IAS 12 Income Taxes

This briefing document summarizes the main themes and important ideas or facts presented in the provided sources related to IAS 12 Income Taxes.

1. Core Concepts of Deferred Tax

• Temporary Differences: The foundation of deferred tax accounting lies in temporary differences, which arise when the carrying amount of an asset or liability in the financial statements differs from its tax base.
• “A taxable or deductible temporary difference arises when the carrying amount of an asset or a liability differs from its tax base.”
• These differences are “temporary” because they will reverse in one or more future periods.
• Tax Base: The tax base of an asset is the amount deductible for tax purposes against taxable economic benefits when the asset’s carrying amount is recovered. If the economic benefits are not taxable, the tax base equals the carrying amount.
• “‘…the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount’ (IAS 12.7).”
• The tax base of a liability is its carrying amount less any amount deductible for tax purposes in future periods related to that liability. For revenue received in advance, it’s the carrying amount less any portion of the revenue not taxable in the future.
• “‘…its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is 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’ (IAS 12.8).”
• Deferred Tax Liabilities and Assets: Taxable temporary differences result in deferred tax liabilities (future tax payable), while deductible temporary differences result in deferred tax assets (future tax recoverable).
• “A taxable temporary difference gives rise to a deferred tax liability. A deductible temporary difference gives rise to a deferred tax asset.”
• Deferred tax assets also arise from unused tax losses carried forward.
• “Deferred tax assets also arise from unused tax losses that tax law allows to be carried forward…”
• Deferred tax is accounted for in accordance with IAS 12.

2. Recognition of Deferred Tax Assets

• A deferred tax asset is recognized for deductible temporary differences and unused tax losses only when it is probable that sufficient future taxable profits will be available against which these can be utilized.
• “Therefore, an entity recognises deferred tax assets only when it is probable that taxable profits will be available against which the deductible temporary differences can be utilised.”
• “entity recognises deferred tax assets only when it is probable that taxable profits will be available against which the deductible temporary differences can be utilised.”
• The existence of unused tax losses is strong evidence that future taxable profit may not be available, requiring careful assessment by management and auditors.
• “The existence of unused tax losses is strong evidence that future taxable profit may not be available”.
• Questions to consider include the probability of future taxable profits before the losses expire and whether the losses resulted from non-recurring identifiable causes.
• When assessing the availability of taxable profits, entities consider whether tax law restricts the sources of taxable profits against which deductions can be made upon the reversal of deductible temporary differences.
• “When an entity assesses whether taxable profits will be available against which it can utilise a deductible temporary difference, it considers whether tax law restricts the sources of taxable profits against which it may make deductions on the reversal of that deductible temporary difference.”
• If no such restrictions exist, a combined assessment of all deductible temporary differences relating to the same taxation authority and entity is performed. If restrictions apply (e.g., capital losses offsettable only against capital gains), the assessment is done in combination with other deductible temporary differences of that specific type.
• The assessment of probable future taxable profit generally excludes the effects of reversing the deductible temporary differences themselves or taxable amounts arising from deductible temporary differences expected to originate in future periods.
• “(i) compares the deductible temporary differences with future taxable profit that excludes tax deductions resulting from the reversal of those deductible temporary differences.”
• “(ii) ignores taxable amounts arising from deductible temporary differences that are expected to originate in future periods, because the deferred tax asset arising from these deductible temporary differences will itself require future taxable profit in order to be utilized.”

3. Measurement of Deferred Tax

• Deferred tax liabilities and assets are measured using the tax rates expected to apply when the asset is realized or the liability is settled, based on tax rates and laws enacted or substantively enacted by the end of the reporting period.

4. Presentation of Deferred Tax

• Current tax assets and liabilities are generally offset if there is a legally enforceable right to set off the amounts and the intention to settle on a net basis.
• Deferred tax assets and liabilities are offset if, and 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 taxation authority on either the same taxable entity or different taxable entities with the intention to settle current tax amounts net or realize assets and settle liabilities simultaneously in future periods.
• If deferred tax assets and liabilities relate to different taxable entities within a group, offsetting is only permitted if they intend to settle current tax amounts net or simultaneously realize assets and settle liabilities, which is generally the case for entities in a tax group filing consolidated returns.

5. Specific Scenarios and Considerations

• Decrease in Fair Value of Debt Instruments: A decrease in the fair value of a debt instrument may create a deductible temporary difference. The utilization of this difference depends on the availability of probable future taxable profits.
• Leases: Upon initial recognition of a right-of-use asset and a lease liability under IFRS 16, entities assess whether temporary differences arise to determine the need for deferred tax recognition.
• Decommissioning and Restoration Liabilities: Amendments to IAS 12 address deferred tax related to decommissioning, restoration, and similar liabilities and the corresponding amounts recognized as part of the cost of the related asset.
• Investment Property: Changes in the fair value of investment property are generally recognized in profit or loss, which can impact taxable profit and the tax base of the asset.
• Minimum Tax Regimes: In jurisdictions with minimum tax provisions (e.g., Pakistan), the relationship between accounting profit and taxable profit may become less relevant. The applicability and calculation of deferred tax under such regimes require careful consideration. Some argue that the concept of timing differences may not apply if a company consistently pays minimum tax.
• Investments in Subsidiaries, Branches, and Associates: Deferred tax liabilities are generally recognized for all taxable temporary differences associated with these investments. An exception applies if the parent/investor can control the timing of the reversal and it’s probable the difference will not reverse in the foreseeable future. Deferred tax assets are recognized for deductible temporary differences to the extent it is probable they will be utilized.
• Compound Financial Instruments: The tax base of the liability component of a compound financial instrument upon initial recognition may equal the initial carrying amount of both the liability and equity components, leading to a taxable temporary difference arising from the separate recognition of the equity component.
• Employee Benefits (e.g., Share-based Payments): Temporary differences can arise between the carrying amount of employee benefits and their tax base, leading to deferred tax assets or liabilities.
• Revaluations of Non-Current Assets: Revaluations creating a surplus in equity can also lead to taxable temporary differences, with the related tax charge often being recognized directly in equity to align with the matching principle.
• Group Accounts: In preparing group accounts, the carrying value refers to the consolidated carrying value, while the tax base is determined based on the individual entities’ tax bases. A group itself is not a legal entity subject to tax, so consolidation involves cross-casting individual tax assets and liabilities.
• Impact of International Tax Reforms (Pillar Two Model Rules): The IASB has issued amendments to IAS 12 to address the accounting for income taxes arising from the OECD’s Pillar Two model rules, which introduce a global minimum tax.

6. Importance of Prudence and Judgement

• The recognition of deferred tax assets relies on the probability of future taxable profits, requiring significant judgment and consideration of various factors, including past performance, future projections, and tax planning opportunities.
• Entities with a history of losses must have strong reasons to believe that the conditions causing those losses will not recur to justify the recognition of a deferred tax asset.
• In some cases, entities may choose not to recognize deferred tax assets due to prudence, even if temporary differences exist.

This briefing document highlights the key aspects of IAS 12 discussed in the provided sources. For a comprehensive understanding, refer to the full text of the standard and related interpretations.