Page 1 Institute of Certified Public Accountants of Kenya ICPAK IAS 12 - Income taxes by Simon...

Institute of Certified Public Accountants of Kenya

ICPAK

IAS 12 - Income taxes

by Simon Fisher

31 March 2011


This slide presentation has been prepared for general guidance only, and does not constitute professional advice. You should not act upon the information contained in these slides without obtaining specific professional advice. Accordingly, to the extent permitted by law, RSM Ashvir (and its employees and agents) accept no liability, and disclaim all responsibility, for the consequences of anyone acting, or refraining from acting, in reliance on the information contained in these slides or for any decision based on it, or for any consequential, special or similar damages even if advised of the possibility of such damages.

Income taxes


Course objectives

By the end of today you should:

• know the components making up tax expense

• have a good understanding of the basic concepts of IAS 12

• understand the main exemptions within IAS 12

• be able to compute deferred tax on commonly encountered assets and liabilities

• know what disclosures are required under IAS 12

• be able to prepare a ‘tax reconciliation’

• be aware of differences between full IFRS and the IFRS for SMEs.

This course does not cover the computation of taxable profit.

Income taxes


Tax expense …

… is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax (12.5).

Income taxes


Agenda/Contents

Section 1: Accounting for current tax

Section 2: Accounting for deferred tax


Current tax

Current tax is the amount of income tax payable/recoverable in respect of the taxable profit/loss for the period (12.5).

Current tax for current and prior periods should, to the extent unpaid, be recognised as a liability (12.12).

Accounting for current tax


Agenda/Contents

Section 1: Accounting for current tax

Section 2: Accounting for deferred tax


Deferred tax

We will be looking at:• Basic concepts• Measurement

- the rule- the exceptions to the rule

• Recognition• Presentation and disclosure.

Accounting for deferred tax


Basic concepts

What is deferred tax?

Why do we need it?

How is it calculated?



What is deferred tax accounting …..

Accounting for the tax consequences of the future recovery/settlement of the carrying amount of assets/liabilities in a company’s balance sheet.

IAS 12 (effective from 1998) uses the balance sheet liability method (as opposed to the deferral method) and focuses on ‘temporary differences’ existing at the balance sheet date (not ‘timing differences’)



Basic concepts

What is deferred tax?

Why do we need it?

How is it calculated?



Measurement – the rule



The IAS 12 approach to calculating deferred tax

For every asset and liability in the balance sheet, and for tax losses carried forward:

Carrying amount of asset/liability X

Less: tax base of asset/liability (X)

Temporary difference X

@applicable tax rate X%

Deferred tax asset/liability X



What is a temporary difference?

Temporary difference = [the carrying value of an asset or liability] - [its tax base]:


Less: tax base of asset/liability (X)




The tax base is …..

…… “the amount attributed to that asset or liability for tax purposes” (12.5)

The tax base of an asset is the amount that will be deductible for tax purposes … when the entity recovers the carrying amount of the asset (12.7).

ie Tax base = future deductible amount

Note: if the future recovery of the asset is not taxable, the tax base is equal to the carrying amount.



Examples 1, 2 and 3



The tax base is …..

…… the amount attributed to that asset or liability for tax purposes

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 (12.8).

Note: in the case of revenue 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.



Examples

Examples 4, 5 & 6



Revaluations …..

Revaluations of property, plant and equipment increase the carrying amount of an asset without affecting the tax base.

They therefore create additional temporary differences on which deferred tax must be recognised (12.20).



Consolidation

Compare the group carrying value with the tax base.

Temporary differences may be affected by:• Elimination of inter-company items • Fair value adjustments – eg on acquisition of a subsidiary• Unification of accounting policies.



Question 1



Temporary differences can be …..

• taxable differences - giving rise to deferred tax liabilities; or

• deductible differences - giving rise to deferred tax assets (12.5)



Measurement –

the exceptions to the rule



Specific Exemption - Initial recognition

The tax effect of all temporary differences arising on initial recognition of an asset or liability which:

• is not a business combination

• at the time of the transaction, affects neither accounting profit nor taxable profit/loss,

should not be recognised (12.15).



Initial recognition of assets and liabilities

Related to abusiness combination?

At the time of the transaction,affects accounting profitor taxable profit (tax loss)?

Don’t recognise DTA/DTL

Recognise DTA/DTL

Yes

No

No


Yes


Initial recognition …..

Question 2

Saloon Car



Saloon car – part 2



Revaluations …..

Revaluations of property, plant and equipment increase the carrying amount of an asset without affecting the tax base.

The resulting change in the temporary difference has not arisen on initial recognition. Therefore the deferred tax must be recognised (12.20).



Specific Exemption - Goodwill

No deferred tax liability shall be recognised in respect of goodwill arising in a business combination for which impairment is not deductible for tax purposes (12.15(b)).



Measurement – Applicable rate



The applicable rate …..



Tax base of asset/liability (X)


@applicable tax rate X%

Deferred tax asset/liability X


Expected manner

The measurement of deferred tax assets and liabilities should reflect the tax consequences that follow from the manner in which the enterprise expects to recover or settle the respective asset or liability (12.51).



Rate to be applied …..

Deferred tax assets and liabilities should be computed at the rate expected to apply in the period when the asset is realised or the liability settled, based on rates enacted or substantively enacted at the balance sheet date (12.46).



Example of origination and reversal of temporary differences - PPE

A

B

Carrying value = A

Tax base = B

Taxable temporary ___

difference = C

===

C1Provide via profit and loss account at income tax rates

Value

Carrying value

Tax base

Time

Cost

C2C3



Examples

Examples 7 & 8



Measurement - discounting

Deferred tax assets and liabilities should not be discounted (12.53).



Question 3



Recognition



Recognition …..

All deferred tax liabilities should be recognised, except on goodwill and temporary differences subject to the initial recognition exception (12.15).

Deferred tax assets should be recognised to the extent that it is probable that taxable profit will be available against which the deductible temporary difference (including carry forward tax losses) can be utilised (12.24).

Annual reassessment is required (12.37).



Recognition …..

Tax losses

The existence of tax losses is strong evidence that future taxable profit may not be available – there therefore has to be convincing evidence that it will be available (12.35).



Question 4 and 5



Presentation and disclosure



Presentation ….

Deferred tax should be recognised in the profit and loss account except where the transaction giving rise to the asset or liability is recognised directly in equity, or from a business combination (12.58): eg

• prior year adjustments

• revaluation surpluses

• “excess” depreciation.



Offsetting ….

Deferred tax assets and liabilities may be offset only if:• The entity has a legally enforceable right to set off current tax

assets against current tax liabilities• The deferred tax assets and liabilities relate to income taxes

levied by the same tax authority on the same taxable entity (12.74).



Disclosure in the notes to the profit and loss account…..

Definition: Tax expense is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax (12.5).

The components of the tax expense should be disclosed eg

• current tax

• deferred tax movement

• prior period under/over provision

• deferred tax asset not previously recognised (12.79).



Also …..

• Tax relating to discontinued operations (12.81(h)).



And …..

….. a reconciliation of:

• the tax expense, to

• the accounting profit multiplied by the applicable tax rate

The “proof of tax” (12.81(c)).



Proof of tax


Tax computationAccounting profit X

Add back: items not tax deductible in period (X)

Sub total X

Deduct: non-taxable income and allowances X

Taxable profit X


Proof of tax


Tax computation

Tax effect

Accounting profit X

Adjustment for permanent differences X

Sub total X

Origination and reversal of temporary differences X

Taxable profit X A?


Proof of tax


Tax computation

Tax effect

Accounting profit X

Adjustment for permanent differences X

Sub total X C?

Origination and reversal of temporary differences X B?

Taxable profit X Current tax


Proof of tax


Tax computation

Tax effect

Accounting profit X D

Adjustment for permanent differences X E

Sub total X Tax expense

Origination and reversal of temporary differences

X Deferredtax mvt



Proof of tax


Tax computation

Tax effect

Accounting profit X D

Adjustment for permanent differences X E

Sub total X Tax expense

Origination and reversal of temporary differences X Deferredtax mvt


Proof of tax

Proof of tax


Question 6



Example …..


Accounting profit 1,200,000

Tax at applicable rate of 30% 360,000Tax effect of:

Expenses not allowed for tax purposes 60,000

Income not subject to tax (80,000)Effect of change of tax rate on deferred tax

liability(20,000)

Prior period over-provision (10,000)

Tax expense 310,000


And in the notes to the balance sheet …..

• The movement of gross deferred tax assets and liabilities analysed by category of temporary difference (12.81(g))

• The evidence supporting recognition of deferred tax assets if the entity is making losses (12.82)

• The amount of temporary differences and unused tax losses for which no deferred tax asset is recognised (12.81(e)).



Case study



Exposure draft – Income TaxIssued on 31 March 2009 …

• … has been abandoned, but unfortunately was ‘borrowed’ for the IFRS for SMEs



IFRS for SMEs – Income tax

• No initial recognition exemption, other than for goodwill, but• Section 29.3(c): “the tax basis of assets and liabilities is

determined by the consequences of sale of the assets …”• Section 29.24: “an entity shall measure current and deferred

tax … using the probability-weighted average amount of all the possible outcomes, assuming that the tax authorities will review the amounts reported and have full knowledge of all relevant information”

• all deferred tax assets should be recognised and then a valuation allowance is used, if necessary.




Conflict:

Section 29.3(c): “the tax basis of assets and liabilities is determined by the consequences of sale of the assets …”

Section 29.20: “the measurement of deferred tax … shall reflect the consequences that would follow from the manner in which the entity expects … to recover … the carrying amount of the related assets …”




Gobbledegook:

Section 29.32(b): an entity shall disclose “an explanation of the significant differences in amounts presented in the statement of comprehensive income and amounts reported to tax authorities”

Which amounts – Revenue? Expenses?

Surely what was meant was: “an explanation of the significant differences between the effective tax rate and the applicable statutory tax rate”?



Amendment to IAS 12 – Recovery of underlying assets

• Issued 20 December 2010• Effective for accounting periods beginning on or after 1

January 2012• Introduces the presumption that the carrying value of an

investment property carried at fair value is recovered entirely through sale

• The presumption is rebutted if the investment property 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.



Conclusion

IAS 12 is a rule based standard:

• Rule 1: Deferred tax = (carrying amount - tax base) x applicable tax rate.


Thank you!Thank you!

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