IAS 12 INCOME TAXES

1 INTRODUCTION

The objective of IAS 12 is to prescribe the accounting treatment for income taxes. Income taxes include all domestic and foreign taxes which are based on taxable profits and also include taxes, such as withholding taxes, which are payable by a subsidiary, joint venture or associate on distributions to the reporting entity (IAS 12.2).

This chapter consists of two main areas:

• Accounting treatment of current tax, which is the amount of income taxes payable with respect to the taxable profit for the current period (see Section 2).
• Accounting treatment of deferred tax, i.e. of future tax advantages and disadvantages (see Section 3).

2 CURRENT TAX

The entity calculates the amount of current tax payable on the basis of taxable profit for the period (taxable profit · tax rate = current tax payable). Current tax for current and prior periods is, to the extent unpaid, recognized as a liability. If the amount already paid relating to current and prior periods exceeds the amount due for those periods, the excess is recognized as an asset (IAS 12.12).

Current tax liabilities (current tax assets) are measured at the amount expected to be paid to (recovered from) the taxation authorities on the basis of the tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period (IAS 12.46).

Current tax is normally recognized in profit or loss. However, to the extent that the tax arises from a transaction or event that is recognized outside profit or loss, i.e. either in other comprehensive income or directly in equity, the relating tax is recognized in the same way. Moreover, if the tax arises from a business combination, it is neither recognized in profit or loss, nor in other comprehensive income (IAS 12.58 and 12.61A).1

Current tax assets and current tax liabilities have to be offset if the entity has a legally enforceable right to set off the recognized amounts and intends either to settle on a net basis or to realize the asset and settle the liability simultaneously (IAS 12.71–12.73).

3 DEFERRED TAX

3.1 The Logic Behind Recognizing Deferred Tax

The recognition of deferred tax in the statement of financial position may be necessary with respect to temporary differences, the carryforward of unused tax losses, and the carryforward of unused tax credits.

Temporary differences are differences between the carrying amount of an item for tax purposes (its tax base) and its carrying amount according to IFRS which will result in future tax advantages or disadvantages for the entity. Temporary differences resulting in future tax advantages are referred to as “deductible temporary differences,” whereas those resulting in future tax disadvantages are called “taxable temporary differences” (IAS 12.5). Temporary differences that meet the recognition criteria2 are multiplied by the tax rate and recognized as a deferred tax asset (if the difference represents a future tax advantage) or as a deferred tax liability (if the difference represents a future tax disadvantage).

Conceptionally, there is the presumption that the carrying amount for tax purposes will increase or decrease to the carrying amount according to IFRS in the future. It is assumed that the difference between these carrying amounts will affect taxable profit when the carrying amount of the asset or liability is recovered or settled. Assume that the carrying amount of a piece of land is CU 10 according to IFRS and CU 8 for tax purposes. A fictitious sale of the land for CU 10 (i.e. at the carrying amount according to IFRS) would result in a gain of CU 2 under the applicable tax law. Hence, the entity's taxable profit would increase by CU 2 and (assuming that the tax rate is 25%) current tax payable would increase by CU 0.5. This means that a sale in a future period would result in a tax disadvantage of CU 0.5 for the entity. Consequently, the entity recognizes this disadvantage of CU 0.5 as a deferred tax liability.

In practice, it would be time-consuming to perform a detailed analysis for each asset or liability as in the example above. Instead, application of a simplified rule is recommendable. An example is the “poorer-richer-rule” (poorer in the statement of financial position according to IFRS = asset; richer in the statement of financial position according to IFRS = liability), which is illustrated in the table below:

In the table previously the differences between the carrying amounts have to be multiplied by the tax rate. This results in the carrying amount of the deferred tax liability or deferred tax asset. It is important to note that recognition of deferred tax assets and deferred tax liabilities in the statement of financial position requires that the recognition criteria (see below) are met.

3.2 Recognition Criteria

3.2.1 Taxable Temporary Differences

Taxable temporary differences give rise to the recognition of a deferred tax liability. An important exception to this rule relates to goodwill. Deferred tax liabilities arising from the initial recognition of goodwill must not be recognized in the statement of financial position (IAS 12.15 and 12.21–12.21B).

3.2.2 Deductible Temporary Differences

A future tax advantage in the form of reductions in tax payments will flow to the entity only if it earns sufficient taxable profits against which the deductions can be offset (IAS 12.27). Hence, the Standard requires (with some exceptions) recognition of a deferred tax asset for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilized (IAS 12.24).

This criterion is met when there are sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity which are expected to reverse (IAS 12.28)

• in the same period as the expected reversal of the deductible temporary difference, or
• in periods into which a tax loss arising from the deferred tax asset can be carried forward or back.

When there are insufficient taxable temporary differences, the deferred tax asset is recognized to the extent that (IAS 12.29):

• it is probable that the entity will have sufficient taxable profit relating to the same taxation authority and the same taxable entity in the same period as the reversal of the deductible temporary difference (or in the periods into which a tax loss arising from the deferred tax asset can be carried forward or back),3 or
• tax planning opportunities are available to the entity that will create taxable profit in appropriate periods (e.g. generating disposal gains on assets for tax purposes in a particular jurisdiction by sale and leaseback).

The existence of a history of recent losses is strong evidence that future taxable profit may not be available (IAS 12.31 and 12.35–12.36).

If the carrying amount of goodwill arising in a business combination is less than the amount that will be deductible for tax purposes with respect to goodwill, the difference gives rise to a deferred tax asset. The deferred tax asset arising from the initial recognition of goodwill is recognized as part of the accounting for a business combination to the extent that it is probable that taxable profit will be available against which the deductible temporary difference could be utilized (IAS 12.32A).

3.2.3 Unused Tax Losses and Unused Tax Credits

The recognition criteria for deferred tax assets arising from the carryforward of unused tax losses and tax credits are the same as those for deferred tax assets arising from deductible temporary differences (IAS 12.35).

3.2.4 Reassessment of Unrecognized Deferred Tax Assets

At the end of each reporting period, it is reassessed whether previously unrecognized deferred tax assets currently meet the recognition criteria. They are recognized to the extent that the recognition criteria are met, at the current balance sheet date. Examples of events that may result in such recognition in hindsight are a business combination or an improvement in trading conditions (IAS 12.37).

3.2.5 Outside Basis Differences vs. Inside Basis Differences

When a subsidiary, a jointly controlled entity or an associate is consolidated, proportionately consolidated or accounted for using the equity method, deferred tax is systematized as follows:

• Inside basis differences I: Differences between the carrying amounts of the investee's assets and liabilities according to IFRS and for tax purposes in the investee's statement of financial position.
• Inside basis differences II: Fair value adjustments initially arising on consolidation, proportionate consolidation or application of the equity method, which are not recognized according to the applicable tax law.
• Outside basis difference: A difference between the investment's carrying amount determined according to the equity method, consolidation or proportionate consolidation and its carrying amount for tax purposes.

A deferred tax liability is recognized for all taxable temporary outside basis differences except to the extent that both of the following criteria are met (IAS 12.39):

A deferred tax asset is recognized for all deductible temporary outside basis differences to the extent that it is probable that both of the following criteria are met (IAS 12.44):

3.3 Measurement

3.3.1 Applicable Tax Rates and Tax Laws

The measurement of deferred tax assets and liabilities is usually based on the tax rates and tax laws that have been enacted or substantively enacted by the end of the reporting period (IAS 12.47).

3.3.2 Manner of Recovery or Settlement of the Carrying Amount of an Asset or a Liability

In some jurisdictions, the manner in which an entity recovers (settles) the carrying amount of an asset (liability) may affect either or both of the following (IAS 12.51A):

• Tax rate applicable on recovery (settlement).
• Carrying amount of the asset (liability) for tax purposes.

In such cases, the deferred tax liabilities and deferred tax assets are measured using the tax rate and the tax base that are consistent with the expected manner of recovery or settlement (IAS 12.51–12.51A).

3.3.3 Prohibition of Discounting

The Standard prohibits discounting of deferred tax liabilities and assets (IAS 12.53).

3.3.4 Impairment and Reversal of Impairment

The carrying amount of a deferred tax asset has to be reviewed at the end of each reporting period. The carrying amount of a deferred tax asset is reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax asset to be utilized (“impairment”). Any such reduction is reversed to the extent that it becomes probable that sufficient taxable profit will be available (reversal of “impairment”) (IAS 12.56).

3.4 Presentation

Deferred tax is recognized in profit or loss. However, there are exceptions to this rule (IAS 12.58 and 12.61A):

• Deferred tax is recognized in other comprehensive income if it relates to an item recognized in other comprehensive income.
• Deferred tax is recognized directly in equity, if it relates to an item recognized directly in equity.
• Moreover, if the deferred tax arises as part of the initial accounting of a business combination at acquisition date, it is neither recognized in profit or loss, nor in other comprehensive income.4

Deferred tax assets and deferred tax liabilities have to be offset, if both of the following criteria are met (IAS 12.74):

3.5 Specific Issues

3.5.1 Change in the Tax Rate

In the case of a change in the tax rate, the carrying amount of the deferred tax assets and liabilities changes even though there is no change in the amount of the related temporary differences. The adjustment of the carrying amount is recognized in profit or loss or outside profit or loss, depending on the manner of previous recognition (IAS 12.60).

3.5.2 Business Combinations

The accounting treatment of deferred tax relating to goodwill and fair value adjustments arising as part of the initial accounting of a business combination at acquisition date has been dealt with in the previous sections.

As a result of a business combination, the following situations may occur with respect to the acquirer's deferred tax assets (IAS 12.67):

• A previously unrecognized deferred tax asset of the acquirer has to be recognized.
• A previously recognized deferred tax asset of the acquirer does not meet the recognition criteria anymore.

In these cases, the acquirer recognizes a change in the deferred tax asset in the period of the business combination but does not include it as part of the accounting for the business combination. Therefore, the acquirer does not take it into account in determining goodwill (IAS 12.67).

An acquiree's income tax loss carryforwards or other deferred tax assets might not satisfy the criteria for separate recognition on initial accounting of a business combination. If the recognition criteria are met, subsequently, the following applies (IAS 12.68):

• Acquired deferred tax benefits recognized within the measurement period5 (IFRS 3.45) that result from new information about facts and circumstances that existed at the acquisition date reduce the carrying amount of any goodwill related to that acquisition (“Dr Deferred tax asset Cr Goodwill”). If the carrying amount of that goodwill is zero, any remaining deferred tax benefits are recognized in profit or loss (“Dr Deferred tax asset Cr Income”).
• All other acquired deferred tax benefits realized subsequently are recognized in profit or loss (“Dr Deferred tax asset Cr Income”), or, if IAS 12 so requires, outside profit or loss.

4 TAX (OR TAX RATE) RECONCILIATION

A tax (or tax rate) reconciliation has to be disclosed in the notes. Thereby, the product of profit before tax according to IFRS multiplied by the applicable tax rate is reconciled to the total of current and deferred tax expense (income). This reconciliation is presented either on an absolute number basis and/or percentage-wise. Percentage-wise means that the numbers are expressed as percentages of profit before tax according to IFRS (IAS 12.81c). The following example of a tax (rate) reconciliation takes only basic issues into account. The profit before tax according to IFRS and the applicable tax rate, as well as the expenses not deductible for tax purposes, are based on random numbers.

5 EXAMPLES WITH SOLUTIONS

References to other chapters

Deferred tax arising in business combinations is also dealt with in the chapter on IFRS 3 (Examples 5 and 6b). Deferred tax arising in the case of revaluations of property, plant, and equipment is dealt with in the chapter on IAS 16 (Example 7). The effects of a retrospective adjustment on deferred tax are illustrated in the chapter on IAS 8 (Example 6).

Example 1

Current tax

Entity E has to pay income tax of CU 5 for the year 01. This amount only relates to transactions recognized in profit or loss according to IFRS. In E's jurisdiction, entities have to make prepayments during the year (e.g. during 01) on their payable income tax for the year (e.g. for 01). These prepayments are based on taxable profit for the previous year (e.g. for 00).

Version (aa)

In 01, E has made prepayments of CU 4. E recognizes such prepayments in profit or loss during the year.

Version (ab)

In 01, E has made prepayments of CU 4. During the year, E recognizes such prepayments on a separate account which comprises the amounts already paid to the taxation authorities as receivables (clearing account with taxation authorities).

Version (ba)

In 01, E has made prepayments of CU 6. E recognizes such prepayments in profit or loss during the year.

Version (bb)

In 01, E has made prepayments of CU 6. During the year, E recognizes such prepayments on the clearing account with taxation authorities as receivables.

Required

Prepare any necessary entries in E's financial statements as at Dec 31, 01.

Hints for solution

In particular Section 2.

Solution (aa)

E's financial statements have to include current tax expense of CU 5. Current tax of CU 1 not yet settled has to be recognized as a liability:

Solution (ab)

E's financial statements have to include current tax expense of CU 5. Current tax of CU 1 not yet settled has to be recognized as a liability. The clearing account with taxation authorities is an interim account that is not included in the financial statements.

Solution (ba)

E's financial statements have to include current tax expense of CU 5. The prepayments were CU 6. Hence, E is able to reclaim an amount of CU 1 from the taxation authorities. That amount is recognized as a receivable:

Solution (bb)

E's financial statements have to include current tax expense of CU 5. The amount of CU 1 prepaid in excess is reclaimed from the taxation authorities, by E. Hence, it is recognized as a receivable. The clearing account with taxation authorities is an interim account that is not included in the financial statements.

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Example 2

Deferred tax – introductory example

Version (a)

On Jan 01, 01, entity E acquires software for CU 12, which is available for use on the same day. The software's useful life is three years according to IFRS and four years under E's tax law.

Version (b)

On Jan 01, 01, entity E acquires software for CU 12, which is available for use on the same day. The software's useful life is four years according to IFRS and three years under E's tax law.

Required

Prepare any necessary entries relating to deferred tax in E's financial statements as at Dec 31, 01. The tax rate is 25%. Assume for simplification purposes that deferred tax assets (if any) meet the recognition criteria of IAS 12.6

Hints for solution

In particular Section 3.1.

Solution (a)

Amortization for 01 is CU 4 according to IFRS and CU 3 for tax purposes. Thus, the carrying amount of the software as at Dec 31, 01 is CU 8 (= CU 12 – CU 4) according to IFRS and CU 9 (= CU 12 – CU 3) for tax purposes.

The carrying amount of the software is lower according to IFRS than for tax purposes, meaning that E is poorer in its financial statements according to IFRS. Hence, E recognizes a deferred tax asset according to the “poorer-richer-rule” (poorer in the statement of financial position according to IFRS = asset; richer in the statement of financial position according to IFRS = liability).7

The logic of recognizing the deferred tax asset can also be explained as follows: the determination of deferred tax is based on the presumption that the carrying amount for tax purposes (CU 9) will adjust to the carrying amount according to IFRS (CU 8) in the future.

This means that it is assumed that the entry “Dr Expense Cr Asset CU 1” will be made in the future, for tax purposes. As a result of this entry, taxable profit will decrease by CU 1 in the future. Assuming that the tax rate is 25%, this will lead to a reduction of the current tax liability by CU 0.25. In other words, a tax advantage of CU 0.25 will arise in the future. That future tax advantage is already recognized as an asset (deferred tax asset) on Dec 31, 01 (since it is presumed in this example that the recognition criteria for deferred tax assets are met):

Solution (b)

Amortization for 01 is CU 3 according to IFRS and CU 4 for tax purposes. Thus, the carrying amount of the software as at Dec 31, 01 is CU 9 (= CU 12 – CU 3) according to IFRS and CU 8 (= CU 12 – CU 4) for tax purposes.

The carrying amount of the software is higher under IFRS than for tax purposes, which means that E is richer in its financial statements according to IFRS. Hence, E recognizes a deferred tax liability according to the “poorer-richer-rule” (poorer in the statement of financial position according to IFRS = asset; richer in the statement of financial position according to IFRS = liability).8

The logic of recognizing the deferred tax liability can also be explained as follows: the determination of deferred tax is based on the presumption that the carrying amount for tax purposes (CU 8) will adjust to the carrying amount according to IFRS (CU 9) in the future. This means that it is assumed that the entry “Dr Asset Cr Income CU 1” will be made in the future, for tax purposes. As a result of this entry, taxable profit will increase by CU 1 in the future. Assuming that the tax rate is 25%, this will lead to an increase of the current tax liability by CU 0.25. In other words, a tax disadvantage of CU 0.25 will arise in the future. That future tax disadvantage is already recognized as a liability (deferred tax liability) on Dec 31, 01:

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Example 4

Deferred tax and tax (rate) reconciliation

Entity E was founded on Jan 01, 01. E's profit before tax according to IFRS for 01 is CU 100. E's taxable profit for 01 is CU 104. The difference between these amounts arose as follows:

• On Nov 01, 01, E acquired a machine for CU 120. The machine was available for use on the same day. E depreciates the machine on a monthly basis. However, under E's tax law, the machine has to be depreciated for six months in 01 because depreciation starts at the beginning of the half-year in which the machine is available for use. The machine's useful life is 10 years according to IFRS as well as for tax purposes.
• In 01, expenses of CU 8 were incurred for charitable donations. These are not deductible for tax purposes.

Required

(a) Prepare any necessary entries in E's financial statements as at Dec 31, 01, taking current and deferred tax into account. The tax rate is 25%. Assume that no tax prepayments (see Example 1) are necessary.

(b) Prepare (a) the tax reconciliation in absolute numbers (IAS 12.81(c)(i)) as well as (b) the tax rate reconciliation (IAS 12.81(c)(ii)) for 01.

Hints for solution

In particular Sections 3.1 and 4.

Solution (a)

Current tax for 01 is CU 26 (= taxable profit of CU 104 · 25%).

Donation:

Expenses not deductible for tax purposes do not result in deferred tax.

Machine:

Depreciation for November and December 01 is CU 2 (= CU 120 : 10 years : 12 months · 2 months).

Deferred tax:

On Dec 31, 01, the machine's carrying amount according to IFRS is CU 118 (= CU 120 – CU 2). By contrast, for tax purposes, depreciation for 01 is calculated on a six month basis, which results in depreciation of CU 6 (= CU 120 : 10 years : 12 months · 6 months). Thus, the carrying amount for tax purposes on Dec 31, 01 is CU 114 (= CU 120 – CU 6).

Solution (b)

Tax reconciliation in absolute numbers (IAS 12.81 (c)(i)):

Profit before tax according to IFRS	100
Applicable tax rate	25%
Fictitious tax (at the applicable tax rate)	25
Expenses not deductible for tax purposes	2	= 8 · 25%
(Current and deferred) tax expense	27	= 26 + 1 or 25 + 2

The following table shows the tax rate reconciliation (IAS 12.81(c)(ii)). In this reconciliation, the percentages are derived by dividing the respective numbers from the table previously by profit before tax according to IFRS.

Applicable tax rate	25%
Expenses not deductible for tax purposes	2%
Average effective tax rate	27%

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Example 5

Continuation of Example 4 in the following year

In the following year 02, entity E's profit before tax according to IFRS is CU 100. E's taxable profit for 02 is CU 140. The difference between these amounts arose as follows:

1. On Sep 01, 01, E acquired shares for CU 200 which are accounted for at fair value through other comprehensive income (IFRS 9.5.7.1b and 9.5.7.5). Fair value of the shares is CU 208 as at Dec 31, 02. On Dec 31, 01, fair value was CU 200. In 02, E received a dividend of CU 4 for the period Sept 01, 01 to Dec 31, 01. The dividend is outside the scope of taxation under E's tax law. According to E's tax law, the shares are measured at cost.

2. Regarding a lawsuit, E has recognized a provision of CU 100 according to IFRS. The carrying amount of that provision for tax purposes is CU 80.

3. In 02, an amount of CU 16 was paid to E's non-executive directors. According to E's tax law, only half of that amount is deductible for tax purposes.

4. On Jan 01, 02, E acquired a building for CU 2,000. The building is available for use on the same day. Under E's tax law depreciation is 3% p.a. The building's useful life according to IFRS is 25 years.

5. The carrying amount of a provision of E for tax purposes is CU 4. That provision does not meet the recognition criteria according to IFRS.

Posting status:

Apart from current tax and deferred tax for 02, all necessary entries have already been correctly effected. The current tax liability recognized for the year 01 has already been settled and this has already been entered correctly. The fair value change of the shares has been recognized as follows:9

The dividend of CU 4 has been recognized in profit or loss (IFRS 9.5.7.6).

Required

(a) Prepare any necessary entries in E's financial statements as at Dec 31, 02, with respect to current and deferred tax. The tax rate is 25%. Assume that no tax prepayments (see Example 1) are necessary. Assume for simplification purposes that deferred tax assets (if any) meet the recognition criteria of IAS 1210 and that the criteria for offsetting deferred tax assets and deferred tax liabilities in the statement of financial position11 are met.

(b) Prepare (a) the tax reconciliation in absolute numbers (IAS 12.81(c)(i)) as well as (b) the tax rate reconciliation (IAS 12.81(c)(ii)) for 02.

Hints for solution

In particular Sections 3.1 and 4.

Solution (a)12

Current tax for 02 is CU 35 (= taxable profit of CU 140 · 25%).

Deferred tax:

Solution (b)

Tax reconciliation in absolute numbers (IAS 12.81(c)(i)):

Profit before tax according to IFRS	100
Applicable tax rate	25%
Fictitious tax (at the applicable tax rate)	25
Expenses not deductible for tax purposes	2	= 8 · 25% (half of the compensation for non-executive directors)
Income outside the scope of taxation	−1	= −4 · 25% (dividend)
(Current and deferred) tax expense	26	= 25 + 2 – 1 or current tax expense (35) less deferred tax income (9)

Tax rate reconciliation (IAS 12.81(c)(ii)):

Applicable tax rate	25%
Expenses not deductible for tax purposes	2%
Income outside the scope of taxation	–1%
Average effective tax rate	26%

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Example 7

Deferred tax – change in the tax rate13

Entity E holds the following shares which were each acquired for CU 900:

Shares of entity A: These shares meet the definition of “held for trading” (IFRS 9, Appendix A). Therefore, they are accounted for at fair value through profit or loss (IFRS 9.4.1.1–9.4.1.4, 9.5.7.1b, and 9.5.7.5). On Dec 31, 01, the carrying amount of these shares is CU 1,000 according to IFRS and CU 900 for tax purposes.

Shares of entity B: These shares are accounted for at fair value through other comprehensive income (IFRS 9.4.1.1–9.4.1.4, IFRS 9.5.7.1b, and 9.5.7.5). On Dec 31, 01, the carrying amount of these shares is CU 1,000 according to IFRS and CU 900 for tax purposes. The fair value reserve is CU 100.

On Dec 31, 01, the tax rate is changed from 30% to 25%.

Posting status:

All necessary entries have already been effected correctly. However, the change in the tax rate has not yet been taken into account.

Required

Prepare any necessary entries in E's financial statements as at Dec 31, 01.

Hints for solution

In particular Section 3.5.1.

Solution

The deferred tax liabilities relating to the shares of A and B change as follows:

Carrying amount according to IFRS as at Dec 31, 01	1,000
Carrying amount for tax purposes as at Dec 31, 01	900
Taxable temporary difference	100
Deferred tax liability as at Dec 31, 01 (on the basis of a tax rate of 30%)	30
Deferred tax liability as at Dec 31, 01 (on the basis of a tax rate of 25%)	25
Adjustment	−5

A change in a deferred tax liability is recognized in profit or loss except to the extent that it relates to items previously recognized outside profit or loss (IAS 12.60, 12.58, and 12.61A). Hence, the change in the deferred tax liability for the shares of A is recognized in profit or loss, while the change in the deferred tax liability for the shares of B is recognized in other comprehensive income. In the latter case, the fair value reserve increases by the reduction in the deferred tax liability of CU 5.

Shares of A:

Shares of B:

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Example 8

Business combinations14 and income tax loss carryforwards of the acquiree

On Dec 31, 01, entity E acquires 100% of the shares of entity S for CU 100. S is free of debt.

A simplified illustration of S's statement of financial position as at Dec 31, 01 is presented below. For simplification purposes it is assumed that it is identical with S's statement of financial position II as at the same date.

The value of the assets of S on acquisition date determined according to IFRS 3 is CU 95. Moreover, S owns income tax loss carryforwards amounting to CU 40 that do not meet the recognition criteria when the business combination is initially accounted for as at Dec 31, 01.

Version (a)

On Dec 31, 02, new information about facts and circumstances that existed at the acquisition date indicates that the recognition criteria for the income tax loss carryforwards were met on the acquisition date.

Version (b)

On Dec 31, 02, the recognition criteria are met due to a significant improvement in S's performance after acquisition date.

In its separate financial statements E accounts for its investment in S (shares) at cost (IAS 27.38a).

Posting status (in E's separate financial statements):

Posting status (capital consolidation in E's consolidated financial statements):

Required

Prepare any necessary entries in E's consolidated financial statements as at Dec 31, 02 regarding deferred tax. The tax rate is 25%.

Hints for solution

In particular Section 3.5.2.

Solution (a)

Acquired deferred tax benefits recognized within the measurement period (IFRS 3.45) that result from new information about facts and circumstances that existed at the acquisition date reduce the carrying amount of any goodwill related to that acquisition. If the carrying amount of that goodwill is zero, any remaining deferred tax benefits are recognized in profit or loss (IAS 12.68a). In this example, the deferred tax benefit is CU 10 (= CU 40 · 25%).

Solution (b)

In contrast to version (a), the recognition criteria are met on Dec 31, 02, because of events arising after the acquisition date. This means that meeting the recognition criteria at that date is not the result of new information about facts and circumstances that existed at the acquisition date. Therefore, recognition of the deferred tax asset of CU 10 (= CU 40 · 25%) results in the recognition of income in the same amount and goodwill is not changed (IAS 12.68b).

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Example 9

Recognition of deferred tax with respect to goodwill

On Jan 01, 01, entity E acquires all of the shares of entity F. This business combination results in:

(a) Goodwill of CU 80 according to IFRS. The carrying amount of goodwill for tax purposes is zero.

(b) Goodwill of CU 80 according to IFRS. The carrying amount of goodwill for tax purposes is zero. On Dec 31, 01, an impairment loss of CU 10 is recognized with respect to goodwill according to IFRS.

(c) Goodwill of CU 80 according to IFRS. The carrying amount of goodwill for tax purposes is CU 60. According to the applicable tax law, goodwill has to be amortized over 15 years on a straight-line basis.

Required

Prepare the necessary entries (if any) in E's consolidated financial statements as at Dec 31, 01 for deferred tax relating to goodwill. The tax rate is 25%.

Hints for solution

In particular Section 3.2.1.

Solution

Case (a)

The taxable temporary difference of CU 80 results from the initial recognition of goodwill. A corresponding deferred tax liability must not be recognized because this is prohibited by the Standard (IAS 12.15a).

Case (b)

The taxable temporary difference of CU 80 results from the initial recognition of goodwill. A corresponding deferred tax liability must not be recognized (IAS 12.15a). This procedure is not affected by the impairment loss of CU 10 recognized on Dec 31, 01, according to IFRS (IAS 12.21A).

Case (c)

A taxable temporary difference of CU 20 results from the initial recognition of goodwill. A corresponding deferred tax liability must not be recognized (IAS 12.15a).

On Dec 31, 01, amortization expense of CU 4 (= CU 60 : 15 years) is recognized with respect to goodwill for tax purposes, which decreases the goodwill's carrying amount for tax purposes to CU 56. Since the pro rata carrying amount of goodwill according to IFRS (excluding the amount of CU 20 discussed above) is still CU 60, a taxable temporary difference of CU 4 arises. This difference has not been caused by the initial recognition of goodwill. Thus, a deferred tax liability is recognized (IAS 12.21B).

Pro rata carrying amount of goodwill according to IFRS as at Dec 31, 01	60
Carrying amount for tax purposes as at Dec 31, 01	56
Taxable temporary difference	4
Tax rate	25%
Deferred tax liability	1

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1 See the chapter on IFRS 3 regarding business combinations.

2 See Section 3.2.

3 Within the frame of this evaluation, taxable amounts arising from deductible temporary differences that are expected to originate in future periods are ignored because the deferred tax asset arising from these deductible temporary differences will itself require future taxable profit in order to be utilized (IAS 12.29).

4 See the chapter on IFRS 3, regarding business combinations.

5 See the chapter on IFRS 3, Section 6.7.

6 See Section 3.2.2.

7 See Section 3.1.

8 See Section 3.1.

9 If IFRS 9 were not yet applied, the same entry would be necessary if the shares were classified as “available for sale” (IAS 39.9).

10 See Section 3.2.2.

11 See Section 3.4.

12 The solution of this example would not change if IFRS 9 and its consequential amendments were not applied early and if the shares were classified as “available for sale” according to the “old” version of IAS 39 (IAS 39.9 and 39.55b).

13 The solution of this example would be the same if IFRS 9 (and its consequential amendments) were not applied early and if the shares of B were classified as “available for sale” (IAS 39.9 and 39.55b).

14 See the chapter on IFRS 3 with regard to the basics of business combinations.