700

+

C400

=

C400

 

 

Or the tax base can be calculated as the carrying amount of C700 − future taxable amount of C800 (including C100 of tax depreciation that will be clawed back) + future deductible amount of C500 (because C100 of tax depreciation will be clawed back) = C400.

 

The temporary difference is C700 − C400 = C300 on which deferred tax should be provided. This amount matches the tax that would be payable if the asset was sold at its carrying amount at the balance sheet date (that is, revaluation surplus of C200 + tax depreciation of C100 previously claimed = C300).

Scenario B − Recovery of asset gives rise to taxable amounts but not to deductible amounts

Example 1 – Tax base of interest receivable

Interest receivable has a carrying amount of C1,000. The related interest will be taxed on a cash basis.

The amount of the receivable that will be deductible for tax purposes when the interest is received is Cnil, which is its tax base.

Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C1,000

C1,000

+

Cnil

=

Cnil

 

 

There is a taxable temporary difference of C1,000 (C1,000 – Cnil).

Example 2 – Tax base of foreign currency debtor

Foreign currency debtor has a carrying amount of C1,150 after recognising an exchange gain of C50 in profit or loss. The original amount of C1,100 was included in taxable profit. Exchange gains are taxable only when realised.

Because the original amount of C1,100 has already been included in taxable profit, it will not be taxable in the future when the asset is recovered. So an element of the foreign currency debtor is not taxable. This is similar to scenario A example 5. Where part of the carrying amount is not taxable, it is equivalent to a tax deduction being available for that amount. Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C1,150

C50

+

Cnil

=

C1,100

 

 

There is a taxable temporary difference of C50 (C1,150 − C1,100).

 

The non-taxable element of the carrying amount (C1,100) forms part of the tax base (that is, the carrying amount of C1,150 less the future taxable amount of C50). Any deductible amounts to be received in the future should also be considered. In this case there are none, so the future deductible amount is Cnil.

Example 3 – Tax base of development expenditure

Development expenditure with a carrying amount of C1,000 is claimed as a deduction when paid. For accounting purposes, the development expenditure is amortised over 5 years.

When the development expenditure's carrying amount is recovered in the future through amortisation, the amount that will be deductible for tax purposes is Cnil, which is its tax base.

Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C1,000

C1,000

+

Cnil

=

Cnil

 

 

There is a taxable temporary difference of C1,000 (C1,000 – Cnil).

Example 4 – Tax base of interest paid

Interest paid of C1,000 is capitalised as part of the asset's carrying amount. Tax deductions were obtained when the interest was paid.

When the asset's carrying amount is recovered in the future through amortisation, the amount of the interest expenditure that will be deductible for tax purposes is Cnil, which is its tax base.

Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C1,000

C1,000

+

Cnil

=

Cnil

 

 

There is a taxable temporary difference of C1,000 (C1,000 – Cnil).

Scenario C − Recovery of asset does not give rise to taxable amounts but gives rise to deductible amounts

Example – Tax base of trade debtors

A portfolio of trade debtors with similar credit risk characteristics has a carrying amount of C5,000 after recognising a bad debt provision of C250. The original amount of C5,250 has already been included in taxable profits. The provision for bad debt is not tax deductible, but would be so when the individual assets are derecognised.

The first part of the definition of tax base would suggest that the debtor's tax base is C250, because that is the amount that will be deductible for tax purposes when the carrying amount of C5,000 is recovered. The second part of the definition would suggest that the tax base is equal to the carrying amount of C5,000, because the economic benefits are not taxable. But that is not the case, as noted in scenario A example 5. Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C5,000

Cnil

+

C250

=

C5,250

 

 

There is a deductible temporary difference of C250 (C5,000 − C5,250).

Scenario D − Recovery of asset does not give rise to either taxable amounts or deductible amounts

Example 1 – Tax base of trade debtors with specific bad debt provision

Trade debtors have a carrying amount of C5,000 after recognising a specific provision of C250. The original amount of C5,250 has already been included in taxable profits. Specific provision of C250 is deductible for tax purposes when it is made.

Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C5,000

Cnil

+

Cnil

=

C5,000

 

 

The temporary difference is C5,000 − C5,000 = Cnil.

Example 2 – Tax base of dividend receivable

Management has recognised a dividend receivable of C100,000 from a wholly owned subsidiary in a single-entity set of financial statements. The dividend is not taxable.

Applying the formula, we have:

 

 

 

 

 

 

 

Carrying amount of asset

Future taxable amount

+

Future deductible amounts

=

Tax base

C100,000

Cnil

+

Cnil

=

C100,000

 

 

The temporary difference is C100,000 − C100,000 = Cnil.

Tax base of a liability

13.120 The tax base of a liability is its carrying amount less any amount that will be deductible for tax purposes in respect of that liability in future periods. For revenue that is received in advance, the tax base of the resulting liability is its carrying amount less any amount of the revenue that will not be taxable in future periods. [IAS 12 para 8].

13.121 The standard focuses on the future tax consequences of settling a liability at its carrying amount, as it does for assets. Management does not need to estimate the amount that might be payable on settlement. For example, where a premium is payable on redemption of a debt instrument, the tax base of the liability is calculated using the premium that has been accrued at the balance sheet date and not the premium that would be payable on redemption. Similarly, where a liability is recorded at a discounted amount under IAS 37, its tax base is determined using that amount and not the gross amount payable in the future; for example, where a tax deduction is available on settlement of a decommissioning liability.

13.122 A formula can be derived from first principles for determining a liability's tax base. But because the settlement of a liability's carrying amount involves the outflow rather than an inflow of economic resources, a liability can be regarded as a negative asset; therefore the equation for a liability's tax base can be obtained simply by changing the sign of each term in the formula for an asset's tax base as follows:

Tax base of liability = Carrying amount − Future deductible amounts + Future taxable amounts

13.122.1 The temporary difference on a liability is the difference between the liability's carrying amount and tax base. The formula is as follows:

Temporary difference = Future deductible amounts − Future taxable amounts

The future taxable amount of a liability is often nil, because no part of a liability's carrying amount (for example, a loan of C1,000) would normally be taxable or deductible when the liability is settled (but see example 3 below). So the formula above is consistent with the standard's definition in paragraph 13.120. Various examples are given below.

Example 1 – Tax base of a loan payable

A loan payable has a carrying amount of C1,000 at the balance sheet date. The repayment of the loan will have no tax consequences.

Applying the formula, we have:

Carrying amount of liability

Future deductible amounts

+

Future taxable amount

=

Tax base

C1,000

Cnil

+

Cnil

=

C1,000

 

The temporary difference is C1,000 − C1,000 = Cnil.

Example 2 – Tax base of accrued fines and penalties

Accrued fines and penalties that are not deductible for tax purposes have a carrying amount of C1,000 at the balance sheet date.

Applying the formula, we have:

Carrying amount of liability

Future deductible amounts

+

Future taxable amount

=

Tax base

C1,000

Cnil

+

Cnil

=

C1,000

 

The temporary difference is C1,000 − C1,000 = Cnil.

Example 3 – Tax base of foreign currency loan payable

 

Foreign currency loan payable has a carrying amount of C950 after recognising an exchange gain of C50 in profit or loss. Exchange gains are taxable only when realised.

When the loan is repaid at its carrying amount at the balance sheet date, the amount that would be included in future taxable amount is C50; and no part of the carrying amount would be deductible. Applying the formula, we have:

Carrying amount of liability

Future deductible amounts

+

Future taxable amount

=

Tax base

C950

Cnil

+

C50

=

C1,000

 

There is a taxable temporary difference of C50 (C950 − C1,000).

Example 4 – Tax base of accrued wages

Wages payable to employees amounting to C1,000 were accrued at the balance sheet date and allowed as a tax deduction when the expense was recognised.

Because wages have already been allowed as a deduction for tax, no further deductible or taxable amounts would arise in the future when the wages are paid.

Applying the formula, we have:

Carrying amount of liability

Future deductible amounts

+

Future taxable amount

=

Tax base

C1,000

Cnil

+

Cnil

=

C1,000

 

The temporary difference is C1,000 − C1,000 = Cnil.

Example 5 – Tax base of accrued long-service leave

A liability of C150,000 for long-service leave has been accrued at the balance sheet date under IAS 19. No deduction will be available for tax until the long-service leave is paid.

Applying the formula, we have:

Carrying amount of liability

Future deductible amounts

+

Future taxable amount

=

Tax base

C150,000

C150,000

+

Cnil

=

Cnil

 

There is a deductible temporary difference of C150,000 (C150,000 − Cnil).

Tax base of revenue received in advance

13.123 The formula for the tax base of a liability that is 'revenue received in advance' is consistent with the definition in paragraph 13.120.

Tax base = Carrying amount − Amount of revenue that will not be taxable in future periods

Where revenue is taxed on a cash basis, amounts recognised in the balance sheet as 'revenue received in advance' will not be taxed in a future period when recognised as revenue for accounting purposes. In this case (or if the revenue is not taxed at all), the tax base of the revenue received in advance is equal to zero. But the tax base of revenue received in advance is equal to its carrying amount if the entire amount is taxed when subsequently recognised as revenue. These situations are dealt with in the following examples.

Example 1 – Tax base of rents received in advance

Rents received in advance amounted to C1,000 at the balance sheet date. The rental income will be taxed in future periods when accommodation is provided to tenants.

Applying the formula, we have:

Carrying amount of revenue received in advance

Amount of revenue that will not be taxable in future periods

=

Tax base

C1,000

Cnil

=

C1,000

The temporary difference is C1,000 – C1,000 = Cnil.

Example 2 – Tax base of government grant

A government grant of C1,000 is recognised at the balance sheet date as deferred income rather than being deducted against the cost of the asset. No tax is payable on receipt of the grant or on amortisation. The cost of the asset is fully deductible.

Applying the formula, we have:

Carrying amount of revenue received in advance

Amount of revenue that will not be taxable in future periods

=

Tax base

C1,000

C1,000

=

Cnil

There is a deductible temporary difference of C1,000 (C1,000 – Cnil).

Example 3 – Tax base of royalties

Royalties from users of licensed technology for the following financial year amounted to C25,000 at the balance sheet date. Royalties are taxed on a cash receipts basis. The royalty income is deferred in the balance sheet until the period that it relates to.

Applying the formula, we have:

Carrying amount of revenue received in advance

Amount of revenue that will not be taxable in future periods

=

Tax base

C25,000

C25,000

=

Cnil

There is a deductible temporary difference of C25,000 (C25,000 – Cnil).

Tax bases with no recognised carrying amounts

13.124 Some items might have a tax base but are not recognised as assets or liabilities on the balance sheet. Where a transaction during the reporting period does not give rise to an asset or liability on the balance sheet but affects taxable profits of future periods, its tax base is calculated using the amount that would affect taxable profits in future periods; for example, expenditure incurred during the year that is written off for accounting purposes but is carried forward in the tax balance sheet at an amount that will be allowable as a deduction in future periods. The difference between the tax base of the costs expensed and the carrying amount of nil is a deductible temporary difference that gives rise to a deferred tax asset. [IAS 12 para 9].

Tax bases not immediately apparent

13.125 The above formulae for determining the tax bases of assets and liabilities should give the correct result in most circumstances. There may be circumstances where the formulae cannot be readily applied or where the tax base of an asset or liability is not immediately apparent. An entity should consider the fundamental principle of recognition of deferred tax: a deferred tax liability (asset) is recognised whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (smaller) than if such recovery or settlement had no tax consequences. [IAS 12 para 10]. Example C of paragraph 51A of IAS 12 (not reproduced here) illustrates how the fundamental principle is applied where the tax base of an asset or a liability depends on the expected manner of recovery or settlement (see further para 13.170). An example is given in paragraph 13.172.

Recognising deferred tax liabilities

13.126 All taxable temporary differences give rise to deferred tax liabilities and, with some exceptions, are recognised in the financial statements. A deferred tax liability is recognised even if future tax losses are expected to settle the tax liability. A taxable temporary difference might be expected to reverse in a period in which a tax loss arises. The entity may not have to pay any tax for the reversing temporary difference; but the entity will still suffer a sacrifice of future economic benefits. The benefit derived from the tax loss in future periods will be reduced by the amount of the reversing taxable temporary difference. All deferred tax liabilities are recognised, except in the limited circumstances described below.

13.127 A deferred tax liability should be recognised for all taxable temporary differences, except where it arises from:

The initial recognition of goodwill (see para 13.158 onwards).

 

The initial recognition of an asset or liability in a transaction which:

 

is not a business combination; and

 

at the time of the transaction, does not affect accounting profit or taxable profit (tax loss) (see para 13.162 onwards).

 

Investment in subsidiaries, branches and associates, and interests in joint ventures, where:

 

the parent, investor or venturer is able to control the timing of the reversal of the temporary difference; and

 

it is probable that the temporary difference will not reverse in the foreseeable future (see paras 13.233.2 onwards and 13.255 onwards).

[IAS 12 paras 15, 39].

13.127.1 The method of accounting for a taxable temporary difference depends on the nature of the transaction that led to the asset or liability being recognised initially. A transaction that is not a business combination and does not affect accounting profit or taxable profit, an entity would, in the absence of the exemption described in the second bullet point above, recognise any resulting deferred tax liability (or deferred tax asset – see para 13.128) and adjust the asset or liability's carrying amount by the same amount. The standard states that such adjustments would make the financial statements less transparent. So an entity does not recognise the resulting deferred tax liability (or asset), either on initial recognition or subsequently. Also, an entity does not recognise changes in the unrecognised deferred tax liability or asset as the asset is depreciated. [IAS 12 para 22(c)]. See further paragraph 13.162 onwards.

13.127.2 Tax planning opportunities are not considered in determining the amount of a deferred tax liability to be recognised. For example, an entity cannot avoid recognising an existing deferred tax liability on the grounds that future tax losses will prevent the transfer of economic benefits. Tax planning opportunities can only be considered in determining the extent to which an existing deferred tax asset will be recovered, as explained in paragraph 13.138.

Recognising deferred tax assets

13.128 An asset is recognised in the balance sheet when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. When deductible temporary differences reverse in future periods, they result in deductions in calculating the taxable profits of those future periods. But economic benefits of the tax deductions can only be realised if the entity earns sufficient taxable profits against which the deductions can be offset. So a deferred tax asset should be recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised, unless the deferred tax asset arises from:

The initial recognition of an asset or liability in a transaction which:

 

is not a business combination; and

 

at the time of the transaction, does not affect accounting profit or taxable profit (tax loss).

[IAS 12 para 24].

13.129 An entity should also recognise a deferred tax asset for all deductible temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, to the extent that it is probable that:

the temporary difference will reverse in the foreseeable future; and

taxable profit will be available against which the temporary difference can be utilised.

[IAS 12 para 44].

13.129.1 Deferred tax assets arising on the initial recognition of goodwill are not included in the exception in paragraph 24 of IAS 12. If the carrying amount of goodwill arising in a business combination is less than its tax base, the difference gives rise to a deferred tax asset. The deferred tax asset arising from the initial recognition of goodwill is recognised as part of the accounting for a business combination; to the extent that it is probable that taxable profit will be available against which the deductible temporary difference could be utilised. [IAS 12 para 32A]. This differs from the situation where a deferred tax liability arises on the initial recognition of goodwill, where an exception does apply (see paras 13.159 and 13.161.1).

13.130 The term 'probable' (referred to in para 13.128) is not defined in IAS 12; but IFRS 5 states: "For the purposes of IFRSs, probable is defined as 'more likely than not'". [IFRS 5 App A, BC 81]. In other words, if it is more likely than not that all or some of the deferred tax asset will be recovered, a deferred tax asset should be recognised for the whole or the part that is more likely than not to be recovered.

13.131 In order to recover a deferred tax asset, an entity would have to do more than simply not make losses in future: it would have to make sufficient taxable profits.  

13.132 All available evidence has to be considered to support recognising deferred tax assets; this means both favourable and unfavourable evidence. If there is no unfavourable evidence, and the entity has historically been profitable and paid taxes, it may well be concluded that the situation will continue in the absence of knowledge of facts to the contrary; and, since there is an expectation of sufficient future taxable profit, that recording a deferred tax asset is appropriate. However, greater care is needed if the losses are very significant relative to expected annual profits. Any unfavourable evidence should also be considered carefully. Unfavourable evidence can often be objectively verified where it arises from a past event. But it is more difficult to objectively verify positive evidence of future taxable profits. Therefore, evidence of future taxable profits might be assigned lesser weight in assessing whether a deferred tax asset should be recorded when there is other unfavourable evidence. The assessment of future taxable profits, including the period over which such an assessment is made, is considered further in paragraph 13.135.3.

Sources of future taxable profit available to offset deductible temporary differences

13.133 The future realisation of deferred tax assets depends on whether sufficient taxable profit of the appropriate type (trading profit or capital gain) is expected to be available for the utilisation of deductible temporary differences or unused tax losses. The sufficient taxable profit must be available to the 'taxable entity' where those deductible temporary differences or unused tax losses originated, in order for an asset to be recognised by that entity. The meaning of 'taxable entity' is considered further in paragraph 13.156. The following sources of future taxable profit might be available under the tax law to offset deductible temporary differences.

Future reversals of existing taxable temporary differences

13.134 The future reversal of existing taxable temporary differences gives rise to an increase in taxable income. So, to the extent that those profits:

relate to the same taxable entity (see para 13.156 onwards);

are assessed by the same taxation authority; and

arise in the same period in which existing deductible temporary differences are expected to reverse or in a period to which a tax loss arising from the reversal of the deferred tax asset might be carried back or forward;

 

 

the asset is regarded as recoverable. [IAS 12 para 28]. In other words, where deferred tax liabilities meeting the above offset criteria exceed deferred tax assets at the balance sheet date and the reversal periods are consistent, a deferred tax asset is recognised.

Example 1 – Recovery of capital tax losses

An entity has a portfolio of properties and has brought forward capital tax losses that can be carried forward indefinitely. In the current year, the entity has revalued its land and buildings; this has resulted in a deferred tax liability for land on a capital gains tax basis being recognised in respect of land and buildings. The entity does not expect to realise the capital gain arising from the revaluation for a number of years. Is the entity required to recognise a deferred tax asset now in respect of the capital losses?

Deferred tax assets are recognised for all deductible temporary differences to the extent that taxable profit will be available against which the deductible temporary differences can be utilised. The entity is required to recognise a deferred tax asset in respect of the capital losses,if those losses can properly be utilised against the future crystallisation of the capital gains.

If there is no current intention to realise the capital gain by selling the properties, the recognition of the deferred tax liability is not affected. The difference between the tax base (which remains the same despite the revaluation) and the asset's revalued carrying amount is a temporary difference that gives rise to a deferred tax liability.

In terms of presentation, the entity offsets the deferred tax liability arising from the revaluation and the deferred tax asset in respect of the capital losses if they meet the criteria in paragraph 74 of IAS 12 (that is, if there is a legal right to offset the deferred tax assets and liabilities and they relate to the same taxation authority).

Example 2 – Recovery of deferred tax asset against deferred tax liabilities

An entity has taxable temporary differences of C80,000 in respect of fair value adjustments in a business combination; these are expected to be included in taxable income at a rate of C20,000 a year in years 1 to 4. The entity also has a warranty provision of C40,000 that is expected to be deductible for tax purposes as follows: C30,000 in year 2 and C10,000 in year 3. In addition, the entity has unused tax losses of C60,000. A schedule of the reversal of temporary differences and the utilisation of tax losses carried forward is shown below:

 

 

 

 

 

 

Year 1

Year 2

Year 3

Year 4

 

C

C

C

C

Taxable temporary differences – expected reversal profile

Beginning of year

80,000

60,000

40,000

20,000

Recognised in taxable income

(20,000)

(20,000)

(20,000)

(20,000)

 


End of year

60,000

40,000

20,000

 


 

Deductible temporary differences – expected reversal profile

(a) Warranty provisions

Beginning of year

40,000

40,000

10,000

Deducted for tax purposes

(30,000)

(10,000)

 


End of year

40,000

10,000

 


(b) Tax losses

Beginning of year

60,000

40,000

50,000

40,000

Increase (utilisation) in year

(20,000)

10,000

(10,000)

(20,000)

 


End of year

40,000

50,000

40,000

20,000

 


Total deductible temporary differences

80,000

60,000

40,000

20,000

 


At the end of year 1, the entity would recognise a deferred tax asset in respect of at least C60,000 of the deductible temporary differences and tax losses at the appropriate tax rate. This is because there are taxable temporary differences in respect of deferred tax liabilities of the same amount that are expected to be included in taxable income; and against which the expected reversal of deductible temporary differences and the tax losses can be utilised.

 

For similar reasons, a deferred tax asset in respect of at least C40,000 of deductible temporary differences and tax losses would be recognised at the end of year 2, and C20,000 at the end of year 3, if circumstances remained the same at those dates.

 

However, in order to recognise a deferred tax asset in any of years 1 to 4 with respect to the C20,000 of tax losses that remain unutilised, the entity might need to look for sources of taxable profit other than reversals of temporary differences (see para 13.135).

13.134.1 The implications of existing deferred tax liabilities with regards to recognising a deferred tax asset in relation to a deficit on a defined benefit pension scheme are considered in paragraph 13.203.1.

Future taxable profits

13.135 Where there are insufficient taxable temporary differences against which the deferred tax asset can be offset, management should consider the likelihood that taxable profits will arise in the same period(s) as the reversal of the deductible temporary differences (or in the periods into which a tax loss arising from the deferred tax asset can be carried back or forward). [IAS 12 para 29(a)]. The assessment of taxable profits should take account of the tax rules governing the relief of losses, such as the type of profits permitted to be used (that is, trading profit or capital gain). Also, management needs to consider if the assessment of taxable profits is restricted to the entity with the losses, or whether group relief is available.

13.135.1 Deductible temporary differences that originate in future periods are generally not taken into consideration in determining future taxable profits. The deferred tax asset arising from them will require future taxable profit in order to be utilised. [IAS 12 para 29(a)].

Example – Determining future taxable profits

An entity has tax losses carried forward of C125, which expire after 5 years, and is considering how much of this total can be recognised as a deferred tax asset. Profits before tax allowances for depreciation of plant are expected to be C25 for each of the next 5 years (that is, C125 in total), less tax deductions of C10 per annum; this would result in profits after tax allowances of C15 per annum for the five years (C75 in total). Profits after 5 years are expected to be nil; so, if the tax allowances are deferred, profits will not support their subsequent recovery.

If the tax allowances are claimed in years 1 to 5, the taxable profits will be as follows:

 

Years 1 to 5

Years 6 to 10

Total

 

C

C

C

Taxable profit before deduction

125

125

Tax deduction for plant

(50)

(50)


Taxable profit

75

75

Loss carry-forwards utilised

(75)

(75)


 

 

In this situation, C50 of the losses remain unutilised.

 

If the allowances are disclaimed in years 1 to 5 (so they are available for deduction in years 6 to 10), the taxable profit will be as follows:

 

 

 

 

 

 

Years 1 to 5

Years 6 to 10

Total

 

C

C

C

Taxable profit before deduction

125

125

Tax deduction for plant

(50)

(50)


Taxable profit

125

(50)

75

 

 

 

 

Adjustment for disclaimed tax deductions (see below)

(50)

50


 

 

 

 

Taxable profit before utilisation of losses

75

75


 

 

The result of disclaiming the tax allowances is higher taxable profit in years 1 to 5 of C125 in total. But the overall expected future taxable profits are still C75 in total. So the total tax deductions of C50 should be considered when determining the amount of taxable profit available for utilisation of the brought-forward losses.

 

Thus, the amount of profit available for recovering the deferred tax asset will be C15 × 5 = C75, rather than C25 × 5 = C125 which would be the amount of profit if the tax deductions were not claimed. 

 

This is because the entity only has an asset if it will gain future economic benefits from the item in question. If it can only gain those future economic benefits by deferring or waiving other future economic benefits due to the entity, in 'net' terms there is no asset.

13.135.1.1 In determining the sufficiency of taxable profits, taxable amounts arising from future deductible temporary differences are generally ignored. Careful analysis is needed where losses cannot be carried forward indefinitely. A deferred tax asset is recognised where an entity has tax planning opportunities that will create taxable profit in appropriate periods (see para 13.136 onwards). This can mean that unused losses are recoverable out of taxable profits made available by deferring claims for deductions, as this creates a deductible temporary difference. A similar situation arises without tax planning where deductions are given under the relevant tax rules in later periods than the related accounting charge; this also creates a deductible temporary difference.

13.135.1.2 Particular issues arise where profit forecasts include the amounts relevant for tax purposes (rather than the accounting deductions); and where losses that would otherwise expire are only recoverable against taxable profits arising as a result of future deductible temporary differences. In such cases, those taxable profits can only be taken into account if the deferred tax assets relating to the future deductible temporary differences can also be recovered.

Example – Interaction of losses and deductible temporary differences

An entity has unused losses of C300 and is assessing whether it can recognise a deferred tax asset. The losses expire in 5 years' time. The entity is forecasting an accounting loss of C100 in year 1, but this is after charging C400 for a loss on a loan. The tax deduction for the loan can be deferred, and the entity intends to claim this after year 5 (that is, in years 6 to 10).

Accounting profits in years 2 to 5 are forecast to be nil, and in years 6 to 10 to be C600 in total.

 

Years 1 to 5

Years 6 to 10

Total

 

C

C

C

Accounting result before loan loss

300

600

 900

Loan loss

(400)

(400)


Accounting result

(100)

600

500


 

 

 

 

Taxable profit before loan loss deduction

300

600

900

Loan loss deduction

(400)

(400)

Loss carry-forwards utilised

(300)

(300)


Taxable profit

200

200


 

 

Overall, there are sufficient taxable profits (C900) to recover both the loss carry-forwards (C300) and the loan loss deduction (C400). So a deferred tax asset in respect of the loss carry-forwards is recognised in the current year.

13.135.1.3 A deferred tax asset is not recognised when it is only recoverable through the future creation of, or replacement with, a new unrecoverable deferred tax asset. But a deferred tax asset is recognised where an otherwise profitable entity has expiring unused losses that can be recovered by tax planning (or other deferral of deductions), and those losses create originating deductible temporary differences that are themselves recoverable.

13.135.2 To avoid double counting, taxable profits resulting from the reversal of deferred tax liabilities are excluded from the estimation of future taxable profits where they have been used to support the recognition of deferred tax assets in accordance with paragraph 28 of IAS 12 (see para 13.134).

13.135.3 A strong earnings history can provide objective evidence of future profitability when assessing the extent to which a deferred tax asset can be recognised. Hence, there would be less need for profitable entities to consider the pattern and timing of the reversals of existing temporary differences.

13.135.4 Where there is a balance of favourable and unfavourable evidence, careful consideration is given to recoverability of a deferred tax asset based on the entity's projections for taxable profits for each year after the balance sheet date. The amount of taxable profits considered more likely than not for each period is assessed. Management should have regard to any time limit on carry forward of tax losses. The level of taxable profit might be more difficult to predict the further into the future an assessment is required; but there should be no arbitrary cut-off in the time period over which such an assessment is made. Management should also ensure that the projections on which such assessments are based are broadly consistent with the assumptions made about the future in relation to other aspects of financial accounting (for example, impairment testing), except where relevant standards require a different treatment. Consideration should be given to the disclosures about key sources of uncertainty required by paragraph 125 of IAS 1 (see para 13.307.1).

13.135.5 Some entities by their nature would not ordinarily recognise deferred tax assets not supported through reversals of existing temporary differences. Examples of such entities are development stage enterprises and start-up businesses. The lack of a track record for profits means that a deferred tax asset is unlikely to be recognised. Evidence of future taxable profits might be assigned lesser weight in assessing whether a deferred tax asset should be recorded when there is other unfavourable evidence (such as actual trading losses).

13.135.6 The assessment of the likelihood that taxable profits will arise when there has been a history of trading losses is discussed in paragraph 13.144 onwards.

Tax planning opportunities

13.136 Entities sometimes take advantage of tax planning opportunities to reduce their future tax liabilities. An entity should consider whether it expects to create suitable taxable profits by undertaking tax planning opportunities. [IAS 12 para 29(b)].

13.137 A tax planning opportunity is an action that the entity would not normally take – except to prevent, say, an unused tax loss from expiring. Such actions could include:

Accelerating taxable amounts or deferring claims for writing-down allowances to recover losses being carried forward (perhaps before they expire) – see paragraph 13.137.1.

Changing the character of taxable or deductible amounts from trading gains or losses to capital gains or losses, or vice versa.

Switching from tax-free to taxable investments.

[IAS 12 para 30].

13.137.1 Where tax planning opportunities bring taxable profit from a later period to an earlier period, a tax loss or tax credit carry-forward can only be utilised where there is future taxable profit from sources other than future originating temporary differences. [IAS 12 para 30]. This is considered further in paragraph 13.135.1.1 onwards.

13.138 Tax planning opportunities should only be considered to determine the extent to which an existing deferred tax asset will be realised. They cannot be used to create a new deferred tax asset or to avoid recognising or reducing a deferred tax liability (see para 13.141). The feasibility of the tax planning opportunity is assessed based on the individual facts and circumstances of each case. Whatever tax planning opportunities are considered, management should be capable of undertaking and implementing them, and should have the expectation that it will implement them.

13.139 An entity might incur various expenses in implementing a tax planning opportunity. A question arises whether the tax benefit of the expenses could be included in the carrying amount of any deferred tax asset recognised as a result of the plan's implementation, or included in current tax expense. We believe that any deferred tax asset recognised as a result of implementing a tax planning opportunity should be recorded net of the tax effects of any expenses or losses expected to be incurred as a result of the opportunity; this is because that is the net amount by which future tax payments will be reduced as a result of implementing it.

Example – Expenses of tax planning opportunity

An entity has gross deductible temporary differences of C1,000 in respect of a deferred tax asset that is not recognised in the balance sheet. The tax rate is 30% and so the unrecognised deferred tax asset is C300. As a result of implementing a tax planning opportunity, the entity expects to generate taxable profits of at least C1,000. But the cost of implementing the opportunity is expected to be C200. Therefore, only C800 of future taxable profits would be available against which the deferred tax asset can be offset. A maximum deferred tax asset of C240 (C800 @ 30%) would qualify for recognition. The remaining C60 will remain unrecognised. In other words, the deferred tax asset of C300 is reduced by C60, which is the tax benefit of the expenses that the entity expects to incur for implementing the tax planning opportunity.

13.140 Where a tax planning opportunity is used to support realisation of unused tax losses in a business combination, the same principles apply; so the benefit of any deferred tax asset recognised should also be reduced by the tax effects of any expenses or losses incurred to implement a tax planning opportunity.

13.141 Tax planning opportunities cannot be taken into account to reduce a deferred tax liability. For instance, an entity cannot avoid recognising an existing deferred tax liability on the grounds that future tax losses will prevent the transfer of economic benefits. See also paragraph 13.126.

13.142 Some examples of tax planning opportunities are considered below:

Example 1 – Sale of appreciated assets when operating losses are projected

An entity has experienced operating losses over the last five years; accumulated tax losses of C20m have given rise to a potential unrecognised deferred tax asset of C6m. Based on its plans to introduce a new product line, management is currently projecting that for the next three years it will experience losses of at least C1m per year (and of approximately C5m in total); it then expects to 'turn the corner' and become profitable. Because of appreciation in the property market, the entity's investment in a shopping centre property is now valued at approximately C500,000 more than the carrying amount in the balance sheet. The entity proposes to recognise a deferred tax asset of C150,000 (C500,000 × 30%) based on a tax planning opportunity to sell the investment. The shopping centre property is not a 'core' asset of the entity; and management says that it would sell the property, if necessary, before it would permit the unused tax losses to expire.

We believe that this tax planning opportunity does not justify recognising a deferred tax asset. A tax planning opportunity to sell appreciated assets constitutes a subset of the broader source of future taxable profit from operations. So a deferred tax asset is not recognised when the tax planning opportunity appears merely to reduce an expected future loss. In the above case, based on (a) the entity's history of losses, (b) an unproved new product line, and (c) the fact that the entity does not anticipate being profitable for at least three years, little weight can be assigned to the projected profitability. Accordingly, there is no incremental tax benefit (at least for the foreseeable future), as the potential gain on the sale of the shopping centre property would only reduce what is otherwise a larger operating loss.

Example 2 – Acquisition of a profitable entity

An entity that has incurred losses for many years proposes a tax planning opportunity to support its deferred tax asset related to unused tax losses. The entity will use a portion of the cash balances it received from a recent public share offering to acquire an entity that generates significant taxable profits. Could such a tax planning opportunity be considered to recognise the deferred tax asset?

No. We believe that a proposed business combination and the accompanying availability of sufficient taxable profits should not be anticipated for the purpose of supporting a deferred tax asset. Until the acquisition of the entity is irrevocable and there are no further statutory or regulatory impediments, the acquirer needs the co-operation of others to make the tax planning opportunity effective. That is, the acquirer does not control an essential part of the tax planning opportunity (the target entity). It would not be appropriate to use future taxable profits in the target entity to support recognising the acquirer's tax losses, as the target entity does not form part of the group holding the tax losses and will not do so until the business combination occurs. As a result, the tax effects of an event such as the acquisition of an entity should not be recognised before the event has occurred. However, once the acquisition has taken place, the acquirer can recognise a deferred tax asset as a credit to the tax charge in the post-acquisition period under paragraph 67 of IAS 12 (see further para 13.250).

Example 3 – Unused tax losses in an acquiree

Entity B has unrecognised deferred tax assets related to unused tax losses. Entity C bought entity B in December 20X3.

Entity C's management intends to integrate entity B's operations into entity C in the first quarter of 20X4 to take advantage of the tax losses. Entity C has a track record of generating taxable profits; and management expects this to continue for the foreseeable future.

In this situation, management should recognise a deferred tax asset in respect of the unused tax losses in the consolidated financial statements for the period ended 31 December 20X3 if it is probable that management will carry out the integration, and also that entity C will generate enough taxable profit to absorb entity B's unused tax losses. This will impact the goodwill calculation in the consolidated financial statements.

This contrasts with the situation in example 2, as both the newly acquired entity holding the losses (entity B) and the profitable entity (entity C) are part of the same group at the balance sheet date.

 

Unused tax losses and unused tax credits

Trading losses

13.144 Where an entity has tax losses that can be relieved against a tax liability for a previous year, those losses are recognised as an asset, because the tax relief is recoverable by refund of tax previously paid. [IAS 12 para 14]. This asset can be shown separately in the financial statements as a debtor, or it can be offset against an existing current tax balance.

13.145 Where tax losses can be relieved only by carry-forward against taxable profits of future periods, a deductible temporary difference arises. If an entity maintains a deferred tax account that will result in future tax payable, the tax losses will be recoverable by offset against taxable income that arises when those taxable temporary differences reverse. [IAS 12 para 36(a)]. So losses carried forward can be offset against deferred tax liabilities carried in the balance sheet, as discussed in paragraph 13.134.

13.146 Where the deferred tax liabilities are not sufficient to absorb all the tax losses, management should consider other convincing evidence suggesting that suitable taxable profits will be generated in future (see the example in para 13.134). This consideration becomes difficult, because the very existence of unrelieved tax losses is strong evidence that future taxable profit might not be available. Because of this significant uncertainty about future taxable profits being available, in the absence of profits arising from the reversals of existing temporary differences, the amount of the deferred tax asset and the nature of the evidence supporting its recognition should be disclosed (see para 13.306). [IAS 12 para 35].

13.147 The standard includes criteria that should be considered to determine whether a deferred tax asset in respect of unused tax losses or unused tax credits should be recognised. Some of these criteria are the same as for recognising deferred tax assets in respect of deductible temporary differences, such as the availability of sufficient taxable temporary differences and tax planning opportunities (discussed above).

13.148 For unrelieved trading losses resulting from identifiable causes, it is important to consider whether those losses are likely to recur. Where they are likely to recur, it is unlikely that a deferred tax asset can be recognised. Another criterion considered by the standard is the availability of taxable profits before unused tax losses or unused tax credits expire. [IAS 12 para 36(b)].

13.149 A strong earnings history may provide objective evidence of future profitability when assessing the extent to which a deferred tax asset can be recognised. This justification becomes stronger if the tax loss arises from identifiable causes that are unlikely to recur, as stated above.

13.150 For entities with no record of profit in recent years, a more rigorous assessment is required of the probability that taxable profit will be available against which unrelieved tax losses can be utilised. A history of recent losses creates a level of uncertainty about an entity's future profitability that could be difficult to rebut. If it is not probable that taxable profit will be available, the deferred tax asset is not recognised. [IAS 12 para 35]. See also paragraph 13.135.5 for start-up businesses.

13.150.1 For entities with only a limited record of profits in recent years, it might be difficult to place significant reliance on internal management projections. If the future taxable profits are nonetheless considered probable, the entity will need to develop projections on which to measure the recoverable deferred tax asset. The further into the future it is necessary to look for sufficient taxable profits, the more subjective the projections become. In the past, one approach has been to project income into the future using the average annual income for a past period. This approach would ultimately need to be reconciled with the requirement to assess the probable future taxable profits.

13.150.2 There should be no arbitrary cut-off in the time period over which an assessment of expected taxable profits is made (for example, the recoverability test should not be limited using an arbitrary look-out period solely because budget information is not available after a certain number of years). The assessment should be broadly consistent with the assumptions used for impairment testing (see further chapter 18), allowing for adjustments for the different time-frame (if the tax losses have expiry dates) and the different methods; these include discounting and the value in use model in IAS 36 as compared to a calculation with no discounting and including the impact of future asset improvements under IAS 12.

13.150.3 It could be argued that the probability of taxable profits decreases over time; so there could be a point when taxable profits are no longer probable. However, we consider that management should not generally assume without specific facts (for example, significant contracts or patent rights terminating at a specific date) that no taxable profits are probable after a specified date. The calculation should include the maximum taxable profits that are more probable than not until the expiry of tax losses. This could result in lower estimates for years in the distant future, but it does not mean that those years should not be considered.

13.150.4 Another issue is whether a limited look-out period might be acceptable for industries that historically have profit- and loss-making cycles. Similar to the arguments above, we consider that management cannot generally assume that the entity will not make taxable profits after a limited number of years of industrial upturn. The cyclical downturns should be considered in determining the 'probable' future cash flows, but they should not be used to introduce an arbitrary cut-off date for the recoverability test.

13.150.5 This approach should not lead to recognising only the full or a nil deferred tax asset (that is, an 'all or nothing' approach). An assessment should be made of future taxable profits looking forward, with no arbitrary or specified cut-off period. A deferred tax asset is recognised to the extent it is probable that there will be future taxable profits.

13.150.6 In considering whether to provide guidance on how to apply the probability criterion for recognising deferred tax assets arising from unused tax losses, in June 2005 the IFRS IC noted that the criterion should be applied to portions of the total amount of unused tax losses and not just to the amount of unused tax losses taken as a whole. This is consistent with the guidance above.

13.150.7 Where an entity determines its future taxable profits to support recognising a deferred tax asset for trading losses, management should consider a tax planning opportunity that could be undertaken to allow the deferred tax asset to be recovered (see para 13.138). A restructuring or exit plan is normally regarded as an ordinary part of running a business and might be considered, depending on the likelihood of implementing the plan and its expected success.

Example – Strategy to implement an exit plan

 

An entity has a history of recent losses. Management has developed an exit plan in which a loss-making activity will be discontinued. Management intends to implement the measures from March 20X4. The current date is January 20X4 and the plan has not yet been made public.

 

Management expects to reverse the losses over the two years following the implementation of the exit plan, and proposes to recognise a deferred tax asset in respect of the losses in the 31 December 20X3 financial statements, using the exit plan to justify the recognition of the deferred tax asset.

 

A deferred tax asset should be recognised in respect of the losses to the extent that it is probable that future taxable profit will be available against which the unused tax losses can be utilised.

 

The probability of future taxable profits should be assessed based on circumstances as at the balance sheet date.

 

The following factors should be considered:

 

 

The probability that management will implement the plan.

Management's ability to implement the plan (for example, obtaining concessions from labour unions or regulatory approval).

The level of detailed analysis and sensitivity analysis that management has prepared.

 

 

Judgement will be required to establish whether it is probable that the exit plan will go ahead and that taxable profits will be earned. If, at the balance sheet date, management has not finalised its decision to sell, it could be difficult to argue that it is more likely than not that the exit plan will be implemented.

 

In some cases, management will also need to assess the probability of the disposal at the balance sheet date for the purposes of IFRS 5. If a subsidiary's disposal is considered 'highly probable' for the purposes of IFRS 5 and a taxable profit is expected to be made on the transaction, this would strongly indicate that a deferred tax asset should be recognised in respect of the previously unrecognised losses.

Capital losses

13.151 The offset rules in tax legislation might mean that a deferred tax asset in respect of a capital loss cannot be offset against deferred tax liabilities arising from trading items. A deferred tax asset will be recognised only if it can be offset against recognised deferred tax liabilities on unrealised capital gains, or there is strong evidence that it will be recoverable against capital gains that are expected to arise in the future. Capital gains might arise in the future as a result of taxable temporary differences in existence at the balance sheet date, from generating future taxable profits, or through tax planning opportunities (see para 13.134 onwards).

 

Effect of a going concern uncertainty

13.153 Disclosure is required when management concludes that there is uncertainty regarding an entity's ability to continue as a going concern for a reasonable period of time (see chapter 4). [IAS 1 para 25]. The inclusion of such disclosure would generally constitute significant unfavourable evidence under IAS 12; so recognising all or a portion of a deferred tax asset would not be justified, unless realisation is assured by either (a) carry-back to prior tax years or (b) reversals of existing taxable temporary differences. But there could be circumstances where the cause of the going concern uncertainty is not directly related to the entity's profitability. For example, the uncertainty might arise from concerns relating to liquidity or other issues unrelated to profitability (such as uncertainty about the renewal of an operating licence) while it is expected that the entity will continue to generate taxable profits. In these situations, it might be appropriate to recognise a deferred tax asset, provided it is probable that future taxable profits will be available. The specific facts and circumstances giving rise to the uncertainty should be considered in determining whether a deferred tax asset is recoverable. Also, the absence of significant uncertainty regarding an entity's ability to continue as a going concern does not, by itself, constitute favourable evidence that deferred tax assets will be realised.

 

Re-assessment of recoverability

13.155 A deferred tax asset's carrying amount should be reviewed at each balance sheet date. Management needs to assess whether a net deferred tax asset recognised in the balance sheet is still recoverable and has not been impaired. For example, an entity might have recognised a deferred tax asset in respect of tax losses in a previous period based on information available at that time. A year later, circumstances might have changed so that it is no longer probable that the entity would earn sufficient future taxable profits to absorb all the tax benefit. The asset has suffered an impairment and should be written down. If circumstances giving rise to the previous write down no longer apply or it is probable that sufficient future taxable profit will be available, the reduction should be reversed. [IAS 12 para 56].

13.155.1 Similarly, where an entity has been unable to recognise a deferred tax asset because sufficient taxable profit is unavailable, management should review the situation at each subsequent balance sheet date to ascertain whether some or all of the unrecognised balance should now be recognised. For example, an improvement in trading conditions or the acquisition of a new subsidiary might make it more likely that a previously unrecognised tax loss in the acquiring entity will be recovered. [IAS 12 para 37]. Where a previously unrecognised deferred tax asset is recognised, this is a change in estimate that should be reflected in the results for the year under IAS 8.

Assessment of the recoverability in a group situation

13.156 In various jurisdictions, entities can form 'tax groups' within which tax losses or other deductible temporary differences could be transferred between entities. This means that tax losses or other deductible temporary differences in an unprofitable entity could be used to reduce the taxable profits of another entity within the tax group, thus benefiting the group as a whole.

13.156.1 The recoverability of deferred tax assets should be assessed with reference to the 'taxable entity'. [IAS 12 paras 28-30, 36]. In our view, it is reasonable to interpret the 'taxable entity' to mean the wider group of entities in the same tax group. In assessing whether a deferred tax asset should be recognised in consolidated financial statements, taxable profits of all entities in the wider tax group could be taken into account. To the extent that tax losses or deductible temporary differences generated can be recovered by a tax group, we consider that it would be appropriate to recognise a deferred tax asset in consolidated financial statements that include the entities of that tax group.

13.156.2 Where tax losses or other deductible temporary differences are transferred within a tax group, the question arises whether a deferred tax asset should be recognised at the entity level. The entity that generated the losses (or where the deductible temporary differences originated) might not itself have sufficient taxable profits to support recognising a deferred tax asset. In such cases, asset recognition at an entity level will depend on whether future economic benefit will flow to the entity; for example, the surrendering entity might have a contract in place to receive payment for transferring its tax benefits. This would indicate that an asset should be recognised at the entity level. In each case, the relevant facts and circumstances should be taken into account to determine the appropriate treatment.   

Exceptions to the recognition rules

13.157 Deferred tax liabilities and deferred tax assets (subject to the availability of future taxable profits) should be recognised for all temporary differences, subject to the exceptions in paragraphs 13.127 to 13.129. These exceptions are not based on any conceptual thinking that underpins the balance sheet liability method. Rather they relate to situations where applying the general rule for deferred tax on temporary differences was in the past considered undesirable and meaningless. The specific situations are as follows:

 

 

Initial recognition of goodwill arising in a business combination (for deferred tax liabilities only) (see para 13.158 onwards).

 

Initial recognition of an asset or liability in a transaction that is not a business combination and does not affect accounting profit or taxable profit (see para 13.162 onwards).

 

Investments in subsidiaries, branches, associates and joint ventures, but only where specified criteria apply (see para 13.233 onwards for separate financial statements and para 13.253 onwards for consolidated financial statements).

Taxable temporary difference on goodwill arising in a business combination

13.158 Goodwill arising on a business combination is recognised as an asset and is not amortised. Instead, it is tested annually for impairment or more frequently if events or changes in circumstances indicate that it is impaired; if it is impaired, it is written down to its recoverable amount. See chapter 25.

13.159 Where goodwill arising on a business combination is non-deductible for tax purposes, the goodwill has a tax base of nil. Reductions in the carrying amount of the goodwill for impairment are not allowed as a deductible expense in determining taxable profits, and the cost of the goodwill is not deductible when the subsidiary is sold. Any difference between the carrying amount of the goodwill and its tax base of nil gives rise to a taxable temporary difference; this would usually result in a deferred tax liability. But such a deferred tax liability is not recognised because goodwill is measured as a residual; and recognition of the deferred tax liability would increase the carrying amount of the goodwill (which would not add to the relevance of financial reporting). [IAS 12 para 21]. Thus, there is an assumption that the carrying amount of the goodwill is recovered on an after-tax basis, while other assets and liabilities are recovered and settled at their carrying amounts.

13.160 If an entity recognises an impairment loss on goodwill that is not tax deductible, the amount of the unrecognised taxable temporary difference (and the unrecognised deferred tax liability) on goodwill is reduced. This decrease in the value of the unrecognised deferred tax liability is also regarded as relating to the initial recognition of the goodwill; it is not recognised. [IAS 12 para 21A].

13.161 Where the goodwill arising in a business combination is deductible for tax purposes, a taxable temporary difference will arise on which a deferred tax liability should be recognised. This situation is considered further in paragraph 13.240 onwards.

13.161.1 Where a deductible temporary difference results from the initial recognition of goodwill arising on a business combination, there is no exception. Where sufficient future taxable profits are available, a deferred tax asset is recognised as part of the accounting for the business combination. The initial recognition exception does not apply in this case, as the deferred tax asset reduces, rather than increases, goodwill. The accounting for a deferred tax asset reflects the fact that there will be a tax deduction in future periods, and any tax deduction greater than the goodwill's book value will alter the effective tax rate.

Initial recognition of an asset or liability

13.162 Where a temporary difference arises on initial recognition of an asset or liability, other than on a business combination, and the recognition does not affect accounting profit or taxable profit at the time of the transaction, any deferred tax asset or liability in respect of that temporary difference is not recognised [IAS 12 paras 15, 24]. Also, an entity does not recognise subsequent changes in the unrecognised deferred tax liability or asset as the asset is depreciated (see para 13.164). [IAS 12 para 22(c)].

13.163 For example, if an asset's cost is not deductible for tax purposes, either over a number of periods or on disposal, the asset's tax base is nil (as explained in para 13.112). This creates a taxable temporary difference because the recovery of the asset's carrying amount gives rise to taxable profits; but no deduction for the asset's cost is available. The resulting deferred tax liability is not immediately recognised by debiting profit or loss, because that does not allocate the tax expense over the asset's life. Also the deferred tax expense is not added to the asset's cost, because it is difficult to assess whether the consideration paid for the asset takes into account the tax treatment applied by the tax authorities. Therefore the standard does not permit a deferred tax liability to be recognised for the origination or reversal of such temporary difference. The following flow chart and examples illustrate the application of the above rules.

Temporary difference arising on initial recognition of an asset or liability

Does the temporary difference arise on the initial recognition of an asset or liability?

No

Recognise deferred
tax liability or asset
(subject to other
exceptions)

Yes

 

 

Was the asset or liability acquired in a business combination?

Yes

No

 

 

Does the transaction giving rise to the asset or liability affect either accounting profit or taxable profit at the time of the transaction?

Yes

No

 

 

 

 


Do not recognise deferred tax

 

 

Example 1 – Initial recognition – none of the cost of an asset is deductible for tax purposes

 

An entity acquired an intangible asset (a licence) for C100,000 that has a life of five years. The asset will be solely recovered through use. No tax deductions can be claimed as the licence is amortised or when it expires. No tax deductions are available on disposal. Trading profits from using the licence will be taxed at 30%.

 

As the cost of the intangible asset is not deductible for tax purposes (either in use or on disposal), the tax base of the asset is nil. A temporary difference of C100,000 arises; prima facie a deferred tax liability of C30,000 should be recognised on this amount. But no deferred tax is recognised on the asset's initial recognition that arose from a transaction that was not a business combination and did not affect accounting or taxable profit at the time of the recognition. At the end of year 1, the asset will have a carrying amount of C80,000. In earning taxable amounts of C80,000, the entity will pay tax of C24,000. The deferred tax liability is not recognised, because it arises from initial recognition of an asset. Similarly, no deferred tax is recognised in later periods.

 

Although it might appear imprudent not to recognise the deferred tax liability in these circumstances, this can be understood in the following context. If the entity acquired the asset in an arm's length transaction, the price would reflect the asset's non-deductibility for tax purposes. So it would not be appropriate to recognise a loss on the date of purchase.

 

The above exception does not apply if the intangible asset was acquired in a business combination. The recognition of a deferred tax liability on acquisition increases goodwill and does not result in overstating the asset's cost or recognising an expense.

Example 2 – Initial recognition – a proportion of the asset's cost is deductible for tax purposes and book and tax depreciation rates are identical

 

An entity acquired an asset for C120,000, which it expects to recover solely through use in the business. For tax purposes, only 60% of the asset is deductible when the asset's carrying amount is recovered through use. The asset is depreciated for both tax and accounting purposes at 25% per annum. The tax rate is 30%.

Carrying amount

Tax base

Temporary difference

Deferred tax

C

C

C

C

Year 1 – On initial recognition

120,000

72,000

48,000

Book/tax depreciation

30,000

18,000


End of year 1

90,000

54,000

36,000

Book/tax depreciation

30,000

18,000


End of year 2

60,000

36,000

24,000

Book/tax depreciation

30,000

18,000


End of year 3

30,000

18,000

12,000

Book/tax depreciation

30,000

18,000


End of year 4

nil

nil


 

As it recovers the asset's carrying amount, the entity will earn taxable income of C120,000, but 60% of C120,000 = C72,000 will be deductible for tax purposes. No deferred tax is recognised on the temporary difference of C48,000 as it arises on initial recognition. At the end of year 1, the entity will be expected to generate C90,000 of taxable income, but 60% of C90,000 = C54,000 will be deductible for tax purposes. No deferred tax is recognised on the temporary difference of C36,000, because it results from the asset's initial recognition

 

An alternative approach is to consider that the asset effectively consists of two assets: one that is deductible for tax purposes and so should be tax effected; and the other that is not deductible and should be ignored, because it arises on initial recognition. On this basis, 60% of the cost of the asset that is deductible in full (that is, C72,000) would be tax effected in the normal way.

Example 3 – Initial recognition – a proportion of the asset's cost is deductible for tax purposes and book and tax depreciation rates are different

 

Where an asset is depreciated at a different rate for accounting and tax purposes, a question arises as to how the accounting depreciation should be allocated to the asset. In our view, the accounting depreciation should be allocated pro rata between the deductible and non-deductible portions of the asset.

 

The facts are the same as in example 2, except that the asset is depreciated at 25% for accounting purposes and 33% per annum for tax purposes. The tax rate is 30%.

Carrying amount

Tax base

Temporary difference

Unrecognised temporary difference

Recognised temporary difference

Deferred tax

C

C

C

C

C

C

On initial recognition

120,000

72,000

48,000

48,000

Book/tax depreciation

30,000

24,000

 


 

 

 

 

End of year 1

90,000

48,000

42,000

36,000

6,000

1,800

Book/tax depreciation

30,000

24,000

 


 

 

 

 

End of year 2

60,000

24,000

36,000

24,000

12,000

3,600

Book/tax depreciation

30,000

24,000

 


 

 

 

 

End of year 3

30,000

nil

30,000

12,000

18,000

5,400

Book/tax depreciation

30,000

(18,000)

(5,400)

 


 

 

 

 

End of year 4

nil

nil

Nil

Nil

 

The asset's carrying amount of C120,000 exceeds the tax base of C72,000; this gives a taxable temporary difference of C48,000. This amount is covered by the initial recognition exception, so no deferred tax is recognised. The asset is consumed at a rate of 25% per year (C30,000 accounting depreciation). So the amount of depreciation that relates to the temporary difference of C48,000 is C12,000 (48,000 × 25%). This amount is treated as a reversal of the temporary difference covered by the initial recognition exception.

 

In addition, there is a new originating taxable temporary difference of C6,000; this results from the difference in depreciation rates used for book and tax, that is between the remaining book depreciation (C18,000) and the tax deductions (C24,000).

 

In summary, the overall reduction of C6,000 in the temporary difference comprises:

 

C

Reversal of part of the temporary difference covered by the IRE

(12,000)

New originating temporary difference

6,000

 


Overall reduction in temporary difference

(6,000)

 


 

The same result is obtained by carrying out the analysis on the basis that the entity has acquired two assets. As in example 2, no deferred tax is recognised on the part of the asset costing C48,000 with a tax base of nil, because it arises on initial recognition. The other part of the asset costing C72,000 is subject to tax effect accounting. At the end of year 1, the carrying amount of this part of the asset is C54,000 (after book depreciation of C18,000), and the tax base is C48,000 (after tax depreciation of C24,000). To recover the carrying amount of C54,000, the entity will have to earn taxable income of C54,000, but will only be able to deduct tax depreciation of C48,000. The difference between the carrying amount of C54,000 and the tax base of C48,000 gives rise to a taxable temporary difference of C6,000. So the entity recognises a deferred tax liability of C1,800 (C6,000 @ 30%) representing the tax that it would pay when it recovers the asset's carrying amount. Similar reasoning applies in years 2 and 3. At the end of year 4, any deferred tax liability is reversed when the asset is fully depreciated.

Example 4 – Initial recognition – subsequent revaluation of an asset

 

The facts are the same as in example 2, except that the asset is revalued to C100,000 at the beginning of year 3.

Carrying amount

Tax base

Temporary difference

Unrecognised temporary difference

Recognised temporary difference

Deferred tax @ 30%

C

C

C

C

C

C

On initial recognition

120,000

72,000

48,000

48,000

Book/tax depreciation

30,000

18,000

 


 

 

End of year 1

90,000

54,000

36,000

36,000

Book/tax depreciation

30,000

18,000

 


 

 

End of year 2

60,000

36,000

24,000

24,000

Revaluation at beginning of year 3

40,000

 


 

 

100,000

36,000

64,000

24,000

40,000

12,000

Book/tax depreciation

50,000

18,000

 


 

 

End of year 3

50,000

18,000

32,000

12,000

20,000

6,000

Book/tax depreciation

50,000

18,000

(20,000)

(6,000)

 


 

 

End of year 4

nil

nil

nil

nil

 


 

 

 

As in example 2, no deferred tax is recognised on the initial temporary difference of C48,000 or in years 1 and 2. At the beginning of year 3, the asset is revalued to C100,000; but the asset's tax base is C36,000, giving rise to a temporary difference of C64,000. Of this amount, only C24,000 arises on initial recognition. The remaining C40,000 arises on the asset's subsequent revaluation; deferred tax of C12,000 (C40,000 @ 30%) should be provided on this amount. The deferred tax liability that arises on the asset's revaluation is debited direct to the revaluation reserve (see para 13.288.1). By the end of year 3, half of the temporary difference reverses; this results in a corresponding reduction in the deferred tax liability to C6,000. In year 4, the remaining temporary difference reverses when the asset is fully depreciated.

13.163.1 A deferred tax asset may arise on an asset's initial recognition. For example, a building costing C1 million is constructed in an enterprise zone that attracts 150% tax-deductible allowances on that building. The asset's tax base on initial recognition is C1.5 million. The difference between the carrying amount of C1 million and the tax base of C1.5 million gives rise to a deductible temporary difference of C0.5 million that would reduce future tax payable as the asset is recovered through use. The resulting deferred tax asset is not immediately recognised by crediting profit or loss, because that does not allocate the tax income over the asset's life. Also the deferred tax income is not deducted from the asset's cost, because it is difficult to assess whether the consideration paid for the asset takes into account the tax treatment applied by the tax authorities. And the standard does not permit a deferred tax asset to be recognised for the origination or reversal of such temporary difference. Another example where a deferred tax asset arises on initial recognition is the receipt of a non-taxable government grant. This situation is dealt with in paragraph 13.194 onwards.

13.163.2 In addition to revaluing an asset's carrying amount after initial recognition, it is also possible to 'revalue' the tax base after initial recognition. This can occur if the tax base is subject to an inflation adjustment, such as 'indexation'. Changes such as these (after the initial recognition exception has been applied) are considered in the following paragraphs.

Subsequent changes in an unrecognised deferred tax liability or asset

13.164 The examples in paragraph 13.163 show how subsequent changes in the temporary difference relating to an asset are treated, for instance where the asset is depreciated or revalued upwards. Where a deferred tax liability or asset has not been recognised as a result of the initial recognition exception, an entity does not recognise changes in the unrecognised deferred tax liability or asset as an asset is depreciated. [IAS 12 para 22(c)].

13.164.1 It might not be clear in practice whether subsequent changes in a temporary difference represent (i) a reversal of an amount covered by the initial recognition exception or (ii) a new temporary difference on which deferred tax is recognised. Where changes in a temporary difference (because of subsequent movements in the carrying amount or the tax basis) result from changes in the underlying economics, the general principle is that these should be properly reflected in the deferred tax accounting. The temporary difference on initial recognition arises because one element (carrying amount or tax base) exceeds the other. As a general rule, we consider that a reduction of this excess amount (due to a decrease in the larger element) is treated as a reversal of the unrecognised temporary difference and no deferred tax arises. But an increase of the larger element or a reduction of the other element (that is, the smaller amount) is treated as a new temporary difference; and deferred tax is recognised (subject to the criteria for deferred tax assets in IAS 12). The situation is more complicated where a subsequent change increases the smaller element (and so reduces the temporary difference); and there may be diversity in practice.

13.164.2 This concept is illustrated in the following examples for an asset with a carrying amount of C100,000 and a tax base of C90,000 on initial recognition. The resulting taxable temporary difference of C10,000 is subject to the initial recognition exception. Subsequent changes that reduce the carrying amount (up to C10,000) are reversals of the amount covered by the initial recognition exception (see example 1). Changes that increase the temporary difference result in a new temporary difference, and so deferred tax is recognised (see examples 2 and 3). If the temporary difference reduces because of an increase in the tax base (the smaller element), there are alternative acceptable views (as set out in example 4).

Example 1 – Subsequent accounting downwards revaluation

 

 

 

 

 

 

 

 

Carrying amount

Tax base

Temporary difference

Unrecognised temporary difference

Recognised temporary difference

Deferred tax liability/(asset)@ 30%

 

C

C

C

C

C

C

Initial recognition

100,000

90,000

10,000

10,000

Devaluation

(30,000)

(30,000)

(3,000)

(27,000)

(8,100)

 


 

70,000

90,000

(20,000)

7,000

(27,000)

(8,100)

 


 

 

In this case, the accounting devaluation is similar to depreciation and reduces the asset's carrying amount. Consistent with the pro rata approach in example 3 in paragraph 13.163, the amount of devaluation that relates to the temporary difference of C10,000 is C3,000. This amount is treated as a reversal of the temporary difference covered by the initial recognition exception. The remaining devaluation of C27,000 is treated as a new deductible temporary difference; a deferred tax asset is recognised on this amount (provided it meets the recognition criteria).

Example 2 – Subsequent accounting upward revaluation

 

 

 

 

 

 

 

 

Carrying amount

Tax base

Temporary difference

Unrecognised temporary difference

Recognised temporary difference

Deferred tax liability/(asset)@ 30%

 

C

C

C

C

C

C

Initial recognition

100,000

90,000

10,000

10,000

Revaluation gain

30,000

30,000

30,000

9,000

 


 

130,000

90,000

40,000

10,000

30,000

9,000

 


 

 

The revaluation of C30,000 increases the asset's carrying amount and the temporary difference. This results in a new taxable temporary difference on which a deferred tax liability is recognised.

Example 3 – Subsequent tax devaluation

 

 

 

 

 

 

 

 

Carrying amount

Tax base

Temporary difference

Unrecognised temporary difference

Recognised temporary difference

Deferred tax liability/(asset)@ 30%

 

C

C

C

C

C

C

Initial recognition

100,000

90,000

10,000

10,000

Devaluation

(30,000)

30,000

30,000

9,000

 


 

100,000

60,000

40,000

10,000

30,000

9,000

 


 

 

The change of C30,000 reduces the asset's tax base and increases the temporary difference. This represents a new taxable temporary difference on which a deferred tax liability is recognised.

Example 4 – Subsequent tax upward revaluation

 

 

 

 

 

 

 

 

Carrying amount

Tax base

Temporary difference

Unrecognised temporary difference

Recognised temporary difference

Deferred tax liability/(asset)@ 30%

 

C

C

C

C

C

C

Initial recognition

100,000

90,000

10,000

10,000

Revaluation gain

30,000

(30,000)

(30,000)

(9,000)

 


 

100,000

120,000

(20,000)

10,000

(30,000)

(9,000)

 


 

 

The change of C30,000 reduces the taxable temporary difference (and changes it to a deductible temporary difference). But this is because an increase in the tax base rather than a reduction in the carrying amount that gave rise to the unrecognised temporary difference. So, under the general principle in paragraph 13.164.1, the C30,000 represents a new deductible temporary difference on which a deferred tax asset is recognised (provided it meets the recognition criteria).

 

There is an alternative acceptable view: an increase in the smaller component (in this example, the tax base) reduces the previously unrecognised temporary difference. Under this view, C10,000 is a reversal of the temporary difference covered by the initial recognition exception. The remaining C20,000 is treated as a new deductible temporary difference.

13.164.3 The above examples show the position where the initial recognition exception applies to a taxable temporary difference on an asset. A similar approach applies in relation to a deductible temporary difference. In this case, the temporary difference arises because the asset's tax base is higher than the carrying amount. An entity does not recognise changes in the unrecognised deferred tax liability or asset as an asset is depreciated. [IAS 12 para 22(c)]. In our view, 'depreciation' applies to the tax base (as well as the carrying amount) where this represents a reversal of the unrecognised temporary difference. So, for an unrecognised deductible temporary difference on an asset, depreciation or devaluation of the tax base will represent a reversal of the unrecognised temporary difference (on a pro rata basis, as above).

13.164.4 Changes that increase the deductible temporary difference (such as an accounting or tax or depreciation) are not reversals, but represent new temporary differences on which deferred tax is recognised. The situation is more complicated where the temporary difference is reduced because of an increase in the asset's carrying amount, as illustrated in the following example.

Example – Subsequent accounting upward revaluation

 

 

 

 

 

 

 

 

Carrying amount

Tax base

Temporary difference

Unrecognised temporary difference

Recognised temporary difference

Deferred tax liability/(asset)@ 30%

 

C

C

C

C

C

C

Initial recognition

90,000

100,000

(10,000)

(10,000)

Revaluation gain

30,000

30,000

30,000

9,000

 


 

120,000

100,000

20,000

(10,000)

30,000

9,000

 


 

 

The change of C30,000 reduces the deductible temporary difference (and changes it to a taxable temporary difference). But this is because of an increase in the carrying amount rather than a reduction in the tax base that gave rise to the unrecognised temporary difference. So, under the general principle in paragraph 13.164.1, the C30,000 represents a new taxable temporary difference on which a deferred tax liability is recognised.

 

There is an alternative acceptable view: an increase in the smaller component (in this case, the asset's carrying amount) reduces the previously unrecognised temporary difference. Under this view, C10,000 is a reversal of the temporary difference covered by the initial recognition exception. The remaining C20,000 is treated as a new taxable temporary difference.

13.164.5 The above examples show that where the initial recognition exception applies, any changes in the temporary difference needs to be analysed to determine if they represent a reversal of the amount covered by the initial recognition exception or a new temporary difference.

13.164.6 The above examples show the position where a temporary difference on an asset is subject to the initial recognition exception. The principle and approach in paragraph 13.164.1 apply similarly to temporary differences (taxable or deductible) on liabilities that are subject to the initial recognition exception.

Measurement issues

Introduction

13.165 Deferred tax is measured at the tax rates that are expected to apply when the asset is realised or the liability is settled. The tax rates are based on laws that have been enacted or substantively enacted at the balance sheet date. [IAS 12 para 47].

13.166 Realising an asset or settling a liability could take many years. But the tax rate is not normally known in advance. An entity uses the rate that has been enacted or substantively enacted by the balance sheet date. Enacted means that the rate is part of tax law.See paragraph 13.69 onwards for the meaning of 'substantively enacted'.

Change in tax rates

13.166.1 An entity's tax rate might change as a result of new legislation. The impact of changes in rates depends on the nature and timing of the legislative changes. Any impact is recognised in accounting periods ending on or after the date of substantive enactment (and might be disclosable before that date). Changes in tax rates are often prospective, so there may be no impact on current tax assets and liabilities that arose before the change's effective date. But deferred tax balances are likely to be affected.

Example – Change in tax rates

A change in tax rate from 30% to 28% was substantively enacted on 26 June 20X7 with effect from 1 April 20X8. The change has no impact on current tax liabilities arising before its effective date. But the measurement of deferred tax assets and liabilities will be affected for accounting periods (including interim periods) ending on or after 26 June 20X7.

Management needs to determine when the deferred tax balance is expected to reverse and what tax rate will apply in the reversal period. The reduction in tax rate will not affect deferred tax that is expected to reverse before 1 April 20X8, but it will affect later reversals. It will be more complicated for entities with a financial year that straddles 1 April 20X8. They will need to calculate an effective tax rate for reversals in the financial year in which the change takes effect.

The impact of this reduction in tax rate might affect profit or loss, or other comprehensive income or equity (see further para 13.288.7).

The change in tax rate might be disclosable as a non-adjusting post-balance sheet event for accounting periods ending before 26 June 20X7. [IAS 10 para 22(h)].

Average rates

13.167 Management normally needs to calculate an average tax rate only if the enacted or substantively enacted tax rates are graduated; that is, if different rates apply to different levels of taxable income. This average rate is the rate expected to apply to taxable profit (or loss) in the years in which management expects the temporary differences to reverse. [IAS 12 para 49]. Assume the first C5m of profit is taxed at 20%, and profit above that is taxed at 30%. Management needs to estimate the average rate where it expects to earn annual taxable profit in excess of C5m in the future. To determine the rate (which would be between 20% and 30%), management estimates future annual taxable profits, including reversing temporary differences. It is not usually necessary in practice to determine the net reversals of temporary differences for deferred tax assets and liabilities. But management should consider the effect of an abnormal level of taxable profit or any abnormally large temporary difference that could reverse in a single future year and distort the average rate.

Example – Different tax rates applicable to different levels of income

An entity operates in a country where different rates apply to different levels of taxable income. The net deductible temporary differences total C30,000 at 31 December 20X3. The temporary differences are expected to reverse over the next seven years. The average projected profit for the next seven years is C60,000.

A deductible temporary difference relating to impairment of trade receivables of C25,000 is expected to fully reverse in 20X5, when the related expense will be deductible for tax purposes. The taxable profit for 20X5 will be C35,000 (that is, C60,000 – C25,000).

The reversal of this large temporary difference will distort the average tax rate; so management should consider the impact of this separately when calculating the average rate that it will use for deferred tax assets and liabilities.

An example of the calculation of the deferred tax assets and liabilities, assuming graduated tax rates, is:

 

 

Average

Year 20X5

Range

Tax rate

Profit

Income tax

Profit

Income tax

C

%

c

c

c

c

0 – 1,000

18

1,000

180

1,000

180

1,001 – 11,000

25

10,000

2,500

10,000

2,500

11,001 – 36,000

30

25,000

7,500

24,000

7,200

36,001 +

40

24,000

9,600

 

 


 

 

60,000

19,780

35,000

9,880

 

 


Average rate

 

 

33%

 

28%

 

 

 

 

 

 

Management uses a 28% tax rate in the 20X3 financial statements for the deferred tax asset relating to impairment of trade receivables; it uses a 33% rate for the remaining temporary differences.

13.168 The requirement to calculate an average tax rate applies to different levels of profit; but it is not used for different rates that are expected to apply to different types of taxable profit or in different tax jurisdictions. If different rates apply to different types of taxable profit (for example, trading profits and capital gains), the rate used will reflect the nature of the temporary difference. The rates used for measuring deferred tax arising in a specific tax jurisdiction will be the rates expected to apply in that jurisdiction. Management should take care when considering tax in countries where state or provincial tax systems apply. Management should apply the appropriate rates for each state or province to the transactions in those states or provinces and avoid using an average rate for the country unless the impact is immaterial.

 

Expected manner of recovery or settlement of an asset or a liability

13.170 The tax consequences of recovering or settling the carrying amount of assets and liabilities might depend on the manner in which the asset is recovered or the liability is settled. So the tax base might be different depending on how the asset or liability is recovered or settled in practice. The carrying amount of an asset is normally recovered through use, sale, or use and sale. The cumulative amount that is deducted for tax purposes if the asset is recovered through use might be different from the amount that would be deductible on the asset's sale, for example, because of indexing the cost.

13.171 In some jurisdictions, different tax rates apply to income and capital gains. For example, if an entity expects to sell an asset, and the transaction would be subject only to capital gains tax, it should measure the related deferred tax liability at the balance sheet date at the capital gains rate. But if it expects to retain the asset and recover its carrying amount through use, it should measure the deferred tax at the rate applicable to taxable income.

13.172 Entities should measure deferred tax assets and liabilities using the tax rates and tax bases that are consistent with the manner in which the entity expects, at the balance sheet date, to recover or settle the carrying amount of assets and liabilities. [IAS 12 para 51A]. See guidance on the expected manner of recovery of investment properties measured at fair value in paragraph 13.219.4 onwards.

13.172.1 There is debate over the deferred tax accounting where a group holds a single asset within a corporate entity (or 'corporate wrapper') and expects to ultimately 'recover' the asset by selling the investment in the corporate entity. In our view, management should determine the asset's expected manner of recovery for the purpose of calculating the related deferred tax on the basis of the asset's recovery within the corporate entity, not by reference to the expected manner of recovery of the investment in the corporate entity. This applies even if the group expects to recover its investment in the corporate entity without an impact on taxable profit (or with a lesser impact than from selling the asset itself). Deferred tax is recognised on temporary differences; a temporary difference is defined as the difference between an asset's carrying amount and its tax base (see para 13.93). As it is the asset itself that is recognised in the group's balance sheet (as opposed to the investment in the corporate entity in which the asset resides), the relevant tax base is that of the asset, not that of the investment.

13.172.1.1 Where a group holds assets within a corporate entity (for example, in a subsidiary or a joint venture), it should determine the assets' expected manner of recovery on the basis of their recovery within that corporate entity. The resulting temporary differences are sometimes referred to as 'inside basis' differences. There could be a further temporary difference: the difference between the carrying amount of the investment in the corporate entity and its tax base (sometimes referred to as 'outside basis' difference). See paragraph 13.254 for more guidance on temporary differences arising on investments in subsidiaries, branches, associates and joint ventures.

13.172.1.2 The impact of management expectations on the measurement of deferred tax assets and liabilities is an important principle in the standard. This is true particularly where the tax base of an asset or liability is not immediately apparent.

Example – Expected manner of recovery based on use

 

A parent entity acquired a subsidiary that held a piece of plant. The fair value of the plant was C10m and it will be depreciated over 10 years to its residual value of nil. The accounting depreciation of C1m charged in year 1 and later years is not deductible for tax purposes. If the plant is used in the business for its full 10-year life, it will be fully consumed and will have to be scrapped. No tax deductions will be available for scrapping the asset. But if the asset is sold, the cost of the asset to the subsidiary of, say, C8m (after adjusting for inflation) is deductible on sale. The tax rate is 30% for income and 25% for capital gains.

 

In this example, the tax base is not immediately apparent. It could be nil if the asset is to be used; or it could be C8m if the asset is to be sold. So management needs to consider how it expects to recover the asset's carrying amount. Management will use the plant for carrying out its business (supported by the fact that the asset is being depreciated to a nil residual value). The plant's full carrying amount is expected to be recovered through use; and there are no tax consequences of scrapping the asset at the end of its life. The tax base that is consistent with the expected manner of recovery through use is nil, as no part of the carrying amount is deductible for tax purposes against the future economic benefits expected to flow from the plant's use. So a temporary difference arises of C10m, which is the difference between the carrying amount on initial recognition and the tax base of nil. This temporary difference reduces to C9m because part of the carrying amount is recovered through depreciation in year 1. On this basis, management would provide a deferred tax liability of C3m at the income tax rate of 30% on the date of the business combination. This deferred tax liability will have reduced to C2.7m at the balance sheet date.

13.172.1.3 The standard has some examples (in para 51A) of how this principle is applied. Other examples are considered elsewhere in this chapter; for example, the expected manner of recovery of revalued non-monetary assets is discussed in paragraph 13.211 onwards.

Dual manner of recovery

13.172.2 An entity might plan to use an asset for a number of years and then sell it. The deferred tax should reflect this expected 'dual manner of recovery'. It is recognised on the basis of normal income tax rules for the portion of the asset's carrying amount that is expected to be recovered through use; and it is recognised using disposal tax rules for the remainder of the asset's carrying amount that is expected to be recovered through sale.

13.172.3 The 'dual manner of recovery' expectation will often affect assets such as properties and intangible assets. A residual value might indicate that the dual manner of recovery is applicable. Paragraph 6 of SIC 21 supports this. The dual manner of recovery could still apply even when there is no residual value; for example, where the asset is expected to be disposed of or abandoned (either during or at the end of its useful life) in order to recover any tax base available on disposal or abandonment. This might affect properties or intangibles with nil residual values or other types of asset such as mining assets. The guidance in SIC 21 has been incorporated into IAS 12 by the amendment to IAS 12 issued in December 2010. For guidance on the expected manner of recovery for investment properties measured at fair value, refer to paragraph 13.219.7 onwards; and for guidance on intangible assets with indefinite lives, refer to paragraph 13.225.1 onwards.

13.172.3.1 Where an asset has a nil residual value, it might appear that it will be recovered solely through use. But it is likely that management will take the commercial decision to sell the asset at the end of its useful life if this would recover the asset's tax base. Proceeds are likely to be low (as the asset is at the end of its life), but the asset's cost or indexed cost might be tax deductible. Thus the sale could generate a significant capital loss. If there is a valid expectation that management would sell the asset, a dual manner of recovery expectation would apply.

13.172.4 When a dual manner of recovery expectation applies, deferred tax is calculated as follows:

 

Ascertain the expected manner of recovery of the asset's carrying amount.

 

For instance, where assets are depreciable (such as buildings), they are expected to be held during their useful life and a portion of the carrying amount recovered through use, with the residual amount (which might be nil) recovered through a disposal at the end of the useful life. Land is not depreciable and it can only be recovered through ultimate disposal (see further para 13.213).

 

 

 

Split the asset's carrying amount between amounts to be recovered through use and through sale.

 

The split might be based on the residual value determined for the purpose of depreciation under the cost model of IAS 16 or IAS 38. This residual value is the estimated value (in present prices at the balance sheet date) of the relevant asset in its expected state at the end of its useful life. But the split could arguably be based on a residual value measured on the same price basis as the carrying amount (that is, based on prices ruling at the date the asset was acquired).

 

 

 

Under the revaluation model in IAS 16, the residual value is likely to be measured on the same price basis as the carrying amount.

 

 

 

Determine the expected period of recovery through use and the expected date of sale or abandonment.

 

For depreciable assets accounted for under the cost or revaluation model, the expected period of recovery through use is normally the asset's useful life as defined in IAS 16 or IAS 38.

 

 

 

Determine the tax consequences of recovery through use and the temporary differences that will arise.

 

The future taxable amount will be the portion of the carrying amount expected to be recovered through use. The tax consequences of recovering this amount through the receipt of operating income (that is, through use) are determined by considering any deductions available during the period of recovery. In a simple situation, this might mean just deducting the expected tax depreciation allowances (if any) from the amount expected to be recovered through use, to determine the resulting temporary difference.

 

 

 

Where an asset is expected to be recovered through use without any disposal, it might also be necessary to consider any capital gains tax consequences of abandoning the asset and any resulting temporary differences.

 

 

 

Where an asset is expected to be held and used for a period before disposal, it might be necessary to consider the income tax consequences of the disposal; these could affect tax depreciation allowances relating to the carrying amount that is expected to be recovered through use (for example, claw backs of, or additional, tax depreciation allowances based on the disposal proceeds, if applicable).

 

 

 

Determine the tax consequences of recovery through sale and the temporary differences that will arise.

 

The future taxable amount will be the portion of the carrying amount expected to be recovered through disposal. This will be the residual value or adjusted residual value (see the second bullet point above). The tax consequences will be the taxable gain arising on such disposal.

 

 

 

Determine which of the temporary differences arising from recovery through use and through sale should be recognised.

 

The temporary differences arising from the analysis in the above two steps should be considered separately (rather than determining a net temporary difference) if the tax liability (or asset) arising from use and the tax asset (or liability) arising from sale could not be offset. Such offset might not be possible if the amounts are taxed in a different manner (for example, if income tax losses cannot be fully offset against capital gains) or if they are taxed at a different time (for example, a tax loss arising on the reversal of a deductible temporary difference may not be offsettable against taxable income arising from the earlier reversal of a taxable temporary difference).

13.172.5 The impact of the expected manner of recovery and use of residual values is illustrated below:

Example – Impact of expected manner of recovery and residual values

An entity acquired a property during a business combination before transition to IFRS. The total fair value on acquisition of the property was C3.5m (that is, 'cost' to the entity); this was split between land of C1m and buildings of C2.5m.

The property was revalued on transition to IFRS. A revaluation uplift of C2m was recognised; and the revalued amount of C5.5m is used as deemed cost. C800,000 of this revaluation uplift related to the land element, and C1.2m to the building element.

There are no tax deductions for use, but the total cost (plus an adjustment for inflation) is deductible on sale. The tax rate is 30% throughout.

Deferred tax on the land is calculated on a sale basis (see further para 13.213). But the expected manner of recovery for the buildings will have a significant impact on deferred tax.

Expected manner of recovery based on use

If the use basis alone is appropriate for the buildings:

 

Land

Buildings (use)

 

C'000

C'000

Carrying amount

1,800

3,700

 

 

 

Tax base

 

 

Cost

1,000

Inflation adjustment (say)

200

 


Total tax base

1,200

 


Temporary difference – liability

600

3,700

 


 

The entity recognises a deferred tax liability on land for the taxable temporary difference (TTD) of C0.6m and a deferred tax liability on buildings for the TTD of C3.7m; that is a total TTD of C4.3m @ 30%, giving a total deferred tax liability of C1.29m.

 

 

Dual manner of recovery with a residual value

 

If a dual manner of recovery is appropriate for the buildings:

 

Assume that C1.8m of the buildings will be recovered through sale (residual value) and C1.9m through use.

 

 

 

 

 

Land

Buildings
(sale)

Buildings
(use)

 

C'000

C'000

C'000

Carrying amount

1,800

1,800

1,900

 


Tax base

 

 

 

Cost

1,000

2,500

Inflation adjustment (say)

200

500

 


Total tax base

1,200

3,000

 


Temporary difference – liability (asset)

600

(1,200)

1,900

 


 

The deductible temporary difference (DTD) on the sale element of the buildings can be recognised only if it is recoverable under IAS 12's rules. In many jurisdictions, a DTD calculated on a sale element cannot be offset against the TTD on the use element, because capital losses cannot be offset against trading income. It is generally reasonable to assume that the land and buildings will be sold together. So to the extent that the DTD calculated on a capital (that is, sale) basis is covered by a TTD on the related land that is also calculated on a capital basis, it can be offset against it. So the deferred tax liability recognised might relate only to the buildings' use element.

 

If C0.6m of the DTD is recognised against the C0.6m TTD on the land, the entity recognises a deferred tax liability on the buildings of C1.9m @ 30% = C0.57m.

 

The remaining deferred tax asset (on DTD of C0.6m) can only be recognised if it meets the recognition criteria for assets.

 

 

Dual manner of recovery with a nil residual value

 

The dual manner of recovery might be appropriate for the buildings even if there is no residual value; for example, if the entity expects to sell the property at the end of its useful life in order to recover the buildings' tax base together with the disposal of the land, or can recover the buildings' tax base at the end of their useful lives in another way. If nearly all of the buildings' carrying amount is expected to be recovered through use, followed by disposal together with the related land:

 

 

 

 

 

Land

Buildings
(sale)

Buildings
(use)

 

C'000

C'000

C'000

Carrying amount

1,800

3,700

 


Tax base

 

 

 

Cost

1,000

2,500

Inflation adjustment (say)

200

500

 


Total tax base

1,200

3,000

 


Temporary difference – liability (asset)

600

(3,000)

3,700

 


 

 

 

 

There is a DTD on the sale element of the buildings. To the extent it is covered by a TTD (calculated on a capital basis) on the related land, it can be offset against it.

 

If C0.6m of the DTD is recognised against the C0.6m TTD on the land, the entity recognises a deferred tax liability on the buildings of C3.7m @ 30% = C1.11m.

 

The remaining deferred tax asset (on DTD of C2.4m) can only be recognised if it meets the recognition criteria for assets.

 

Comparison of methods

 

The expected manner of recovery, the useful economic lives and the residual values attributed to the buildings need to reflect management's expectations, as this is the basis of allocating the buildings' carrying amount between the use and sale elements. This allocation, in turn, affects the deferred tax recognised on these elements. Consider the impact of the different manner of recovery expectations in the above scenarios:

 

 

 

 

 

 

Use only

Dual manner (with residual)

Dual manner (with nil residual)

 

C'000

C'000

C'000

Deferred tax liability on use element of buildings

1,110

570

1,110

Deferred tax liability on land

180

180

180

Deferred tax asset on sale element of buildings (offset against land)

(180)

(180)

 


Deferred tax liability recognised

1,290

570

1,110

Remaining deferred tax asset on sale element of buildings (available for recognition if IAS 12 criteria are met)

(180)

(720)

 


Reduction in net assets

1,290

390

390

 


 

 

 

 

Where there is a residual value, a significant difference arises between the outcome under the single use expectation and the dual manner of recovery expectation.

 

Even where there is a nil residual value, the outcome under the dual manner of recovery differs from that for single use. Some of the deferred tax asset arising on sale of the buildings can be recognised under the dual manner of recovery expectation; this reduces the deferred tax liability on the land by C180,000.

 

If the TTD on the land was larger, the difference between the outcome under the dual manner of recovery and that for single use would be even greater; as more of the deferred tax asset arising on sale of the buildings could be recognised.

 

Dual manner of recovery – implications of the initial recognition exception

13.173.1 Where a temporary difference arises on initial recognition of an asset (other than on a business combination), and the transaction does not affect accounting profit or taxable profit at the time of the transaction, any deferred tax asset or liability in respect of that temporary difference is not permitted to be recognised (see para 13.162 onwards). [IAS 12 paras 15, 24].

Example – Dual manner of recovery and initial recognition exception

Using the example in paragraph 13.172.5, but assuming that the property is separately acquired. On revaluation, the property's residual value was revisited; this resulted in changes to the carrying amounts of the land and both elements of the buildings (that is, sale and use).

 

 

Cost

Revaluation

Carrying amount

 

C'000

C'000

C'000

Land

1,000

800

1,800

Buildings – recovered through sale

1,200

600

1,800

Buildings – recovered through use

1,300

600

1,900

 


Total

3,500

2,000

5,500

 


 

 

Expected manner of recovery for buildings solely through use

 

The implications of the initial recognition exception (IRE) at the date of the property's acquisition are:

 

Land: taxable temporary difference of nil – carrying amount (cost of C1m) less tax base (C1m).

 

Buildings: taxable temporary difference of C2.5m – carrying amount (cost of C2.5m) less tax base (nil) – deferred tax liability not recognised because of the IRE.

 

After revaluation, if recovery solely through use is appropriate for the buildings:

 

 

Land

Buildings
(use)

 

C'000

C'000

Carrying amount

1,800

3,700

 


Tax base

 

 

Cost

1,000

Inflation adjustment (say)

200

 


Total tax base

1,200

 


Temporary difference

600

3,700

Covered by initial recognition exemption

2,500

 


New temporary difference

600

1,200

 


 

This example ignores depreciation (which reduces the original temporary difference covered by the IRE). The entity recognises a deferred tax liability on the land (TTD of C0.6m) and a deferred tax liability on buildings (TTD of C1.2m); that is a total TTD of C1.8m @ 30%, giving a total deferred tax liability of C0.54m.

 

Dual manner of recovery with a residual value

 

The implications of the IRE at the date of the property's acquisition would be:

 

Land: taxable temporary difference of nil – carrying amount (cost of C1m) less tax base (C1m).

Buildings – sale element: deductible temporary difference of C1.3m – carrying amount (allocated cost of C1.2m) less tax base (C2.5m) – deferred tax asset not recognised because of the IRE.

Buildings – use element: taxable temporary difference of C1.3m – carrying amount (allocated cost of C1.3m) less tax base (nil) – deferred tax liability not recognised because of the IRE.

After revaluation, if a dual manner of recovery is expected for the buildings:

 

 

 

 

 

Land

Buildings
(sale)

Buildings
(use)

 

C'000

C'000

C'000

Carrying amount

1,800

1,800

1,900

 


Tax base

 

 

 

Cost

1,000

2,500

Inflation adjustment (say)

200

500

 


Total tax base

1,200

3,000

 


Temporary difference

600

(1,200)

1,900

Covered by IRE

1,300

(1,300)

 


New temporary difference

600

100

600

 


 

 

 

 

This example ignores depreciation (which reduces the original temporary difference covered by the IRE).

 

After revaluation, the sale element of the buildings has a carrying amount (C1.8m) that is less than its tax base (C3m); thus a DTD of C1.2m exists at the balance sheet date. On initial recognition, a DTD of C1.3m existed but was not recognised because of the initial recognition exception. So the original DTD has been reduced by C0.1m as a result of the revaluation (C0.6m), partly offset by indexation (C0.5m).

 

Under the initial recognition exception, the temporary difference resulting from the original carrying amount (and its subsequent depreciation, if applicable) and the original tax base are excluded from recognition. Any increases in the asset's carrying amount or the tax base are considered separately for deferred tax purposes (see further para 13.164.4). In this case, a new revaluation event has occurred, producing an asset with an incremental carrying amount of C0.6m and an incremental tax base of C0.5m. This gives rise to a taxable temporary difference of C0.1m.

 

So the entity recognises a deferred tax liability on land (TTD of C0.6m), a deferred tax liability on the sale element of the buildings (TTD of C0.1m) and a deferred tax liability on the use element of the buildings (TTD of C0.6m); that is a total TTD of C1.3m @ 30%, giving a total deferred tax liability of C0.39m.

 

Dual manner of recovery with a nil residual value

 

If nearly all of the buildings' carrying amount is expected to be recovered through use, followed by disposal together with the related land, the implications of the IRE at the date of the property's acquisition would be:

 

Land: taxable temporary difference of nil – carrying amount (cost of C1m) less tax base (C1m).

Buildings – sale element: deductible temporary difference of C2.5m – carrying amount (allocated cost of Cnil) less tax base (C2.5m) – deferred tax asset not recognised because of the IRE.

Buildings – use element: taxable temporary difference of C2.5m – carrying amount (allocated cost of C2.5m) less tax base (nil) – deferred tax liability not recognised because of the IRE.

After revaluation, if the dual manner of recovery is used for the buildings:

 

 

 

 

 

Land

Buildings
(sale)

Buildings
(use)

 

C'000

C'000

C'000

Carrying amount

1,800

3,700

 


Tax base

 

 

 

Cost

1,000

2,500

Inflation adjustment (say)

200

500

 


Total tax base

1,200

3,000

 


Temporary difference

600

(3,000)

3,700

Covered by IRE

2,500

(2,500)

 


New temporary difference

600

(500)

1,200

 


 

 

 

 

There is no revaluation of the sale element of the buildings for accounting purposes because this is all attributed to the use element. But there is a revaluation (of C0.5m) of the tax base because of indexation allowance. Assuming there is no restriction of the indexation allowance, the revaluation gives rise to a new DTD (as explained above); to the extent it is covered by a TTD (capital basis) on the related land, it can be offset against this.

 

If the DTD of C0.5m is recognised against the C0.6m TTD on the land, the entity recognises a deferred tax liability on the land (TTD C0.1m) and buildings (TTD C1.2m); that is a total TTD of C1.3m @ 30%, giving a total deferred tax liability of C0.39m.

 

Comparison of methods

 

 

 

 

 

Use only

Dual manner (with residual)

Dual manner (with nil residual)

 

C'000

C'000

C'000

Deferred tax liability on use element of buildings

360

180

360

Deferred tax liability on land

180

180

180

Deferred tax liability/(asset) on sale element of buildings

30

(150)

 


Deferred tax liability recognised

540

390

390

 


 

Comparing this with the scenarios in paragraph 13.172.5, which did not apply the initial recognition exception, the initial recognition exception reduces the difference between the single use and the dual method. But the difference can still be significant.

 

Under both methods, deferred tax is recognised on the revaluation gains on the buildings. But the dual method also considers the effect of the inflation adjustment on calculating the sale element of the buildings. This reduces the deferred tax liability arising on the revaluation of that element (and could result in a deferred tax asset, subject to any restriction of the inflation adjustment); this might give rise to a smaller overall deferred tax liability than the single use method.

Implications of inflation adjustments

13.173.2 Inflation adjustments for tax purposes can have a significant impact on the deferred tax calculation where there is a dual manner of recovery expectation. Inflation adjustments are generally an allowance relating to tax on capital gains (as opposed to income tax); so any adjustments to the tax base relating to inflation on the buildings are relevant only to the sale element of the buildings. Inflation adjustments are not allocated to the element of the buildings that will be used in the ongoing business. Instead, inflation adjustments on the buildings' total cost are included in the calculation of deferred tax on the sale element of the property.

13.173.3 Because inflation adjustments are effectively a revaluation of the tax base and arise after initial recognition, they are not subject to the initial recognition exception. The adjustments will increase the asset's tax base and thus reduce the taxable temporary difference relating to the sale element of the buildings.

13.173.3.1 The accounting implications of revaluations for tax purposes are addressed further in paragraph 13.217 onwards.

Property devaluations

13.173.4 Where the use element of a building is revalued downwards below its allocated original cost, this is treated similarly to depreciation of the building (see para 13.212 onwards). Where the initial recognition exception applies, an entity does not recognise later changes in the unrecognised deferred tax liability as the asset is depreciated or devalued. [IAS 12 para 22(c)]. The downward revaluation is a reversal of the originating temporary difference arising on the asset's initial recognition; so it is not recognised in the deferred tax calculation.

13.173.5 Where the sale element of a building is revalued downwards below its allocated original cost, this increases the deductible temporary difference arising on the asset's initial recognition. It is not a reversal of the originating temporary difference on initial recognition. The downward revaluation is a new temporary difference and is recognised in the deferred tax calculation. Any resulting deferred tax asset is recognised only if it can be offset against a deferred tax liability on the related land, or if the IAS 12 recognition criteria are met in some other way.

Change in intention about the expected manner of recovery

13.174 The manner in which management expects to recover an asset's carrying amount or settle a liability's carrying amount might change. The change in the manner of recovery or settlement could affect the deferred tax balances already recognised for that asset or liability. The deferred tax balances should be remeasured using the tax rates and tax bases that are consistent with the revised expected manner of recovery. Any adjustments resulting from the remeasurement should be recognised in profit or loss or if they relate to items previously recognised outside profit or loss, they should be recognised in other comprehensive income or directly in equity, as appropriate. [IAS 12 para 60(c)]. See the example below and scenario 2 in paragraph 13.211.

Example – Change in intention on expected manner of recovery

An entity acquired a piece of plant in a business combination on 1 January 20X6 at cost of C800,000. The plant is fully deductible in use at a rate of 25% per annum. Accounting depreciation is charged at 10% per annum and the residual value is nil.

If the plant is sold, any chargeable gain will be taxable at 40%. The chargeable gain will be the excess of proceeds over the original cost, adjusted for inflation, less any deductions already claimed.

The rate for income and capital gains tax is 40%.

Management intended initially to recover the asset in full through use. At the end of its life, the asset would be scrapped and there would be no tax consequences. So deferred tax is calculated on a use basis as at 31 December 20X6.

At the end of 20X7, the intention changes and the plant is expected to be sold. deferred tax is calculated on a sale basis as at 31 December 20X7.

 

NBV

TB

TD

DTL

 

C

C

C

C

At 1 January 20X6

800,000

800,000

Depreciation/tax allowances

(80,000)

(200,000)

120,000

48,000

 


At 31 December 20X6

720,000

600,000

120,000

48,000

Depreciation/tax allowances

(80,000)

(200,000)

120,000

48,000

 


At 31 December 20X7

640,000

400,000

240,000

96,000

 

 

 

 

 

Change in expected manner of recovery

 

 

 

 

Tax cost of plant

800,000

800,000

320,000

Inflation adjustment (say)

4,000

4,000

1,600

Clawback of allowances claimed

(400,000)

(400,000)

(160,000)

 


New temporary difference at 31 December 20X7

640,000

404,000

236,000

94,400

 


 

The adjustment to the deferred tax liability of C1,600 arises from the change in the manner of recovery; and this is credited to the profit or loss. The deferred tax balance of C94,400 reflects the tax consequences if the entity sold the plant at its carrying amount at the balance sheet date. The movement of C1,600 represents the tax effect of the inflation adjustment (C4,000 @ 40%).

Tax consequences of dividends

13.175 Measurement can be more complicated when distributed and undistributed income are taxed at different rates. In some jurisdictions, corporate taxes are payable at a higher or lower rate if part or all of the net profit or retained earnings are distributed as dividends. For example, undistributed profits might be taxed at 45% and distributed profits at 30%. In such situations, deferred tax assets and liabilities should be measured using the tax rates on undistributed profits (45% in the example; that is, with no anticipation of future dividend). [IAS 12 para 52A].

13.175.1 IAS 10 prohibits accrual of a dividend that is proposed or declared after the end of the reporting period but before the financial statements are authorised for issue. Any tax consequences of paying a dividend are recognised when the dividend is subsequently declared and recognised as a liability. [IAS 12 para 52B]. Referring to the example above, assume that tax is recoverable if the entity pays a dividend in the subsequent accounting period. In that case, the entity recognises the refundable part of income taxes (45% – 30% = 15%) as a current tax asset and a reduction of current tax expense when it recognises the dividend. It continues to recognise deferred tax assets and liabilities using the undistributed rate.

13.175.2 In the example above, assume that the tax rate for distributed profits had been higher than that for undistributed profits, say 40% and 30% respectively. A current tax liability and increase of current tax expense would be recognised based on the incremental tax rate of 10% when the dividend was recognised.

Example – Tax consequences of a dividend

A dividend of C400 was declared in February 20X4, payable on 31 March 20X4. Under IAS 10, no liability was recognised for the dividend at 31 December 20X3. The profit before tax was C2,000. The tax rate is 30% for undistributed profits and 40% for distributed profits. Should the tax rate applicable to distributed profits be applied for the portion of net profit corresponding to dividends declared after the balance sheet date?

No, the tax rate applicable to undistributed profit should be applied; because the tax rate for distributed profit is used only where the obligation to pay dividends has been recognised. So the current income tax expense is C600 (C2,000 × 30%).

During 20X4 a liability of C400 will be recognised for dividends payable. An additional tax liability of C40 (C400 × 10%) is also recognised as a current tax liability and an increase of the current income tax expense for 20X4.

13.176 The incremental tax effect of the dividend payment (that is, the additional tax @ 10%) is not recognised in equity but in profit or loss, even though the dividend payment is charged to equity. The tax consequences of dividends in such situations are more directly linked to past transactions or events than to distributions to owners. [IAS 12 para 52B]. The past transactions and events in this instance are those that gave rise to profits that were initially taxed at 30% and that were recognised in profit or loss.

13.177 In some jurisdictions, an entity pays tax only when part or all of its net profits or retained earnings are paid out as dividends. The tax consequences of such dividends are also included as part of the tax charge in profit or loss for the same reasons. The tax payable primarily relates to items recognised in profit or loss and is not different from income taxes generally, even though it arises from paying a dividend. But an exception is made when the amounts payable are in effect a withholding tax for the benefit of the shareholders. The recipients of the dividends would typically be entitled to a tax credit at least equal to the tax paid by the entity. In this case, the subjects of taxation are the shareholders and not the entity. So the tax is charged directly to equity as part of the dividends, as explained further in paragraph 13.52. [IAS 12 paras 52B, 58, 65A]. Finally, the entity should disclose the tax that would result if retained earnings were paid out as dividends (see para 13.304). [IAS 12 para 81(i)].

13.178 In its consolidated financial statements, a parent that has a subsidiary operating in a dual-rate tax jurisdiction, and which does not expect to re-invest the earnings permanently, should measure the deferred taxes on temporary differences relating to the investment in the subsidiary (that is, the outside basis difference) at the rate that would apply to distributed profits. This is on the basis that the undistributed earnings are expected to be recovered through their distribution up the group and, under paragraph 51 of IAS 12, the deferred tax should be measured in accordance with the expected manner of recovery.

Discounting of deferred tax assets and liabilities

13.179 Discounting of deferred tax assets and liabilities is prohibited. [IAS 12 para 53]. Although the balance sheet liability method can lead to the accumulation of large deferred tax assets and liabilities over a prolonged period, discounting is not permitted. This is because it is impracticable or complex to schedule the timing of reversal of each temporary difference. [IAS 12 para 54].

13.180 But deferred taxes are discounted to some extent, at least implicitly. Temporary differences are calculated by reference to the carrying amount of an asset or liability. Where that carrying amount is already calculated on a discounted basis, as in the case of retirement benefit obligations (see IAS 19), the deferred tax asset or liability is implicitly discounted. In such situations, temporary differences are calculated using the (discounted) carrying amount of assets and liabilities; the implicit effect of discounting should not be reversed. [IAS 12 para 55].

 

Changes in tax status of an entity or its shareholders

13.186 The tax status of an entity can change because of, say, public listing of its equity instruments, restructuring of its equity or a change in tax jurisdictions of its shareholders; the change could affect current tax assets and liabilities as well as deferred tax assets and liabilities. The entity could be taxed at a different rate in the future or it might lose or gain various tax incentives that affect the tax bases of its assets and liabilities. SIC 25 deals with the resulting change in accounting treatment.

13.187 The current and deferred tax consequences of a change in tax status should be dealt with in profit or loss; unless they relate to transactions and events that result (in the same or a different period) in amounts recognised in other comprehensive income, or in a direct charge or credit to the recognised amount of equity. Tax consequences relating to amounts recognised in other comprehensive income are recognised in other comprehensive income. Tax consequences relating to direct changes in equity are charged or credited directly to equity. [SIC 25 para 4]. 

13.188 An entity should identify the transactions and events that gave rise to current and deferred tax balances. Where transactions and events are recognised outside profit or loss (for example, asset revaluations), additional current and deferred tax consequences should also be recognised outside profit or loss. So the cumulative amount of tax recognised outside profit or loss would be the same amount that would have been recognised if the new tax status had applied previously. [SIC 25 para 8].

Example – Change in tax status of an entity

On 31 August 20X2, entity A changed its status from one type of entity to another. It became subject to a higher income tax rate (30%) than previously (25%). The change in applicable tax rate applies to taxable income generated from 1 September 20X2. The tax rates applicable to a profit on sale of land also increased from 30% to 40%.

The information below relates to temporary differences that exist at 1 January 20X2 and at 31 December 20X2 (the end of accounting period) and which will all reverse after 1 January 20X3.

 

 

 

 

 

 

01 Jan X2

 

31 Dec X2

 

 

Carrying amount

Tax base

Temporary difference

Carrying amount

Tax base

Temporary difference

Trade receivables

2,200

2,500

(300)

2,500

2,800

(300)

Land (carried at revalued amount)

800

500

300

800

500

300

Plant and machinery

3,000

800

2,200

2,900

600

2,300

Warranty provisions

(1,000)

0

(1,000)

(1,000)

0

(1,000)

 


Total

5,000

3,800

1,200

5,200

3,900

1,300

 


 

 

 

 

 

 

 

The tax consequences of the change in applicable tax rate should be included in profit or loss, unless they relate to items originally recognised outside profit or loss. The deferred tax at the opening and closing balance sheet dates is calculated as follows:

 

 

 

 

 

01Jan X2

31Dec X2

 

Temporary difference

Deferred tax

Temporary difference

Deferred tax

Trade receivables

(300)

 

(300)

 

Plant and machinery

2,200

 

2,300

 

Warranty provisions

(1,000)

 

(1,000)

 

 


Total

900

225
(900 × 25%)

1,000

300
(1,000 × 30%)

 

 

Land (carried at revalued amount)

300

90
(300 × 30%)

300

120
(300 × 40%)

 


 

The change in deferred tax relating to receivables, the plant and machinery and the warranty provision is included in profit or loss. The change in deferred tax relating to the land is recognised in other comprehensive income, because the revaluation of land itself is recognised in other comprehensive income.

13.189 The deferred tax effects of items recognised outside profit or loss might themselves have been determined pro rata (as discussed in para 13.288.5); in that case, a change in tax status also affects those transactions and events. So the tax effects of the change in tax status should also be allocated in a similar pro rata basis as adopted previously, unless the allocation can be made on a more appropriate basis.

13.190 The tax consequences of a change in tax status could affect deferred tax balances that arose from a previous acquisition. Where the change in tax status arose in the period after acquisition, the tax effects of the change should be dealt with in profit or loss and not as an adjustment against goodwill. But where an entity's tax status is changed because of its acquisition, the tax effects of the business combination should be measured in the acquirer's consolidated financial statements using the revised tax laws and rates; also affecting goodwill. The accounting treatment in the acquired entity's separate financial statements would be as discussed above.

Specific applications

Accelerated capital allowances

13.191 Tax relief for capital expenditure on plant and machinery is given in some jurisdictions by way of capital allowances; these are a form of standardised tax depreciation. Capital allowances are deducted from accounting profit to arrive at taxable profit; the amount of depreciation charged in the financial statements is disallowed in the tax computation. Depreciation for tax and accounting purposes is the same over the asset's life, but differs from year to year; this gives rise to temporary differences under IAS 12, because of differences between the asset's carrying amount and tax base. The capital allowances often depreciate the asset at a faster rate for tax purposes than the rate of depreciation charged in the financial statements; this results in carrying amounts in excess of tax base. The temporary differences created are referred to as 'accelerated capital allowances'. The following example shows the origination and reversal of a temporary difference on an asset qualifying for capital allowances.

Example – Origination and reversal of temporary differences

An entity buys a machine in 20X1 for C100,000. The asset is expected to be recovered fully through use over five years. Depreciation is charged on a straight line basis for accounting purposes and is C20,000 per annum. The rate of capital allowances is 25% per annum on a reducing balance basis. The machine will be scrapped at the end of its useful life; and the entity will use any unclaimed capital allowances against future trading income.

The temporary difference will arise as follows:

Per financial statements

20X1

20X2

20X3

20X4

20X5

 

C'000

C'000

C'000

C'000

C'000

Carrying amount of asset

100

80

60

40

20

Depreciation charge

20

20

20

20

20

 


Book written down value (A)

80

60

40

20

0

 


Per tax computation

 

 

 

 

 

Carrying amount of asset

100

75

56

42

32

Capital allowance

25

19

14

10

8

 


Tax written down value = Tax base (B)

75

56

42

32

24

 


Temporary difference (A) – (B)

5

4

(2)

(12)

(24)

 

 

 

 

 

 

Originating (reversing)

 

 

 

 

 

Capital allowance allowed

25

19

14

10

8

Depreciation charged

20

20

20

20

20

 


 

5

(1)

(6)

(10)

(12)

 


A temporary difference of C5,000 originates in year 1. This begins to reverse from year 2 onwards. At the end of year 1, the asset's carrying amount is C80,000 and its tax base is C75,000. To recover the carrying amount of C80,000, the entity will have to generate taxable income of at least C80,000; but it will only be able to deduct capital allowances of C75,000. The difference of C5,000 gives rise to a taxable temporary difference on which deferred tax is provided.

 

This temporary difference unwinds as the benefit of lower current tax in the first year (that is, when capital allowances exceed depreciation) reverses from year 2 onwards; at this point, capital allowances have fallen below depreciation. From year 2 onwards, the current tax assessed and recognised in profit for the period is higher than the total amount due on the profit reported in the financial statements.

 

The cumulative deductible temporary difference at the end of year 5 will gradually reverse from year 6 onwards as it is utilised against future trading income.

13.191.1 A change in legislation can change the rates at which capital allowances are granted; this could affect the tax base of the asset on which deferred tax is measured. If an entity has taken into account the phasing of the reversal of temporary differences when recognising deferred tax, it will need to take into account changes in the timing of capital allowances. This change is accounted for in the period when the change in rates was substantively enacted (see further para 13.165).

Long-life assets and changes in tax allowances

13.192 On a use basis, an asset's tax base represents the amount that will be deductible for tax purposes against taxable income earned from its use in future periods. For non-current assets (such as property, plant and equipment), accounting depreciation is often recognised at a slower rate than tax depreciation is claimed. As the asset is used, accelerated tax allowances result in the asset's tax base being lower than its carrying amount. This gives rise to a taxable temporary difference on which a deferred tax liability is recognised. After all tax allowances have been claimed, the deferred tax liability unwinds as the asset continues to be used and depreciated for accounting purposes.

13.193 In a number of jurisdictions, legislation has been amended so that tax allowances can no longer be claimed for existing and new assets (that is, to reduce the tax depreciation rate to zero). The removal of future tax depreciation on an existing asset significantly reduces its tax base when deferred tax is measured on a use basis, because future deductions are no longer available. So the deferred tax liability for the existing asset increases; and there is often a tax expense in the income statement in the accounting period when substantive enactment occurs (see para 13.69).

Government grants

13.194 The accounting treatment of government grants and their treatment for tax purposes can give rise to temporary differences. Under IAS 20, government grants relating to assets are presented in the balance sheet in one of two ways: by recognising the grant as deferred income, or by deducting the grant in arriving at the asset's carrying amount. Grants given as a contribution towards an asset's cost of acquisition might be non-taxable; but some are in effect taxed by reducing the cost of fixed assets for capital allowance purposes. Other grants (such as revenue-based grants) are usually taxable on a cash received basis.

13.195 If the grant relating to an asset is not taxable, it has a tax base of nil and gives rise to a deductible temporary difference on initial recognition. This applies in two situations: first, where the grant is deducted from the asset's carrying amount; in this case, a deductible temporary difference arises, because the carrying amount is less than the asset's tax base which is cost; and, secondly, where the grant is set up as deferred income; in this case, the difference between the deferred income and its tax base of nil is a deductible temporary difference. But a deferred tax asset cannot be recognised because of the initial recognition exception noted in paragraph 13.162 and explained in paragraph 13.163.1. It would be irrational to recognise the tax benefit associated with this temporary difference on initial recognition when the income from the grant itself is recognised over a number of periods.

13.195.1 For grants related to assets, there might be a temporary difference relating to the asset as well as the deductible temporary difference relating to the grant. Where the grant is deducted from the asset's cost, any taxable temporary difference relating to the asset (for example, where tax deductions exceed accounting depreciation) needs to be calculated on the difference between the following two amounts: the asset's net book value excluding the grant (that is, gross cost less accumulated depreciation calculated on the gross cost) and its tax written down value also excluding the grant (that is, gross cost less tax allowances claimed).

13.196 Where a grant relating to an asset is taxable, the nature of the deferred tax adjustment depends on how the grant is treated for tax and accounting purposes. If the grant is deducted from the cost of fixed assets for financial reporting and tax purposes, the deferred tax calculation is relatively straightforward where capital allowances for tax purposes are calculated on a reduced cost. If the grant is treated as a deferred credit for financial reporting purposes, but deducted against the asset's cost for capital allowance purposes, the deferred tax calculation consists of two components: a deferred tax asset arises on the unamortised grant; and this is netted off against the deferred tax liability arising on the accelerated capital allowances. In practice, the balance on the deferred income account reduces the asset's book value for the purpose of calculating the temporary difference.

Example – Capital allowances restricted by amount of grant

An entity buys a fixed asset for C120,000. The asset qualifies for a grant of C20,000; the grant is treated in the financial statements as a deferred credit. The asset has a useful economic life of five years. The entity claims capital allowances (25% reducing balance), but these are restricted by the amount of the grant. The temporary differences for deferred tax purposes are calculated as follows:

Per financial statements

20X1

20X2

20X3

20X4

20X5

 

C

C

C

C

C

Cost of asset

120,000

96,000

72,000

48,000

24,000

Depreciation

(24,000)

(24,000)

(24,000)

(24,000)

(24,000)

 


Net book value

96,000

72,000

48,000

24,000

 


Unamortised deferred income

16,000

12,000

8,000

4,000

 


 

Per tax computation

20X1

20X2

20X3

20X4

20X5

 

C

C

C

C

C

Cost of asset

120,000

 

 

 

 

Less grant

(20,000)

 


 

 

 

 

Cost net of grant

100,000

75,000

56,250

42,187

31,640

Capital allowances @ 25%

(25,000)

(18,750)

(14,063)

(10,547)

(7,910)

 


Tax base

75,000

56,250

42,187

31,640

23,730

 


Temporary difference

 

 

 

 

 

Net book value of fixed asset

96,000

72,000

48,000

24,000

Unamortised grant

(16,000)

(12,000)

(8,000)

(4,000)

 


 

80,000

60,000

40,000

20,000

Tax base

(75,000)

(56,250)

(42,187)

(31,640)

(23,730)

 


Cumulative temporary difference

5,000

3,750

(2,187)

(11,640)

(23,730)

 


The temporary difference profile will be the same if the grant is deducted directly from the asset's cost and the net amount is written off over five years.

13.197 Non-taxable revenue-based grants have no deferred tax consequences, the amortised credit to the income statement does not enter into the determination of taxable profits. If a revenue-based grant is taxable, a temporary difference will arise between its carrying amount and its tax base. Where a revenue-based grant is taxed on receipt but amortised over a period for financial reporting purposes, it gives rise to a deductible temporary difference; this is the difference between the carrying amount of the unamortised balance and a nil tax base. A deferred tax asset is recognised on the deductible temporary difference if it is probable that the entity will earn sufficient taxable profit in later accounting periods (as the deferred credit unwinds through amortisation) so that it will benefit from the reduction in tax payments. A grant that was taxed on receipt might become repayable, and the repayment qualifies for tax relief in the year when the repayment is made; any deferred tax asset previously carried forward should be immediately written off as part of the tax charge.

Leases

13.198 Many entities enter into lease and hire purchase contracts giving them the right to use or purchase assets. In many jurisdictions, a lease contract does not provide for legal title to the leased asset to pass to the lessee. A hire purchase contract has similar features to a lease, except that the hirer can acquire legal title by exercising an option to purchase the asset on fulfilment of specified conditions (often the payment of a number of instalments).

13.199 Assets acquired under leases and hire purchase contracts give rise to temporary differences between the carrying amount and tax base. Where the asset is bought under a hire purchase agreement, the hirer normally accounts for the fixed asset's acquisition and can claim the capital allowances and therefore no particular deferred tax problems arise. Similarly, no deferred tax problems normally arise in accounting for an operating lease. The amount that is charged to rentals by the lessee in its income statement is likely to be the same as the amount charged in arriving at the taxable profit. An exception to this is where accrued rentals give rise to short-term temporary differences.

Finance leases – Lessees

 

13.200 When a lessee enters into a finance lease, an asset and a liability are recognised in its balance sheet. On inception of the lease, this accounting has no immediate tax impact in most territories. Both the tax base of the asset and the tax base of the liability are nil, as generally tax deductions are received when the lease payments are made. IAS 12 does not specifically address the tax effects of finance leases and there are two principal approaches to the deferred tax accounting. The choice of approach is a matter of accounting policy, to be applied on a consistent basis.

13.200.1 One approach considers the lease as a single transaction in which the asset and liability are integrally linked, so there is no net temporary difference at inception. Subsequently, as the settlement of the liability and the amortisation of the leased asset diverge, there will be a net temporary difference on which deferred tax is recognised. A deferred tax asset  would be subject to IAS 12 recognition criteria.

13.200.2 The second approach, which was developed by the Interpretations Committee in April 2005, considers the asset and the liability separately. The temporary difference on each item (the difference between the carrying amount and a tax base of nil) does not give rise to deferred tax since the initial recognition exception applies.

13.200.3 Additionally some take the view that the initial recognition exception does not apply under the second approach. Paragraphs 15 and 24 of IAS 12 refer to 'the initial recognition of an asset or liability'; in this case, an asset and a liability are recognised at the same time, with equal and opposite temporary differences. This approach results in a similar net deferred tax amount recognised in the balance sheet to that recognised under the first approach but disclosures are different as both the deferred tax asset and deferred tax liability should be presented in the notes at their gross amounts.

13.200.4 The Interpretations Committee noted that there is diversity in practice in applying the requirements of IAS 12 to assets and liabilities arising from finance leases and agreed in June 2005 not to develop any guidance because the issue fell directly within the scope of the Board's short-term convergence project on income taxes. However, this project was suspended and there have been no further developments.

13.200.5 Subsequent changes to the finance lease asset and liability will need to be considered whenever the initial recognition exception applies. Management will need to analyse the movements in the temporary differences to see if they are due to subsequent changes in the amount that gave rise to the temporary differences on initial recognition or whether they are new temporary differences on which deferred tax is recognised (see para 13.164 onwards).

13.200.6 The accounting implications of the two main approaches for determining deferred tax on finance lease in the lessee's financial statements are shown in the following example.

Example – Deferred tax on finance lease asset and liability

 

 

 

An entity leases a car under a 3 year finance lease contract. Lease payments are spread evenly over the lease term.

 

 

 

Cost of the car

C10,000

Expected residual value

C0

Economic life of the car

3 years

Tax rate

30%

Interest rate

5%

 

The asset is depreciated on a straight-line basis over 3 years.

 

The leased asset and liability recognised in the balance sheet and income statement are as follows:

 

 

Initial recognition

Year 1

Year 2

Year 3

Balance sheet:

 

 

 

 

Asset

10,000

6,667

3,334

0

Liability

(10,000)

(6,831)

(3,501)

(0)

 

 

 

 

 

Income statement:

 

 

 

 

Depreciation

3,333

3,333

3,334

Interest

428

267

96

 


Total

3,761

3,600

3,430

 


Assume that tax deductions will be received when the lease payments are made, so there is no deduction for asset depreciation or finance costs. The two principal approaches for determining the deferred tax in respect of the leased asset and liability in the lessee's financial statements illustrated below.

 

Approach 1– Leased assets and liabilities as integrally linked

 

 

 

 

 

 

 

 

 

 

Initial recognition

Year 1

Year 2

Year 3

Temporary differences:

 

 

 

 

Carrying amount of asset

10,000

6,667

3,334

0

Carrying amount of liability

(10,000)

(6,831)

(3,501)

(0)

 


Net carrying amount of finance lease

0

(164)

(167)

(0)

 


Tax base of asset

0

0

0

0

Tax base of liability (carrying amount less deduction)

0

0

0

0

 


Net tax base of finance lease

0

0

0

0

Deductible temporary difference

0

(164)

(167)

(0)

Deferred tax asset @ 30%

49

50

0

 

Initial recognition

 

The asset's tax base is nil because there are no associated tax deductions from recovering the asset. The liability's tax base (carrying amount less future deductions) is also nil because the lease payments are deductible in the future . So the net tax base of the finance lease is nil.

 

As the net carrying amount of the asset and liability is nil, there is no temporary difference associated with the net amount of the finance lease.

 

Subsequent changes

 

The asset is depreciated and the liability decreases as rental payments are made. As the asset and liability carrying amounts decrease at different rates, a net liability arises.

 

The tax base of the net liability remains nil, so the net book liability that arises results in a deductible temporary difference. A deferred tax asset is recognised subject to IAS 12's recognition criteria .

 

 

Initial recognition

Year 1

Year 2

Year 3

Temporary differences:

 

 

 

 

Carrying amount of asset

10,000

6,667

3,334

0

Tax base

 


Taxable temporary difference

10,000

6,667

3,334

Covered by initial recognition exception

10,000

6,667

3,334

 


Remaining deductible temporary difference not covered by initial recognition exception

 


Total deductible temporary difference

 


Carrying amount of liability

(10,000)

(6,831)

(3,501)

(0)

Tax base (carrying amount less deduction)

 


Deductible temporary difference

(10,000)

(6,831)

(3,501)

(0)

Covered by initial recognition exception

(10,000)

(6,831)

(3,501)

(0)

 


Remaining deductible temporary difference not covered by initial recognition exception

 


Total deductible temporary difference

 


Deferred tax asset @ 30%

 


 

Initial recognition

 

The asset's tax base is nil because there are no associated tax deductions from recovering the asset; so there is a temporary difference equal to the asset's carrying amount on initial recognition.

 

The liability's tax base (carrying amount less future deductions) is also nil; so there is a temporary difference equal to the liability's carrying amount on initial recognition.

 

These temporary differences are covered by the initial recognition exception; so no deferred tax arises on initial recognition.

 

Subsequent changes

 

The temporary differences decrease as the asset is depreciated and the liability is repaid. Both temporary differences were covered by the initial recognition exception and subsequent changes are also covered by the initial recognition exception and therefore no deferred tax is recognised. [IAS 12 para 22(c)].

Finance leases – Lessors

13.201 When a lessor enters into a finance lease, the leased asset is derecognised and the amount due from the lessee under the finance lease is recognised in its balance sheet as a receivable at an amount equal to the lessor's net investment in the lease, with any gain or loss recognised in profit or loss. In many jurisdictions, tax deductions continue to be given for the leased asset with the lease payments taxed upon receipt.

13.201.1 The derecognition of the leased asset and the recognition of the finance lease receivable should be considered as a single transaction in which the finance lease receivable and the leased asset are linked. At inception the tax base of the leased asset might be equal to or different from the carrying amount of the lease receivable. Deferred tax is recognised to the extent there is a temporary difference. Subsequently, the temporary difference will change or arise and the corresponding deferred tax should be recognised.

13.201.2 An alternative in which the lessor considers each item separately and applies the initial recognition exception to the initial temporary difference arising on the lease receivable is not acceptable. The substance of this transaction is the exchange of one asset (the fixed asset) for consideration (lease receivable) with any difference recognised in profit or loss and so the initial recognition exception would not apply.

13.201.3 The accounting implications of the approach for determining deferred tax on a finance lease in the lessor's financial statements are shown in the following example.

Example – Deferred tax on finance lease asset and liability

 

 

 

An entity leases a car that it owns under a 3 years finance lease contract. Lease payments are spread evenly over the lease term.

 

 

 

Carrying amount of the car

C9,000

Selling price of the car

C10,000

Economic life of the car

3 years

Tax rate

30%

Interest rate

5%

 

 

The asset is depreciated on a straight-line basis over 3 years for tax purposes.

 

 

 

The leased asset is derecognised and a lease receivable is recognised in the balance sheet and income statement as follows:

 

 

 

Initial recognition

Year 1

Year 2

Year 3

Balance sheet:

 

 

 

 

Asset (Previous carrying amount C9,000)

Lease receivable (Selling price of the car)

10,000

6,831

3,501

 

 

 

 

 

Income statement:

 

 

 

 

Gain

1,000

Interest income

428

267

96

 


Total

1,000

428

267

96

 


Assume that tax deductions will be received when the lease payments are made, so there is no deduction for asset depreciation or finance costs. As noted in paragraph 13.200, there are two principal approaches for determining the deferred tax in respect of the leased asset and liability in the lessee's financial statements. These approaches are illustrated below.

 

Leased assets and receivable integrally linked

 

 

 

 

 

 

 

 

 

 

Initial recognition

Year 1

Year 2

Year 3

Temporary differences:

 

 

 

 

Carrying amount of leased asset

Carrying amount of lease receivable

10,000

6,831

3,501

 


Net carrying amount of finance lease

10,000

6,831

3,501

 


Tax base of leased asset

9,000

6,000

3,000

Tax base of lease receivable

 


Net tax base of the finance lease

9,000

6,000

3,000

Taxable temporary difference

1,000

831

501

Deferred tax liability @ 30%

300

249

150

 

Initial recognition

 

The leased asset is derecognised but is not sold for tax purposes so its tax base remains unchanged. The lease receivable's tax base is nil because lease payments are taxable in the future as they are received. So the net tax base of the finance lease equals the tax base of the leased asset.

 

The temporary difference associated with the net amount of the finance lease arises from the recognition of a gain that affects the profit or loss. It is not covered by the initial recognition exception and a deferred tax liability should be recognised.

 

Subsequent changes

 

The asset is depreciated for tax purposes and the lease receivable decreases as rental payments are received. The temporary difference associated with the net amount of the finance lease decreases over time, as does the taxable temporary difference.

Decommissioning assets and obligations

13.202 Decommissioning costs arise in a number of industries, such as the electricity and nuclear industries; abandonment costs in the mining and extractive industries; and environmental clean-up costs in a number of industries. IAS 37 requires management to recognise a provision at the outset for the obligation to decommission an asset and to capitalise a corresponding decommissioning asset in addition to the underlying asset. The decommissioning asset is depreciated over the life of the underlying asset. The accounting for decommissioning obligations (also referred to as 'asset retirement obligations') and the related asset is discussed in chapter 21. In many jurisdictions, this will have deferred tax implications.

13.202.1 Similar to finance lessees, the initial recognition of the asset and the obligation has no immediate tax impact in most territories. Both the tax base of the asset and the tax base of the liability are nil, because in many jurisdictions the tax deduction for the decommissioning cost is only available when an entity incurs the expenditure. We consider that there are two principal approaches for the deferred tax accounting. The choice of approach is a matter of accounting policy, to be applied on a consistent basis. Under both approaches, the deferred tax accounting applies to discounted carrying amounts for assets and liabilities; so, on initial recognition, the tax deductions are based on the discounted amounts, rather than the gross amounts payable in the future. IAS 12 focuses on the future tax consequences of recovering an asset or settling a liability at its carrying amount, which is the discounted amount (see paras 13.113 and 13.121).

13.202.2 One approach considers that the decommissioning assets and liabilities are integrally linked and should be viewed on a net basis. No deferred tax arises at inception, but a temporary difference arises subsequently as the asset carrying amount decreases due to its depreciation and the liability carrying amount increases due to the unwinding of the discount. Deferred tax would be recognized on this temporary difference. Any deferred tax asset would be recognised subject to IAS 12 recognition criteria.

13.202.3 The alternative approach allocates the future tax deductions to the liability. The asset's tax base is nil because there are no associated tax deductions; so there is a temporary difference equal to the asset's carrying amount on initial recognition. The liability's tax base (that is, carrying amount less future deductions) is also nil; so there is a temporary difference equal to the liability's carrying amount on initial recognition. For decommissioning obligations (and related assets) arising outside a business combination and which do not affect accounting profit or taxable profit on initial recognition, these temporary differences will be covered by the initial recognition exception (see para 13.162); so no deferred tax arises on initial recognition.

13.202.4 For later changes to decommissioning assets and liabilities, management will need to determine how to account for them under the relevant approach. The two approaches will not necessarily give the same results, due to the intricacies of the initial recognition exception. In particular, where the initial recognition exception applies, management will need to analyse the movements in the temporary difference; this is to see if they are due to reversals of the amount that gave rise to the temporary difference or whether they are new temporary differences on which deferred tax is recognised (see para 13.164 onwards).

13.202.5 The accounting implications of the two approaches for determining deferred tax on decommissioning assets and liabilities are shown in the following example.

Example – Deferred tax on decommissioning asset and obligation

An entity will incur decommissioning costs of C1m relating to its plant in 3 years' time. The plant was not acquired as part of a business combination. The applicable discount rate is 8% and the tax rate is 30%.

Expected decommissioning cost in 3 years' time

C1,000,000

Expected decommissioning cost (discounted)

C794,000

 

 

Under IAS 37, the decommissioning asset and liability are recorded at C794,000 on initial recognition.

 

The asset is depreciated on a straight-line basis over 3 years.

 

It is assumed that there are no changes in estimates.

 

The decommissioning costs recognised in the balance sheet and income statement are as follows:

 

 

 

 

 

 

 

Initial recognition

Year 1

Year 2

Year 3

 

C'000

C'000

C'000

C'000

Balance sheet:

 

 

 

 

Asset

794

529

264

Liability

(794)

(858)

(926)

(1,000)

 

 

 

 

 

Income statement:

 

 

 

 

Depreciation (total = 794)

 

265

265

264

Interest (total = 206)

 

64

68

74

 

 


Total (= 1,000)

 

329

333

338

 

 


 

 

 

Assume that tax deductions will be received when the expenditure is incurred. There are two main approaches for determining the deferred tax in respect of the decommissioning asset and liability. These approaches are illustrated below.

 

Approach 1 – Tax deductions allocated to the decommissioning asset

 

 

 

 

 

 

 

Initial recognition

Year 1

Year 2

Year 3

 

C'000

C'000

C'000

C'000

Temporary differences:

 

 

 

 

Carrying amount of asset

794

529

264

Carrying amount of liability

794

858

926

1,000

 


Net carrying amount of the decommissioning assets and liabilities

0

(329)

(662)

(1,000)

 


 

 

 

 

 

Tax base of asset

0

0

0

0

Tax base of liability (carrying amount less deductions)

0

0

0

0

 


Net tax base of the decommissioning assets and liabilities

0

0

0

0

Deductible temporary difference

 

(329)

(661)

(1,000)

 

 

 

 

 

Deferred tax asset @ 30%

0

99

198

300

 


Initial recognition

 

The asset's tax base is nil because there are no associated tax deductions. The liability's tax base  is also nil because of the future tax deduction when the liability is settled (the tax base of the liability equals its carrying amount less future deductions). So the net tax base of the decommissioning asset and liability is nil.

 

As the net carrying amount of the asset and liability is nil, there is no temporary difference associated with the net amount of the decommissioning asset and liability.

 

Subsequent changes

 

As the asset is depreciated and the liability increases because of the unwinding of the discount, a net liability arises and increases over time.

 

The net tax base of the asset and liability remains nil, so the net liability that arises results in a deductible temporary difference. A deferred tax asset is recognised (subject to IAS 12's recognition criteria).

 

Approach 2 – Tax deductions allocated to the decommissioning liability

 

 

 

 

 

 

 

Initial recognition

Year 1

Year 2

Year 3

 

C'000

C'000

C'000

C'000

Temporary differences:

 

 

 

 

Carrying amount of asset

794

529

264

0

Tax base

0

0

0

0

 


Taxable temporary difference

794

529

264

0

Covered by initial recognition exception

(794)

(529)

(264)

0

 


Remaining taxable temporary difference not covered by initial recognition exception

0

0

0

0

 


 

 

 

 

 

Carrying amount of liability

794

858

926

1,000

Tax base (carrying amount less deductions)

0

0

0

0

 


Deductible temporary difference

(794)

(858)

(926)

(1,000)

Covered by initial recognition exception

794

794

794

794

 


Remaining deductible temporary difference not covered by initial recognition exception

0

(64)

(132)

(206)

 


 

 

 

 

 

Total deductible temporary difference

0

(64)

(132)

(206)

 

 

 


Deferred tax asset @ 30%

0

19

40

62

 


 

Initial recognition

 

The asset's tax base is nil because there are no associated tax deductions; so there is a temporary difference equal to the asset's carrying amount on initial recognition. The liability's tax base  is also nil because of the future tax deduction when the liability is settled (the tax base of the liability equals its carrying amount less future deductions). So there is a temporary difference equal to the liability's carrying amount on initial recognition.

 

Assuming that the decommissioning obligation (and related asset) does not arise from a business combination, these temporary differences will be covered by the initial recognition exception; so no deferred tax arises on initial recognition.

 

Subsequent changes

 

As the asset is depreciated, the temporary difference that was covered by the initial recognition exception is reduced; the reduction is also covered by the initial recognition exception and so no deferred tax asset is recognised. [IAS 12 para 22(c)].

 

The unwinding of the discount on the liability increases the temporary difference; it is not a reduction of the initial amount but rather the creation of a new temporary difference. It is not covered by the initial recognition exception so a deferred tax asset is recognised (subject to IAS 12's recognition criteria).

13.202.6 Similar to approach one, the above alternative assumes the application of the initial recognition exception. There is an additional view that the initial recognition exception does not apply under approach 2. This is based on the fact that paragraphs 15 and 24 of IAS 12 refer to 'the initial recognition of an asset or liability'; in this case, an asset and a liability are recognised at the same time, with equal and opposite temporary differences. Under this view, a deferred tax liability would be recognised in respect of the taxable temporary difference on the decommissioning asset; and (subject to IAS 12's recognition criteria) a deferred tax asset would be recognised in respect of the deductible temporary difference on the decommissioning liability. Subsequent changes to the decommissioning asset and liability would also have a deferred tax impact, because the initial recognition exception has not been applied. Given that different approaches are acceptable, an entity should make clear its accounting policy for deferred tax on decommissioning obligations if this is material. This approach results in a similar net deferred tax amount recognised in the balance sheet than under approach 1 but disclosures are different since under this approach the deferred tax asset and deferred tax liability should be presented in the notes at their gross amounts.

13.202.7 In some situations, tax deductions are available on some (but not all) of the decommissioning expenditure. Management needs to understand the basis for the tax deductions in order to determine the deferred tax implications. If the tax deduction relates to (or is a proxy for) specific types of expenditure, it might be necessary to treat this expenditure as a separate component of the decommissioning asset and liability for the purpose of allocating the deductions. There might be no relationship to specific expenditure, but tax deductions are given instead as a percentage of total expenditure; in this case, the tax base is determined using that percentage figure.

Post-retirement benefits

13.203 Accounting for pension costs and other post-retirement benefits gives rise to a temporary difference for deferred tax purposes. Tax relief on employers' pension contributions is often given in the period when they are paid, rather than when the costs are recognised in the financial statements, with the possible exception of some large contributions, where tax relief might be spread over a period. In an unfunded plan, and in the case of provisions for unfunded benefits (such as post-retirement healthcare), the tax relief is often given when the pensions or other benefits are paid. In the financial statements, on the other hand, pension costs and other post-retirement benefits are recognised under IAS 19 as service is provided by the employee.

13.203.1 A deductible temporary difference arises between the carrying amount of the net defined benefit liability and its tax base; the tax base is usually nil, unless tax relief on contributions paid is received in a period subsequent to payment. In most cases, this deductible temporary difference will reverse, but it might take a long time. This is particularly relevant for defined benefit pension plans, unfunded pensions and post-retirement benefit plans. A deferred tax asset is recognised under IAS 12 for these temporary differences if it is recoverable.

13.203.2 A deferred tax asset should be recognised to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised. [IAS 12 para 24]. The question arises whether deferred tax liabilities resulting from other temporary differences can be taken into account in determining the recoverability of the deferred tax asset relating to pensions. Future reversals of existing taxable temporary differences are dealt with in paragraph 13.134 onwards. A deferred tax asset for a pension obligation cannot be recognised simply because there are sufficient taxable temporary differences at the balance sheet date; the timing of reversal of the taxable temporary differences also needs to be taken into account.

13.203.3 Management might need to schedule the reversal of temporary differences to justify recognising the deferred tax asset. In many jurisdictions, the entity has to have plans in place to eliminate the pension deficit – simply making the normal contributions will not eliminate the deficit. Recognising a tax asset in respect of the pension obligations should take into account the expected timing of regular and one-off contributions necessary to eliminate the deficit.

13.203.4 If the entity has incurred losses in the past and also in the current period, this could impact the recognition of tax assets. For example, if the entity continues to make losses in the next few years but the amount of the reversal of the existing taxable temporary differences in those years is not enough to create taxable profits (with the effect that any pension contributions made in those years simply add to the tax loss), the deferred tax asset might not be recoverable. For an assessment of the likelihood that taxable profits will be available when there has been a history of trading losses, see paragraph 13.144 onwards.

13.203.5 Where a net defined benefit asset arises (for example, in respect of a surplus in the pension plan), a taxable temporary difference will arise and a deferred tax liability will be recognised.

13.203.5.1 Guidance on how entities should assess the recoverability of a defined benefit pension surplus is given in IFRIC 14 (see further chapter 11). If a pension surplus refund is subject to a tax other than income tax, an entity measures the amount of the refund net of the tax. [IFRIC 14 para 13]. But if a surplus refund is subject to income tax, the deferred tax liability relating to the pension surplus is determined under IAS 12 and recognised separately from the pension asset.

13.203.5.1.1 IAS 1 requires information to be disclosed about key sources of estimation uncertainty; IFRIC 14 states that such information might include restrictions on the current realisability of the surplus; it might also include the basis used to determine the amount of the economic benefit available. The manner of recovery could also impact deferred tax accounting in jurisdictions where refunds of surplus are subject to income tax at a different rate from the normal corporate income tax rate.

13.203.5.2 The right to a refund or the right to a reduction of future contributions needs to exist in order to recognise a pension asset; but IAS 12 requires the entity to consider its expected manner of recovery in determining the relevant tax rate and tax base for calculating the deferred tax liability relating to the pension asset. So the entity could have a right to a refund from the plan (and immediately pass the IFRIC 14 test), but it might expect to realise the economic benefits of the surplus through reductions in future contributions. For instance, this might be the case where a lower tax rate applies to reduced contributions than to a refund.

13.203.5.3 Where the entity expects to recover the surplus through reduced contributions, it will need to confirm that it has sufficient capacity to reduce future contributions over the scheme's remaining life. In some cases, the entity might expect to recover the pension asset in part through reduced contributions and in part through a refund; the appropriate tax rates and tax bases should be used to determine the deferred tax liability for each part of the expected recovery.

13.203.6 IAS 19 requires actuarial gains and losses to be recognised as they arise, outside profit or loss. Pension cost accounting might give rise to current tax (tax relief on contributions) and deferred tax (on the temporary difference between the net defined benefit asset or liability and its tax base). There is no direct relationship between the components of pension cost reported in the performance statements and the contributions and benefits paid in a period; so current and deferred tax need to be allocated between the performance statements.

13.203.7 Current and deferred tax should be recognised outside profit or loss if the tax relates to items that are recognised outside profit or loss. [IAS 12 para 61A]. It can sometimes be difficult to determine the amount of current and deferred tax that relates to items recognised outside profit or loss. In this case, current and deferred tax should be allocated on a reasonable pro rata basis, unless another method of allocation is more appropriate in the circumstances. [IAS 12 para 63].

13.203.8 IAS 12 does not specify a method of allocating current and deferred tax relating to post-retirement benefits. It is acceptable for tax relief on pension contributions to be allocated so that the contributions cover profit and loss items first and actuarial losses second (unless some other allocation is more appropriate). If contributions exceed those items, tax relief relating to the excess is credited in profit or loss (unless it is more appropriate to allocate it to other comprehensive income). Where a special contribution is made to fund a deficit arising from an identifiable cause (such as an actuarial loss), an alternative method of allocation might be appropriate; in that case, the tax relief should be allocated to other comprehensive income. But, if there is no clear link between the special contribution and the items recognised in the performance statements, the first method shown above should be used.

13.203.9 The allocation of current and deferred tax is illustrated in the following simplified examples, which show the movements in the pension balance during the year. A tax rate of 30% is assumed.

Example 1 – Defined benefit asset with an actuarial loss

 

 

 

Change in defined
benefit asset

Current tax
relief (30%)

Deferred
tax liability (30%)

 

C

C

C

Brought forward

120

 

(36)


Contributions

70

(21)

 


Income statement – net pension cost

(60)

18

Other comprehensive income – actuarial loss

(20)

3

3


 

(80)

21

3


Carried forward

110

(33)


 

Current tax relief of C21 arises on contributions paid of C70. This is allocated first to cover pension cost of C60 reported in the income statement (resulting in a credit of C18 in the tax charge). The balance of the contributions paid of C10 is allocated to the actuarial loss; hence, current tax of C3 is credited in other comprehensive income. Deferred tax of C3 is attributable to the balance of the actuarial loss of C10; this is credited in other comprehensive income.

Example 2 – Defined benefit liability with an actuarial loss

 

 

 

 

 

Change in defined
benefit liability

Current tax
relief (30%)

Deferred
tax asset (30%)

 

C

C

C

Brought forward

(200)

 

60


Contributions paid

80

(24)

 


Income statement – net pension cost

(70)

21

Other comprehensive income – actuarial loss

(20)

3

3


 

(90)

24

3


Carried forward

(210)

63


 

Current tax relief of C24 arises on contributions paid of C80. This is allocated first to cover pension cost of C70 reported in the income statement (resulting in a credit of C21 in the tax charge). The balance of the contributions paid of C10 is allocated to the actuarial loss; hence, current tax of C3 is credited in other comprehensive income. Deferred tax of C3 is attributable to the balance of the actuarial loss of C10; this is credited in other comprehensive income.

Example 3 – Defined benefit liability with an actuarial gain

 

If, in the above example, there was an actuarial gain rather than an actuarial loss, the whole of the current tax relief of C24 would be credited in the income statement. None of the current tax can be allocated to other comprehensive income because there is no debit in other comprehensive income. Thus, the initial C21 (30% of C70) is allocated to the income statement, nil is allocated to other comprehensive income, and the excess of C3 is allocated to the income statement. Deferred tax attributable to the actuarial gain would be charged in other comprehensive income, as shown below.

 

 

 

 

 

Change in defined benefit liability

Current tax relief (30%)

Deferred tax asset (30%)

 

C

C

C

Brought forward

(200)

 

60


Contributions

80

(24)

 


Income statement – net pension cost

(70)

24

(3)

Other comprehensive income – actuarial gain

20

(6)


 

(50)

24

(9)


Carried forward

(170)

51


13.203.10 The allocation is more complicated if a large contribution is made in the period (for example, to reduce an existing pension deficit). Assume that, in example 2 above, an additional contribution of C100 was paid and tax deductions were received in the period.

Example – Receipt of tax relief on additional contribution

 

 

 

 

 

Change in defined benefit liability

Current tax relief (30%)

Deferred tax asset (30%)

 

C

C

C

Brought forward

(200)

 

60


'Normal' contributions paid

80

(24)

 

Additional contributions paid

100

(30)

 


Income statement – net pension cost

(70)

21

Other comprehensive income:

 

 

 

Current year actuarial loss

(20)

3

3

Relating to previous actuarial losses

30

(30)


 

(90)

54

(27)


Carried forward

(110)

33


 

If tax deductions on the normal contribution of C80 and the additional contribution of C100 are all received in the period (that is, no spreading of deductions), the current tax relief of C24 on the 'normal' contributions is allocated as follows: first, against the pension cost in the income statement; and the balance is allocated against the actuarial loss.

 

Further current tax deductions of C30 are received on the additional contribution. So there is an excess deduction to be considered. Under the allocation hierarchy in paragraph 13.203.7, this excess would go to the income statement, unless another method of allocation is more appropriate. The treatment of the deferred tax in relation to the additional contribution will depend on the reason for making that contribution. In this case, it is likely that the additional contribution is funding past actuarial losses. So it is necessary to determine where the underlying items – giving rise to the deficit that is being funded – were originally recognised; this is done by backwards-tracing the items in the performance statement. Thus the tax movement is allocated to other comprehensive income, as illustrated above.

 

But if the additional contribution was made to fund current year actuarial losses as well as previous actuarial losses, C3 would be allocated to other comprehensive income (to cover the C10 of actuarial loss made in the current year not yet tax affected). There is an excess deduction of C27 after allocating to the net pension cost in the income statement and any actuarial losses in other comprehensive income. Again, this should be allocated to other comprehensive income if the contribution was made to fund the accumulated actuarial losses. Notably, this has the same outcome as the allocation method illustrated in the table above. An element of judgement will be needed when considering why the additional contribution was made.

 

It will be necessary to backwards-trace further if the deductions received in the year exceed the current and prior year actuarial losses that had not been allocated current tax deductions. If it can be established (using backwards-tracing) that the tax deductions relate to prior year actuarial losses, the excess tax deductions will be recognised in other comprehensive income; and there will be a corresponding reversal of deferred tax (as shown above).

 

Just because a pension liability recognised on transition to IFRS was charged to equity, current tax deductions or subsequent changes in any related deferred tax asset will not necessarily also be recognised in equity (see further para 13.288.7).

13.203.11 If tax deductions are spread across more than one accounting period, this will impact on the deferred tax calculation because the deduction received in the current year will be lower. Assume that, in the example above, the tax relief for the additional contribution of C100 is spread over three periods; that is, only one-third of the relief on the additional contribution is received in the current period.

Example – Spreading of tax relief on additional contribution

 

 

 

 

 

Change in defined benefit liability

Current tax relief (30%)

Deferred tax asset (30%)

 

C

C

C

Brought forward

(200)

 

60


'Normal' contributions paid

80

(24)

 

Additional contributions paid

100

(10)

 


Income statement – net pension cost

(70)

21

Other comprehensive income:

 

 

 

Current year actuarial loss

(20)

3

3

Relating to previous actuarial losses

10

(10)


 

(90)

34

(7)


Carried forward

(110)

53


 

Note that the deferred tax balance at the period end is not 30% of the pension balance.

 

Assuming that a deferred tax asset has been recognised in relation to the pension liability at the beginning of the period, part of this deferred tax asset reverses as a result of the tax deductions received in the period. But, if the contributions paid do not receive tax relief in the period, a corresponding portion of the deferred tax asset on the opening pension liability will continue to be carried forward (assuming the recognition criteria are met); and this portion will reverse in the future when the tax deductions are received.

 

The deferred tax asset can be summarised as:

 

 

C

On pension liability at year end (110 × 30%)

33

Outstanding deductions on contributions made (100 × 30% × 2/3)

20

 


Total deferred tax asset

53

 


 

In terms of the pension liability's tax base, the tax base of a liability is its carrying amount less any amount that will be deductible for tax in future periods (see para 13.122). So the deductible temporary difference will be equal to the future deductible amounts. If, in arriving at the pension liability of C110, contributions of C100 had been paid in the period on which tax relief is spread over 3 years (with tax relief on C33 received in the current year), the tax base will be the carrying amount of the liability (C110) less future deductible amounts (C110 + C67 = C177) = a tax base of – C67. In other words, the carrying amount in the balance sheet is a liability; but the tax base is an asset (of C67), representing the deductions receivable in the future for payments made and payments to be made. This gives a deductible temporary difference of C110 – (– C67) = C177 (that is, equal to the future deductible amounts).

 

A deferred tax asset of C177 × 30% = C53 should be recognised to the extent that it is probable that the deferred tax asset will be recovered.

Share-based payment transactions

Equity-settled transactions

13.204 IFRS 2 requires entities to recognise the cost of equity-settled share-based awards to employees on the basis of the fair value of the award at the date of grant, spread over the vesting period (see further chapter 12). But any deduction available for tax purposes in the case of equity-settled transactions often does not correspond to the amount charged to profit or loss under IFRS 2.

13.205 A deductible temporary difference arises between the tax base of the remuneration expense recognised in profit or loss (that is, the amount permitted by the tax authorities as a deduction in future periods) and its carrying amount of nil on the balance sheet (the credit is against retained earnings). This gives rise to a deferred tax asset. The calculation of the deferred tax asset is complicated by the fact that the future tax deduction will be based on the share price at the date of exercise; and the price is not known until that date. So the amount of the tax deduction to be obtained in the future (that is, the tax base) should be estimated on the basis of the information available at the end of the period. Thus, the measurement of the deductible temporary difference should be based on the entity's share price at the balance sheet date. [IAS 12 para 68B].

13.205.1 Management will estimate the future tax deductions available based on the share options' intrinsic value at the balance sheet date. The estimate of the tax deduction should be based on the number of options expected to be exercised (as opposed to the number of options outstanding at the balance sheet date); this will give the best estimate of the amount of the future tax deduction.

13.206 The amount of the future tax deduction (calculated as set out above) is unlikely to be the same as the remuneration expense recognised in profit or loss and credited to equity. If the amount of the estimated future tax deduction exceeds the cumulative amount of the remuneration expense, this indicates that the tax deduction relates to an equity item as well as the remuneration expense. In that situation, the excess deferred tax should be recognised in equity under the principle that the tax should follow the item. This also applies to any excess current tax that arises in the year of exercise. [IAS 12 para 68C]. (See further para 13.288.2.)

13.206.1 The accounting for excess deferred tax on an equity-settled share-based award is illustrated in the following example.

Example – Excess deferred tax on an equity-settled share-based award

On 1 January 20X3, 100,000 options are issued with a fair value of C360,000. The vesting period is 3 years and all options are expected to be exercised. All of the share options are exercised in year 4. The tax rate is 30%. The intrinsic value of the share options (that is, market value of the underlying shares less exercise price) at the end of years 1, 2 and 3 and at the date of exercise in year 4 is C330,000, C300,000, C380,000 and C400,000, respectively.

The total staff cost recognised in each of the first 3 years is C120,000. At the end of the first year, the estimated corresponding tax benefit available in the future is C33,000 (30% × × C330,000); this is calculated using the intrinsic value at the balance sheet date. The gross amount giving rise to the tax benefit is C110,000, which is less than the cumulative remuneration expense of C120,000 recognised to date; so the entire amount of the estimated future tax benefit of C33,000 is recognised in the income statement.

At the end of year 2, the cumulative amount of the estimated tax benefit available in the future is C60,000 (30% × × C300,000). The gross amount giving rise to the tax benefit of C200,000 is less than the cumulative remuneration expense of C240,000 recognised to date; so the entire amount is recognised through the income statement. The amount recognised in year 2's income statement is C27,000 (C60,000 − C33,000).

At the end of year 3, the cumulative amount of the estimated tax benefit available in the future is C114,000 (30% × C380,000). The amount giving rise to the benefit of C380,000 exceeds the cumulative remuneration expense of C360,000 recognised to date; so the excess expected future tax benefit of C6,000 (30% × C20,000) is recognised in equity. The cumulative position at the end of year 3 is shown below.

Income statement Dr (Cr)

Equity Dr (Cr)

Balance sheet Dr (Cr)

Year

Expense

Current tax

Deferred tax

Current tax

Deferred tax

Current tax

Deferred tax

 

C

C

C

C

C

C

C

1

120,000

(33,000)

33,000

2

120,000

(27,000)

60,000

3

120,000

(48,000)

(6,000)

114,000

 


 


Cumulative position at end of year 3

360,000

(108,000)

(6,000)

 


 

 

 

In year 4, all 100,000 options are exercised. The actual current tax deduction obtained is C120,000 (30% × C400,000 intrinsic value at the date of exercise). This amount exceeds the tax effect of an amount equal to the cumulative remuneration expense of C360,000; so the excess current tax of C12,000 (30% × C40,000) is recognised in equity. The deferred tax asset of C114,000 at the end of year 3 is reversed through the income statement and equity. The double entry is as follows:

 

 

 

 

C

C

Dr

 

Current tax claim (balance sheet)

120,000

 

 

Cr

 

Current tax (income statement)

 

108,000

 

Cr

 

Current tax (equity)

 

12,000

 

 

 

 

 

 

Dr

 

Deferred tax (income statement)

108,000

 

Dr

 

Deferred tax (equity)

6,000

 

 

Cr

 

Deferred tax (balance sheet)

 

114,000

The overall position is shown below:

 

 

Income statement Dr (Cr)

Equity Dr (Cr)

Balance sheet Dr (Cr)

 

Expense

Current tax

Deferred tax

Current tax

Deferred tax

Current tax

Deferred tax

 

C

C

C

C

C

C

C

Cumulative position at end of year 3

360,000

(108,000)

(6,000)

114,000

 

 

 

 

 

 

 

 

Movement in year 4

(108,000)

108,000

(12,000)

6,000

120,000

(114,000)

 


Total

360,000

(108,000)

(12,000)

120,000

 


 

 

The tax credit recognised in the income statement of C108,000 is equal to the tax benefit calculated by applying the applicable tax rate of 30% to the remuneration expense of C360,000 recognised in the income statement over the vesting period. Any excess tax deduction received is recognised in equity. A comprehensive example of equity-settled transaction is also included in example 5 of appendix B to the standard.

 

13.206.4 The deferred tax in respect of an equity-settled share-based payment award should be calculated for each separate award (or tranche of an award where some options have been exercised and deferred tax is being reversed) and not for all awards in total. Each separate award has its own tax base (that is, the tax deductions that will be received on exercise of the options). This tax base is compared to the carrying amount of each separate award to calculate the temporary difference; and deferred tax should be recognised, where appropriate. The movement on the deferred tax for each grant is allocated between profit or loss and equity based on the cumulative share-based payment charge recognised in profit or loss (as outlined in para 13.206). An appropriate method (for example, weighted average or FIFO) should be used on a consistent basis to identify options that have been exercised or settled.

13.206.5 When the tax is allocated between profit or loss and equity, each award should be considered separately. The allocation should not be done on a total basis, because this could mask underlying movements in relation to specific awards.

Example – Allocation of deferred tax movements on separate awards

 

 

 

 

 

 

 

An entity has two share-based payment awards. Tax deductions will be received based on the market value of the shares at the date of exercise. The cumulative share-based payment charge under IFRS 2 and the expected tax deductions (measured using the share price at the balance sheet date) for each scheme are given below.

 

 

 

 

It is assumed that the recognition criteria for deferred tax assets are met and the tax rate is 30%.

 

 

 

 

 

Award 1

Award 2

Total

 

C'000

C'000

C'000

Cumulative charge (income statement)

100

100

200

Expected tax deduction

160

80

240

Deferred tax asset (30% of expected tax deduction)

48

24

72

 

 

 

 

Allocation performed on a grant by grant basis

 

For Award 1, C100 of the tax deduction relates to the charge recognised in the income statement. The remaining C60 of tax deduction is an equity item.

 

 

 

 

 

 

 

 

 

 

C'000

C'000

Dr

 

Deferred tax asset

48

 

 

Cr

 

Income statement (100 × 30%)

 

30

 

Cr

 

Equity (60 × 30%)

 

18

 

 

 

 

 

 

For Award 2, the tax deduction expected is lower than the cumulative charge in the income statement. The full deduction is seen as relating to the charge in the income statement.

 

 

 

 

 

 

 

 

 

 

C'000

C'000

Dr

 

Deferred tax asset

24

 

 

Cr

 

Income statement (80 × 30%)

 

24

 

 

 

 

 

The total credit recognised in the income statement is C54; and a credit of C18 is taken to equity.

 

Allocation performed on a total basis

 

Looking at the awards on a total basis, it appears that C200 of the tax deductions relate to charges recognised in the income statement. The allocation of the tax deduction would credit the income statement with C60 (200 × 30%) and take the balance of C12 directly to equity.

 

Allocation on a total basis would result in the tax credit in the income statement being overstated; so it is not considered acceptable.

13.206.6 The allocation between profit or loss and equity is also relevant when a deferred tax asset in respect of a share-based payment is reduced because the share price has fallen. When the deferred tax asset has a corresponding portion of tax credit that was previously recorded in equity (under para 68C of IAS 12), the reduction of the deferred tax asset needs to be analysed to determine how much of the reduction should be recognised in equity. The reversal of deferred tax assets and liabilities should be recognised in the statement in which the initial item was recognised (see para 13.288). So, if the share-based payment's tax base reduces, the deferred tax balance needs to be analysed to determine the extent of reversal (if any) from equity.

Example – Allocation of deferred tax when share price has fallen

An equity-settled share-based payment award for employees vests after 4 years of service. An award is made for 2,000 shares. The fair value of the award at the date of grant is C6 (per share).

The entity expects all the shares in the scheme to vest. So, under IFRS 2, the accounting expense is 2,000 shares × C6 = C12,000 × ¼ = C3,000 per annum for 4 years. At the end of year 2, the cumulative IFRS 2 charge is C6,000. The share price at the end of year 2 is C10, but it drops to C7 by the end of year 3. The position at the end of years 2 and 3 is summarised below.

 

End of year 2

End of year 3

Number of equity instruments earned for IFRS 2 purposes

1,000

1,500

Cumulative IFRS 2 charge

C6,000

C9,000

Share price (= tax value per share)

C10

C7

Tax base

C10,000

C10,500

Deferred tax (@ 30%)

C3,000

C3,150

The movement in deferred tax in year 3 is analysed as follows:

 

 

 

 

Split

 

Cumulative IFRS 2 charge

Tax base

Deferred tax

Income statement

Equity

 

C'000

C'000

C'000

C'000

C'000

Opening balance

6,000

10,000

3,000

1,800

1,200

Closing balance

9,000

10,500

3,150

2,700

450

 

 

 


Movement

 

 

150

900

(750)

 

 

 


There is a deferred tax credit of C900,000 in the income statement reflecting the deferred tax on the share-based payment charge of C3,000,000 in the period.

Where the share-based payment's tax base reduces, but does not fall below the cumulative accounting charge under IFRS 2, the excess tax deduction is reduced; so it is recognised in equity. The deferred tax charge of C750,000 in equity comprises:

 

 

A charge of C900,000, being the impact of the drop in share price on the opening deferred tax asset (1,000 shares × (C10 – C7) × 30%).

A credit of C150,000, being the excess tax credit on the award earned in the period (500 shares × (C7 – C6) × 30%).

If the share-based payment's tax base falls below the cumulative accounting charge, the full amount that was previously recognised in equity will be fully reversed; the movement in the income statement will comprise a tax credit in respect of the share-based payment charge and a charge in respect of any reduction in the tax base below the cumulative accounting charge.

13.206.7 In jurisdictions where a tax deduction is given when the share options are exercised, there might be no tax deduction where share options lapse after the vesting date and are not exercised. But the share-based payment charge in the income statement for options that lapse after vesting is not reversed. [IFRS 2 para 23]. So, where share options have lapsed after vesting and no tax deduction is available, the total current tax credit in the income statement will be less than the share-based payment charge tax-effected at the standard rate of tax. This reflects the fact that part of the share-based payment charge has not received a tax deduction because the related share options lapsed after vesting.

Example – Share options lapse after vesting

This example uses the facts in the example in paragraph 13.206.2, but assumes that some share options lapse after vesting.

On 1 January 20X3, 100,000 options are issued with a fair value of C360,000. The vesting period is 3 years and all options are initially expected to be exercised. The tax rate is 30%. The intrinsic value of the 100,000 share options (that is, market value of the underlying shares less exercise price) at the date of exercise in year 4 is C400,000. (At the end of years 1, 2 and 3 it is C330,000, C300,000 and C380,000 respectively.)

During years 1, 2 and 3, the expected tax benefit is recognised as explained in the example in paragraph 13.206.2. The cumulative position at the end of year 3 is shown below.

 

Income statement Dr (Cr)

Equity Dr (Cr)

Balance sheet Dr (Cr)

Year

Expense

Current tax

Deferred tax

Current tax

Deferred tax

Current tax

Deferred tax

 

C

C

C

C

C

C

C

1

120,000

(33,000)

33,000

2

120,000

(27,000)

60,000

3

120,000

(48,000)

(6,000)

114,000

 


 


Cumulative position at end of year 3

360,000

(108,000)

(6,000)

 

 

 


 

 

In year 4, 85,000 of the share options are exercised and 15,000 lapse without being exercised. The actual current tax deduction obtained is C102,000 (30% × C400,000 total intrinsic value at the date of exercise × 85/100).

The accounting charge in the income statement relating to the 85,000 options that are exercised is C306,000 (360,000 × 85/100); so the tax effect relating to this charge is C91,800 (306,000 × 30%).

The deferred tax asset of C114,000 at the end of year 3 is reversed through the income statement and equity. The double entry is as follows: 

 

 

 

 

C

C

Dr

 

Current tax claim (balance sheet)

102,000

 

 

Cr

 

Current tax (income statement)

 

91,800

 

Cr

 

Current tax (equity)

 

10,200

 

 

 

 

 

 

Dr

 

Deferred tax (income statement)

108,000

 

Dr

 

Deferred tax (equity)

6,000

 

 

Cr

 

Deferred tax (balance sheet)

 

114,000

 

 

 

 

 

 

The overall position is shown below: 

 

 

Income statement Dr (Cr)

Equity Dr (Cr)

Balance sheet Dr (Cr)

 

Expense

Current tax

Deferred tax

Current tax

Deferred tax

Current tax

Deferred tax

 

C

C

C

C

C

C

C

Cumulative position at end of year 3

360,000

(108,000)

(6,000)

114,000

 

 

 

 

 

 

 

 

Movement in year 4

(91,800)

108,000

(10,200)

6,000

102,000

(114,000)

 


Total

360,000

(91,800)

(10,200)

102,000

 


In the original example, when all the options were exercised, the overall tax position in year 4 was as follows: nil in the income statement (comprising a current tax credit of C108,000 offset by a deferred tax charge of C108,000); and a net tax credit of C6,000 to equity because of the increase in share price since the end of year 3 (comprising a current tax credit of C12,000 offset by a deferred tax charge of C6,000).

Where only 85,000 options are exercised and the remaining options lapse, the overall tax position in year 4 is:

A net charge of C16,200 in the income statement. This comprises a current tax credit of C91,800 (360,000 × 85/100 × 30%) and a deferred tax charge of C108,000 reversing the previously recognised asset. This net charge reflects the fact that the expected tax credit on 15,000 options was not received.

 

 

A net credit of C4,200 in equity. This comprises a current tax credit of C10,200, being the excess tax credit on the 85,000 options that were exercised ((400,000 – 360,000) × 85/100 × 30%) and a deferred tax charge of C6,000 reversing the previously recognised asset.

13.206.8 In some jurisdictions, a tax deduction in respect of a share-based payment award is received upfront or part way through the vesting period. The receipt of the tax deduction crystallises the amount; so re-measurement based on share price would not apply after this point, but there are implications for the deferred tax accounting. IAS 12 does not specifically address the situation where the tax deduction is received before the related accounting expense; but similar logic to that in IAS 12 applies. [IFRS 2 paras BC312 to BC314]. The receipt of an upfront tax deduction in respect of share-based payments gives rise to a deferred tax liability. [IFRS 2 para BC314].

Example – Tax deduction received upfront

An equity-settled share-based payment award for employees vests after 3 years of service. An award is made for 1,000 shares. The fair value of the award at the date of grant is C120 (per share).

The entity expects all the shares in the scheme to vest. So the accounting expense under IFRS 2 is 1,000 shares × 120 = C120,000 × = C40,000 per annum for 3 years.

Under the tax rules of the entity's jurisdiction, the entity receives a tax deduction upfront (at 30%) for the total number of options based on an amount (C140) that exceeds the fair value of the award at the date of grant. So the amount deductible for tax purposes is C140,000 (1,000 × 140).

A deferred tax liability of C42,000 (140,000 × 30%) is recognised on the tax deduction received upfront; this is unwound over the 3-year vesting period.

A deferred tax credit of C12,000 (40,000 × 30%) is recognised in the income statement each year, in line with the IFRS 2 charge; so a total of C36,000 tax credit is recognised in the income statement.

The excess tax deduction of C6,000 (42,000 – 36,000) is recognised in equity. In our view, this amount is also unwound over the 3-year vesting period (that is, a tax credit of C2,000 per annum is recognised in equity); this is consistent with the unwinding of the deferred tax credit recognised in the income statement.

13.206.9 In group situations, some parent entities may recharge their subsidiaries where those subsidiary entities' employees participate in the parent entity's share option schemes. The accounting for share-based payments in a group situation is dealt with in chapter 12. Tax accounting issues arise in the group if the subsidiary receives a tax deduction on the recharge and not when the employee exercises the options. If the tax relief on the recharge is clearly linked to the share-based payment (that is, it is based on an amount derived from the share-based payment, such as the option's intrinsic value or fair value, and there is no other tax relief for the share-based payment), our view is that the tax relief in the consolidated financial statements is treated in accordance with paragraphs 68A to 68C of IAS 12. So, where the tax deductible amount is no greater than the share-based payment expense, the tax relief is reflected in the consolidated income statement. Any excess of the tax relief over the amount of the tax effect of the IFRS 2 charge is reflected in equity. If the recharge is not clearly linked to the share-based payment, the tax deduction on the recharge should be credited to the consolidated income statement (like tax deductions on management recharges in general).

13.206.10 Whether or not a deferred tax asset is recognised in the consolidated financial statements for the expected tax deductions on recharges depends on the arrangement between the parent and the subsidiary. If the recharge is made at the parent's discretion, a deferred tax asset is not recognised; this is because a tax deduction will not arise unless there is a recharge. Where a parent agrees to make a recharge when options are exercised, a deferred tax asset should be recognised (subject to meeting IAS 12's criteria) over the period of service in relation to any expected tax deductions that are considered recoverable. The expected tax deduction for the recharge can be regarded as a tax deduction in respect of the share-based payment charge to the extent that it is recharged.

Cash-settled transactions

13.207 Cash-settled share-based payment transactions (such as share appreciation rights issued to employees) give rise to a liability and not a credit to equity. The fair value of the liability is re-measured at each reporting date until the liability is settled. A deductible temporary difference might arise if the liability's carrying amount exceeds the liability's tax base (that is, the carrying amount less any amounts that will be deductible for tax purposes in the future); this would result in a deferred tax asset (subject to IAS 12's recognition criteria). The tax effects of such transactions are always recognised in the income statement.

Revaluation of non-monetary assets

General rule

13.208 Many entities revalue their non-monetary assets such as land and buildings. In some jurisdictions, the revaluation or other restatement (increase or decrease) of an asset to fair value affects taxable profit (loss) for the current period. The tax base of the asset is adjusted and no temporary difference arises. The resulting current tax that arises on the revaluation is recognised. In other jurisdictions, the revaluation or restatement of an asset does not affect taxable profit in the current period; as a result, the asset's tax base is not adjusted. The increase or decrease does not enter into the determination of taxable profit for the current period; but the future recovery of the carrying amount will result in a taxable flow of economic benefits to the entity, and the amount that is deductible for tax purposes will differ from the amount of those economic benefits. The difference between the carrying amount of a revalued asset and its tax base is a temporary difference; and it gives rise to a deferred tax liability or asset. The resulting deferred tax expense or income arising from the revaluation is recognised in other comprehensive income (see para 13.288.1). This is true even if:

The entity does not intend to dispose of the asset. In such cases, the asset's revalued carrying amount will be recovered through use; and this will generate taxable income which exceeds the depreciation that will be allowable for tax purposes in future periods.

Tax on capital gains is deferred where the proceeds of the asset's disposal are invested in similar assets. In such cases, the tax will become payable on sale or use of the similar assets. See further paragraph 13.216 onwards.

[IAS 12 para 20].

13.209 The precise nature of the liability that arises on an asset's revaluation depends on the asset's taxation status. In some jurisdictions, assets that do not attract tax depreciation (such as land) give rise to chargeable gains or losses for tax purposes if they are sold above or below their tax indexed cost (that is, original cost uplifted by an indexation allowance, where applicable). For accounting purposes, such assets are sometimes revalued but rarely depreciated. Depreciable assets, on the other hand, might or might not be revalued. If such an asset is revalued in excess of cost and sold at the revalued amount, a further tax liability – in addition to any liability arising on the capital gain – might arise if the asset was eligible for capital allowances. This further liability (which arises by way of a balancing charge in some jurisdictions) is designed to claw back any tax depreciation previously claimed in respect of the asset.

13.210 The measurement of the liability also depends on the manner in which the entity expects to recover the carrying amount of an asset that has been revalued in the financial statements – whether through use, sale, or use and sale (that is, 'dual manner of recovery'). The following paragraphs consider the deferred tax consequences of revaluing assets and the different ways in which the entity expects to recover the revalued carrying amounts. For guidance relating to the expected manner of recovery for investment properties measured at fair value, refer to paragraph 13.219.4 onwards.

13.210.1 An approach for applying this 'dual manner of recovery' is set out in paragraph 13.172.3. Use of this approach for properties can be summarised as follows:

 

Ascertain the expected manner of recovery of the asset's carrying amount.

 

Split the asset's carrying amount between amounts to be recovered through use and through sale.

 

Determine the expected period of recovery through use and the expected date of sale or abandonment.

 

Determine the tax consequences of recovery through use and the temporary differences that will arise.

Determine the tax consequences of recovery through sale and the temporary differences that will arise.

Determine which of the temporary differences arising from recovery through use and through sale should be recognised.

Upward revaluation of depreciable assets

13.211 Where a depreciable asset that qualifies for tax is revalued upwards, the revaluation gives rise to a further originating temporary difference; this is in addition to the temporary difference that arises from accelerated tax depreciation. Because the revaluation represents a new originating temporary difference, deferred tax should be provided in a way that reflects how the entity expects  to recover the asset's revalued carrying amount – whether through use, sale, or use and sale. Various scenarios arise.

 

Example – Upward revaluation of depreciable assets

An entity acquired a building in a business combination at a cost of C1,000,000 on 1 January 20X1. The useful life of the building is 20 years and it will be depreciated to a residual value of C150,000. The building is eligible for allowances of 50% initial allowance and 4% writing down allowance (WDA) each year (up to a total of C500,000) until disposal. On disposal, the proceeds are liable to capital gains tax, subject to a deduction where that cost exceeds capital allowances previously claimed. The tax rate for capital gains and income is 30%. In each of the four years until revaluation, the deferred tax provided is calculated as shown below. Note that the example deals only with the deferred tax on the buildings – a dual manner of recovery expectation is applied, and the residual value is attributed to the carrying amount of the sale element on initial recognition (see further para 13.172.3). There are no changes to the estimated residual value in years 1 to 4. The land element is not a depreciable asset (see further para 13.213).

In the tables: NBV = net book value; TB = tax base; TD = temporary difference; DTL = deferred tax liability; DTA = deferred tax asset.

Use element

NBV

TB

TD

DTL/(DTA)

 

C

C

C

C

At 1 January 20X1

850,000

1,000,000

(150,000) 

(45,000) 

Depreciation/tax allowances – initial + WDA

(42,500)

(540,000)

 497,500

 149,250

 


At 31 December 20X1

807,500

460,000

347,500

104,250

Depreciation/tax allowances – WDA

(42,500)

(40,000)

(2,500)

(750)

 


At 31 December 20X2

765,000

420,000

345,000

103,500

Depreciation/tax allowances – WDA

(42,500)

(40,000)

(2,500)

(750)

 


At 31 December 20X3

722,500

380,000

342,500

102,750

Depreciation/tax allowances – WDA

(42,500)

(40,000)

(2,500)

(750)

 


At 31 December 20X4

680,000

340,000

340,000

102,000

 


Sale element

NBV

TB

TD

DTL

 

C

C

C

C

At 1 January 20X1

150,000

0

150,000

45,000

 


At 31 December 20X1, 20X2, 20X3 and 20X4

150,000

0

150,000

45,000

 


 

The tax base on sale is determined using the tax base expected to be available on the sale element at the date of sale. In this case, that is cost of C1,000,000 less tax depreciation claimed while the building is in use (C1,000,000). The tax base on sale is not shown as cost less tax depreciation claimed to date at each balance sheet date because this would result in double counting of the tax base between the use and sale elements. Rather, the tax base in each calculation is based on management's expectation of how tax deductions will be received. The deferred tax liability of C45,000 represents the tax that management expects to pay on recovery of the building's residual value. This deferred tax liability will remain on balance sheet until the building is sold.

Scenario 1 – Entity expects to recover the revaluation uplift of the building through use

 

At the beginning of 20X5, the building is revalued to C1,400,000; a revaluation gain of C570,000 is recognised. Management still considers the residual value of the building to be C150,000. So the carrying amounts for the use and sale elements are C1,250,000 and C150,000 respectively. As such, the revaluation will affect the use calculation only.

 

 

 

 

 

Use element

NBV

TB

TD

DTL

 

C

C

C

C

At 31 December 20X4

680,000

340,000

340,000

102,000

Revaluation

570,000

570,000

171,000

 


At 1 January 20X5

1,250,000

340,000

910,000

273,000

Depreciation/tax allowances – WDA

(78,125)*

(40,000)

(38,125)

(11,438)

 


At 31 December 20X5

1,171,875

300,000

871,875

261,562

 


* The building has a remaining useful life of 16 years at the date of revaluation; so depreciation is C1,250,000/16 = C78,125. This is equal to the annual depreciation on historical cost plus an uplift for the revaluation gain: C42,500 + C570,000/16 = C78,125.

 

 

 

 

 

Sale element

NBV

TB

TD

DTL

 

C

C

C

C

At 31 December 20X4

150,000

0

150,000

45,000

Revaluation

 


At 1 January 20X5 and 31 December 20X5

150,000

0

150,000

45,000

 


The journal entries at 1 January 20X5 and 31 December 20X5 are as follows:

 

Dr

Cr

1 January 20X5

 

 

Dr

 

Property, plant and equipment – cost

400,000

 

Dr

 

Property, plant and equipment – accumulated depreciation

170,000

 

 

Cr

 

Revaluation reserve

 

570,000

Dr

 

Revaluation reserve – tax at 30% (income tax rate) on C570,000

171,000

 

   

Cr

 

Deferred tax liability

 

171,000

 

 

 

31 December 20X5

 

 

Dr

 

Depreciation charge

78,125

 

   

Cr

 

Property, plant and equipment – accumulated depreciation

 

78,125

Dr

 

Deferred tax liability – use (B/S)

11,438

 

   

Cr

 

Deferred tax charge – use (I/S)

 

11,438

The deferred tax liability of C171,000 arising on the revaluation surplus is added to the opening balance of C102,000 brought forward; this gives the total of C273,000 shown above. In addition, the deferred tax liability is reduced by C11,438 (C273,000 − C261,562) during 20X5 because the temporary difference of C38,125 (C78,125 − C40,000) is reversed; this reduction is credited to the income statement rather than the revaluation reserve because the entity expects to recover through use the carrying amount of the revalued asset of C1,250,000 (C1,400,000 less the residual value of C150,000).

 

But the entity might decide to transfer an amount from the revaluation reserve to retained earnings, which represents the difference between depreciation based on the asset's revalued amount and depreciation based on the asset's cost. If the entity makes such a transfer, the amount transferred is net of any related deferred tax. [IAS 12 para 64]. In the above example, the entity would transfer C78,125 (depreciation based on revalued amount) − C42,500 (depreciation based on cost) = C35,625 less tax of C10,688 (30% of C35,625) = C24,937.

 

Scenario 2 – Entity expects to recover the revaluation uplift of the building through use and sale

 

The building has been revalued as in scenario 1 above. But management now considers the residual value to be C200,000. The entity expects to recover the uplift to the building's carrying amount through use and sale.

 

The impact of the revaluation and change in residual value is illustrated as follows:

Use element

NBV

TB

TD

DTL

 

C

C

C

C

At 31 December 20X4

680,000

340,000

340,000

102,000

Revaluation

520,000

520,000

156,000

 


At 1 January 20X5

1,200,000

340,000

860,000

258,000

 


Depreciation/tax allowances – WDA

(75,000)*

(40,000)

(35,000)

(10,500)

 


At 31 December 20X5

1,125,000

300,000

825,000

247,500

 


 

 

* The building has a remaining useful life of 16 years at the date of revaluation; so depreciation is C1,200,000/16 = C75,000. This is equal to the annual depreciation on historical cost plus an uplift for the revaluation gain: C42,500 + C520,000/16 = C75,000.

 

 

Sale element

NBV

TB

TD

DTL

 

C

C

C

C

At 31 December 20X4

150,000

0

150,000

45,000

Revaluation

50,000

50,000

15,000

 


At 1 January 20X5 and 31 December 20X5

200,000

0

200,000

60,000

 


 

 

 

 

 

The journal entries at 1 January 20X5 and 31 December 20X5 are as follows:

 

 

 

 

 

Dr

Cr

1 January 20X5

 

 

Dr

 

Property, plant and equipment – cost

400,000

 

Dr

 

Property, plant and equipment – accumulated depreciation

170,000

 

 

Cr

 

Revaluation reserve

 

570,000

Dr

 

Revaluation reserve – tax @ 30%

171,000

 

   

Cr

 

Deferred tax liability – use basis

 

156,000

  

Cr

 

Deferred tax liability – sale basis

 

15,000

 

 

 

31 December 20X5

 

 

Dr

 

Depreciation charge

75,000

 

   

Cr

 

Property, plant and equipment – accumulated depreciation

 

75,000

Dr

 

Deferred tax liability – use (B/S)

10,500

 

 

Cr

 

Deferred tax charge – use (I/S)

 

10,500

 

The deferred tax movement of C171,000 arising on the revaluation surplus recognised on 1 January 20X5 impacts both the sale and use calculations as shown above. The reduction in the deferred tax liability during 20X5 that arises from depreciation is recognised in the income statement rather than the revaluation reserve, as discussed in scenario 1 above. To the extent that the asset is recovered through use, a transfer could be made between the revaluation reserve and retained earnings (as discussed in scenario 1). In this case, the transfer is C75,000 (depreciation based on revalued amount) – C42,500 (depreciation based on cost) = C32,500 less tax of C9,750 (30% of C32,500) = C22,750.

 

 

 

 

 

Scenario 3 – Entity changes its manner of recovery expectation from dual manner of recovery to sale

 

Following on from scenario 1, at 31 December 20X6 (two years after revaluation), the entity changes its expectation from recovering the building's carrying amount through the dual manner of recovery (use and sale) to sale. The sale is imminent as at 31 December 20X6; so the building's full carrying amount at that date is expected to be recovered through sale.

 

 

 

 

 

Use element

NBV

TB

TD

DTL

 

C

C

C

C

At 31 December 20X5

1,171,875

300,000

871,875

261,562

Depreciation/tax allowances – WDA

(78,125)

(40,000)

(38,125)

(11,437)

 


 

1,093,750

260,000

833,750

250,125

Change in expected manner of recovery

(1,093,750)

(260,000)*

(833,750)

(250,125)

 


At 31 December 20X6

 


 

 

 

 

 

*No further capital allowances are available if the building is no longer in use. 

 

 

 

 

 

Sale element

NBV

TB

TD

DTL

 

C

C

C

C

At 31 December 20X5

150,000

0

150,000

45,000

Change in expected manner of recovery

1,093,750

260,000

833,750

250,125

 


At 31 December 20X6

1,243,750

260,000*

983,750

295,125

 


 

 

 

 

 

* The tax base on sale is equal to cost (C1,000,000) less capital allowances claimed during the period in which the building is in use of C740,000 (that is, initial allowance of C500,000 plus six years' allowance of C40,000).

 

As in scenario 1, the reduction in the deferred tax liability by C11,437 (C261,562 − C250,125) during 20X6 that arises from depreciation is credited to the income statement; this is because the entity expects to recover the building's carrying amount through use. A transfer could be made between the revaluation reserve and retained earnings, which would be a further C24,937 as in scenario 1. However, at 31 December 20X6, the entity changes its expectation about the manner of the building's recovery from the dual manner of recovery to sale. This gives rise to the following additional journal entry:

 

 

 

 

Dr

Cr

Dr

 

Deferred tax liability – use

250,125

 

 

Cr

 

Deferred tax liability – sale

 

250,125

 

The change in expected manner of recovery has no impact on net assets in this case. But the overall deferred tax liability would be affected if the tax base on sale was subject to adjustments for inflation or if the tax rates for income and capital gains were different. This change would generally be recognised in the income statement; but, where it relates to deferred tax recognised on a previous revaluation gain, it would be recognised in other comprehensive income.

 

The deferred tax balance of C295,125 reflects the tax consequences that would follow if the entity sold the asset at its carrying amount at the balance sheet date. In other words, if the asset is sold at its carrying amount of C1,243,750, the total taxable profit would be C983,750. This is calculated as proceeds of C1,243,750 less C260,000 (being the original cost of C1,000,000 less capital allowances claimed of C740,000) = C983,750, on which tax @ 30% = C295,125 would be payable.

 

Scenario 4 – Entity sells revalued building

 

Following on from scenario 3, suppose the entity sells the building at 1 January 20X7 for C1,500,000 and pays tax at 30% on the taxable profit:

 

 

 

 

 

 

Taxable profit

Accounting profit

 

 

C

C

Sales proceeds

 

1,500,000

1,500,000

Tax base/carrying amount before sale

 

260,000

1,243,750

 

 


Taxable/accounting profit

 

1,240,000

256,250

 

 


Tax @ 30% on taxable/accounting profit

 

372,000

76,875

 

 


Current tax is generally included in profit or loss, unless it arises from a transaction or event that is recognised (in the same or a different period) in other comprehensive income or directly in equity (see para 13.45). Under the principle that deferred tax should follow the related item (see para 13.288), the journal entries for the current tax and for the release of the deferred tax liability of C295,125 (see scenario 3) are as follows:

 

 

 

 

Dr

Cr

Dr

 

Current tax (I/S) 1

201,000

 

Dr

 

Current tax (other comprehensive income) 2

171,000

 

 

Cr

 

Current tax (B/S)

 

372,000

 

 

 

Dr

 

Deferred tax (B/S)

295,125

 

 

Cr

 

Deferred tax (I/S) 3

 

124,125

 

Cr

 

Deferred tax (other comprehensive income) 2

 

171,000

 

 

 

1 Current tax recognised in the income statement of C201,000 is the difference between the total current tax payable of C372,000 and the amount recognised in other comprehensive income of C171,0002.

2 Current tax recognised in other comprehensive income is calculated as the previously recognised gain of C570,000 × 30% = C171,000, which equals the deferred tax previously recognised in other comprehensive income.

3 The deferred tax released of C124,125 represents the deferred tax previously recognised in the income statement, being the difference between the total deferred tax liability of C295,125 and the amount previously recognised in other comprehensive income of C171,000.

 

 

 

The tax impact can be summarised as follows:

 

 

 

 

 

Tax charge in income statement

 

 

Current tax

 

 

 201,000

Deferred tax – release

 

 

 (124,125)

 

 

 


Total tax charge in income statement

 

 

 76,875

 

 

 


Tax charge in other comprehensive income

 

 

 

Current tax

 

 

171,000

Deferred tax – release

 

 

(171,000)

 

 

 


Total tax charge in other comprehensive income

 

 

 

 

 


 

The total tax charge of C76,875 in the income statement is the same as tax payable on the accounting profit. No reconciling difference arises, because the deferred tax liability recorded reflected the manner in which the entity expected to recover the carrying amount of the property (that is, through sale). After the building's sale, the revaluation surplus is realised and the entity will transfer the original surplus of C570,000 net of tax of C171,000 = C399,000 from the revaluation reserve to retained earnings. (This assumes that no annual transfer has been made – see last paragraph of scenario 1). [IAS 12 para 64].

Downward revaluation of depreciable assets

13.212 Where a depreciable asset is revalued downwards, the tax consequence of the impairment loss is similar to depreciation and represents a reversal of an originating temporary difference. This reversal could give rise to a deferred tax asset or a reduction in the deferred tax liability; the treatment will depend on the asset's tax base just before the downward revaluation was recognised. Similarly, where a depreciable asset that was revalued upwards is subsequently revalued downwards, the downward revaluation will first reverse the previous upward revaluation; and any excess reversal is recognised in profit or loss.

Example – Downward revaluation of depreciable assets

Facts are generally the same as in scenario 3 in paragraph 13.211; but at 31 December 20X6, two years after revaluation and immediately before sale, the asset is revalued downwards to C600,000. The entity expects to recover the full carrying amount of the building through sale.

There is no use element as at 31 December 20X6 because the expected manner of recovery is solely through sale. The impact of the devaluation on the sale element is shown below.

Sale element

NBV

TB

TD

DTL

 

C

C

C

C

At 31 December 20X6 (before impairment)

1,243,750

260,000

983,750

(295,125)

Impairment loss

(643,750)

− 

(643,750)

(193,125)

 


At 31 December 20X6

600,000

260,000

340,000

102,000

 


 

Of the impairment loss of C643,750, C570,000 reverses the earlier revaluation surplus and is recognised in other comprehensive income (debited to the revaluation reserve); the balance of C73,750 is debited to the income statement. The corresponding tax credits of C171,000 (30% of C570,000) and C22,125 (30% of C73,750) are similarly recognised in other comprehensive income (credited to the revaluation reserve) and in the income statement.

 

If the entity has transferred an element of the C570,000 revaluation surplus from the revaluation reserve to retained earnings the amount of the impairment debited directly to the revaluation reserve would be capped at the amount of revaluation surplus remaining in the revaluation reserve at the time of the impairment. [IAS 16 para 40].

Upward revaluation of non-depreciable asset

13.213 Where a non-depreciable asset (such as land having an infinite life) is revalued upwards above the tax deductible amount on sale (including any inflation allowance), the revaluation gives rise to an originating temporary difference on which deferred tax should be provided. The asset is not depreciated, so no part of the asset's carrying amount is expected to be recovered (that is, consumed) through use. It follows that the carrying amount of a non-depreciable asset can only be recovered through sale [SIC 21 para 5; IAS 12 (amended) para 51B].

13.214 The following examples illustrate the tax consequences of revaluing a non-depreciable asset under IAS 16.

 

Example 1 – Upward revaluation of non-depreciable asset

On transition to IFRS, entity B elected to re-measure its land and buildings at fair value at the date of transition, as permitted by IFRS 1. This fair value was subsequently used as deemed cost for the purpose of historical cost accounting. Entity B does not have a policy of annual revaluations.

One of entity B's assets is a piece of land. The tax base of the land is its original cost when acquired by entity B, increased each year in line with the Retail Price Index.

There is a temporary difference between the revalued accounting base and the tax base of the land. The temporary difference will reduce over time as the tax base is increased by changes in the Retail Price Index. Management expects to hold the land for the foreseeable future; and it expects that the land's tax base will exceed the accounting base before the land is disposed of.

In this situation, management should recognise deferred tax in respect of the land based on the difference between the accounting base and the tax base at the balance sheet date. Management should not anticipate future changes in the land's tax base arising from changes in the Retail Price Index. 

Example 2 – Indexation of tax base on revalued non-depreciable asset

An entity acquired a plot of land for C1,000,000 on 1 January 20X1 when the tax indexed cost was also C1,000,000. On disposal, the proceeds in excess of indexed cost are subject to capital gains tax @ 30%, which is also the rate of tax on income other than capital gains. The price index for calculating indexation allowances increases by 2% in 20X1 and 2.5% in 20X2. But the tax rules state that indexation allowance cannot create or increase a loss. The deferred tax asset recognised in each of those years (if sufficient taxable profits are available) is calculated as follows.

NBV

TB

TD

DTL (A)

C

C

C

C

At 1 January 20X1

1,000,000

1,000,000

Increase in tax indexed cost @ 2% (see note below)

 

 


At 31 December 20X1

1,000,000

1,000,000

Increase in tax indexed cost @ 2.5% (see note below)

 

 


At 31 December 20X2

1,000,000

1,000,000

 


The land is carried at cost during 20X1 and 20X2. If the land is sold at its carrying amount of C1,000,000 at the balance sheet date, the amount deductible for tax purposes is its original cost without the benefit of the indexation allowance. The tax rules applicable to the entity state that indexation allowance cannot create or increase a loss. So the tax base is not increased by indexation of C20,000 (2%) in year 1 and C25,500 (2.5%) in year 2; and a temporary difference does not arise.

 

During 20X3, the entity revalued the land to C1,500,000 when the indexation allowance has increased by 3%. The tax effect of the revaluation is calculated as follows:

NBV

TB

TD

DTL (A)

C

C

C

C

Cost

1,000,000

1,000,000

 

 

Accounting revaluation

500,000

 

 

 

Increase in tax indexed cost in previous periods*

 

45,500

 

 

Increase in tax indexed cost in current period @ 3%

 

31,365

 

 

 


 

 

At 31 December 20X3

1,500,000

1,076,865

423,135

126,940


 

* The increase in the land's carrying amount as a result of the revaluation means that the tax base is increased by the indexation allowance arising in year 1 (C20,000) and year 2 (C25,500), because this no longer creates a loss.

 

The revaluation surplus of C500,000 is recognised in other comprehensive income (credited to the revaluation reserve); but the deferred tax liability recognised in other comprehensive income (in the revaluation reserve) is C126,940 (C423,135 @ 30%) because the surplus includes a tax-free amount of C76,865 resulting from inflation since the asset was acquired.

 

The accounting implications of a revaluation for tax purposes are considered further in paragraph 13.217 onwards.

Example 3 – Sale of revalued non-depreciable asset

 

Following on from example 2, suppose the land is sold during 20X6 for C2,000,000. There is additional indexation allowance of C23,135 up to the time of sale, so the indexed cost is C1,100,000. Assume the tax effect of the indexation allowance in the period of sale is recognised in other comprehensive income. The entity pays tax at 30% on the taxable profit as follows:

 

 

 

Taxable profit

Accounting profit

C

C

Sales proceeds

2,000,000

2,000,000

Tax base/carrying amount before sale

1,100,000

1,500,000

 


Taxable/accounting profit

900,000

500,000

 


Tax @ 30%

270,000

150,000

 


 

The journal entries for the current tax and for the release of the deferred tax liability of C126,940 (see example 2) are as follows:

 

 

 

 

 

Dr

Cr

Dr

Current tax (I/S) 1

150,000

 

Dr

Current tax (other comprehensive income) 2

120,000

 

 

Cr

Current tax (B/S)

 

270,000

 

 

 

Dr

Deferred tax (B/S)

126,940

 

 

Cr

Deferred tax (other comprehensive income) 3

 

126,940

 

 

1 Current tax recognised in the income statement of C150,000 is the difference between the total current tax payable of C270,000 and the amount recognised in other comprehensive income of C120,000; and it represents the gain in the income statement of C500,000 @ 30%.

2 Current tax recognised in other comprehensive income is calculated as the tax on the gain previously recognised in other comprehensive income reduced by indexation; that is, gain of C500,000 less indexation of (C76,865 + C23,135) = gain of C400,000 @ 30% = C120,000.

3 The reversal of deferred tax of C126,940 represents the deferred tax previously recognised in other comprehensive income. No deferred tax was previously recognised in the income statement; so there is no reversal in the income statement.

 

 

 

Tax charge in income statement

 

 

Current tax

 

150,000

Deferred tax  – release

 

 


Total tax charge in income statement

 

150,000

 


Tax charge in other comprehensive income

 

 

Current tax

 

120,000

Deferred tax – release

 

(126,940)

 


Total tax credit in other comprehensive income

 

(6,940)

 


 

The tax credit in other comprehensive income of C6,940 arises because of an additional tax-free amount of C23,135 (C1,100,000 − C1,076,865) that has arisen during the year before the disposal date, as a result of indexation (C23,135 @ 30% = C6,940).

 

IAS 12 does not specify how this additional indexation should be allocated. This example assumes that the indexation is treated consistently with the previous indexation, and is regarded as relating to the accounting gain that has been recognised in other comprehensive income. But other methods of allocation might be appropriate, depending on the entity's accounting policy (for example, allocating the indexation pro rata between the gain recognised in the income statement and the gain previously recognised in other comprehensive income).

Downward revaluation of non-depreciable asset

13.215 Where a non-depreciable asset (that has not been previously revalued) is revalued downwards, an originating temporary difference arises if a capital loss will arise for tax purposes. But, if capital losses can only be offset against chargeable capital gains, a deferred tax asset is not normally recognised unless deferred tax has been provided (in the same or an earlier accounting period) for chargeable gains on upward revaluations of other assets. Where a downward revaluation of a non-depreciable asset simply reverses a previous upward revaluation of the same asset, the tax effect recorded should reverse the tax effect that was previously recorded for the upward revaluation.

Rollover and holdover reliefs

13.216 In some jurisdictions, the tax arising on a taxable gain – when certain assets used for trading purposes (such as properties) are disposed of – might not need to be paid immediately if the sale proceeds are reinvested (within specified time limits) in other qualifying assets. One type of relief ('rollover relief') reduces the 'base cost' of the replacement asset by the taxable gain 'rolled over. A higher taxable gain will arise on disposal of the replacement asset (and higher tax might become payable) than if the original gain had not been rolled over. It might be possible to claim rollover relief on the gain when the replacement asset is sold, so that tax on that gain again does not need to be paid. This situation can theoretically continue indefinitely and will depend on the specific tax rules.

13.216.1 Another type of relief ('holdover relief') delays payment of tax on the original gain where reinvestment of the proceeds satisfies certain conditions. The taxable gain on disposal of the old asset is not deducted from the new asset's cost; instead, the current tax on the gain is delayed (that is, 'held over') and is payable at a future date, depending on the specific tax rules.

13.216.2 Where rollover relief is claimed, the standard might require a deferred tax liability to be recognised on the new asset (often similar in amount to the current tax that did not need to be paid on the old asset). The new asset's tax base has been reduced; so tax might become payable when the new asset is sold or used.

13.216.3 The new asset's reduced tax base is likely to result in a temporary difference when compared with its carrying amount in the financial statements. A temporary difference that results from rollover relief is not covered by the initial recognition exception (see further para 13.162 onwards). It does not arise from the asset's initial recognition, but instead arises as a result of relief given on an asset that was previously disposed of.

13.216.4 The following example considers the deferred tax position on initial recognition of an asset with a tax base reduced by rollover relief – including the interaction with the dual manner of recovery (see further para 13.172.2 onwards) and the initial recognition exception.

Example – Rollover relief

An entity disposes of a building which (without rollover relief) would result in a taxable gain of C400,000. The entity invests in a new building at a cost of C2,500,000. It claims rollover relief so that no taxable gain or loss arises on disposal of the old building. Instead, the taxable gain on the old building reduces the acquisition cost of the new building that will be allowable for tax purposes when it is sold. So the new building's tax base (on a sale basis) is as follows:

 

 

C'000

Acquisition cost

 

2,500

Rolled-over gain

 

(400)

 

 


Tax base (sale basis)

 

2,100

 

 


 

 

Tax rate applicable to gain on disposal = 30%.

 

Assuming there are no tax deductions for use of the building, the deferred tax position on initial recognition (in various scenarios) is as follows:

 

 

 

 

 

 

Residual value = C1m

Residual value = nil

Residual value = C2.5m

 

Use

Sale

Use

Sale

Use

Sale

 

C'000

C'000

C'000

C'000

C'000

C'000

 

 

 

 

 

 

 

Carrying amount

1,500

1,000

2,500

2,500

 


 

 

 

 

 

 

 

Tax base – original cost

2,500

2,500

2,500

Rolled-over gain

(400)

(400)

(400)

 


New tax base

2,100

2,100

2,100

 


 

 

 

 

 

 

 

Taxable/(deductible) temporary difference

1,500

(1,100)

2,500

(2,100)

400

 

 

 

 

 

 

 

Less: initial temporary difference

(1,500)

1,500

(2,500)

2,500

 


Remaining taxable temporary difference not covered by the IRE

400

400

400

 


 

 

 

 

 

 

 

Deferred tax liability @ 30%

120

120

120

 


As noted in paragraph 13.216.3, to the extent that the temporary difference results from rollover relief, it is not covered by the initial recognition exception. So the amount of the temporary difference covered by the initial recognition exception excludes the amount attributable to rollover relief. It is calculated as the carrying amount less the tax base resulting from original cost (that is, C2.5m).

Management should, therefore, recognise a deferred tax liability of C120,000 on the taxable temporary difference resulting from rollover relief of C400,000. But the resulting taxable temporary difference might enable otherwise unrecognised deferred tax assets on the same (for example, related land) or other assets to be recognised if the criteria in IAS 12 are met.

13.216.5 Where holdover relief is claimed, current tax remains payable in the future (as noted in para 13.216.1). If the entity discounts current taxes (see para 13.73), the carrying amount of the tax payable could be materially reduced if the deferral period is significant.

Revaluation for tax purposes

13.217 An asset can sometimes be revalued for tax purposes; and that revaluation might or might not be reflected for accounting purposes. Where an asset revaluation for tax purposes relates to an accounting revaluation of an earlier period (or to one that is expected to be carried out in a future period), the tax effects of the asset revaluation and the adjustment of the tax base are recognised in other comprehensive income in the periods in which they occur. [IAS 12 para 65]. This is consistent with the general principle that tax follows the item.

13.217.1 Where an asset revaluation for tax purposes does not relate to an accounting revaluation of an earlier period (or to one that is expected to be carried out in a future period), the tax effects of adjusting the tax base are recognised in profit or loss. [IAS 12 para 65].

13.217.2 If an asset is carried at a revaluation ('deemed cost') under the transitional rules of IFRS 1, but the entity has no ongoing accounting policy of revaluation, the effect of changes in the tax base are recognised in profit or loss. This is discussed further in paragraph 13.219 onwards.

13.217.3 The impact of changes in the tax revaluation is only recognised in other comprehensive income if a relationship is established between the accounting revaluation and the tax revaluation. That relationship does not have to be one of perfect correlation. When a general basis of indexation for tax purposes applies to all entities, the reporting entity needs to establish the relationship. It might be helpful to consider how valuations of the relevant class of assets have correlated with the tax index in the past, as well as any indicators that suggest changes in that correlation in the future. Also, where significant amounts are involved, the entity should have regard to the significant judgements disclosure requirements under IAS 1 (see para 13.277.2). [IAS 1 para 122].

13.217.4 If an entity's accounting policy is to revalue an asset (so that a revaluation surplus is taken to reserves in the same or a previous period) – and a relationship between the accounting revaluation and the tax revaluation has been established – then if the tax base is revalued we consider that (to the extent that the tax revaluation is no greater than the cumulative accounting revaluation) the tax revaluation arguably relates to the earlier accounting revaluation; as a result, the effect of the adjusted tax base is recognised in other comprehensive income. But where the tax revaluation exceeds the cumulative accounting revaluation, it is a matter of judgement as to whether the tax revaluation relates to an accounting revaluation expected in the future. If it is judged to be so, the effect of the adjusted tax base is recognised in other comprehensive income; otherwise, it is recognised in profit or loss.

13.217.5 If it is clear that the tax basis revaluation does not relate to the accounting revaluation, the effect of the tax revaluation is taken to profit or loss. This might arise if the basis for the asset's tax revaluation bears no relationship to asset price development in the market. For example the tax basis is general inflation but the class of assets has had a reducing fair value in the past – as has been the case for technology products. The tax revaluation might be expected to be upwards, but the accounting revaluation would not be.

13.218 The following paragraphs consider the accounting treatment of changes in deferred tax as a result of tax revaluations.

13.218.1 An entity's accounting policy might be to carry an asset at depreciated cost. If the tax base is revalued for tax purposes, the effect of the tax base's revaluation is recognised in profit or loss because it does not relate to a prior accounting revaluation and none is anticipated in future periods.

Example – Asset carried at cost

Entity A acquires an asset which has an initial tax base equal to its cost.

The asset's tax base is increased each year by an amount based on asset price inflation.

Entity A accounts for the asset using a policy of cost (that is, with no accounting revaluation) under IAS 16.

 

 

Tax revaluation

Cost

 

Initial tax base

If a tax revaluation is available in this situation (that is, the tax revaluation can create or increase a loss), then the impact of the increase in the tax base as a result of the tax revaluation is recognised in profit or loss. It does not relate to an accounting revaluation that has been recognised in other comprehensive income.

13.218.2 Where an entity's accounting policy is to revalue an asset and there is a related tax revaluation, the effect of adjusting the tax base is recognised in other comprehensive income.

Example – Asset carried at revaluation

Entity A acquires an asset which has an initial tax base equal to its cost.

The asset's tax base is increased each year by an amount based on asset price inflation.

Entity A accounts for the asset using a policy of revaluation under IAS 16.

Revaluation gain

 

 

 

Tax revaluation

Cost

 

Initial tax base

To the extent that the increase in the tax base as a result of the tax revaluation is no greater than the cumulative accounting revaluation surplus recognised in other comprehensive income, the tax revaluation arguably relates to an earlier accounting revaluation; as a result, the effect of the adjusted tax base is recognised in other comprehensive income.

Where the tax revaluation exceeds the cumulative accounting revaluation, the comments in paragraph 13.217.4 apply to the excess amount.

The tax revaluation arising in the period of the asset's disposal is allocated between the income statement and other comprehensive income; see further example 2 in paragraph 13.214.

13.218.3 The situation is more complicated when an acquired asset's tax base has been reduced by rolled-over gains and the tax revaluation is given on the reduced tax base. In summary, the rolled-over gain reduces the new asset's tax base; see further paragraph 13.216 onwards.

Example 1 – Tax base reduced by rolled-over gains, asset carried at cost

Entity A acquires an asset and the initial tax base is reduced by rolled-over gains.

The asset's reduced tax base is increased each year by an amount based on asset price inflation.

Entity A accounts for the asset using a policy of cost (that is, with no accounting revaluation) under IAS 16.

 

 

Tax revaluation 'lost' due to rollover

 

 

Tax revaluation

Cost

 

Tax base on which revaluation is granted

 

Rolled-over gain

If the tax base of an asset carried at cost has been reduced by rolled-over gains (so that it is lower than the accounting cost) and the tax revaluation is given on the reduced tax base, the increase in the tax base as a result of the tax revaluation is recognised in profit or loss; this is because it does not relate to an accounting revaluation that has been recognised in other comprehensive income.

The tax revaluation reduces the deferred tax arising on the rolled-over gain. But the impact of the change in tax is not 'backwards traced' for accounting purposes to the previously rolled-over gain (this is because it is not related to the rollover, even though it is reversing its effect).

Example 2 – Tax base reduced by rolled-over gains, asset carried at revaluation

Entity A acquires an asset and the initial tax base is reduced by rolled-over gains.

The asset's reduced tax base is increased each year by an amount based on asset price inflation.

Entity A accounts for the asset using a policy of revaluation under IAS 16.

Revaluation gain

 

 

 

Tax revaluation 'lost' due to rollover

 

Tax revaluation

Cost

 

Tax base on which revaluation is granted

 

Rollover gain

The accounting is similar to the example in paragraph 13.218.2 (for revalued assets), except that the tax revaluation will be lower; this is because it is given on a lower tax base. As in paragraph 13.218.2, to the extent that the increase in the tax base as a result of the tax revaluation is no greater than the cumulative accounting revaluation surplus recognised in other comprehensive income, the tax revaluation arguably relates to an earlier accounting revaluation; as a result, the effect of the adjusted tax base is recognised in other comprehensive income.

In other words, the accounting in this scenario is similar to that in paragraph 13.218.2; but it will take longer for the tax revaluation to reach the accounting revaluation gain because it is given on a lower tax base.

We do not consider that the impact of the tax revaluation up to the accounting cost of the asset (that is, to the extent of the rolled-over gain) should first be taken to the income statement. This would suggest that the tax revaluation relates to the reinstatement of the cost (that is, it somehow replaces the impact of the rollover election). We do not believe that this is the case. The rollover reduces the amount of tax revaluation that is available, but otherwise the scenario is similar to the example in paragraph 13.218.2 for revalued assets; and so similar accounting should apply.

The above accounting will apply unless the tax revaluation exceeds the accounting revaluation gain.

 

 

Tax revaluation

Revaluation gain

 

 

Cost

 

Tax base on which revaluation is granted

 

Rollover gain

To the extent that the increase in the tax base as a result of the tax revaluation exceeds the cumulative accounting revaluation, it is a matter of judgement as to whether the tax revaluation relates to an accounting revaluation expected in the future or whether it is reinstating the tax base back to initial cost and reducing the deferred tax arising on the rolled-over gain; in which case, this element is similar to example 1 above and would be recognised in profit or loss.

13.218.4 Where an asset is acquired in a business combination and the asset's tax base is lower than its fair value at the acquisition date, the accounting in the parent's consolidated financial statements will be the same whether the acquired entity had revalued the property before acquisition by the group or whether the property was revalued on acquisition. In both cases, under IFRS 3, the asset's fair value at the acquisition date is the deemed cost from the acquiring group's perspective; and any deferred tax liability arising as a result of the lower tax base at the acquisition date will form part of the goodwill calculation.

Example 1 – Asset carried at a policy of cost (that is, based on fair value at acquisition date)

Entity A acquires an asset in a business combination.

The asset's tax base is lower than its fair value at the acquisition date. The asset's initial tax base is increased each year by an amount based on asset price inflation. The tax base at acquisition date reflects the tax revaluation to date.

Entity A accounts for the asset using a policy of cost (that is, based on the asset's fair value at the acquisition date, with no subsequent accounting revaluation) under IAS 16.

Fair value on acquisition

 

 

 

Tax revaluation

 

Initial tax base

If the asset's tax base is lower than its fair value at the acquisition date, the deferred tax liability forms part of the goodwill calculation in the consolidated financial statements. Any subsequent increase in the tax base as a result of tax revaluation is recognised in profit or loss, because it does not relate to an accounting revaluation that has been recognised in other comprehensive income.

Example 2 – Asset acquired in business combination subsequently carried at a policy of revaluation

 

Entity A acquires an asset in a business combination.

 

The asset's tax base is lower than its fair value at the acquisition date. The asset's initial tax base is increased each year by an amount based on asset price inflation; and the tax base at the acquisition date reflects the tax revaluation to date.

 

Entity A accounts for the asset using a policy of revaluation under IAS 16.

 

There are several acceptable accounting treatments (described below) for determining how the impact of the tax revaluation is allocated to the performance statements. The accounting treatment selected should be applied on a consistent basis.

 

(a)

The tax revaluation is first applied to any shortfall between the asset's 'cost' and tax base at the acquisition date. This might or might not result from a rollover election and/or higher fair value than original cost to the acquired entity. Either way, from the acquirer's perspective, the asset has a lower tax base. This method reflects the natural order in which the revaluation arises (that is, the fair value revaluation at acquisition arises before any post-acquisition revaluation; and so the tax revaluation is first allocated against the fair value adjustment).

 

 

Revaluation gain

 

 

 

Tax revaluation –
equity

Fair value on acquisition

 

Tax revaluation –
income statement

 

Initial tax base

 

 

 

To the extent that the increase in the tax base as a result of tax revaluation builds the tax base up to the fair value at the acquisition date, the accounting treatment is similar to that in example 1 above. The increase in the tax base is recognised in profit or loss, because this element does not relate to an accounting revaluation that has been recognised in other comprehensive income.

 

 

 

Then to the extent that any further increase in the tax base as a result of tax revaluation is no greater than the cumulative post-acquisition accounting revaluation surplus recognised in other comprehensive income, the tax revaluation arguably relates to an earlier accounting revaluation; and so the effect of this adjustment to the tax base is recognised in other comprehensive income.

 

 

 

Note: if the tax indexation exceeds the accounting revaluation, the comments in paragraph 13.217.4 apply.

 

 

(b)

The tax revaluation is first considered to relate to any post-acquisition revaluation gain; and so the impact is recognised in other comprehensive income (subject to the comments in para 13.217.4). This is consistent with the general principle in example 2 of paragraph 13.218.3 for revalued properties, where the tax revaluation is first considered to relate to the accounting revaluation.

 

 

Revaluation gain

 

 

 

Tax revaluation –
equity

Fair value on acquisition

 

 

Tax revaluation –
income statement

 

Initial tax base

 

 

 

To the extent that the increase in the tax base as a result of the tax revaluation is no greater than the cumulative accounting revaluation surplus recognised in other comprehensive income, arguably relates to the accounting revaluation that has been recognised in other comprehensive income; and so the effect of the adjusted tax base is recognised in other comprehensive income. This is consistent with example 2 in paragraph 13.218.3.

 

 

 

To the extent that the increase in the tax base as a result of the tax revaluation exceeds the cumulative accounting revaluation recognised in other comprehensive income, it would be considered to relate to the element of revaluation arising on acquisition (that is, the fair value adjustment); in that case, the increase in the tax base as a result of indexation would be recognised in profit or loss.

 

 

 

To the extent that the tax revaluation exceeds the cumulative accounting revaluation (recognised in other comprehensive income and arising on acquisition), it is a matter of judgement as to whether the tax revaluation relates to an accounting revaluation expected in the future. If it does, the effect of the adjusted tax base would be recognised in other comprehensive income; otherwise, it would be recognised in profit or loss.

 

 

(c)

The tax revaluation would be allocated pro rata.

 

 

Revaluation gain

 

 

 

Tax revaluation

 

Equity

Income statement

Fair value on acquisition

 

 

 

Initial tax base

 

 

 

The tax revaluation would be allocated pro rata to the revaluation arising on acquisition (that is, change in tax recognised in profit or loss) and the post-acquisition accounting revaluation (that is, change in tax recognised in other comprehensive income).

 

 

13.219 The accounting treatments described above apply regardless of whether a deferred tax liability was recognised on transition to IFRS or later. But the fact that a deferred tax liability recognised on transition to IFRS was charged to equity (as part of the transition adjustment) does not mean that changes in the liability will also be recognised in equity. Instead, management should use the entity's current accounting policies to determine where the items that gave rise to the original deferred tax would have been recognised if IFRS had applied in the earlier periods.

13.219.1 Where it is not possible to assess where the items that gave rise to the original deferred tax would have been recognised if IFRS had applied in the earlier periods, the changes in the deferred tax should, by default, be recognised in profit or loss.

13.219.2 An entity might recognise an asset at a revalued amount ('deemed cost') on transition to IFRS, in lieu of cost, but does not otherwise treat the asset as revalued. Where the entity does not have an accounting policy of revaluing its assets, there is no revaluation surplus shown in the financial statements. In our view, changes in the related deferred tax liability arising as a result of tax revaluation are not regarded as relating to an accounting revaluation recognised in other comprehensive income; and so the impact of the tax revaluation should be recognised in profit or loss.

13.219.3 Similarly, an entity might have recognised deferred tax relating to a business combination on transition to IFRS and taken it (under IFRS 1) to retained earnings. Where the entity does not have an accounting policy of revaluing its assets, this was a one-off entry in lieu of adjusting goodwill (which IFRS 1 only permits in limited circumstances). A later tax revaluation does not relate to an accounting revaluation that has been recognised in other comprehensive income; and so (consistent with example 1 in para 13.218.4) the increase in the tax base as a result of tax revaluation would be recognised in profit or loss.

Investment properties

13.219.4 Investment properties are held to earn rentals or for capital appreciation or both. Under IAS 40, an entity can choose to measure the investment property at cost or at fair value.

13.219.5 In 2010 the IASB amended IAS 12 for investment properties. The amendments introduced a presumption that an investment property measured at fair value is recovered entirely through sale. This presumption is rebutted if the investment property is depreciable and is held within a business model whose objective is to consume substantially all of the investment property's economic benefits over time rather than through sale. The presumption cannot be rebutted for an investment property (or portion of an investment property) that would be considered non-depreciable if IAS 16 were applied (such as freehold land).

Carried at fair value

13.219.6 In some jurisdictions, an investment property does not qualify for tax depreciation (whatever measurement basis is used); and so no part of the property's cost is deductible against taxable rental income. Instead, the cost of the property (uplifted by an allowance for inflation, where applicable) is allowed as a deduction against sales proceeds for the purpose of computing any chargeable gain arising on sale.

13.219.7 Even in jurisdictions where an investment property qualifies for tax depreciation, there is a presumption that an investment property carried at fair value will be recovered entirely through sale. This presumption is rebutted if the investment property would be considered depreciable if IAS 16 were applied and it is held within a business model whose objective is to consume substantially all of the investment property's economic benefits over time rather than through sale.

13.219.8 Therefore, deferred tax for investment properties carried at fair value should generally be provided using the tax base and rate that are consistent with recovery entirely through sale, and using capital gains tax rules – or other rules regarding the tax consequences of sale (such as rules designed to claw back any tax depreciation previously claimed in respect of the asset). If the presumption is rebutted, deferred tax should be measured reflecting the tax consequences of the expected manner of recovery. [IAS 12, para 51C]. The guidance at paragraph 13.170 (on how to apply the expected manner of recovery approach to assets and liabilities) can also be applied to investment properties carried at fair value.

13.219.9 The presumption also applies where investment property is acquired in a business combination and the acquirer uses fair value to measure the investment property later.

Carried at cost

13.220 Where an investment property is carried at cost, it would be depreciated in the normal way over its useful economic life for accounting purposes; the rebuttable presumption that the asset will be recovered through sale does not apply. The asset's expected manner of recovery might be through a combination of use and sale; in that case, the asset's carrying amount is split between the use and sale elements, and these carrying amounts are compared to the respective tax bases. Where the only tax deduction available for the property is on sale, the tax base of the building's use element carried at cost would be nil on initial recognition and in all future periods.

13.221 This can be illustrated by the following example.

Example – Dual manner of recovery for investment property carried at cost

 

An entity purchased a building on 1 January 20X7 for C50m that had a useful life of 25 years and an estimated nil residual value. For tax purposes, the asset's cost is not deductible against taxable rental income; but any sales proceeds are taxable after deducting cost at the date of sale. The tax rate is 30% for taxable income and 40% for chargeable capital gains. A carrying amount of nil would be attributed to the sale element of the building on initial recognition, creating a deductible temporary difference of C50m on the sale element. A taxable temporary difference would arise on the use element on initial recognition, being the carrying amount of C50m less the tax base of nil. At the end of year 1, assuming the residual value was still nil, the element of the asset to be recovered through use would have a depreciated cost of C48m (C50m less C2m depreciation charge). The temporary difference on the use element at the balance sheet date is C48m; but no deferred tax is provided because this amount is part of the C50m temporary difference that arose in relation to the use element on initial recognition. It follows that no deferred tax liability will arise on the building's use element where the investment property is carried at depreciated cost. At the end of year 1, the deductible temporary difference for the building's sale element would remain; but, as with the taxable temporary difference above, this will be covered by the initial recognition exception – so no deferred tax is recognised.

 

Transfers to or from investment property

13.225 A property might be transferred from investment property carried at fair value to property, plant and equipment following commencement of owner-occupation; or it might be transferred from property, plant and equipment to investment property that will be carried at fair value following end of owner-occupation. This reclassification could have consequences for the deferred tax balances recognised.

Example 1 – Transfer from investment property held at fair value to property, plant and equipment

An entity acquired an investment property on 1 January 20X7. The building element of the property is valued at C50m . Management initially expects to use the building for 10 years to generate rental income, with no residual value. The initial expectation is that the building will be sold at the end of year 10 to recover its tax base. The presumption that it will be recovered through sale is not rebutted.

For tax purposes, the asset's cost is not deductible against rental income; but any sales proceeds are taxable after deducting cost. The tax rate is 30% for taxable income and 40% for chargeable capital gains.

On initial recognition, no temporary differences arose. During years 1 to 5, changes in the building's fair value were credited to profit or loss. The entity also recognised deferred tax on the changes in fair value in profit or loss.

Five years after acquisition, the property was transferred from investment property to property, plant and equipment following a change in use. At the date of transfer, the building's fair value and the corresponding deferred tax liability were C60m and C4m (40% of C10m) respectively; and the building was estimated to have a remaining life of 20 years with a nil residual value.

Where an investment property carried at fair value is transferred to property, plant and equipment, the property's fair value at the date of transfer becomes its deemed cost for subsequent accounting under IAS 16. [IAS 40 para 60]. So no adjustment is made to the carrying amount at the date of transfer. Howeve,r the building will now be expected to be recovered through use and sale. A taxable temporary difference of C60m will arise in relation to the use element (carrying value of C60m less tax deductions through use of nil), of which C50m would have been originally covered by the initial recognition exception if the property had always been classified as property, plant and equipment. A deductible temporary difference of C50m will remain on the sale element (tax deductions through sale of C50m less expected residual value of nil), but this would also have been covered by the initial recognition exception. So a deferred tax liability of C3m (30% of C10m) should be recognised due to the difference in the tax rates between capital and income. This reduction of C1m in the deferred tax balance is recognised through the revaluation reserve.

At the end of the year, the building's use element would have a depreciated carrying amount of C57m; this would give rise to a taxable temporary difference at that date of C57m. Of this amount, C47.5m arose on initial recognition (being the original temporary difference on initial recognition of C50m less a year's depreciation charge of C2.5m). The remaining C9.5m arose after initial recognition; so deferred tax should be provided on this amount. This results from the C10m uplift in the building's valuation (that occurred after initial recognition) less a year's depreciation charge against this (of C0.5m). So the deferred tax balance at the end of the year would be C2.85m (30% of C9.5m). This reduction of C0.15m in the deferred tax balance (from C3m to C2.85m) is recognised through the income statement. The deferred tax liability will continue to reverse at the rate of C0.15m per annum until it has been reversed in full over the building's remaining useful life.

Assuming no change in residual value or tax base for the building's sale element, there would be no impact on the deferred tax calculation for the sale element.

Example 2 – Transfer from property, plant and equipment to investment property held at fair value

A building was purchased on 1 January 20X7 for C50m, with a useful life of 25 years and an estimated residual value of nil. The building was used in the business; so it was classified as property, plant and equipment. For tax purposes, the asset's cost is not deductible in use, but any sales proceeds are taxable after deducting the cost. The tax rate is 30% for taxable income and 40% for chargeable capital gains.

On initial recognition, a carrying amount of nil was attributable to the building's sale element; this created a deductible temporary difference. A taxable temporary difference existed in relation to the building's use element; but no deferred tax was recognised because these differences were covered by the initial recognition exception.

Five years after acquisition, the property was transferred from property, plant and equipment to investment property following a change in use. At the date of transfer, the property's depreciated cost was C40m (C50m less five years' annual depreciation of C2m). The property's fair value at the date of transfer amounted to C60m. The presumption that the property will be recovered through sale will apply after the transfer.

Where an entity transfers an owner-occupied property to investment property that will be carried at fair value, the difference between the fair value and the property's depreciated cost is treated in the same way as a revaluation under IAS 16. [IAS 40 para 61]. In other words, the difference of C20m (C60m less C40m) is credited to the revaluation reserve and recognised in other comprehensive income. The entity also recognises deferred tax on the revaluation surplus charged to the revaluation reserve in other comprehensive income.The deferred tax could be calculated by reference to the C10m difference between the revised carrying value and the tax base through sale; or some take the view that the deferred tax could be calculated by reference to the full uplift of C20m at the date of transfer (because C10m of the C50m of cost on initial recognition has already reversed through the depreciation charge).

Intangible assets

13.225.1 The amendments to IAS 12 made by 'Deferred tax: Recovery of underlying assets', issued in December 2010, incorporate the guidance in SIC 21, which has been withdrawn for entities applying the amendments.

13.225.2 Paragraph 107 of IAS 38 states that "an intangible asset with an indefinite useful life shall not be amortised". This might be the case with, for example, trademarks or brands (see further chapter 15). Non-amortisation of an asset is arguably an indication that the asset is not recovered through use; so the measurement of deferred tax presumes that the asset's carrying amount will be recovered through sale; and the tax base determination follows that presumption.

13.225.3 The carrying amount of a non-depreciable asset (such as land having an unlimited life) will only be recovered through sale. [IAS 12 para 51B]. The asset is not depreciated and no part of its carrying amount is expected to be recovered (or consumed) through use. The question arises whether the same conclusion should be applied to intangible assets with indefinite useful lives.

13.225.4 There are some distinctions to be drawn between land and intangible assets with indefinite lives. The fact that an asset has an indefinite life does not mean that the future economic benefits arising from the asset will not eventually be consumed; it is simply that the timing of that consumption is uncertain. Indeed, the requirement to test intangible assets with indefinite lives for impairment at least annually is an acknowledgement that recovery through use might occur. The intangible asset can be used to generate income on an ongoing basis in the business; so recovery through sale should not be presumed where that is not currently expected.

13.225.5 Consistent with the factors above, we consider that management should use judgement based on individual facts and circumstances to determine the expected manner of recovery of intangible assets with indefinite lives and whether paragraph 51B of IAS 12 should be applied.

13.225.6 In some circumstances, the tax base of an intangible asset with an indefinite life can be determined solely on a sale basis. If revenues generated by intangible assets with indefinite lives are not (and are not expected to be in the future) a recovery of the asset's carrying amount, recovery through sale might be acceptable. But the following factors should be considered:

Recovery through sale may not be presumed for intangible assets that have been the subject of an impairment write-down – such a write-down is evidence of recovery through use.

If the asset's carrying amount is subject to impairment in the future, the expected manner of recovery could change to recovery through use; this will have an impact on deferred taxes recognised in current earnings, in addition to the impact of the impairment.

Management might need to disclose the presumption of recovery through sale to comply with paragraph 122 of IAS 1, which requires disclosure of judgements made by management that have significant effects on amounts recognised.

Financial instruments

Financial assets carried at fair value

13.226 Significant deferred tax balances could arise on financial instruments. An entity should consider the expected manner of recovery for each instrument and the associated tax implications to measure and report the deferred tax. Instruments might be recovered through use, through sale or through a combination of both (that is, a dual manner of recovery). Generally, financial assets that are held for trading purposes will be recovered through sale, whereas financial assets that are intended to be held to maturity will be recovered through use. However, the measurement and reporting of deferred tax related to available-for-sale financial assets will often be based on an assumed recovery through sale, but might warrant a dual manner of recovery in some circumstances.

13.226.1 All entities (including non-financial entities) are required or permitted under IAS 39 to measure certain financial assets and liabilities at fair value; and changes in fair values are reported through profit or loss or in other comprehensive income.

13.227 Where financial assets are carried at fair value with adjustments through profit or loss, tax laws might recognise the gains and losses arising from changes in fair value as they accrue; this means that such gains and losses would be subject to current tax when they are recognised and no deferred tax would arise. In other circumstances, the gains and losses might be taxed only when they are realised at a later date. In that case, a temporary difference arises between the asset's fair value and its tax base; so a deferred tax liability or asset (subject to meeting the recognition test) should be recognised through profit or loss.

13.227.1 Where a financial asset is classified as 'available-for-sale' and changes in fair value are recognised in other comprehensive income, the tax effects of such gains and losses should also be recognised in other comprehensive income. In some tax jurisdictions, such gains and losses are taxed in the same period in which they arise; in other tax jurisdictions, they are taxable when the financial asset is sold. In either situation, the related current or deferred tax effects should also be recognised in other comprehensive income.

13.227.2 When an available-for-sale financial asset is derecognised on sale or is impaired, the cumulative gain or loss previously recognised in other comprehensive income is reclassified to profit or loss. [IAS 39 paras 55(b), 67]. A question arises whether the tax on the gain recognised in other comprehensive income should be reclassified to profit or loss. Although IAS 12 is silent on this, we believe that the tax effects of gains and losses recognised in other comprehensive income should be reclassified to profit or loss in the same period as the gains or losses to which they relate. This is a sensible treatment, because reclassifying any cumulative gains or losses to profit or loss ensures that tax on the gain recognised in profit or loss is the same as the tax paid on that gain.

Example – Deferred tax on fair value gains

An entity acquired an equity security for C10,000; the security is classified on initial recognition as 'available-for-sale'. At the year end, the security's fair value increases to C12,000. The tax rate is 30%. 

The change in fair value of C2,000 is recognised in other comprehensive income under IAS 39. Ignoring indexation, the tax arising on this gain at the balance sheet date is 30% of (C12,000 – C10,000) = C600. A current or deferred tax liability of C600 will be recognised at the balance sheet date (with a corresponding debit recognised in other comprehensive income), depending on whether the tax on the gain is payable in the current period or deferred until the investment is sold.

The security is sold in the following year at its market value of C11,500. A loss arises for accounting purposes between sales proceeds of C11,500 less carrying amount of C12,000 = C500. Also (under IAS 39) the gain of C2,000 (before tax) previously recognised in other comprehensive income is reclassified to profit or loss; this means that the gain reported in profit or loss is C1,500, which is sales proceeds less original cost.

Ignoring any inflation adjustments for tax purposes, the current tax that arises on sale will depend on whether tax was paid or deferred on the earlier gain.

Scenario 1 – Gains or losses are taxed in the period in which they arise

A taxable loss of C500 arises between sales proceeds of C11,500 and carrying amount for tax purposes of C12,000; this gives rise to a current tax credit of C150 (C500 @ 30%), assuming this is recoverable. The taxable loss of C500 differs from the accounting gain of C1,500; this is because tax on the gain of C2,000 arising in a prior period was paid as current tax. There would have been no deferred tax arising in the previous period; but the current tax of C600 would have been recognised in other comprehensive income.

Where tax on the gain that was previously recognised in other comprehensive income was paid when the gain arose, the reclassification of the tax paid in the current period is regarded as an adjustment of the current tax of prior periods:

 

Book profit

Equity*

 

C

C

Sales proceeds

11,500

 

Carrying amount before sale

12,000

 

 


 

Loss before reclassification

(500)

Reclassification of gain

2,000

(2,000)

 


Result of sale, as reported 

1,500

(2,000)

Current tax – in period

150

Current tax – reclassified

(600)

600

 


Net gain and related tax

1,050

(1,400)

 


 

 

 

* The amounts shown under 'equity' are recognised in other comprehensive income.

 

The net loss of C350 (C1,400 loss recognised in other comprehensive income less the C1,050 gain recognised in profit or loss) is the C500 loss for the period less tax at 30% = C150.

 

The tax credit of C150 would be reported as a current tax credit, and the reclassified tax of C600 would be described as 'prior-year adjustment to current tax' or 'reclassification from equity'. The result is a total tax charge of C450, which is the tax that arises on the net gain of C1,500. A current tax recoverable of C150 would be recognised in the balance sheet.

 

 

Scenario 2 – Gains or losses are deferred and taxed in the period in which the investment is sold

 

In this situation, a taxable gain of C1,500 arises between sales proceeds of C11,500 and carrying amount for tax purposes of C10,000; this gives rise to a current tax charge of C450 = 30% of (C11,500 – C10,000). The taxable and accounting gains are the same, as would be expected; this is because tax on the gain of C2,000 arising in a prior period was deferred. A deferred tax liability of C600 would have been recognised in the previous period (C2,000 @ 30%); and this is released in the current period.

 

Where tax on the previous gain was deferred, the current tax is recognised in profit or loss; and deferred tax is released through other comprehensive income:

 

 

 

 

 

Book profit

Equity*

 

C

C

Sales proceeds

11,500

 

Carrying amount before sale

12,000

 

 


 

Loss before reclassification

(500)

Reclassification of gain

2,000

(2,000)

 


Result of sale, as reported 

1,500

(2,000)

Current tax

(450)

Deferred tax release

600

 


Net gain/(loss) and related tax

1,050

(1,400)

 


 

 

* The amounts shown under 'equity' are recognised in other comprehensive income.

 

As in scenario 1, the net loss of C350 (C1,400 loss recognised in other comprehensive income less the C1,050 gain recognised in profit or loss) is the C500 loss for the period less tax at 30% = C150.

 

The tax payable of C450 would be reported as a current tax charge. A current tax liability of C450 would be recognised in the balance sheet; and the deferred tax liability of C600 that was previously recognised would be credited to other comprehensive income.

13.227.3 An equity investment might be recovered through receipt of dividends or through disposal or a combination of both. Where the tax implications differ, the expected manner of recovery needs to be considered.

Example – Expected manner of recovery of available-for-sale investment

An entity holds an available-for-sale investment − that is, shares in a listed entity. The tax base of the shares is C400,000, which was the amount initially paid for the shares. The fair value of the shares at the year end is C1,000,000.

At the balance sheet date, the entity expects to receive dividends of C500,000 over five years and then sell the shares. The shares are currently trading ex-dividend and the future distributions are not expected to impair the carrying amount of the investment when paid.

Dividends are non-taxable. Based on current tax legislation, if the shares were sold after five years, capital gains tax at a rate of 10% would be payable on the excess of sales price over cost.

How much deferred tax (if any) should the entity recognise at the balance sheet date?

An entity should recognise deferred tax based on the expected manner of recovery of an asset or liability at the balance sheet date. [IAS 12 para 51].

The entity expects to derive the dividends from the investee's future earnings rather than from its existing resources at the balance sheet date. The entity does not expect the investment's carrying amount at the balance sheet date to be recovered through future dividends.

Therefore the entity expects to recover the investment through sale. The carrying amount of C1,000,000 has a corresponding tax base of C400,000 on sale. There is a taxable temporary difference of C600,000 at the balance sheet date. Tax is payable at the capital gains rate of 10%.

The entity should recognise a deferred tax liability of C60,000 relating to the shares.

But, if the entity expects that the future dividends will result in a recovery of the investment's carrying amount, applying the dual manner of recovery might be appropriate.

13.227.4 An entity might use a derivative instrument (for example, a foreign currency forward contract) to hedge its foreign exchange risk exposure on cash flows in connection with a future purchase of an item of property, plant and equipment. The derivative is carried at fair value; and, if it qualifies as a cash flow hedge under IAS 39, gains and losses are initially recognised in other comprehensive income. The entity has an accounting policy choice as to the amount at which to record the hedged asset when it is purchased (see further chapter 6). The entity could record the asset at cost and then reclassify the gain or loss from other comprehensive income to profit or loss gradually as the asset is depreciated. [IAS 39 para 98(a)]. Or the gain or loss on the derivative could be reclassified immediately out of other comprehensive income and added to (or deducted from) the asset's initial cost. [IAS 39 para 98(b)]. If the latter policy is adopted and the asset's cost is adjusted, a temporary difference will arise on the asset's initial recognition. The following example considers the deferred tax implications of this temporary difference and the recognition of tax relating to the derivative in the performance statements.

Example – Cash flow hedge of property, plant and equipment

An entity purchases an item of property, plant and equipment (PPE) in a foreign currency. Before the purchase, it enters into a foreign currency forward contract that meets the criteria for hedge accounting in IAS 39 and is a fully effective cash flow hedge. Under the tax rules of the jurisdiction where the entity is based, the gain or loss on the forward contract is taxed when the forward contract matures (that is, when the asset is purchased). The entity intends to recover the asset entirely through use; the tax authority grants capital allowances over the asset's useful economic life based on its equivalent purchase price in the entity's functional currency on the date of purchase.

The entity's accounting policy for cash flow hedges of this type is to reclassify the gain or loss on the derivative immediately out of other comprehensive income and add it to (or deduct it from) the asset's initial cost. [IAS 39 para 98(b)]. This adjustment to the PPE's cost means that its carrying amount differs from its tax base; so a temporary difference arises on recognising the PPE.

(a) Does the initial recognition exception apply to the temporary difference arising from an asset's cost adjustment for a cash flow hedge?

In our view, the initial recognition exception does not apply; and so deferred tax should be recognised. Any tax on settling the forward contract is inherently linked to the PPE's purchase. This is because the forward contract was a designated hedge for this purchase, and the initial temporary difference on the PPE arises as a result of the hedge accounting. As such, the PPE's purchase cannot be looked at in isolation. So the purchase of the PPE has an impact on accounting profit (that is, the current tax on the derivative) that is inherently linked to the purchase. The criteria for the initial recognition exception in IAS 12 (see para 13.162) are not met.

(b) When should the tax effect of the gain or loss on the forward contract be recognised in profit or loss?

Any deferred tax previously recorded in other comprehensive income should be reclassified out of other comprehensive income and into profit or loss in line with the underlying accounting. This can be achieved by recognising the current tax on the forward contract in profit or loss and unwinding the existing deferred tax asset or liability against other comprehensive income. The net effect to the income tax charge will be nil in this case, because a new deferred tax asset or liability is recognised on initial recognition of the asset (as a result of the temporary difference referred to in (a) above).

Financial assets carried at amortised cost

13.228 Financial instruments carried at amortised cost can also give rise to deferred tax consequences.

Example – Deferred tax and financial assets carried at amortised cost

An entity acquires a 5% bond with a nominal value of C100,000 at a discount of 20% to the nominal value; the bond is repayable in five years' time at a premium of 20% to the nominal value. The costs of acquisition are C5,000, and interest is received annually in arrears. The entity expects to hold the bond to maturity. The costs of acquisition are taxed as part of the cost of the bond; interest is taxed when received; and any profit on redemption (proceeds less cost) is taxed on redemption.

Net purchase cost of bond

C

 

Total receivable over life

C

Nominal value

100,000

 

Nominal value

100,000

Discount on issue

(20,000)

 

Redemption premium

20,000

Cost of acquisition

5,000

 

Interest @ 5% for five years

25,000

 


 

 


Total

85,000

 

Total

145,000

 


 

 


The total return on the bond over five years is C60,000 (C145,000 – C85,000). This amount should be amortised over the period to maturity using the effective interest method. The effective interest rate is 12.323% that exactly discounts the future cash inflows over the five-year period to the net proceeds received.

Year

Amortised cost at beginning of the period

Effective interest
@ 12.323 % *

Interest received

Amortised cost at end of the period

Tax Base

Temporary Difference

 

C

C

C

C

C

C

1

85,000

10,474

(5,000)

90,474

85,000

5,474

2

90,474

11,149

(5,000)

96,623

85,000

11,623

3

96,623

11,906

(5,000)

103,529

85,000

18,529

4

103,529

12,757

(5,000)

111,286

85,000

26,286

5

111,286

13,714

(5,000)

120,000

85,000

35,000


60,000

(25,000)

 

 


 

 

 

 

* Carrying amount of the bond × effective interest rate.

 

The cost of the bond for tax purposes is C85,000 (C80,000 initial cost plus C5,000 costs) and is deductible against total redemption proceeds. So this is the asset's tax base throughout the bond's ownership. The entity provides deferred tax each year on the taxable temporary difference between the amortised cost and the tax base, as shown above. Just before redemption, the amortised cost will have risen to C120,000; so there will be a taxable temporary difference of C35,000. Current tax payable on the taxable gain of C35,000 (proceeds of C120,000 less tax cost of C85,000) will be offset by the release of deferred tax provided on this taxable temporary difference during the period the bond is held. If the investment also qualifies for indexation allowance, the tax base of C85,000 would change each year; and the temporary difference calculated above would include the effects of indexation.

 

But if the tax authorities assess tax on the basis of the effective interest (consistent with the manner in which the bond is accounted for each year), the asset's tax base at the end of each year would be equal to its carrying amount; and no deferred tax would arise.

Compound financial instruments

13.229 Compound financial instruments (such as convertible notes) might contain liability and equity components: the liability component represents a borrowing with an obligation to repay; and the equity component represents an embedded option to convert the liability into the entity's equity. Under IAS 32, the issuer is required to present the liability and equity components separately on its balance sheet. First, the carrying amount of the liability component is determined by measuring the fair value of a similar liability that does not have an associated equity component. Secondly, this amount is deducted from the fair value of the instrument as a whole; and the residual amount is assigned to the equity component.

13.230 In some jurisdictions, the tax base of a compound financial instrument that is a simple convertible note (comprising a loan and an equity component) will often be its face value. The tax base is not split. When such an instrument is split for accounting purposes, the carrying amount of the liability component will initially be less than the face value of the instrument as a whole and less than the tax base and a taxable temporary difference arises. Even though the tax base of the liability is different from its carrying amount on initial recognition, the initial recognition exception does not apply. The taxable temporary difference arises from the initial recognition of the equity component separately from the liability component. So a deferred tax liability should be recognised on the taxable temporary difference. [IAS 12 para 23].

13.231 The equity component of the compound instrument is recognised in equity; so the deferred tax liability is also charged directly to equity (as a reduction in the carrying amount of the equity component). But the discount associated with the liability component of the compound instrument unwinds through profit or loss; so the reduction in the associated deferred tax liability in the balance sheet (resulting from the reversal of the temporary difference) is also recognised through profit or loss. This is consistent with the principle that tax follows the item. [IAS 12 para 23]. The following example (based on example 4 of appendix B to IAS 12) illustrates the accounting for the tax effects of a compound financial instrument where the tax base is not split.

Example – Deferred tax on convertible loan where the tax base is not split

An entity issues a non-interest-bearing convertible loan for proceeds with a fair value of C1,000 (which is also the loan's face value) on 31 December 20X4; the loan is repayable at par on 1 January 20X8. Under IAS 32, the entity classifies the instrument's liability component as a liability and the equity component as equity. The entity assigns an initial carrying amount of C751 to the liability component and C249 to the equity component. The entity later recognises imputed discount as an interest expense at an annual rate of 10% on the liability component's carrying amount at the beginning of each year. The tax authorities do not allow the entity to claim any deduction for the imputed discount on the liability component of the convertible loan. The tax rate is 40%.

The temporary differences associated with the liability component (and the resulting deferred tax liability and deferred tax expense and income) are as follows:

 

Year

20X4

20X5

20X6

20X7

 

C

C

C

C

Carrying amount of liability component

751

826

909

1,000

Tax base

1,000

1,000

1,000

1,000

 


Taxable temporary difference

249

174

91

 


Opening deferred tax liability at 40%

0

100

70

37

Deferred tax charged to equity

100

Deferred tax expense (income)

(30)

(33)

(37)

 


Closing deferred tax liability at 40%

100

70

37

 


 

 

At 31 December 20X4, the entity recognises the resulting deferred tax liability by adjusting the initial carrying amount of the equity component of the convertible liability (as explained in para 23 of IAS 12). So the amounts recognised at that date are as follows:

 

C

Liability component

751

Deferred tax liability

100

Equity component (C249 less C100)

149


1,000


 

 

Later changes in the deferred tax liability are recognised in profit or loss as tax income. [IAS 12 para 23]. So the entity's income statement is as follows:

 

Year

20X4

20X5

20X6

20X7

 

C

C

C

C

Interest expense (imputed discount)

75

83

91

Deferred tax (income @ 40%)

(30)

(33)

(37)


45

50

54


13.232 The deferred tax balances need to reflect the tax consequences arising from the manner in which the entity expects to recover or settle the carrying amount of its assets and liabilities. If there are various settlement options with different tax consequences, the entity needs to assess (at each reporting date) the most likely option that the investors or the issuer will take. For example, management might expect that a convertible instrument will be redeemed or converted early (for instance, in the next accounting period), and the deferred tax liability previously provided does not fully reflect the tax consequences that would follow from conversion or redemption; in that case, the deferred tax liability should be adjusted accordingly. Any adjustment should be made through equity or through profit or loss depending on the tax consequences that would follow from early conversion or redemption. For example, if no tax is payable on early conversion, any outstanding deferred tax liability should be derecognised by crediting equity; this is consistent with the principle that tax follows the item. On conversion, the liability component is transferred directly to equity and no gain or loss arises. It is also consistent with the treatment that the reversal of the deferred tax liability does not arise from the unwinding of the discount. Because the option to convert generally lies with the instrument's holders, the deferred tax balance should only be adjusted for the tax effects of the conversion if there is sufficient evidence that it is probable that the instrument's holders will convert. On the other hand, if early redemption of the convertible instrument would have further tax consequences, any adjustment to the deferred tax liability previously provided should be made through profit or loss.

Payments made under equity instruments that give rise to income tax reduction

13.232.2 There are financial instruments that have some characteristics of debt but nevertheless are equity instruments for accounting purposes. Examples include a perpetual bond that carries a coupon that the issuer can defer indefinitely, or annuity commitments that are payable in the event a dividend distribution is made. Such payments are accounted for as charges to equity, and are often deductible for tax purposes. .

13.232.3 The income tax consequences of distributions to holders of an equity instrument shall be accounted for in accordance with IAS 12. [IAS 32.35A]. Under IAS 12, income tax that relates to items recognised in equity should be recognised in equity [IAS 12.61A]. However, the tax consequences of dividends to shareholders should generally be recognised in profit or loss [IAS 12.52A and IAS 12.52B] because they are linked to past transactions or events (that is, prior earnings) rather than to distributions to owners. 

13.232.4 As noted above, sometimes payments to holders of equity instruments other than dividends are reflected as distributions of equity. Where such payments also give rise to income tax deductions, it is not always clear whether such tax consequences should be recognised within equity or profit or loss. As various equity instruments have different features and tax law varies by country, the nature of the payment must be assessed in each circumstance to determine whether the tax impact should be reflected within equity or profit or loss. Indicators that might provide evidence that the payment is not a dividend to shareholders include:

 

The related payments can be made regardless of available profit in the year or prior year earnings;

Holders of the related equity instruments are not also required to be shareholders;

The related payments result in a reduction to the carrying amount of the equity instrument.

Investments in subsidiaries, branches, associates and joint ventures

13.233 This section deals with the deferred tax implications of investments in subsidiaries, branches, associates and joint ventures in separate financial statements. When a parent entity or investor acquires such an investment it is accounted for in the separate financial statements of the parent or investor at cost (which is the amount paid for the shares or the business) or under IAS 39. A temporary difference might arise between the investment's carrying amount in the separate financial statements and its tax base (which is often cost or indexed cost).

13.233.1 Where an investment is carried at cost, any increase in the investment's value is not recognised. The investee's post-acquisition profits are not recognised in the parent or investor's separate financial statements; so these are not reflected in the investment's carrying amount in determining the temporary difference.

13.233.2 An entity should recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, except to the extent that both of the following conditions are satisfied:

 

the parent, investor or venturer is able to control the timing of the reversal of the temporary difference; and

 

it is probable that the temporary difference will not reverse in the foreseeable future.

[IAS 12 para 39].

13.233.3 An entity should recognise a deferred tax asset for all deductible temporary differences arising from investments in subsidiaries, branches and associates, and interests in joint ventures, to the extent that it is probable that:

 

the temporary difference will reverse in the foreseeable future; and

 

taxable profit will be available against which the temporary difference can be utilised.

[IAS 12 para 44].

13.233.4 For guidance on the way in which the above exemptions (for temporary differences relating to investments in subsidiaries, branches, associates, and interests in joint ventures) interact with the initial recognition exceptions in paragraphs 15 and 24 of IAS 12, see paragraph 13.233.10.

13.233.5 The carrying amounts for such investments can be recovered through distributions or disposal or both. Management needs to determine the deferred tax implications based on the manner in which it expects to recover the investment.

13.233.6 The application of the above exceptions from recognising deferred tax in separate financial statements is addressed in the section dealing with deferred tax implications of investments in subsidiaries, associates and joint ventures in consolidated financial statements, from paragraph 13.253 onwards.

Investment in branches

13.233.7 A reporting entity that operates a branch recognises the branch's assets and liabilities in its own financial statements. Where temporary differences arise in relation to those assets and liabilities, deferred tax assets and liabilities are also recognised on those temporary differences in the reporting entity's financial statements under IAS 12. In some jurisdictions, there might be tax consequences where the branch distributes profits or is sold. This is similar to the position for subsidiaries in consolidated financial statements. A temporary difference might arise between the total carrying amount of the reporting entity's net assets in the branch and the tax base of the reporting entity's investment in the branch. Where the reporting entity has determined that the retained profits in the branch will not be distributable in the foreseeable future, and that the branch will not be sold, it does not recognise a deferred tax liability in relation to its investment in the branch. [IAS 12 para 40]. See paragraph 13.274 for foreign branches.

Investments in tax-transparent entities

13.233.8 Around the world, there are a number of entities that do not pay tax but whose profits are taxable in the hands of the investors. Examples of such entities are partnerships, UK limited liability partnerships (LLPs) and US limited liability companies (LLCs). This type of tax structure can give rise to accounting issues in the investor's separate financial statements.

13.233.9 For instance, where an entity invests in a tax-transparent entity ('the investee'), it will initially record its investment at cost in its separate financial statements. But, because the investee is tax transparent, its initial tax base will not necessarily be its cost, but the sum of the tax bases of the underlying assets and liabilities within the investee. As such, there might be an initial taxable temporary difference. A question arises as to whether this is covered by the initial recognition exception (see para 13.162) or whether deferred tax should be provided on initial recognition.

13.233.10 In our view, the initial recognition exception applies, because recognition of the investment in the tax-transparent entity represents the initial recognition of an asset in a transaction that is not a business combination (in the investor's separate financial statements) and which does not affect accounting profit or taxable profit at the time of the transaction. [IAS 12 para 15(b)]. We consider that the reference made in paragraph 15 of IAS 12 to the exemption in paragraph 39 of IAS 12 (see para 13.233.2) – for which different conditions have to be met in order for the exemption to be taken – applies to temporary differences in respect of investments in subsidiaries, branches, associates and joint ventures arising after initial recognition.

13.233.11 Similar logic would apply for the interaction of the exemptions in paragraphs 24 and 44 of IAS 12 if there was an initial deductible temporary difference arising on the investment of the tax-transparent entity.

13.233.12 For the accounting in consolidated financial statements for tax relating to an investment in a tax-transparent entity, see paragraph 13.269 onwards.

Treatment of tax in consolidated financial statements

Introduction

13.234 The treatment of tax in consolidated financial statements involves the same considerations that apply to individual financial statements (that is, deferred tax should be provided on temporary differences that arise between the carrying amounts of assets and liabilities reported in the consolidated balance sheet and their tax bases). The tax base is determined in one of two ways: by reference to a consolidated tax return in jurisdictions that require such a return; or by reference to the tax returns of each individual entity in the group in other jurisdictions. [IAS 12 para 11].

13.234.1 In a group, the tax positions of the individual group members are unlikely to be similar. Some group members might be profitable but others might make a loss; this will lead to different tax considerations. Some group members might operate in the same tax jurisdiction, but others might operate in different tax jurisdictions. Consolidated financial statements are prepared as if the parent entity and its subsidiaries were a single entity; so it follows that the group's tax position needs to be viewed as a whole. A group's total tax liability is determined by adding together the tax liability assessed under local tax laws and borne by individual group members.

13.235 Under IAS 27 and IFRS 10 (effective for accounting periods beginning on or after 1 January 2013), a group should follow uniform accounting policies in preparing consolidated financial statements. Adjustments might be required at the consolidation level where an overseas subsidiary has not followed group accounting policies (for example, because of local requirements) in preparing its own financial statements. These adjustments could result in additional temporary differences in the consolidated financial statements for which deferred tax should be recognised.

13.236 Adjustments are also required to eliminate various intra-group transactions so the group can be treated as a single economic entity. Such adjustments affect the carrying amount of assets and liabilities reported in the consolidated balance sheet; so they give rise to additional temporary differences that defer or accelerate tax (from the perspective of treating the group as a single entity). Such tax effects are recognised as part of the group's deferred tax (see further para 13.252).

13.237 The types of events and transactions that normally give rise to deferred tax adjustments at the group level are as follows:

Business combinations that are accounted for as acquisitions such as:

Fair value adjustments.

Tax deductible goodwill.

Any additional assets and liabilities that are recognised at the date of acquisition.

Deferred tax assets and liabilities that were not recognised by the acquiree as a result of initial recognition exception.

Deferred tax asset in respect of unrecognised tax losses or deductible temporary differences of the acquiree.

Deferred tax asset in respect of unrecognised tax losses or deductible temporary differences of the acquirer.

Reverse acquisitions.

Intra-group transactions eliminated on consolidation.

Investments in subsidiaries, associates and joint ventures.

Foreign currency translation.

Business combinations

Fair value adjustments

13.238 In a business combination, the identifiable assets and liabilities of the acquired business are recognised in the consolidated financial statements at their fair values at the date of acquisition (with limited exceptions). These fair values of the individual assets and liabilities are often different from the book values appearing in the acquired entity's own financial statements. The tax bases of the assets and liabilities often remain the same; although they sometimes change as a result of the acquisition. So temporary differences arise on consolidation where the tax bases of the related assets and liabilities are not affected by the business combination or are affected differently. For example, a taxable temporary difference arises as a result of the acquisition when the carrying amount of a non-monetary asset (such as a building of the acquired entity) is increased to fair value at the date of acquisition but its tax base remains at cost to the previous owner. The deferred tax liability arising from this taxable temporary difference is recognised in the consolidated financial statements to reflect the future tax consequences of recovering the building's recognised fair value. The resulting deferred tax liability affects goodwill. [IAS 12 para 19].

Example – Deferred tax effects of fair value adjustments

On 1 January 20X5, entity H acquired all the share capital of entity S for C1,500,000. The book values and the fair values of the identifiable assets and liabilities of entity S at the date of acquisition are set out below, together with their tax bases in entity S's tax jurisdictions. Any goodwill arising on the acquisition is not deductible for tax purposes. The tax rates in entity H's and entity S's tax jurisdictions are 30% and 40% respectively.

 

Net assets acquired

Book values

Tax base

Fair values

 

C'000

C'000

C'000

Land and buildings

600

500

700

Property, plant and equipment

250

200

270

Inventory

100

100

80

Accounts receivable

150

150

150

Cash and cash equivalents

130

130

130

 


Total assets

1,230

1,080

1,330

Accounts payable

(160)

(160)

(160)

Retirement benefit obligations

(100)

(100)

 


Net assets before deferred tax liability

970

920

1,070

Deferred tax liability between book and tax basis (50 @ 40%)

(20)

 

 

 


Net assets at acquisition

950

920

1,070

 


Calculation of deferred tax arising on acquisition of entity S and goodwill

 

C'000

C'000

Fair values of S's identifiable assets and liabilities (excluding deferred tax)

 

1,070

Less: Tax base

 

(920)

 

 


Temporary difference arising on acquisition

 

150

 

 


Net deferred tax liability arising on acquisition of entity S (C150,000 @ 40%) – replaces book deferred tax

 

60

 

 


Purchase consideration

 

1,500

Fair values of entity S's identifiable assets and liabilities (excluding deferred tax)

1,070

 

Deferred tax

(60)

1,010

 


Goodwill arising on acquisition

 

490

 

 


The tax base of the goodwill is nil, so a taxable temporary difference of C490,000 arises on the goodwill ; but no deferred tax is recognised on the goodwill (as explained in para 13.159). The deferred tax on other temporary differences arising on acquisition is provided at 40% (not 30%), because taxes will be payable or recoverable in entity S's tax jurisdictions when the temporary differences are reversed.

 

Tax deductible goodwill

13.240 Goodwill arising in a business combination is sometimes deductible for tax purposes through amortisation over a number of years rather than against proceeds from sale of the acquired business. The goodwill is carried on the balance sheet without amortisation; so management needs to determine the appropriate tax base of the goodwill that reflects the manner in which it is expected to be recovered. If goodwill impairment is not expected in the foreseeable future, there might not appear to be an expectation of imminent recovery through use; and so it might be expected that the goodwill will be recovered solely through sale. The cost of the goodwill is not deductible against sales proceeds; so, if this analysis is appropriate, its tax base is nil and a taxable temporary difference exists between the carrying amount and the tax base. But no deferred tax should be recognised on initial recognition or later – see the exception outlined in paragraph 13.158. But the expected manner of recovery should be considered more closely. When a business is acquired, impairment of the goodwill might not be expected imminently; but it would also be unusual for a sale to be expected imminently. So it might be expected that the asset will be sold a long way in the future; in that case, recovery through use over a long period (that is, before the asset is sold) might be the expected manner of recovery. Management needs to exercise judgement to determine the expected outcome; and this might be a key judgement that should be disclosed (see para 13.307.2).

13.241 Goodwill is not amortised for accounting purposes; but goodwill arising in a business combination is an asset that can be consumed. The goodwill's carrying amount needs to be tested for impairment annually and whenever there is an indication that it might be impaired. Any impairment loss is recognised immediately in profit or loss. Where an entity expects to recover the goodwill's carrying amount at least partially through use (that is, not solely through sale), temporary differences might arise using the tax base that is consistent with recovery through use. Taxable temporary differences arising at the time of the business combination would not be recognised (see the exception outlined in para 13.158). If goodwill is amortised for tax purposes but no impairment is recognised for accounting purposes, any temporary differences arising between the (amortised) tax base and the carrying amount will have arisen after the goodwill's initial recognition; so they should be recognised.

13.242 Referring to the example in paragraph 13.238, assume that goodwill of C490,000 is deductible for tax purposes at the rate of 20% per annum (but there is no tax deduction on sale). The goodwill has a tax base in use of C490,000 on initial recognition, and no temporary difference arises where it is expected to be recovered wholly through use. At the end of the year, following a claim for tax deduction in that year of C98,000 (20% of C490,000), the tax base of the goodwill will reduce to C392,000. The carrying amount remains unchanged at C490,000 without any impairment; so a taxable temporary difference of C98,000 arises (carrying amount of C490,000 less tax base of C392,000). This taxable temporary difference arises during the year and not on initial recognition; so a deferred tax liability is recognised. [IAS 12 para 21B]. The tax deduction that should be recognised on consolidation is C39,200 (40% of C98,000) because the goodwill's carrying amount is recovered against S's taxable profits. By the end of year 5, the deferred tax liability would increase to C196,000, as the cost of the goodwill would have been fully amortised for tax purposes. The temporary difference at that date would be C490,000 (carrying amount of C490,000 less tax base of Cnil). This temporary difference and the corresponding deferred tax liability will remain until a reversal occurs, either on the goodwill's impairment or when the subsidiary is sold.

13.243 In some jurisdictions, the goodwill's cost is deductible (for tax purposes) only against proceeds from sale of the acquired business. Where the acquiring entity expects to recover the goodwill's carrying amount through use, a temporary difference arises in use. The goodwill's carrying amount exceeds its tax base of nil. But no deferred tax is provided on a taxable temporary difference arising on initial recognition of goodwill (see para 13.158). On the other hand, if (a number of years after acquiring the business) the entity changes its intended method of recovering the goodwill from use to sale, the tax base of the goodwill reverts to its original cost on initial recognition. A deferred tax asset might arise if (after initial recognition) the goodwill has been impaired so that its carrying amount is less than its tax base applicable on sale.

13.243.1 An acquired entity might have tax-deductible goodwill from its own prior acquisitions. For accounting purposes, the existing goodwill is included in the goodwill arising on the new acquisition. But, in some jurisdictions, the tax base in the original goodwill remains available to the acquired entity and will be deductible over the remaining tax life. A question arises as to how the temporary difference (if any) related to the tax-deductible goodwill is determined. We believe that management needs to establish whether some of the goodwill arising in the new acquisition relates to the tax-deductible goodwill from the prior acquisition. If it does, an appropriate proportion of the new goodwill should be allocated to that entity for the purpose of determining the temporary difference. This approach is consistent with the requirement in IAS 36 to allocate goodwill to groups of cash-generating units for impairment testing purposes. The allocation should be made in a manner consistent with the guidance in IAS 36 (that is, allocated to cash-generating units that are expected to benefit from the synergies of the combination). This approach is also consistent with the requirement in IAS 21 to allocate goodwill to the different functional currencies in the acquired entity. The deductible or taxable temporary difference is based on this allocation.

Additional assets and liabilities recognised on acquisition

13.244 Additional assets and liabilities might be recognised that were not recognised in the acquiree's financial statements before the acquisition. Examples of such assets and liabilities include some intangible assets (see para 13.245) and contingent tax liabilities (see para 13.246).

Intangible assets

 

13.245 An acquirer recognises an all identifiable intangible assets of the acquire at the acquisition date as assets separately from goodwill, regardless of whether they were recognised by the acquiree before the business combination. See further chapter 25

13.245.1 Where such additional assets are recognised, the deferred tax effects should also be recognised. The initial recognition exception for deferred tax that applies to goodwill is not extended to such intangible assets arising on a business combination. This is because, unlike goodwill, such intangible assets are not residuals. Also, a reason for not recognising deferred tax on goodwill is to avoid having to gross-up both sides of the balance sheet because goodwill and the related deferred tax are mutually dependent (see para 13.159); such dependency does not exist for other intangible assets.

Example – Deferred tax on intangible assets

The facts are the same as in the example in paragraph 13.238, except that an intangible asset not previously recognised by the acquiree was identified on acquisition and measured at its fair value of C130,000. The intangible asset will be amortised over its useful life of 10 years, but the amortisation will not be deductible for tax purposes.

 

 

 

 

C'000

C'000

Fair values of entity S's identifiable assets and liabilities (excluding deferred tax) as before

 

1,070

Intangible asset identified on acquisition and recognised separately from goodwill

 

130

 

 


Fair value of entity S's identifiable assets and liabilities at acquisition

 

1,200

Less: Tax base as before

 

(920)

 

 


Temporary difference arising on acquisition

 

280

 

 


Net deferred tax liability arising on acquisition of entity S (C280,000 @ 40%)

 

112

 

 


Purchase consideration

 

1,500

Fair values of entity S's identifiable assets and liabilities (excluding deferred tax)

1,200

 

Deferred tax

(112)

1,088

 


Goodwill arising on acquisition

 

412

 

 


Note: The goodwill arising on acquisition of C490,000 has been reduced further by the recognition of a previously unrecognised intangible asset of C130,000, net of its deferred tax effect of C52,000; this gives a net reduction of C78,000. In the periods after initial recognition on consolidation, the deferred tax liability of C52,000 will be released to the income statement by C5,200 each year (in line with the intangible asset's recovery through amortisation).

13.245.2 Even if the intangible asset acquired on the business combination has an indefinite useful life (and is not amortised for accounting purposes and is also not deductible for tax purposes), a deferred tax liability should be recognised based on management's expectation of the asset's manner of recovery, for the reasons stated in the previous paragraph. So, in this situation, the goodwill arising on acquisition would be calculated in the same way as indicated above. The only difference is that the deferred tax liability of C52,000 would remain on the balance sheet, but would be released through profit or loss on sale or impairment. See further paragraph 13.225.1.

 

Contingent tax liabilities – IFRS 3

13.246.2 Contingent liabilities are separately recognised in a business combination where fair value can be measured reliably. [IFRS 3 para 23]. Contingent liabilities recognised in acquisition accounting are measured subsequently at the higher of the amount recognised in accordance with IAS 37 and the amount initially recognised less any amortisation recognised under IAS 18. [IFRS 3 para 56]. This differs from IAS 37's requirements, where a provision is recognised only when the outflow of economic resources is probable.

13.246.3 The exceptions to IFRS 3's basic recognition and measurement principles are listed in its introduction. The list of exceptions includes assets and liabilities falling within IAS 12's scope. But the detailed guidance specifies only that deferred tax assets and liabilities in a business combination should be accounted for under IAS 12; and it is silent about current tax assets and liabilities and tax contingencies.

13.246.4 We believe that there are two acceptable approaches to recognising contingent tax liabilities in a business combination. IFRS 3 refers to IAS 37 only in the context of contingent liabilities; and income taxes are listed in the introduction to IFRS 3 as an exception to the recognition and measurement principles. So it can be argued that IFRS 3 does not apply to tax contingencies. Contingent tax liabilities might be recognised when the outflow is probable under IAS 12 (see para 13.74 onwards). Alternatively it could be argued that IFRS 3 applies to all contingent liabilities and that the exception applies only to deferred taxes; so it is also acceptable to recognise and measure contingent tax liabilities at fair value under IFRS 3.

Adjustments arising from initial recognition exception taken by the acquiree

13.247 In some circumstances, the deferred tax effects of temporary differences arising on acquisition might not have been recognised by the acquiree because those differences fell within the initial recognition exception (see para 13.162). The deferred tax effects of such temporary differences should be recognised on consolidation, even though they were not recognised by the acquired entity itself. This is because (from the group's perspective) any additional deferred tax balances are recognised as a result of the business combination and not from an initial recognition of the asset or liability.

Example – Impact of initial recognition exception taken by the acquiree

The facts are the same as in the example in paragraph 13.238, except that entity S purchased a specialised factory in an enterprise zone where such factories are eligible for tax allowances at 150% of their purchase cost. The factory cost C150,000; and that amount was also its fair value at the date of acquisition. The tax base of the property on initial recognition was C225,000, but no deferred tax asset was recognised on the excess tax allowances of C75,000 because of the initial recognition exception.

 

C'000

C'000

Fair values of entity S's identifiable assets and liabilities (excluding deferred tax) as before

 

1,070

Specialised property

 

150

 

 


Fair value of entity S's identifiable assets and liabilities at acquisition

 

1,220

Less: Tax base (C920,000 as before + C225,000 on specialised property)

 

(1,145)

 

 


Temporary difference arising on acquisition

 

75

 

 


Net deferred tax liability arising on acquisition of S (C75,000 @ 40%)

 

30

 

 


Purchase consideration

 

1,500

Fair values of entity S's identifiable assets and liabilities (excluding deferred tax)

1,220

 

Deferred tax

(30)

1,190

 


Goodwill arising on acquisition

 

310

 

 


Note: The goodwill arising on acquisition of C490,000 has been reduced by a further C180,000. This reduction relates to the fair value of the specialised property of C150,000 plus a deferred tax asset of C30,000 arising on the excess tax allowances of C75,000 @ 40%; this amount was not recognised by S because of the initial recognition exception. In the periods after acquisition, the deferred tax asset will be released through profit or loss as the excess tax benefit is realised through additional tax allowances.

 

Unrecognised tax losses of acquiree

13.249.3 An acquirer accounts under IAS 12 for the potential tax effects of an acquiree's temporary differences and carry-forwards that exist at the acquisition date or arise as a result of the acquisition. [IFRS 3 para 25]. A deferred tax asset is recognised for the carry-forward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and credits can be utilised (see para 13.144 onwards). [IAS 12 para 34].

13.249.4 In some circumstances, the acquiree might not have recognised a deferred tax asset in respect of its past tax losses, because it was uncertain whether future taxable profits would be available. But, as a result of its acquisition, the acquirer might determine that it is probable that other entities within the group will have sufficient taxable profits in the future to realise the tax benefits through transfer of those losses as permitted by the tax laws. So a deferred tax asset attributable to the unrelieved losses should be recognised as a fair value adjustment. The acquired entity's deferred tax assets are recognised in purchase accounting (even if they had not been recognised before the acquisition), provided they meet IAS 12's recognition criteria in the context of the enlarged group.

13.249.5 If the potential benefits of the acquiree's unused tax losses or other deferred tax assets do not satisfy the criteria for separate recognition when a business combination is initially accounted for but are subsequently realised, an entity recognises these deferred tax assets as follows:

 

Acquired deferred tax benefits recognised within the measurement period (resulting from new information about facts and circumstances that existed at the acquisition date) are applied to reduce the carrying amount of any goodwill related to that acquisition. If the carrying amount of that goodwill is zero, any remaining deferred tax benefits are recognised in profit or loss.

 

All other acquired deferred tax benefits realised are recognised in profit or loss (or outside profit or loss, if required by IAS 12).

[IAS 12 para 68].  

13.249.6 An example of the above is included in Table 13.1.

 

13.249.7 Deferred tax benefits acquired in a business combination might not be recognised at the acquisition date but are recognised later; in that case, a description of the event or change in circumstances that caused the deferred tax benefits to be recognised needs to be disclosed. [IAS 12 para 81(k)]. See paragraph 13.292.2.

Unrecognised tax losses of the acquirer

13.250 As a result of a business combination, an acquirer might consider it probable that it will recover its own unused tax losses against the future taxable profit of the acquiree. In that situation, the standard does not permit a deferred tax asset to be recognised in the fair value exercise or any consequential effect on goodwill arising on the business combination. [IAS 12 para 67]. This is because those losses are not the acquiree's losses; so they would not have met the criteria for separate recognition as an identifiable asset in paragraph 10 of IFRS 3. Instead, the deferred tax asset should be recognised in the separate and consolidated financial statements of the acquirer; and there should be a corresponding credit to the tax charge in profit or loss.

13.250.1 Paragraph 67 of IAS 12 refers to any change in the probability of realising a pre-acquisition deferred tax asset of the acquirer as a result of a business combination. An acquirer might consider it probable that it will recover its own deferred tax asset that was not recognised before the business combination. For example, the acquirer might be able to utilise the benefit of its unused tax losses against the acquiree's future taxable profit. Or the business combination might no longer be probable that the deferred tax asset will be recovered from future taxable profit. In such cases, the acquirer recognises a change in the deferred tax asset in the period of the business combination, but does not include it in the accounting for the business combination. In other words, the acquirer does not take it into account in measuring the goodwill or bargain purchase gain recognised in the business combination. [IAS 12 para 67].

13.250.2 If a business combination changes the amount recognised by the acquirer for its pre-acquisition deferred tax asset, the amount of that change is required to be disclosed. [IAS 12 para 81(j)]. See paragraph 13.292.2.

Reverse acquisitions

13.251 In some business combinations, the acquirer (for accounting purposes) is the entity whose equity interests have been acquired; and the legal parent entity is treated as the acquired entity. These combinations are commonly referred to as 'reverse acquisitions'. [IFRS 3 para B19]. Accounting for reverse acquisitions is dealt with in chapter 25.

13.251.1 For deferred tax accounting, where a temporary difference arises on the initial recognition of an asset or liability in a business combination, the initial recognition exception referred to in paragraph 13.162 does not apply. What does this mean in the case of a reverse acquisition?

13.251.2 Under reverse acquisition accounting, the legal acquired entity is treated (for the purposes of the consolidated financial statements) as the acquirer; and the legal parent is treated as the acquired entity. So it is the legal parent's assets and liabilities that are fair valued under IFRS 3. In a business combination, the acquired entity's assets and liabilities do not qualify for the initial recognition exception, but the acquirer is unaffected. This is the case, even if the acquirer for accounting purposes is not the legal acquirer. In other words, the entity that is the legal acquired subsidiary (but which, for accounting purposes, is the acquirer) continues to qualify for the initial recognition exception because its net assets are recorded in the consolidated financial statements at existing book values. The entity that is the new legal parent (but which, for accounting purposes, is the acquired entity) does not qualify for the initial recognition exception; so deferred tax is recognised in the consolidated financial statements on any temporary differences on its assets and liabilities.

13.251.3 A similar situation arises where a new parent entity is added to an existing group; this is achieved by setting up a new shell entity (newco) that issues equity shares to the existing shareholders in exchange for shares in the existing group. Such a transaction is accounted for as a 'reorganisation'. Where a reorganisation has occurred, the new entity's consolidated financial statements are prepared using the book values from the previous holding entity's consolidated financial statements. Any previous use of the initial recognition exception by the previous holding entity would be carried forward into the new consolidated financial statements. Accounting for a new entity added to a group is dealt with in chapter 25.

Tax effects of intra-group transactions

13.252 Consolidation adjustments can have tax consequences. Where such adjustments give rise to temporary differences, deferred tax should be provided under IAS 12. A typical consolidation adjustment is where unrealised profits and losses are eliminated on an intra-group transfer of inventories. Such an adjustment gives rise to a temporary difference that will reverse when the inventory is sold outside the group.

Example – Deferred tax effects of intra-group transactions

A subsidiary sells goods costing C60,000 to its parent entity for C70,000; and these goods are still held in inventory at the year end. A consolidation adjustment is required in the financial statements to eliminate the unrealised profit of C10,000 from consolidated income statement and from group inventory. The sale of inventory between the two companies is a taxable event that changes the inventory's tax basis. The difference between the carrying amount of the inventory of C60,000 in the consolidated financial statements and the appropriate tax base of C70,000 (from the parent's perspective) gives rise to a deductible temporary difference.

If the parent and the subsidiary were resident in the same tax jurisdiction and paid income tax at 30%, a deferred tax asset of C3,000 (C10,000 @ 30%) would be recognised in the consolidated financial statements. The resulting credit to income would offset the tax charge on the profit made by the subsidiary. The deferred tax asset would be recovered when the parent sells the inventory to a party outside the group.

But if the parent and subsidiary were resident in different tax jurisdictions and paid income tax at 40% and 30% respectively, a deferred tax asset of C4,000 (C10,000 @ 40%) would be recognised in the consolidated financial statements. The new tax basis of the inventory (C70,000) is deductible on the buyer's tax return when the cost of the inventory (that is, C60,000 after elimination of intra-entity profit) is recovered. Since tax is expected to be paid at 40% when the inventory is sold by the intermediate buyer, it follows (from the expected manner of recovery rule discussed in para 13.170) that the resulting deferred tax asset arising on the deductible temporary difference should be measured at that rate. In the consolidated financial statements, the resulting tax credit of C4,000 would exceed the tax charge of C3,000; and the excess of C1,000 (representing the excess tax benefit attributable to the transferred inventory) would reduce the consolidated tax expense (income) of the period, even though the pre-tax effects of the transaction had been eliminated in full.

Investments in subsidiaries, branches, associates and joint ventures

Introduction

13.253 This section deals with the deferred tax implications in consolidated financial statements of investments in subsidiaries, branches, associates and joint ventures. (The deferred tax implications of such investments in the separate financial statements of the parent or investor are dealt with in para 13.233 onwards.) In the consolidated financial statements of the parent or investor, the investment is recorded by consolidating the subsidiary's net assets (line-by-line) or by using the equity method for interests in associates or joint ventures.

13.254 A temporary difference might arise between the investment's carrying amount in the consolidated financial statements and its tax base (which is often cost or indexed cost). This temporary difference is sometimes referred to as 'outside basis' difference. It is additional to the temporary differences relating to the investee's underlying assets and liabilities (sometimes referred to as 'inside basis' difference). The temporary difference relating to the investment might arise in a number of situations. The most common situation is where undistributed profits in the investee increase the parent's investment in the investee to above its tax cost. Other situations include a reduction in the investment's carrying amount to below tax cost due to impairment; and changes in the investment's carrying amount as a result of changes in foreign exchange rates where the investing entity and its investees are based in different countries. [IAS 12 para 38]. The carrying amounts for such investments or interests can be recovered through distributions or disposal. Management needs to determine the deferred tax implications based on the manner in which it expects to recover the investment.

13.255 Accordingly, an entity should recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, except to the extent that both of the following conditions are satisfied:

the parent, investor or venturer is able to control the timing of the reversal of the temporary difference; and

it is probable that the temporary difference will not reverse in the foreseeable future.

[IAS 12 para 39].

13.255.1 Deferred tax assets arising on investments in subsidiaries, branches and associates, and interests in joint ventures, are addressed in paragraph 13.268 onwards.

Investment in subsidiaries

13.256 In a parent/subsidiary relationship, the parent controls the subsidiary's financial and operating policies (including its dividend policy). So the parent can control the timing of the reversal of the temporary differences arising from that investment (including the temporary differences arising from undistributed profits and from any foreign exchange translation differences). Therefore, where the parent entity (and thus the economic entity – the group) has determined that the subsidiary's profits and reserves will not be distributed in the foreseeable future and that the subsidiary will not be disposed of, it does not recognise a deferred tax liability that arises from the investment in the subsidiary in its separate and consolidated financial statements. [IAS 12 para 40].

13.257 Where no deferred tax is provided, the total amount of taxable temporary difference should still be disclosed (see further para 13.303). But the group continues to recognise (subject to adjustments arising on consolidation) the deferred tax assets and liabilities that are recognised in the subsidiary's own financial statements and those that arise from fair value adjustments on acquisition of that subsidiary.

13.258 The parent's management needs to be able to provide sufficient evidence that the undistributed earnings will continue to be reinvested for the foreseeable future as part of the parent's continuing investment in that subsidiary. This evidence might include documentary resolutions by the parent's management, formal communication to minority shareholders and specific plans for reinvesting the funds. Such plans should take into consideration some or all of the following factors: (a) the financial requirements of the parent and the subsidiary; (b) long-term and short-term operational and fiscal objectives; (c) remittance restrictions imposed by governments, financing agreements or others; and (d) tax consequences of any remittances.

13.259 In practice, most parent entities would not recognise a deferred tax liability in respect of a subsidiary's undistributed profits; exceptions are where profits will be distributed in the foreseeable future, or the subsidiary will be disposed of. It is often difficult to determine the amount of further taxes that would be payable on remittance, as it will depend on the following factors: the tax laws and rates in the countries where the parent and subsidiary are located; the terms of the tax treaties (if any) between the two countries; and/or the time when the profits were earned and the level of the parent entity's local taxable profits at the time of remittance. Difficulties might also arise if the reporting entity has complex structures. For example, a reporting entity with many layers of intermediate holding companies might have several alternative routes for recovering an investment; and each route could have different tax consequences. In such cases, management should judge the manner in which the investment is expected to be recovered; and it should calculate any deferred tax on that basis.

13.260 An example illustrating the above principles is given in example 3 of appendix B to the standard; and it is reproduced here with appropriate adjustments and amendments.

Example – Deferred tax on investment in subsidiary

 

 

 

On 1 January 20X5, entity A acquired 100% of the shares of entity B at a cost of C600,000. At the acquisition date, the tax base (in entity A's tax jurisdiction) of A's investment in entity B is C600,000. Reductions in the carrying amount of goodwill are not deductible for tax purposes; and the goodwill would also not be deductible if entity B disposed of its underlying business. The tax rate in entity A's tax jurisdiction is 30%; and the tax rate in entity B's tax jurisdiction is 40%.

 

 

 

Goodwill arising on consolidation is calculated as follows:

C'000

C'000

Fair values of entity B's identifiable assets and liabilities (excluding deferred tax) at 1 January 20X5

 

504

Less: Tax base of assets acquired and liabilities assumed

 

(369)

 

 


Temporary difference arising on acquisition

 

135

 

 


Deferred tax liability arising on acquisition of entity B (C135,000 @ 40%)

 

 

54

 

 


Purchase consideration

 

600

Fair values of entity B's identifiable assets and liabilities (excluding deferred tax)

504

 

Deferred tax liability calculated as above

(54)

450

 


Goodwill arising on acquisition

 

150

 

 


No deduction is available in entity B's tax jurisdiction for the cost of the goodwill. So the tax base of the goodwill in entity B's jurisdiction is nil. But, under IAS 12, entity A does not recognise any deferred tax liability for the taxable temporary difference associated with the goodwill in entity B's tax jurisdiction (see para 13.159).

 

 

 

During the year ended 31 December 20X5, entity B made a profit of C150,000 and declared a dividend of C80,000. The dividend was appropriately authorised; and it was recognised as a liability by entity B at 31 December 20X5. The net assets of entity B at 31 December 20X5 are as follows:

 

 

 

Net assets at 1 January 20X5 (incorporating the above fair value adjustments)

 

450

Retained profits (net profit of C150,000 less dividends payable of C80,000)

 

70

 

 


Net assets at 31 December 20X5

 

520

 

 


Entity A's separate financial statements

 

 

Investment in entity B

 

600

Tax base

 

600

 

 


Temporary difference

 

Nil

 

 


Entity A recognises a liability for any withholding tax or other taxes that it will incur on the accrued dividend receivable of C80,000.

 

 

 

Entity A's consolidated financial statements

 

 

At 31 December 20X5, the carrying amount of entity A's underlying investment in entity B (excluding accrued dividend) is as follows:

 

 

 

Net assets of entity B

 

520

Goodwill

 

150

 

 


Carrying amount

 

670

 

 


Temporary difference associated with entity A's investment in entity B is

 

 

Carrying amount as above

 

670

Tax base

 

600

 

 


Temporary difference = cumulative retained profits since acquisition

 

70

 

 


If entity A has determined that it will not sell the investment in the foreseeable future and that entity B will not distribute its retained profits in the foreseeable future, no deferred tax liability is recognised in relation to entity A's investment in entity B. But entity A discloses the amount of the temporary difference of C70,000 that is not expected to reverse in the foreseeable future.

 

On the other hand, if entity A expects to sell the investment in entity B (or that entity B will distribute its retained profits in the foreseeable future), it recognises a deferred tax liability to the extent that the temporary difference is expected to reverse. The tax rate should reflect the manner in which entity A expects to recover the carrying amount of its investment (that is, through dividends or by selling or liquidating the investment). If entity B is dissolved and retained profits are remitted, the realisation of its assets and the remittance of the proceeds could result in capital gains taxes and/or withholding taxes in entity B's tax jurisdictions and capital gains taxes in entity A's tax jurisdictions

Changes in management intentions about a subsidiary's undistributed profits

13.261 A parent's management might decide to recover the carrying amount of its investment in a subsidiary through future distributions. For example, suppose that a parent entity has not previously recognised a deferred tax liability on a subsidiary's undistributed profits amounting to C1,000,000. The subsidiary currently expects to generate earnings of at least C200,000 a year for the foreseeable future. So the parent's management decides to realise earnings (through future dividend payments from the subsidiary) of C200,000 a year. The fact that the subsidiary intends to distribute earnings would initially call into question the 'reinvestment for the foreseeable future' assertion. But, if management can establish that the distributions will be no more than future earnings, the 'reinvestment for the foreseeable future' assertion might still be sustainable.

13.262 So, if the parent can provide sufficient corroborating evidence (as discussed in para 13.258) regarding the need to reinvest for the foreseeable future the undistributed profits that have been brought forward – and if it is reasonable to expect the subsidiary to generate annual earnings of at least C200,000 – there is no need to recognise a deferred tax liability relating to the undistributed earnings that have been brought forward. On the other hand, if management intends to distribute C200,000 a year (regardless of the subsidiary's earnings), circumstances will have changed regarding the 'reinvestment for the foreseeable future' assertion; so a deferred tax liability will need to be recognised immediately (at the applicable tax rate) and there should be a corresponding tax charge in profit or loss.

Investment in branches

13.263 A reporting entity that operates a branch will recognise the branch's assets and liabilities and related deferred tax in its own financial statements. In some jurisdictions, tax consequences might arise when the branch distributes profits or is sold. A temporary difference might arise between the carrying amount of the reporting entity's net assets in the branch and the tax base of the reporting entity's investment in the branch (as for subsidiaries). Where the reporting entity has determined that the retained profits in the branch will not be distributable in the foreseeable future, and that the branch will not be sold, it does not recognise a deferred tax liability in relation to its investment in the branch. [IAS 12 para 40]. See further paragraph 13.274.

Investments in associates

13.264 In the investor's consolidated financial statements, an associate is accounted for using the equity method of accounting. The carrying amount of the investment is initially cost, adjusted for the post-acquisition change in the investor's share of the associate's net assets. Where the investment is expected to be recovered through sale, the tax base is often the amount paid for the shares in the associate. So a temporary difference arises between the investment's carrying amount and its tax base (for the reasons set out in para 13.254).

13.265 An investor has significant influence over the associate: it has the power to participate in the associate's financial and operating policy decisions; but it does not have control over those policies. So the investor cannot control the associate's dividend payments. Unless there is an agreement that the associate's profits will not be distributed in the foreseeable future, an investor recognises a deferred tax liability in relation to taxable temporary differences arising from the associate's undistributed profits. [IAS 12 para 42]. In practice, such an agreement is unlikely to exist; so a deferred tax liability would be recognised for most associates in respect of post-acquisition earnings. But (for reasons stated in para 13.259) it might not be possible to determine the tax that will be payable when the investment cost is recovered – whether through distribution of the retained profits or through disposal. In that case, the standard suggests that the entity should recognise the minimum amount that can be determined. [IAS 12 para 42].

Example – Deferred tax on investment in associate

 

On 1 January 20X5, entity A acquired 40% of the shares of a foreign entity B at a cost of FC1m (FC = foreign currency). At the acquisition date, the tax base (in entity A's jurisdiction) of entity A's investment in entity B is C500,000.

 

During the year ended 31 December 20X5, entity B made a profit of FC240,000. The exchange rate at 1 January 20X5 was C1:FC2; and at 31 December 20X5 it was C1:FC1.6. The tax rate in entity A's jurisdiction is 30%.

 

 

 

Entity B's net assets

FC'000

C'000

Book value = Fair values of entity B's identifiable assets and liabilities at 1 Jan 20X5

1,200

 

Profit for the year

240

 

 


 

Net assets at 31 December 20X5

1,440

 

 


 

Calculation of goodwill on acquisition

 

 

Purchase consideration

1,000

 

Share of entity B's net assets at acquisition (40% of FC1,200,000)

(480)

 

 


 

Goodwill arising on acquisition

520

 

 


 

 

 

 

Equity carrying amount of investment in entity B at 31 December 20X5

 

 

Share of entity B's net assets at 31 December 20X5 (40% of FC1,440,000 @ 1.6)

 

360

Goodwill arising on acquisition (FC520,000 @ 1.6)

 

325

 

 


Equity interest at 31 December 20X5

 

685

Tax base = cost of shares

 

500

 

 


Temporary difference

 

185

 

 


Temporary difference comprises

 

 

Share of retained profits (40% of FC240,000 @ 1.6*)

 

60

Share of exchange difference on opening net assets – 40% of (FC1,200,000 × (1/1.6 – 1/2))

 

60

Exchange difference on goodwill – FC520,000 × (1/1.6 – 1/2)

 

65

 

 


 

 

185

 

 


* Under IAS 21, a weighted average exchange rate is used for translating the share of profit (see chapter 7). For simplicity in this example it is assumed that the weighted average exchange rate is the same as the closing rate.

 

 

 

Entity A would recognise a deferred tax liability in its consolidated financial statements as follows:

 

 

 

 

 

 

C'000

C'000

 

 

 

Dr

Cr

Dr

Deferred tax expense in profit or loss on share of profits @ 30%

18.0

 

Dr

Deferred tax expense in other comprehensive income on opening exchange difference on net assets @ 30%

18.0

 

Dr

Deferred tax expense in other comprehensive income on exchange difference on goodwill @ 30%

19.5

 

 

Cr

Deferred tax liability @ 30% on C185,000

 

55.5

Investments in joint ventures

13.266 The IASB issued IFRS 11 to replace IAS 31; and the new standard is effective for annual periods beginning on or after 1 January 2013. Under the new standard, joint arrangements could be joint operations or joint ventures. In the case of joint operations, the joint operator recognises in its balance sheet the assets that it holds and the liabilities that it has incurred in respect of the joint operation, including its share of assets held jointly and liabilities incurred jointly. The related tax bases would also be included in the joint operator's tax balance sheet. So any temporary differences arising between the carrying amounts and the tax bases of the assets and liabilities should be recognised; and deferred taxes should be provided in the normal way.

13.267 In the case of joint ventures, the investor accounts for its investment using the equity method. Temporary differences would arise between the carrying amount of the investor's interest (that is, the investor's capital contributions plus its share of undistributed profit) and the tax base of the investment. The terms of the contractual arrangement between the venturers on the retention of any profit in the joint venture will determine whether any deferred tax should be provided on the temporary difference (that is, similar to the treatment for associates – see para 13.264 onwards). Where the venturer can control the timing of the distribution of its share of the profits, and it is probable that the profits will not be distributed in the foreseeable future, a deferred tax liability is not recognised. [IAS 12 para 43]. But the amount of any taxable temporary difference should be disclosed.

Deferred tax asset arising on investments in subsidiaries, associates and joint ventures

13.268 An entity should recognise a deferred tax asset for all deductible temporary differences arising from investments in subsidiaries, branches and associates, and interests in joint ventures, to the extent that it is probable that:

the temporary difference will reverse in the foreseeable future; and

taxable profit will be available against which the temporary difference can be utilised.

[IAS 12 para 44].

13.268.1 A deferred tax asset might arise in the reporting entity's separate or consolidated financial statements in relation to its investment in a subsidiary, associate or joint venture. For example, the carrying amount of the investment might have been written down to its recoverable amount as a result of impairment, but the tax base remains unaffected. A deferred tax asset that arises should be recognised only if the reporting entity expects that the temporary difference will reverse in the foreseeable future and also expects that taxable profit will be available against which the temporary difference can be utilised. For instance, the temporary difference could be reversed if the investment is sold or if a tax deduction is received for an impairment charge that was previously disallowed. The entity should consider the guidance (set out at para 13.128 onwards) to determine whether the deferred tax asset should be recognised. It should be noted that this deferred tax asset is separate from those that might arise in the financial statements of the subsidiary, associate or joint venture.

Investments in tax-transparent entities (consolidation issues)

13.269 A number of entities around the world do not pay tax (see para 13.233.8); but their profits are taxable in the hands of the investors. Examples of such entities are partnerships, UK limited liability partnerships (LLPs) and US limited liability companies (LLCs). As well as giving rise to accounting issues in the investor's separate financial statements (see para 13.233.8 onwards), this tax structure can give rise to accounting issues in the investor's consolidated financial statements.

13.269.1 One accounting issue relates to the presentation of tax in profit or loss where an investment in a tax-transparent entity is accounted for in consolidated financial statements under the equity method. Consider an investor that has a number of subsidiaries and an investment in an associate. The associate is a limited liability partnership, which is not itself subject to tax; but its investors are taxed on their share of the profits. When the associate is included in the investor's consolidated financial statements, a question arises on the tax impact (current and deferred) of the associate's profits: should they be included within the associate's equity-accounted profits and net assets; or should they be reported within the group's tax charge and as part of the group's current and deferred tax liability?

13.269.2 Our view is that the tax (current and deferred) is reported as part of the group's tax charge; and the corresponding liability is added to the group's current and deferred tax liability. This view is supported by the example in IAS 1, which has a footnote explaining that the equity-accounted profit of an associate is "… the share of associates' profit attributable to owners of the associates, ie it is after tax and non-controlling interests in the associates". We consider that the tax (current and deferred) should be reported as part of the group's tax (and not as part of the associate's equity-accounted profit and net assets) because the tax does not arise in the associate but is levied instead on the investor.

13.269.3 Another deferred tax accounting issue arises on acquisition of a tax-transparent associate. If a taxable temporary difference arises, management needs to consider how to account for that temporary difference. We consider that there are two acceptable accounting treatments.

13.269.4 The acquisition of the associate does not give rise to an initial accounting or taxable profit; so it does not logically follow that a deferred tax charge should be recorded in profit or loss. We consider that the initial recognition exception in paragraph 15(b) of IAS 12 applies because the acquisition of an associate is not a business combination (see further para 13.162). So no deferred tax is generally recognised on initial acquisition of a tax-transparent associate.

13.269.5 The alternative acceptable view is that the deferred tax liability arising on acquisition of the associate (for example, on previously unrecognised intangibles or goodwill) is recognised. Any deferred tax liabilities arising on this acquisition are recognised as deferred tax liabilities of the group (as explained in para 13.269.2) – that is, outside the associate's equity-accounted amounts. The question then arises of how to account for the debit relating to this deferred tax liability. We consider that the debit is taken to the associate's equity-accounted share of net assets. This follows from applying business combination principles and adjusting deferred tax against goodwill. But, because goodwill on acquisition of an associate is combined with all the other assets and liabilities for presentation in the consolidated financial statements, it is this single line item that should be debited to allow recognition of deferred tax. IAS 28 requires that an associate is initially recorded at cost. Under the IASB's Framework, cost is the amount of cash or cash equivalents paid or the fair value of other consideration given. It can be argued that the assumption of the tax liability by the investor is part of the consideration for the acquisition, and so increases its cost.

13.269.6 The accounting treatment set out in paragraph 13.269.5 adds the debit to the carrying amount of the equity-accounted investment; so the accounting carrying amount is changed. Any consequential effect on the temporary difference would need to be considered. This accounting treatment could result in an iterative process to arrive at the carrying amount of the equity-accounted investment and the deferred tax liability.

Foreign currency translation

13.270 Gains or losses arising on the translation of an entity's own overseas assets (including investments in subsidiaries and associated companies) and liabilities can give rise to temporary differences; this depends on whether or not the gains or losses have a tax effect. Also, the translation of foreign entities' financial statements can sometimes give rise to temporary differences on which deferred tax might need to be recognised.

Foreign currency assets and liabilities

13.271 An entity's foreign currency monetary assets and liabilities are translated at the end of each reporting period; and the resulting gain or loss is recognised in profit or loss. Such gains or losses might be taxable (or tax deductible) in the period in which they are realised. So the tax base of the asset or liability is not changed as a result of the change in exchange rate. The difference between the translated carrying amount and its tax base (that is, original carrying amount) might give rise to a taxable or deductible temporary difference.

Example – Foreign currency and deferred tax

 

Entity A sold goods to overseas customers for FC250,000 on 1 November 20X3. At 31 December 20X3, the receivable was still outstanding. Revenue is recognised on an accrual basis for both accounting and tax purposes. Exchange differences are not assessable for tax purposes in entity A's country until they are realised.

The exchange rates prevailing at the date of sale and at the end of the financial year are as follows:

 

 

1 November 20X3

C1:FC1.60

31 December 20X3

C1:FC1.65

 

 

Management should calculate the tax base of the receivable balance at 31 December 20X3 as follows:

 

C

 

 

Carrying amount

151,515

 

(FC250,000/1.65)

Future taxable income

 

(Tax was assessed when revenue was recognised)

Future deductible amount

4,735

 

(Exchange loss deductible when realised)

 


 

 

Tax base

156,250

 

(FC250,000/1.60)

 


 

 


Entity A has a deductible temporary difference of C4,735 (C151,515 − C156,250); management should recognise a deferred tax asset in respect of this temporary difference. Movements in exchange rates change the taxable or deductible temporary differences of foreign currency-denominated asset or liabilities if the exchange gain or loss is not recognised for tax purposes until it is realised.

13.271.1 The related deferred tax is recognised in profit or loss (see scenario B, example 2 in para 13.119). But, where the exchange differences are recognised outside profit or loss (for example, foreign currency borrowings hedging a net investment in the consolidated financial statements or qualifying as a hedging instrument in a cash flow hedge), the deferred tax is also recognised outside profit or loss.

13.272 Where an entity holds a non-monetary asset in a foreign country, the asset's carrying amount (in the absence of any impairment) is its historical purchase price translated at the exchange rate at the date of purchase. To the extent that the asset's realisation (through use or sale) gives rise to tax consequences in the foreign country, the asset's tax base changes as the exchange rate changes; but the carrying amount remains the same. A deferred tax asset (subject to meeting the recognition test) or a deferred tax liability should be recognised on the temporary difference that arises (see also para 13.274).

Foreign subsidiaries, associates and joint ventures

13.273 Exchange differences arise when the results and financial position of a foreign operation are translated into a presentational currency (for inclusion in the reporting entity's financial statements) by consolidation, or the equity method. Such exchange differences arise because the income statement items are translated at the average rate; and balance sheet assets and liabilities are translated at the closing rate. Exchange differences also arise when the opening net assets are translated at a different closing rate to the previous closing rate. All such exchange differences are recognised in a separate component of equity in the consolidated financial statements; and they are shown in other comprehensive income. From a deferred tax perspective, such exchange differences should not give rise to any temporary differences associated with the foreign operation's assets and liabilities. This is because the carrying amounts of the assets and liabilities and their respective tax bases will be measured in the foreign entity's functional currency at the balance sheet date; so any temporary differences arising would have been recognised by the foreign entity as part of its deferred tax balances in its own financial statements. These deferred tax balances (translated at the year-end exchange rate) will simply flow through on consolidation; and no further adjustment is necessary.

13.273.1 Although temporary differences do not arise from translation of the financial statements of a foreign operation, they might arise on consolidation; this occurs as a result of the difference between the translated amount of the reporting entity's net investment in the foreign operation (effectively the group's share of net assets) and the tax base of the investment itself in the reporting entity. See paragraph 13.256 onwards and an example in paragraph 13.265 illustrating the tax effect of exchange differences.

Foreign branches

13.274 Where the activities of a reporting entity's foreign branch are carried out as an extension of the reporting entity (rather than being carried out with any significant degree of autonomy), the foreign branch's functional currency is the same as that of the reporting entity. But changes in exchange rates give rise to temporary differences if the foreign branch's taxable profit or tax loss (and hence the tax base of its non-monetary assets and liabilities) is determined in the foreign currency. This is because the carrying amounts of the foreign branch's non-monetary assets and liabilities (which are translated into the reporting entity's currency at the historical rate) differ from their tax bases (which are translated at exchange rates prevailing at the reporting date). A deferred tax asset (subject to the recognition test) or a deferred liability should be recognised on such temporary differences. The resulting deferred tax is credited or charged to profit or loss. [IAS 12 para 41]. Note that these deferred tax balances relate to the foreign branch; and they are in addition to those that can arise from the reporting entity's investment in the foreign branch (discussed above).

Example – Deferred tax and foreign branch

 

An entity operates a foreign branch that has the same functional currency as the entity. At 1 January 20X5, the foreign branch acquires a property for FC540,000 (FC = foreign currency) when the exchange rate is C1:FC12. The asset has an expected useful life of 5 years and zero residual value. For tax purposes, the asset is written off over 3 years. The exchange rate at 31 December 20X5 is C1:FC9. The tax rates in the entity's country and the foreign country are 30% and 25% respectively.

 

At 31 December 20X5, a temporary difference arises in respect of the property as follows:

 

Foreign branch

Exchange rate

Entity

 

FC

C1 = FC

C

Net book value of property

 

 

 

Cost

540,000

12

45,000

Depreciation charge for the year

(108,000)

 

(9,000)

 


Net book value

432,000

 

36,000

 


Tax base of property

 

 

 

Cost

540,000

 

 

Tax depreciation claimed

(180,000)

 

 

 


 

 

 

360,000

9

40,000 *

 


Temporary difference

72,000

 

(4,000)

 


Deferred tax @ 25%**

18,000

 

(1,000)

 


* The tax base is measured at the year-end rate because this rate gives the best measure of the reporting currency amount that will be deductible in future periods.

 

** The tax rate is 25% (that is, the rate applicable to the foreign country) because the entity will be taxed on the asset's recovery in that jurisdiction.

 

A taxable temporary difference arises in the foreign entity; but a deductible temporary difference arises in the reporting entity. This is because (following the change in exchange rate from FC12 to FC9) the foreign currency revenue required to recover the asset's reporting currency carrying amount is C36,000 @ 9 = FC324,000; but the tax base of the asset remains at FC360,000. This difference of FC36,000 @ 9 = C4,000 gives rise to a deductible temporary difference; a deferred tax asset @ 25% (that is, C1,000) should be recognised in the entity's financial statements for this temporary difference.

 

If the tax base had not been translated at the year-end rate, it would have been recorded at C30,000 (C45,000 less tax depreciation of C15,000) at the year end. This would have given rise to a temporary difference of C6,000 (C36,000 – C30,000); the entity would have provided deferred tax liability of C1,500 (25% of C6,000) on this temporary difference. But translating the tax base at year-end rate resulted in a deferred tax asset of C1,000. The difference of C2,500 is attributable to the tax effect of currency translation on the tax base, that is 25% of (C40,000 – C30,000) = C2,500.

13.274.1 The following extract from the financial statements of Tenaris explains the tax effect of currency translation on the tax base:

Tax holidays

13.275 The governments or tax authorities of some jurisdictions offer investment incentives by way of temporary reductions of tax (known as 'tax holidays'). Tax holidays result in tax reductions regardless of an entity's level of taxable profit. A lower tax rate or nil tax rate is normally applied to the taxable profits arising within the tax holiday period. Where deferred tax arises on temporary differences that reverse within the tax holiday period, it is measured at the tax rates that are expected to apply during the tax holiday period (that is, the lower tax rate or nil tax rate). Where deferred tax arises on temporary differences that reverse after the tax holiday period, it is measured at the enacted or substantively enacted tax rates that are expected to apply after the tax holiday period.

13.275.1 The example below considers the deferred tax implications when the start of a tax holiday is delayed until the period when an entity has taxable profits (after using any carried-forward losses).

Example – Tax holidays

 

A jurisdiction grants a tax holiday to specified entities. The tax holiday provides a 0% tax rate for the first two years of the holiday and a tax rate of 20% for the following three years. The normal tax rate is 40%.

 

The tax holiday does not commence until the year in which an entity generates taxable profits (after use of carried-forward losses). The entity does not expect to generate taxable profits (after use of carried-forward losses) for three years.

 

An entity's forecast taxable profit is as follows:

 

Year 1

Year 2

Year 3

Year 4

 

C'000

C'000

C'000

C'000

Taxable (losses)/profit in the year

(300)

100

200

250

Use of carried-forward losses

(100)

(200)

 


Taxable (losses)/profit after use of carried-forward losses

(300)

0

0

250

 


 

 

In this scenario, the tax holiday begins in year 4.

 

(a) At the end of year 1, assuming the recoverability criteria in IAS 12 are met, should a deferred tax asset in respect of the taxable losses be recognised?

 

The entity is receiving a benefit, because the existence of the unused losses effectively delays the start of the tax holiday period. Without these unused losses (and assuming no taxable profit in year 1), the entity would begin paying taxes in year 4 instead of year 6. So a deferred tax asset of C120,000 (C300,000 × 40%) should be recognised.

 

(b) If the entity does not expect the tax holiday to begin until year 4 (and so it will not pay tax until year 6), should it recognise deferred tax liabilities for any taxable temporary differences on assets or liabilities that will reverse in years 2 to 5?

 

IAS 12 provides the following exceptions to recognising deferred tax liabilities: for the initial recognition of goodwill; for the initial recognition of assets or liabilities that do not affect accounting or taxable profit; and for some specified investment in subsidiaries. IAS 12 does not provide an exception to recognising deferred tax liabilities based on an expectation of future taxable losses.

 

So, deferred tax liabilities should be recognised and measured at the rate that will be in effect when the temporary differences reverse. For the temporary differences reversing before the start of the tax holiday (years 2 and 3), the appropriate rate is the normal tax rate (40%). For the temporary differences reversing during the first two years of the tax holiday (years 4 and 5), the appropriate rate is 0%.

 

Note that deferred tax on temporary differences reversing in the remaining three years of the tax holiday is measured at 20%.

13.275.1.1 A temporary difference might arise on the initial acquisition of an asset or liability during the tax holiday period; and it might appear to be subject to the initial recognition exception. For example, an entity might receive an upfront fee during a tax holiday period; and it would record deferred revenue. The jurisdiction might assess tax on revenue when cash is received; because the tax holiday period provides for a nil tax rate, it might seem that the initial acquisition of the deferred revenue liability does not impact accounting or taxable profit. But the initial recognition exception does not apply because the upfront fee does impact taxable income, even though a nil tax rate is applied as a result of the tax holiday (as opposed to being exempt from tax).

Investment and other tax credits

13.275.2 The governments or tax authorities of some jurisdictions offer investment incentives by way of credits to be applied in determining tax liabilities. In general, tax credits are tax benefits received other than tax deductions that normally arise (at standard rates) from deductible expenditures. Tax credit schemes vary significantly across jurisdictions and can be complex in practice, so each scheme's characteristics warrant careful consideration to determine the appropriate accounting. For example, some tax credits schemes are structured as in substance government grants that are available regardless of the level of an entity's taxable profits, while others offer tax credits that are only recoverable if the entity has sufficient taxable profits against which the credit can be applied. 

 

 

Tax credit schemes are comprised of (i) investment tax credits and (ii) other tax credits. There is no definition in IFRS of either investment tax credits or other tax credits. While the treatment of unused tax credits is addressed by IAS 12, the standard does not deal with accounting for investment tax credits. [IAS 12 para 4]. Investment tax credits are also outside IAS 20's scope. [IAS 20 para 2].

 

 

13.275.3 Therefore, the following questions arise:

 

 

 

What differentiates investment tax credits from other tax credits?

What is the accounting for investment tax credits and other tax credits?

 

 

13.275.4 Other tax credits are within IAS 12's scope. A deferred tax asset is recognised for unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax credit can be utilised (see further para 13.144 onwards). [IAS 12 para 34]. The credit entry for the deferred tax asset (and any subsequent adjustment to the asset) will be to the tax line in the income statement in the period the tax credit arises. Where receipt of a tax credit is subject to the entity complying with specific substantive conditions in future periods, the credit is recognised only when the conditions are met. 

 

 

13.275.5 Investment tax credits are generally tax benefits received for investment in specific qualifying assets (other than tax deductions that are available as part of the asset's tax base in use or on disposal). We believe that this definition should be interpreted narrowly, although in some circumstances, it might also be applied to credits for investments in qualifying but non-capitalised research and development expenditure. When there are substantive additional requirements to be met that are not directly related to the investment, the benefit should not be treated as an investment tax credit, but rather, as an 'other tax credit'. Examples of such requirements would include maintaining a certain number of employees or reaching a certain level of export revenues.

 

 

13.275.6 Management needs to use judgement in assessing the substance of each tax credit scheme. Conditions may be attached to a scheme that are perfunctory and do not determine whether the tax benefit will be received; in which case it may still be appropriate to classify the tax benefit as an investment tax credit. For example, if the only additional criterion for receiving a tax credit is to maintain at least 200 employees, but the entity needs at least 2,000 employees to operate the qualifying equipment purchased under the scheme, the additional criterion would be perfunctory and the tax benefit classified as an investment tax credit.

 

 

13.275.7 There are three alternative accounting models to account for investment tax credits, which analogise to either IAS 12 or IAS 20. The most appropriate model to apply will depend on the nature of the credit and the specific circumstances of the entity, including previous policy choices.  

 

 

Tax credit (or flow though) model

 

13.275.8 This treatment is based on the assumption that investment tax credits are often not substantially different from other tax credits. So it is acceptable to have the same accounting treatment for investment tax credits as previously described for other tax credits (see para 13.144). This model would apply equally to tax credits available as a result of qualifying but non-capitalised research and development expenditure. 

 

 

Government grant (or deferral) model

 

13.275.9 This treatment is based on characterising the investment tax credit as being similar to a government grant and recognises the tax benefit in pre-tax profit or loss over the related asset's useful life. The credit results in a reduction to the current tax liability or the recognition of a deferred tax asset (where unused), and under IAS 20 the benefit (that is, the credit entry) is either:

 

 

 

recognised separately from the related asset as deferred income; in which case the deferred income is amortised over the related asset's life in the income statement as 'other income'; or

recognised as a reduction of the related asset's carrying amount; in which case, the benefit arises through a lower depreciation charge.

 

A new temporary difference between the book and tax base of the asset may arise where a non-taxable grant results in adjustment to the asset's carrying value but not its tax base. Alternatively, where such a grant is recognised as deferred income, the difference between the deferred income balance and its tax base of nil will also be a temporary difference. Whichever method of presentation is adopted, the resulting deferred tax asset that arises on the initial recognition of the asset or deferred income is not recognised. [IAS 12 para 33].

 

In the limited circumstances where this approach is adopted for tax credits on qualifying expenditure that does not result in a capitalised asset, the tax credit entry is generally recognised in pre-tax profit or loss when the related expenditure is incurred.

 

 

13.275.10 If an entity is considering adopting this accounting model, it should consider potential consequences for subsequent accounting. For instance, where a deferred tax asset resulting from an investment tax credit cannot be recovered because of unexpected tax losses, should the deferred income (or adjustment to asset carrying amount) be reversed? One view separates the future measurement of the deferred tax asset from the deferred income (or carrying amount of the asset). The recovery of the deferred tax asset depends on future profits and is not linked to the circumstances that gave rise to the grant. Government grants are not adjusted if the granted assets are impaired. An alternative view is that writing off the deferred tax asset is a repayment of government grant, so the deferred income (or adjustment to the carrying amount of the asset) should be reversed. We consider that either approach is acceptable; and the choice of approach is a matter of accounting policy to be applied consistently. However, recognising the complexities that may result from this approach, including the impact of any subsequent reversal of any deferred tax asset, many entities may find it preferable to account for such credits as other tax credits rather than as investment tax credits, unless measurement of the credit is reasonably straightforward, and there is a high expectation of its recovery (for example, where recovery of the tax credit is not dependent on the level of an entity's future taxable profits).  

 

 

Change of tax base (or IRE) model

 

13.275.11 Where a related asset is recorded on the balance sheet, in some circumstances it might be acceptable to view the investment tax credit as an increase of the related asset's tax base. Where the asset was not acquired in a business combination (and the related asset's initial recognition does not affect accounting or taxable profit), the deductible temporary difference that arises will qualify for the initial recognition exception in paragraph 15 of IAS 12 (see para 13.162 onwards). Therefore, no deferred tax asset is recognised at the time the tax credit arises, but recognition occurs as a reduction of current tax as the credit is realised.

Presentation and disclosures

General

13.276 Tax effects (regardless of how they have been calculated) should be shown in the financial statements separately from the items or transactions to which they relate. The standard contains a considerable number of disclosure requirements in respect of taxation. Most of the disclosure requirements apply to the financial statements of individual companies as well as to consolidated financial statements. The paragraphs that follow deal with the disclosure requirements of current and deferred tax.

Accounting policies

13.277 There is no specific requirement in IAS 12 to disclose accounting policies in respect of current and deferred tax. However IAS 1 requires disclosure of significant accounting policies that are relevant to an understanding of the entity's financial statements. [IAS 1 para 117]. In respect of deferred tax, the policy note should state the measurement basis on which deferred tax has been recognised.

13.277.1 Examples of accounting policies on current and deferred tax under IAS 12 are given in Tables 13.3 and 13.4 below.

13.277.2 IAS 1 also requires disclosure in the financial statements of judgements (apart from those involving estimations – see para 13.307.1) that management has made in the process of applying the accounting policies and that have the most significant effect on the amounts recognised in those financial statements. [IAS 1 para 122]. This is discussed in detail in chapter 4.

13.277.3 An example of disclosure of critical judgements in respect of tax is given in Table 13.5 below.

Balance sheet presentation

13.278 Liabilities and assets for current tax should be presented separately on the face of the balance sheet. [IAS 1 para 54(n)]. Similarly, deferred tax liabilities and deferred tax assets should be presented separately on the face of the balance sheet. [IAS 1 para 54(o)]. Where an entity presents current and non-current assets (and current and non-current liabilities) as separate classifications on the face of the balance sheet, it should not classify deferred tax assets (liabilities) as current assets (liabilities). [IAS 1 para 56]. In other words, deferred tax assets and liabilities are always presented as non-current.

13.279 The amount of an asset or liability that is expected to be recovered or settled more than 12 months after the balance sheet date should be disclosed in the following situation: where an entity has a line item that combines (a) amounts expected to be recovered or settled no more than 12 months after the balance sheet date and (b) amounts expected to be recovered or settled more than 12 months after the balance sheet date. [IAS 1 para 61]. This situation might apply to deferred tax assets and liabilities because they are always presented as non-current (see para 13.278); even though they could contain an element expected to be recovered or settled no more than 12 months from the balance sheet date.

13.280 To meet the IAS 1 requirement, an entity should first calculate the amount that becomes due no more than 12 months after the balance sheet date (that is, the 'current' component of the total asset or liability balance). That amount is then deducted from the total balance to give the 'non-current' component. It might be difficult to estimate the current component in practice, because management might need to make subjective judgements on the probable timing of the reversal of taxable and deductible temporary differences and on the probable timing of the reversal of tax losses. Indeed, it is sometimes impossible to obtain a reliable split without making arbitrary assumptions. Nevertheless, it appears that such a split is required to comply with paragraph 61 of IAS 1, even though the entire deferred tax asset or liability balance is presented as non-current in the balance sheet.

Offset

13.281 Although current tax assets and liabilities are separately measured and recognised, they should be offset for presentation purposes if, and only if, the entity:

has a legally enforceable right to set off the recognised amounts; and

intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

[IAS 12 para 71].

13.282 The above offset criteria are similar to those established for financial instruments in paragraph 42 of IAS 32. The 'legal right of offset' criterion is met only where income taxes are levied by the same tax authority that accepts or requires settlement on a net basis. [IAS 12 para 72].

13.283 In consolidated financial statements, current tax assets of one group member could be offset against a current tax liability of another member if there is a legally enforceable right to offset the recognised amounts; and the entities intend to make settlement on a net basis or to recover the asset and settle the liability simultaneously. [IAS 12 para 73]. Simultaneous settlement means that the cash flows are equivalent to a single net amount; this is because the realisation of the current tax asset and the settlement of the current tax liability occur at the same moment.

13.284 Similar conditions apply to offsetting deferred tax assets and liabilities. An entity should offset deferred tax assets and deferred tax liabilities for presentation purposes if, and only if:

the entity has a legally enforceable right to set off current tax assets against current tax liabilities; and

the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same taxation authority on either:

the same taxable entity; or

different taxable entities which intend either to settle current tax liabilities and assets on a net basis, or to realise the assets and settle the liabilities simultaneously, in each future period in which significant amounts of deferred tax liabilities or assets are expected to be settled or recovered.

 [IAS 12 para 74].

13.285 Simultaneous realisation of the asset and settlement of the liability (in the final point above) is particularly relevant to deferred taxes. Without this requirement, offset of specific deferred tax balances could take place only if the temporary differences giving rise to a deferred tax asset reverse before (or at the same time as) those giving rise to a deferred tax liability. If those giving rise to the liability reverse first, there will be a requirement to pay tax before any entitlement to recover tax. The IASB felt that the need to schedule the timings of the reversals of individual temporary differences (to measure the extent to which the balances should be offset for presentation purposes) would be impractical and unnecessarily costly. [IAS 12 para 75].

13.285.1 In rare circumstances, an entity might have a legally enforceable right of offset (and an intention to settle net) for some periods but not for others. Detailed scheduling would be required to establish reliably whether the deferred tax liability of one taxable entity will result in increased tax payments in the same period in which a deferred tax asset of another taxable entity will result in decreased payments by that second taxable entity. [IAS 12 para 76].

13.285.2 The requirement in paragraph 13.284 effectively prohibits offset of deferred tax assets and liabilities relating to different tax jurisdictions in consolidated financial statements. It also means that a net group tax liability cannot be presented by offsetting group tax assets on the grounds of a group tax planning opportunity, unless the opportunity relates to taxes levied by the same tax authority on different group members and the entities are treated as a group for tax purposes.

13.285.3 An entity might have a large number of different temporary differences (giving rise to deferred tax assets and liabilities) that arise during a period. Although these deferred tax assets and liabilities are measured separately, the ability to offset assets against liabilities depends on (a) the nature of the balances (for example, tax rules might not permit deferred tax assets for capital losses to be offset against deferred tax liabilities for trading item tax allowances, such as accelerated capital allowances) and (b) who they are due to or from.

Performance statements and equity

13.286 IAS 12 requires the tax expense (or income) related to profit or loss from ordinary activities to be presented in the statement of comprehensive income. If an entity presents the profit or loss components in a separate income statement (as described in para 81 of IAS 1), it presents the tax expense (or income) related to profit or loss from ordinary activities in that separate statement. [IAS 12 paras 77, 77A].

13.286.1 The treatment of tax in the performance statements is considered further in the following sections.

Items recognised in profit or loss

13.287 Deferred tax is recognised as income or expense and included in profit or loss for the period, except to the extent that the tax arises from:

A transaction or event that is recognised (in the same period or a different period) outside profit or loss, either in other comprehensive income or directly in equity (see para 13.288).

A business combination (see para 13.238 onwards).

[IAS 12 para 58].

13.287.1 IAS 12 distinguishes between tax on items recognised in other comprehensive income and tax on items recognised directly in equity; and it requires that the two amounts are presented accordingly and separately disclosed.

Items recognised outside profit or loss

13.288 Under the principle that tax follows the item, deferred tax relating to items that are recognised (in the same or a different period) in other comprehensive income is recognised in other comprehensive income. Similarly, deferred tax relating to items that are recognised (in the same or a different period) directly in equity is recognised directly in equity. [IAS 12 para 61A].

13.288.1 Some examples of items on which deferred tax is recognised in other comprehensive income (including some noted in para 62 of IAS 12) are given below:

A change in the carrying amount following revaluation of property, plant and equipment (see para 13.208).

The recognition of valuation movements on available-for-sale investments (see para 13.226).

The translation of the financial statements of foreign operations (see para 13.273).

13.288.2 Some examples of items on which deferred tax is recognised directly in equity (including some noted in para 62A of IAS 12) are given below:

An adjustment to opening retained earnings where a change in accounting policy is applied retrospectively or an error has been corrected.

The initial classification of a compound financial instrument where the tax base is not split between the two components (see para 13.229).

The amount of the tax deduction (estimated or known) that exceeds the cumulative amount of the expense in an equity-settled share-based payment award (see para 13.206).

13.288.3 The most common type of deferred tax that is recognised in other comprehensive income is on the revaluation of an asset (such as property, plant and equipment). But the deferred tax liability is always released through profit or loss because the revalued asset's carrying amount is recovered through use by way of a depreciation charge. An entity can sometimes make a transfer directly between reserves (from the revaluation reserve to retained earnings) of an amount equal to the difference between depreciation based on the revalued amount and depreciation based on cost. In this case, the transfer should be made net of deferred tax. [IAS 12 para 64]. This issue is addressed in scenario 1 of the example in paragraph 13.211.

13.288.4 IAS 12 does not specify the reserve in which tax charged (or credited) to other comprehensive income or directly to equity should be recognised. But the tax should be recognised in the same reserve as the underlying item (unless such treatment is prohibited by another standard or by the legal requirements relating to that reserve). This is consistent with the general principle in IAS 12 that an entity accounts for the tax consequences of transactions and other events in the same way that it accounts for the transactions and other events themselves. This is supported by paragraph 64 of IAS 12, which requires transfers from revaluation reserve to be made net of tax (see para 13.288.3); this indicates that the tax has been included in that reserve in the first instance.

13.288.5 It can be difficult to determine the amount of deferred tax that relates to items that are recognised outside profit or loss, either in other comprehensive income or directly in equity. For example, this might be the case where:

There are graduated rates of income tax and it is not possible to determine the rate at which a specific component of taxable profit (tax loss) has been taxed.

A change in the tax rate or other tax rules affects a deferred tax asset or liability relating (in whole or in part) to an item that was previously recognised outside profit or loss.

An entity determines that a deferred tax asset should be recognised (or should no longer be recognised in full) and the deferred tax asset relates (in whole or in part) to an item that was previously recognised outside profit or loss.

 

 

In such situations, the attributable tax is calculated on a reasonable pro rata basis, or another basis that is more appropriate in the circumstances. [IAS 12 para 63].

Example – Apportionment of deferred tax credit

 

An entity was unable to recognise a deferred tax asset of C5m (of which C1m relates to items charged to other comprehensive income) because it was not probable that sufficient taxable profits would be available against which the deductible temporary difference could be utilised. After a few years, circumstances have changed and the entity expects to recover at least C3m of the unrecognised deferred tax asset. Unless the entity cannot analyse the particular categories of deductible temporary differences (which will be rare in practice), some form of apportionment is needed. For example, the entity could allocate part of the C3m (for instance, 1/5 × 3 = C0.6m) to other comprehensive income and the balance of C2.4m to profit or loss.

 

Changes in the carrying amounts of deferred tax assets and liabilities

13.288.7 The carrying amount of deferred tax assets and liabilities can change without a change in the temporary difference. Such changes might arise as a result of:

A change in tax rates or laws.

A re-assessment of the recoverability of deferred tax assets (see para 13.155).

A change in the expected manner of recovery of an asset (see para 13.174).

 

 

The resulting change in deferred tax should be recognised in profit or loss except to the extent that it relates to items previously recognised outside profit or loss (see further para 13.288). [IAS 12 para 60]. This is sometimes referred to as 'backwards-tracing'.

Example 1 – Backwards-tracing of property revaluations

 

An entity has a policy of revaluing property under paragraph 31 of IAS 16. As a result of revaluation gains, a taxable temporary difference has arisen between the properties' carrying amount and their tax base; this has led to recognition of a deferred tax liability at the period end.

 

The revaluation gains were recognised in other comprehensive income under IAS 16; and the related deferred tax liability was also recognised in other comprehensive income (following the principles of paragraph 60 of IAS 12, as noted above).

 

The corporation tax rate has changed from 40% to 35% with an effective date of 31 May 20X8. This change has been substantively enacted at the balance sheet date and will impact the reversal of the temporary difference from 31 May 20X8 onwards; so the deferred tax liability will be reduced.

 

Any adjustment to deferred tax resulting from the tax rate change should be traced back to the original transaction recognised in other comprehensive income. As such, the impact of any adjustment to this deferred tax liability would be recognised in other comprehensive income. (This differs from the accounting for reversals of the deferred tax liability resulting from depreciation charged; in that case, the reversal is recognised in profit or loss – see para 13.211.)

Example 2 – Backwards-tracing of defined benefit liabilities

 

An entity has a defined benefit pension scheme that is in deficit at the period end. A deferred tax asset has been recognised for the deductible temporary difference in relation to the pension deficit.

 

The corporation tax rate has changed from 40% to 35% with an effective date of 31 May 20X8. This change has been substantively enacted at the balance sheet date and will impact the reversal of the temporary difference from 31 May 20X8 onwards; so the deferred tax asset will be reduced.

 

Having identified the transactions that gave rise to the temporary difference, management will need to trace the impact of the tax rate change to the same place. In this case, the pension deficit might have arisen as a result of service costs or other income statement charges, or actuarial losses recognised in other comprehensive income, or both.

 

Depending on how the pension deficit arose (and thus how the deferred tax asset was originally booked), the reduction in the deferred tax asset will be recognised in profit or loss, in other comprehensive income, or it will be split between the two.

 

The backwards-tracing for the tax rate change should be consistent with the approach used for allocating tax deductions (see para 13.203.8). The deferred tax asset (which is impacted by the tax rate change) represents the tax on amounts against which tax deductions have not yet been allocated. Where amounts in the performance statements are covered by deductions received on contributions, no deferred tax arises. The deferred tax arises on any excess amounts in the performance statements; and the backwards-tracing should be carried out on that basis.

 

If the deferred tax relates to a pension liability recognised on transition to IFRS, management needs to determine where the pension items on which the original deferred tax arose would have been recognised if IFRS had been applied in the prior periods (as explained in para 13.288.8). If this is not possible, the deferred tax would generally be recognised in profit or loss.

13.288.8 In some cases, a deferred tax asset or liability might have been recognised on the initial adoption of IFRS. In our view, the fact that deferred tax was charged to equity (as part of the transition adjustment) does not mean that subsequent changes in the deferred tax asset or liability will also be recognised in equity. Instead, management needs to determine (using the entity's current accounting policies) where the items on which the original deferred tax arose would have been recognised if IFRS had applied in the earlier periods. If it is not possible to assess where those items would have been recognised, the deferred tax changes would generally be recognised in profit or loss (under para 58 of IAS 12).

13.288.9 Where deferred tax arose on the initial adoption of IFRS, the implications of any transitional rules in IFRS 1 for the underlying items will need to be considered; this is for the purpose of backwards-tracing when accounting for deferred tax changes. For instance, if an asset is recognised at 'deemed cost' on the initial adoption of IFRS (with related deferred tax on the transition adjustment), any changes in that deferred tax should be recognised in profit or loss (see para 13.219 onwards). Similarly, where an item or an adjustment is deemed to be nil (for accounting purposes) under the transitional rules in IFRS 1, any subsequent changes in related deferred tax should not be backwards-traced to other comprehensive income or retained earnings, but should instead be recognised in profit or loss. For example, if an entity applies the exemption in para D13 of IFRS 1, cumulative translation differences for all foreign operations are deemed to be nil at the date of transition to IFRS.

13.288.10 A different situation arises where an exemption in IFRS 1 applies for disclosure purposes only; for example, some defined benefit scheme disclosures can be made prospectively from the date of transition to IFRS. [IFRS 1 para D11]. In this case, our view is that backwards-tracing to other comprehensive income should be applied for changes in deferred tax, unless it is not possible to assess where the items on which the original deferred tax arose would have been recognised (see the example in para 13.288.7); this is because the exemption does not apply to the underlying accounting.

Exchange differences on deferred foreign tax liabilities or assets

13.289 IAS 21 is silent on where exchange gains and losses should be shown in the income statement. IAS 12 makes it clear that exchange differences on foreign deferred tax assets and liabilities can be included as part of the deferred tax expense (income) if that presentation is considered to be the most useful to financial statement users. [IAS 12 para 78]. A more usual presentation would be to include the exchange differences on deferred taxes as part of the foreign exchange gains and losses that are credited or charged in arriving at profit before tax.

Disclosures in the notes

13.290 A considerable amount of information about current and deferred tax is disclosed in the notes. In this section, the disclosure requirements are grouped under appropriate headings for ease of reference; and examples from published financial statements are included where relevant.

Analysis of tax expense (income)

13.291 The major components of the tax expense (income) should be identified and disclosed separately. [IAS 12 para 79]. Such components might include:

In respect of current tax:

The current tax expense (income).

Any adjustments recognised in the period for current tax of prior periods.

The amount of the benefit arising from a previously unrecognised tax loss, tax credit or temporary difference of a prior period that is used to reduce current tax expense.

The amount of tax expense (income) relating to changes in accounting policies and errors that are included in profit or loss (under IAS 8) because they cannot be accounted for retrospectively.

In respect of deferred tax:

The amount of deferred tax expense (income) relating to the origination and reversal of temporary differences.

The amount of deferred tax expense (income) relating to changes in tax rates or the imposition of new taxes.

The amount of the benefit arising from a previously unrecognised tax loss, tax credit or temporary difference of a prior period that is used to reduce deferred tax expense.

Deferred tax expense arising from the write-down (or reversal of a previous write-down) of a deferred tax asset that has been reviewed at the balance sheet date.

The amount of tax expense (income) relating to changes in accounting policies and errors that are included in profit or loss (under IAS 8) because they cannot be accounted for retrospectively.

[IAS 12 para 80].

13.292 The total current and deferred tax relating to items that are charged or credited directly to equity should be disclosed. [IAS 12 para 81(a)]. An example that shows the amount of tax charged directly to equity is provided in Table 13.5.1.

13.292.1 The amount of income tax relating to each component of other comprehensive income (including reclassification adjustments) should be disclosed in the statement of comprehensive income or in the notes. [IAS 12 para 81(ab)]. Components of other comprehensive income can be presented on the face of the statement of comprehensive income net of related tax effects; or they can be presented before related tax effects. If an entity presents items of other comprehensive income before related tax effects (with the total tax shown separately), it should allocate the tax between the items that might be reclassified later to profit or loss and those that will not be reclassified.[IAS 1 paras 90, 91]. This is considered further in chapter 4.

13.292.2 The following disclosures should be made in the case of business combinations:

 

If a business combination (in which the entity is the acquirer) causes a change in the amount recognised for its pre-acquisition deferred tax asset (see para 13.250.1), the amount of that change.

 

If the deferred tax benefits acquired in a business combination are not recognised at the acquisition date but are recognised after the acquisition date (see para 13.249.5), a description of the event or change in circumstances that caused the deferred tax benefits to be recognised.

[IAS 12 para 81(j), (k)].

13.293 The standard does not require the current tax charge (credit) reported in profit or loss to be analysed further between domestic and foreign tax. Entities with significant amounts of foreign tax might find it useful to give an extra analysis in the tax note as shown below:

 

C'000

C'000

Domestic tax

 

 

Current tax on income for the period
Adjustments in respect of prior periods

X
X

 

 


 

 

X

 

Double tax relief

X

 

 


 

 

 

X

Foreign tax

 

 

Current tax on income for the period
Adjustments in respect of prior periods

X
X

 

 


 

 

 

 

 


Current tax expense

 

X

Deferred tax expense

 

X

 

 


Tax on profit on ordinary activities

 

X

 

 


 

A non-mandatory format (including some of the disclosure requirements stated in para 13.291) is given in example 2 of appendix B to IAS 12.

13.294 The originating and reversing temporary differences are disclosed as a single figure within the deferred tax expense in profit or loss; this figure should be further analysed by each type of temporary difference and each type of unused tax losses and tax credits (if this is not apparent from the changes in the amounts recognised in the balance sheet). [IAS 12 para 81(g)(ii)]. These temporary differences are likely to include the tax effects of accelerated capital allowances, fair value gains, material provisions, utilisation of unrelieved tax losses and other temporary differences. In practice, the above disclosure will form part of the balance sheet movements of principal types of deferred tax assets and liabilities. So it will be clear from the changes in balance sheet amounts; and it will not usually need to be disclosed as a separate note to the tax expense or income in profit or loss.

13.294.1 An example of an entity disclosing each type of temporary difference and tax losses is given in Table 13.7 (in para 13.301.1).

Discontinued operations

13.295 The amount of tax attributable to discontinued operations should be disclosed; and it should be analysed between the tax expense relating to:

The gain or loss on discontinuance.

The profit or loss from the ordinary activities of the discontinued operation for the period, together with the corresponding amounts for each prior period presented.

[IAS 12 para 81(h)].

13.295.1 The presentation of tax on discontinued operations is dealt with in chapter 26.

Explanation of the relationship between tax expense and accounting profit

13.296 The standard requires an explanation of the relationship between tax expense and accounting profit. This relationship can be affected by factors including: significant tax-free income and significant disallowables; tax losses utilised; different tax rates in the locations of foreign-based operations; adjustments related to prior years; unrecognised deferred tax; and tax rate changes. An explanation of these matters enables financial statement users to understand whether the relationship between tax expense and accounting profit is unusual; and it helps the users to understand the significant factors that could affect that relationship in the future. The explanation should be in either or both of the following numerical forms:

A reconciliation between tax expense (income) and the product of accounting profit multiplied by the applicable tax rate(s); the basis for computing the applicable tax rate(s) should also be disclosed.

A reconciliation between the average effective tax rate (tax expense divided by the accounting profit) and the applicable tax rate; the basis for computing the applicable tax rate should also be disclosed.

[IAS 12 paras 81(c), 84].

13.297 IAS 12 requires the total tax charge (current and deferred), rather than the current tax charge, to be reconciled to the theoretical tax on accounting profit.

13.298 The starting point for preparing the numerical reconciliation (whether in absolute or in percentage terms) is to determine an applicable tax rate. In the context of a single economic entity (that is, the group), it is important to use an applicable tax rate that provides the most meaningful information to financial statement users. The most relevant rate is often the rate applicable in the reporting entity's country. This rate should be used even if some of the group's operations are conducted in other countries. In that situation, the impact of different tax rates applied to profits earned in other countries would appear as a reconciling item. The basis for computing the applicable tax rate should be disclosed (as well as an explanation of changes in the applicable tax rate(s) compared to the previous accounting period). [IAS 12 para 81(d)]. This is because sometimes it may not be possible to determine a meaningful single applicable tax rate (particularly for multi-national groups).

13.299 Another method is to aggregate separate reconciliations prepared using the applicable tax rate in each individual jurisdiction; and then provide a reconciliation from the aggregation to a single applicable tax rate (that is, the reporting entity's rate). Such information would normally be requested as part of the group reporting packs; and it would greatly simplify the process for presenting the tax reconciliation in the consolidated financial statements.

Example – Reconciliation of tax expense

 

Entity L is a non-operating holding entity incorporated in Luxembourg. It has subsidiaries in Italy, Finland and Brazil. The following table provides information on the statutory tax rate and profit before tax for each member of the group:

 

The tax charge in the consolidated financial statements is C520.

 

 

 

 

 

 

 

 

Country

Statutory tax rate
(A)

Profit before tax
(B)

Tax at statutory tax rate
(A x B)

Tax at difference between Luxembourg rate and statutory rate
(A − 25%) × (B)

Luxembourg

25%

20

5

-

Finland

37%

700

259

84

Italy

29%

400

116

16

Brazil

33%

500

165

40

 


Total

 

1,620

545

140

 


 

 

Management would prefer to present a reconciliation of monetary amounts rather than a reconciliation of the tax rates. Management could choose to reconcile the tax charge to the tax rate of the parent (entity L) or to reconcile to an aggregate of separate reconciliations for each country.

 

The following illustrates the two methods:

 

Reconciliation of tax expense

 

 

 

Tax rate of parent

Average tax rate

 

C

C

Profit before tax

1,620

1,620

 


Tax at the domestic rate of 25%

405

n/a

Tax calculated at the domestic rates applicable to profits in the country concerned

n/a

545

Income not subject to tax

(50)

(50)

Expenses not deductible for tax purposes

25

25

Effect of different tax rates in countries in which the group operates

140

n/a

 


Tax charge

520

520

 


13.299.1 An example of reconciliation using monetary amounts is shown in Table 13.2 (see para 13.274.1); an example using tax rates is shown in Table 13.6:

13.300 Where a group operates mainly outside its local territory, a third method is to use an average tax rate (weighted in proportion to accounting profits earned in each geographical territory) as the applicable tax rate. This method is not included in the standard, but it could be used – provided the basis for computing the applicable tax rate is disclosed (under IAS 12, para 81(c)).

Example – Determination of 'applicable rate' for a group with significant overseas subsidiaries

 

 

 

 

 

 

 

 

 

 

Country

Profit

Tax rate

Weighted average

UK

100

30%

100/2030 × 30% =

1.48

US

600

40%

600/2030 × 40% =

11.82

France

500

35%

500/2030 × 35% =

8.62

Germany

450

38%

450/2030 × 38% =

8.42

Australia

380

33%

380/2030 × 33% =

6.18

 


Total

2,030

Average rate =

36.52

 


The average rate of 36.52% should be used in the tax reconciliation. The basis for calculating the rate should also be disclosed (as stated in para 13.296).

13.300.1 Use of a weighted average tax rate method might be appropriate where all the group entities have made a profit. But this method might not provide a meaningful tax rate where some entities within a group have profits and others have losses. For example, the entity might calculate the weighted average tax rate based on absolute values (that is, making all values positive); in that case, the tax rate obtained might appear meaningful, but there will be a reconciling item in the tax reconciliation. On the other hand, the weighted average rate might be calculated based on actual values; even though the theoretical tax expense will be the correct amount, the weighted average tax rate might not be meaningful because it might be higher than any individual rate. So it might not be appropriate to use the weighted average tax rate method in this situation.

Analysis of deferred tax assets and liabilities (balance sheet)

13.301 Deferred tax assets and liabilities (of the current and previous periods) should be analysed by each type of temporary difference and each type of unused tax losses and tax credits. [IAS 12 para 81(g)(i)]. The significant types of temporary difference that generally need to be disclosed separately include: accelerated capital allowances; revaluation of assets; other short-term taxable temporary differences that affect accounting or taxable profit; provisions; and tax losses carried forward. A format for disclosure is given in example 2 of appendix B to IAS 12. The amount of deferred tax income or expense recognised in profit or loss should be similarly analysed (if this is not apparent from the balance sheet movement of each component – see para 13.294). [IAS 12 para 81(g)(ii)].

13.301.1 An example of an entity disclosing each type of temporary difference and tax losses is given in Table 13.7. (Note that comparatives have not been reproduced.)

13.301.2 The standard requires an analysis of each type of temporary difference. Where a temporary difference comprises the net amount of deferred tax assets and liabilities that have met the criteria for offset (see para 13.284), we believe that the disclosure applies to the net position for that temporary difference.

 

Example – Analysis of each type of temporary difference

 

At its year end, entity A has property, plant and equipment (PPE) with carrying amounts, tax bases and temporary differences outlined below. The differences arise because the assets are deductible for tax purposes in a way that differs from the depreciation recognised for accounting purposes.

 

 

 

 

 

Class of PPE

Carrying amount

Tax base

Temporary difference

DT asset/(liability) @ 30%

 

C'000

C'000

C'000

C'000

Property

100

75

25

(7.5)

Cars

50

65

(15)

4.5

Office equipment

20

10

10

(3.0)

 


Total

170

150

20

(6.0)

 


At an effective tax rate of 30%, the property and office equipment give rise to a deferred tax liability of C10,500; and the cars give rise to a deferred tax asset of C4,500. Entity A can use the deferred tax asset to offset the deferred tax liabilities; so the entity discloses the net deferred tax liability position of C6,000 on the face of the balance sheet.

 

Deferred tax assets and liabilities should be analysed by each type of temporary difference. [IAS 21 para 81(g)].

 

In respect of the above amounts, we do not believe that IAS 12 requires a gross presentation, because the deferred tax noted in the table above relates to the same type of temporary difference (that is, differences between depreciation for tax and accounting purposes).

 

Entity A has the right to offset the deferred tax asset and liability (and thus presents the net position in the balance sheet). The amount of the net position relating to the difference between the carrying amount and tax base of PPE is C6,000; that amount should be disclosed as a component of the total deferred tax liability recognised.

Unrecognised temporary differences

13.302 Disclosures are also required in respect of unrecognised temporary differences, such as:

The amount (and expiry date, if any) of deductible temporary differences, unused tax losses and unused tax credits for which no deferred tax has been provided. [IAS 12 para 81(e)]. Although not required by the standard, it might be helpful to explain the circumstances in which the deferred tax asset would be recovered.

The total amount of temporary differences associated with investments in subsidiaries, branches and associates and interests in joint ventures for which deferred tax liabilities have not been recognised. [IAS 12 para 81(f)].

13.303 For investments in subsidiaries, branches, associates and interests in joint ventures, disclosure is required of the total amount of temporary differences (rather than the deferred tax assets and liabilities associated with such temporary differences). But the standard encourages disclosure of the deferred tax amounts. This is because it might sometimes be difficult (particularly for foreign investments) to quantify the future tax payable in view of a number of factors (for example, the tax laws and tax rates in force, the intended timing of future remittances, and the terms of any tax treaty that might exist between the two countries). [IAS 12 para 87].

13.303.1 For an example of an entity disclosing unrecognised temporary differences on subsidiaries and joint ventures, see Table 13.8. The example also shows the amount of the potential deferred tax (see para 13.303). For an example of disclosure of tax losses and deductible temporary differences for which no deferred tax has been recognised, see Table 13.8.1. That example also shows unrecognised temporary differences on subsidiaries, associates and joint ventures.

Tax consequences of dividends

13.304 An entity generally recognises any tax consequences of the payment of a dividend at the time when the dividend is recognised as a liability in the financial statements (see para 13.175 onwards). But the amount of income tax arising on dividends that were proposed or declared before the financial statements were authorised for issue (but are not recognised as a liability in the financial statements) should be disclosed. [IAS 12 para 81(i)].

13.305 Where tax rates vary between distributed and undistributed profits, the nature of the potential tax consequences (that would result from the payment of dividends to shareholders) should also be disclosed. In making this disclosure, an entity should also disclose:

The important features of the tax systems and the factors that will affect the amount of the potential income tax consequences of dividends. [IAS 12 para 87A].

The amount of the potential tax consequences arising from the payment of dividends to shareholders (where it is practical to determine such amounts). [IAS 12 para 82A]. For example, in a consolidated group, a parent and some of its subsidiaries might have paid income taxes at a higher rate on undistributed profits; but they are aware of the amount of the tax refund that would arise if future dividends are paid at the lower rate. In that situation, the refundable amount should be disclosed. [IAS 12 para 87B].

Whether there are any potential tax consequences that it is not practical to determine. [IAS 12 para 82A]. This could arise where the entity operates a large number of foreign subsidiaries and it would not be practicable to compute the tax consequences arising from the payment of dividends to shareholders. In that situation, an entity simply discloses that fact (as stated above). In the parent's separate financial statements (if any), the disclosure of the potential tax consequences should relate to the parent's retained earnings. [IAS 12 para 87B].

Deferred tax asset of loss-making entities

13.306 Where an entity has incurred a loss in the current or a preceding period and the recovery of the deferred tax asset depends on future taxable profits in excess of those arising from the reversals of existing taxable temporary differences, the amount of the deferred tax asset and the nature of the evidence supporting its recognition should be disclosed. [IAS 12 para 82]. See further paragraph 13.146.

13.307 Recognition of the deferred tax asset should be supported by evidence showing why future profits are likely be available against which the deferred tax assets can be recovered (see further para 13.133 onwards). The evidence might also include tax-planning strategies (see para 13.136 onwards). Any statements made to explain how the asset would be recovered should be balanced, realistic and consistent with the other disclosures made in the financial statements (particularly in the management commentary). References to any profit forecasts etc should be avoided as far as possible.

Estimation uncertainty

13.307.1 "An entity shall disclose information about the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. In respect of those assets and liabilities, the notes shall include details of: (a) their nature, and (b) their carrying amount as at the end of the reporting period." [IAS 1 para 125].

13.307.2 The disclosures required in respect of estimation uncertainty are different from those required for key judgements in applying accounting policies (see further para 13.277.2). The estimation uncertainty disclosures deal with situations where the entity has incomplete or imperfect information (often relating to the future).

13.307.3 Areas that could require disclosure in respect of estimation uncertainty are:

Status of negotiations with tax authorities.

Assessing the probabilities that sufficient future taxable profits will be available to enable deferred tax assets resulting from deductible temporary differences and tax losses to be recognised.

Other assumptions about the recoverability of deferred tax assets (see also para 13.306).

13.307.4 Examples of disclosure in respect of estimation uncertainty on tax are given in Tables 13.9 and 13.10.

13.307.5 Disclosure of estimation uncertainty is dealt with in chapter 4.

Tax-related contingencies

13.308.1 An example of an entity disclosing contingent liabilities for taxation is given in Table 13.11.

Post balance sheet changes in tax rates

13.309 IAS 12 requires the use of tax rates a

13.308 It is quite common for an entity to have tax assessments of earlier years still open and disputed by the tax authorities. In those situations, contingent liabilities and assets might well arise. The entity should disclose the following information (consistent with IAS 37) on these tax-related contingencies: the nature of the contingency, an indication of the uncertainty affecting whether the further tax will become payable and an estimate of the financial effect. [IAS 12 para 88].

nd laws that have been substantively enacted by the balance sheet date (rather than by the date when the financial statements are authorised for issue); this means that information received after the year end about changes in tax rates and laws is not an adjusting post balance sheet event. But changes in tax rates or laws enacted or announced after the balance sheet date that have a significant effect on current and deferred tax assets and liabilities should be disclosed under IAS 10. [IAS 10 para 22(h); IAS 12 para 88].

Cash flows relating to taxes on income

13.310 Cash flows from taxes on income should be separately disclosed and classified as cash flows from operating activities (unless they can be specifically identified with financing and investing activities). [IAS 7 para 35]. These issues are considered further in chapter 30.


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