Although we support the other proposed amendments, we have suggestions for clarifications in relation to the following proposed amendments:

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1 Ernst & Young Global Limited Becket House 1 Lambeth Palace Road London SE1 7EU Tel: +44 [0] Fax: +44 [0] International Accounting Standards Board 30 Cannon Street London EC4M 6XH 5 September 2012 Dear IASB members Invitation to comment Exposure Draft of Annual Improvements to International Financial Reporting Standards (IFRSs) Cycle The global organisation of Ernst & Young is pleased to submit its comments on the above Exposure Draft (ED). Other than the proposed amendment to IAS 12 Income Taxes, we generally support the proposed amendments. We do not support the proposed amendments to IAS 12 and we recommend these amendments are not pursued as part of the Annual Improvements process. The proposed amendments to IAS 12 have, for us, highlighted a broader more fundamental issue with IAS 12, which we believe should be addressed before we can comment on the clarifying amendments proposed in this ED. Although we support the other proposed amendments, we have suggestions for clarifications in relation to the following proposed amendments: 1. The proposed amendment to IFRS 2 Share Based Payments to clarify the definition of vesting condition is helpful, however, we believe changes to the proposed wording are necessary to make these amendments operational. 2. The proposed amendment to IAS 24 Related Party Disclosures addresses issues in the asset management sector but could create structuring opportunities for other sectors. In addition to these suggestions to clarify the proposed amendments, we encourage the Board to consider broader implications of the following two proposed amendments: 1. The proposed amendment to IAS 1 Presentation of Financial Statements intends to clarify when a liability is classified as non-current. However, we believe that part of the proposal contradicts existing principles in IAS 1 and changes the standard beyond the scope of an annual improvement. 2. While we agree with the proposed amendment to IAS 7 Statement of Cash Flows, we encourage the Board to clarify the standard s underlying principle along with the outcome of the current IFRS Interpretations Committee s discussions on IAS 7. Ernst & Young Global Limited is a company limited by guarantee registered in England and Wales. No

2 2 Our responses to specific questions in the Invitation to Comment in relation to these five proposed amendments and two other proposed amendments are in the Appendices to this letter. Other than the comments in the Appendices, we support the proposed amendments, transitional provisions and effective dates in the ED. Should you wish to discuss the contents of this letter with us, please contact Leo van der Tas at Yours faithfully

3 3 APPENDIX 1 Exposure Draft May 2012 Annual Improvements to IFRSs Cycle General Questions (applicable to all proposed amendments) 1. Do you agree with the Board s proposal to amend the IFRS as described in the exposure draft? If not, why and what alternative do you propose? 2. Do you agree with the proposed transitional provisions and effective date for the issue as described in the exposure draft? If not, why and what alternatives do you propose? IFRS 2 Share Based Payments definition of vesting condition Question 1 We agree that adding definitions for a performance condition and a service condition would help clarify IFRS 2, however we have a number of suggested wording changes below that will assist in making these changes operational. In addition, these changes do not address some of the wider issues surrounding the lack of definition for a non-vesting condition. Accordingly, we encourage the Board to consider providing further clarifications to assist users in determining what constitutes a non-vesting condition as part of their future annual improvements cycle. Within the proposed definition of a performance condition, the first criterion (paragraph a) is, in fact, the definition of a service condition. However, the definition of a service condition makes it clear that a service condition does not require a performance target to be met. As a result, some could interpret criterion (a) to require all elements of the performance condition that includes a market condition to be recognised in the grant date fair value (i.e., in accordance with paragraph 21), including an estimate of achieving the service period. We do not believe this was the Board s intention. Accordingly, we believe it should be made clear that failing to meet a required period of service would result in adjusting the number of equity instruments included in the measurement of the transaction amount (IFRS 2.19) even if that service is subsumed in the definition of a performance condition. In our view, adding a cross reference to the definition of a service condition would clarify that failing to meet a service period that is part of a performance condition results in the same accounting as if that service condition is not met. This would align with the rationale set out in BC7. To achieve this, the words (i.e., a service condition) could be added after criterion (a). BC6 emphasises that the proposed amendments clarify that in order to constitute a performance condition, any performance target needs to have an explicit or implicit service requirement for at least the period during which the performance target is being measured. However, we do not believe that the proposed changes do, in fact, make this as explicit as it could be. For clarity, we think the wording from BC6 should be carried into criterion (b) of the definition of a performance condition. This will make it explicit that the employee must be rendering service for the period that the performance target is being measured.

4 4 Paragraph (b) in the definition of performance condition begins with specified performance targets. Since each target comprises a separate performance condition perhaps the paragraph should be amended. A possible solution would be to change specified performance targets to a specific performance target to be met.... We believe that the proposed wording may result in unintended consequences for group share based payment transactions. To resolve any issues, we would recommend changing the definition of the performance condition to refer to the Group s equity instruments instead of the entity s equity instruments. We also believe that a strict reading of BC6 could suggest that the duration of the performance condition needs to be wholly within the period of the related service requirement. There may, in limited circumstances, be instances where the period of the performance condition could begin before or after the period of the service condition (e.g., the performance target is measured from 1/1/11 through 31/12/12 but the service period is from 1/1/12 through 31/12/12). Would these instances (1/1/11 through 31/12/11 in the example) also meet the definition of a performance condition? We believe that the Board s intention was to exclude these performance targets where the period of achieving the performance target exceeded the period of service. As such, we recommend that the wording in BC6 (and in the standard) should reflect this view. In order to address the above issues, a possible revision could be: Performance condition A vesting condition that requires: (a) the counterparty to complete a specified period of service (i.e., a service condition); and (b) a specificed performance targets to be met while prior to or upon completion of the counterparty s specified period of service the counterparty is rendering the service required in (a). A performance target is defined by reference to the entity s own operations (or activities) or the price (or value) of its or another entity in the same group s equity instruments (including shares and share options). A performance target might relate either to the performance of the entity as a whole or to some part of the entity, such as a division or an individual employee. BC6 The Board observed that the current IFRS 2 does not explicitly require the duration of a performance target to be achieved prior to or upon completion of wholly within the period of the related service requirement for it to constitute a performance condition. However, the Board noted that the definition of vesting conditions makes clear that a vesting condition (including a performance condition) must determine

5 5 whether the entity receives the services that entitle the counterparty to receive the share-based payment. In addition, paragraph BC171A elaborates on the definition of a vesting condition by highlighting a feature that distinguishes a performance condition from a non-vesting condition: a performance condition has an explicit or implicit service requirement and a non-vesting condition does not. Consequently, the Board proposes to make clear the length of the performance period within the definition of performance condition. This is so that, in order to constitute a performance condition, any performance target needs to have an explicit or implicit service requirement for at least to the end of the period during which the performance target is being measured. In proposed paragraph 19 vesting condition is in italics and then paragraph 63B uses vesting conditions, also in italics. These should both be vesting condition as this is the defined term proposed in the ED. Question 2 We support the proposed transition provisions and effective date.

6 6 IFRS 3 Business Combinations Accounting for contingent consideration in a business combination Question 1 We generally support the proposed amendment but we encourage the Board to clarify the consequential amendment to IFRS 9. The proposed consequential amendment to paragraph 4.2.1(e) of IFRS 9 states "...contingent consideration in a business combination (see IFRS 3 Business Combinations). Such financial liabilities shall be subsequently measured at fair value with changes in the fair value of the financial liabilities being presented in accordance with paragraphs as if they had been designated at fair value through profit or loss at initial recognition." (Emphasis added) For a contingent consideration that meets the definition of a derivative financial liability or contains an embedded derivative, the above consequential amendment, as currently drafted, would result in fair value movements that are attributable to credit risk of the contingent consideration derivative to be included in other comprehensive income (OCI) (unless this creates an accounting mismatch). Meanwhile IFRS 9 requires the entire fair value movement on derivatives (unless they qualify and are designated for hedge accounting) to be included in profit or loss. Did the Board intend to require the credit risk relating to fair value movements of a contingent consideration that is a derivative financial liability to be included in OCI, unlike all other derivatives? We believe the accounting for derivatives resulting from contingent considerations should be consistent with the accounting for other derivative financial liabilities. Therefore, a possible revision to paragraph 4.2.1(e) of IFRS 9 would be:...contingent consideration in a business combination (see IFRS 3 Business Combinations). Such financial liabilities shall be subsequently measured at fair value with changes in the fair value accounted for in accordance with IFRS 9 in accordance with paragraphs as if they had been designated at fair value through profit or loss at initial recognition. Question 2 We support the proposed transition provisions and effective date.

7 7 IFRS 13 Fair Value Measurement Short-term receivables and payables Question 1 We agree that the clarification in relation to short-term receivables and payables is helpful, particularly the clarification that there was no intention to change practice. However, we think there is merit in reinstating the last sentence of paragraph AG79 of IAS 39 Financial Instruments: Classification and Measurement, short-term receivables and payables with no stated interest rate may be measured at the original invoice amount if the effect of discounting is immaterial, into IAS 39 and IFRS 9 and not just putting it into the BC of IFRS 13. IFRS 13 defines fair value as an exit price. While, in many instances an exit price and an entry price may be the same or materially similar, it is possible that there could be differences between the fair value of receivables and payables that have no stated interest rate and the invoice amount beyond discounting (which is the only difference mentioned in IAS 39.AG79). That is, to sell a receivable, an entity would likely need to assume it was entering into a factoring arrangement. Market participants involved in a factoring arrangement are likely to consider the stated terms & conditions (including deferred payment terms) and, in addition, will likely want to be compensated for the risk that the cash flows will vary in timing or amount from those stated terms and conditions. This would make the materiality assessment difficult and burdensome. If the amendment is only added to the BC, an entity would, theoretically, need to prove that the original invoice amount is materially the same as an exit price for the asset or liability measured in accordance with IFRS 13, before they could use the original invoice amount. This is an issue for auditors and preparers primarily. Reinstating the last sentence of IAS 39.AG79 into IAS 39 and IFRS 9 could help. Question 2 We support the transitional provisions and effective date for the proposed amendment.

8 8 IAS 1 Presentation of Financial Statements Current/non-current classification of liabilities Question 1 We generally support the proposed amendment specifically that the roll over or refinancing has to be with the same lender. However, we believe the proposed amendment same or similar terms conflicts with other principles in IAS 1. It is our understanding that IAS 1 currently gives guidance on the principle of unconditional right to defer the settlement in paragraph 69(d). We interpret this to mean that an entity needs to have the intention and the discretion to defer the settlement under an existing loan facility and with the same lender, irrespective of the terms and conditions of the deferral. The notion of same or similar terms would therefore introduce a new element into the analysis that is, in our view, not consistent with the principle in paragraph 69(d). As part of Improvements to IFRSs issued in 2007 the Board amended paragraph 69(d) to state that a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification. BC38H states that a liability should be classified based on the requirement to transfer cash. In other words, the Board clarified that settlement relates to the timing of a transfer of cash. In our view the same principle should be applied in paragraph 73. Same or similar terms would not, necessarily, affect the timing of a transfer of cash. In addition, the term same lender in the proposed amendment is unclear when a loan facility is held by a consortium of lenders. We believe the term same lender should also include the same group of lenders and the proposed amendment should be amended to include this clarification. We encourage the Board to not introduce the notion of same or similar terms to paragraph 73 and clarify that the same lender includes the same consortium of lenders. The following wording is a possible solution: If an entity expects, and has the discretion, to refinance or roll over an obligation for at least twelve months after the reporting period under an existing loan facility with the same lender or group of lenders, on the same or similar terms, it classifies the obligation as non-current. We understand that the National Standard Setters group and the IFRS Interpretations Committee only identified diversity in practice when loan facilities were renegotiated at different terms and the proposed amendment is intended to resolve this diversity. In order to clarify the principle in IAS 1, as stated above, and resolve the diversity in practice, wording could be added to the BC clarifying that the presentation on the balance sheet is based on the requirement to transfer cash. The BC should also highlight that any change in terms would need to be assessed to determine whether a substantial modification of the liability has occurred in accordance with IAS 39 [paragraph 40] but that a change in terms would not necessarily lead to a reclassification from non-current to current.

9 9 If the Board retains the phrase on same or similar terms, we believe there may be unintended consequences and the Board should clarify how these situations could be resolved. The proposed amendment raises the question of what the phrase same or similar terms means. BC1 of the ED makes reference to the derecognition principles in IAS 39 and IFRS 9. These standards give guidance in assessing whether a liability is derecognised as a result of a substantial modification of its terms. When a modification is considered substantial, the derecognition of the old loan and the recognition of the new loan would have happened at or before the reporting date. As a result, the new loan would already reflect the changed terms. In our view this is different from the scenario that paragraph 73 is addressing, where by default no derecognition was required for the loan under assessment. It would only affect the classification of the old loan. The application of the derecognition test in AG62 of IAS 39 to the assessment of same or similar terms raises practice issues, as well. For many roll over or refinancing transactions, the contractual interest rate of the new loan is only set at the date of the roll over or refinancing (i.e., after the reporting date). However, the assessment of whether a loan has to be classified as current or non-current is performed at the reporting date. AG62 requires the cash flows of the new or modified loan to be discounted with the effective interest rate (EIR) of the original loan. This raises the question of how the cash flows of the rolled over loan will be determined? Ideally, this would be the forward rate derived from the current yield curve. We believe this would be burdensome for many entities as most entities do not have this information readily available. Further, entities might have an option to either roll over into a new loan having a short-term floating interest rate or to roll over into a loan with a fixed interest rate, both at the then prevailing market rate, making the assessment even more complicated. The assessment in AG62 of IAS 39 is mainly driven by the difference between the new contractual interest rate and the original EIR, and the maturity of the new instrument. The likelihood for current classification would increase if the loan is rolled over for a longer period (e.g., for 10 years instead of 1 year only). Again, we think this contradicts the principle in paragraph 69(d), which only requires a deferral of the settlement for at least 12 months. In addition, a literal reading of BC2 in the ED seems to define terms as the rights and obligations of the parties to the loan facility. However, the maturity of the rolled over loan, by definition, would be different from the original loan, as a loan due within 12 months has to be rolled over into a new loan to defer settlement for at least 12 months. Based on this definition nearly all roll overs or refinancing will have different terms and be classified as a current liability. Question 2 We support the transitional provisions and effective date for the proposed amendment.

10 10 IAS 7 Statement of Cash Flows interest paid that is capitalised Question 1 While we generally support the proposed amendment to IAS 7, we believe the Board should clarify the underlying principle in classifying cash flows instead of fixing individual issues on a piece-by-piece basis. The IFRS Interpretations Committee is currently discussing cash flow classification in a broader sense and we suggest the Board takes into consideration the outcome of these discussions when re-deliberating this proposed amendment. Question 2 We support the transitional provisions and effective date for the proposed amendment.

11 11 IAS 12 Income Taxes Recognition of deferred tax assets for unrealised losses The amendments to IAS 12 proposed in the ED intend to clarify the following three points: i) when considering whether to recognise a deferred tax asset a combined assessment of all temporary differences should be undertaken, but, where tax law restricts the offset of losses against profits only of a certain type, this assessment should only consider the offset of deductible temporary differences against future taxable profits of the appropriate type; ii) iii) taxable profit against which an entity assesses a deferred tax asset for recognition is the amount of profits before any reversal of deductible temporary differences so that the deductible temporary difference is not double counted; and an action that results only in the reversal of existing deductible temporary differences is not a tax planning opportunity as it does not create or increase taxable profit. We agree with each of these points and we also agree that adding some additional wording to IAS 12 to clarify these points would be helpful. We have not however provided detailed comments on the wording proposed in the ED because in considering our response this has highlighted a number of significant issues with the current drafting of IAS 12. We do not think that the amendments proposed in the ED deal with or clarify these issues, and we believe these issues, which relate to the fundamental principles of IAS 12, should be addressed before amendments clarifying the points above can be incorporated. Specifically, our discussions have highlighted different views about the meaning and intention of some existing requirements of IAS 12. These differences appear to be between different jurisdictions rather than between individuals in the same jurisdiction, which may indicate that national GAAP prior to the adoption of IAS 12 has resulted in IAS 12 being read in significantly different ways in different countries. In effect, these issues probably go back to at least 1996 when the current version of IAS 12 was first issued, but it is only discussion of the recent proposed amendment that has brought them to the surface. We are not seeking any change to IAS 12, nor are we expecting a definitive interpretation or clarification in respect of the differences of views. However, we would like to seek some clarification of what the Board believes it was attempting to achieve by the proposed amendment, and also to explore whether the Board is aware of the divergence in practice on the application of IAS 12. We have attached at Appendix 2 two examples, one in respect of land and one in respect of available for sale (AFS) debt securities, each of which under the current drafting of IAS 12 can logically result in two divergent views. The points of principle can be reduced to the following:

12 12 1. In assessing future taxable profits for the purposes of recognising a deferred tax asset relating to a given asset, should the entity take account of taxable profits arising directly from that specific asset? Or does such an approach conflict with the requirement of the objective of the standard to account for the tax consequences of realising an asset at its carrying amount? 2. What exactly is meant by the words in proposed paragraph 29(a)(i) of IAS 12 future taxable profit before deducting the amounts resulting from those temporary differences (emphasis added)? Is the Board's intention with the amendments contained in the ED to clarify that, where an AFS debt security has been written down but not impaired, simply holding the security to maturity does not provide a source of taxable profits to allow recognition of a deferred tax asset on the write-down? We have heard suggestions that some believe this would be the effect of the amendment. However, we have identified that the proposed amendments may have exactly the opposite effect. Those that believe the proposed amendments allow for simply holding the security to maturity as a source of taxable income believe that it is quite right to recognise a deferred tax asset. Those who take this view are further concerned that the new example proposed to be added after paragraph 29(b) of IAS 12 can be read as to presuming an assumption of recovery through sale, which they believe may not be consistent with IAS if the entity intends to hold the asset until it matures. The discussion in Issue 2, View 1, in the attached paper explains this further. We consider that the two questions outlined above should be addressed first, and given that these concern the fundamental principles of IAS 12, that this is done outside of the Annual Improvements process.

13 13 IAS 24 Related Party Disclosure key management personnel Question 1 We generally support the proposed amendment to IAS 24 as it addresses diversity that arose in the asset management sector. However, we believe the proposed amendment would have unintended consequences, especially for entities outside the asset management sector. The new definition for related parties and the new disclosure requirements in paragraphs 17A and 18A would require compensation for key management personnel (KMP) paid to a management entity to be disclosed as a single amount instead of providing more detailed information as required in paragraph 17. Payments to a management entity for managerial services could well contain compensation in the form of post-employment benefits, other long-term benefits, termination benefits and/or share-based payment, all or part of it could be variable payments linked to the performance of the entity and/or the individual KMP (i.e., a bonus). However, the proposed amendment would only require the disclosure of the total amount. We believe that a detailed disclosure of the above categories (as required by paragraph 17 for KMP compensation) would be useful information for users of the financial statements. The proposed amendment could also provide companies with structuring opportunities. This might give KMPs an incentive to set-up a management company through which their compensation is paid in order to avoid detailed disclosures on the composition of the compensation. We do not believe that this was the Board s intention. We believe the Board s proposed amendments should only apply to KMP compensation paid to a management service entity that provides similar management services to other unrelated entities. A management service entity could be defined as an entity that generates significant revenues from more than one management service agreement and that has a significant amount of its employees providing such management services. KMP compensation to other entities that do not fulfil these criteria must be disclosed as per paragraph 17. In addition to creating a structuring opportunity, the proposed amendment could have unintended consequences. The new definition of a related party would require more disclosures in certain scenarios. The new definition of KMPs would cause related party relationships to be established that would not be reciprocal, such as the example described in Scenario 1 below. In our view, related party relationships should be reciprocal. Scenario 1 An employee of Company A is a director of Company B and the employee s compensation is paid directly from B to A. As a result of the proposed amendments, A becomes a related party to B, and B would have to disclose all transactions with A. On the other hand, B does not become a related party to A.

14 14 In group structures, such as illustrated in Scenario 2 below, it is common that KMPs, often employed in a separate management company (i.e., subsidiary), are also KMPs of subsidiaries within the group. The fees for the services are usually re-charged within the group. In such a scenario, the management company would become a management entity and compensation to those KMPs of the reporting entity would be disclosed under paragraph 18A in one line item only. We believe the disclosures in paragraph 17 would be more appropriate. Scenario 2 The Chief Executive Officer (CEO) of group A (reporting entity) is employed by subsidiary B and is a director of several subsidiaries of group A. The fees for the directorships are recharged within the group. As a result, subsidiary B becomes a management entity and compensation to the CEO has to be disclosed as per paragraph 18A instead of paragraph 17. Question 2 We support the transitional provisions and effective date for the proposed amendment.

15 15 APPENDIX 2 Issue 1 Land Scenario 1 Contract for imminent sale Company A is subject to a tax rate of 10%. It holds land with a carrying value of CU2,000 and a tax basis of CU5,000 giving rise to a deductible temporary difference of CU3,000, and a potential deferred tax asset of CU300. The sale of land would result in a capital gain or loss, which could not be offset against routine trading profits or losses. The sale of land for less than its tax base can give rise to a capital tax loss. At the balance sheet date, A has a firm commitment to sell the land for CU9,000. A therefore expects a future accounting profit of CU9,000 CU2,000 = CU7,000. When preparing its tax calculation A will use the tax base of 5,000, giving to a taxable capital gain of CU9,000 CU5,000 = CU4,000, and tax payable of CU400. View 1 A deferred tax asset of CU300 should be recognised. The binding contract to sell the land gives rise to future taxable profits of CU7,000 (before deduction of the CU3,000 excess of tax base over cost representing the deductible temporary difference at the balance sheet date). This is greater than the CU3,000 deductible temporary difference and therefore the deferred tax asset should be recognised. Supporters of view 1 believe that the requirement of IAS 12 to recognise the tax consequences of the future recovery of the carrying value of the land is intended to clarify only that the amount of the temporary difference should be based on the carrying value of the land, not its future selling price. However, because the temporary difference is a deductible temporary difference, it must be assessed for recoverability before the related deferred tax asset can be recognised. Recognition of a deferred tax asset requires the entity to consider the existence of future profits of the same category as the deferred tax asset that is being evaluated. Those profits do not exclude future profits associated to the recovery of the land. If assessment of the recoverability of deferred tax assets were based on the assumption that all assets are recovered for their carrying amount, there could not be any future profit at all and therefore no deferred tax could be recognised. View 2 No deferred tax asset should be recognised. IAS 12 requires deferred tax to be measured based on the consequences of recovering an asset at its carrying amount (see IAS 12 Objective, paragraphs 16 and 51). View 1 conflicts with that objective by effectively considering the tax consequences of disposal of the land for more than its carrying amount. A deferred tax asset can be recognised only if there are

16 16 sources of appropriate taxable profit other than profits related to the asset or liability giving rise to the deferred tax asset. Scenario 2 No contract for imminent sale As in Scenario 1, Company A is subject to a tax rate of 10%. It holds land with a carrying value of CU2,000 and a tax basis of CU5,000 giving rise to a deductible temporary difference of CU3,000, and a potential deferred tax asset of CU300. The sale of land would result in a capital gain or loss, which could not be offset against routine trading profits or losses. The sale of land for less than its tax base can give rise to a capital tax loss. At the balance sheet date A does not intend to sell the land and A does not expect other future capital losses. View 1A A deferred tax asset of CU300 should be recognised. IAS 12 presumes that the carrying amount of a non depreciated asset will be realised through sale. IAS states, a deferred tax asset shall be recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised. As such, in contrast to IAS 12.44, it does not require that the temporary difference will reverse in the foreseeable future, only that an assessment is made as to whether, at the time that the temporary difference eventually reverses, future taxable profit will be available against which the deductible temporary difference can be utilised. So the question should not be, Will the difference reverse? but instead, What conditions will prevail when it does eventually reverse?. In the present case, therefore, there is no need to demonstrate that a sale is probable, only that, when a sale occurs, it is probable that there would be sufficient taxable profit against which the difference could be utilised. Such profit could include, but need not be limited to, any gain or loss associated with the disposal of the land. As the entity does not expect future capital losses, it only has to assess whether the sale of the land would create sufficient profit against which the deductible temporary difference can be utilised or that there are other assets that have appreciated in value and are not integral to the company s operations which could be sold creating income of a capital nature. If the fair value of the land is CU9,000, it could be viewed as probable, at the balance sheet date, that a sale would attract a profit of CU7,000, against which the deductible temporary difference could be utilised. Therefore, the deferred tax asset of CU300 can be recognised. View 1B No deferred tax asset should be recognised due to lack of evidence of future taxable profits. In Scenario 1 there is a binding sale contract, which provides evidence of probable future taxable profits. By contrast, the fact that fair value of the land is CU9,000 at the balance sheet date does not provide sufficient evidence that it is probable that land could be disposed of for that amount at any future date. This further presumes the company does not have

17 17 other assets that have appreciated in value that could be sold and create capital profits (or there is a lack of sufficient evidence of the probability of such a sale). In addition, because there is no contractual means to recover the value of the land, even if the company did have plans to sell the land, the company cannot consider the income from a potential sale that is not binding as a source of taxable income. View 2 No deferred tax asset should be recognised because no value of the land other than its current carrying amount should be considered. IAS 12 requires deferred tax to be measured based on the consequences of recovering an asset at its carrying amount (see IAS 12 Objective, paragraphs 16 and 51). Views 1A and 1B conflict with that objective by effectively considering the tax consequences of disposal of the land for more than its carrying amount. A deferred tax asset can be recognised only if there are sources of appropriate taxable profit.

18 18 Issue 2 Available for Sale (AFS) debt securities Company B pays tax at 20%. It has invested CU1,000 in an AFS debt security with a nominal value of CU1,000 payable on maturity in 5 years. Interest is paid annually at a rate of 2%, taxable when received. The current market rate is 5%. The fair value of the security is CU870. The shortfall against nominal value is due solely to the difference between market rate and the nominal rate on the security there is no impairment. If the security were sold for CU870, a capital loss of CU130 would be generated for tax purposes which cannot be offset against ordinary profits or losses. Interest income is classed as trading profit. Tax basis is the original cost of CU1,000. The tax law provides that any difference between contractual cash flows received (CU1,100) 1 and tax basis (CU1,000) is taxable as trading profit. The unrealised loss as well as the revaluation of the security back up to its nominal value is not taxable. However, if a similar investment were acquired today for CU870, future interest income of 230 (future cash proceeds of CU1,100 minus tax basis of CU870) would be taxable at 20%. There is a deductible temporary difference of CU1,000 CU870 = CU130 on the balance sheet date. Should a deferred tax asset of CU26 (20% at 130) be recognised? View 1 Assuming that the entity intends to hold the debt security until maturity (recovery through use assumption), a deferred tax asset should be recognised, so long as taxable profit is sufficient. Supporters of View 1 agree that a deductible temporary difference exists at the balance sheet date but question why the only means to recover that temporary difference is to have capital income. If the company can, and intends to, avoid a capital loss by holding the security, holders of View 1 question why taxable profit is limited to capital profit and does not include all taxable profit. IAS12.51 provides that the measurement of deferred tax assets and liabilities shall reflect the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities. The classification of the security as AFS does not imply that the carrying value will be recovered through sale. The provision of the tax law that any difference between contractual cash flows received (nominal value CU1,000+ interest to be received CU1,000*2%*5) and tax basis (CU1,000) is taxable as trading profit is consistent with an assumption of recovery through use. If the entity does not intend to sell the security, it must assess the recoverability of the deferred tax asset by considering whether sufficient trading profit will be available. Trading 1 Comprising nominal value CU1,000 plus interest CU100 [CU1,000 x 2% x 5 years]

19 19 profits includes all sources of profits and is not limited to profits associated with the recovery of the security giving rise to the deferred tax asset. Those that hold View 1 agree that a deductible temporary difference exists. It is the nature of the taxable income that is necessary to realise that deductible temporary difference that those that hold View 1 debate. Because the company is recovering the security through use (not sale), the capital nature of the loss can be avoided, requiring only sufficient taxable profits to recognise the deferred tax asset (just as with any other deferred tax asset). The cumulative tax computations of the entity (in respect of the investment) until the investment matures can be summarised as follows. CU Profit before tax Interest (2% x CU1,000 x 5 years) 100 Revaluation back to nominal value Adjustments Non taxable revaluation (130) Taxable profit 100 The Board states in the ED that it wishes to clarify that,when an entity considers future taxable profits when assessing whether or not to recognise a deferred tax asset, it should take into account future taxable profits before any reversal of deductible temporary differences. In the computation above, the contribution of the security to taxable profit before any reversal of deductible temporary differences is CU230. However, taxable profits should not be limited to profits from the individual security. Rather taxable profits should be expanded to all taxable profits assuming that the entity intends to recover the asset through use. Recovery through use will allow the entity to avoid a capital loss and therefore all taxable profits should be considered when assessing whether the deductible temporary difference of 130 should be recognised. Those that hold this view argue that to not account for the temporary difference is contrary to IAS 12. If the security is held for use, taxable income includes interest income (i.e., the difference between the contractual cash flows received and the tax basis) and if the security is sold taxable income includes a loss (or gain) on the sale (i.e., the difference between proceeds received from sale and tax basis). In either circumstance, a temporary difference exists if the tax basis differs from carrying value.

20 20 View 2 No deferred tax asset should be recognised. IAS provides that a deferred tax asset can be recognised only to the extent that it is probable that there will be a future taxable profit against which the deductible temporary difference can be utilised. In this context, utilised means and can only mean actually deducted from a real tax liability. This will occur only if the asset is sold and deducted from capital profit. But there is no intention to sell the asset. Therefore, supporters of View 2 argue that the deductible temporary difference will never be recovered in any real economic sense, just as the revaluation of the security back up to par will not be taxed. Since both the write down and the revaluation are, given the expected manner of recovery of the asset, effectively tax free transactions, it is therefore inappropriate to attribute a tax effect to them for accounting purposes. Those who support View 2 believe that the analysis is consistent with the objective (a) of the proposed amendment to clarify that, where the tax law distinguishes different categories of gains and losses, a deferred tax asset in a particular category can be recognised only if there is an expectation of taxable profits of the same category. Those who hold View 2 also acknowledge that objective (b) of the proposed amendment (clarification that taxable profits be assessed before reversal of deductible temporary differences) appears to support View 1. However, supporters of View 2 believe that this highlights a drafting error in the amendment, rather than the deliberate intention of the Board. They argue that the Board s intention was to avoid double counting in situations such as the following. Suppose the entity makes a provision for decontamination costs of CU100 in Year 0 which is deductible for tax purposes only when the cash is actually spent at Year 5. Suppose that profit before tax in Year 5 (all of which is taxable) is CU150. The tax computation for Year 5 would then be: CU Profit before tax 150 Adjustments Cash spent on decontamination work (100) Taxable profit 50 Supporters of View 2 believe that the proposed amendment was seeking to clarify that, in assessing future taxable profit, the correct figure is the CU150 (before the reversal of the CU100 temporary difference), not the final CU50 recorded on the tax return. This seems no different from the deduction for the accretion of the discount in the tax computation illustrating View 1 above. However, those who support View 2 believe that there is a fundamental qualitative difference which the drafting of the proposed amendment has failed to capture. The deduction for the cash spent on decontamination relates to a timing difference in other words the same cost is expensed in both the financial statements and the tax return, but in different periods. By contrast the deduction for the accretion of

21 21 the discount relates to a permanent difference in other words, the accretion of the discount appears only in the financial statements and never in the tax return. The total taxable profits over the remaining life of the AFS asset are CU100, not CU230, and would always be CU100, irrespective of the quantum of any write down of the asset. Some supporters of View 2 also believe that View 1 conflicts with the requirement of IAS 12 to measure deferred tax based on the consequences of recovering an asset at its carrying amount (see IAS 12 Objective, paragraphs 16 and 51). In their opinion, View 1 effectively considers the consequences of recovering the asset at CU1,000, not its current carrying amount of CU870.