TOPIC 8 - IAS 12 Income Taxes IAS 12 prescribes the accounting treatment for income taxes. What is Current Tax? Current Tax is the amount of income taxes payable in respect of the taxable profit for a period. Income Taxes Payable recognised as a provision (Dr Statement of Profit or Loss (Tax Charge); Cr Tax Payable (Current Liability)) Difference Between Current Tax Charge in Statement of Profit or Loss & Tax Liability in Statement of Financial Position Example Entity X Taxable Profits - $300,000; Tax Rate 30% Current Tax Charge $90,000 DR Statement of Profit or Loss (Tax Expense); CR Current Tax Payable (Liability) However, if the entity has already paid some of the tax for the financial period, the current tax liability (SOFP) will be less than the total current tax (IS) for the year Tax Under Provided or Over Provided The tax charge on profits for the year recognised in profit or loss is an estimate. The actual tax charge is not agreed with the tax authorities until after the financial statements have been issued. Actual Tax < Tax Expense in Statement of Profit or Loss = Over Provision Tax Charge in the following Year is reduced (CR Statement of Profit or Loss; Dr Tax in the SOFP) 1
Actual Tax > Tax Expense in the Statement of Profit or Loss = Under Provision Tax charge in the following year is increased (DR Statement of Profit or Loss; CR Tax in the SOFP) DEFERRED TAX Accounting Base of An Asset/Liability V.s. Tax Base of an Asset/liability 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. Taxable Profits can differ from accounting profits due to 1. Permanent differences 2. Temporary differences Permanent Differences E.g. Company reports profit of $100,000 after charging client entertainment expenses of $20,000. But taxable profit will be $120,000 as 2
client entertainment expenses are disallowed. Permanent differences are therefore ignored for accounting purposes. Temporary differences occur when an item of expense (or income) is included in the accounting profits for one financial year and is included in the taxable profits for a different financial year. e.g. Depreciation & capital allowances; interest income receivable (i.e. where interest is not taxed until received, then the accrued income is recorded in the FS, but tax will be paid at some point in the future hence a deferred tax liability), development costs capitalised Temporary differences produce differences between accounting profits which are only temporary, over a period of time these differences will cancel each other out. Taxable Temporary Differences Deferred Tax Liability Deductible Temporary Differences Deferred Tax Asset The deferred tax charge for the year can be calculated by applying the tax rate to changes in the total of the temporary timing differences An increase in the deferred tax liability during the year adds to the total tax charge and a reduction in the deferred tax liability reduces the total tax charge DEFERRED TAX ASSET Deferred Tax Usually a liability Occasionally a deferred tax asset may arise Deferred tax assets should only be recognised if the company expects that future profits will be sufficient to recover the deferred tax No offsetting between deferred tax asset and deferred tax liability except in limited circumstances if the following apply 1. The entity has a legally enforceable right to set off the recognised amounts 2. The entity intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously Remember - deferred tax asset/liability classified as a non current assets/liabilities only 3
Accrued Pension Costs which are allowed as a taxable deduction only when paid, is a deferred tax asset because, this expense will be claimed as a deductible expense for tax at some stage in the future DEFERRED TAX AND ASSET REVALUATION On revaluation of an asset, unrealised gain is Credited to Revaluation reserve The Unrealised gain should be net of deferred tax ( ONLY where you are instructed to do so in a question!!!) Net unrealised gain should be reported as other comprehensive income DEFERRED TAX AND ASSET REVALUATION Example A company revalues an asset from $8m to $10m tax rate 30% Dr Asset Cost 2,000,000 Cr Revaluation Reserve 1,400,000 Cr Deferred Tax Liability 600,000 Report the gain as other comprehensive income as $1.4m Further examples of taxable temporary differences Transactions that affect profit or loss 1 Interest revenue is received in arrears and is included in accounting profit on a time apportionment basis but is included in taxable profit on a cash basis. 2 Revenue from the sale of goods is included in accounting profit when goods are delivered but is included in taxable profit when cash is collected. (note: as explained in B3 below, there is also a deductible temporary difference associated with any related inventory). 3 Depreciation of an asset is accelerated for tax purposes. 4 Development costs have been capitalised and will be amortised to the statement of comprehensive income but were deducted in determining taxable profit in the period in which they were incurred. 5 Prepaid expenses have already been deducted on a cash basis in determining the taxable profit of the current or previous periods. 4
Transactions that affect the statement of financial position 6 Depreciation of an asset is not deductible for tax purposes and no deduction will be available for tax purposes when the asset is sold or scrapped. (note: paragraph 15(b)of the Standard prohibits recognition of the resulting deferred tax liability unless the asset was acquired in a business combination, see also paragraph 22 of the Standard). 7 A borrower records a loan at the proceeds received (which equal the amount due at maturity), less transaction costs. Subsequently, the carrying amount of the loan is increased by amortisation of the transaction costs to accounting profit. The transaction costs were deducted for tax purposes in the period when the loan was first recognised. (notes: (1) the taxable temporary difference is the amount of transaction costs already deducted in determining the taxable profit of current or prior periods, less the cumulative amount amortised to accounting profit; and (2) as the initial recognition of the loan affects taxable profit, the exception in paragraph 15(b) of the Standard does not apply. Therefore, the borrower recognises the deferred tax liability). 8 A loan payable was measured on initial recognition at the amount of the net proceeds, net of transaction costs. The transaction costs are amortised to accounting profit over the life of the loan. Those transaction costs are not deductible in determining the taxable profit of future, current or prior periods. (notes: (1) the taxable temporary difference is the amount of unamortised transaction costs; and (2) paragraph 15(b) of the Standard prohibits recognition of the resulting deferred tax liability). 9 The liability component of a compound financial instrument (for example a convertible bond) is measured at a discount to the amount repayable on maturity (see IAS 32Financial Instruments: Presentation). The discount is not deductible in determining taxable profit (tax loss). Fair value adjustments and revaluations 10 Financial assets or investment property are carried at fair value which exceeds cost but no equivalent adjustment is made for tax purposes. 11 An entity revalues property, plant and equipment (under the revaluation model treatment in IAS 16 Property, Plant and Equipment) but no equivalent adjustment is made for tax purposes. (note: paragraph 61A of the Standard requires the related deferred tax to be recognised in other comprehensive income). 5
TAX IN THE STATEMENT OF PROFIT OR LOSS 3 COMPONENTS 1. Tax on Current Year Profits (Estimate) 2. Plus Under Provision or Minus Over Provision of tax in the Previous Year 3. Plus /minus deferred tax differences Deferred Tax and Non Current Asset Revaluations IAS 12 Income Taxes IAS 16 Property, Plant and Equipment Per IAS 12, when an asset is revalued to fair value, a difference then arises between (a) The Carrying Amount of the Asset (i.e. its fair value) AND (b) The TWDV of the asset It is this difference that gives rise to a deferred tax liability/asset on revaluation. When an asset is revalued upwards, the carrying amount of the asset increases and is greater than the TWDV of the Asset and hence gives rise to deferred tax liability. The Unrealised gain taken to Revaluation Reserve should be net of deferred tax (wherever such information is provided). When an asset like Land ( which is not depreciated) is revalued upwards, the value of the revalued asset will be recovered by generating future economic benefits (i.e. taxable income) through use Therefore even if the asset is not planned to be sold, the gain on revaluation will lead a deferred tax liability based on the future economic benefits (i.e. taxable income) which will arise through use which will be subject to tax at some stage in the future Exam Note: The examiner will instruct as to whether or not the gain/loss taken to revaluation reserve should be net of deferred tax 6
Example Deft ltd has the following accounting profits after charging depreciation Statement Year 1 Year 2 Year 3 Year 4 of Profit or Loss Accounting Profit 300 400 500 600 Deft ltd bought a machine at the start of year 1 for 200 and charges depreciation of 50 each year For tax purposes capital allowances are given at 50% in year 1 and 50% in year 2. Assume a tax rate of 30%. Tax Computation Year 1 Year 2 Year 3 Year 4 Accounting 300 400 500 600 Profit Addback : 50 50 50 50 Depreciation Less: Captial 100 100 Allowances Taxable Profit 250 350 550 650 Tax Payable @ 30% 75 105 165 195 The accounting profits and taxable profits are different, the reason for this is that depreciation and capital allowances are calculated differently Calculate Deferred Tax Provision Compare the carrying amount of asset in statement of financial position with its corresponding TWDV and then multiply the resultant difference by the tax rate. This approach gives the deferred tax provision balance at the end of the year; to compute the deferred tax charge or credit for the year it is necessary to compare the opening and closing deferred tax provision. Year 1 Year 2 Year 3 Year 4 Carrying 150 100 50 0 Amount TWDV 100 0 0 0 Cumulative 50 100 50 0 Timing Differences Deferred Tax 15 30 15 0 Provision (30% Income Tax Rate) Deferred Tax 15 Charge 15 Charge 15 Credit 15 Credit Charge/Credit 7
Example Example Revaluation of Tangible Non Current Assets Tangible non current assets with a carrying amount of 100 are revalued upwards to 190. The TWDV of the assets are 60. The tax rate is 30% Deferred Tax Provision Carrying Amount At Year End - Without Revaluation AT Year End With Revaluation Increase in Provision TWDV Cumulative Timing Difference Income Tax Rate 100 60 40 30% 12 190 60 130 30% 39 Deferred Tax Provision An unrealised gain of 90 arises on revaluation of the asset, however if deferred tax is accounted for, the net unrealised gain will be 63, with a credit to deferred tax provision of 27 Dr Non Current Asset 90 Cr Deferred Tax Provision 27 Cr Revaluation Reserve 63 27 8
The Unrealised gain taken to Revaluation Reserve should be net of deferred tax (wherever such information is provided). Exam Note: The examiner will instruct as to whether or not the gain/loss taken to revaluation reserve should be net of deferred tax Example -Impairment Loss Tangible non current asset with a carrying amount of 100 and a TWDV of 60 is impaired by 20. The tax rate is 30% Carrying Amount At Year End Without Impairment At Year End With Impairment TWDV Cumulative Timing Difference Income Tax Rate 100 60 40 30% 12 80 60 20 30% 6 Cr Tangible Non Current Asset 20 Dr Statement of Profit or Loss 20 Dr Deferred Tax Provision 6 Cr Income Tax (Inc. Statement) 6 Deferred Tax Provision Assuming no revaluation reserve existed for the impaired asset Example - Development Expenditure If development costs are capitalised in the SOFP, this situation can give rise to deferred tax implications Assume a company has capitalised 200,000 of development expenditure in its SOFP. The tax rate is 30% The tax treatment is to deduct the expenditure incurred in arriving at the taxable profit thus giving rise to a timing difference of 200,000. The timing difference of 200,000 is multiplied by the tax rate of 30% to give a deferred tax provision of 60,000. In the next year 50,000 of the development expenditure deferred is amortised to profit or loss. In this year there is a reversing timing which results in a reduction in the deferred tax provision of 50,000 multiplied by 30% which amounts to 15,000. 9
Losses Losses in so far as they will reduce future taxable profits have deferred tax implications Year 1 Year 2 Profit/(Loss) Before (200,000) 500,000 Tax Income Tax (90,000) Deferred Tax 60,000 (60,000) Profit/(Loss) After Tax (140,000) 350,000 Tax Computation Without Loss 500,000 * 30% = 150,000 With Loss (500,000 200,000) * 30% = 90,000 The loss in Year 1 gives rise to a reduction in the tax payable by 200,000 multiplied by 30% which amounts to 60,000. In this case a deferred tax asset of 60,000 arises. The key assumption here is that there will be future profits to utilise this loss against. 10
Tutorial Question: Based on P2 ACR Q1 April 2010 Note 10 Greenville - Accounts for the Year Ended 31 December 2009 The taxation rate applicable for all taxes is 25%. The figure shown for taxation in Greenville draft trial balance as at 31 December 2009 is 1,200,000 in the Credit Column. This figure represents the balance on the deferred tax account as at 31 December 2008. A figure of 1,800,000 should be provided in the company's financial statements for the year ended 31 December 2009 in respect of taxation. This figure takes account of all items, including adjustments, with the exception of the following: 1) Greenville was fortunate to be able to generate large cash surpluses at certain times during 2009 which it was able to put on deposit. Interest receivable at 31st December 2009 included in other receivables amounts to 1,200,000. Interest is taxed on a receipts basis. 2) The net book value of plant & equipment at 31st December 2009 after providing for depreciation is 4,032,000. The tax written down value is 1,032,000 3) Other payables at 31st December 2009 include an accrual for pension contributions of 1,400,000. Pension costs are deductible for tax purposes when paid. 11
Past Exam Questions P1 IAS 12 Q3 (3) April 15 Past Exam Questions P2 IAS 12 Q1 April 2010 Note 10 Q2 Aug 13 Q1 Apr 09 Note 12 Q3 Aug 12 Q3 April 2012 Q2,Q3 April 2011 Q2 Apr 2010 IAS 12 Income Taxes Homework Question The deferred tax balance at 31 December 2012 is an asset of 1,100,000. The adjustments for 2012 have not yet been considered. All temporary differences are to be taxed at 12.5% in 2012. At 31 December 2012, the following were relevant: 1) The tax written down value of the group s non current assets exceeded its book value by 2.8 million. This difference is due entirely to the different rates of depreciation and capital allowances on the company s tangible assets 2) At 31 December 2012 the defined benefit pension obligation was 1.006 million. The equivalent tax base was 300,000. You may assume that, for tax purposes, the pension expense is allowed only when it is paid. 3) Included in trade and other payables is an accrual for interest charges. The accrual relates to interest on a 10 million 5% bank loan that was issued on 1 January 2012. Interest is charged semi annually on the loan and is paid, in arrears, in August and February of each year. A payment for the first 6 months of the year was duly made on 1 st August 2012. The capital sum is due to be repaid in one lump sum in 2019. 4) One of the group s 100% subsidiaries, OMIY Ltd, made a tax adjusted loss of 2.54 million during the year. The only relief for this tax loss is to carry forward for offset against future taxable profits of the company. OMIY Ltd is expected to be profitable in future years. 5) The remaining temporary taxable timing differences affecting the statement of comprehensive income in 2012 amount to 2,970,000 Required: The deferred tax impact of the above 5 items represent the closing balance for deferred tax at 31.12.12. Prepare workings for each item and the overall adjustment required for deferred tax at 31.12.12 12