INCOME TAXES

05/01/23 1IAS 12

05/01/23 2IAS 12

Prescribe accounting treatment for income taxes Account for current and future tax consequences of:

• Transactions recognised in the current period• Future recovery of assets in the balance sheet• Future settlement of liabilities in the balance sheet

Recognise a deferred tax liability if recovery of an asset will increase future tax payments

Recognise a deferred tax asset if settlement of a liability will cause decrease future tax payments

Recognise tax effects in same way as the transaction causing the effect

• Profit of loss• Directly in equity• By adjusting goodwill

Recognise deferred tax assets from unused tax losses or credits

Presentation and disclosure of income taxes

05/01/23 3IAS 12

Income taxes• Domestic and foreign taxes based on

taxable profits• Withholding and other taxes payable by

subsidiaries on distribution to the reporting entity

• Excludes government grants and investment tax credits but includes temporary differences arising from them

05/01/23 4IAS 12

Accounting profit: profit or loss for the period before deducting tax Taxable profit: accounting profit adjusted for rules of tax regime

forming the basis on which tax is charged Tax expense: amount of current and deferred tax in profit or loss for

the period Current tax: income tax payable on taxable profit for the current

period Deferred tax liability: income tax payable in future periods on

taxable temporary differences Deferred tax asset: income tax recoverable in future periods on

• Deductible temporary differences• Unused tax losses carried forward• Unused tax credits carried forward

Temporary differences: difference between carrying amount of an asset or liability in the balance sheet and its tax base

• Taxable temporary differences: will result in taxable amounts in future periods when carrying amount of asset or liability is recovered or settled

• Deductible temporary differences: will result in tax deductible amounts in future periods when carrying amount is recovered or settled

Tax base: amount attributed to an asset or liability for tax purposes Tax expense/income: Current tax and deferred tax expense/income

05/01/23 5IAS 12

05/01/23 6IAS 12

ASSETS LIABILITIES Certain assets give rise to tax

liabilities E.g. Trade receivables

• Dr Trade receivable (asset), Cr Income (Income statement)

• Income x current tax rate = tax liability Dr Tax expense, Cr Liability

If the item is not taxed in the year of recognition, but in later years, the tax liability is deferred causing a taxable temporary difference

Temporary differences reverse when the tax liability becomes due and is recognised as a current tax expense

Certain liabilities give rise to a decrease in a tax liability, or a tax asset

E.g. Accrued expenses• Dr Expense, Cr Liability• Expense x current tax rate =

reduction in tax liability• Cr Tax expense, Dr liability

If the tax asset is not deductible in the year of recognition, but in later years, the tax asset is deferred causing a deductible temporary difference

Temporary differences reverse when the liability is reduced or a tax claim is made

05/01/23IAS 12 7

Tax base of an asset: amount that is tax deductible against taxable income at the time when the carrying amount of the asset is recovered• E.g. Tax written down value of a machine

If income at that time is not taxable, then the carrying amount =tax base (no tax liability) e.g.

Carrying amount of trade receivables as revenue already in tax computation when asset is recognised

Dividends receivable that are not taxable Loan receivable with no tax consequences on

repayment

05/01/23 8IAS 12

Tax base of a liability: carrying amount (CA) - amount deductible for tax in future periods (TDfp)

• Accrued expenses £100 Dr expense, Cr Accruals Deduct against taxable income when cash paid (future years) CA - TDfp = nil (100-100 = nil) OR Deduct against taxable income in current year CA – TDfp = 100 (100 – 0 = 100)

• Accrued Disallowed expenses: not tax deductible e.g. fines and penalties CA – TDfp = CA (CA – 0 = CA)

• Loans Repayments have no tax consequences, therefore CA – 0 = CA

Tax base of revenue in advance: carrying amount – revenue not taxable in future periods (OR any amount taxed in past and current periods)

• Interest revenue received in advance £100 Taxed when cash was received CA – taxed = nil (100 – 100 = 0)

05/01/23 9IAS 12

05/01/23IAS 12 10

Items with a tax base may not be recognised as asset or liability• E.g. research costs £100• Dr Research Costs, Cr Cash• £60 is allowed as tax deduction in future periods

(£40 disallowed)• CA – TDfp = nil – 60 = 60 • Tax base is £60• There is no carrying amount in the balance sheet• There is a temporary difference between

accounting profit and tax profit of £60• There is a permanent difference between

accounting profit and tax profit of £40

05/01/23 11IAS 12

Consolidated financial statements: Assets & liabilities in consolidated financial statements versus consolidated tax return

In jurisdictions where consolidated tax returns are not filed:• Single entity tax returns versus assets &

liabilities in each entity in the group

05/01/23IAS 12 12

05/01/23 13IAS 12

CURRENT TAX LIABILITY CURRENT TAX ASSET Unpaid charge for

current and prior periods Amount claimed for

overpaid tax for current and prior periods and recognised as tax receivable

Tax loss carried back to prior period tax profit to recover current charge of the prior period and recognised as tax receivable• Recognise in period that

loss occurs• Probable that benefit will

flow to the entity and can be reliably measured

05/01/23 14IAS 12

05/01/23 15IAS 12

DEFERRED TAX LIABILITIES DEFERRED TAX ASSETS Arise from taxable temporary differences

• Income/asset recognised already but taxed in future periods

Recognise DTL on taxable temporary differences associated with investments in subsidiaries, branches, associates and joint ventures unless

• Probable that temporary difference will not reverse in the foreseeable future AND

• Parent, investor or venturer is able to control timing of reversal of temporary difference

Exception: No deferred tax liability is recognised on taxable temporary differences arising on initial recognition of:-

• Goodwill• Assets and liabilities not part of business

combinations• Assets and liabilities that do not affect

accounting profit/loss or taxable profits/loss

Arise from deductible temporary differences if probable that taxable profit will be available

Recognise DTA on deductible temporary differences associated with investments in subsidiaries, branches, associates and joint ventures

Exception: No deferred tax asset is recognised on deductible temporary differences arising on initial recognition of assets and liabilities-:

• Not part of business combinations

• That do not affect accounting or taxable profits and losses

05/01/23 16IAS 12

05/01/23 17IAS 12

Carrying amount of an asset will be recovered in future economic benefits that flow to the entity

If carrying amount (e.g. £60) > tax base (e.g. £50), then taxable economic benefit > future tax deduction

Gives rise to taxable temporary difference (e.g. 60 – 50 = 10)

Obligation to pay future income tax creates deferred tax liability at current rate of tax (e.g. 10 x 25% = 2.5)

As carrying amount of asset is recovered, timing difference will reverse and entity will have a taxable profit

Probable that tax payments will flow from entity in future, therefore liability must be recognised except as specified by exemptions in IAS 12 slide 14

05/01/23 18IAS 12

Asset with cost of £150 is recognised in balance sheet and income tax rate (itr) is 25%

Cost – tax deductible written down allowance = tax written down value carried forward• 150 – 90 = 60• Tax base (tb) of asset = £60

Cost – accumulated depreciation = carrying amount• 150 – 50 = 100• Entity must earn taxable income of £100 to recover carrying

amount • Tax base of £60 is deductible• CA – tb = taxable temporary difference (TTD)(100 – 60 = 40)• TTD x itr = 40 x .25 = 10• A deferred tax liability of £10 is recognised representing income

taxes that will be paid when the entity recovers the carrying amount of the asset.

05/01/23IAS 12 19

Taxable temporary differences resulting in deferred tax liabilities e.g.

Income arises in current period, but is taxed in later periods Interest revenue receivable

• Spread in accounts evenly across period earned• Profit taxed when cash collected in future• Tax base of carrying amount of asset = nil

Expense arises in current period, but is deducted for tax in later period

Depreciation• Accounting deduction may differ from tax deduction• CA – tax base = temporary difference• Tax deductions > accounting depreciation = taxable TD and DT liability• Tax deductions < accounting depreciation = deductible TD and DT asset

Development costs• Capitalise and amortise over future periods• Deduct immediately for tax when incurred• Tax base nil as not deductible in future periods• Temporary difference: CA – tax base of nil

05/01/23IAS 12 20

05/01/23IAS 12 21

Year

Carrying Amount

Tax Base

Timing Difference

Tax Rate

Deferred Tax Liability

Deferred Tax Charge

1 80 75 5 .25 1.25 1.252 60 50 10 .25 2.5 1.253 40 25 15 .25 3.75 1.254 20 Nil 20 .25 5 1.255 nil nil nil .25 nil -5Asset = £100Annual depreciation = £20Tax deduction = £25Current tax rate = 25%If tax deduction accelerated (> than depreciation) recognise DT liabilityIf tax deduction decelerated (< depreciation) recognise DT asset05/01/23 22IAS 12

05/01/23IAS 12 23

Business combinations are recognised at fair value of assets & liabilities acquired

The tax base of acquired liabilities and assets is at cost, creating a temporary timing difference

Resulting deferred tax assets or liabilities recognised at acquisition date

Affects value of goodwill (FV of net assets – cost)

Exemption: Do not recognise deferred tax liabilities arising on initial recognition of goodwill

05/01/23 24IAS 12

IFRSs permit or require assets to be carried at fair value or a revalued amount

If the tax base is also adjusted, no temporary difference arises

If the tax base is not adjusted, the carrying amount less tax base = temporary difference

Gives rise to a deferred tax liability or asset• If entity does not intend to dispose of asset, revalued amounts

generates taxable income through use exceeding allowable tax deduction in future

• If income tax on capital gain is deferred to cost of purchase of similar assets, tax will become payable on sale of those assets

Examples of IFRSs permitting or requiring revaluation of assets

• IAS 16 Property, plant and equipment• IAS 38 Intangible Assets• IAS 39 Financial Instruments: Recognition and Measurement• IAS 40 Investment Property

05/01/23 25IAS 12

NOT PERMITTED ON INITIAL RECOGNITION OF GOODWILL

PERMITTED ON SUBSEQUENT TAX DEDUCTIONS

Goodwill = excess of cost over the fair value of the assets and liabilities acquired

When goodwill is not tax deductible as depreciation expense or as part of the cost of the sale of a subsidiary, the tax base is nil

The difference between the carrying amount and the tax base does not give rise to a deferred tax liability as it will increase the carrying amount of goodwill, and goodwill is measured as a residual

No deferred tax liability is permitted on initial recognition of any goodwill (including subsequent impairment loss adjustments)

Recognise liability that does not arise on initial recognition e.g. on tax deductible depreciation of 20% per annum

Year

BS£

Tax Base

DTL

1 100 80 6

2 100 60 12

3 100 40 18

4 100 20 24

5 100 0 30

Example with tax rate of 30%

05/01/23 26IAS 12

Recognise temporary difference on initial recognition of assets or liabilities as follows:• Business combination

As part of identifiable assets and liabilities acquired; asset will increase goodwill; liability will decrease goodwill

• Effect on accounting or taxable profit (e.g. depreciation) Dr Deferred tax asset, Cr Deferred tax income OR Dr Deferred tax expense, Cr Deferred tax liability

• Effect on carrying amount of asset or liability (i.e. neither of the above) Do not recognise deferred tax asset or liability and do

not adjust the carrying amount of the asset or liability On initial recognition or subsequent changes

05/01/23 27IAS 12

Carrying amount

Tax base Taxable income

Income tax

Year 1 1,000 Nil 1000 400Year 2 800 Nil 800 320Year 3 600 Nil 600 240Year 4 400 Nil 400 160Year 5 200 Nil 200 80Asset cost: £1,000Useful economic life: 5 yearsResidual value: nilIncome tax rate 40%; Capital base cost nil (Capital loss not allowed)Depreciation is not tax deductibleTo recover the carrying amount of the asset, the entity will earn taxable income in each year, resulting in income tax charges. The entity does not recognise the resulting deferred tax liability at the end of each period, because it results from the initial recognition of the asset.

05/01/23IAS 12 28

IAS 32 requires separate classification of equity and debt element e.g. convertible bonds (debt that coverts into shares at maturity)

Tax base of liability = total debt + equity Taxable temporary difference arises from initial

recognition split therefore the IAS 12 exception does not apply in this case

Deferred tax is charged directly to the carrying amount of the equity component

Recognise subsequent changes in the deferred tax liability as deferred tax income or expense

05/01/23IAS 12 29

05/01/23 30IAS 12

Carrying amount of liability will be settled in future periods

All or part of liability may be tax deductible in future periods

Carrying amount of liability - tax base = temporary difference

E.g. if tax base of an impaired asset > its carrying amount, deductible temporary difference gives rise to a deferred tax asset

2 types of deferred tax asset:• Tax recoverable in future periods (by deducting part of

liability) = deferred tax asset• If carrying amount of asset < tax base, then (CA-TB) x

income tax rate =deferred tax asset

05/01/23 31IAS 12

Carrying amount£

Tax deductible £

Tax base£

Deductible temporary difference

Deferred Tax asset£

100 100 nil 100 25Tax deductible when the entity pays claimsIncome tax rate 25%Carrying amount (CA): Dr Provision (IS), Cr Liability (BS)Tax deductible amount: CA when paid in futureTax base (TB): CA – TDfp = 100 – 100 = 0Deductible temporary difference: CA – TB = 100 – 0 = 100Deferred tax asset: DTD x income tax rate = 100 x .25 = 25

05/01/23IAS 12 32

CA of liability – tax base = temporary difference• CA – TDfp = nil• Tax base nil• Economic future

benefit of tax deduction in future

• Therefore, recognise deferred tax asset

05/01/23IAS 12 33

Research costs• Expensed when

incurred• Tax deduction in future

periods• Tax base = amount

deductible in future• Carrying amount = nil

(as paid)• TB – CA = deductible

temporary difference• Recognise deferred

tax asset

Cost of business combination• Fair value of net assets

at acquisition date• Liability recognised• Tax deductible in

future periods• Deductible temporary

difference• Deferred tax asset• OR FV of asset < tax

base• Increases goodwill

05/01/23IAS 12 34

It is probable that taxable profit will be available to utilise tax deductions when:

• Sufficient taxable profit in period when deductible temporary difference (DT asset/expense) will reverse or tax loss can be carried back or forward Ignore deferred tax assets that will reverse in future periods as they will relate

to profits in future periods• Sufficient taxable temporary differences (deferred tax liabilities/income)

will reverse In same period as reversal of deductible temporary difference (deferred tax

assets/expense) In periods when tax loss (DR) from deferred tax asset/expense (DR) can be

carried back or forward• Tax planning opportunities will create taxable profits in appropriate

future periods to use up a tax loss or tax credit Election to tax interest on received or receivable basis Defer tax deductions Sale and leaseback of appreciated assets Sale of non-taxable asset to buy asset that generates taxable income

05/01/23 35IAS 12

Balance sheet Income statement

Tax assetDebit

TaxLiability Credit

Total Tax expenseDebit

Tax incomeCredit

Total

DTA 50 50DTL 100 50 DTL 100 50 expCT charge

500 500

CT deduct

150 150

DTA reverse

50 50

DTL reverse

100 300 TL 100 300 exp05/01/23IAS 12 36

Ignore exception of recognising deferred tax asset on initial recognition when:• Government grant is deducted from carrying

amount of an asset• Government grant is not deducted from tax

base • Carrying amount < tax base = deductible

temporary difference Government grant treated as deferred

income (Dr cash Cr liability)• Deferred income has tax base of nil• No deferred tax asset recognised as not tax

deductible05/01/23 37IAS 12

Recognise deferred tax asset • for carry forward of unused tax losses and credits• when probable that future taxable profit will be available for

utilisation If history of losses, only recognise the asset if

• convincing evidence of future tax profit• Sufficient taxable temporary differences (deferred tax liabilities)

Disclose amount of deferred tax asset Disclose nature of evidence supporting its recognition Criteria to consider

• Sufficient taxable temporary differences to create tax profit in future

• Probable taxable profits before tax losses and credits expire• Likelihood of losses recurring from identifiable causes• Tax planning opportunities to create taxable profits in the future• If not probable that tax profit will be available to utilise, do not

recognise the asset

05/01/23 38IAS 12

Re-assess unrecognised deferred tax assets at each balance sheet date

Recognise if it has become probable that taxable profit will become available to recover the deferred tax asset• Improvement in trading conditions• New business combination

05/01/23 39IAS 12

Parent recognises:• cost or fair value of investment in own accounts • Share of net assets including goodwill in consolidated

accounts Temporary differences arise when amounts

above becomes different from the tax base (such as cost) e.g.• Undistributed profits in acquired entity• Changes in foreign exchange rate when foreign sub

acquired Taxable profit of foreign sub calculated in foreign currency Difference on translation to reporting currency creates DT

asset or liability that is adjusted to profit or loss Reduction of investment to its recoverable amount

05/01/23IAS 12 40

Recognise deferred tax liability for taxable temporary differences associated with investments in other entities

Exception if 2 conditions satisfied:• Investor can control timing of

reversal of temporary difference Via control of dividend policy by

parent (excludes associates unless agreement in place not to distribute profit or consent required)

• Probable that the temporary difference will not reverse in the foreseeable future Management have no plans to

distribute profits If impracticable to determine

amount of income taxes in event of distribution, recognise a minimum amount

Recognise deferred tax asset for deductible temporary differences from investments in other entities only if probable that:• Temporary differences

will reverse in foreseeable future

• Taxable profit will be available to utilise temporary difference

05/01/23IAS 12 41

05/01/23 42IAS 12

Measure deferred tax assets and liabilities at the amount expected to be paid to or recovered from tax authorities• Use tax rate enacted or substantially enacted at

the balance sheet date• Use tax rate expected to apply at time of

payment or recovery• Reflect the tax consequences from the manner in

which the amount will be paid or recovered• Do not discount deferred tax assets and liabilities• Review at each balance sheet date• Reverse DT asset to extent that taxable profit

will be available to utilise the asset

05/01/23 43IAS 12

INCOME STATEMENT EQUITY Recognise as tax income

or expense Include in profit or loss Exclude tax from

transactions in equity and business combinations

Changes may arise from• Change in tax rates/laws• Recoverability re-

assessment• Manner of recovery

If transaction recognised directly in equity, tax is recognised in equity

If difficult to determine amount, use a reasonable pro rata

Examples: • Transfer depreciation on

revaluation – depreciation on cost from revaluation surplus to retained earnings net of deferred tax

• Withholding tax charged to equity as part of dividends

05/01/23IAS 12 44

BUSINESS COMBINATION SHARE-BASED PAYMENTS• Recognise deferred tax assets or

liabilities as identifiable assets and liabilities at acquisition date

• Do not recognise deferred tax liabilities from initial recognition of goodwill

• Recognise previously unrecognised DT assets of acquirer separately from assets of business combination if profits become available as result of business combination

• If acquiree DT assets not recognised, and later realised, reduce goodwill and treat as expense to cancel out DT income Do not create or increase negative

goodwill

Amount and timing of tax deduction can differ from expense

IFRS 2 requires expense to be spread over life of share option; tax is deducted on exercise

DTA based on tax base of value of remuneration for service and carrying amount of nil (same as research cost)

Estimate amount of tax deduction at end of period if not known

Use share price at end of period If tax deduction > expense it

relates to equity and remuneration expense, therefore the excess is recognised directly in equity

05/01/23IAS 12 45

OFFSET TAX EXPENSE Current tax assets and

liabilities if:• Legally enforceable right• Settled or realised on net

basis Levied by same tax authority Permits single net payment Apply equally to groups

Deferred tax assets and liabilities if:• Legally enforceable right• Same tax authority• Settled on net basis,

simultaneously in each future period

Tax expense/income related to profit or loss from ordinary activities on the face of the income statement

Classify exchange differences on deferred foreign tax liabilities or assets as deferred tax expense/income in income statement if useful to users of FS

05/01/23IAS 12 46

Disclose major components of tax income/expense separately• Current tax• Adjustments of prior periods• Deferred tax on temporary differences• Deferred tax on changes in tax rates or laws• Write-down of deferred tax assets• Tax on changes in accounting policies and errors

because they cannot be accounted for retrospectively

• Tax losses, credits or temporary difference of prior period to reduce Current tax expense Deferred tax expense

05/01/23 47IAS 12

Current and deferred tax recognised in equity Numerical reconciliation between

• (Accounting profit x tax rate) and tax expense Exempt revenue Non-deductible expenses Tax losses Foreign tax rates

• Average effective tax rate and applicable tax rate AER = tax expense/accounting profit

• Basis of applicable tax rate Domestic tax rate of country of domicile Aggregate national and local rates Aggregate of separate reconciliations for each domestic jurisdiction of

several jurisdictions

Changes in applicable tax rates

05/01/23IAS 12 48

Unrecognised deferred tax assets of:• Deductible temporary differences• Unused tax losses & credits

Unrecognised deferred tax liabilities• Temporary differences associated with

investments (when impracticable to compute deferred tax liabilities)

• Dividends proposed & declared before FS authorised for issue

For each type of temporary difference, unused tax loss and unused tax credit• Deferred tax assets and liabilities recognised• Deferred tax income or expense

05/01/23IAS 12 49

Discontinued operations• Gain/loss on discontinuance• Profit/loss on ordinary activities of discontinued operation and

corresponding amount for prior period Potential income tax consequences from payment of

dividends• Amount practicably determinable• Factors affecting amount• Potential income tax consequences not practicably determinable• Important features of income tax system

Amount of deferred tax asset• Nature of evidence supporting recognition when

Utilisation dependent on future tax profit > reversal of taxable temporary differences

Loss suffered in current or previous period in same tax jurisdiction

05/01/23IAS 12 50

Tax-related contingent liabilities and contingent assets (IAS 37)• Unresolved disputes with tax authorities• Changes in tax rates and tax laws after the

balance sheet date• Significant effect on current and deferred

tax assets and liabilities

05/01/23IAS 12 51

IAS 12 prescribes accounting treatment of income tax

Recognise unpaid and overpaid current tax using applicable domestic tax rates

Recognise deferred tax assets and liabilities caused by a temporary difference between carrying amounts of assets and liabilities and their tax base

Tax base is the amount taxable or deductible in future periods

Some amounts with a tax base have no carrying amount in the balance sheet e.g. research costs tax deductible in future periods

05/01/23IAS 12 52

Deferred tax assets and liabilities reverse when carrying values are utilised and current tax has been charged

Measure deferred tax at amounts expected to be paid or recovered using latest available rates

Recognise deferred tax in equity, net assets of business combinations or income statement where transaction on which deferred tax is based has been recognised

Make detailed relevant disclosures and perform reconciliation of charges and rates to accounting profits

05/01/23IAS 12 53