Income Taxes (HKAS 12) 8 October 2007 Nelson Lam 林智遠 MBA MSc BBA ACA CFA CPA(Aust) CPA(US) FCCA FCPA(Practising) MSCA 2005-07 Nelson 1 Today s Agenda I. Introduction II. HKAS 12 Income Taxes A. Current Taxes B. Deferred Taxes III. HK(SIC) Interpretation 21 Income Tax Recovery of Revalued Non-Depreciable Assets IV. Further discussion 2005-07 Nelson 2 1
I. Introduction Objective of HKAS 12 The objective of IAS 12 is to prescribe the accounting treatment for income taxes. The principal issue in accounting for income taxes is how to account for the current and future tax consequences of: a) the future recovery (settlement) of the carrying amount of assets (liabilities) that are recognised in an entity's balance sheet; and b) transactions and other events of the current period that are recognised in an entity's financial statements. 2005-07 Nelson 3 I. Introduction Scope of HKAS 12 HKAS 12 shall be applied in accounting for income taxes. For the purposes of HKAS 12, income taxes include all domestic and foreign taxes which are based on taxable profits. taxes, such as withholding taxes, which are payable by a subsidiary, associate or joint venture on distributions to the reporting entity. HKAS 12 does not deal with the methods of accounting for government grants (see HKAS 20) or investment tax credits. However, HKAS 12 does deal with the accounting for temporary differences that may arise from such grants or investment tax credits. 2005-07 Nelson 4 2
I. Introduction Income taxes Deferred taxes Current taxes Deferred Tax Liabilities Deferred Tax Assets Current Tax Liabilities Current Tax Assets Tax expense (tax income) is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax. 2005-07 Nelson 5 Today s Agenda II. HKAS 12 Income Taxes A. Current Taxes B. Deferred Taxes 2005-07 Nelson 6 3
A. Current Taxes Income taxes Current taxes Current Tax Liabilities Current Tax Assets 2005-07 Nelson 7 A. Current Taxes Current Taxes is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period. Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable). 2005-07 Nelson 8 4
A. Current Tax Liabilities or Assets Current Tax Liabilities Current tax for current and prior periods shall, to the extent unpaid, be recognised as a liability. Current Tax Assets If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess shall be recognised as an asset. The benefit relating to a tax loss that can be carried back to recover current tax of a previous period shall be recognised as an asset. When a tax loss is used to recover current tax of a previous period, an entity recognises the benefit as an asset in the period in which the tax loss occurs because it is probable that the benefit will flow to the entity and the benefit can be reliably measured. 2005-07 Nelson 9 A. Current Tax Measurement Current tax liabilities (assets) for the current and prior periods shall be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been enacted or substantively enacted by the balance sheet date. 2005-07 Nelson 10 5
A. Current Tax Presentation An entity shall offset current tax assets and current tax liabilities if, and only if, the entity: a) has a legally enforceable right to set off the recognised amounts; and b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously The tax expense (income) related to profit or loss from ordinary activities shall be presented on the face of the income statement. Other disclosures (to be discussed with deferred tax) 2005-07 Nelson 11 Today s Agenda II. HKAS 12 Income Taxes A. Current Taxes B. Deferred Taxes 1. Overview of deferred taxes 2. Tax base 3. Temporary differences 4. Recognition of deferred tax assets/liabilities 5. Measurement 6. Recognition of deferred tax charge/credit 7. Presentation 8. Disclosure 2005-07 Nelson 12 6
B. Deferred Taxes Income taxes Deferred taxes Deferred Tax Liabilities Deferred Tax Assets 2005-07 Nelson 13 1. Overview of Deferred Taxes Deferred taxes Temporary difference Tax base HKAS 12 Income taxes adopts Balance sheet liability method - Largely referenced to the temporary difference between an asset or liability's carrying amount and its tax base Full provision approach - Recognised all differences, except for some limited cases 2005-07 Nelson 14 7
1. Overview of Deferred Taxes Case Deferred taxes Temporary difference Tax base Deferred taxation is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the accounts. 2004 Annual Report, HKEX 2005-07 Nelson 15 2. Tax Base Tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes HKAS 12 with reference to AASB 1020 Income Taxes of the Australian Accounting Research Foundation provides further guidance on calculating tax base Tax base 2005-07 Nelson 16 8
2. Tax Base Assets Tax base = Carrying amount - Future taxable + amount Future deductible amount Liabilities Tax base = Carrying amount - Future deductible amount Liabilities for revenue received in advance + Future taxable amount Tax base = Carrying amount - Revenue that will not be taxable in future periods 2005-07 Nelson 17 2. Tax Base Tax base The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity 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. 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 which 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. 2005-07 Nelson 18 9
2. Tax Base Calculate the tax base of the following items. A car with a cost $1,000 was acquired in 2006. For tax purposes, depreciation allowance of $400 has been already deducted. The remaining cost can be deductible in future periods. Revenue generated from the machine is taxable. Example Tax base = $600 If revaluated? Trade receivables has a carrying amount of Tax base = $1,000 $800 after an impairment loss of $200. The related revenue has already been included in taxable profits. The impairment loss of $200 has not been deducted for the tax purposes. (carrying amount $800 + future deductible amount $200) 2005-07 Nelson 19 2. Tax Base Calculate the tax base of the following items. Freehold land with a cost of $2 million is revalued to $3 million. For tax purposes, there is no depreciation. Revenue generated from the use of the freehold land is taxable. However, any gain on disposal of the land at the revalued amount will not be taxable. Example Tax base is the original cost: Carrying amount: $2 million $3 million What is it? 2005-07 Nelson 20 10
3. Temporary Difference Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax base. Temporary difference = Carrying amount - Tax base Tax base 2005-07 Nelson 21 3. Temporary Difference Temporary difference Temporary differences may be either: a) taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or b) deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. 2005-07 Nelson 22 11
3. Temporary Difference Taxable temporary difference Temporary difference Deductible temporary difference 2005-07 Nelson 23 3. Temporary Difference Temporary differences Carrying amount For Assets For Liabilities - Tax Tax base Positive Negative Positive Negative Taxable temporary difference e.g. an asset s carrying amount is higher than its tax base Deductible temporary difference e.g. an asset s carrying amount is lower than its tax base 2005-07 Nelson 24 12
3. Temporary Difference Temporary differences Carrying amount For Assets For Liabilities - Tax Tax base Positive Negative Positive Negative Balance sheet liability method Taxable temporary difference Deductible temporary difference Unused tax losses &/or credits Deferred tax liability Deferred tax asset 2005-07 Nelson 25 3. Temporary Difference Deferred tax assets or liabilities Temporary = x Tax rates differences Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: a) deductible temporary differences; b) the carryforward of unused tax losses; and c) the carryforward of unused tax credits. Balance sheet liability method Taxable temporary difference Deductible temporary difference Unused tax losses &/or credits Deferred tax liability Deferred tax asset 2005-07 Nelson 26 13
3. Temporary Difference Example Some items have a tax base but are not recognised as assets and liabilities in the balance sheet. For example, research costs of $1,000 are recognised as an expense in determining accounting profit in the period in which they are incurred may not be permitted as a deduction in determining taxable profit (tax loss) until a later period. The difference between the tax base of the research costs, being the amount the taxation authorities will permit as a deduction in future periods (i.e. $1,000), and the carrying amount of nil is a deductible temporary difference that results in a deferred tax asset. 2005-07 Nelson 27 3. Temporary Difference Where the tax base of an asset or liability is not immediately apparent, it is helpful to consider the fundamental principle upon which HKAS 12 is based: that an entity shall, with certain limited exceptions, recognise a deferred tax liability (asset) whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (smaller) than they would be if such recovery or settlement were to have no tax consequences. HKAS 12.52 Example C illustrates circumstances when it may be helpful to consider this fundamental principle, for example, when the tax base of an asset or liability depends on the expected manner of recovery or settlement. Deferred tax liability Future tax payment larger 2005-07 Nelson 28 14
3. Temporary Difference In consolidated financial statements, temporary differences are determined by comparing the carrying amounts of assets and liabilities in the consolidated financial statements with the appropriate tax base. The tax base is determined by reference to a consolidated tax return in those jurisdictions in which such a return is filed, or in other jurisdictions, the tax returns of each entity in the group. 2005-07 Nelson 29 3. Temporary Difference Deferred tax implications Example Melody Ltd. sold goods at a price $6 million to its parent, Bonnie, and made a profit of $2 million on the transaction. The inventory of these goods recorded in Bonnie s balance sheet at the year end of 31 May 2007 was $3 million. The entities file income tax return individually. Answers To the group, the carrying amount of the inventory, excluding unrealised profit, is $2 million ($3 million x 4/6) while the tax base is $3 million (the unrealised profit taxed in the seller, Melody). A deferred tax asset is resulted from a deductible temporary difference (whether to be recognised or not subject to certain limitations under HKAS 12, to be discussed later). 2005-07 Nelson 30 15
3. Temporary Difference Example Bonnie purchased an item of plant for $2,000,000 on 1 Oct. 2006. It had an estimated life of eight years and an estimated residual value of $400,000. The plant is depreciated on a straight-line basis. The tax authorities do not allow depreciation as a deductible expense. Instead a tax expense of 40% of the cost of this type of asset can be claimed against income tax in the year of purchase and 20% per annum (on a reducing balance basis) of its tax base thereafter. The rate of income tax can be taken as 25%. Calculate l the deferred d tax impact for years up to 30 Sep. 2009 2005-07 Nelson 31 3. Temporary Difference Example Answers On 1 Oct. 2006, Bonnie purchased a plant: Purchase cost $2,000,000 Estimated residual value $400,000 Estimated useful life 8 years Depreciation basis Straight-line Depreciation $1,600,000 8 years $ 200,000 The tax authority does not allow depreciation as a deductible expense but grants: Initial allowance 40% on cost $ 800,000 Annual allowance 20% p.a on tax base Income tax rate 25% 2005-07 Nelson 32 16
3. Temporary Difference Example Answers ($ 000) Carrying amount Tax base Addition 2,000 2,000 Depreciation (200) (800) 2007 year end 1,800 1,200 2005-07 Nelson 33 3. Temporary Difference Example Answers ($ 000) Carrying amount Tax base Temporary difference Deferred tax liabilities Deferred tax charge/ (credit) Addition 2,000 2,000 Depreciation (200) (800) 25% 2007 year end 1,800 1,200 600 150 150 2005-07 Nelson 34 17
3. Temporary Difference Example Answers ($ 000) Carrying amount Tax base Temporary difference Deferred tax liabilities Deferred tax charge/ (credit) Addition 2,000 2,000 Depreciation (200) (800) 2007 year end 1,800 1,200 600 150 150 Depreciation (200) (240) 2008 year end 1,600 960 640 160 10 Depreciation (200) (192) 2009 year end 1,400 768 632 158 (2) 2005-07 Nelson 35 3. Temporary Difference Example Examples of circumstances resulting in taxable temporary differences: 1. Depreciation of an asset is accelerated for tax purposes. p Taxable Deferred 2. Interest revenue is received in arrears temporary tax liability and is included in accounting profit on difference a time apportionment basis but is included in taxable profit on a cash basis. 3. Development costs have been capitalised and will be amortised to the income statement but were deducted in determining taxable profit in the period in which they were incurred. 4. Prepaid expenses have already been deducted on a cash basis in determining the taxable profit of the current or previous periods. 5. Financial assets or investment property are carried at fair value which exceeds cost but no equivalent adjustment is made for tax purposes. 6. An entity revalues property, plant and equipment (under HKAS 16) but no equivalent adjustment is made for tax purposes. 2005-07 Nelson 36 18
3. Temporary Difference Example Examples of circumstances resulting in deductible temporary differences: 1. Accumulated depreciation of an asset in the financial statements is greater than the cumulative depreciation allowed up to the balance sheet date for tax purposes. 2. The net realisable value of an item of inventory, or the recoverable amount of an item of property, plant or equipment, is less than the previous carrying amount and an entity therefore reduces the carrying amount of the asset, but that reduction is ignored for tax purposes until the asset is sold. 3. Research costs are recognised as an Deductible expense in determining accounting Deferred temporary profit but are not permitted as a tax asset difference deduction in determining taxable profit until a later period. 4. Income is deferred in the balance sheet but has already been included in taxable profit in current or prior periods. 5. Financial assets or investment property are carried at fair value which is less than cost, but no equivalent adjustment is made for tax purposes. 2005-07 Nelson 37 Today s Agenda II. HKAS 12 Income Taxes A. Current Taxes B. Deferred Taxes 1. Overview of deferred taxes 2. Tax base 3. Temporary differences 4. Recognition of deferred tax assets/liabilities 5. Measurement 6. Recognition of deferred tax charge/credit 7. Presentation 8. Disclosure 2005-07 Nelson 38 19
4. Recognition of Deferred Tax Assets / Liabilities All recognised? Taxable temporary difference Deductible temporary difference Deferred tax liability Deferred tax asset Balance sheet liability method Full provision approach Unused tax losses or credits 2005-07 Nelson 39 4. Recognition of Deferred Tax Assets / Liabilities Except for Some cases specified in HKAS 12 A deferred tax liability shall be recognised for all taxable temporary differences Taxable temporary difference Deferred tax liability 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 Deductible temporary difference Unused tax losses or credits Deferred tax asset Full provision approach 2005-07 Nelson 40 20
4. Recognition of Deferred Tax Assets / Liabilities Case 2006 Annual Report Deferred tax is recognised on temporary differences between the carrying amount of assets and liabilities in the balance sheet and the amount attributed to such assets and liabilities for tax purposes. Deferred tax liabilities are generally recognised for all taxable temporary differences and Deferred tax assets are recognised to the extent it is probable that future taxable profits will be available against which deductible temporary differences can be utilised. 2005-07 Nelson 41 4. Recognition of Deferred Tax Assets / Liabilities Except for Some cases specified in HKAS 12 A deferred tax liability shall be recognised for all taxable temporary differences Taxable temporary difference Deferred tax liability Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: a) deductible temporary differences, b) the carry-forward of unused tax losses, and c) the carry-forward of unused tax credits Full provision approach Deductible temporary difference Unused tax losses or credits Deferred tax asset 2005-07 Nelson 42 21
4. Recognition of Deferred Tax Assets / Liabilities Taxable temporary differences Some cases specified in HKAS 12 A deferred tax liability shall be recognised for all taxable temporary differences Taxable temporary difference Deferred tax liability Except to the extent that the deferred tax liability arises from: a) the initial recognition of goodwill; or Goodwill exemption b) the initial recognition of an asset or liability in a transaction which 1. is not a business combination; and 2. at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss) Initial recognition exemption 2005-07 Nelson 43 4. Recognition of Deferred Tax Assets / Liabilities Deductible temporary differences Some cases specified in HKAS 12 A deferred tax asset shall be Deductible recognised dfor temporary all deductible temporary differences difference to the extent that it is probable that taxable profit will be available against Unused tax which the deductible temporary losses or difference can be utilised credits unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction that: Deferred tax asset - the initial recognition of an asset or liability in a transaction which 1. is not a business combination; and 2. at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss) Initial recognition exemption 2005-07 Nelson 44 22
4. Recognition of Deferred Tax Assets / 4. Recognition of deferred tax assets/liabilities Liabilities Initial recognition exemption Does deferred tax arise from initial recognition of an asset or liability? Yes Is the recognition resulted from a business combination? No Does it affect either accounting profit/loss or taxable profit/loss at the time of the transaction? No Not recognise deferred tax asset/liability No Yes Yes Recognise deferred d tax (subject to other exceptions) - the initial recognition of an asset or liability in a transaction which 1. is not a business combination; and 2. at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss) 2005-07 Nelson 45 4. Recognition of Deferred Tax Assets / Liabilities Initial recognition exemption Examples in Hong Kong: Land cost of a property? Cost of demolishing of a building? Intangible assets not tax deductible e.g. purchase of trademarks? Prescribed fixed assets? - the initial recognition of an asset or liability in a transaction which 1. is not a business combination; and 2. at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss) 2005-07 Nelson 46 23
4. Recognition of Deferred Tax Assets / Liabilities Case Galaxy Entertainment Group Limited (2005 Annual Report) Deferred taxation is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. However, if the deferred tax arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss, it is not accounted for. 2005-07 Nelson 47 4. Recognition of Deferred Tax Assets / Liabilities Goodwill Some cases specified in HKAS 12 As discussed, an entity shall not recognise a deferred tax liability arising from a) the initial recognition of goodwill Business Combination Goodwill 2005-07 Nelson 48 24
4. Recognition of Deferred Tax Assets / Liabilities Goodwill The cost of a business combination is allocated by recognising the identifiable assets acquired and liabilities assumed at their fair values at the acquisition date. Temporary differences arise when the tax bases of the identifiable assets acquired and liabilities assumed are not affected by the business combination or are affected differently. Business Combination 2005-07 Nelson 49 4. Recognition of Deferred Tax Assets / Liabilities Goodwill Goodwill arising in a business combination is measured as the excess of the cost of the combination over the acquirer s interest in the net fair value of the acquiree s identifiable assets, liabilities and contingent liabilities. Deferred tax relating to goodwill arising from initial recognition of goodwill when taxation authority does not allow any movement in goodwill as a deductible expense in determining taxable profit (or when a subsidiary disposes of its underlying business), goodwill has a tax base of nil any difference between the carrying amount of goodwill and its tax base of nil is a taxable temporary difference HKAS 12 does not permit the recognition of such resulting deferred tax liability because goodwill is measured as a residual and the recognition of the deferred tax liability would increase the carrying amount of goodwill Goodwill 2005-07 Nelson 50 25
4. Recognition of Deferred Tax Assets / Liabilities Goodwill HKAS 12 does not permit the recognition of the resulting deferred tax liability because goodwill is measured as a residual and the recognition of the deferred tax liability would increase the carrying amount of goodwill Subsequent reductions in a deferred tax liability that is unrecognised because it arises from the initial recognition of goodwill are also regarded as arising from the initial recognition of goodwill and are therefore not recognised Deferred tax liabilities for taxable temporary differences relating to goodwill are, however, recognised to the extent they do not arise from the initial recognition of goodwill Goodwill 2005-07 Nelson 51 4. Recognition of Deferred Tax Assets / Liabilities Goodwill Example Deferred tax implications for the Bonnie Group of companies Bonnie Ltd. acquired Melody Ltd. on 1 January 2007 for $6 million when the fair value of the net assets was $4 million, and the tax written down value of the net assets was $3 million. According to the local tax laws for Bonnie, amortisation of goodwill is not tax deductible. Answers The Cohort group Carrying Tax amount base Goodwill $2 million - Net assets $4 million $3 million Temporary differences $2 million $1 million Provision is made for the temporary differences of net assets But NO provision is made for the temporary difference of goodwill As an entity shall not recognise a deferred tax liability arising from initial recognition of goodwill. Deferred tax liability 2005-07 Nelson 52 26
4. Recognition of Deferred Tax Assets / Liabilities Compound Financial Instruments In accordance with IAS 32 Financial Instruments: Disclosure and Presentation the issuer of a compound financial instrument (for example, a convertible bond) classifies the instrument s liability component as a liability and equity component as equity. Liability Equity To discuss more later 2005-07 Nelson 53 4. Recognition of Deferred Tax Assets / Liabilities Unused tax losses and tax credits A deferred tax asset shall be recognised for the carry-forward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised Deductible temporary difference Unused tax losses or credits Deferred tax asset To the extent that it is not probable that taxable profit will be available against which the unused tax losses or unused tax credits can be utilised, the deferred tax asset is not recognised. 2005-07 Nelson 54 27
4. Recognition of Deferred Tax Assets / Liabilities Unused tax losses and tax credits Example Examples criteria in assessing available taxable profit: a) whether there are sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity b) whether it is probable to have taxable profits before the unused tax losses or unused tax credits expire; c) Whether the unused tax losses result from identifiable causes which are unlikely to recur; and d) whether tax planning opportunities are available 2005-07 Nelson 55 4. Recognition of Deferred Tax Assets / Liabilities Case Unused tax losses and tax credits Melco Development Limited (2005 Annual Report) A deferred tax asset has been recognised to the extent that realisation of the related tax benefit through future taxable profit is probable. A deferred tax asset is recognised on the balance sheet in view that the relevant subsidiary in the investment banking and the financial services segment has been profit making in recent years. No deferred tax asset has been recognised in respect of the remaining tax loss due to the unpredictability of future profit streams. 2005-07 Nelson 56 28
4. Recognition of Deferred Tax Assets / Liabilities Unrecognised deferred tax assets Periodic Re-assessment At each balance sheet date, an entity re-assesses unrecognised deferred tax assets The entity recognises a previously unrecognised deferred tax asset to the extent that it has become probable that future taxable profit will allow the deferred tax asset to be recovered 2005-07 Nelson 57 4. Recognition of Deferred Tax Assets / Liabilities Unrecognised deferred tax assets Example Examples to Indicate Recognition of Previously Unrecognised Deferred Tax Assets a) An improvement in trading conditions This may make it more probable that the entity will be able to generate sufficient taxable profit in the future for the deferred tax asset to meet the recognition criteria set out above b) Another example is when an entity re-assesses deferred tax assets at the date of a business combination or subsequently 2005-07 Nelson 58 29
4. Recognition of Deferred Tax Assets / Liabilities Subsidiary, branch, associate, JV An entity shall recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, except to the extent that both of the following conditions are satisfied: a) the parent, investor or venturer is able to control the timing of the reversal of the temporary difference; and b) it is probable that the temporary difference will not reverse in the foreseeable future 2005-07 Nelson 59 4. Recognition of Deferred Tax Assets / Liabilities Subsidiary, branch, associate, JV An entity shall recognise a deferred tax asset for all deductible temporary differences arising from investments in subsidiaries, branches and associates, and interests in joint ventures, to the extent that, and only to the extent that, it is probable that: a) the temporary difference will reverse in the foreseeable future; and b) taxable profit will be available against which the temporary difference can be utilised. 2005-07 Nelson 60 30
5. Measurement a.tax rate Deferred tax tax assets or or liabilities Temporary = x Tax differences Tax rates Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the balance sheet date The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that would follow from the manner in which the entity expects, at the balance sheet date, to recover or settle the carrying amount of its assets and liabilities Deferred tax assets and liabilities shall not be discounted 2005-07 Nelson 61 Deferred 5. Measurement tax tax assets or or liabilities Temporary = x Tax differences Tax rates Example Changes in the applicable tax rate An entity has an asset with - a carrying amount of $100 - a tax base of $60 Tax rate - 20% for the asset were sold - 30% for other income Answers Temporary difference: $40 ($100 - $60) a) If it expects to sell the asset without further use Deferred tax liability: $8 ($40 at 20%) b) if it expects to retain the asset and recover its carrying amount through use Deferred tax liability: $12 ($40 at 30%) 2005-07 Nelson 62 31
5. Measurement a.tax rate b. Deferred tax assets Deferred tax tax assets or or liabilities Temporary = x Tax differences Tax rates The carrying amount of a deferred d tax asset shall be reviewed at each balance sheet date An entity shall reduce the carrying amount of a deferred tax asset to the extent that it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax asset to be utilised Any such reduction shall be reversed to the extent that it becomes probable bl that t sufficient i taxable profit will be available 2005-07 Nelson 63 5. Measurement Case Deferred tax tax assets or or liabilities Temporary = x Tax differences Tax rates 2004/05 Annual Report The carrying amount of a deferred tax asset is reviewed at each balance sheet date and is reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow the related tax benefit to be utilized. Any such reduction is reversed to the extent that it becomes probable that sufficient taxable profit will be available. 2005-07 Nelson 64 32
Deferred tax tax 5. Measurement assets or assets or liabilities Dr??? Cr Deferred tax liabilities Dr Deferred tax assets Cr??? Current and deferred tax shall be recognised as income or an expense and included in the profit or loss for the period Dr Tax expenses Cr Deferred tax liabilities Dr Deferred tax assets Cr Tax income That simple? 2005-07 Nelson 65 Today s Agenda II. HKAS 12 Income Taxes A. Current Taxes B. Deferred Taxes 1. Overview of deferred taxes 2. Tax base 3. Temporary differences 4. Recognition of deferred tax assets/liabilities 5. Measurement 6. Recognition of deferred tax charge/credit 7. Presentation 8. Disclosure 2005-07 Nelson 66 33
6. Recognition of deferred tax charge/credit Dr Tax expenses, or Equity, or Goodwill Cr Deferred tax liabilities Dr Deferred tax assets Cr Tax income, or Equity, or Goodwill Current and deferred tax shall be recognised as income or an expense and included in the profit or loss for the period except to the extent that the tax arises from: a) a transaction or event which is recognised, in the same or a different period, directly in equity; or b) a business combination that is an acquisition 2005-07 Nelson 67 6. Recognition of deferred tax charge/credit Charged or credited to equity directly Dr Tax expenses and Equity Cr Deferred tax liabilities Current tax and deferred tax shall be charged or credited directly to equity if the tax relates to items that are credited or charged, in the same or a different period, directly to equity Example Extract of trial balance at year end HK$ 000 Deferred tax liabilities (Note) 5,200 Note: Deferred tax liability is to be increased to $7.4 million, of which $1 million is related to the revaluation gain of a property Answers HK$ 000 HK$,000 Dr Deferred tax expense ($7.4 - $5.2 - $1) 1,200 Revaluation reserves 1,000 Cr Deferred tax liabilities ($7.4 $5.2) 2,200 2005-07 Nelson 68 34
6. Recognition of deferred tax charge/credit Charged or credited to equity directly Dr Tax expenses and Equity Cr Deferred tax liabilities Current tax and deferred tax shall be charged or credited directly to equity if the tax relates to items that are credited or charged, in the same or a different period, directly to equity Certain HKASs and HKASs require or permit certain items to be credited or charged directly to equity, examples include 1. Revaluation difference on property, plant and equipment under HKAS 16 2. Adjustment resulted from either a change in accounting policy or the correction of an error under HKAS 8. 3. Exchange differences on translation of a foreign entity s financial statements under HKAS 21. 4. Available-for-sale financial assets under HKAS 39 2005-07 Nelson 69 6. Recognition of deferred tax charge/credit Deferred tax arising from a business combination Dr Tax expenses or Goodwill Cr Deferred tax liabilities Dr Deferred tax assets Cr Tax income or Goodwill Temporary differences may arise in a business combination. In accordance with HKFRS 3, an entity recognises any resulting deferred tax assets (to the extent they meet the recognition criteria) or deferred tax liabilities are recognised as identifiable assets and liabilities at the date of acquisition Consequently, those deferred tax assets and liabilities affect goodwill or negative goodwill. However, in accordance with HKAS 12, an entity does not recognise deferred tax liabilities arising from the initial recognition of goodwill. 2005-07 Nelson 70 35
6. Recognition of deferred tax charge/credit Deferred tax arising from a business combination Dr Tax expenses or Goodwill Cr Deferred tax liabilities Dr Deferred tax assets Cr Tax income or Goodwill For example, the acquirer may be able to utilise the benefit of its unused tax losses against the future taxable profit of the acquiree. In such cases, the acquirer recognises a deferred d tax asset, but does not include it as part of the accounting for business combination, and therefore does not take it into account in determining the goodwill or the negative goodwill. 2005-07 Nelson 71 6. Recognition of deferred tax charge/credit Deferred tax arising from a business combination Dr Tax expenses or Goodwill Deferred tax assets can be recognised Cr Deferred tax liabilities subsequent to the date of acquisition but the acquirer cannot recognise Dr Deferred tax assets negative goodwill, nor does it increase Cr Tax income or Goodwill the negative goodwill. Example Fair BV at Tax value subsidiary base Net assets acquired $1,200 $1,000 $1,000 Subsidiary s used tax losses $1,000 Tax rate 20% Taxable temporary difference $200 Deductible temporary difference $1,000 Deferred tax assets may be recognised as one of the identifiable assets in the acquisition (subject to limitations). 2005-07 Nelson 72 36
6. Recognition of deferred tax charge/credit Deferred tax arising from a business combination Example An entity acquired a subsidiary that had deductible temporary differences of $300. The tax rate at the time of the acquisition was 30%. The resulting deferred tax asset of $90 was not recognised as an identifiable asset in determining the goodwill of $500 that resulted from the business combination. 2 years after the combination, the entity assessed that future taxable profit should be sufficient to recover the benefit of all the deductible temporary differences. 2005-07 Nelson 73 6. Recognition of deferred tax charge/credit Deferred tax arising from a business combination Example The entity recognises a deferred tax asset of $90 and, in P/L, deferred tax income of $90. The entity also reduces the carrying amount of goodwill by $90 and recognises an expense for this amount in profit or loss. Consequently, the cost of the goodwill is reduces to $410, being the amount that would have been recognised had the deferred tax asset of $90 been recognised as an identifiable asset at the acquisition date. If the tax rate had increased to 40%, the entity would recognise a deferred tax asset of $120 ($300 at 40%) and, in P/L, deferred tax income of $120. If the tax rate had decreased to 20%, the entity would recognise a deferred tax asset of $60 ($300 at 20%) and deferred tax income of $60. In both cases, the entity would also reduce the carrying amount of goodwill by $90 and recognise an expense for the amount in profit or loss. 2005-07 Nelson 74 37
Today s Agenda II. HKAS 12 Income Taxes A. Current Taxes B. Deferred Taxes 1. Overview of deferred taxes 2. Tax base 3. Temporary differences 4. Recognition of deferred tax assets/liabilities 5. Measurement 6. Recognition of deferred tax charge/credit 7. Presentation 8. Disclosure 2005-07 Nelson 75 7. Presentation 7. a. Offset An entity shall offset deferred tax assets and deferred tax liabilities if, and only if: a) the entity has a legally enforceable right to set off current tax assets against current tax liabilities; and b) the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same taxation authority on either: i) the same taxable entity; or ii) different taxable entities which intend either to settle current tax liabilities and assets on a net basis, or to realise the assets and settle the liabilities simultaneously, in each future period in which significant amounts of deferred tax liabilities or assets are expected to be settled or recovered 2005-07 Nelson 76 38
7. Presentation 7. a. Offset b. Tax expenses and income The tax expense and income related to profit or loss from ordinary activities shall be presented on the face of the income statement 2005-07 Nelson 77 Today s Agenda II. HKAS 12 Income Taxes A. Current Taxes B. Deferred Taxes 1. Overview of deferred taxes 2. Tax base 3. Temporary differences 4. Recognition of deferred tax assets/liabilities 5. Measurement 6. Recognition of deferred tax charge/credit 7. Presentation 8. Disclosure 2005-07 Nelson 78 39
8. Disclosure Selected major items to be disclosed separately Major components of tax expense (income) Tax relating to items that are charged or credited to equity; A tax reconciliation An explanation of the relationship between tax expense (income) and accounting profit in either or both of the following forms: 1. a numerical reconciliation between tax expense (income) and the product of accounting profit multiplied by the applicable tax rate(s), disclosing also the basis on which the applicable tax rate(s) is (are) computed; or 2. a numerical reconciliation between the average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed; 2005-07 Nelson 79 8. Disclosure Selected major items to be disclosed separately Major components of tax expense (income) Tax relating to items that are charged or credited to equity; A tax reconciliation Example Example note on tax reconciliation (no comparatives) HK$ 000 % Profit before tax 3,500 Tax on profit before tax, calculated at applicable tax rate 613 17.5 Tax effect of non-deductible expenses 50 1.4 Tax effect of non-taxable revenue (215) (6.1) Tax effect of unused tax losses not recognised 102 2.9 Effect on opening deferred tax balances resulting from an increase in tax rate during the year 200 5.7 Over provision in prior years (150) (4.3) Tax expenses and effective tax rate 600 17.1 2005-07 Nelson 80 40
8. Disclosure Selected major items to be disclosed separately Major components of tax expense (income) Tax relating to items that are charged or credited to equity; A tax reconciliation An explanation of changes in the applicable tax rate(s) compared to the previous period 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 recognised The aggregate amount of temporary differences associated with investments in subsidiaries, branches and associates and interests in joint ventures, for which deferred tax liabilities have not been recognised 2005-07 Nelson 81 8. Disclosure Selected major items to be disclosed separately Example In respect of each type of temporary difference, and in respect of each type of unused tax losses and unused tax credits: i) the amount of the deferred tax assets and liabilities recognised in the balance sheet for each period presented; ii) the amount of the deferred tax income or expense recognised in the income statement, if this is not apparent from the changes in the amounts recognised in the balance sheet; and Example note Depreciation allowances in Deferred tax excess of related Revaluation arising from: depreciation of properties Total HK$ 000 HK$ 000 HK$ 000 At 1 January 2003 800 300 1,100 Charged to income statement (120) - (120) Charged to reserves - 2,100 2,100 At 31 December 2003 680 2,400 3,080 2005-07 Nelson 82 41
8. Disclosure Selected major items to be disclosed separately In respect of discontinued operations, the tax expense relating to: i) the gain or loss on discontinuance; and ii) the profit or loss from the ordinary activities of the discontinued operation for the period, together with the corresponding amounts for each prior period presented; and 2005-07 Nelson 83 8. Disclosure Selected major items to be disclosed separately The amount of income tax consequences of dividends to shareholders of the entity that were proposed or declared before the financial statements were authorized for issue, but are not recognised as a liability in the financial statements The amount of a deferred tax asset and the nature of the evidence supporting its recognition, when: a) the utilization of the deferred tax asset is dependent on future taxable profits in excess of the profits arising from the reversal of existing taxable temporary differences; and b) the entity has suffered a loss in either the current or preceding period in the tax jurisdiction to which the deferred tax asset relates 2005-07 Nelson 84 42
Today s Agenda I. Introduction II. HKAS 12 Income Taxes A. Current Taxes B. Deferred Taxes III. HK(SIC) Interpretation 21 Income Tax Recovery of Revalued Non-Depreciable Assets 1. Issue 2. Basis for Conclusions 3. Conclusions 4. Implication to Property in HK 5. Effective Date 2005-07 Nelson 85 II. HK(SIC) Interpretation 21 Income Tax Recovery of Revalued Non-Depreciable Assets 1. Issue 2. Basis for Conclusions 3. Conclusions 4. Implication to Property in HK 5. Effective Date 2005-07 Nelson 86 43
1. Issue Under HKAS 12.51, the measurement of deferred tax liabilities and assets should reflect the tax consequences that would follow from the manner in which the entity expects, at the balance sheet date, to recover or settle the carrying amount of those assets and liabilities that give rise to temporary differences. Recover through usage? Recover from sale? 2005-07 Nelson 87 1. Issue HKAS 12.20 notes that the revaluation of an asset does not always affect taxable profit (tax loss) in the period of the revaluation and that the tax base of the asset may not be adjusted as a result of the revaluation. If the future recovery of the carrying amount will be taxable any difference between the carrying amount of the revalued asset and its tax base is a temporary difference and gives rise to a deferred tax liability or asset. 2005-07 Nelson 88 44
1. Issue The issue is how to interpret the term recovery in relation to an asset that is not depreciated (non-depreciable asset) and is revalued under the revaluation model of HKAS 16 (HKAS 16.31). HK(SIC) Interpretation 21 also applies to investment properties which are carried at revalued amounts under HKAS 40.33 but would be considered nondepreciable if HKAS 16 were to be applied. Interpretation 20 (superseded) also applies to investment properties which are carried at revalued amounts under SSAP 13. Implied that an investment property if under HKAS 16 would be depreciable, like land in HK, the conclusion in HK(SIC) Interpretation 21 is not applicable to that property 2005-07 Nelson 89 2. Basis for Conclusions The Framework indicates that an entity recognises an asset if it is probable that the future economic benefits associated with the asset will flow to the entity. Generally, those future economic benefits will be derived (and therefore the carrying amount of an asset will be recovered) through sale, through use, or through use and subsequent sale. Recover through usage? Recover through use and sale? Recover from sale? 2005-07 Nelson 90 45
2. Basis for Conclusions Recognition of depreciation implies that the carrying amount of a depreciable asset is expected to be recovered through use to the extent of its depreciable amount, and through sale at its residual value. Consistent with this, the carrying amount of a non-depreciable asset, such as land having an unlimited life, will be recovered only through sale. Depreciable asset Nondepreciable asset Recovered through use (and final sale) Recovered through sale That is, because the asset is not depreciated, no part of its carrying amount is expected to be recovered (that is, consumed) through use. Deferred taxes associated with the non-depreciable asset reflect the tax consequences of selling the asset. 2005-07 Nelson 91 2. Basis for Conclusions The expected manner of recovery is not predicated on the basis of measuring the carrying amount of the asset. For example, if the carrying amount of a non-depreciable asset is measured at its value in use, the basis of measurement does not imply that the carrying amount of the asset is expected to be recovered through use, but through its residual value upon ultimate disposal. Depreciable asset Nondepreciable asset Recovered through use (and final sale) Recovered through sale 2005-07 Nelson 92 46
3. Conclusions The deferred tax liability or asset that arises from the revaluation of a non-depreciable asset under the revaluation model of HKAS 16 (HKAS 16.31) should be measured on the basis of the tax consequences that would follow from recovery of the carrying amount of that asset through sale, regardless of the basis of measuring the carrying amount of that asset. Recover through usage? Recover through use and sale? No depreciation implies not expected to recover from usage Recover from sale? 2005-07 Nelson 93 3. Conclusions Tax rate on sale Not the same Tax rate on usage Used for nondepreciable asset What s the implication on land in HK? Accordingly, if the tax law specifies a tax rate applicable to the taxable amount derived from the sale of an asset that differs from the tax rate applicable to the taxable amount derived from using an asset the former rate is applied in measuring the deferred tax liability or asset related to a non-depreciable asset. 2005-07 Nelson 94 47
4. Implication to Property in HK Tax rate on sale Not the same Tax rate on usage Used for nondepreciable asset HK(SIC) Interpretation 21 also applies to investment properties which are carried at revalued amounts under HKAS 40.33 but would be considered non-depreciable if HKAS 16 were to be applied. What s the implication on land in HK? Remember the scope identified in issue before Implied that an investment property if under HKAS 16 would be depreciable, like land in HK, the conclusion in HK(SIC) Interpretation 21 is not applicable to that property 2005-07 Nelson 95 4. Implication to Property in HK Tax rate on sale Not the same Tax rate on usage Used for nondepreciable asset What s the implication on land in HK? It implies that the management cannot rely on HK(SIC) Interpretation 21 to assume the tax consequences being recovered from sale It has to consider which tax consequences that would follow from the manner in which the entity expects to recover the carrying amount of the investment property As an investment property is generally held to earn rentals the profits tax rate would best reflect the tax Different from the consequences of an investment property in HK past in most cases unless the management has a definite intention to dispose of the investment property in future 2005-07 Nelson 96 48
4. Implication to Property in HK Tax rate on sale Tax rate on usage How s your usage on your investment property? Recover through usage? Recover from sale? 2005-07 Nelson 97 4. Implication to Property in HK Case Melco Development Limited (2005 Annual Report) Deferred Taxes related to Investment Properties In previous periods, deferred tax consequences in respect of revalued investment properties were assessed on the basis of the tax consequence that would follow from recovery of the carrying amount of the properties through sale in accordance with the predecessor Interpretation. In the current period, the Group has applied HKAS Interpretation 21 Income Taxes Recovery of Revalued Non-Depreciable Assets which removes the presumption that the carrying amount of investment properties are to be recovered through sale. 2005-07 Nelson 98 49
4. Implication to Property in HK Case Melco Development Limited (2005 Annual Report) Deferred Taxes related to Investment Properties Therefore, the deferred tax consequences of the investment properties are now assessed on the basis that reflect the tax consequences that would follow from the manner in which the Group expects to recover the property at each balance sheet date. In the absence of any specific transitional provisions in HKAS Interpretation 21, this change in accounting policy has been applied retrospectively resulting in a recognition of HK$9,492,000 deferred tax liability for the revaluation of the investment properties and HK$9,492,000 deferred tax asset for unused tax losses on 1 January 2004. 2005-07 Nelson 99 4. Implication to Property in HK Case Interim Report 2005 clearly stated that: The directors consider it inappropriate for the company to adopt two particular aspects of the new/revised HKFRSs as these would result in the financial statements, in the view of the directors, either: not reflecting the commercial substance of the business or being subject to significant potential short-term volatility, as explained below. 2005-07 Nelson 100 50
4. Implication to Property in HK Case Interim Report 2005 clearly stated that: HKAS 12 Income Taxes, together with HKAS-INT 21 Income Taxes Recovery of Revalued Non-Depreciable Assets, requires deferred taxation to be recognised on any revaluation movements on investment properties. It is further provided that any such deferred tax liability should be calculated at the profits tax rate in the case of assets which the management has no definite intention to sell. The company has not made such provision in respect of its HK investment properties since the directors consider that such provision would result in the financial statements not reflecting the commercial substance of the business since, should any such sale eventuate, any gain would be regarded as capital in nature and would not be subject to any tax in HK. Should this aspect of HKAS 12 have been adopted, deferred tax liabilities amounting to HK$2,008 million on the revaluation surpluses arising from revaluation of HK investment properties would have been provided. (estimate - over 12% of the net assets at 30 June 2005) 2005-07 Nelson 101 4. Implication to Property in HK Case 2006 Annual Report stated that: In prior years, the group was required to apply the tax rate that would be applicable to the sale of investment properties to determine whether any amounts of deferred tax should be recognised on the revaluation of investment properties. Consequently, deferred tax was only provided to the extent that tax allowances already given would be clawed back if the properties were disposed of at their carrying value, as there would be no additional tax payable on disposal. As from 1 January 2005, in accordance with HK(SIC) Interpretation 21, the group recognises deferred tax on movements in the value of an investment property using tax rates that are applicable to the property s use, if the group has no intention to sell it and the property would have been depreciable had the group not adopted the fair value model 2005-07 Nelson 102 51
III. For Further Discussion Impact of some new HKFRS/HKAS 1. HKAS 16, 17 and 40 2. HKAS 32 and 39 3. HKFRS 2 2005-07 Nelson 103 1. Impact of HKAS 16, 17 and 40 Property, leases and Investment property 2005-07 Nelson 104 52
1. Impact of HKAS 16, 17 and 40 Example GV purchased a property for $100 million in Hong Kong in 2006 In fact, it is a lease of land and building with 50 remaining years Based on relative fair value of land and building Estimated land element is $60 million No tax deduction!? Estimated building element is $40 million Claim CBA,IBA or other The accounting policy of the company: Rental payments on operating lease is recognised over the lease term on a straight line basis Building is depreciated over 50 years on a straight-line basis. What is the deferred tax implication? Also depend on the tax authority s practice 2005-07 Nelson 105 1. Impact of HKAS 16, 17 and 40 Example Property can be classified as: Owner-occupied property Investment property Property intended for sale in the ordinary course of business Property being constructed for 3rd parties Property leased out under finance lease Property being constructed for future use as investment property Which HKAS? HKAS 16 & 17 HKAS 40 HKAS 2 HKAS 11 HKAS 17 HKAS 16 & 17 Accounting Land and building separated Single (Cost or FV) say as a single asset Lower of cost or NRV With attributable profit/loss In substance sales Single (Cost or FV), say as a single asset 2005-07 Nelson 106 53
1. Impact of HKAS 16, 17 and 40 Example Property can be classified as: Owner-occupied property Which HKAS? HKAS 16 & 17 Accounting Land and building separated If a property located in HK is purchased and is carried at cost as office Land element can fulfil initial recognition exemption, i.e. no deferred tax recognised Building element deferred tax resulted from the temporary difference between its tax base and carrying amount For example, at year end 2006: Carrying amount ($40M - $40M 50 years) $ 39.2 million Tax base ($40M (1 4%, CBA)) 38.4 million How if IBA? Temporary difference $ 0.8 million @ HK profit tax rate (as recovered by usage) 17.5% 2005-07 Nelson 107 1. Impact of HKAS 16, 17 and 40 Example Property can be classified as: Investment property Which HKAS? HKAS 40 Accounting Single (Cost or FV) say as a single asset Simple.. Follow HK(SIC) Interpretation 21 Income Tax Recovery of Revalued Non-Depreciable Assets The management has to consider which tax consequences that would follow from the manner in which the entity expects to recover the carrying amount of the investment property. As an investment property is generally held to earn rentals the profits tax rate (i.e. 16%) would best reflect the tax consequences of an investment property in HK unless the management has a definite intention to dispose of the investment property in future 2005-07 Nelson 108 54
2. Impact of HKAS 32 and 39 Financial Instruments 2005-07 Nelson 109 2. Impact of HKAS 32 and 39 Recap on selected items of HKAS 32 and 39 HKAS 32 Preference shares dividend as interest expenses Compound financial instrument HKAS 39 FA at FV through P/L at Fair Value through profit or loss AFS financial assets HTM investments Loans and receivables at Fair Value through equity at Cost at Amortised Cost at Amortised Cost Also depend on the tax authority s practice How s HK s IRD practice? 2005-07 Nelson 110 55