Ias 12
Ias 12
Ias 12
Objective of IAS 12: The objective of IAS 12 is to prescribe the accounting treatment for income taxes. In
meeting this objective, IAS 12 notes the following:
• It is inherent in the recognition of an asset or liability that that asset or liability will be recovered or
settled, and this recovery or settlement may give rise to future tax consequences which should be
recognised at the same time as the asset or liability
• An entity should account for the tax consequences of transactions and other events in the same way it
accounts for the transactions or other events themselves.
In financial reporting, the financial statements need to reflect the effects of taxation on a company.
Guidance is provided by the fundamental accounting concepts of accruals and prudence. Tax rules
determine the cash flows; these must be matched to the revenues which gave rise to the tax and tax
liabilities must be recognised as they are incurred, not merely when they are paid. The consistency must
be applied in the presentation of income and expenditure.
Current tax
Deferred tax
Key definitions
Accounting profit Profit or loss for a period before deducting tax expense.
Taxable profit (tax loss) The profit (loss) for a period, determined in accordance with the
rules established by the taxation authorities, on which income
taxes are payable (recoverable).
Tax expense (tax income) The aggregate amount included in the determination of profit or
loss for the period in respect of current tax and deferred tax.
Taxable temporary differences 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.
Deductible temporary differences 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.
Deferred tax liabilities The amounts of income taxes payable in future periods in
respect of taxable temporary differences.
Deferred tax assets The amounts of income taxes recoverable in future periods in
respect of:
1. deductible temporary differences
2. the carryforward of unused tax losses, and
3. the carryforward of unused tax credits
1. Basic principles of tax
Taxation: Taxation is a major expense for business entities. IAS 12 Income Taxes notes that there are
two elements to tax that an entity must deal with:
• Current tax – the amount payable to the tax authorities in relation to the trading activities of the
current period.
• Deferred tax – an accounting measure used to match the tax effects of transactions with their
accounting treatment. It is not a tax that is levied by the government that needs to be paid, but simply
an application of the accruals concept.
2. Current tax
Accounting for current tax: Current tax is the amount expected to be paid to the tax authorities by
applying the tax laws and tax rates in place at the reporting date. Current tax is recognised in the
financial statements by posting the following entry:
Amount of income tax to recognise: The following formula summarises the amount of tax to be
recognised in an accounting period:
Tax to recognise for the period = Current tax for the period + Movement in deferred tax balances for the
period
The income tax charged in the statement of comprehensive income is an estimate. Any over/under
provisions are cleared in the following period's statement of comprehensive income and do not give rise
to a prior period adjustment.
Current tax expense and income: IAS 12 contains the following requirements relating to current tax.
• Unpaid tax for current and prior periods should be recognised as a liability. Overpaid current tax is
recognised as an asset. The benefit of a tax loss which can be carried back to recover current tax of a
prior period is recognised as an asset.
• Current tax should be accounted for in profit or loss unless the tax relates to an item that has been
accounted for in equity.
• If the item was disclosed as an item of other comprehensive income and accounted for in equity, then
the tax should be disclosed as relating to other comprehensive income and allocated to equity.
• Tax is measured at the amount expected to be paid. Tax rates used should be those that have been
enacted or substantively enacted by the reporting date.
Where to recognise income tax for the period: Current and 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:
[IAS 12.58]
transactions or events that are recognised outside of profit or loss (other comprehensive income
or equity) - in which case the related tax amount is also recognised outside of profit or loss [IAS
12.61A]
a business combination - in which case the tax amounts are recognised as identifiable assets or
liabilities at the acquisition date, and accordingly effectively taken into account in the
determination of goodwill when applying IFRS 3 Business Combinations. [IAS 12.66]
Example: An entity undertakes a capital raising and incurs incremental costs directly attributable to the
equity transaction, including regulatory fees, legal costs and stamp duties. In accordance with the
requirements of IAS 32 Financial Instruments: Presentation, the costs are accounted for as a deduction
from equity.
Assume that the costs incurred are immediately deductible for tax purposes, reducing the amount of
current tax payable for the period. When the tax benefit of the deductions is recognised, the current tax
amount associated with the costs of the equity transaction is recognised directly in equity, consistent
with the treatment of the costs themselves.
IAS 12 provides the following additional guidance on the recognition of income tax for the period:
Where it is difficult to determine the amount of current and deferred tax relating to items
recognised outside of profit or loss (e.g. where there are graduated rates or tax), the amount of
income tax recognised outside of profit or loss is determined on a reasonable pro-rata
allocation, or using another more appropriate method [IAS 12.63]
In the circumstances where the payment of dividends impacts the tax rate or results in taxable
amounts or refunds, the income tax consequences of dividends are considered to be more
directly linked to past transactions or events and so are recognised in profit or loss unless the
past transactions or events were recognised outside of profit or loss [IAS 12.52B]
The impact of business combinations on the recognition of pre-combination deferred tax assets
are not included in the determination of goodwill as part of the business combination, but are
separately recognised [IAS 12.68]
The recognition of acquired deferred tax benefits subsequent to a business combination are
treated as 'measurement period' adjustments (see IFRS 3 Business Combinations) if they qualify
for that treatment, or otherwise are recognised in profit or loss [IAS 12.68]
Tax benefits of equity settled share based payment transactions that exceed the tax effected
cumulative remuneration expense are considered to relate to an equity item and are recognised
directly in equity. [IAS 12.68C]
Accounting for Withholding Tax: Companies make payments net of tax (e.g. dividends). Income tax is
deducted at the source and paid to the tax authorities according to specified local rules. Companies
themselves are taxed on their taxable profit. If they have received interest net of a deduction, then they
will have already incurred taxation on this piece of income which will then be taxed again in the tax
computation for the year.
Therefore, they need to account for the fact that they have been taxed in order to reduce the future
liability. If a company has an income tax payable at year end, include it in payable. If a company has
income tax recoverable (i.e. the company has net income tax incurred for the year):
The need to provide for deferred tax: There are generally differences between accounting standards
(such as IFRS Standards) and the tax rules of a particular jurisdiction. This means that accounting profits
are normally different from taxable profits. Transactions which are recognised in the accounts in a
particular period may have their tax effect deferred until a later period.
-A second set following the tax rules of the jurisdiction in which the company operates.
The differences between the two sets of rules will result in different numbers in the financial statements
and in the tax computations. These differences may be viewed from the perspective of:
-The current tax charge for the period will be based on the tax authority's view of the profit, not the
accounting view. This will mean that the relationship between the accounting profit before tax and the
tax charge will be distorted. It will not be the tax rate applied to the accounting profit figure, but the tax
rate applied to a tax computation figure.
• Fines, political donations and entertainment costs would be expensed to the statement of profit or
loss but are normally disallowed by the tax authorities. Therefore, these costs are eliminated ('added
back') in the company's tax computation.
• Capital assets might be written down at different rates for tax purposes than they are in the financial
statements.
Temporary differences may mean that profits are reported in the financial statements before they are
taxable. Conversely, it might mean that tax is payable even though profits have not yet been reported in
the financial statements.
According to the accruals concept, the tax effect of a transaction should be reported in the same
accounting period as the transaction itself. Therefore, an adjustment to the tax charge may be required.
This gives rise to deferred tax.
Deferred tax only arises on temporary differences. It is not accounted for on permanent differences.
A temporary difference is the difference between the carrying amount of an asset or liability and its tax
base.
The tax base is the 'amount attributed to an asset or liability for tax purposes'.
IAS 12 takes a "balance sheet" perspective. Accounting for deferred taxation involves the recognition of
a liability (or an asset) in the statement of financial position. The difference between the liabilities at
each year end is taken to the statement of comprehensive income.
Example:
$
Deferred taxation balance at the start of the year 1,000
Transfer to the statement of comprehensive income (as a balancing figure) 500
Deferred taxation balance at the end of the year 1,500
Asset or Liability Amounts: The calculation of the balance to be included in the statement of financial
position is, in essence, very simple. It involves the comparison of the carrying values of items in the
accounts to the tax authority's view of the amount (known as the tax base of the item). The difference
generated in each case is due temporary difference.
Illustration 1 – Basic principles of deferred tax: Prudent prepares financial statements to 31 December
each year. On 1 January 20X0, the entity purchased a non-current asset for $1.6 million that had an
anticipated useful life of four years. This asset qualified for immediate tax relief of 100% of the cost of
the asset.
For the year ending 31 December 20X0, the draft accounts showed a profit before tax of $2 million. The
directors anticipate that this level of profit will be maintained for the foreseeable future.
Prudent pays tax at a rate of 30%. Apart from the differences caused by the purchase of the non-current
asset in 20X0, there are no other differences between accounting profit and taxable profit or the tax
base and carrying amount of net assets.
Required: Compute the pre, and post-tax profits for Prudent for each of the four years ending 31
December 20X0–20X3 inclusive and for the period as a whole assuming:
(a) No deferred tax: First of all, it is necessary to compute the taxable profits of Prudent for each period
and the current tax payable:
The statements of profit or loss for each period and for the four years as a whole, are given below:
In fact the decline in profits is caused by the timing of the current tax charge on them.
In 20X0, some of the accounting profit escapes tax, but the tax is only postponed until 20X1, 20X2 and
20X3, when the taxable profit is more than the accounting profit.
(b) Deferred tax is recognised: The deferred tax figures that are required in the statement of financial
position are given below:
• Tax deductions for the cost of non-current assets that have a different pattern to the write-off of the
asset in the financial statements.
• Pension liabilities that are accrued in the financial statements, but are allowed for tax only when the
contributions are made to the pension fund at a later date.
• Intra-group profits in inventory that are unrealised for consolidation purposes yet taxable in the
computation of the group entity that made the unrealised profit.
• A loss is reported in the financial statements and the related tax relief is only available by carry
forward against future taxable profits.
• Assets are revalued upwards in the financial statements, but no adjustment is made for tax purposes.
• Development costs are capitalised and amortised to profit or loss in future periods, but were deducted
for tax purposes as incurred.
• The cost of granting share options to employees is recognised in profit or loss, but no tax deduction is
obtained until the options are exercised.
Calculating temporary differences: Deferred tax is calculated by comparing the carrying amount of an
asset or liability to its tax base. The tax base is the amount attributed to the asset or liability for tax
purposes. To assist with determining the tax base, IAS 12 notes that:
The following formula can be used in the calculation of deferred taxes arising from unused tax losses or
unused tax credits:
Deferred tax asset = Unused tax loss or unused tax credits x Tax rate
When looking at the difference between the carrying amount and the tax base of an asset or liability:
• If the carrying amount exceeds the tax base, the temporary difference is said to be a taxable
temporary difference which will give rise to a deferred tax liability or debit balances in the financial
statements compared to the tax computations.
• If the tax base exceeds the carrying amount, the temporary difference is a deductible temporary
difference which will give rise to a deferred tax asset or credit balances in the financial statements
compared to the tax computations.
Example:
$
Carrying amount of asset 6,000
Tax base of the asset (5,000)
Temporary difference 1,000
Deferred tax balance required (@30%) 300
-The IAS 12 justification is that ownership of this asset will lead to income of $6,000 in the future. The
company will only have $5,000 as an expense to charge against this for tax purposes. The$1,000 that is
not covered will be taxed and should be provided for now.
-Deferred tax accounting is about accounting for items where the tax effect is deferred to a later period.
Circumstances under which temporary differences arise include:
-When income or expense is included in accounting profit in one period but included in the taxable
profit in a different period. For example:
-items which are taxed on a cash basis but which will be accounted for on an accruals basis
Example: The accounts of Fady show interest receivable of $10,000. No cash has yet been received and
interest is taxed on a cash basis. The interest receivable has a tax base of nil. Deferred tax will be
provided on the temporary difference of $10,000. Situations where the accounting depreciation does not
equal tax allowable depreciation.
Example: Fady has non-current assets at 31 December with a cost of $4,000,000. Aggregate
depreciation for accounting purposes is $750,000. For tax purposes, depreciation of $1,000,000 has
been deducted to date. The noncurrent assets have a tax base of $3,000,000. The provision for deferred
tax will be provided on the taxable temporary difference of $250,000.
-Revaluation of assets where the tax authorities do not amend the tax base when the asset is revalued.
-Unfortunately, the definition of temporary difference captures other items which should not result in
deferred taxation accounting (e.g. accruals for items which are not taxed or do not attract tax relief).
-IAS 12 therefore includes rules to exclude such items. For example, "If those economic benefits will not
be taxable, the tax base of the asset is equal to its carrying amount".
-The wording seems a little strange, but the effect is to exclude such items from the deferred taxation
calculations.
Example: Fady provided a loan of $250,000 to John. At 31 December, Bill's accounts show a loan payable
of $200,000. The repayment of the loan has no tax consequences. Therefore, the loan payable has a tax
base of $200,000. No temporary taxable difference arises.
Example: The following information relates to the Dhoondo Co as at 31 December 2015:
Payables:
Fine 10000
Interest payable 2000
Note 1: The trade receivables balance in the accounts is made up of the following amounts:
$
Balances 55,000
Doubtful debt allowance (5,000)
50,000
Further information:
(3) Allowances for doubtful debts are not deductible for tax purposes. Amounts are only deductible on
application of a court order to a specific amount.
Required: Calculate the deferred tax provision which is required at 31 December 2014 and the charge
to the profit or loss for the period.
Solution:
Payables:
Fine 10000 10000 0
Interest payable 2000 0 (2000)
Temporary Difference Deferred tax
@ 30%
Deferred tax liabilities 26,000 7,800
Deferred tax assets (7,000) (2,100)
5,700
Tax bases: The tax base of an item is crucial in determining the amount of any temporary difference,
and effectively represents the amount at which the asset or liability would be recorded in a tax-based
balance sheet. IAS 12 provides the following guidance on determining tax bases:
• Assets: The tax base of an asset is the amount that will be deductible for tax purpose against any
taxable economic benefits from recovering the carrying amount of the asset. Where recovery of an asset
will have no tax consequences, the tax base is equal to the carrying amount.
• Revenue received in advance. The tax base of the recognised liability is its carrying amount, less
revenue that will not be taxable in future periods.
• Other liabilities. 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.
• Unrecognised items. If items have a tax base but are not recognised in the statement of financial
position, the carrying amount is nil.
• Tax bases not immediately apparent. If the tax base of an item is not immediately apparent, the tax
base should effectively be determined in such as manner to ensure the future tax consequences of
recovery or settlement of the item is recognised as a deferred tax amount.
• Consolidated financial statements. In consolidated financial statements, the carrying amounts in the
consolidated financial statements are used, and the tax bases determined by reference to any
consolidated tax return (or otherwise from the tax returns of each entity in the group).
Examples: The determination of the tax base will depend on the applicable tax laws and the entity's
expectations as to recovery and settlement of its assets and liabilities. The following are some basic
examples:
Property, plant and equipment. The tax base of property, plant and equipment that is depreciable for
tax purposes that is used in the entity's operations is the unclaimed tax depreciation permitted as
deduction in future periods.
Receivables. If receiving payment of the receivable has no tax consequences, its tax base is equal to its
carrying amount.
Goodwill. If goodwill is not recognised for tax purposes, its tax base is nil (no deductions are available).
Revenue in advance. If the revenue is taxed on receipt but deferred for accounting purposes, the tax
base of the liability is equal to its carrying amount (as there are no future taxable amounts). Conversely,
if the revenue is recognised for tax purposes when the goods or services are received, the tax base will
be equal to nil.
Loans. If there are no tax consequences from repayment of the loan, the tax base of the loan is equal to
its carrying amount. If the repayment has tax consequences (e.g. taxable amounts or deductions on
repayments of foreign currency loans recognised for tax purposes at the exchange rate on the date the
loan was drawn down), the tax consequence of repayment at carrying amount is adjusted against the
carrying amount to determine the tax base (which in the case of the aforementioned foreign currency
loan would result in the tax base of the loan being determined by reference to the exchange rate on the
draw down date).
Recognition of deferred tax liabilities: The general principle in IAS 12 is that a deferred tax liability is
recognised for all taxable temporary differences. There are three exceptions to the requirement to
recognise a deferred tax liability, as follows:
• Liabilities arising from initial recognition of goodwill or goodwill, for which amortisation is not tax
deductible.
• Liabilities arising from the initial recognition of an asset/liability other than in a business combination
which, at the time of the transaction, does not affect either the accounting or the taxable profit
• Liabilities arising from temporary differences associated with investments in subsidiaries, branches,
and associates, and interests in joint arrangements, but only to the extent that the entity is able to
control the timing of the reversal of the differences and it is probable that the reversal will not occur in
the foreseeable future.
Issues
All taxable temporary differences: Temporary differences include all differences between accounting
rules and tax rules, not just those which are temporary. IAS 12 contains other provisions to correct this
anomaly and excludes items where the tax effect is not deferred, but rather, is "permanent" in nature.
Affects neither accounting profit nor taxable profit (tax loss): This rule is an application of the idea that
if an item is not taxable, it should be excluded from the calculations.
-If the revaluation of the asset is also reflected in the tax base, then no temporary difference arises.
-If the revaluation does not affect the tax base, then a temporary difference does arise and deferred tax
must be provided.
-When the cost of acquiring a business is allocated by reference to fair value of the assets and liabilities
acquired, but no equivalent adjustment has been made for tax purposes.
Example: The following information relates to Moti:
Calculate the deferred tax provision required in respect of this asset as at 31 December 2014.
Solution:
Example: An entity undertaken a business combination which results in the recognition of goodwill in
accordance with IFRS 3 Business Combinations. The goodwill is not tax depreciable or otherwise
recognised for tax purposes.
As no future tax deductions are available in respect of the goodwill, the tax base is nil. Accordingly, a
taxable temporary difference arises in respect of the entire carrying amount of the goodwill. However,
the taxable temporary difference does not result in the recognition of a deferred tax liability because of
the recognition exception for deferred tax liabilities arising from goodwill.
Recognition of deferred tax assets: A deferred tax asset is recognised for deductible temporary
differences, unused tax losses and unused tax credits to the extent that it is probable that taxable profit
will be available against which the deductible temporary differences can be utilised, unless the deferred
tax asset arises from:
• The initial recognition of an asset or liability other than in a business combination which, at the time of
the transaction, does not affect accounting profit or taxable profit.
Deferred tax assets for deductible temporary differences arising from investments in subsidiaries,
branches and associates, and interests in joint arrangements, are only recognised to the extent that it is
probable that the temporary difference will reverse in the foreseeable future and that taxable profit will
be available against which the temporary difference will be utilised.
The carrying amount of deferred tax assets are reviewed at the end of each reporting period and
reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow
the benefit of part or all of that deferred tax asset to be utilised. Any such reduction is subsequently
reversed to the extent that it becomes probable that sufficient taxable profit will be available.
A deferred tax asset is recognised for an unused tax loss carryforward or unused tax credit if, and only if,
it is considered probable that there will be sufficient future taxable profit against which the loss or credit
carryforward can be utilised.
Issues:
-Most of the comments made about deferred tax liabilities also apply to deferred tax assets.
-Major difference between the recognition of deferred tax assets and liabilities is in the use of the
phrase "to the extent that it is probable that taxable profit will be available against which the deductible
temporary difference can be utilised".
-An asset should only be recognised when the company expects to receive a benefit from its existence.
The existence of deferred tax liability (to the same jurisdiction) is strong evidence that the asset will be
recoverable.
Debt Instruments Measured at Fair Value: In August 2014 the IASB issued an ED to clarify that
unrealised losses on debt instruments measured at fair value give rise to deductible temporary
differences. The amendment to IAS 12 is proposed to deal with situations in which the value of such
instruments falls below cost but the tax base remains cost.
The ED further clarifies that recognition of a deferred tax asset should be based on the existing
principles of IAS 12 (i.e. on the availability of taxable temporary differences, future taxable profits and
tax planning opportunities).
Deferred tax is charged or credited to other comprehensive income or directly to equity if the tax relates
to items that are credited or charged, in the same or different period, to other comprehensive income
or directly to equity. Deferred tax should be debited to goodwill in respect of the difference in the fair
value and the carrying value of the subsidiaries net assets acquired. This will only relate to the year of
acquisition of the subsidiary.
Tax rates: The tax rate used is the rate that is expected to apply to the period when the asset is realised
or the liability is settled, based on tax rates that have been enacted by the end of the reporting period.
4. Losses may be carried forward for offset, one-third into each of the next three years
Required: Calculate the deferred tax provision that is required at 31 December 2014.
Temporary difference
$
Non-current assets(460,000 -320,000) 140,000
Losses (90,000)
Deferred tax liability (31% ×140,000) 43,400
Deferred tax asset
Reversal in 2015 (30,000 ×34%) (10,200)
Reversal in 2016 (30,000 ×32%) (9,600)
Reversal in 2017 (30,000 ×31%) (9,300)
Deferred tax 14,300
The tax rate used should reflect the tax consequences of the manner in which the entity expects to
recover or settle the carrying amount of its assets and liabilities.
Change in Tax Rates: Companies are required to disclose the amount of deferred taxation in the tax
expense that relates to change in the tax rates.
Required: Set out the note showing the movement on the deferred tax account showing the charge to
profit or loss and clearly identify that part of the charge that is due to an increase in the rate of
taxation.
Measurement of deferred tax: Deferred tax assets and liabilities are 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/laws that have been enacted or substantively enacted by the end of the reporting period. The
measurement reflects the entity's expectations, at the end of the reporting period, as to the manner in
which the carrying amount of its assets and liabilities will be recovered or settled.
• Where the tax rate or tax base is impacted by the manner in which the entity recovers its assets or
settles its liabilities (e.g. whether an asset is sold or used), the measurement of deferred taxes is
consistent with the way in which an asset is recovered or liability settled [IAS 12.51A]
• Where deferred taxes arise from revalued non-depreciable assets (e.g. revalued land), deferred taxes
reflect the tax consequences of selling the asset [IAS 12.51B]
• Deferred taxes arising from investment property measured at fair value under IAS 40 Investment
Property reflect the rebuttable presumption that the investment property will be recovered through sale
[IAS 12.51C-51D]
• If dividends are paid to shareholders, and this causes income taxes to be payable at a higher or lower
rate, or the entity pays additional taxes or receives a refund, deferred taxes are measured using the tax
rate applicable to undistributed profits [IAS 12.52A]
The entry to profit or loss and other comprehensive income in respect of deferred tax is the difference
between the net liability (or asset) at the beginning of the year and the net liability (or asset) at the end
of the year. It is important to note that:
• If the item giving rise to the deferred tax is dealt with in profit or loss, the related deferred tax should
also be presented in profit or loss.
• If the item giving rise to the deferred tax is dealt with in other comprehensive income, the related
deferred tax should also be recorded in other comprehensive income and held within equity.
Offsetting: IAS 12 notes that it is appropriate to offset deferred tax assets and liabilities in the statement
of financial position as long as:
• The entity has a legally enforceable right to set off current tax assets and current tax liabilities
• The deferred tax assets and liabilities relate to tax levied by the same tax authority.
5. Specific situations
Revaluations: Deferred tax should be recognised on the revaluation of property, plant and equipment
even if:
• Any tax due on the gain made on any sale of the asset can be deferred by being ‘rolled over’ against
the cost of a replacement asset.
Revaluation gains are recorded in other comprehensive income and so any deferred tax arising on the
revaluation must also be recorded in other comprehensive income.
Investment properties and deferred tax: The deferred tax calculation must take into consideration how
the asset is measured together with how the entity expects to recover its value. In some jurisdictions,
trading profits are taxed at different rates than capital gains.
IAS 12 presumes that the carrying amount of investment properties measured at fair value will be
recovered from a sales transaction, unless there is evidence to the contrary.
IAS 40 illustration: Melbourne has an investment property, which is measured using the fair value
model in accordance with IAS 40, comprising the following elements:
• Unrealised changes in the carrying value of investment property do not affect taxable profit.
• If an investment property is sold for more than cost, the reversal of accumulated tax allowances will
be included in taxable profit and taxed at the standard rate.
• The standard rate of tax is 30%, but for asset disposals in excess of cost, the tax rate is 20%, unless the
asset has been held for less than two years, when the tax rate is 25%.
Required: Calculate the deferred tax liability required if:
(a) Melbourne expects to hold the investment property for more than two years.
(b) Melbourne expects to sell the investment property within two years.
Solution: A summary of cost, fair value, and accumulated allowances claimed to date, together with tax
base and temporary difference is as follows:
(a) If Melbourne expects to hold the investment property for more than two years: The reversal of the
accumulated tax allowances claimed on the building element will be charged at the standard rate of
30%, whilst the proceeds in excess of cost will be charged at 20% as follows:
$000
Accumulated tax allowances (600 × 30%) 180
Proceeds in excess of cost (1,000 × 20%) 200
Deferred tax liability 380
(b) If Melbourne expects to sell the investment property within two years: The reversal of the
accumulated tax allowances claimed on the building element will be charged at the standard rate of
30%, whilst the proceeds in excess of cost will be charged at 25% as follows:
$000
Accumulated tax allowances (600 × 30%) 180
Proceeds in excess of cost (1,000 × 25%) 250
Deferred tax liability 430
Share option schemes: Accounting for share option schemes involves recognising an annual
remuneration expense in profit or loss throughout the vesting period. Tax relief is not normally granted
until the share options are exercised. The amount of tax relief granted is based on the intrinsic value of
the options (the difference between the market price of the shares and the exercise price of the option).
This delayed tax relief means that equity-settled share-based payment schemes give rise to a deferred
tax asset.
The following pro-forma can be used to calculate the deferred tax asset arising on an equity-settled
share-based payment scheme:
$ $
Carrying amount of share-based payment Nil
Less:
Tax base of the share-based payment* (X)
× Tax rate % X
Deferred tax asset X
* The tax base is the expected future tax relief (based on the intrinsic value of the options) that has
accrued by the reporting date.
Where the amount of the estimated future tax deduction exceeds the accumulated remuneration
expense, this indicates that the tax deduction relates partly to the remuneration expense and partly to
equity. Therefore, the deferred tax must be recognised partly in profit or loss and partly in equity.
Unused tax losses: Where an entity has unused tax losses, IAS 12 allows a deferred tax asset to be
recognised only to the extent that it is probable that future taxable profits will be available against
which the unused tax losses can be utilised.
IAS 12 advises that the deferred tax asset should only be recognised after considering:
• Whether an entity has sufficient taxable temporary differences against which the unused tax losses
can be offset.
• Whether it is probable the entity will make taxable profits before the tax losses expire.
• Whether the cause of the tax losses can be identified and whether it is likely to recur (otherwise, the
existence of unused tax losses is strong evidence that future taxable profits may not be available).
6. Business combinations and deferred tax: Accounting for a business combination, such as the
consolidation of a subsidiary, can have several deferred tax implications.
Fair value adjustments: The identifiable assets and liabilities of the acquired subsidiary are consolidated
at fair value but the tax base derives from the values in the subsidiary's individual financial statements.
A temporary difference is created, giving rise to deferred tax in the consolidated financial statements.
The deferred tax recognised on this difference is treated as part of the net assets acquired and, as a
result, impacts upon the amount of goodwill recognised on the acquisition of the subsidiary.
The goodwill itself does not give rise to deferred tax because IAS 12 specifically excludes it.
Provisions for unrealised profit: When one company within a group sells inventory to another group
company, unrealised profits remaining within the group at the reporting date must be eliminated. The
following adjustment is required in the consolidated financial statements:
Cr Inventory (SFP)
This adjustment reduces the carrying amount of inventory in the consolidated financial statements but
the tax base of the inventory remains as its cost in the individual financial statements of the purchasing
company.
This creates a deductible temporary difference, giving rise to a deferred tax asset in the consolidated
financial statements.
Note: you may find it easier to think of this adjustment in terms of profits. The unrealised profit on the
intra-group transaction is removed from the consolidated financial statements and therefore the tax
charge on this profit must also be removed.
Unremitted earnings: A temporary difference arises when the carrying amount of investments in
subsidiaries, associates or joint ventures is different from the tax base.
• The carrying amount in consolidated financial statements is the investor’s share of the net assets of
the investee, plus purchased goodwill. The tax base is usually the cost of the investment. The difference
is the unremitted earnings (i.e. undistributed profits) of the subsidiary, associate or joint venture.
• IAS 12 says that deferred tax should be recognised on this temporary differences except when:
– The investor controls the timing of the reversal of the temporary difference and
– It is probable that the profits will not be distributed in the foreseeable future.
• An investor can control the dividend policy of a subsidiary, but not always that of other types of
investment. This means that deferred tax does not arise on investments in subsidiaries, but may arise on
investments in associates and joint ventures.
Financial assets may give rise to deferred tax if they are revalued.
Presentation: The amount of tax expense (or income) related to profit or loss is required to be
presented in the statement(s) of profit or loss and other comprehensive income.
The tax effects of items included in other comprehensive income can either be shown net for each item,
or the items can be shown before tax effects with an aggregate amount of income tax for groups of
items (allocated between items that will and will not be reclassified to profit or loss in subsequent
periods).
Major components of tax expense (tax income) [IAS 12.79] Examples include:
aggregate current and deferred tax relating to items recognised directly in equity
tax relating to each component of other comprehensive income
explanation of the relationship between tax expense (income) and the tax that would be
expected by applying the current tax rate to accounting profit or loss (this can be presented as a
reconciliation of amounts of tax or a reconciliation of the rate of tax)
changes in tax rates
amounts and other details of deductible temporary differences, unused tax losses, and unused
tax credits
temporary differences associated with investments in subsidiaries, branches and associates, and
interests in joint arrangements
for each type of temporary difference and unused tax loss and credit, the amount of deferred
tax assets or liabilities recognised in the statement of financial position and the amount of
deferred tax income or expense recognised in profit or loss
tax relating to discontinued operations
tax consequences of dividends declared after the end of the reporting period
information about the impacts of business combinations on an acquirer's deferred tax assets
Recognition of deferred tax assets of an acquiree after the acquisition date.
In addition to the disclosures required by IAS 12, some disclosures relating to income taxes are required
by IAS 1 Presentation of Financial Statements, as follows:
Disclosure on the face of the statement of financial position about current tax assets, current tax
liabilities, deferred tax assets, and deferred tax liabilities [IAS 1.54(n) and (o)]
Disclosure of tax expense (tax income) in the profit or loss section of the statement of profit or
loss and other comprehensive income (or separate statement if presented). [IAS 1.82(d)]
7. Other issues
Arguments for recognising deferred tax: If a deferred tax liability is ignored, profits are inflated and the
obligation to pay an increased amount of tax in the future is also ignored. The arguments for recognising
deferred tax are summarised below.
• The accruals concept requires tax to be matched to profits as they are earned.
– Distortion of earnings per share and of the price/earnings ratio, both important indicators of an
entity’s performance
Arguments for not recognising deferred tax: Some people believe that the ‘temporary difference’
approach is conceptually wrong. The framework for the preparation and presentation of financial
statements defines a liability as an obligation to transfer economic benefits, as the result of a past event.
In practice, a liability for deferred tax is often recognised before the entity actually has an obligation to
pay the tax.
For example, suppose that an entity revalues a non-current asset and recognises a gain. It will not be
liable for tax on the gain until the asset is sold. However, IAS 12 requires that deferred tax is recognised
immediately on the revaluation gain, even if the entity has no intention of selling the asset (and realising
the gain) for several years.
As a result, the IAS 12 approach could lead to the build-up of liabilities that may only crystallise in the
distant future, if ever.