(Part B is to be read after Part A which is published earlier)
Temporary differences
- Definition
Temporary differences are differences between carrying amount of an asset or liability in the balance sheet and its tax base. Temporary differences may be either:-
Ø Debit balance in the financial statements compared to the tax computations. These will lead to differed tax credit balances. These are known as “taxable temporary differences”.
Ø Credit balances in the financial statements compared to the tax computations. These will lead to deferred tax debit balances. These are known as “deductible temporary differences”.
- Situations where temporary differences may arise
Ø When income or expenses is included in accounting profit in one period but included in the taxable profit in a different period.
Ø Finance leases recognize din accordance with the provisions of IAS 17 but which fall to be treated as operating leases under local tax legislation.
Ø Revaluation of assets where the tax authorities do not amend tax based when the asset is revalued.
Ø The tax base of an item differs from its initial carrying amounts. For example when an entity receives a non taxable government grant relating to assets.
Ø Cost of a business combination where the net assets are recognized at their fair values but the tax authorities do not allow adjustments.
Taxable temporary differences
Ø These will normally result in deferred tax liabilities
Exclusion of non-taxable items
Ø Unfortunately the definition of temporary differences captures other items that should not result in deferred taxation accounting. For example accruals for items which are not taxed or do not attract tax relief.
Ø The standard includes provisions to exclude such items. The wording of one such provisions is as follows:
“If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.”
Ø The wording seems a little strange but the effect is to exclude such items from the deferred taxation calculations.
Recognition of deferred Tax Liabilities
The Rule
- A deferred tax liability should be recognized for all taxable temporary differences, under the deferred tax liability arises form:
- The initial recognition of goodwill; or
- Goodwill for which amortization is not deductible for tax purposes; 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 profits nor taxable profit.
Discussion
All Taxable temporary differences
Ø The standard requires recognition of a deferred tax liability for all taxable temporary differences unless they are excluded by the paragraph above.
Goodwill foe which amortization id not deductible
Ø No deferred tax is recognized if goodwill is not tax deductible. This is consistent with the requirement in IAS 12 that there is no temporary difference – nor a resulting tax liability/asset – if an item is never taxable/deductible.
Ø Deferred tax would be recognized on any temporary difference arising if goodwill is tax deductible.
Initial recognition --- not a business combination
Ø If the initial recognition is a business combination deferred tax may arise
Affects neither accounting profit nor loss
Ø No deferred tax liability would be recognized if the item will not affect profits – it is irrelevant for tax purpose, as no tax will arise on this item.
Recognition of deferred tax assets
The rule
- A deferred tax asset should be recognized for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary differences can be utilized, unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction which:
- Is not in business combination; and
- At the time of transaction, affects neither accounting profit nor taxable profit (tax loss).
- A deferred tax asset will also be recognized for the carry forward of tax losses and tax credits to the extent that it is probable that future taxable profits will be available against which those losses and credit can be used.
- The carrying amount of a deferred tax asset should be revised at each balance sheet date. The carrying value of a deferred tax asset should be reduced to the extent that it is no longer probable that sufficient taxable profit will be available to utilize the asset.
Discussion
Ø General issues
o Most of the comments made in respect of deferred tax liabilities also apply to deferred tax assets.
o Major differences between the recognition of deferred tax assets and liabilities are 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 utilized”.
o An asset should only be recognized when the entity expects to receive a benefit from its existence. The existence of deferred tax liability is strong evidence that the asset will be recoverable.
“Initial recognition of an asset or liability in a transaction that affects neither accounting nor tax profit”
Ø This is the same rule as for deferred tax liabilities.
Tax losses and credits
Ø A deferred tax asset will be recognized if the credits or losses can be used.
Measurement issues:-
- Rates;
- The tax rate should be used is the rate that is expected to apply to the period when the asset is realized or the liability is settled, based on tax rates that have been enacted by the balance sheet date.
- The tax rate used should reflect the consequences of the manner in which the entity expects to recover or settle the carrying amount of its assets and liabilities.
- Change in rates
- Companies are required to disclose the amount of deferred taxation in the tax expense that relates to change in the tax rates.
- Accounting for the movement on the deferred tax balance
- Deferred tax should be recognized as income or an expense and included in the net profit or loss for the period, except to the extent that the tax arises from;
i. A transaction or event which is recognized, in the same or a different period directly in equity; or
ii. Or a business combination that is an acquisition.
- Deferred tax should be charged or credited directly to equity if the tax relates to items that are credited to charge in the same or different period, directly to equity.
4, Presentation and disclosure
1. Deferred taxation presentation
Ø Tax assets and liabilities should be presented separately from other asset and liabilities in the balance sheet.
Ø Deferred tax asset and liabilities should be distinguished from current tax asset and liabilities.
Ø Offset asset and liabilities if – has a legal enforceable right to setoff the recognized amounts and intents either to settle on a net basis, or to realize the asset and settle the liability simultaneously.
Ø An entity should offset deferred tax asset and deferred tax liabilities if and only if;
o The entity has legal enforceable right to setoff current tax assets against current tax liabilities; and
o The deferred tax asset or deferred tax liability relate to income taxes levied by the same taxation authority on either;
§ The same taxable entity; or
§ Different taxable entities which intend rather to settle current tax liabilities and assets on a net basis, or to realize the asset and settle the liabilities simultaneously, in each future period in which significant amounts of deferred tax liabilities and assets are expected to settled or recovered.
Ø The tax expense related to (income) related to profit/loss from ordinary activities should be presented on the face of the income statement.
2. Deferred taxation—separate discloser
Ø The major components of tax expense/ income including:
o Current tax expense/income
o Adjustments in respect of prior period;
o Deferred tax expense/income;
o Deferred tax expenses/income arising due to change in tax rates;
o Due to change in policy or of a correction of fundamental error.
Ø The aggregate current and deferred tax relating to items that are charged or credited to equity.
Ø As explanation of the relationship between tax expense(income) and accounting profit in the form of a numerical reconciliation either between:
o Tax expense (income) and the product of accounting profit multiplied by the applicable tax rate & basis on which the rate is computed.
o The average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed.
Ø An explanation of changes in applicable tax rates compared to the previous accounting period.
Ø The amount (and expiry date, if any) of deductible temporary differences, unused tax losses and unused tax credits for which no deferred tax asset is recognized in the balance sheet.
Ø The aggregate amount of temporary differences associated with investments in subsidiaries, branches and associates and interest in joint ventures.
Ø For each type of temporary difference and each type of unused tax losses and unused tax credit:
o The amount of deferred tax asset and liabilities recognized in the balance sheet for each period presented;
o The amount of deferred tax income or expense recognized in the income statement, if this is not apparent form the changes in the amounts recognized in the balance sheet.
Ø Gain or loss on discontinued operations also from ordinary activities of the discontinued operations for the period. Together with the corresponding amounts for each prior period presented.
Ø An entity should disclose the amount of deferred tax asset and the nature of the evidence supporting its recognition, when:
o The utilization of deferred tax asset is dependant of future taxable profits in excess of the profits arising from the reversal of existing taxable temporary differences and
o The entity has suffered a loss in either the current or preceding period in the tax jurisdiction to which the deferred tax asset relates.