A Refresher Course on Current Financial Reporting Standards 2013 (Day 5) HKAS 12 Income Taxes 1
COOPERATION REQUESTED Please make sure that your mobile phones and pagers have been switched off or turned to the vibration mode 2
DISCLAIMER The Hong Kong Institute of Certified Public Accountants and the speakers DO NOT accept any responsibility or liability, and DISCLAIM all responsibilities and liabilities, in respect of the contents of this workshop and any consequences that may arise from any person acting or refraining from action as a result of any materials in this course. Any reliance on the materials in this workshop is solely at the user s risk. 3
HKAS 12 Income Taxes 4
Agenda Part 1 - HKAS 12 Income Taxes Part 2 - Amendments to HKAS 12 Income Taxes 5
Part 1 HKAS 12 Income Taxes 6
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. 7
Scope HKAS 12 shall be applied in accounting for income tax HKAS 12.2 defines these as all domestic and foreign taxes that are based on taxable profits Income taxes also include taxes, such as withholding taxes, that are payable by a subsidiary, associate or joint venture on distributions to the reporting entity "Taxable profit" = Taxable income minus deductible amounts ( a net rather than a gross basis) 8
Scoped Out Sales taxes Transactional taxes based on sales value Interest and penalties assessed on underpayment or late payment of income tax Tonnage tax paid on basis of tonnage transported, tonnage capacity or a notional profit Scoped out from HKAS 12 Scoped out from HKAS 12 Scoped out from HKAS 12 Such taxes should be presented based on its nature, either as finance cost (e.g. interest) or operating expense (e.g. penalty) 9
Current tax 10
Definitions Current tax: Current tax is defined as the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period [HKAS 12.5] It is the tax that the entity expects to pay (recover) in respect of the financial period Taxable profit (tax loss) Taxable profit (tax loss) is defined as the profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable) [HKAS 12.5] 11
Current Tax Recognition Basic requirements: [HKAS 12.12-13] Current tax for current and prior periods shall, to the extent unpaid, be recognised as a liability 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 12
Current Tax Recognition (cont'd) Generally, current tax is recognised in profit or loss Exceptions: [HKAS 12.58] where the current tax arises as a result of a transaction or event which is recognised, in the same or a different period, outside profit or loss, either in other comprehensive income or directly in equity or where the current tax arises from a business combination 13
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 end of the reporting period 14
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) 15
Deferred tax 16
Deferred Tax Overview HKAS 12 Income Taxes adopts: Balance sheet liabiity method largely focuses on the statement of financial position by recognising the tax effects of temporary differences between the carrying amount of an asset or a liability and its tax base Full provision approach recognised all differences, except for some limited cases 17
Deferred Tax - Definitions Deferred tax liabilities: Deferred tax liabilities are defined as the amounts of income taxes payable in future periods in respect of taxable temporary differences [HKAS 12.5] Deferred tax assets: Deferred tax assets are defined as the amounts of income taxes recoverable in future periods in respect of : [HKAS 12.5] Deductible temporary differences; the carryforward of unused tax losses; and the carryforward of unused tax credits 18
Principal steps in arriving at deferred tax assets/liabilities Step 1: Calculate the tax base of each asset and liability in the statement of financial position Step 2: Calculate the temporary difference (if any) for each of the above items Step 3: Identify those temporary differences that will give rise to deferred tax assets or liabilities taking into account the recognition criteria and initial exemption laid down in the Standard Step 4: Calculate the deferred tax attributable to those temporary differences by multiplying each temporary difference by the tax rate that is expected to apply when the temporary difference reverses based on enacted or substantively enacted tax rates Step 5: Recognise the movement between the deferred tax balances in the opening and closing statements of financial position in profit or loss, in other comprehensive income, in equity, or as part of the initial accounting for a business combination 19
Step 1: Deferred tax Tax bases The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes The amount of the tax base can vary according to the manner in which the entity expects to recover the asset, or settle the liability e.g. properties held for use e.g. properties held for sale 20
Step 2: Deferred tax - temporary differences Temporary difference is the difference between the carrying amount of an asset or liability in the statement of financial position and its tax base When the recovery of an asset (non-taxable assets) or settlement of a liability (non-deductible liabilities) has no tax consequences, the tax base is equal to the carrying amount (i.e., temporary difference is nil) Two types of temporary differences: taxable temporary difference deductible temporary difference 21
Temporary difference Examples of circumstances resulting in taxable temporary differences: Depreciation of an asset is accelerated for tax purposes 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 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 Prepaid expenses have already been deducted on a cash basis in determining the taxable profit of the current or previous periods Financial assets or investment property are carried at fair value which exceeds cost but no equivalent adjustment is made for tax purposes An entity revalues property, plant and equipment (under HKAS 16) but no equivalent adjustment is made for tax purposes 22
Temporary difference (cont d) Examples of circumstances resulting in deductible temporary differences: 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 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 Research costs are recognised as an expense in determining accounting profit but are not permitted as a deduction in determining taxable profit until a later period Income is deferred in the balance sheet but has already been included in taxable profit in current or prior periods Financial assets or investment property are carried at fair value which is less than cost, but no equivalent adjustment is made for tax purposes 23
Examples: Temporary difference Carrying amount Property held for use Tax base 300 (Tax written down value) Revalued property held for use Bad debt expense 500 1000 450 (gross amt of 500, less allowance for bad debt of 50) 300 (Tax written value) 500 (allowance only deductible upon write-off) Deferred revenue 800 (deferred revenue received in advance) 0 (taxable on a cash receipt basis) Temporary difference/ deductible temporary difference 200 700 (50) (800) 24
Step 3: Deferred tax Temporary difference that gives rise to deferred assets and liabilities Balance sheet liability method - full provision approach Taxable temporary difference Deferred tax liability All recognised? General rule: Recognise all unless specific exceptions apply (to be discussed later) Deductible temporary difference Unused tax losses or credits Deferred tax asset 25
Taxable/deductible temporary differences Carrying amount tax base Type of temporary difference Gives rise to Asset Positive Taxable Deferred tax liability Asset Negative Deductible Deferred tax asset Liability Positive Deductible Deferred tax asset Liability Negative Taxable Deferred tax liability 26
Step 4: Deferred tax Measurement Computation of deferred tax assets and liabilities To calculate the amount of a deferred tax asset or liability, HKAS 12 contains the following formula: Deferred tax liabilities or assets Taxable or deductible temporary difference = Tax rate A deferred tax asset can also arise from tax losses that have been carried forward. These deferred tax assets are calculated as follows: Deferred tax asset Unused tax losses and / or tax credit = Tax rate 27
Step 4: Deferred tax Measurement (cont'd) Applicable tax rates and laws Deferred assets and liabilities shall be measured: at the tax rates that are expected to apply to the period when the temporary difference reverses based on tax rates and tax laws enacted or substantively enacted at the end of the reporting period 28
Step 4: Deferred tax Measurement (cont'd) Example: A PRC joint venture is entitled to tax concessions during its initial years of operation The standard income tax rate is 30%. However, the joint venture is fully exempted from PRC income tax for 2 years starting from its first profit-making year, followed by a 50% reduction in the PRC income tax rate for the next 3 years The joint venture has an item of equipment that cost RMB 12,000, which is depreciated over 6 years for accounting purposes and 3 years for PRC income tax purposes, using the straight-line method. The first year that the joint venture has taxable profit is 2011 29
Step 4: Deferred tax Measurement (cont'd) The temporary differences arising as a result of the accelerated tax depreciation will reverse during years 2014, 2015 and 2016 as follows: Carrying amount Tax base Temporary difference Reversal of temporary difference Tax rate Deferred tax liability RMB RMB RMB RMB RMB 2011 10,000 8,000 2,000 N/A 0% 300 (2,000x15%) 2012 8,000 4,000 4,000 N/A 0% 600 (4,000x15%) 2013 6,000 0 6,000 N/A 15% 1,200 (4,000x15%) +(2,000x30%) 2014 4,000 0 4,000 2,000 15% 900 (2,000x15%) +(2,000x30%) 2015 2,000 0 2,000 2,000 15% 600 (2,000x30%) 2016 0 0-2,000 30% - The above table illustrates that, where tax rates vary, it is necessary to estimate the tax rate that willl apply when the temporary difference reverses. In the example, it is predictable that the temporary difference arising in 2011 will reverse in 2014 and, therefore, the appropriate tax rate for deferred tax purposes is 15% rather than 0%. Similarly, the temporary differences arising in 2012 and 2013 will reverse in 2015 and 2016, and tax rates of 15% and 30% should therefore be applied for the temporary differences arising in 2012 and 2013 respectively. 30
Step 4: Deferred tax Measurement (cont'd) Progressive or graduated tax rates When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are measured using the average rates that are expected to apply to the taxable profit (tax loss) of the periods in which the temporary differences are expected to reverse [HKAS 12.49] 31
Step 4: Deferred tax Measurement (cont'd) Substantively enacted tax rates Current and deferred tax assets and liabilities are usually measured using the tax rates and tax laws that have been enacted. However, in some jurisdictions, announcements of tax rates and tax laws by the government have the substantive effect of actual enactment, which may follow the announcement by a period of several months. In these circumstances, tax assets and liabilities are measured using the announced tax rate and tax laws [HKAS 12.48] 32
Step 4: Deferred tax Measurement (cont'd) Changes in tax rates after the reporting period Where there is a change in tax rates or laws after the reporting period, no adjustment is made to the carrying amounts of deferred tax assets and liabilities However, where the effect of the change is such that "nondisclosure could influence the economic decisions of users taken on basis of the financial statements", disclosure will be required in accordance with HKAS 10 Event after the Reporting Period [HKAS 10.21] 33
Step 4: Deferred tax Measurement (cont'd) Discounting HKAS 12 explicitly prohibits the use of discounting for the measurement of deferred tax assets and liabilities [HKAS 12.53] 34
Step 4: Deferred tax Measurement (cont'd) 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 end of the reporting period, to recover or settle the carrying amount of its assets and liabilities [HKAS 12.51] 35
Examples: An item of PPE has a carrying amount of 100 and a tax base of 60 Tax rate of 20% would apply if the asset were sold Tax rate of 30% would apply to other income The entity recognises a deferred tax liability of 8 (40 at 20%) if it expects to sell the item without further use or a deferred tax liability of 12 (40 at 30%) if it expects to retain the item and recover its carrying amount through use 36
Examples: An item of PPE with a cost of 100 and a carrying amount of 80 is revalued to 150 No equivalent adjustment is made for tax purposes Cumulative depreciation for tax purposes is 30 and tax rate is 30% If the item is sold for more than cost, the cumulative tax depreciation of 30 will be included in taxable income, but sale proceeds in excess of cost will not be taxable Tax base = 70 Taxable temporary difference = 80 if the entity expects to recover the carrying amount by using the item, it must generate taxable income of 150, but will only be able to deduct depreciation of 70 On this basis, there is a deferred tax liability of 24 (80 at 30%) If the entity expects to recover the carrying amount by selling the item immediately for proceeds of 150, the deferred tax liability is: Cumulative tax depreciation Proceeds in excess of cost Taxable temporary difference Tax rate Deferred tax liability 30 30% 9 50 nil - Total 80 9 37
Step 5: Deferred tax - Recognition of movement Deferred tax should be recognised as income or an expense and included in the net profit or loss for the period, except to the extent that the movement in deferred tax: [HKAS 12.58, 61A & 66] Relates to an item recognised in other comprehensive income, deferred tax also recognised in other comprehensive income Relates to an item recognised in equity, deferred tax also recognised in equity Arises in relation to a business combination, adjusts goodwill. 38
Example: Deferred tax liability arising on the revaluation of a property B Limited revalues a property from a carrying amount of $100,000 to $150,000. The tax base of the asset is $100,000. The carrying amount of the property is expected to be recovered through use. The applicable tax is 30%. A taxable temporary difference of $50,000 ($150,000-$100,000) arises on revaluation, giving rise to a deferred tax liability of $15,000 ($50,000 x 30%). The following entries record the revaluation and the deferred tax liability: DR CR $ $ Property, plant and equipment 50,000 Property revaluation reserve 50,000 Property revaluation reserve 15,000 Deferred tax liability 15,000 39
Example : Deferred tax liability arising on the revaluation of a property (Cont'd) In subsequent periods, the property will be depreciated for both accounting and tax purposes, changing the temporary difference. Any movements in the deferred tax liability are recognised in the income statement. For instance, if the carrying amount of the property at the end of the next reporting period is $120,000 and tax base is $90,000, there is a taxable temporary difference of $30,000 and a deferred tax liability of 9,000 ($30,000x30%). This movement for the year is recorded as follows: DR CR $ $ Deferred tax liability ($15,000 -$9,000) 6,000 Deferred tax (I/S) 6,000 40
Presentation Classification: Tax assets and liabilities may not be combined with other assets and liabilities, but must be shown separately on the statement of financial position Deferred tax assets and liabilities must be presented separately from current tax assets and liabilities; and Deferred tax assets and liabilities must be classified as non-current 41
Presentation (cont'd) Offset of current tax An entity should offset current tax assets and current tax liabilities if, and only if, the entity: [HKAS 12.71] has a legally enforceable right to set off tax assets/tax liabilities; and intends either to settle tax assets/liabilities on a net basis, or to realise the asset and settle the liability simultaneously An entity normally has a legally enforceable right to set off current tax assets against current tax liabilities when they relate to taxes levied by the same taxation authority, and that authority permits the entity to make or receive a single net payment [HKAS 12.72] 42
Presentation (cont'd) Offset of current tax (cont'd) Where a company is preparing consolidated financial statements, current tax assets and liabilities arising from different group companies should not be offset unless: [HKAS 12.73] the companies concerned have a legally enforceable right to make or receive a single net payment; and the companies intend to make or receive such a net payment or to recover the asset and settle the liability simultaneously 43
Presentation (cont'd) Offset of deferred tax assets and liabilities An entity should offset deferred tax assets and deferred tax liabilities if, and only if: [HKAS 12.74] the entity has a legally enforceable right to set off current tax assets against current tax liabilities; and the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same taxation authority on either: the same taxable entity; or 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 44
Disclosure HKAS 12 has extensive disclosure requirements on income tax Statement of comprehensive income Major components of the tax charge or credit in the statement of comprehensive income are required to be separately identified, including: Current tax expense or income; Adjustments to current tax of prior periods Deferred tax expense (income) relating to: Origination and reversing of temporary differences Changes in tax rates or new taxes 45
Disclosure Reconciliation of tax charge or credit to accounting profit: HKAS 12 requires the presentation of an explanation of the relationship between the tax expense (income) and accounting profit in either or both of the following forms: A numerical reconciliation between tax expense (income) and the product of accounting profit multiplied by the applicable tax rates disclosing also the basis on which the applicable tax rates are computed; or A numerical reconciliation between the average effective tax rate (being the tax expense (income) divided by the accounting profit) and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed An explanation is required of changes in the applicable tax rates compared to the previous accounting period 46
Disclosure: Reconciliation of tax charge (i) Reconciliation in absolute terms 20X1 20X0 $'000 $'000 Accounting profit 8,740 8,775 Tax at the applicable rate of 35% (20X0:40%) 3,059 3,510 Tax effect of expenses that are not deductible in determining taxable profit 122 480 Reduction in opening deferred tax liability resulting from reduction in tax rate (1,127) - Tax expense 2,054 3,990 (ii) Reconciliation in percentage terms 20X1 20X0 % % Applicable tax rate 35.0 40.0 Tax effect of expenses that are not deductible in determining taxable profit 1.4 5.5 Effect on opening deferred tax liability of reduction in tax rate (12.9) - Average effective tax rate (tax expense divided by profit before tax 23.5 45.5 47
Disclosure Deferred tax For each type of temporary difference, unused tax loss and tax credit: Amount of the deferred tax assets and liabilities recognised Amount of deferred tax income or expense recognised in profit or loss The amount and expiry date of temporary differences, unused tax losses and tax credits; and The amount of temporary differences associated with investments in subsidiaries, branches and associate and interests in joint ventures, for which deferred tax liabilities have not been recognised. and many others (please refer to the standard itself for a comprehensive list) 48
Deferred tax Recognition exceptions Balance sheet liability method - full provision approach Taxable temporary difference Deferred tax liability All recognised? General rule: Recognise all unless specific exceptions apply (to be discussed later) Deductible temporary difference Unused tax losses or credits Deferred tax asset 49
Deferred tax Recognition exceptions Initial recognition of an asset or liability which affects neither accounting profit or loss nor taxable profit or loss, other than from a business combination Initial recognition of goodwill An investment in a subsidiary, branch, associates or joint ventures, if the parent, investor or venturer 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 Deferred tax assets recognised only to the extent that recoverability is probable 50
Recognition exception Initial recognition of an asset or liability Temporary differences are not permitted to be recognised where the difference arises in respect of the initial recognition of an asset or liability in a transaction that: is not a business combination; and at the time of the transaction, affects neither accounting profit (loss) nor taxable profit (tax loss) 51
Recognition exception Initial recognition of an asset or liability HKAS 12 requires the recognition of deferred tax on temporary differences arising on the initial recognition of an asset or liability when: a transaction affects the income statement (e.g. anticipation of income receivable (asset), or accrual of costs payable (liability); or a transaction affects taxable income (e.g. expenditure on assets such as computer equipment allowed for tax purposes when paid (asset), or deferral of income recognition in respect of funds that are taxable when received (liability); or a business combination 52
Recognition exception Initial recognition of an asset or liability Does the temporary difference arise on the initial recognition of an asset or a liability? Yes Was the asset or liability acquired in a business combination? No Did the transaction giving rise to the asset or liability affect either the accounting result or the taxable profit (loss) at the time of the transaction? No No Yes Yes Recognise deferred tax impact (subject to other exceptions) Do not recognise deferred tax impact 53
Example 1: Deferred tax liability arising on the recognition of an asset asset depreciated at the same rate for tax and accounting purposes Company A purchases an asset for $100,000. Only $60,000 is qualifying expenditure for tax purposes. The carrying amount of the asset will be recovered through use in taxable manufacturing operations. The asset is depreciated on a straight-line basis at 25% for both tax and accounting purposes. Carrying amount Tax base Temporary difference Unrecognised difference Deferred tax Year $ $ $ $ $ 20X0 100,000 60,000 40,000 40,000-20X1 75,000 45,000 30,000 30,000-20X2 50,000 30,000 20,000 20,000-20X3 25,000 15,000 10,000 10,000-20X4 0 0 - - - No deferred tax is ever recognised in respect of the original temporary difference 54
Example 2: Deferred tax liability arising on the recognition of an asset different depreciation rates for tax and accounting purposes Facts same example 1, but the asset is depreciated at 25% for accounting purposes and 33 1/3% for tax purposes. The tax rate is 17.5%. Carrying amount Tax base Temporary difference Unrecognised temporary difference Recognised temporary difference Deferred tax liability Year $ $ $ $ $ $ A B A-B=C D* C-D=E E x17.5% 20X0 100,000 60,000 40,000 40,000 - - 20X1 75,000 40,000 35,000 30,000 5,000 875 20X2 50,000 20,000 30,000 20,000 10,000 1,750 20X3 25,000 0 25,000 10,000 15,000 2,625 20X4 0 0 - - - - * Being the initial temporary difference of 40,000 of which initial recognition exception applied Hong Kong Institute of Certified Public 55
Example 3: Deferred tax liability arising on the recognition of an asset asset subsequently revalued Fact as per example 1 (i.e. depreciation at 25% or both tax and accounting purposes), but assume that the asset is revalued for accounting purposes to $120,000 at the end of the first year. Carrying amount Tax base Temporary difference Unrecognised temporary difference Recognise d temporary difference Deferred tax liability Year $ $ $ $ $ $ A B A-B=C D* C-D=E** EX17.5% 20X0 100,000 60,000 40,000 40,000 - - 20X1 120,000 45,000 75,000 30,000 45,000 7,875 20X2 80,000 30,000 50,000 20,000 30,000 5,250 20X3 40,000 15,000 25,000 10,000 15,000 2,625 20X4 0 0 - - - - * Being the initial temporary difference of 40,000 of which initial recognition exception applied ** The recognised temporary difference is the amount by which the asset has been revalued upwards in comparison with the depreciated original cost (i.e. the difference between $120,000 and $75,000, being the carrying amount of the asset at the time of the revaluation). 56
Recognition exception Initial recognition of goodwill HKAS 12 prohibits the recognition of a temporary difference in respect of goodwill at initial recognition Non-deductible goodwill no deferred tax impact 57
Example Goodwill Exemption Deferred tax implications for the CEF Group of companies CEF Ltd acquired DEF Ltd on 1 January 2012 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 CEF Ltd, impairment of goodwill is not tax deductible. Answers The CEF group Carrying Tax amount base Goodwill $2 million - Net assets $4 million $3 million Temporary differences $2 million $1 million Deferred tax liability? 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. 58
Recognition exception Investments in subsidiaries/associates/joint ventures Taxable temporary differences associated with investments in subsidiaries, branches and associates and interests in joint ventures required to be recognised as deferred tax liability, except for taxable temporary differences where: [HKAS 12.39] The investor is able to control the timing of the reversal; and It is probable that the difference will not reverse in the foreseeable future Temporary difference may arise if: Gain from sale investment is taxable Dividends received from investment is taxable No temporary difference where recovery has no tax impact 59
Recognition exception Undistributed profits in an associate Example: A Ltd. has an associate, B Ltd., which operates in the PRC. At 31 December 2012, A Ltd. had accounted for $20,000 profits of B Ltd., using the equity method of accounting During the period, B Ltd. had paid dividends of $5,000 to B Ltd. No tax arises in A Ltd's country of operation on receipt of dividends. However, under the PRC, tax is withheld at 25% of dividends paid, and is not recoverable Assuming that it is anticipated that the investment in B Ltd. will be recovered through distributions, in accounting for the incremental profits of $15,000 in its consolidated financial statements, A Ltd. should also recognise the tax consequences if those profits were remitted as dividends A deferred tax liability of $3,750 ($15,000 x 25%) should therefore be recognised in the consolidated financial statements at 31 December 2012, in addition to the recognition of the tax consequences arising from the remittance of $5,000 60
Recognition exception Undistributed profits in a subsidiary Entity A has a subsidiary with a carrying amount of $2M and a tax base of $1.8M. Entiy A controls the distribution of dividends by the subsidiary Entity A does not have any need for the subsidiary to make a distribution and has active plans for the undistributed profits to be reinvested for expansion Entity A can control the timing of the reversal and the temporary difference is not expected to reverse in the foreseeable future Entity A cannot recognise a deferred tax liability on the temporary difference of $200K 61
Recognition exception Undistributed profits in a subsidiary Entity A has a subsidiary with a carrying amount of $2M and a tax base of $1.8M. Entity A controls the distribution of dividends by the subsidiary Entity A has a cash flow problem and needs to extract funding in the subsidiary in the form of a cash dividend Although entity A can control the timing of the reversal, it is probable that the temporary difference will reverse in the foreseeable future Entity A should recognise the deferred tax liability for the portion of the earnings to be remitted 62
Recognition Business combination Due to adjustments on acquisition (e.g., fair value adjustments on acquisition, additional assets/liabilities identified on acquisition, deferred tax not recognised by the acquiree) the carrying amount in the consolidated financial statements is different from the tax base No initial recognition exception on the temporary differences arising on business combination HKAS 12 requires recognition of the deferred tax impact of business combinations New temporary differences arise which are adjusted against goodwill/gain from bargain purchase 63
Example Business combination Background On 1 January 2012, entity H acquired 100% of entity S for $3,500 At the date of acquisition, entity S had net assets at carrying amount of $2,500 (including $140 recognised deferred tax liability) Fair value of owner-occupied property is revalued upward by$400 An intangible asset is recognised at its fair value of $200 A provision for an onerous lease contract of $300 is recognised Applicable tax rate is 20% 64
Example Business combination Net assets at carrying amount 2,500 Fair value adjustment of property 400 Fair value of intangible assets 200 Provision for onerous contract (300) Deferred tax on: - fair value adjustment of property (20% X 400) (80) - fair value of intangible assets (20% X 200) (40) - provision for onerous contract (20% X 300) 60 Fair value of net assets acquired 2,740 Goodwill 760 Consideration paid 3,500 65
Example: Elimination of unrealised profits on consolidation Fact pattern: Entity H sold inventory costing $100 to its overseas subsidiary, entity S, for $160 Entity H s tax rate: 30% Entity S s tax rate: 25% The inventory remains on hand at year-end and unrealised profit of $60 to be eliminated on consolidation No change in tax base What is the deferred tax balance? 66
Example: Elimination of unrealised profits on consolidation (cont'd) Analysis: Entity H: recognises a current tax liability of $18 ($60 profit at 30%) does not recognise any deferred tax balances, no future tax consequences from entity H s point of view Entity S entitled to a future deduction for $160 paid for the inventory tax base for the inventory is $160 In entity S s individual financial statements, the tax base is equal to the carrying amount, and no temporary difference arises 67
Example: Elimination of unrealised profits on consolidation (cont'd) Analysis: Consolidated F/S of entity H the carrying amount of the inventory is reduced from $160 to $100 on consolidation A $60 deductible temporary difference arises, representing the difference between the carrying amount ($100) and the tax base ($160) A deferred tax asset is calculated by multiplying the temporary difference of $60 by 25%, as the deduction is available to entity S at that rate when the unrealised profit is realised outside the group on sale of the inventory by S Limited The deferred tax asset arising of $15 is recognised on consolidation 68
Recognition exceptions Unused tax loss/credit 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 69
Recognition exceptions Unused tax loss/credit (cont'd) Availability of future profits A deferred tax asset represents a future tax deduction It is valuable only if the entity will have future taxable profits against which the deduction can be offset Important question to answer is when can it be considered probable that an entity will have sufficient taxable profits available in the future to enable the deferred tax asset to be recovered? 70
Recognition exceptions Unused tax loss/credit Examples criteria in assessing available taxable profit: a) whether there are sufficient taxable temporary differences (deferred tax liabilities) relating to the same taxation authority and the same taxable entity b) whether it is probable that the entity will have sufficient taxable profits before the unused tax losses or unused tax credits expire; and c) whether tax planning opportunities are available 71
Recognition exceptions Unused tax loss/credit Recognition 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 72
Amendments to HKAS 12 Income Taxes 73
Amendment to HKAS 12 Deferred tax of investment properties General principle: Measurement of deferred tax assets or liabilities which reflect the tax consequences that would follow the manner in which management expects to recover or settle the carrying amount of the entity's assets or liabilities Management may expect to recover the investment property by using it, by selling it, or by a combination of use and sale Such expectation can affect the measurement of deferred taxes when different tax rates or tax bases apply to the profits generated from using and selling the investment property 74
Highlights of amendments to HKAS 12 HKAS 12 has been updated to include: A rebuttable presumption that deferred tax on investment property measured using the fair value model in HKAS 40 should be determined on the basis that its carrying amount will be recovered through sale; and A requirement that deferred tax on non-depreciable assets, measured using the revaluation model in HKAS 16, should always be measured on a sale basis 75
Impact Who will be affected? For entities holding investment property measured at fair value in territories where a) the capital gains tax rate is different from the income tax rate, and/or; b) the tax base from sale is different from tax base from use Example : For investment properties in Hong Kong, movement in the fair value will not be tax-affected as there is no capital gains tax in Hong Kong. Deferred tax liabilities will be reduced significantly 76
Further considerations The presumption can be rebutted if the investment property is depreciable and is held within a business model whose objective is to consume substantially all of the economic benefits embodied in the investment property over time, rather than through sale this is not a policy choice it also applies when a deferred tax arises from measuring investment property in a business combination if the entity will use the fair value model for subsequent measurement 77
Further considerations (cont.) For entities subject to Hong Kong tax, recovery of investment property through sale does not necessarily mean that the deferred tax liability on fair value gains is nil Need to consider the possible claw back of previously granted tax allowances in respect of the property If the IRD considers the investment property is held for trading purposes (i.e., disposal would not be deemed to be a capital transaction), the zero rate applicable to capital gains will not apply 78
Further considerations (cont.) Impact on deferred tax assets Applying the presumption does not change the principles to be adopted when recognising and measuring deferred tax assets The amendment is likely to reduce significantly deferred tax liabilities The entity might need to reconsider the recoverability of the entity's deferred tax assets due to the changes in the nature and amount of deferred tax liabilities 79
Illustrations Example 1 On 1 Jan 2010, entity B purchased an investment property for $100K The investment property does not have a freehold land component and is measured at fair value subsequently At 31 Dec 2012, the fair value of the investment property is $120K Tax depreciation of 4% of the cost per annum is claimed for investment properties. Income tax rate is 30% The cumulative tax depreciation claimed previously will be included in the taxable income if the investment property is sold for more than the tax written-down value Sale proceeds in excess of the cost are not taxed The tax written down value is $88K at 31 Dec 2012 80
Scenario B's management does not have any plan to sell the investment property but to hold it for rental income and capital appreciation. The investment property may be sold in the future. HKAS 12 (before amendment) Amendment to HKAS 12 At 31 December 2012 At 31 December 2012 $'K $'K Fair value 120 Fair value in excess of cost ($20K x 0%) 0 Tax base (88) Claw back of depreciation Taxable temporary difference 32 allowance claimed ($12K x 30%) 3.6 Deferred tax liabilities at 30% 9.6 Total deferred tax liabilities 3.6 The lack of a plan to sell the investment property in the future may result in measuring the deferred tax on the basis of use As the presumption of recovery through sale is not rebutted, deferred tax is measured based on the tax consequences of sale 81
Illustrations Example 2 Background An entity holds an investment property with the following details: Cumulative Cost Fair value tax depreciation Land (unlimited useful life) 40 60 N/A Buildings 60 90 30 Total 100 150 tax rate If sales > cost 20% Claw back of tax depreciation claimed if sales > cost 30% 82
Illustrations Example 2 if the presumption is NOT rebutted Taxable temporary Deferred tax difference Tax rate liabilities Claw back of depreciation allowance claimed 30 30% 9 Fair value in excess of cost (150-100) 50 20% 10 80 19 83
Illustrations Example 2 if the presumption is rebutted Buildings Fair value in excess of Taxable temporary Deferred tax difference Tax rate liabilities tax base (90-30) 60 30% 18 Land (with unlimited useful life) Fair value in excess of tax base (60-40) 20 20% 4 80 22 84
Illustrations Example 3 Entity P acquired the entire shares of entity S for $500K on 31 Dec 2010 The identifiable assets acquired included an investment property of fair value $250K and other net assets (excluding deferred tax on property) with a fair value of $100K Entity S purchased the investment property for $180K. The cumulative tax depreciation at 31 Dec 2010 is $45K Income tax rate is 30% The cumulative tax depreciation claimed previously will be included in the taxable income if the investment property is sold for more than the tax written-down value Sale proceeds in excess of the cost are not taxed 85
HKAS 12 (before amendment) Amendments to HKAS 12 Amendments to HKAS 12 At 31 December 2010 Cost Model Fair value Fair value 250 250 Tax base (180 45) (135) (135) Taxable temporary difference $'K $'K $'K 115 115 Fair value in excess of cost ($70K x 0%) Claw back of depreciation allowance claimed ($45K x 30%) 0 13.5 Deferred tax liabilities at 30% 34.5 34.5 Total deferred tax liabilities 13.5 The deferred tax on acquisition is the same regardless of which model (cost or fair model) is applied for subsequent measurement P Co Ltd applies cost model and assumes recovery of the investment property through use Assuming the presumption of recovery through sale is not rebutted, deferred tax is measured based on the tax consequences of sale 86
HKAS 12 (before amendment) Amendments to HKAS 12 Cost model Fair value model $'K $'K $'K Purchase consideration 500 500 500 Fair value of investment property (250) (250) (250) Fair value of other identifiable net assets (100) (100) (100) Deferred tax liability on the investment property 34.5 34.5 13.5 Goodwill 184.5 184.5 163.5 The choice of the accounting polices for subsequent measurement of investment properties acquired in a business combination might affect the goodwill 87
Effective date An entity shall apply these amendments for annual periods beginning on or after 1 January 2012 The amendments do not contain any transitional provisions, which means that they need to be applied retrospectively in accordance with HKAS 8, except if retrospective application is impracticable 88
Disclosures HKAS 8 Disclose the impact of retrospective application, including: Nature and description Impact in current and prior periods presented for each line item affected Impact on earnings per share (basic and diluted) (HKAS 8.28) Disclose judgments made by management that have had the most significant effect on the financial statements (HKAS 1.122) 89
Disclosure (cont.) Present a statement of financial position as at the beginning of the earliest comparative period for a change in accounting policy adopted retrospectively or retrospective restatements / reclassifications (HKAS 1.10(f)) e.g., if the amendments are adopted early for a December year end entity. Present a statement of financial position as at 31 December 2012 31 December 2011 1 January 2010 90
Disclosure (cont.) (for a listed entity) Adjust the 5 year financial summary included in the annual report presented under para 19 of Appendix 16 / GEM 18.33. When an entity has not applied the amendments (because they have been issued but are not yet effective), disclose: This fact Known or reasonably estimable information relevant to assessing the possible impact in the period of initial application (HKAS 8.30) 91
Disclosure (cont.) When it is impracticable to adjust comparative information, disclosure such circumstances and a description of how and from when the change in accounting policy has been applied (HKAS 8.28(h)) 92
Thank you for your attention 93