IAS 12 – Income Taxes
IAS 12 prescribes the accounting treatment of, the measurement for, recognition and disclosure for income taxes. This standard also deals with the recognition of deferred tax assets arising on tax losses or tax credits.
Tax issues arise on transactions resulting in the recovery of assets in future or settlement of liabilities as well as transactions of the existing period.
For example, a fixed asset recovers through use and this is reflected in the transaction “depreciation”. IAS 12 deals with the current impact of tax on this depreciation both in the current year and in future years.
If the impact of future transactions is such that it results in a tax expense in future, a deferred tax liability (DTL) will be created in the financial statements.
Conversely, if the impact of future transactions is expected to result in a tax income or refund (or a reduction in tax), then a deferred tax asset (DTA) is recorded in the financial statements with limited exceptions (will be discussed in detail in coming sections).
This accounting standard requires the tax effects of transactions to be recognized in the same manner the transactions have been recognized.
For example, if a transaction is accounted for in an Entity’s Statement of Profit or Loss, its tax effect will also be included in the Statement of Profit or Loss. Similarly, if a transaction is recorded in “Statement of Other Comprehensive Income”, its related tax effect will also be included in “Statement of Other Comprehensive Income”. For transactions recognized in equity, their tax impact will also be recorded directly in the equity.
This standard is applicable for the accounting of income taxes.
Income taxes are those which are levied on taxable income of a particular period including both domestic and foreign taxes. These also include taxes which are payable by a subsidiary, associate, or a joint venture on distributions (e.g. payment of dividends) to the reporting entity.
This standard does not deal with the accounting for the government grants under IAS 20 or investment tax credits. However, it deals with accounting for temporary differences arising on such grants or investment tax credits.
Accounting Profit is the profit for a period before income tax.
Taxable Profit is the profit for a financial period calculated according to the rules established by the income tax authority on which income tax will be payable.
Taxable Loss is the loss for a financial period calculated according to the rules and regulations established by the income tax authority on which income tax credit will be obtained or which will be adjusted against the profit of future periods.
Tax Expense is the expense arising on accounting profit or loss for a financial period and it includes both current tax expense and deferred tax expense.
Tax Income is the benefit arising on accounting profit or loss for a financial period and it includes both current tax income and deferred tax income.
Note: it is not necessary that tax expense arises on taxable profit and tax income arises on taxable loss because the treatment of certain transactions is entirely different in tax laws.
Current Tax is the income tax expense (or income) arising on taxable income or loss for a period.
Deferred Tax Liabilities are expected tax liabilities arising on certain transactions or balances to be settled in future when these transactions realize or actualize in accordance with tax laws. Such liabilities arise in respect of taxable differences.
For example, a fixed asset is recorded in accounting books at a net book value of AED 4,000. However, as per tax laws, its net book value is AED 3,000. This is because tax laws have allowed more depreciation in past period than accounting depreciation. Hence, in future, there will be less tax depreciation than accounting depreciation, which means more taxable income than accounting income (as less amount of depreciation will be deducted against taxable income and more depreciation against accounting income).
This will result in more tax expense in future than a tax based on accounting income. Hence a liability exists to pay more tax in future called as deferred tax liability (DTL).
Deferred Tax Assets (DTA) are the assets arising from certain transactions which will result in some tax benefits (for example low tax) in future. These types of assets arise from:
- Deductible temporary differences;
- Unused tax credits and losses.
Temporary Differences are the differences arising on transactions between their accounting treatments and tax treatments and such differences become nil at some point in time.
For example, carrying value of accrued income differs in tax and accounting treatment if tax only recognizes actual income and not accrued income. However, once this income is realized, tax will also account for this income and their carrying amounts will become equal.
Temporary Differences are of two types:
- Deductible Temporary Differences are those differences which result in less or reduced tax expense (or give rise to tax income) in financial periods in which carrying amounts of assets or liabilities are realized.
- Taxable Temporary Differences are those differences which result in more tax expense in financial periods in which carrying amounts of assets or liabilities are realized.
Tax Base is the carrying value of a liability or asset in accordance with tax laws and standards.
Tax Base of an Asset
This can be described as the amount that will be subject to deduction against economic benefits that are expected to flow to the Entity when the carrying value of the asset is recovered.
In case, the said benefits are not taxable then in such a scenario the asset’s tax base will be equivalent to its carrying value.
An item of furniture and fixture is purchased recently and has a cost of AED 500. For tax purposes, the whole amount of cost i.e. AED 500 is deductible in the form of depreciation against future taxable profits arising from the use of such asset i.e. through revenue generation. Hence, the base of this asset from the tax point of view is AED 500.
Tax depreciation is 20% on a straight line. At the end of year 1, a depreciation of AED 100 will be charged against taxable profit. Hence at the end of year 1, carrying value of the asset for tax authorities will become AED 400. At end of year 1, we will say that the asset’s tax base is AED 400, because this is the amount as of today that will be deductible (as depreciation) in future against economic benefits generated by the asset (such economic benefits mean that asset will be used to generate revenue for the Entity which is taxable).
If, however, revenue generated by this asset and the profit on disposal are not taxable as per tax laws, then we will take the tax base equal to carrying value at each point. The purpose is to make difference between carrying amount and tax base zero, so that no deferred tax asset or liability arises on such asset.
Let’s assume that the carrying value of an Entity’s interest receivable is AED 5,000. As per tax, interest is taxed only on a cash basis i.e. when received. Hence, there is no amount that can be deducted against this interest revenue in future. So, the taxable base of interest receivable is Zero.
However, if this interest revenue is not taxable, then the second part of definition applies. That is “when the economic benefits of an asset are not taxable”, its tax base will become the same as it’s carrying value. So in such cases, tax base of interest receivable would be AED 5,000.
Standard has come up with this definition to record DTL or DTA only on such assets which have future tax consequences, for example, tax will be paid on these assets or tax benefit will be received.
Deferred liability or asset is recorded on the net difference between the carrying value of an asset and its liability.
In the case of interest receivable, in the first case (interest is taxable when it will be received), the Entity will have to pay a tax in future when this interest is received. So there exists a DTL for this asset.
If we analyze the same in accordance with definition, it should also result in the same tax liability i.e.
|Carrying value of interest receivable||AED 5000|
|Less: Tax base of interest receivable||(AED 0)|
|DTL (AED 5,000 *30% tax rate)||AED 150|
Similarly, in the second scenario when interest is not taxable, there should be no tax consequence i.e. zero tax. If by the above definition, it is analyzed, it should also give a zero tax. As the carrying amount and tax base of interest receivable are equal in this case, there will be a difference of zero between the two and hence tax effect will be zero.
Trade receivables amount to AED 2,000. The related revenue has already been included in income statement and tax has been paid on this amount.
According to second part of definition of tax base of an asset, that, if economic benefits are not taxable then the carrying value of an asset is equal to its tax base.
In this case, this amount of AED 2,000 when received will not be subject to tax as the related revenue has already been subject to tax which means that these economic benefits are not taxable in future. Hence the tax base of this asset is AED 2,000.
Tax base is now equal to its carrying value of AED 2,000 which will give zero difference between the two. Accordingly, no deferred liability or asset will be recorded on this asset as there is no future expected tax benefit or expense against this amount.
Dividends receivable from a subsidiary has a carrying value of AED 5,000. The dividends are not taxable.
Thus, the benefits are not taxable. According to second part of definition, the tax base of this asset should be equal to its carrying value i.e. AED 5,000.
This will result in no difference between the carrying amount and tax base, as both are same and hence there will be zero tax i.e. no tax liability or asset.
A loan receivable has a carrying value of AED 2,000. This is the principal portion only and does not include interest income. The repayment of this interest will not result in any tax consequences, as it will not be the part of income or expense.
Hence, based on the 2nd part of definition, where an asset has no tax consequences, its tax base should be equal to its carrying value i.e. AED 2,000.
The difference between carrying amount and tax base will be zero as both are same and hence tax consequence will also be zero as per definition.
However, if this loan also includes interest income of AED 500, which is taxable on receipt basis, then there should be tax payable on this amount in future when interest will be received. Accordingly, a tax liability exists today on this amount.
In this case, the first part of definition will apply, and second part no longer remains applicable as economic benefits are now taxable.
According to the first part, the tax base should be the amount that will be subject to deduction against any taxable economic benefits that are expected to flow to the Entity in the future financial periods. There will be no amount that will be subject to deduction against this interest income of AED 500, hence the tax base of this interest receivable is zero.
Therefore, the net difference between the accounting and tax base will be AED 500, upon which deferred liability will be recorded at applicable tax rate.
Tax Base of a Liability
The tax base of advance received from customer (advance revenue) and other liabilities are defined separately.
|Tax base of a liability (other than revenue received in advance):|
|The carrying value of the liability||XXX|
|Less: Any amount that will be subject to deduction for tax purposes||(XXX)|
|Tax base of the liability||XXX|
|Tax base of advance received from the customer:|
|The carrying value of advance received from the customer||XXX|
|Less: Any amount of revenue that will not be taxable in future||(XXX)|
|Tax base of the liability||XXX|
An accrued expense has a carrying value of AED 750. For tax purposes, this expense will be deductible only when it will be paid (i.e. on cash basis). What is the tax base of this accrued expense?
|Tax base of accrued expense:||AED|
|Carrying value of accrued expense||750|
|Less: Any amount that will be subject to deduction for tax purposes in relation to accrued expense in future||(750)|
|Tax base of accrued expense||–|
Amount that will be subject to deduction in accordance with the applicable tax laws and standards will be the actual expense that will be paid in future. Once this is paid, it will be deducted from taxable profit to arrive at final taxable profit on which tax will be calculated and paid.
Interest revenue received in advance has a carrying value of AED 400. This interest revenue was taxed on cash basis when it was received. What is the tax base of Interest revenue received in advance?
|Carrying value of Interest Revenue||400|
|Less: Any amount of revenue that will not be taxable in future||(400)|
|Tax base of Interest Revenue||–|
Since, all interest has been taxed in advance when it was received, so there is no amount that will be taxable in future. Hence, the amount of AED 400 is not taxable.
Accrued expenses have a carrying amount of AED 5,000. When this expense was recorded, it was already deducted in tax books as well to arrive at taxable profit. What is the tax base of this accrued expense?
|Tax base of accrued expense:||AED|
|Carrying amount of accrued expense||5,000|
|Less: Any amount that will be subject to deduction in accordance with tax laws and standards in respect of accrued expense in future||–|
|Tax base of the accrued expense||5,000|
Accrued traffic fines imposed by traffic authority are AED 2,400 as recorded in the books. As per tax regulations, these expenses are not allowed in calculating taxable income. What is the tax base of accrued fines?
|Tax base of accrued fines:||AED|
|Carrying amount of accrued fines||2,400|
|Less: Any amount that will be deducted in respect of accrued fines in future||–|
|Tax base of the liability||2,400|
When this tax base will be matched against the carrying value of accrued expense which is the same, and the difference between carrying amount and tax base having zero value will result into nil deferred tax as there is no tax impact of this transaction (i.e. there is no tax payable or recoverable on this transaction in current or future periods).
Items that have a Tax Impact but not Recognized in the Balance Sheet
Some items do not appear in the balance sheet, but they have a deferred tax impact. For example, costs incurred on research under IAS 38 are not recognized as an intangible asset and are expensed out when incurred. However, in certain jurisdictions, they may be included in the carrying value of asset which will have a tax impact in future when this asset will be amortized.
Accordingly, a deferred tax will result into such transaction and need to be recorded in the financial statements.
Tax Base of Items Included in Consolidated Financial Statements
In case if tax is applicable based on consolidated financial statements, the tax base will be calculated based on such tax laws applicable to the consolidated financial statements.
If, however, tax is based on separate financial statements and consolidation adjustments do not matter in tax laws, then tax base will be calculated on the tax laws applicable to such separate transactions.
The consolidated financial statements include accrued expense of AED 1,500 that have been shown net of inter-subsidiary transactions of AED 500 (Total accrued expenses before the adjustment were AED 2,000). As per tax laws, tax is payable on consolidated FS and related adjustments (i.e. inter-subsidiary net offs) are applicable for tax laws. However, the expenses will only be allowed when paid.
The tax base of accrued expense will be:
|Carrying amount of accrued expense||1,500|
|Less: Any amount that will be deductible for tax purposes in respect of accrued expense in future||(1,500)|
|Tax base of the liability||0|
However, if tax is applicable on separate financial statements and consolidation adjustments are not allowed as per tax laws, then tax base will be calculated on the numbers of separate financial statements of all subsidiaries and parents and the related DTA or DTL will be simply added together for consolidated Financial Statements.
As defined earlier, current tax means tax on taxable income payable to tax authorities on profit for a particular period.
If this tax is not paid at year end (at the time it becomes due), it will be recognized as a tax liability in the financial statements. However, if tax paid is more than that is due or otherwise paid in advance, then a current tax asset will be recorded.
A tax asset shall also be recognized against tax losses that can be brought forward to future periods for adjustment against taxable income subject to certain conditions that will be discussed later.
A DTL will be recognized for all taxable differences. As the name suggests, such differences are taxable. Simply explained, the taxable temporary differences are those that will result in more tax in future.
For example, the carrying value of an asset is more than its tax base, meaning that in future more depreciation will be charged as per accounting which will ultimately lead to less income in future periods. However, tax will allow less depreciation (due to lower tax base) and hence taxable profit will increase in comparison to accounting profit. This will result in more tax in future.
Exceptions for Non-recognition of Deferred Tax Liability
There are a few exceptions on which no deferred tax will be recorded on taxable temporary differences. These include:
- No deferred tax will be recorded on Goodwill when it is initially recorded.
- No deferred tax will be recorded on such assets and liabilities when they are initially recorded that does not arise on business combinations and such transaction does not affect accounting profit or tax profit.
An example of part (b) is an asset which has a cost of AED 6,000 as per accounting. However, as per tax laws, this full value is not allowed and only a maximum of AED 4,000 is allowed to be deducted in the form of depreciation. This normally occurs in cases when tax authorities want to limit the use of certain luxury items such as vehicles. This transaction results in an initial difference of AED 2,000 between tax base and carrying amount. However, as per exception above, no deferred tax will be recorded on this asset on initial recognition.
In future, however, there may be differences between the depreciation rates in tax and accounting. This will result in recognition of deferred tax on this asset in future but only relating to the amount of AED 4,000.
An intangible asset has a cost of AED 5,000 at the start of year 1. The useful life of asset is 4 years. Accounting amortization rate is 25% while it is 50% as per tax laws. Tax rate is 10%. What will be the deferred tax at each year?
At the date of recognition, the variance between tax base and carrying amount is nil. So, no deferred tax is recorded at the date of recognition of this asset. However, there will exist a difference at year end due to difference in amortization expense in tax and accounting, which will result in a taxable temporary difference and a deferred liability will be recorded.
|Accounting Carrying Amount||Tax base|
|Year End||Opening||Amortization @ 25%||Closing||Opening||Amortization @ 50%||Closing||Temporary Difference||Deferred Tax Liability @ 10%|
At each year end, the carrying value is higher than tax base. The tax has allowed major amortization in the first year and there is no amortization in last two years. While for accounting a smaller amount than tax is charged in each year. This resulted in a taxable temporary difference in each year meaning that more tax will be paid in future (in future depreciation will be more but will not be allowed by tax so tax profit will increase as compared to accounting profit, resulting in more tax expense). Hence a deferred tax liability is recorded for these differences.
Examples of Temporary Differences Arising due to Timing
Interest receivable arises in the accounting books as interest is recognized on effective interest method, however, tax regulations may require this recognition based on collection. So, if an interest receivable is appearing in the books, there will be no tax base against this amount. Hence, a taxable difference will arise in future when this amount will be received i.e. tax will increase in future.
Deferred Tax on Business Combinations
When a business is acquired in accordance with IFRS 3, all liabilities and assets of acquiree are fair valued at the acquisition date. But tax normally does not take into account the treatment under IFRS 3 and instead as per tax assets and liabilities have their tax bases as they appear in the books of subsidiary i.e. fair value is not taken into consideration.
This gives rise to temporary differences and accordingly DTL or DTA is recorded for these.
Company Z acquired a subsidiary X. Out of many assets acquired is a PPE item. This item was fair valued to AED 2,500 on consolidation. However, as per tax it has a tax base of AED 2,000 which has not changed due to fair valuation. Find out DTL or DTA in consolidated FS if the tax rate is 25%.
Answer: Difference between tax base and fair value (i.e. the carrying value) is AED 500 meaning this cost will be depreciated in future i.e. expensed in accounting but not allowed in tax. So, tax profit will increase and hence tax will also increase.
So, a tax liability of AED 125 (500*25%) will be recorded in the consolidated books against this asset.
Other Fair Valuations (Other than Business Combinations)
Deferred tax on other assets carried at fair values such as investment properties, financial assets, property and equipment under revaluation model etc. are accounted for as follows:
- If the tax also takes into account the fair values, then no difference will arise and hence no additional deferred tax will be recorded.
- In cases, tax authorities do not take into account fair valuations, in those cases a deferred tax will arise and be recorded accordingly.
Treatment of Deferred Tax Arising on Goodwill
Tax authorities normally do not consider goodwill and hence it has no tax base. Accordingly, a carrying value of goodwill less a nil tax base results into a taxable temporary difference, but this standard requires NOT to recognize deferred tax on goodwill on initial recognition.
Subsequently, in such cases, if goodwill is impaired, even then no deferred tax is recognized as this is considered to arise from initial recognition of goodwill and also tax authorities do not consider goodwill in their books.
However, if the tax authorities consider goodwill and recognized the same amount as tax base as is the carrying value in the books, initially no deferred tax arises. Subsequently, if the tax authorities amortize this goodwill, then a temporary difference will arise as the accounting books do not depreciate goodwill and rather impair it, if required. A deferred tax will be recorded for this difference as it is not arising from initial recognition of goodwill but arises from different amortization rate and treatment in the tax.
Treatment of Deferred Tax Arising on Compound Financial Instruments
Deferred tax on compound financial instruments that are broken into equity and liability component is initially recorded in equity and subsequently it is recorded in the Entity’s income statement.
Deductible Temporary Differences
A DTA shall be recognized for all the deductible differences when it is probable that profit will be available in future that can be utilized against such temporary differences to get economic benefits.
Unused Tax Credits and Losses
A DTA can be recorded for unused tax credits and losses if tax laws allow the use of use tax credits and carry forward of tax losses and it is probable that in future, profit will be available that can be used to absorb these losses to get economic benefit in the form of decrease in tax.
The carrying value of tax asset shall be reviewed at each reporting period to assess if it is still recoverable. If it is not recoverable, necessary adjustments will be made to reflect the amount that can be recovered against this asset.
Recognition of Deferred and Current Tax
Income tax is recognized in profit or loss. Deferred tax is recognized with reference to the asset, liability or equity to which it pertains.
Presentation and Disclosure
DTAs and DTLs can only be offset if there is a legal right to do so and it is intended to be settled on net basis.
An Entity shall present tax expense separately from other expenses in P&L.
A reconciliation of tax expense will be presented which reconciles tax rates as per authorities with effective tax.