(revised 2000) 1
Authoritive pronouncements (revised 2000) SIC 21: Income taxes; Recovery of revalued Non-depreciable assets SIC 25: Income taxes; Changes in the tax status of an enterprise or its shareholders Overview Key points Current taxes Deferred taxes temporary differences calculation of deferred taxes consolidation and deferred taxes business combination and deferred taxes presentation and disclosures 2
- the Key Points Comprehensive application required using the balance sheet liability method Partial provisioning not acceptable No discounting permitted Deferred tax assets on deductible temporary differences and tax loss carry forwards recognised only -...when it is probable that taxable profits will be available... for utilisation : The key points Liability method Required by Deferred taxes calculated using rate of tax expected to apply when asset is recovered or the liability is settled Focuses on the balance sheet Deferred tax balance adjusted to the new tax rate The IS includes the effect of the changes 3
Current Tax Assets and Liabilities Current tax for current and prior periods should be recognised as a liability. If the amounts already paid exceed the amounts due, the excess should be recognised as an asset Tax loss carry back benefits that can be used to recover current tax of a previous period should be recognised as an asset Calculation of Current Tax Expense 20X8 20X9 Financial Tax Financial Tax Statements Return Statements Return Income before income taxes 100,000 100,000 100,000 100,000 Profit on contract in progress (40,000) 40,000 ------------- ------------ ------------- ------------ Net income - financial 100,000 100,000 statements ====== ====== Net income - tax return 60,000 140,000 ====== ====== Tax expense (50%) 30,000 70,000 ====== ====== 4
Comparative Income Statements? Presentation of Income Tax Expense Without Provision for Deferred Taxes 20X8 20X9 Financial statement income before income taxes 100,000 100,000 Income tax expense (30,000) (70,000) ------------ ------------ Net income 70,000 30,000 ======= ======= Tax as % of income before taxes 30% ======= 70% ======= Comparative Income Statements? Presentation of Income Tax Expense With Provision for Deferred Taxes 20X8 20X9 Financial statement income before income taxes 100,000 100,000 Income taxes: Current (30,000) (70,000) Deferred (20,000) 20,000 ------------ ------------ Total tax expense (50,000) (50,000) ------------ ------------ Net income 50,000 50,000 ======= ======= Tax as % of income before taxes 50% ======= 50% ======= 5
Journal Entries Balance Sheet DR CR DR CR 20X8 Current tax expense 30,000 Deferred tax expense 20,000 Current tax payable 30,000 Deferred tax liability 20,000 Income Statement 20X9 Current tax expense 70,000 Deferred tax expense 20,000 Current tax payable 70,000 Deferred tax liability 20,000 Illustration - Without Deferred Taxes Machinery costs $ 5,000,000 Useful life IAS books = 10 years Useful life tax books = 5 years Year 1 2 3 4 5 6 7 8 9 10 A Profit before depreciati on and tax 5,000,000 7, 8,400,000 6,450,000 8,000,000 10,325,000 6,000,000 11,000,000 2,250,000 7,300,000 B Tax depreciati on 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 - - - - - C Taxable income 4,000,000 6, 7,400,000 5,450,000 7,000,000 10,325,000 6,000,000 11,000,000 2,250,000 7,300,000 D Tax 25% 1,000,000 1,625,000 1,850,000 1,362,500 1,750,000 2,581,250 1, 2,750,000 562,500 1,825,000 E Book depreciati on F Pre-tax income (A-E) 4, 7,000,000 7,900,000 5,950,000 7, 9,825,000 5, 10, 1,750,000 6,800,000 G Tax ratio (D/F x 100%) 22.2 % 23.2 % 23.4 % 22.9 % 23.3 % 26.3 % 27.3 % 26.2 % 32.1 % 26.8 % 6
Illustration - With Deferred Taxes Year IAS net book value Tax net book value Cum. temporar y differenc e Cum. deferred taxes Deferred tax charge (credit) Current tax charge (as before) Total tax charge New tax rati o 1 4, 4,000,000 125,000 125,000 1,000,000 1,125,000 25 % 2 4,000,000 3,000,000 1,000,000 250,000 125,000 1,625,000 1,750,000 25 % 3 3, 2,000,000 1, 375,000 125,000 1,850,000 1,975,000 25 % 4 3,000,000 1,000,000 2,000,000 125,000 1,362,500 1,487,500 25 % 5 2, - 2, 625,000 125,000 1,750,000 1,875,000 25 % 6 2,000,000-2,000,000 (125,000) 2,581,250 2,456,250 25 % 7 1, - 1, 375,000 (125,000) 1, 1,375,000 25 % 8 1,000,000-1,000,000 250,000 (125,000) 2,750,000 2,625,000 25 % 9-125,000 (125,000) 562,500 437,500 25 % 10 - (125,000) 1,825,000 1,700,000 25 % Entries? What entries are required when adopting IFRS for the first time? in year 5? in year 6? 7
Entries Year 5 DR Deferred tax charge 125 DR Retained Earnings 500 CR Deferred tax liability 625 Entries Year 6 DR Retained Earnings 625 CR Deferred tax income 125 CR Deferred tax liability 500 8
Deferred Taxes Temporary differences The 4-step approach Tax losses Consolidation and deferred taxes Business combination and deferred taxes Presentation and disclosures Temporary differences: Definitions Temporary differences: differences between the carrying amount of an asset or liability in the balance sheet and its tax base Taxable temporary differences: will result in taxable amounts in determining taxable profit of future periods when the carrying amount of the asset or liability is recovered or settled Deductible temporary differences: will result in amounts that are deductible in determining taxable profit of future periods when the carrying amount of the asset or liability is recovered or settled 9
Temporary vs timing differences All timing differences are temporary differences Temporary differences include more than timing differences Temporary vs Permanent differences (1) For financial reporting purposes, company Z amortises goodwill over 30 years. However the income tax law mandates an amortisation period over 15 years. Temporary DT Liability To comply with IAS, company A used a different method for inventory valuation than for tax financial statements, which results in lower inventories for book purposes. Temporary DT Asset A company deducted payments of penalty/fine for book income but not for taxable income. Permanent A German entity recognised accruals for future expenses for tax financial statements. However this type of accruals is not allowed under IAS. To comply with IAS the entity reverses these accruals. Temporary DT Liability Dividends receivable from a subsidiary have a carrying amount of 100. Dividends are not taxable. Permanent 10
Temporary vs Permanent differences (2) For consolidation purposes the Austrian entity of D-Division lowers its general bad debt reserve from 2% to 1%. Temporary DT Liability Due to different depreciation methods, during this year company Y recognises higher fixed assets in its financial statements than for tax purposes. Temporary DT Liability Conversion to IAS required the recognition of accrued pension cost, which are higher than the pension accrual under tax reporting. Temporary DT Asset Temporary Differences: exceptions (1) Deferred tax liabilities are recognised for all taxable temporary differences unless they arise from: Goodwill Initial recognition of an asset or liability in a transaction which: is not a business combination and at the time of the transaction, affects neither accounting profit or taxable profit (loss) 11
Temporary Differences: exceptions (2) Deferred tax assets are recognised for all deductible temporary differences unless they arise from: Initial recognition of an asset or liability in a transaction which: is not a business combination and at the time of the transaction, affects neither accounting profit or taxable profit (loss) Calculation of Deferred Tax 4 steps Step 1: determine differences between tax and IFRS balance sheets Step 2: determine which of them are future taxable, which are future deductible, differences Step 3: multiply them by the expected tax rate SIC-21 - Recovery of Revalued Non- Depreciable Assets Step 4: consider if it is probable that taxable profit will be available against which the deductible temporary difference (including unused tax losses) can be utilised and only then show an asset 12
Step 3: Which tax rate? Current tax liabilities/assets = the amount expected to be paid (recovered from) based on tax rate on balance sheet date ( 46) Deferred tax liabilities/assets = tax rate for the period the asset is realised/liability is settled ( 47) Step 3: Different tax rates apply ( 51) Carrying amount of an asset 100 Tax base of an asset 60 Tax rate if asset is sold 20% Tax rate for other income 30% Deferred tax? at what rate Provide at 20% if expected to sell Provide at 30% if further used 13
Step 3: Different tax rates apply (SIC 21) Revalued amount of land 100 Taxable amount of land 60 Tax rate if land is sold 20% Tax rate for other income 30% Deferred tax? at what rate Provide at 20% Step 3: Different tax rates apply ( 52A+B) Undistributed earnings 50% Distributed earnings 40% Deferred tax? at what rate Provide at 50% When distribution recognised: - credit 10% to current tax 14
Step 4: Recognition Current and deferred taxes recognised as income or expense in net profit or loss for the period, except for : a transaction recognised directly in equity (e.g. revaluation, correction of an error or equity component of a compound financial instrument) a business combination Step 4 - Probable Taxable Profit? Sources of future taxable income: offset against deferred tax liabilities reversals of taxable temporary differences future taxable profits carryback income (if available) tax-planning strategies 15
Tax losses Unused tax losses and unused tax credits: Deferred tax asset should be recognised for the carry forward of unused tax losses or unused tax credit if it is probable future taxable profit will be available Review carrying amount of deferred tax asset at each balance sheet date Consolidation and Deferred Tax Consolidation adjustments Elimination of intercompany profits No deferred tax on (non tax deductible) goodwill, as recognition of a deferred tax liability would increase the carrying amount of goodwill 16
Consolidation & Deferred Tax Deferred tax on undistributed profits of subsidiaries, associates, joint ventures An enterprise should recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches, associates and interests in joint ventures except to the extent that both the following conditions are satisfied: The parent is able to control the timing of the reversal of the temporary difference; and It is probable that the temporary difference will not reverse in the foreseeable future Business Combinations & Deferred Tax Cost of the acquisition is allocated to the identifiable assets and liabilities acquired by reference to their fair values In most cases the tax bases of the identifiable assets and liabilities are not affected by the business combination and temporary differences arise Special rules for tax losses (changed by IFRS 3R effective FY beginning after 1/07/2009) 17
Business Combinations & Deferred Tax A acquires B for a value of 1,500 Net assets amount to 1,150 Losses carried forward of 400 (tax rate 30%) were not recognised as an asset due to disputes with tax authorities and uncertainties regarding recovery. Net goodwill 350 In year 2, losses are accepted by tax authorities. Goodwill is impaired by 72. How does IFRS account for this? Business Combinations & Deferred Tax Initially goodwill was recorded at and stood at 350 at the end of year 2. The impairment of 72 is recorded as a loss in the income statement and the deferred tax asset is recognised through the IS as well (IFRS 3 67 & 68). DR Impairment goodwill 72 DR Deferred tax asset 120 CR Goodwill 72 CR Income tax 120 18
Business Combinations & Deferred Tax So the income statement will look as follows: Revenue... Cost of sales... Impairment goodwill (72) Operating result... Finance cost... Result before tax... Income tax 120 Net result... Business Combinations & Deferred Tax A acquires C for a value of 1,500 Net assets amount to 1,450 Losses carried forward of 400 (tax rate 30%) were not recognised as an asset due to disputes with tax authorities and uncertainties regarding recovery. Net goodwill 50 In year 2, losses are accepted by tax authorities. How does IFRS account for this? 19
Business Combinations & Deferred Tax Initially goodwill was recorded at and stood at 50 at the end of year 2. The deferred tax asset is recognised through profit and loss (IFRS 3 67 & 68). DR Deferred tax asset120 CR Income tax 120 Business Combinations & Deferred Tax So the income statement will look as follows: Revenue... Cost of sales... Impairment goodwill... Operating result... Finance cost... Result before tax... Income tax 120 Net result... 20
Business Combinations & Deferred Tax As a result of a business combination, an acquirer may consider it probable that it will recover its own deferred tax asset that was not recognised prior to the business combination (e.g. tax planning strategies) The acquirer recognises the deferred tax asset but does not take this into account in determining the goodwill or any excess arising on the acquisition ( 67) Presentation (1) 1. SIC-25 Changes in the Tax Status of an Enterprise or its Shareholders 2. Deferred taxes to be shown separately from current taxes, both to be shown on the face of the balance sheet 3. Deferred tax assets and liabilities not to be shown as current 4. Offset of deferred tax assets and liabilities only if: - legally enforceable right of tax offset - they relate to taxes levied by the same tax authority on the same entity or entities which intend to net 21
Presentation (2) Tax expense (income) from ordinary activities: presented in the income statement Exchange differences on Deferred Foreign Tax Liabilities or Assets recognised in income statement classified as deferred tax expense (income) if useful for financial statement users Disclosures (1) The components of tax expense Explanation of changes in tax rates compared to the previous year The amount of any current and deferred tax on items recognised directly in equity (i.e. revaluation of land) Tax expenses relating to discontinued operations 22
Disclosures (2) For each type of temporary difference, unused tax losses and unused tax credits: the amount of deferred tax assets and liabilities in the balance sheet the amount of deferred tax income or expense in the income statement Amount and expiry date of deductible temporary differences, unused tax losses and unused tax credits for which no deferred tax asset is recognised Numerical reconciliation of effective to statutory tax rate (2 options: see model NBB) Temporary differences for undistributed profits of subsidiaries etc. that are not provided for Deferred Taxes: the Main Rules Temporary (not only timing) differences Deferred taxes to be set up on (almost) all temporary differences The 4-step approach to calculating deferred taxes Tax losses carried forward are also assets Deferred tax assets to be set up only if it is probable that taxable profit will be available against which the deductible temporary difference can be utilised 23
Deferred Taxes: ED Proposed amendments by IASB Board (comments closed 31 July 2009 final H2 2010) Better definition of tax base (cfr tax basis in USGAAP) amount deductible if asset is sold (= idem US Gaap and simpler) Modify the definition of temporary difference (new model for initial recognition exception ) (= idem US Gaap but complex calculation) Recognise DTA in full + valuation allowance based on criteria more likely than not (= idem US Gaap) Deferred Taxes: ED (continued) Backwards tracing deleted change in tax rate in IS even if originally through equity or OCI, except for share-based payments (= idem US Gaap but might be complex) Exception from recognising deferred taxes on temporary differences limited to foreign subs + foreign permanent JV s when difference will not reverse in foreseeable future Uncertain tax positions measured at weighted average of potential outcomes (= not idem US Gaap (FIN 48) and complex) 24
Deferred Taxes: ED (continued) Undistributed earnings of subs = rate based on expectations of future distribution (= not idem US Gaap but might be complex) Presentation current or non-current based on presentation of underlying item Discounting remains prohibited (= idem US Gaap and simple) Remaining differences with US GAAP after ED IASB and FASB might consider a solution for the following differences: Tax rate used = substantively enacted enacted Unrealised interco profits at buyer s rate at seller s rate Subsequent DTA after business combination = to P&L to goodwill, intangibles and P&L 25
Remaining differences with US GAAP after ED (continued) Undistributed earnings of subs = rate based on expectation of distribution higher of both rates Changes in pre-acquisition tax liabilities = against goodwill or IS if > 1 year against goodwill Disclosure requirements In pratice Model FS from IAS 1 Disclosures in practice: Deceuninck and Bekaert Comparison IFRS US GAAP (as of today) 3 case studies 26