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IAS 12 Income Taxes

IAS 12 Income Taxes. Scope of IAS 12. This Standard deals with in accounting for income taxes and includes all domestic and foreign taxes which are based on taxable profits

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IAS 12 Income Taxes

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  1. IAS 12 Income Taxes

  2. Scope of IAS 12 This Standard deals with in accounting for income taxes and includes all domestic and foreign taxes which are based on taxable profits taxes, such as withholding taxes, which are payable by a subsidiary, associate or joint venture on distributions to the reporting entity deferred taxes This Standard does not deal with the methods of accounting for government grants investment tax credits However, this Standard does deal with the accounting for temporary differences that may arise from such grants or investment tax credits.

  3. IAS 12 Where to account for the tax IAS 12 requires an entity to account for the tax consequences of transactions and other events in the same way that it accounts for the transactions and other events themselves, i.e: • in the statement of comprehensive income • in equity, or • in calculation of goodwill IAS 12 also addresses: • the recognition of deferred tax assets arising from unused tax losses or unused tax credits • the presentation of income taxes in the financial statements, and • the disclosure of information relating to income taxes

  4. Balance Sheet Approach Tax base Carrying amount Tax rate expected to apply Temporary difference ASSET/ LIABILITY

  5. Definitions Related to Deferred Tax Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. Temporary differences may be either: (a) taxable temporary differences, which 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; or (b) deductible temporary differences, which are 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. Tax Base: The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

  6. Temporary Differences Examples of temporary differences: • Tax and book depreciation on fixed assets differs • Certain income or expense is taxed on a cash basis • Assets are revalued for book purposes but not for tax purposes • Fair values are allocated after an acquisition • Tax base of an asset on initial recognition is different from its carrying amount • Carrying amount of investments in subsidiaries becomes different from their tax base • Unutilised losses

  7. Tax Base of an Asset The tax base of an asset is the amount that will be deductible for tax purposes against the taxable economic benefits that will flow to the entity when it recovers the carrying amount of the asset. If these economic benefits will not be taxable, then the tax base of an asset is equal to its carrying amount, so that no deferred tax arises.

  8. Will taxable economic benefits flow to the entity when carrying value is recovered through use or sale? NO YES Tax base = Tax base = Carrying value Amounts that will be recoverable against these benefits Tax Base – accounting asset No deferred tax Deferredtax

  9. Tax Base of an Asset: Scenario 1 A tool costs 100. For tax purposes, depreciation of 30 has been already deducted in the current and prior periods and the remaining cost of 70 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 loss on disposal will be deductible for tax purposes. What will be the tax base? A. 0 B. 30 C. 70 D. 100 Answer: C The tax depreciation rate on a fixed asset is different than book depreciation, but the asset is fully deductible for tax purposes over its life. The tax base value is the amount that will be deductible in the future (its cost net of tax depreciation charged to date); in this case, 70.

  10. Tax Base of an Asset: Scenario 2 Accrued interest receivable has a carrying amount of 100, and it will be taxed on receipt. What will be tax base? A. 0 B. 30 C. 70 D. 100 Answer: A The economic benefits obtained on recovery of the asset (receipt of the interest) will be taxable, and the amount deductible against these benefits will be 0, so the tax base of the asset is also 0. An alternative way of looking at this is that, from a tax point of view, the interest receivable has no value at the balance sheet date, because it will become taxable only when it is received.

  11. Trade receivables have a carrying amount of 100, and the related revenue already has been taxed. What will be the tax base? A. 0 B. 30 C. 70 D. 100 Answer: D - In this scenario, the economic benefits when received (when the receivable is settled) will not be taxable because they have been taxed already. Accordingly, the tax base is the same as the carrying amount, or 100. Tax Base of an Asset: Scenario 3

  12. Determining the Tax Base of a Liability Two key rules apply when determining the tax base of a liability. The aim is to identify any incremental tax effect of settling every liability at its carrying value, and if there is no such tax effect, the tax base value is the same as the carrying value. • The tax base of a liability is its carrying amount, minus any amount that will be deductible for tax purposes in respect of that liability in future periods. • In the case of revenue received in advance, the tax base is its carrying amount, minus any amount of revenue that will not be taxable in future periods.

  13. Tax Base of a Liability: Example Expenses of 100 have been accrued—80 already have given rise to a tax deduction and 20 will be deductible for tax purposes when paid. What is the tax base of the accrued expenses? A. 0 B. 20 C. 80 D. 100 Answer: C - The tax base of a liability is its carrying amount (100 in this case) minus any amount that will be deductible for tax purposes in respect of that liability in future periods (20). Accordingly, the tax base is 80.

  14. Tax Base of a Liability: Example Revenue of 100 has been received in advance and is shown as a liability, but it already has been taxed. What is the tax base of the revenue received in advance? A. 0 B. 20 C. 80 D. 100 Answer: A In the case of revenue received in advance, the tax base of the resulting liability is its carrying amount (100) minus any amount of revenue that will not be taxable in future periods (100). Thus, the tax base is 0.

  15. Current liabilities include accrued expenses with a carrying amount of 100. The related expense will be deducted for tax purposes on a cash basis. Tax base = carrying amount - future deductible amounts 0 = 100 - 100 Therefore the tax base of the accrued expenses is nil. Current liabilities include interest revenue received in advance, with a carrying amount of 100. The related interest revenue was taxed on a cash basis. Tax base = carrying amount - the amount of revenue that will not be taxable in future periods 0 = 100 - 100 Therefore the tax base of the interest received in advance is nil. Tax Base of a Liability: Example

  16. Current liabilities include accrued expenses with a carrying amount of 100. The related expense has already been deducted for tax purposes. Tax base = carrying amount - future deductible amounts 100 = 100 - 0 Therefore the tax base of the accrued expenses is 100. The pension fund obligation of an entity is 100. The fund expenses are deductible when the payment to the pension fund is made. Tax base = carrying amount - future deductible amounts 0 = 100 - 100 Therefore the tax base of the pension fund is nil. Tax Base of a Liability: Example

  17. Definitions Related to Deferred Tax

  18. Exceptions • Tax base where there is no asset or liability in the statement of financial position • Tax base is not immediately apparent :If the tax base of an asset or liability is not immediately apparent, consider the fundamental principle upon which IAS 12.10 is based: • that an entity should, with certain limited exceptions, recognise a deferred tax Liability (or asset) whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (or smaller) than they would be if such recovery or settlement were to have no tax consequences • Consolidated annual financial statements: In consolidated financial statements: Temporary differences = carrying amounts of assets and liabilities in the consolidated financial statements - appropriate tax base The tax base is determined by either: • reference to a consolidated tax return in those jurisdictions in which such a return is filed, or • by reference to the tax returns of each entity in the group (in all other jurisdictions)

  19. Exemptions: Example A research expenditure of 100 is expensed in the period, but this will be allowed as a tax deduction next year. What will be the tax base? A. 0 B. 30 C. 70 D. 100 Answer: D This scenario shows that some items might have a tax base even if they have not been recognized as assets or liabilities, so the tax base is 100.

  20. Deferred Tax

  21. Recognizing Deferred Tax Liability A deferred tax liability should be recognised for all taxable temporary differences, including those arising from: - business combinations - assets carried at fair value - split accounting of financial instruments unless the deferred tax liability arises 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 (or tax loss) Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. Deferred tax liability = taxable temporary difference x tax rate

  22. Taxable Temporary Differences-Example On 1 January 2006, Pyramids Ltd purchases an item of plant for 120,000. This plant has an expected useful life of four years with a zero residual value. The company depreciates on a straight-line basis. The tax authorities allow a three- year amortisation period. The tax rate is 30%. Recovery of an asset: the underlying principle behind the recovery of an asset is that: its carrying amount will be recovered in the form of future benefits that flow into the entity {either through use (by generating income from using the asset) or through sale}. at least the carrying amount will be recovered (120,000).

  23. Taxable Temporary Differences-Example

  24. Recognizing Deferred Tax Liability Business combinations The cost of a business combination is allocated to the identifiable assets and liabilities acquired by reference to their fair values at the date of the exchange transaction. Temporary differences arise when the tax bases of the identifiable assets and liabilities acquired are not affected by the business combination or are affected differently. example. B Inc. acquires S Ltd. The cost of the plant of S Ltd is 800, and its fair value is 1,000. B Inc. recognises the asset at fair value. Carrying amount = 1,000, Tax base = 800, Taxable temporary difference = 200 Deferred tax liability (@30%) = 60 The resulting deferred tax liability affects goodwill i.e. the journal entry is: Dr Goodwill Cr Deferred tax liability

  25. Example Entity A acquires 100% controlling interest in entity B on January 1, 2006. At the date of acquisition entity B’s financial statements include PPE with carrying amount of CU100. Entity A determines fair value of PPE to be CU150 and it recognises the same at CU150 as per IFRS 3. This, however, does not impact tax base of the PPE and same continues to be CU100. Entity A recognises an intangible asset of CU200 as part of PPA exercise; however, amortisation of the same is not allowed for tax purposes. Entity A recognises an impairment loss of CU50 on investment made by B in unquoted equity shares worth CU500; however, this does not change the tax base thereof. For tax purposes, original cost of shares would be allowed as deduction upon sale of the respective investment. Applicable tax rate is 30%. What would be the deferred tax implications of the above adjustments made as per IFRS 3?

  26. Example – response Recognition of the above DTL would affect the amount of goodwill to be determined as per IFRS 3

  27. Recognizing Deferred Tax Liability Assets carried at fair value IFRS permit certain assets to be carried at fair value or to be revalued. For example refer to: • IAS 16: Property, Plant and Equipment • IAS 38: Intangible Assets • IAS 39: Financial Instruments: Recognition and Measurement • IAS 40: Investment Property • IAS 41: Agriculture If the tax authorities recognise the revaluation or fair value adjustment for tax purposes (i.e. adjust the tax base), there will be no difference between the carrying amount and tax base, and hence no temporary difference.

  28. Recognizing Deferred Tax Liability Certain assets may be carried at fair value, or may be revalued at amounts lower than the amount attributed to them for tax purposes Example: Plant with a tax base and previous carrying amount of 55,000 was impaired to its recoverable amount of 35,000. Carrying amount of asset = 35,000 Tax base = 55,000 Deductible temporary difference = 20,000 (55,000 - 35,000) Deferred tax asset (@30%) = 6,000 (20,000 x 30%)

  29. Recognizing Deferred Tax Liability Initial recognition of an asset or liability A temporary difference may arise on initial recognition of an asset or liability. The method of accounting for this temporary difference depends on the nature of the transaction which led to the initial recognition: (a) in a business combination - affects the amount of goodwill (b) if the transaction affects either accounting profit or taxable profit -resulting deferred tax expense or income in the statement of comprehensive income. IAS 12 does not permit an entity to recognise a deferred tax liability or asset arising on initial recognition of an asset or liability acquired other than in a business combination, where the transaction affects neither accounting profit nor taxable profit (loss).

  30. Initial recognition of an asset or liability-Example A non-taxable government grant (200) related to a harvester (600) was given to H Farms Ltd. For tax purposes, the grant is not taxable. The tax rate is 35%. Deferred tax calculation: Carrying amount of harvester = 400 (600 less 200 grant that was offset against cost of the asset according to one of the alternatives under IAS 20) Tax base = 600, Deductible temporary difference = 200 However the entity does not recognise the resulting deferred tax asset, because the initial recognition of an asset or liability in a transaction was not a business combination, and at the time of the transaction, affected neither accounting profit nor taxable profit. As the temporary difference in the above case is somewhat permanent”, we can identify that the IAS 12 exemption on initial recognition applies. Government grants may also be recognized as deferred income under the other alternative in IAS 20, in which case the difference between the deferred income and its tax base of nil is a deductible temporary difference.

  31. Recognizing Deferred Tax Liability Financial Instruments In accordance with IAS 32: Financial Instruments: Presentation, the issuer of a compound financial instrument classifies the instrument in two parts: • the liability component as a liability, and • the equity component as equity. In some jurisdictions, the tax base of the liability component on initial recognition is equal to the initial carrying amount of the sum of the liability and equity components. The resulting taxable temporary difference arises from the initial recognition of the equity component separately from the liability component (and not the initial recognition of an asset or liability). Therefore the exemption does not apply and any resulting deferred tax liability should be recognised. The deferred tax is charged directly to the carrying amount of the equity component. Subsequent changes in the deferred tax liability are recognised in the statement of comprehensive income as deferred tax expense (or income).

  32. Recognizing Deferred Tax Liability Goodwill Many taxation authorities do not allow the amortisation of goodwill as a deductible expense in determining taxable profit or the cost of goodwill to be deducted when a subsidiary disposes of its underlying business. These tax rules lead to taxable temporary differences. However, IAS 12 does not permit the recognition of the resulting deferred tax liability because goodwill is a residual and the recognition of the deferred tax liability would increase the carrying amount of goodwill. Note further: a) 12.21A - Subsequent reductions in deferred tax liability that is unrecognised because it arises from the initial recognition of goodwill are also not recognised (this is in line with the treatment of initial recognition). b) 12.21B - Deferred tax liabilities for taxable temporary differences relating to goodwill are however recognised to the extent that they do not arise from the initial recognition of goodwill (eg. tax laws allow write-off of the balance).

  33. Recognizing Deferred Tax Liability

  34. Recognizing Deferred Tax Assets Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: • deductible temporary differences • the carry forward of unused tax losses, and • the carry forward of unused tax credits Deferred tax asset = (deductible temporary difference and carry forward of unused tax losses) x tax rate and unused tax credits

  35. On 1 January 2006, Osiris Ltd purchases an item of plant for 120,000. This plant has an expected useful life of four years with a zero residual value. The company depreciates on a straight-line basis. The tax authorities allow a five year amortisation period. The tax rate is 30%. Where the carrying amount is less than the tax base, the amounts available for offset against accounting profit are less than amounts to be offset against taxable profit. Therefore, in the future there will be less tax payable (as tax authorities owe a future deduction equal to what has been deducted for accounting purposes) than what one would normally project from the carrying amount of the asset. This tax benefit in the future (deductible temporary difference) needs to be recognised as an asset (i.e. a deferred tax asset), provided that it is probable that the entity will have sufficient taxable profit against which the deductible temporary difference can be utilised. Deductible Temporary Differences-Example

  36. Deductible Temporary Differences-Example

  37. Deferred Tax Assets Arising From Unused Losses In relation to deferred tax assets arising from unused losses, the standard says that the existence of unused losses is strong evidence that profits might not be available. It requires four criteria to be considered before a deferred tax asset can be recognized in respect of unused losses or credits. • Whether the company has enough taxable temporary differences relating to the same tax authority and the same taxable entity, to create taxable amounts against which the losses or credits can be used before they expire. • Whether it is otherwise probable that the entity will have taxable profits in that period. • Whether the unused tax losses result from identifiable causes that are unlikely to recur. • Are tax-planning opportunities available to allow taxable profits to be created in the period in which the losses or credits can be used?

  38. Review of Deferred Tax Assets and Liabilities The determination of whether there is likely to be enough future taxable profit is not a one-off exercise, made only at the time of initially recognizing the asset. The availability of future taxable profits must be reassessed at each balance sheet date, and the amount of deferred tax assets must be adjusted, if necessary. Such an adjustment can be either up or down, if conditions have improved or deteriorated since the last assessment.

  39. Review of Deferred Tax Assets and Liabilities Deferred Tax Assets: • The recoverability of the deferred tax asset is reviewed at each balance sheet date. • The carrying amount should be reduced to the extent that it is no longer probable that enough taxable profit will be available to allow the asset to be recovered. • Any such reduction should be reversed to the extent that it once again becomes probable that enough taxable profit will exist. Deferred Tax Liabilities: For deferred tax liabilities and compound financial instruments, IAS 32 Financial Instruments: Presentation requires a compound instrument to be split between debt and equity components. In those jurisdictions, where the tax base of the liability components on initial recognition is equal to the carrying amount of the sum of the liability and equity components, the resulting deferred tax liability is charged directly to the carrying amount of the equity component.

  40. Investments in Other Entities IAS 12 has special rules for the recognition of deferred tax on temporary differences that are associated with investments in certain entities. These special rules apply to investments in subsidiaries, branches, associates and joint ventures. Temporary differences arise when the carrying amount of investments in subsidiaries, branches and associates or interests in joint ventures becomes different from the tax base (which is often cost) of the investment or interest. Such differences may arise in different circumstances like • the existence of undistributed profits of subsidiaries, branches and associates or joint ventures • changes in foreign exchange rates when a parent and its subsidiary are based in different countries having different currencies • a reduction in the carrying amount of an investment in an associate to its recoverable amount (due to impairment).

  41. Investments in Other Entities The special rules specify that an entity shall recognize 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. An entity shall recognize 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, 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 utilized.

  42. Measuring Deferred Tax Deferred tax is measured at the tax rates that are expected to apply in the period when the deferred tax asset is realized or the liability is settled. The tax must be based on tax rates and laws that have been enacted, or substantively enacted, by the balance sheet date, and it should be based on how the entity expects to recover or settle the asset or liability. It cannot be discounted. The requirement that tax rates and laws have been substantively enacted by the balance sheet date accommodates those jurisdictions in which a government announcement is made some time before actual enactment and is substantively the same as enactment. These rules also apply to the measurement of current tax.

  43. Measuring Deferred Tax Sometimes the manner of recovering an asset (for example, by use or sale) affects its tax base or the rates of tax applying to it. In such cases, the calculation of deferred tax is based on how the entity expects (at the balance sheet date) to recover the asset or settle the liability. SIC-21 clarifies that where a non depreciable asset is revalued, any deferred tax on the revaluation should be calculated by reference to the tax consequences that would arise if the asset were sold at book value, on the basis that the absence of any depreciation charge implies that the asset will not be recovered through use.

  44. Example - The manner of recovery B Ltd has a building that has been revalued by 150,000 in the prior year. Original cost = 350,000 Current fair value = 450,000 Carrying amount = 450,000 Tax base = 300,000 Taxable temporary difference = 150,000 The normal tax rate is 30%, and 50% of capital gains are taxable at 30%, with the remaining 50% being taxed at 0%. Deferred tax calculation - intention to recover through use: Deferred tax liability (150,000 x 30%) = 45,000 Deferred tax calculation - intention to sell: Capital gain = 150,000 (450,000 – 300,000) Deferred tax liability = 22,500 (150,000 x 50% x 30%)

  45. Measurement – SIC 21 example A Company acquired a plot of land at a cost of C1,000,000 on 1 January 20X1 when the tax indexed cost was also C1,000,000. Tax rates Income other than capital gains – 30% Capital gains (Proceeds in excess of indexed cost) – 10% Price index for calculating indexation allowances increases by 2% and 2.5% in 20X1 and 20X2

  46. Measurement – SIC 21 example (cont’d.) During 20X1 and X2, Land is carried at cost. Tax base is indexed cost hence there is a temporary difference of Rs. 20,000 & 45,000 respectively A DTA of Rs 2,000 & Rs. 4,500 will be recognized in these year taking the tax rate @ 10% assuming that the carrying amount of land can be recovered by way of sale Normal tax rate of 30% can not be applied as the carrying amount of the land can not be recovered through its use as it is non depreciable

  47. Measuring Deferred Tax In some jurisdictions, the amount of tax payable on profits changes according to whether it is distributed as a dividend. IAS 12 requires current and deferred tax to be provided at the rate attributable to undistributed profits. The tax consequences of paying a dividend are recognized only when a liability to pay the dividend is recognized, and these consequences are also recognized in the income statement.

  48. Recognizing Tax Income and Expense Rules The normal treatment of tax income and expense is to include it in the income statement. This treatment includes any remeasurement of deferred tax subsequent to its initial recognition; for example, because of a change in tax rates or law, or a change in the expected manner of recovering an asset. It also includes any change in tax assets or liabilities resulting from a change in the tax status of the entity. There are two exceptions to this normal treatment of the income tax and expense rules.

  49. Recognizing Tax Income and Expense Rules Exception 1 – Direct Equity Exception Any current or deferred tax on items recognized directly in equity is itself taken directly to equity. Such items include revaluations of property, changes in fair value of an available for sale financial asset, accounting changes, prior-year adjustments, and exchange differences arising from translating the accounts of a foreign entity. Also, when dividends are paid subject to withholding tax, the tax should be included as part of the dividend charged to equity. Determining how much tax relates to items recognized in equity is sometimes difficult. In these cases, a reasonable pro-rata method, or another method that achieves a more appropriate allocation, can be used.

  50. Recognizing Tax Income and Expense Rules Exception 2 – Fair Value Allocation Exception Temporary differences created as a result of the fair value allocation following an acquisition. Here the deferred tax is part of that allocation, and the other side of the entry is goodwill, not any amount of income or expense. Paragraph 67 of IAS 12 notes that if an acquirer, as a result of a business combination, considers it probable to recover its own deferred tax asset that was not recognized before the business combination, then the acquirer should recognize such asset but does not include it as part of the accounting for the combination.

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