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Taxation
IAS 12 Income taxes
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Main types of taxation
Taxation as costs to the company
Social security charges
Local/regional taxes National corporate income taxes
Taxation on behalf of a third party
Value added tax
VATtax on consumer and not the company
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Taxation as costs
Social Security charges contributions from employer and employees
contribution to pension schemes
Private vs state pensions
Local/Regional Charges
Splitting corporate taxes:
Municipality/council
Regional political unit
National Government
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Taxation as costs (cont.)
National Corporate Income tax
Common type of taxmost visible
Government raise funds through this tax
Can be used to encourage or penalise company
behaviour
Calculation of this tax depends on the tax rules vs
accounting rules
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Value added tax
Imposed on customers at each stage of a productsvalue-added chain, based on the value added at thatpoint
Gross amount of VAT on sales and on purchases is
netted in the accounting system and net amount ispaid periodically to the tax authorities (VAT receivedfrom customers less VAT paid to suppliers)
Not part of revenue or expenses, but included in
receivables and payables (cash flow effect) Credit transactions and payment of VAT. Cash
payment for VAT before customers can pay.
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Corporate income tax
Income tax payable = Taxable profit
Tax rate (e.g. 30%)
Taxable profit is not equal to pre-tax accountingprofit - (difference between Accounting profit and tax profit)
Differences?Some expenses are not allowed tax-wise (entertaining,fines, excess depreciation, excess provisions, etc.)
Special tax allowances (for capital investment,
environmental protection, etc.)Income that is non-taxable
Deferred taxes arise from these differences
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Taxation of dividends
Problem of potential double taxation of dividendsdue to concurrent corporate and personal taxation
Solutions: Profits paid to shareholders are taxed at a lower rate
than those retained in the company, or
Tax credit on the dividend for shareholders
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Deferred taxation
Deferred taxes
Income statement perspective on deferred taxes
Balance sheet perspective on deferred taxes
Presentation of deferred taxes in the financial
statements
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Deferred taxes
Differences between objectives of measuring(accounting) profit for financial reporting purposesand basic tax raising motives of measuring taxable
profit
Accounting rules regarding income taxes:
Tax effects of transactions are recognised in the financial
statements in the same period as the related businesstransactions themselves
Current income tax cost (taxable profit * nominal taxrate) is only part of these tax effects
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Deferred taxes (cont.)
Income statement:deferred tax cost(or benefit)complements current tax cost
Statement of financial position:deferred tax assetsand deferred tax liabilitiesreflect future taxconsequences of transactions that were not treatedidentically for taxation and financial reporting
purposes
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Income statement perspective on
deferred taxes
Reconciliation statement - two types of differences:
Permanent differences
Timing differences
Timing differences arise because the timing of
income and expenses in the income statement
occurs in different period from taxable profit
Timing differences arise in one period and reverse inone or more subsequent periods
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Income statement perspective on
deferred taxes
Permanent differences
Arise because tax authorities do not permit some
expenses as deduction from profits
E.g. fines,
Entertainment
Holding board meetings in holiday resorts
Expensive consumption and supplies to management
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IllustrationTax deductible accelerated
depreciation
Purchase of a fixed asset (P10,000) with tax incentive(accelerated depreciation) in 2011
Useful life = 2 years and no residual value Depreciation
Financial statements: 5,000 in 2011 and in 2012
Tax calculation: 10,000 in 2011 and 0 in 2012
Pre-tax profit of 20,000 in 2011 and 2012 and taxrate of 50 per cent
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IllustrationIncome tax calculation
2011 2012
Pre-tax profit(includes depreciation expense)
20,000 20,000
Timing difference(accelerated depreciation)
- 5,000 + 5,000
Taxable profit 15,000 25,000
Tax due at 50% 7,500 12,500
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or
IllustrationIncome tax calculation
2011 2012
Pre-tax profit 20,000 20,000
Add back depreciation 5,000 + 5,000
Deduct Capital allowance -10,000 0TaxableProfit 15,000 25,000
Tax due at 50% 7,500 12,500
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IllustrationIncome statement effect
without deferred taxes
2011 2012
Pre-tax profit 20,000 20,000
Corporate income taxes
due
- 7,500 - 12,500
Net profit after tax 12,500 7,500
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IllustrationIncome statement
effect including deferred taxes
2011 2012
Pre-tax profit 20,000 20,000
Total tax expense:
Taxes due
Deferred tax expense
Deferred tax income
-7,500
- 2,500
-12,500
+2,500
Net profit after tax 10,000 10,000
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IllustrationDeferred taxes on the
statement of financial position
Deferred tax expense => Deferred tax liability
Indicates that profit in the financial statements has in the
past been higher than for tax purposes Liability: reflects future taxation on the difference
postponement of tax payments to future periods
At reversal of timing difference: Deferred tax income in income statement
Settlement of deferred tax liability
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Alternative illustrationProvision not
accepted for tax purposes
Deferred tax income => Deferred tax asset
Indicates that profit in the financial statements has in the
past been lower than for tax purposes Asset: reflects future tax savings on the differencetaxes
paid, but recoverable in future periods
At reversal of timing difference:
Deferred tax expense in income statement
Use of deferred tax asset
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Balance sheet perspective on deferred
taxes
Deferred taxation based on balance sheet values
Temporary differences: differences between
balance sheet values and tax values of assets and
liabilities
Tax value (tax base) = the amount at which the asset
or liability is recognised for tax purposes
Temporary differencesare broader than timingdifferences
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IAS 12 Income taxes
Two types of temporary differences:
Taxable differencesthat result in deferred tax liabilitiestaxable amounts in determining taxable profit of futureperiods
Deductible differencesthat result in deferred tax assetsamounts that are deductible in determining taxable profitin future periods
Deferred tax asset / liability is measured as the
temporary difference multiplied by the tax rate(applicable when asset is realised or liability issettled)
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Illustration - Tax deductible
accelerated depreciation (repeat)
2011 2012
(a) Accounting balances
Asset carrying amount 1 January
Additions
Accounting depreciation
Asset carrying amount 31 December
0
10,000
-5,000
5,000
5,000
0
-5,000
0
(b) Tax values
Asset tax base 1 January
AdditionsTax depreciation
Asset tax base 31 December
0
10,000-10,000
0
0
00
0
(c) Tempo rary di fferenc es 5,000 0
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Illustration - Tax deductible accelerated
depreciation
Temporary difference of 5,000 in 2011
Taxable or Deductible ?
Tax base of asset < Book value of asset
Future accounting depreciation will be higher than tax depreciation
Future taxes due will be higher than expected on accounting profit=> Taxable temporary difference
Deferred tax liability of 2,500 (50 per cent tax rate)
Deferred tax expense of 2,500
Reversal in 2012
Settlement of deferred tax liability
Deferred tax income of 2,500
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Presentation of deferred taxes in financial
statements
Separate presentation of deferred tax assets(liabilities) in statement of financial position
Classified as non-current items
Tax expense (income) related to ordinary activities
presented on the face of the income statement Additional disclosures in the notes:
Details on major components of tax expense
Numerical explanation of relationship between tax
expense and accounting profit Details on temporary differences and related deferred tax
assets and liabilities
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Transfer pricing
Transfer pricesare the prices at which goods and serviceschange hands between subsidiaries of a group
Artificially fixing transfer prices is a way of determining whereprofits are taxed
Double tax treaties usually state that transfer prices must
be at arms length or at market rates
Intra-group charges (like royalties for use of intellectualproperty and interest charges) are also usually structuredaccording to a tax treaty
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Offshore financial centres
Near relatives of a tax haven, but benefit from
double tax treaties with major trading countries
The corporate tax they levy is sufficiently high for
developed countries not to treat them as a tax
haven, but sufficiently low so as still to be attractive
to companies
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Tax havens
Tax havenstypically offer low tax or flat rate tax forcompanies which are resident but whose activitiesare external to the haven (off-shore) Frequently used by a MNC to provide international
services (like finance, insurance) to the group
Do not generally benefit from tax treaties with othercountries
Costs are not negligible and substantial throughout isneeded to create tax savings
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