1.1 What is the accounting base? The accounting base of an asset or liability is simply the carrying amount of that asset or liability in the statement of financial position. In most cases, the determination of the accounting base of an asset or liability is straightforward, however IAS 12 requires the calculation of deferred tax to take into account the expected manner of recovery or settlement of assets and liabilities. In some cases it might be necessary to consider splitting the carrying value of an asset between an amount to be recovered through use and an amount to be recovered through sale. Section 4 contains a further discussion of assets whose carrying amount is recovered through use and sale. 1.2 What is a tax base? What is the tax base of an asset? The tax base of an asset is defined as: ‘…the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount’ (IAS 12.7). What is the tax base of a liability? The tax base of a liability is defined as: ‘…its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which 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 12.8). Example 1 – the tax base of an asset Company A purchased an item of property, plant and equipment for CU10,000. Over the life of the asset, deductions of CU10,000 will be available in calculating taxable profit through capital allowances. All deductions will be available against trading income and no deductions will be available on sale. Management intends to use the asset. As deductions of CU10,000 will be available over the life of the asset, the tax base of that asset is CU10,000. Tax base of a revalued asset that is not depreciated When an asset is revalued under IAS 16 ‘Property, Plant and Equipment’ and that asset is non-depreciable, the carrying amount of that asset will not be recovered through use. Therefore the tax base and tax rate will be those applicable to the sale of that asset. IAS 12 was amended in December 2010 to incorporate this principle which was previously contained in SIC-21 ‘Income Taxes-Recovery of Revalued Non- Depreciable Assets’. SIC-21 has been withdrawn as a result of these amendments. The same presumption, of recovery through sale rather than use, applies to an investment property that is measured at fair value in accordance with IAS 40 ‘Investment Property’. However, in the case of a building the presumption may be rebutted if the building is held in a business model whose objective is to consume substantially all of the economic benefits embodied in the building over time, rather than through sale. For land that meets the definition of investment property, the presumption of recovery through sale may not be rebutted, as land is a non-depreciable asset. 4 Deferred tax: Section 1 Step 1 Establishing the accounting base of the asset or liability Step 2 Calculate the tax base of the asset or liability Items with a tax base but no accounting base Some items have a tax base but no accounting base, for example carried-forward tax losses and some employee share options. Deferred tax on such items is calculated in the same way as items with an accounting base. Example 2 – an item with a tax base but no accounting base Company A issues 100,000 share options to its employees. The options vest immediately. A charge is recognised in profit or loss of CU100,000. In the country where Company A is domiciled, a tax deduction will be available when the options are exercised, based on the intrinsic value of the share options at the date of exercise. As a tax deduction will be available in the future when the options are exercised, a tax base exists, even though no asset is recognised in the statement of financial position for the options issued. 1.3 What is a temporary difference? A temporary difference arises whenever the accounting base and tax base of an asset or liability are different. A temporary difference can be either a taxable or deductible temporary difference. A taxable temporary difference is described in IAS 12.5 as: ‘…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’ A deductible temporary difference is described in IAS 12.5 as: ‘…temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.’ Example 3 Example 3a – a taxable temporary difference Company A holds an item of property, plant and equipment which has a carrying value of CU7,000 and a tax base of CU4,000 at the reporting date. There is a temporary difference of CU3,000. As the carrying value of the asset is higher than the deductions that will be available in the future, this is, therefore, a taxable temporary difference. Example 3b – a deductible temporary difference Company A contributes to a defined contribution pension scheme. At the year end Company A has recognised an accrual of CU5,000. In the country where Company A is domiciled, contributions to the scheme are taxed on a cash basis, the tax base of this liability is nil and there is a temporary difference of CU5,000. As a tax deduction will be available in the future when these contributions are paid to the scheme, this is a deductible temporary difference. Exempt temporary differences IAS 12 prohibits the recognition of deferred tax on certain temporary differences. The following explains which temporary differences are exempt under the standard: Deferred tax: Section 1 5 Step 3 Identify and calculate any exempt temporary differences 6 Deferred tax: Section 1 Taxable temporary differences A deferred tax liability should be recognised for all taxable temporary differences. However, IAS 12.15 prohibits the recognition of deferred tax on taxable temporary differences that arise from: • the initial recognition of goodwill or • the initial recognition of an asset or liability in a transaction which: − is not a business combination and − at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss). Example 4 – exempt taxable temporary differences Example 4a – goodwill Company A purchases Company B. Goodwill of CU150,000 arises on the acquisition. In the country where Company A is domiciled, no tax deduction is available in the future for this goodwill because it only arises in the consolidated financial statements and tax is assessed on the basis of Company A’s separate financial statements. There is a taxable temporary difference of CU150,000. However, in accordance with the initial recognition exemption in IAS 12.15 deferred tax is not recognised on that taxable temporary difference. Example 4b – initial recognition of an asset Company A purchases an item of property, plant and equipment for CU200,000. In the country where Company A is domiciled, no tax deduction is available for this asset either through its use or on its eventual disposal. There is therefore a taxable temporary difference of CU200,000 on initial recognition of the asset. Assuming that the asset was not purchased in a business combination, the resulting deferred tax liability would not be recognised in accordance with IAS 12.15. Example 4c – impact of temporary differences arising in a business combination If the asset above had been recognised in the consolidated financial statements as a result of a business combination, a deferred tax liability would be recognised on the resulting taxable temporary difference. The effect of this would be to increase goodwill by an equal amount. Deductible temporary differences A deferred tax asset is 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. However, IAS 12.24 prohibits the recognition of a deferred tax asset if that asset arises from the initial recognition of an asset or liability in a transaction that: • is not a business combination and • at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss). Example 5 – exempt deductible temporary difference Company A purchases an item of property, plant and equipment for CU100,000. Tax deductions of CU150,000 will be available for that asset in accordance with the tax legislation in the country where Company A is domiciled. There is therefore a deductible temporary difference of CU50,000. As this temporary difference arose on the initial recognition of an asset, that was not acquired as part of a business combination, no deferred tax should be recognised. Tracking exempt temporary differences As explained above, IAS 12 prohibits the recognition of deferred tax on temporary differences in certain situations, for example on temporary differences that arise on the initial recognition of goodwill. IAS 12 prohibits the recognition of deferred tax on such temporary differences either on the initial recognition or subsequently (IAS 12.22(c)). Example 6 – tracking exempt temporary differences Example 6a – temporary difference arose on initial recognition In Example 4a above, a taxable temporary difference of CU150,000 arose on the initial recognition of goodwill. As this arose on the initial recognition of the goodwill, no deferred tax was recognised. At the end of the first year after acquisition, an impairment of CU75,000 has been recognised against goodwill. The carrying value of this goodwill is therefore CU75,000, the tax base is still nil. Therefore, at the year-end there is a taxable temporary difference of only CU75,000. However, this difference is the unwinding of the initial temporary difference and in accordance with IAS 12 no deferred tax is recognised on this temporary difference either on initial recognition of the asset or subsequently. Example 6b – temporary difference arose after initial recognition Company A purchases the trade and assets of Company C. Goodwill of CU250,000 arises on the acquisition. In the country where Company A is domiciled, tax deductions of CU250,000 are available in the future on goodwill that arises in the individual company accounts of A. Accordingly, at initial recognition there is no temporary difference. At the end of the year, no impairment has been charged on this goodwill. In the tax computation for the year, a deduction of CU5,000 has been allowed. The tax base of the goodwill is therefore CU245,000 (CU250,000 – CU5,000). There is therefore a taxable temporary difference of CU5,000 relating to this goodwill. As this temporary difference did not arise on the initial recognition of goodwill, a deferred tax liability must be recognised. The tracking of initial temporary differences is discussed further in Section 8.2. Exempt temporary differences on investments in subsidiaries, branches and associates, and interests in joint arrangements The standard also includes exemptions for recognising deferred tax on temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements. IAS 12.39 requires an entity to recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, except to the extent that both of the following conditions are satisfied: • the parent, investor, joint venturer or joint operator 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 12.44 requires an entity to recognise a deferred tax asset for all deductible temporary differences arising from investments in subsidiaries, branches and associates, and interests in joint arrangements, to the extent that, and only 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. Example 7 – temporary differences on investments in subsidiaries and associates Example 7a – taxable temporary difference on investment in subsidiary Company A purchased Company B on 1 January 20X1 for CU300,000. By 31 December 20X1 Company B had made profits of CU50,000, which remained undistributed. No impairment of the goodwill that arose on the acquisition had taken place. Based on the tax legislation in the country where Company A is domiciled, the tax base of the investment in Company B is its original cost. In the consolidated accounts of Company A, a taxable temporary difference of CU50,000 therefore exists between the carrying value of the investment in Company B at the reporting date of CU350,000 (CU300,000 + CU50,000) and its tax base of CU300,000. As a parent, by definition, controls a subsidiary it will be able to control the reversal of this temporary difference, for example through control of the dividend policy of the subsidiary. Therefore, deferred tax on such temporary differences is generally not provided unless it is probable that the temporary difference will reverse in the foreseeable future. Deferred tax: Section 1 7 8 Deferred tax: Section 1 In certain jurisdictions, no tax is charged on dividends from investments and on profits from disposal of investments. Therefore, in accordance with the definition of the tax base of an asset and the tax legislation in such jurisdictions, the tax base of such an asset would equal its carrying value. As noted, tax legislation varies from one jurisdiction to another. As such, a detailed understanding of the applicable tax laws is necessary. Example 7b – probable sale of a subsidiary Same facts as Example 7a. However, as of 31 December 20X1, Company A has determined that the sale of its investment in Company B is probable in the foreseeable future. For the purpose of this example, the provisions of IFRS 5 ‘Non-current Assets Held for Sale and Discontinued Operations’ are ignored. The taxable temporary difference of CU50,000 is expected to reverse in the foreseeable future upon Company A’s sale of its shares in Company B. This triggers the recording of a deferred tax liability in the consolidated accounts of Company A as of the reporting date. The measurement of deferred tax should reflect the manner in which Company A expects to recover the carrying amount of the investment. Assuming that the capital gains tax rate on sale of shares is 10%, a deferred tax liability of CU5,000 (CU50,000 × 10%) should be recorded. In determining the appropriate tax rate to use, the legal form of the disposal of the investment (either as sale of the shares or share of the subsidiary’s trade and net assets) should be considered as varying tax rates may apply depending on the nature of the transaction. In addition, the legal form of the transaction may affect whether the temporary difference of CU50,000 will, in fact, reverse. Example 7c – taxable temporary difference on investment in an associate Company A purchases an interest in Associate C on 1 January 20X2 for CU450,000. By 31 December 20X2 Associate C had made profits of CU75,000 (Company A’s share), which remained undistributed. No impairment of the investment in Associate C was required at 31 December 20X2. Based on the tax legislation in the country where Company A is domiciled, the tax base of the investment in Associate C is its original cost. A taxable temporary difference of CU75,000 therefore exists between the carrying value of the investment in Associate C at the reporting date of CU525,000 (CU450,000 + CU75,000) and its tax base of CU450,000. As Company A does not control Associate C it is not in a position to control the dividend policy of Associate C. As a result, it cannot control the reversal of this temporary difference and deferred tax is usually provided on temporary differences arising on investments in associates. 1.4 Calculation of deferred tax – identification of the appropriate tax rate IAS 12 requires deferred tax assets and liabilities to be measured at the tax rates that are expected to apply in the period in which the asset is realised or the liability is settled, based on tax rates that have been enacted or substantively enacted by the end of the reporting period. Although it will be clear when a law has actually been enacted, determining whether a tax rate has been substantively enacted by the end of the reporting period following the announcement of a change in the rate is a matter of judgement. The decision should be based on the specific facts and circumstances concerned, in particular the local process for making and amending the tax laws. Some of the factors to be considered include: • the legal and related processes in the jurisdiction for the enactment of any changes in tax law • the status of proposed tax changes and the extent of the remaining procedures to be performed and • whether those remaining procedures are administrative or ceremonial formalities which can be perfunctorily performed. Step 4 Identify the relevant tax rate and apply this to calculate deferred tax Deferred tax: Section 1 9 In 2005, the IASB noted at its February board meeting that it was supportive of the substantive enactment principle on the basis that it would be achieved when the steps remaining in the process will not change the outcome. For example, in certain jurisdictions, substantive enactment is only deemed to occur when the tax bill is signed by the head of state while in others, the government’s announcement of the new tax rates may be considered a substantive enactment although formal enactment may occur in a later period. As the rate to be used is that applicable to the period in which the temporary difference is expected to reverse, some scheduling of the realisation of deferred tax assets and liabilities might be required. Example 8 Company A is preparing its financial statements for the year ended 30 June 20X1. Company A intends to sell an item of property, plant and equipment which has an associated taxable temporary difference of CU100,000. The tax rate applicable to Company A for the year ended 30 June 20X1 is 24%. Company A expects to sell the property, plant and equipment in 20X2. There is a proposal in the local tax legislation that a new corporation tax rate of 23% will apply from April 1, 20X2. In the country where Company A is domiciled, tax laws and rate changes are enacted when the president signs the legislation. The president signed the proposed tax law on 18 June 20X1. As the proposed tax law was signed, it is considered to be enacted. Therefore, if Company A expects to sell the asset before the new tax rate becomes effective, a rate of 24% should be used to calculate the deferred tax liability associated with this item of property, plant and equipment. Alternatively, if Company A does not expect to sell the asset until after 1 April 20X2, the appropriate tax rate to use is 23%. 1.5 Recognition of deferred tax assets In order to recognise (include in the statement of financial position) a deferred tax asset, there must be an expectation of sufficient future taxable profits to utilise the deductible temporary differences. Economic benefits in the form of reductions in tax payments will flow to the entity only if it earns sufficient taxable profits against which the deductions can be offset. Therefore, an entity recognises deferred tax assets only when it is probable that taxable profits will be available against which the deductible temporary differences can be utilised. IAS 12.28-31 contain guidance on when sufficient taxable profits are expected to arise. IAS 12.28 states that it is probable that taxable profit will be available against which a deductible temporary difference can be utilised when there are sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity which are expected to reverse: • in the same period as the expected reversal of the deductible temporary difference or • in periods into which a tax loss arising from the deferred tax asset can be carried back or forward. When there are insufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, a deferred tax asset is recognised to the extent that: • it is probable that the entity will have sufficient taxable profit relating to the same taxation authority and the same taxable entity in the same period as the reversal of the deductible temporary difference, or in the periods into which a tax loss arising from the deferred tax asset can be carried back or forward or • tax planning opportunities are available to the entity that will create taxable profit in appropriate periods. Management will need to use their judgement in estimating whether there will be sufficient taxable profits in the future to recognise a deferred tax asset. Management will also need to make estimates about the expected timing of reversal of the deductible and taxable temporary differences when considering whether a deferred tax asset can be recognised.
Posted on: Sun, 18 Aug 2013 12:45:14 +0000
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