Ch8-IncomeTaxes

8/13/2019 Ch8-IncomeTaxes

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Chapter 8 Income Taxes

LEARNING OBJECTIVES

1. Define current tax and the recognition of current tax liabilities and assets under IAS

12.

2. Describe the concept of tax base, temporary differences and permanent differences.

3. Understand the purpose of proiding for deferred tax.

!. "a#e the proision for deferred tax on the full proision basis.

$. %xplain the re&uirements of IAS 12 in respect of accounting for deferred tax.

' e c o g n i t i o n (

" e a s u r e m e n t

D e f i n i t i o n

) u r r e n t

* a x

* a x

+ a s e

' e c o g n i t i o n " e a s u r e m e n t

* e m p o r a r y

D i f f e r e n c e s

e r m a n e n t

D i f f e r e n c e s

D e f i n i t i o n

D e f e r r e d

* a x

I n c o m e

* a x

1-


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1. Current Tax !

1.1 /ormally, current tax is recogni0ed as income or expense and included in the net

profit or loss for the period.

1.2 "easurement o# current tax $%a&%$%t%es assets!for the current and prior periods is

ery simple. *hey are measured at the amount expecte' to &e pa%' to reco(ere'

#rom! the tax author%t%es. *he tax rates and tax las used should be those enacted

by the balance sheet date.

1.3 IAS 12 re&uires any unpa%' tax in respect of the current or prior periods to be

recogni0ed as a $%a&%$%t).

1.! )onersely, any excess taxpaid in respect of current or prior periods oer hat is due

should be recogni0ed as an asset.

1.$ Examp$e 1

In 2412, A+) )o had taxable profits of 5124,444. In preious year income tax on

2411 profits had been estimated as 534,444.

Re*u%re'+

)alcualte tax payable and the charge for 2412 if the tax due on 2411 profits as

subse&uently agreed ith the tax authorities as6

a 53$,444

b 52$,444

Any under or oer payments are not settled until the folloing year7s tax payment is

due. *ax rate is 348.

So$ut%on+a

5

*ax due on 2412 profits 5124,444 9 348 3,444

Underpayment for 2411 $,444

*ax charge and liability !1,444

1--


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b

5

*ax due on 2412 profits 5124,444 9 348 3,444

:erpayment for 2411 $,444*ax charge and liability 31,444

1. *a#ing this a stage further, IAS 12 also re*u%res reco,n%t%on as an asset o# the

&ene#%t re$at%n, to an) tax $ossthat can be carr%e' &ac- to reco(er current taxof a

preious period. *his is acceptable because it is probable that the economic benefit

ill flo to the enterprise and it can be reliably measured.

1.- Examp$e

In 2411 A+) )o paid 5$4,444 in tax on its profits. In 2412 the company made tax

losses at 52!,444. *he local tax authority rules allo losses to be carried bac# to

offset against current tax of prior years. *ax rate is 348.

Re*u%re'+

Sho the tax charge and tax liability for 2412.

So$ut%on+

*ax repayment due on tax losses ; 2!,444 9 348 ; 5-,244.

*he


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from the carrying amount.

d /e#erre' tax $%a&%$%t%esare the amounts o# %ncome taxes pa)a&$e %n #uture

per%o'sin respect of taxable temporary differences.

e /e#erre' tax assetsare the amounts o# %ncome taxes reco(era&$e %n #utureper%o'sin respect of6

a Deductible temporary differences

b *he carry forard of unused tax losses

c *he carry forard of unused tax credits

2.2.2 T2o t)pes o# temporar) '%##erences

a A taxa&$e temporar) '%##erence

ill result in an %ncrease %n%ncome tax pa)a&$ein future reporting periods, and gies rise to a 'e#erre'

tax $%a&%$%t).

b A 'e'uct%&$e temporar) '%##erence ill result in a 'ecrease %n

%ncome tax pa)a&$ein future reporting periods, and gies rise to a 'e#erre'

tax asset.

2.2.3 %xamples of taxable temporary differences

a *ransactions affecting the income statement6i Interest reenue receied in arrears, included in the accounting profit

on a time apportionment basis but taxable on a cash basis.

ii Depreciation of an asset is accelerated for tax purposes.

iii Deelopment costs hae been capitali0ed and ill be amortised to the

income statement but ere deducted for tax purposes as incurred.

i repaid expenses hae already been deducted on a cash basis for tax

purposes but are to be charged in the income statement in a later

period.

b *ransactions affecting the statement of financial position

i )urrent inestments are carried at fair alue hich exceeds cost but

remain at cost for tax purposes.

ii /on>current assets are realued upards for accounting purposes ith

no ad


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b *he net reali0able alue of an item of inentory, or the recoerable amount of

an item of property, plant or e&uipment, is less than the preious carrying

amount and an enterprise therefore reduces the carrying amount of the asset,

but that reduction is ignored for tax purposes until the asset is sold.

c 'esearch costs or organi0ation or other start up cost are recognised as an

expense in determining accounting profit but are not permitted as a deduction

in determining taxable profit until a later period.

d Income is deferred in the statement of financial position but has already been

included in taxable profit in current or prior periods.

.3 T2o &as%c pr%nc%p$es #or IAS 1

2.3.1 T2o &as%c pr%nc%p$es

a *he #%rst pr%nc%p$e relates to the issue of 2hether or not a 'e#erre' tax

$%a&%$%t)4asset ex%sts. *his principle states that if it is pro&a&$e that reco(er)

or sett$ement o# the carr)%n, amount o# an asset or $%a&%$%t) ill ma-e

#uture tax pa)ments $ar,er or sma$$erthan they ould be if such recoery

or settlement ere to hae no tax conse&uences, then a 'e#erre' tax $%a&%$%t)

or asset shou$' &e reco,n%5e', ith certain limited exceptions. *hus6

i if an item is accounte' #or %n )ear one, but ill be taxe' or taxdeductible %n )ear t2oor in any subse&uent years, then, a 'e#erre'

tax $%a&%$%t)4assetmust be accounte' #or %n )ear one@

ii if an item is accounted for in year one, and ill be taxed or tax

deductible in year one, then, a tax payable or tax receiable should be

accounted for in year one@ and

iii if an item is accounte' #or %n )ear one, and ill not &e taxe'or tax

deductible, then, there is no tax e##ect to &e accounte' #or.

b *he secon' pr%nc%p$e relates to the issue of ho2 the e##ect o# 'e#erre' tax

shou$' &e accounte' #or. *his principle states that an entity should account

for the e##ect o# the 'e#erre' tax $%a&%$%t)4asset %n the same 2a) that it

accounts #or the un'er$)%n, transact%on or e(ent. *hus, the deferred tax

effect ill be6

i reco,n%5e' as %ncome or expenseand included in profit or loss for the

period, if the un'er$)%n, transact%onor eent is reco,n%5e' %n pro#%t

or $ossfor the period@

ii recogni0ed outs%'e pro#%t or $oss either in other comprehensie

income or directly in e&uity, if the un'er$)%n, transact%onor eent is

1=1


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recogni0ed in the same or a different period, outs%'e pro#%t or $oss@

and

iii recogni0ed as an a'6ustment to ,oo'2%$$if the underlying transaction

or eent ar%ses #rom a &us%ness com&%nat%on.

.7 Reasons #or reco,n%5%n, 'e#erre' tax

2.!.1 If a deferred tax liability is ignored, profits are inflated and the obligation to pay an

increased amount of tax in the future is also ignored. *he argument for recogni0ing

deferred tax are summari0ed belo.

a *he accruals concept re&uires tax to be matched to profits as they are earned.

b *he deferred tax ill eentually become an actual tax liability.

c Ignoring deferred tax oerstates profits, hich may result in6

i oer>optimistic diidend payments based on inflated profits,

ii distortion of earnings per share and of the priceearnings ratio, both

important indicators of an entity7s performance,

iii shareholders being misled.

2.!.2 Examp$e 3

rofits before taxation of A+) Btd for each of the years 2411 and 2412 ere5324,444. *he profits tax rate as 248 in both years. In 2411, plant purchases

amounted to 5244,444. *he rate of depreciation as 2$8 per annum on cost. Cor tax

purposes an initial alloance of 1448 of cost is gien in the year of purchase.

Scenar%o 1+ ABC Lt' accounts #or current taxes on$) %.e. n%$ pro(%s%on or #$o2

throu,h metho'!

Assuming that there are no other differences, taxable profits ill be calculated as

follos6

2411 2412

5 5

rofit before taxation 324,444 324,444

Add6 Depreciation $4,444 $4,444

3-4,444 3-4,444

Bess6 Initial alloance 244,444 >

*axable profit 1-4,444 3-4,444

1=2


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*ax on 248 3!,444 -!,444

rofit after tax ill be arried as follos6


Bess6 roision for taxation 3!,444 -!,444

rofit after taxation 2=,444 2!,444

It may be noticed that though the company7s pro#%t &e#ore tax 2as exact$) the same

%n the t2o )ears, the '%##erence %n the pro#%t a#ter tax %s s%,n%#%cant.

IAS 12 is based on the idea that the 534,444 5-!,444 53!,444 reduction in tax in

2411 is only a temporary gain a liability for it does arise in 2411 but it is deferred

until the three later years in hich the tax charge is increased.

Scenar%o 1+ ABC Lt' pro(%'es #or 'e#erre' tax

In this example, let us assume that A+) Btd does not plan to buy any plant in 2413

and 241! and that the profit before tax and taxation rates are the same in those years.

Eiing effect to the re&uirements of IAS 12, the profit after tax ill be calculated as

follos6

5 5 5 5


Bess6 roision for taxation

> )urrent 3!,444 -!,444

> Deferred 34,444 14,444

!,444 !,444

rofit after taxation 2$,444 2$,444

)alculation of deferred tax based on temporary differences6

*ax alue Accounting alue Difference

5 5 5

:n purchase 244,444 244,444 >

Fear end

2411 4 1$4,444 1$4,444

2412 4 144,444 144,444

2413 4 $4,444 $4,444

1=3


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+eing release of deferred tax at 248 of reersing temporary difference of

5$4,444

17 /r. 0! Cr. 0!Deferred tax Statement of financial position 14,444

Deferred tax Income statement 14,444

+eing release of deferred tax at 248 of reersing temporary difference of

5$4,444

It may be noticed that at the end of 241!, the balance on the deferred tax account is

reduced to nil.

3. Reco,n%t%on o# /e#erre' Tax

3.1 Reco,n%t%on pr%nc%p$e

3.1.1 Reco,n%t%on pr%nc%p$e o# 'e#erre' tax

a a 'e#erre' tax $%a&%$%t) shall be reco,n%5e' #or a$$ taxa&$e temporar)

'%##erences@

b a 'e#erre' tax asset shall be reco,n%5e' #or a$$ 'e'uct%&$e temporar)'%##erences to the extent that it is pro&a&$e that taxa&$e pro#%t 2%$$ &e

a(a%$a&$eagainst hich the deductible temporary difference can be utili0ed.

3.1.2 IAS 12 adopts the #u$$ pro(%s%on metho'of proiding for deferred tax.

3.1.3 *he folloing sections discuss ho deferred tax liability or asset is recogni0ed or not

recogni0ed on temporary differences arising from each of the folloing sources6

+ a l a n c e

S h e e t

I t e m s

' e a l u a t i o n

o f

A s s e t s

C a i r G a l u e

A d < u s t m e n t s

o n + u s i n e s s

) o m b i n a t i o n

E o o d 2 i l l

A r i s i n g f r o m

+ u s i n e s s

) o m b i n a t i o n

I n i t i a l

' e c o g n i t i o n

o f A s s e t (

B i a b i l i t y

I n e s t m e n t

i n

S u b s i d i a r i e s ,

A s s o c i a t e s , e t c .

' e c o g n i t i o n

1=$


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3. Temporar) '%##erences ar%s%n, #rom &a$ance sheet %tems

3.2.1 "ost o# the taxa&$e temporar) '%##erences an' 'e'uct%&$e temporar) '%##erences

ar%sebecause of the '%##erence &et2een the carr)%n, amount an' the tax &ase o#

assets an' $%a&%$%t%esin the statement of financial position.

(a) Tax base of assets

3.2.2 IAS 12 proides that the tax base of an asset is the amount that ill be deductible for

tax purposes against any taxable economic benefit that ill flo to an entity hen it

recoers the carrying amount of the asset.

3.2.3 Examp$e 7 9 Non:current assets

A Btd ith 31 December accounting year>end bought a machinery at a cost of

5344,444 on 1 Hanuary 2411.

Cor accounting purposes, the cost of the machinery is to be depreciated using the

straight>line method oer fie years.

Assume that tax rules allo the cost of the machinery to be claimed oer three years

commencing 2411 on straight>line method.

In the aboe case, the carrying amount of the machinery ill be as follos6

At 31 December 24116 52!4,444

At 31 December 24126 51=4,444

At 31 December 24136 5124,444

At 31 December 241!6 54,444

At 31 December 241$6 5nil

oeer, the tax base of the machinery ill be as follos6

At 31 December 24116 5244,444

At 31 December 24126 5144,444

At 31 December 24136 5nil

)omparing the carrying amount and the tax base of the machinery ill yield the

1=


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folloing taxable temporary differences and deferred tax liabilities, assumes that the

tax rate is 2$86

;ear Carr)%n,amount

Tax &ase Taxa&$e temporar)'%##erence

/e#erre' tax$%a&%$%t%es

2411 2!4,444 244,444 !4,444 14,444

2412 1=4,444 144,444 =4,444 24,444

2413 124,444 4 124,444 34,444

241! 4,444 4 4,444 1$,444

241$ 4 4 4 4

3.2.! Examp$e < 9 Interest %ncome

+ Btd ith 31 December accounting year>end recogni0es interest income on accrual

basis.

:n 31 December 2412, + Btd accrues for an interest income receiable of 5144,444.

Cor tax purposes, the %nterest %s taxa&$e on a cash &as%s.

In the aboe case, the tax &ase o# the %nterest rece%(a&$e account %s 0n%$ . *his is

because for tax purposes the interest receiable account does not exist, since the

interest is taxed hen receied.

)omparing the carrying amount and the tax base of the interest receiable account

ill yield a taxa&$e temporar) '%##erenceof 5144,444 5144,444 nil as at 31

December 2412.

Assuming a tax rate of 2$8, the aboe temporar) '%##erenceill gie rise to a

'e#erre' tax $%a&%$%t) o# 0 9 Tra'e rece%(a&$e

) Btd has recorded a trade receiable account of 5244,444 in its statement of

financial position as at 31 December 2412 arising from sales for the year.

Cor tax purposes, the sales has been included in the computation of taxable profit for

the year.

1=-


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In this case, the tax &aseof the trade receiable account is 0=.

Since the carr)%n, amount o# the tra'e rece%(a&$e account e*ua$s %ts tax &ase ,there is n%$ temporar) '%##erences. Accordingly, there ill be no 'e#erre' tax

$%a&%$%t)4assetas at 31 December 2412.

3.2. Examp$e ? 9 Loan rece%(a&$e

D Btd as a loan receiable account of 5$44,444 in its statement of financial position

as at 31 December 2412.

Under the tax ru$es, the granting and su&se*uent repa)ment o# the $oan has no tax

conse*uences.

In this case, since the $oan %s not taxa&$e, the tax &ase o# the $oan rece%(a&$e

amount is deemed to be e*ua$ to %ts carr)%n, amount o# 0


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3.2.? Examp$e @ 9 Accrua$s on cash &as%s

A+) Btd has an accrued expense payable account of 514,444 in its statement of

financial position as at 31 December 2412.

Cor tax purposes, the related expense ill be 'e'uct%&$e on cash &as%s.

In this case, the tax &ase o# the accrue' expense pa)a&$e account %s 0n%$carrying

amount of 514,444 less deductible amount of 514,444.

)omparing the carrying amount and the tax base of the accrued expense payable

account ill yield a 'e'uct%&$e temporar) '%##erenceo# 01=514,444 5nil as

at 31 December 2412.

Assuming a tax rate of 2$8, the aboe temporary difference ill gie rise to a

'e#erre' tax asset o# 0=


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3.2.12 Examp$e 11 9 Re(enue %n a'(ance

EI Btd has a rent receied in adance account of 514,444 in its statement of

financial position as at 31 December 2412.

Cor tax purposes, the renta$ %ncome 2as taxe' on cash &as%s.

In this case, the tax &aseof the rent receied in adance account is 0n%$ carrying

amount of 514,444 less amount not taxable in the future of 514,444.

)omparing the carrying amount and the tax base of the rent receied in adance

account ill yield a 'e'uct%&$e temporar) '%##erence o# 01=514,444 5nil as

at 31 December 2412.

Assuming a tax rate of 2$8, the aboe temporar) '%##erence 2%$$ ,%(e r%se to a

'e#erre' tax asset o# 0=


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J' Btd has a loan payable account of 514,444 in its statement of financial position

as at 31 December 2412.

Cor tax purposes, the ra%s%n, repa)ment o# the $oanhae no tax conse*uences.In this case, since the loan has no tax conse&uences, the tax &ase o# the $oan

pa)a&$e account %s 'eeme' to &e e*ua$ to %ts carr)%n, amount o# 01=.

*here is thus no temporar) '%##erence, and conse&uently, no 'e#erre' tax

$%a&%$%t)4asset.

(c) Tax base of other items

3.2.1 It should be notes that an item can hae a tax base ithout appearing as an asset or

liability in the statement of financial position.

3.2.1- Examp$e 17 9 Research expense

A+ Btd has commenced a ne research pro


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Deferred tax liability $44,444

During the year 2412, the folloing ere charged to income statement6

a depreciation expenses of 514,444,444@

b proision for doubtful debt of 5$44,444@ and

c proision for arranty of 544,444.

oeer, for tax purposes, the folloing items ere deductible6

a capital alloances of 513,444,444@

b actual bad debt of 544,444@

c actual arranty expenses of 5!44,444.

*here as no other moement for the releant accounts and their respectie balances

as at 31 December 2412 ill be as follos6

a carrying amount of machinery of 534,444,444 tax ritten don alue of

522,444,444@

b proision for doubtful debt of 51,?44,444@ and

c proision for arranty of 51,244,444.

In this case, the temporary differences of KFL Btd as at 31 December 2412 may be

computed as follos6

)arrying

amount

*ax base *emporary

differences

5444 5444 5444

"achinery 34,444 22,444 =,444

roision for doubtful debt 1,?44 > 1,?44

roision for arranty 1,244 > 1,244/et taxable temporary differences !,?44

Assuming a tax rate of 2$8, the deferred tax liability for KFL Btd as at 31 December

2412 is 51,22$,444 5!,?44,444 9 2$8.

Eien that the deferred tax liability as at 31 December 2411 as 5$44,444, it shall be

increased credited by 5-2$,444 to arrie at the balance of 51,22$,444 to be shon

in the balance sheet as at 31 December 2412. *he


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account ill be as follos6

/r. 0! Cr. 0!

*ax expense (B -2$,444

Deferred tax liability -2$,444

1?!


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3.3 Temporar) '%##erence ar%s%n, #rom re(a$uat%on o# assets

3.3.1 Under the on, on, tax ru$es, re(a$uat%on o# an %tem o# propert)= p$ant an'

e*u%pment under IAS 1 does not a##ect the tax &ase o# the asset and the

re(a$uat%on surp$us %s not taxa&$ein the period of realuation. oeer, assuming

the future recoery of the carrying amount ith result in an inflo of taxable

economic benefits to the entity and the amount that ill be deductible for tax purpose

ill differ from the amount of those economic benefits, the difference beteen the

carrying amount of a realued asset and in tax base is a temporary difference.

3.3.2 Examp$e 1> 9 Re(a$uat%on o# assets

A+ Btd ac&uires a piece of land as an inestment property in 2411 at a cost of

514,444,444. :n 31 December 2412, the land is realued to 512,444,444. Assume

that hen the inestment property is sold, the profit thereof ill attract tax at a rate of

2$8.

In this case, hen the land is realued, it gies rise to a temporary difference of

52,444,444, being the difference beteen the carrying amount of 512,444,444 and

the tax base of 514,444,444. Alternatiely, under the first principle, hen the land is

realued and subse&uently recoered at 512,444,444, it ill gie rise to a taxable

profit of 52,444,444 and an additional tax to be paid, and therefore a deferred tax

liability should be recogni0ed at the date of realuation. *hus, a deferred tax liability

of 5$44,444 52,444,444 9 2$8 should be recogni0ed.

Applying the second principle, since the realuation surplus is recorded directly in

realuation resere, the deferred tax liability should similarly be ta#en directly to

realuation resere.

)onse&uently, the realuation in 2412 ill be recorded as follos6

Dr. 5 )r. 5

Band 2,444,444

'ealuation resere 2,444,444

'ealuation resere $44,444


Subse&uently, ho the deferred tax liability is accounted for depends on hether or

1?$


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not the gain on sale of land is taxable.

Scenar%o I

Assume that the land is sold in 2413 for 513,444,444, and the profit thereof attractstax at the rate of 2$8.

In this case, the taxable profit ill be 53,444,444 513,444,444 514,444,444, and

the tax payable ill be 5-$4,444 53,444,444 9 2$8. oeer, the accounting

profit ill only be 51,444,444 513,444,444 512,444,444, and the tax expense

thereof shall be 52$4,444 51,444,444 9 2$8.

*he


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)ash 13,444,444

Band 12,444,444

IS Eain on sale of land 1,444,444

*o record gain on sale of land

Dr. 5 )r. 5


'ealuation resere $44,444

*o record the reersal of the deferred tax liability preiously proided for.

Dr. 5 )r. 5

'ealuation resere 2,444,444

'etained profit 2,444,444

*o record reali0ation of realuation surplus.

3.7 Temporar) '%##erence ar%s%n, #rom #a%r (a$ue a'6ustments

3.!.1 As proided for in IC'S 3, in a business combination, the cost of the business

combination is allocated to the identifiable assets ac&uired and liabilities assumed by

reference to their fair alue at the ac&uisition date commonly referred to as fair alue

ad


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3..2 *hese transactions may affect either accounting profit or taxable profit. Cor example,

interest, royalty or diidend reenue receiable is included in accounting profit on a

time apportionment basis but is included in taxable profit tax loss on a cash basis.

)osts of intangible assets are capitali0ed and amortised but are deductible for tax

purposes hen they are incurred.

3..3 If the transaction a##ects e%ther account%n, pro#%t or taxa&$e pro#%t, an entity

reco,n%5es an) 'e#erre' tax $%a&%$%t) or assetand recogni0es the resulting deferred

tax expense or income.

3..! In some cases, initial recognition of these asset or liability may a##ect ne%ther

account%n, pro#%t nor taxa&$e pro#%t. Cor example, prepayments of expenses

recogni0ed may be deductible in determining the taxable profit tax loss of future

periods only hen the prepayments are recogni0ed as an expense in future periods.

Some items of property, plant or e&uipment may not &ualify for tax depreciation and

no deduction ill be aailable for tax purposes hen the assets are sold or scrapped.

:n %n%t%a$ reco,n%t%on of these assets, temporar) '%##erences ar%se. oeer,

ne%ther account%n, pro#%t nor taxa&$e pro#%t %s a##ecte'. Cor such temporary

differences, IAS 12 'oes not perm%t an ent%t) to reco,n%5ethe resulting 'e#erre'

tax $%a&%$%t) or asset, either on initial recognition or subse&uently.

3..$ Examp$e 18

A Btd bought a building at a cost of 514,444,444 on 1 Hanuary 2411. *he building is

to be depreciated oer its useful life of 2$ years, using the straight>line method.

Cor tax purposes, the building does not &ualify as an Nindustrial buildingO, and

conse&uently, no capital alloances may be claimed on the building, and on disposal,

any capital gainloss ill hae no tax conse&uences.

In this case, een though there is a temporary difference of 5?,44,444 carrying

amount of 5?,44,444 and tax base of 5nil on 31 December 2411, no deferred taxliability is recogni0ed.

Similarly, on 31 December 2412, no deferred tax liability is recogni0ed for the

temporary difference of 5?,244,444 on the building, because it results from initial

recognition of an asset.

*he same applies to all subse&uent periods.

1??


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amount of the inestment i.e. the parent7s share of the net assets including goodill

becomes different from the tax base often the cost of the inestment. Phy do these

differences ariseQ *hese are some examples6

a *here are un'%str%&uta&$e pro#%tsheld by subsidiaries, branches, associates

and


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!.1 *he Inland 'eenue :rdinance I': proides that losses incurred in one period may

be carried forard to subse&uent periods sec 1?)!.

!.2 oeer, sec 1+ proides that the losses may be disregarded unless the

)ommissioner of Inland 'eenue is satisfied that the shareholders hae remained

substantially the same oer the years.

!.3 It should be noted that there is no $%m%t to the t%me per%o'for hich the $osses can

&e carr%e' #or2ar'.

!.! Examp$e

A Btd suffered a loss of 5144,444 in 2411, and made a profit of 5344,444 in 2412

assuming no temporary differences and therefore the accounting profit or loss is

e&ual to tax profit or loss

Cor 2411, A Btd ould hae no tax payable because there as no taxable profit.

Cor 2412, A Btd ould hae a taxable profit of 5244,444, after offsetting the tax loss

of 5144,444 carried forard from 2411 against the profit of 5344,444 in 2412.

Assuming a tax rate of 2$8, A Btd ould hae a tax payable of 5$4,444.

It may be noted that, ithout the loss in 2411, A Btd ould hae a tax payable of

5-$,444 5344,444 9 2$8 instead of 5$4,444 in 2412. *he tax loss of 5144,444 in

2411 gies rise to a tax saing of 52$,444 in 2412.

It may be appreciated, hoeer, that if A Btd does not ma#e any profit in all the years

subse&uent to 2411 before it is ound up, then the benefit relating to the tax loss of

5144,444 in 2411 ill neer be reali0ed.

*hus, there is a benefit relating to the tax loss but the reali0ation of the benefit is

contingent upon sufficient income being made in subse&uent periods.

!.$ IAS 12 proides that a 'e#erre' tax asset shall be reco,n%5e' #or $oss carr%e'

#or2ar' to the extent that it is pro&a&$e that #uture taxa&$e pro#%t 2%$$ &e

a(a%$a&$e a,a%nst 2h%ch the $oss carr%e' #or2ar' can &e ut%$%5e'.

!. *o the extent that it is not probable that future taxable profit ill be aailable against

hich the loss carried forard can be utili0ed, the deferred tax asset is not recogni0ed.

!.- *he folloing is an illustration for a case here deferred tax asset is recogni0ed for

loss carried forard to the extent that it is probable that future taxable profit ill be

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aailable against the loss carried forard can be utili0ed.

!.= Examp$e 1

A Btd commenced operation in 244- and has been operating profitably. It sufferedloss of 5144,444 in 2411 due to labour disputes. Assume there ere no temporary

differences such that the accounting loss is e&ual to tax loss, and a tax rate of 2$8.

*he labour dispute has been settled toards the end of 2411, and the company

expected to operate profitably again in year 2412 and beyond.

In this case, it may be argued it is probable that future taxable profit ill be aailable

against hich the loss forard can be utili0ed. A deferred tax asset in relation to the

loss and the related tax benefit is recogni0ed in 2411.

/r. 0! Cr. 0!

Deferred tax asset 2$,444

*ax credit 2$,444

*o record tax saing to the loss for the year.

Assume that A Btd made a profit of 5344,444 for the year ended 31 December 2412

Assume further there ere no temporary differences such that the accounting loss is

e&ual to tax loss, and a tax rate of 2$8.

*he forard

*he aboe entries could, in fact, be combined as follos6

/r. 0! Cr. 0!

*ax expense -$,444


*ax payable $4,444

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*he releant accounts ill be shon in the 2411 and 2412 financial statements of A

Btd as follos6

Income statements2411 2412

5444 5444

rofitloss before tax 144 344

*ax expensecredit 2$ -$

rofitloss after tax -$ 2$$

Statement o# #%nanc%a$ pos%t%on

2411 2412

5444 5444

Asset

Deferred tax asset 2$

Biability

*ax payable $4

/ote that, in financial accounting, the term Ntax creditO is simply the opposite of

Ntax expenseO@ it does not carry the same meaning as the term Ntax creditO under the

I':.

!.? *he #o$$o2%n, examp$e is an illustration for a case here it is not pro&a&$e that

#uture taxa&$e pro#%t 2%$$ &e a(a%$a&$e a,a%nst 2h%ch the $oss carr%e' #or2ar' can

&e ut%$%5e', and conse&uently, the 'e#erre' tax asset %s not reco,n%5e'.

!.14 Examp$e

+ Btd commenced operation in Hanuary 2411, and suffered a loss of 5144,444 for the

year ended 31 December 2411.

/o deferred tax asset and related tax benefit is recogni0ed in 2411. *he tax saing

relating to the 5144,444 loss in 2411 is accounted for only in the years in hich it is

reali0ed.

Assume that + Btd made a profit of 5344,444 for the year ended 31 December 2412.

In this case, the tax saing relating to the 5144,444 loss in 2411 ill be recogni0ed in

2412.

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*he $4

rofitloss after tax 144 2$4

Statements o# #%nanc%a$ pos%t%on

2411 2412

L%a&%$%t) 5444 5444

*ax payable > $4

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!.11 Eenerally, here an entity has been operating profitably in the past years and the

current year loss is None>offO, it may be argued that it is probable that future taxableprofit ill be aailable against hich the loss carried forard can be utili0ed, and

therefore deferred tax asset in relation to the tax loss is recogni0ed in the year of loss,

as shon in %xample 21 aboe.

!.12 :n the other hand, in cases here an entity has a history of recent losses, it ill be

difficult to argue that it is probable that future taxable profit ill be aailable against

hich the loss carry>forard can be utili0ed, and therefore the tax benefit in relation

to the tax loss is recogni0ed only in the year in hich the benefit reali0ed, as shon in

%xample 22 aboe.

!.13 oeer, if the entity has taxable temporary differences in the year of loss, IAS 12

proides that entity should recogni0e a deferred tax asset arising from the loss carried

forard to the extent of the temporary differences. *he rationale for the re&uirement

is that the taxable temporary differences ill, upon reersal, result in taxable amount

against hich the loss carried forard can be utili0ed.

!.1! Examp$e 3

) Btd commenced operation in 244=, and has been incurred losses. *he cumulatie

loss as at 31 December 2412 is 5144,444. In 2412, the company bought a computer,

and as at 31 December 2412, there is a taxable temporary difference of 5124,444 in

relation to the computer. *he releant tax rate is 2$8.

In this case, the company ill hae to first recogni0e a deferred tax liability in

relation to the taxable temporary difference, as follos6

Dr. 5 )r. 5

*ax expense 34,444

Deferred tax liability 34,444

*he company shall also recogni0e a deferred tax asset in relation to the loss carried

forard, gien that there is sufficient taxable temporary difference against hich the

loss can be utili0ed, as follos6

Dr. 5 )r. 5


*ax credit 2$,444

24


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a(era,e rates that are expected to apply to the taxable profit tax loss of the periods

in hich the temporary differences are expected to reerse.

$.$ In some countries, the ay in hich an entity reco(ers or sett$esthe carrying amount

of an asset or liability may affect the folloing.

a the tax rate applying hen the entity recoerssettles the carrying amount of

the assetliability@

b the tax base of the assetliability.

In such cases, the entity must consider the expected manner of recoery or settlement.

Deferred tax liabilities and assets must be measured accordingly, using an

appropr%ate tax rate an' tax &ase.

$. Examp$e . Share:&ase' a)ment Transact%ons an' /e#erre' Tax

.1 An entity is re&uired to recogni0e an expense in relation to share options oer the

esting period. *he related tax deduction is not, hoeer, receied until the options

are exercised.

.2 In addition the accounting expense is based on the fair alue of the options at the

grant date, hereas the tax alloable expense is based on the share price at the

exercise date.

.3 *here is therefore a deferred tax implication. *his is also true of other forms of share>

based payments here the tax deduction differs from the cumulatie remuneration

expense.

.! *he deductible temporary difference is measured as6

5

)arrying amount of share>based payment expense K

Bess6 *ax base of share>based payment expense estimated amount tax

authorities ill permit as a deduction in future periods, based on year

end information K

*emporary difference K

Deferred tax asset at K8 K

.$ If the amount of the tax deduction or estimated future tax deduction exceeds the

amount of the related cumulatie remuneration expense, this indicates that the tax

deduction relates not only to remuneration expense but also to an e&uity item. In this

situation, the excess of the associated current or deferred tax shall be recogni0ed in

other comprehensie income.

. Examp$e >Bamar )o has the folloing share option scheme at 31 December 24116

Director7s

/ame

Erant date :ptions

granted

Cair alue

of options

at grant date

%xercise

price

Gesting date

5 5

/ Fip 1 Han 2414 24,444 2.$4 3.-$ Dec 2411

D )han 1 Han 2411 ?4,444 2.$4 !.$4 Dec 2413

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*he price of the company7s shares at 31 December 2411 is 5- per share and at 31

December 2414 as 5-.$4 per share.

*he directors must be or#ing for Bamar on the esting date in order for the options

to est.

/o directors hae left the company since the issue of the share options and none are

expected to leae before December 2413. *he shares can be exercised on the first day

of the month in hich they est.

In accordance ith IC'S 2 an expense of 52$,444 has been charged to profits in the

year ended 31 December 2414 in respect of the share option scheme. *he cumulatie

expense for the to years ended 31 December 2411 is 512$,444.

*ax alloances arise hen the options are exercised and the tax alloance is based

on the option7s intrinsic alue at the exercise date.

Assume a notional tax rate of 1 per cent.

Re*u%re'+

Phat are the deferred tax implications of the share option schemeQ

So$ut%on+

Fear to 31 December 2414

5

Cair alue 24,444 9 5-.$4 9 12 -$,444%xercise price of option 24,444 9 53.-$ 9 12 3-,$44

Intrinsic alue estimated tax deduction 3-,$44

Deferred tax asset at 18 ,444

*he cumulatie remuneration expense is 52$,444, hich is less than the estimated

tax deduction of 53-,$44. *herefore6

A deferred tax asset of 5,444 is recognised in the statement of financial position

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*here is deferred tax income of 5!,444 2$,444 9 18

*he excess of 52,444 goes to e&uity

Fear to 31 December 24115

Cair alue 24,444 9 5-.$4 1$4,444

?4,444 9 5- 9 13 214,444

34,444

%xercise price of options

24,444 9 53.-$ -$,444

?4,444 9 5!.$4 9 13 13$,444

Intrinsic alue estimated tax deduction 1$4,444

Deferred tax asset at 18 2!,444

Bess6 reiously recogni0ed ,444

1=,444

*he cumulatie remuneration expense is 512$,444, hich is less than the estimated

tax deduction of 51$4,444. *herefore6

A deferred tax asset of 52!,444 is recognised in the statement of financial

position at 31 December 2411.

*here is potential deferred tax income of 51=,444 for the year ended 31

December 2411.

:f this, 51,444 R18 9 512$,444 52$,444 is recognised in the income

statement.

*he remainder 52,444 is recognised in e&uity.

?. Amen'ments to IAS 1 D/e#erre' Tax+ Reco(er) o# n'er$)%n,

AssetsF

-.1 *he amendments is applicable for annual periods beginning on or after 1 Hanuary

2412.

-.2 *he amendments proide a pract%ca$ approach #or measur%n, 'e#erre' tax

$%a&%$%t%es an' 'e#erre' tax assets hen %n(estment propert) %s measure' us%n,

the #a%r (a$ue mo'e$in IAS !4 NInestment ropertyO.

-.3 Under IAS 12, the measurement o# 'e#erre' tax $%a&%$%t%es an' 'e#erre' tax assets

'epen's onhether an ent%t) expects to reco(er an asset6

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a by us%n,it@ or

b by se$$%n,it.

-.! oeer, it is often difficult and sub


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Ch8-IncomeTaxes

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