SECTION 29 DEFERRED TAX

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Raymond Phillips
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1 SECTION 29 DEFERRED TAX

2 SCOPE Section 29 covers accounting for income tax It requires the recognition of current and future tax consequences of transactions/events recognised in financial statements (s29.2)

3 OBJECTIVE Understand why deferred tax is necessary Understand what is meant by the tax base of an asset and the tax base of a liability Understand what is meant by temporary differences Measure deferred tax balances using the balance sheet approach Understand how to account for deferred tax when the revaluation model is elected for property, plant and equipment Understand the need for a tax rate reconciliation Prepare a tax rate reconciliation Present and disclose deferred tax in the financial statement of a company

4 INTRODUCTION Income tax includes both domestic and foreign taxes as a result of taxable income (s29.1) Accrual basis of accounti ng Reflect substance over form Accounting Use own rules (IFRS) to determine how to recognise income and expenses Accounting profit Differences Tax (SARS) Use own rules (Income Tax Act) to determine what tax is owed Taxable income Income: earlier of receipt or accrual Expenses: when incurred or paid According to legal form

5 THE TAX EXPENSE OF A COMPANY Tax expense is defined as the aggregate amount included in total comprehensive income and equity for the reporting period in respect of current and deferred tax. The tax expense of an entity consists of the following components: Current tax Current year Under/over provision of tax in a prior year Deferred tax Arising on temporary differences

DEFERRED TAX Theoretically: tax expense per SOCI = 28% of profit before tax but it is not due to: Permanent Non-taxable items Non-deductible items Temporary differences differences Timing differences

6 DEFERRED TAX Theoretically: tax expense per SOCI = 28% of profit before tax but it is not due to: Permanent Non-taxable items Non-deductible items Temporary differences differences Timing differences Deferred tax align taxable income with accounting profit in relation to temporary differences Tax rate recon explains what the permanent differences are that causes tax expense per SOCI 28% of profit before tax

7 DEFERRED TAX Page 4 Deferred tax balance = future tax payable or receivable on expected future transactions that have already been recognised in the financial statements (as either assets or liabilities) Deferred tax liability If assets (future inflows) > liabilities (future outflows) = expect future profit = pay tax in future Deferred tax asset If liabilities (future outflows) > assets (future inflows) = expect future loss = pay less tax in future

8 DEFERRED TAX Page 4 Probable that the recovery of the carrying amount will make future tax payments larger Deferred tax liability Probable that the settlement of the carrying amount will make future tax payments smaller Deferred tax asset

9 DEFERRED TAX Page 4 Example 1: Liability giving rise to future tax consequences Waheeda (Pty) Limited has a profit before tax of R in both 2015 and Income received in advance balance at end of 2015 was R and at end of 2016 was R0. The company tax rate remained constant at 28%. You are required to A Calculate the current tax of the company for both 2015 and year B Explain whether or not deferred tax should be recognised in C Explain whether or not we would recognise deferred tax in year 2016.

10 DEFERRED TAX Page 5 Example 1: Liability giving rise to future tax consequences Solution A Profit before tax (accounting profit) Permanent differences - - Temporary differences Less income received in advance opening balance 0 (50 000) Add income received in advance closing balance Taxable income Tax rate 28% 28% Current tax

11 DEFERRED TAX Page 5 Example 1: Liability giving rise to future tax consequences Solution B At the end of 2015, the company had a liability of R for income received in advance. This amount would not have been included in accounting profit for the year but would be seen as taxable income so the company would have paid tax on it in In the following year, the R would be included in accounting profit but as it was already taxed in the previous year it would not be taxed again thus it would be added back in the taxable income calculation. If this amount had been treated the same from the accounting perspective and the tax perspective then the company would have a tax expense of R for both years but as this is not the case the company has had to pay R in 2015 but only R in The liability balance of R at the end of 2015 has resulted in the company paying more tax in 2015 but less in Thus the company would need to record a deferred tax asset at the end of the year as the consequences of the settlement of the liability will result in less tax having to be paid in the future. C At the end of 2016 the company no longer has a liability for the income received in advance thus there will be no deferred tax.

12 TAX BASE Page 5 Deferred tax if: Tax base of asset = Is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to a company when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount (eg investment in shares).

13 TAX BASE Page 5 Example 2: Tax base of prepaid expenses On 31 December 2015, Waheeda (Pty) Limited paid R cash for stationery. The stationery was only delivered in January You are required to A Determine the carrying amount of the prepaid expenses for 2015 and B Determine the tax base of the prepaid expenses for 2015 and C Determine if the prepaid expense asset gives rise to deferred tax for 2015 and 2016.

14 TAX BASE Page 6 Solution A B C At the end of 2015 the company would recognise a prepaid expense asset of R as the stationery had been paid for but not delivered. By the end of 2016 the stationery had been delivered thus there would no longer be a prepaid expense asset. Carrying amount at end of 2015: R Carrying amount at end of 2016: R0 The prepaid expense is an asset for the company at the end of It relates to stationery of the company that will be used in the ordinary course of business to generate future income so it will give rise to future taxable income thus its tax base would be the amount that would be deductible in the future. For tax purposes, the prepaid expense is allowed as a deduction when it has been paid so it will reduce taxable income in Hence in 2016 and any years going forward there will be no further deductions thus at the end of 2015 and going forward the tax base of the prepaid asset would be R0. Tax base at end of 2015: R0 Tax base at end of 2016: R0 Deferred tax arises if at the end ofthe year the carrying amount it different from the tax base. 2015: Carrying amount was R and the tax base was R0 thus there would be deferred tax. 2016: Carrying amount was R0 and the tax base was R0 thus there would be no deferred tax.

15 TAX BASE Page 6 Example 3: Tax base of depreciable asset On 1 July 2013 Waheeda (Pty) Limited bought an machine for R Its accounting policy is to depreciate machine over 5 years using the straight line method. SARS allows a 25% pa wear and tear deduction each year not apportioned for time. The company s financial year end is 31 December. You are required to A Determine the carrying amount of the machine for 2015 and B Determine the tax base of the machine for 2015 and C Determine if the machine gives rise to deferred tax for 2015 and 2016.

16 TAX BASE Page 6 Solution A The machine is an asset for the company. Carrying amount at end of 2015: ( /5*2.5) = R Carrying amount at end of 2016: ( /5*3.5) = R B C The machine is an asset for the company at the end of 2015 and The machine will be used by the company in the ordinary course of business to generate future income so it will give rise to future taxable income thus its tax base would be the amount that would be deductible in the future. For tax purposes, SARS allows a 25% pa wear and tear deduction not apportioned for time. Thus it will allow 25% in 2013, 25% in 2014, 25% in 2015 and 25% in At the end of 2015, the future deductions would be the 25% that SARS will allow in At the end of 2016, there are no further deductions that SARS will allow in the future. Tax base at end of 2015: ( * 0.25) = R Tax base at end of 2015: ( * 0) = R0 Deferred tax arises if at the end ofthe year the carrying amount it different from the tax base. 2015: Carrying amount was R and the tax base was R thus there would be deferred tax. 2016: Carrying amount was R and the tax base was R0 thus there would be deferred tax.

17 TAX BASE Page 7 Tax base of a liability = 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. In the case of revenue that is received in advance, the tax base of the resulting liability is its carrying amount less any amount of the revenue that will not be taxable in future periods.

18 TAX BASE Page 7 Example 4: Tax base of income received in advance On 31 December 2015, Waheeda (Pty) Limited received R cash in respect of the rent income for January 2016 from a tenant. You are required to A Determine the carrying amount of the income received in advance for 2015 and B Determine the tax base of the income received in advance for 2015 and C Determine if the income received in advance liability gives rise to deferred tax for 2015 and 2016.

19 TAX BASE Page 8 Solution Example 5: Tax base of income received in A advance B C At the end of 2015 the company would recognise an income received in advance liability of R as the payment of the rent has been received in 2015 but the tenant will only occupy the space in the next year. By the end of 2016 the tenant would have occupied the space thus there would no longer be an obligation to deliver a service to the tenant or return the money. Carrying amount at end of 2015: R Carrying amount at end of 2016: R0 The income received in advance is a liability for the company at the end of In the case of revenue that is received in advance, the tax base of the resulting liability is its carrying amount less any amount of the revenue that will not be taxable in future periods. For tax purposes, the income will be taxed the earlier or receipt or accrual thus it will it taxed in 2015 even though it will only be recognised as income in As it is taxed in 2015, the R will not be taxed again in the future. Tax base at end of 2015: R R = R0 Tax base at end of 2016: R0 Deferred tax arises if at the end ofthe year the carrying amount it different from the tax base. 2015: Carrying amount was R and the tax base was R0 thus there would be deferred tax. 2016: Carrying amount was R0 and the tax base was R0 thus there would be no deferred tax.

20 TAX BASE Page 8 Example 5: Tax base of provisions On 31 December 2015, Waheeda (Pty) Limited recognised a provision of R for a future lawsuit. In January 2016, the case was decided and Waheeda had to pay R SARS only allows the deduction when the amount is paid. You are required to A Determine the carrying amount of the provision for 2015 and B Determine the tax base of the provision for 2015 and C Determine if the provision liability gives rise to deferred tax for 2015 and 2016.

21 TAX BASE Page 8 Example 5: Tax base of provisions Solution A At the end of 2015 the company would recognise a provision liability of R as the company has an obligation for an uncertain timing or amount at the end of the year for a lawsuit. By the end of 2016 the lawsuit has been resolved and the company has settled the obligation thus no longer has a liability. Carrying amount at end of 2015: R Carrying amount at end of 2016: R0 B The provision is a liability for the company at the end of 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. For tax purposes, the amount will be allowed as a deduction but only when it is paid thus the deduction will only be allowed in Tax base at end of 2015: R R = R0 Tax base at end of 2016: R0 C Deferred tax arises if at the end ofthe year the carrying amount it different from the tax base. 2015: Carrying amount was R and the tax base was R0 thus there would be deferred tax. 2016: Carrying amount was R0 and the tax base was R0 thus there would be no deferred tax.

22 TAX BASE Page 10 Tax base of assets/liabilities not recognised Tax base but no recognised asset or liability Research and development costs Accounting: recognised immediately as an expense in profit or loss Tax: SARS could allow a deduction in later periods

23 TAX BASE Page 10 Example 8: Tax base of research and development costs During 2015, Waheeda (Pty) Limited expensed R developing a computer software. SARS allows a wear and tear deduction of 25% pa not apportioned for time. You are required to A Determine the carrying amount of the research and development costs for 2015 and B Determine the tax base of the research and development costs for 2015 and C Determine if the research and development costs gives rise to deferred tax for 2015 and 2016.

24 TAX BASE Page 10 Solution A As the costs of developing the computer software are internally generated, the company would expense the entire amount in profit or loss for 2015 thus at the end of 2015 the company would not have recognised an asset. Carrying amount at end of 2015: R0 Carrying amount at end of 2016: R0 B The costs of developing the software have not been recognised as an asset but SARS is allowing the cost as a deduction over a period of 4 years. The costs relates to developing a programme that would be used by the company in the ordinary course of business to generate future income so it will give rise to future taxable income thus its tax base would be the amount that would be deductible in the future. For tax purposes, SARS will allow 25% in 2015, 25% in 2016, 25% in 2017 and 25% in Thus at end of 2015, SARS will allow a further 75% and end of 2016, SARS will allow a further 50%. Tax base at end of 2015: R25 000*0.75 = R Tax base at end of 2016: R25 000*0.5 = R C Deferred tax arises if at the end ofthe year the carrying amount it different from the tax base. 2015: Carrying amount was R0 and the tax base was R thus there would be deferred tax. 2016: Carrying amount was R0 and the tax base was R thus there would be deferred tax.

25 TEMPORARY DIFFERENCES Page 11 Difference between

26 TEMPORARY DIFFERENCE Page 11 Not all temporary differences give rise to deferred tax A deferred tax asset is only recognised if it is probable that taxable profit will be available in the future against which the deductible difference can be offset A deferred tax liability is not recognised if it arises from initial recognition of goodwill Both deferred tax assets and liabilities are not recognised if it has arisen from initial recognition of the transaction that is not a business combination and at the time of the transaction neither accounting profit or taxable profit were affected

27 TEMPORARY DIFFERENCES Page 11 Temporary differences 1. The treatment if income received in advance is different to its treatment as per IFRS for SMEs 2. The treatment by SARS of prepaid expenses is different to its treatment per IFRS for SMEs 3. The treatment by SARS of provisions is different to its treatment according to IFRS for SMEs 4. The allowance granted by SARS on depreciable assets is different to the depreciation provided by the business

28 Page 12 MEASUREMENT OF DEFERRED TAX Deferred tax assets or liabilities must be measured: using the tax rates and tax laws that have been enacted or substantively enacted by the reporting date as to reflect the way in which the company intends to recover/realise the asset or settle the liability

29 Page 12 CALCULATION OF DEFERRED TAX Use a deferred tax workings table 1. Add the column headings: Carrying amount, tax base, temporary difference and deferred tax 2. Add in the row headings: Beginning of year, movement and end of year 3. Make a note if the item you are dealing with is either an asset or liability as this impacts how you calculate the tax base and your signs 4. Capture your carrying amount and tax base information ensuring that all debits should be positive and all credits should be negative 5. Calculate the temporary differences do this by taking the tax base LESS the carrying amount 6. Multiply the temporary difference by the applicable tax rate 7. Determine if it gives rise to a deferred tax asset or deferred tax liability (if you have correctly used the table a positive amount would be asset and negative sign would be liability)

30 CALCULATION OF DEFERRED TAX Solution TD = Tax base minus carrying amount Page 14 DT = TD * tax rate Step 1: Col headings Step 2: Row headings Step 3: Asset or liability Step 4: Capture CA & TB Step 5: Calculate TD Step 6: Multiply TD by TR Step 7: DTA or DTL Prepaid expense (ASSET) Carrying amount Tax base Temporary difference Deferred tax Opening balance Movement Closing balance DTL

31 Page 25 PRESENTATION OF DEFERRED TAX Current and non-current distinction Deferred tax assets and liabilities must be disclosed in their respective non-current section in the statement of financial position. Offsetting Current assets and current liabilities, and deferred tax asset and deferred tax liabilities can be offset against each other only when: The company has a legally enforceable right to do so; and It is evident that it intends to settle on a net basis or to realise the asset and liability simultaneously without undue costs or effort.

32 DISCLOSURE OF DEFERRED TAX Page 25 Disclose separately the major components of tax expense (income) (p ): (a) current tax expense (income); (b) any adjustments recognised in the period for current tax of prior periods; (c) the amount of deferred tax expense (income) relating temporary differences; (h) the amount of tax expense (income) relating to those changes in accounting policies and errors that are included in profit or loss in accordance with Section 10 Accounting Policies, Estimates and Errors, because they cannot be accounted for retrospectively.

33 DISCLOSURE OF DEFERRED TAX Page 25 Disclose the following separately (p29.40) (a) the aggregate current and deferred tax relating to items that are recognised as items of other comprehensive income. (b) the aggregate current and deferred tax relating to items that are charged or credited directly to equity. (c) an explanation of any significant differences between the tax expense (income) and accounting profit multiplied by the applicable tax rate. For example such differences may arise from transactions such as revenue that are exempt from taxation or expenses that are not deductible in determining taxable profit (tax loss). (e) for each type of temporary difference: (i) the amount of deferred tax liabilities and deferred tax assets at the end of the reporting period; and (ii) an analysis of the change in deferred tax liabilities and deferred tax assets during the period.

34 DISCLOSURE OF DEFERRED TAX-MODEL EXAMPLE Page 26 A Waheeda (Pty) Limited Extract from statement of comprehensive income for the year ended 31 December Current + R R Profit before tax deferred tax XXX XXX Tax expense d Profit after tax XXX XXX

35 DISCLOSURE OF DEFERRED TAX Solution Waheeda (Pty) Limited Extract from the statement of financial position as at 31 December Assets Current assets Current tax asset/liability R R Page n Liabilities Current liability Current tax asset/liability n Non-current liability Deferred tax Aggregate of all deferred tax balances at year end o

36 DISCLOSURE OF DEFERRED TAX Solution Waheeda (Pty) Limited Extract from the notes to the financial statements for the year ended 31 December 2015 Note 1: Accounting policies Note 1.6 Income tax 8.5 Income tax represents the sum ofcurrent and deferred tax. Current tax Current tax for the year is based on the taxable profit for the year. Current tax is calculated using the tax rates enacted or substantively enacted at the reporting date. Deferred tax Deferred tax is recognised on differences between carrying amounts of assets and liabilities in the financial statements and the corresponding tax bases used in the computation of taxable profit. Deferred tax is accounted for using the balance sheet method. Page 26

37 DISCLOSURE OF DEFERRED TAX Solution continued Note 4: Deferred tax Prepaid 29.40e expenses Machine Total Opening balance Movement Closing balance Movement Closing balance Page 26

38 DISCLOSURE OF DEFERRED TAX Solution continued Note 4: Tax expense R R Current tax a Current period ( * 0.28) & ( * 0.28) Prior period under/(over) provision (35 000) 29.39b Deferred tax c Tax as per the statement of comprehensive income Page 26 A tax rate reconciliation will also need to be accompanied to this disclosure however this was not covered in this update

Income Taxes- Ind AS 12

Income Taxes- Ind AS 12 Agenda 1. Scope and key terms 2. Recognition and Measurement principles 3. Consolidation Outside tax basis 4. Uncertain tax positions 5. Presentation and Disclosures 6. Summary-Nine