1.2.1 No provision for deferred tax (‘flow through’)

If the entity in Example 33.1 above were to account only for the tax legally due in respect of each year (‘current tax’), it would report the amounts in the table below in profit or loss. Accounting for current tax only is generally known as the ‘flow through’ method.

The ‘effective tax rate’ in the last row of the table above is the ratio, expressed as a percentage, of the profit before tax to the charge for tax in the financial statements, and is regarded as a key performance indicator by many preparers and users of financial statements. As can be seen from the table above, over the full five-year life of the asset, the entity pays tax at the statutory rate of 30% on its total profits of €500,000, but with considerable variation in the effective rate in individual accounting periods.

The generally held view is that simply to account for the tax legally payable as above is distortive, and that the tax should therefore be allocated between periods. Under IAS 12 – Income Taxes – this allocation is achieved by means of deferred taxation (see 1.2.2 below).

However, the flow-through method attracts the support of a number of commentators. They argue that the tax authorities impose a single annual tax assessment on the entity based on its profits as determined for tax purposes, not on accounting profits. That assessment is the entity's only liability to tax for that period, and any tax to be assessed in future years is not a present obligation and therefore not a liability as defined in the IASB's Conceptual Framework. Supporters of flow-through acknowledge the distortive effect of transactions such as that in Example 33.1 above, but argue that this is better remedied by disclosure than by creating what they see as an ‘imaginary’ liability for deferred tax.

1.2.2 Provision for deferred tax (the temporary difference approach)

The approach currently required by IAS 12 is known as the temporary difference approach, which focuses on the difference between the carrying amount of an asset or liability in the financial statements and the amount attributed to it for tax purposes, known as its ‘tax base’.

In Example 33.1 above, the carrying value of the PP&E in the financial statements at the end of each reporting period is:

If the tax authority were to prepare financial statements based on tax law rather than IFRS, it would record PP&E of nil at the end of each period, since the full cost of €50,000 was written off in 2020 for tax purposes. There is therefore a difference, at the end of 2020, of €40,000 between the carrying amount of €40,000 of the asset in the financial statements and its tax base of nil. This difference is referred to as a ‘temporary’ difference because, by the end of 2024, the carrying value of the PP&E in the financial statements and its tax base are both nil, so that there is no longer a difference between them.

As discussed in more detail later in this Chapter, IAS 12 requires an entity to recognise a liability for deferred tax on the temporary difference arising on the asset (at 30%), as follows.

IAS 12 argues that, taking the position as at 31 December 2020 as an example, the carrying amount of the PP&E of €40,000 implicitly assumes that the asset will ultimately be recovered or realised by a cash inflow of at least €40,000. Any tax that will be paid on that inflow represents a present liability. In this case, the entity pays tax at 30% and will be unable to make any deduction in respect of the asset for tax purposes in a future period. It will therefore pay tax of €12,000 (30% of [€40,000 – nil]) as the asset is realised. This tax is as much a liability as the PP&E is an asset, since it would be internally inconsistent for the financial statements simultaneously to represent that the asset will be recovered at €40,000 while ignoring the tax consequences of doing so. [IAS 12.16].

The deferred tax liability is recognised in the statement of financial position and any movement in the deferred tax liability during the period is recognised as deferred tax income or expense in profit or loss, with the following impact:

It can be seen that the effect of accounting for deferred tax is to present an effective tax rate of 30% in profit or loss for each period. As will become apparent later in the Chapter, there is some tension in practice between the stated objective of IAS 12 (to recognise the appropriate amount of tax assets and liabilities in the statement of financial position) and what many users and preparers see as the real objective of IAS 12 (to match the tax effects of a transaction with the recognition of its pre-tax effects in the statement of comprehensive income or equity).

This tension arises in part because earlier methods of accounting for income tax, which explicitly focused on tax income and expense (‘income statement approaches’) rather than tax assets and liabilities (‘balance sheet approaches’), remain part of the professional ‘DNA’ of many preparers and users. Moreover, as will be seen later in the Chapter, several aspects of IAS 12 are difficult to reconcile to the purported balance sheet approach of the standard, because, in reality, they are relics of the now superseded income statement approaches.

1.3.1 References to taxes in standards other than IAS 12

There are numerous references in other standards and interpretations to taxes, the more significant of which are noted later in this Chapter. The requirements of IFRS for accounting for income taxes in interim financial statements are discussed in Chapter 41 at 9.5. Other standards and interpretations also refer to taxes that are not necessarily income taxes within the scope of IAS 12. In some cases such taxes are clearly outside the scope of IAS 12, such as sales taxes, payroll taxes and other taxes related to specific items of expenditure. These taxes often fall within the scope of IAS 37 – Provisions, Contingent Liabilities and Contingent Assets – and, in particular, IFRIC 21 – Levies, or by reference to the accounting standard most closely related to the item subject to such a non-income tax (such as IAS 19 – Employee Benefits, in the case of payroll taxes). In other cases, judgement is required to determine whether such taxes fall in the scope of IAS 12, as discussed at 4 below.

4.1.1 Levies

Several governments have introduced levies on certain types of entity, particularly those in the financial services sector. In many cases the levies are expressed as a percentage of a measure of revenue or net assets, or some component(s) of revenue or net assets, at a particular date. Such levies are not income taxes and should be accounted for in accordance with IAS 37 and IFRIC 21 (see Chapter 26 at 6.8).

4.1.2 Hybrid taxes (including minimum taxes)

Some jurisdictions impose income taxes which are charged as a percentage of taxable profits in the normal way, but are subject to a requirement that a minimum amount of tax must be paid. This minimum may be an absolute amount or a proportion of one or more components of the statement of financial position – for example, total equity as reported in the financial statements, or total share capital and additional paid-in capital (share premium). Another form of hybrid arrangement is where the amount of tax payable is the higher of one measure (based on profits) and another (for example based on net assets or on total debt and equity).

Such taxes raise the issue of how they should be accounted for. One view would be that the fixed minimum element is not an income tax and should be accounted for under IAS 37 and IFRIC 21, but any excess above the fixed minimum element is an income tax which should be accounted for under IAS 12. Where the hybrid is the higher of a profit measure and a non-profit measure, only the excess over the liability determined by the non-profit measure is accounted for as an income tax.

An alternative analysis would be to consider the overall substance of the tax. If it is apparent that the overall intention of the legislation is to levy taxes based on income, but subject to a floor, the tax should be accounted for as an income tax in its entirety, even if the floor would not be an income tax if considered in isolation.

This second approach has a number of advantages over the other. Having established the overall intention of the legislation, a consistent basis can be applied from period to period. Under the first view, an entity might have to account for current and deferred tax in periods where net profit results in a higher liability than the non-profit measure, and apply a different basis when taxable profits give an assessment lower than the non-profit measure. Another practical disadvantage is that the future rate of the element accounted for as income tax is unpredictable, as it will depend on the level of profit in future periods. Suppose for example that an entity is required to pay tax at 30% on its taxable profit, but subject to a minimum tax of €100,000 per year. No income tax relief is available for the minimum tax. If its taxable profits were €1 million, it would pay tax of €300,000 (€1,000,000 at 30%). Under the first approach, this €300,000 would be accounted for as comprising a minimum (non-income) tax of €100,000 and income tax of €200,000. The effective rate of tax accounted for as income tax would be 22% [€200,000 / (€1,000,000 – €100,000)]. If, however, the entity's taxable profits were €2,000,000 it would pay tax of €600,000 (€2,000,000 at 30%). In this case, this €600,000 would be accounted for as comprising a minimum (non-income) tax of €100,000 and income tax of €500,000. The effective rate of tax accounted for as income tax would be 26.3% [€500,000 / (€2,000,000 – €100,000)]. This illustrates that, in order to calculate deferred income taxes for the purposes of IAS 12, any future income tax rate would be subject to constant re-estimation, even if the ‘headline’ enacted rate had not changed.

In our view, either of these broad approaches can be adopted so long as it is applied consistently to all taxes of a similar nature in all periods. We would generally expect a common approach to be applied to the same tax in the same jurisdiction.

5.1.1 Meaning of substantive enactment in various jurisdictions

The following table summarises the meaning of ‘substantive enactment’ in various jurisdictions as generally understood in those jurisdictions.⁶

5.1.2 Changes to tax rates and laws enacted before the reporting date

Current tax should be measured at the amount expected to be paid to or recovered from the tax authorities by reference to tax rates and laws that have been enacted, or substantively enacted, by the end of the reporting period. [IAS 12.46]. Accordingly, the effects of changes in tax rates and laws on current tax balances are required to be recognised in the period in which the legislation is substantively enacted. There is no relief from this requirement under IAS 12, even in circumstances when complex legislation is substantively enacted shortly before the end of an annual or interim reporting period. In cases where the effective date of any rate changes is not the first day of the entity's annual reporting period, current tax would be calculated by applying a blended rate to the taxable profits for the year.

Where complex legislation is enacted shortly before the end of the period, entities might encounter two distinct sources of uncertainty:

• uncertainty about the requirements of the law, which may give rise to uncertain tax treatments as defined by IFRIC 23 and discussed at 5.2 and 9 below; and
• uncertainties arising from incomplete information because entities may not have all the data required to process the effects of the changes in tax laws.

It is not necessary for entities to have a complete understanding of every aspect of the new tax law to arrive at reasonable estimates, and provided that entities make every effort to obtain and take into account all the information they could reasonably be expected to obtain up to the date when the financial statements for the period are authorised for issue, subsequent changes to those estimates would not be regarded as a prior period error under IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors. [IAS 8.5]. We expect that only in rare circumstances would it not be possible to determine a reasonable estimate. However, these uncertainties may require additional disclosure in the financial statements. IAS 1 requires entities to disclose information about major sources of estimation uncertainty at the end of the reporting period that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year (see Chapter 3 at 5.2.1). [IAS 1.125‑129].

Whilst the effect of changes in tax laws enacted after the end of the reporting period are not taken into account (see 5.1.3 below), information and events that occur between the end of the reporting period and the date when the financial statements are authorised for issue are adjusting events after the reporting period if they provide evidence of conditions that existed as at the reporting date. [IAS 10.3]. Updated tax calculations, collection of additional data, clarifications issued by the tax authorities and gaining more experience with the tax legislation before the authorisation of the financial statements should be treated as adjusting events if they pertain to the position at the balance sheet date. Events that are indicative of conditions that arose after the reporting period should be treated as non-adjusting events. Judgement needs to be applied in determining whether technical corrections and regulatory guidance issued after year-end are to be considered adjusting events.

Where the effect of changes in the applicable tax rates compared to the previous accounting period are material, an explanation of those effects is required to be provided in the notes to the financial statements (see 14.1 below). [IAS 12.81(d)].

5.1.3 Changes to tax rates and laws enacted after the reporting date

The requirement for substantive enactment by the end of the reporting period is quite clear in the literature. IAS 10 – Events after the Reporting Period – identifies the enactment or announcement of a change in tax rates and laws after the end of the reporting period as an example of a non-adjusting event. [IAS 10.22(h)]. For example, an entity with a reporting period ending on 31 December issuing its financial statements on 20 April the following year would measure its tax assets and liabilities by reference to tax rates and laws enacted or substantively enacted as at 31 December even if these had changed significantly before 20 April and even if those changes had retrospective effect. However, in these circumstances the entity would have to disclose the nature of those changes and provide an estimate of the financial effect of those changes if the impact is expected to be significant (see 14.2 below). [IAS 10.21].

5.1.4 Implications of the decision by the UK to withdraw from the EU

On 29 March 2017, the UK Government started the legal process of negotiating a withdrawal by the UK from the European Union (EU). At the time of writing this Chapter, the UK will leave the EU on 31 October 2019, unless the negotiation period is further extended by unanimous consent of the European Council. Until that date, the UK remains a member of the EU and all laws and regulations continue to apply on that basis. After that date, the UK will cease to be a member of the EU and will acquire ‘third country’ status, the terms of which will be defined in a new arrangement that has yet to be determined.

Tax legislation in EU member states and other countries contains tax exemptions and tax reliefs (e.g. withholding tax and merger relief) that depend on whether or not one or more of the entities involved are EU domiciled. Once the UK leaves the EU, these exemptions and reliefs may no longer apply to transactions between UK entities and entities in those EU member states and other countries. In those cases, additional tax liabilities may crystallise. At the time of writing, it is still uncertain whether any of these exemptions and reliefs will apply to the UK when it ceases to be a member state. Under the terms of a Withdrawal Agreement negotiated between the EU and UK, a transitional period to December 2020 was established, during which the status quo would be maintained. However, while the Withdrawal Agreement was endorsed by EU member state leaders at a special European Council summit on 25 November 2018, it has not been endorsed by the UK Parliament. Without such endorsement, no transitional period would apply. Other scenarios, including ‘no deal’, a further extension of negotiations or a different agreement being reached between the parties are still possible at this stage.

Accordingly, the withdrawal process by the UK raises significant uncertainty about how the existing tax legislation in the UK and in other countries will apply after the UK ceases to be a member of the EU. It has also raised uncertainty about the future tax status of entities, which may lead to changes in the accounting treatment.

Given the uncertainties on taxation, we believe it is appropriate for entities to continue to apply their current accounting policies, until the position becomes clearer. However, these uncertainties will require additional disclosure in the financial statements of entities reporting in the period leading up to any withdrawal date, to reflect any progress between the parties in defining the terms of the UK's withdrawal and in clarifying the position of the UK as a ‘third country’ after its withdrawal from the EU becomes effective. IAS 1 requires entities to disclose the significant accounting policies used in preparing the financial statements, including the judgements that management has made in applying those accounting policies that have the most significant effect on the amounts recognised in the financial statements. [IAS 1.122]. IAS 1 also requires entities to disclose information about the assumptions they make about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. [IAS 1.125]. Therefore, entities will need to carefully consider the assumptions and estimates made about the future impact of tax positions and consider whether additional disclosure is needed of the uncertainties arising from UK withdrawal from the EU.

As the negotiations for withdrawal come to a conclusion, the uncertainties about tax legislation and the application of IAS 12 will be resolved as each jurisdiction confirms the appropriate tax treatment. Therefore, entities will need to consider the current position at each reporting date and may have to revise the accounting treatment and disclosures that have previously been applied. The recognition and measurement of current and deferred taxes will have to reflect the new status of the UK when it becomes effective and have regard to any related legislation when it is (substantively) enacted (see 5.1.2 above and 8.1.1 below). [IAS 12.46, 47]. Enactment after the end of the reporting period but before the date of approval of the financial statements is an example of a non-adjusting event, [IAS 10.22(h)], requiring entities to disclose the nature of any changes and provide an estimate of their financial effect if the impact is expected to be significant (see 5.1.3 above and 8.1.2 below). [IAS 10.21].

6.1.1 Tax base of assets

The tax base of an asset is 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].

In some cases the ‘tax base’ of an asset is relatively obvious. In the case of a tax-deductible item of PP&E, it is the tax-deductible amount of the asset at acquisition less tax depreciation already claimed (see Example 33.1 at 1.2 above). Other items, however, require more careful analysis.

For example, an entity may have accrued interest receivable of €1,000 that will be taxed only on receipt. When the asset is recovered, all the cash received is subject to tax. In other words, the amount deductible for tax on recovery of the asset, and therefore its tax base, is nil. Another way of arriving at the same conclusion might be to consider the amount at which the tax authority would recognise the receivable in notional financial statements for the entity prepared under tax law. At the end of the reporting period the receivable would not be recognised in such notional financial statements, since the interest has not yet been recognised for tax purposes.

Conversely, an entity may have a receivable of €1,000 the recovery of which is not taxable. In this case, the tax base is €1,000 on the rule above that, where realisation of an asset will not be taxable, the tax base of the asset is equal to its carrying amount. This applies irrespective of whether the asset concerned arises from:

• a transaction already recognised in total comprehensive income and already subject to tax on initial recognition (e.g. in most jurisdictions, a sale);
• a transaction already recognised in total comprehensive income and exempt from tax (e.g. tax-free dividend income); or
• a transaction not affecting total comprehensive income at all (e.g. the principal of a loan receivable). [IAS 12.7].

The effect of deeming the tax base of the €1,000 receivable to be equal to its carrying amount will be that the temporary difference associated with it is nil, and that no deferred tax is recognised in respect of it. This is appropriate given that, in the first case, the debtor represents a sale that has already been taxed and, in the second and third cases, the debtors represent items that are outside the scope of tax.

6.1.2 Tax base of liabilities

The tax base of a liability is 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].

As in the case of assets, the tax base of some items is relatively obvious. For example, an entity may have recognised a provision for environmental damage of CHF5 million, which will be deductible for tax purposes only on payment. The liability has a tax base of nil. Its carrying amount is CHF5 million, which is also the amount that will be deductible for tax purposes on settlement in future periods. The difference between these two (equal) amounts – the tax base – is nil. Another way of arriving at the same conclusion might be to consider the amount at which the tax authority would recognise the liability in notional financial statements for the entity prepared under tax law. At the end of the reporting period the liability would not be recognised in such notional financial statements, since the expense has not yet been recognised for tax purposes.

Likewise, if the entity records revenue of £1,000 received in advance that was taxed on receipt, its tax base is nil. Under the definition above, the carrying amount is £1,000, none of which is taxable in future periods. The tax base is the difference between the £1,000 carrying amount and the amount not taxed in future periods (£1,000) – i.e. nil.

Again, if we were to consider a notional statement of financial position of the entity drawn up by the tax authorities under tax law, this liability would not be included, since the relevant amount would, in the notional tax financial statements, have already been taken to income.

An entity may have a liability of (say) €1,000 that will attract no tax deduction when it is settled. In this case, the tax base is €1,000 (on the analogy with the rule in 6.1.1 above that where, realisation of an asset will not be taxable, the tax base of the asset is equal to its carrying amount). This applies irrespective of whether the liability concerned arises from:

• a transaction already recognised in total comprehensive income and already subject to a tax deduction on initial recognition (e.g. in most jurisdictions, the cost of goods sold or accrued expenses);
• a transaction already recognised in total comprehensive income and outside the scope of tax (e.g. non tax-deductible fines and penalties); or
• a transaction not affecting total comprehensive income at all (e.g. the principal of a loan payable). [IAS 12.8].

This is appropriate given that, in the first case, the liability represents a cost that has already been deducted for tax purposes and, in the second and third cases, the liabilities represent items that are outside the scope of tax.

6.1.3 Assets and liabilities whose tax base is not immediately apparent

IAS 12 indicates that where the tax base of an asset or liability is not immediately apparent, it is helpful to consider the fundamental principle on which the standard is based: an entity should, with certain limited exceptions, recognise a deferred tax liability (asset) wherever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (smaller) than they would be if such recovery or settlement were to have no tax consequences. [IAS 12.10]. In other words: provide for the tax that would be payable or receivable if the assets and liabilities in the statement of financial position were to be recovered or settled at book value.

The implication of this is that in the basic ‘equation’ of IAS 12, i.e.

• carrying amount – tax base = temporary difference,

the true unknown is not in fact the temporary difference (as implied by the definitions of tax base and temporary difference) but the tax base (as implied by paragraph 10).

It will be apparent from the more detailed discussion at 6.2 below that this clarification is particularly relevant to determining the tax bases of certain financial liabilities, which often do not fit the general ‘formula’ of carrying amount less amount deductible on settlement.

6.1.4 Tax base of items not recognised as assets or liabilities in financial statements

Certain items are not recognised as assets or liabilities in financial statements, but may nevertheless have a tax base. Examples may include:

• research costs (which are required to be expensed immediately by IAS 38 – Intangible Assets – see Chapter 17);
• the cost of equity-settled share-based payment transactions (which under IFRS 2 – Share-based Payment – give rise to an increase in equity and not a liability – see Chapter 34); and
• goodwill deducted from equity under previous IFRS or national GAAP.

Where such items are tax-deductible, their tax base is the difference between their carrying amount (i.e. nil) and the amount deductible in future periods. [IAS 12.9]. This may seem somewhat contrary to the definition of tax base, in which it is inherent that, in order for an item to have a tax base, that item must be an asset or liability, whereas none of the items above was ever recognised as an asset.⁸ The implicit argument is that all these items were initially (and very briefly) recognised as assets before being immediately written off in full.

Local tax legislation sometimes gives rise to liabilities that have a tax base but no carrying amount. For example, a subsidiary of the reporting entity may receive a tax deduction for a provision that has been recognised in the individual financial statements of that subsidiary prepared under local accounting principles. For the purposes of the entity's consolidated financial statements, however, the provision does not satisfy the recognition requirements of IAS 37. In such situations we consider it appropriate to regard the tax deduction received as giving rise to a deferred tax liability in the consolidated financial statements (by virtue of there being a provision with a tax base but no carrying amount) in addition to the current tax income recorded for the subsidiary.

Similar situations may arise where local tax legislation permits deductions for certain expenditure determined according to tax legislation without reference to any financial statements. Again, in those cases where an equivalent amount of expenditure is likely to be recognised in the financial statements at a later date, we would regard it as appropriate to regard the tax deduction received as giving rise to a deferred tax liability in the consolidated financial statements.

6.1.5 Equity items with a tax base

The definition of ‘tax base’ refers to the tax base of an ‘asset or liability’. This begs the question of whether IAS 12 regards equity items as having a tax base and therefore whether deferred tax can be recognised in respect of equity instruments (since deferred tax is the tax relating to temporary differences which, by definition, can only arise on items with a tax base – see above).

In February 2003 the Interpretations Committee considered this issue. It drew attention to the IASB's proposal at that time to amend the definition of ‘tax base’ so as to refer not only to assets and liabilities but also equity instruments as supporting the view that deferred tax should be recognised where appropriate on equity instruments. This was effectively the approach proposed in the exposure draft ED/2009/2 (see 1.3 above).⁹

An alternative analysis might be that equity items do not have a tax base, but that any tax effects of them are to be treated as items that are not recognised as assets or liabilities but nevertheless have a tax base (see 6.1.4 above).

Given the lack of explicit guidance in the current version of IAS 12 either analysis may be acceptable, provided that it is applied consistently. This is reflected in a number of the examples in the remainder of this Chapter.

6.1.6 Items with more than one tax base

Some assets and liabilities have more than one tax base, depending on the manner in which they are realised or settled. These are discussed further at 8.4 below.

6.1.7 Tax bases disclaimed or with no economic value

In some situations an entity may choose not to claim an available deduction for an item as part of an overall tax planning strategy. In other cases, a deduction available as a matter of tax law may have no real economic effect – for example because the deduction will increase a pool of brought forward tax losses which the entity does not expect to recover in the foreseeable future.

In our view, the fact that the entity chooses not to take advantage of a potential tax deduction, or that such a deduction would have no real economic effect in the foreseeable future, does not mean that the asset to which the deduction relates has no tax base. While such considerations will be relevant to determining whether a deductible temporary difference gives rise to a recoverable deferred tax asset (see 7.4 below), the tax base of an asset is determined by reference to the amount attributed to the item by tax law. [IAS 12.5].

6.2.1 Taxable temporary differences

6.2.2 Deductible temporary differences

6.2.3 Assets and liabilities with no temporary difference (because tax base equals carrying amount)

• Liability for expense already deducted for tax

  An entity accrues £200,000 for electricity costs in the year ended 31 March 2020. The expense is deductible for tax in that period. The temporary difference associated with the liability is zero. This is calculated as the carrying amount of £200,000 less the tax base of £200,000, being the carrying amount (£200,000) less amount deductible for tax in future periods (zero).

• Liability for expense never deductible for tax

  An entity accrues €400,000 for a fine for environmental pollution, which is not deductible for tax. The temporary difference associated with the liability is zero. This is calculated as the carrying amount of €400,000 less the tax base of €400,000, being the carrying amount (€400,000) less amount deductible for tax in future periods (zero).

• Loan repayable at carrying amount

  An entity borrows $2 million. This is the carrying amount of the loan on initial recognition, which is the same as the amount repayable on final maturity of the loan. The temporary difference associated with the liability is zero. This is calculated as the carrying amount of $2 million less the tax base of $2 million, being the carrying amount ($2 million) less amount deductible for tax in future periods (zero).

• Receivable for non-taxable income

  In its separate financial statements an entity records a receivable for a £1 million dividend due from a subsidiary accounted for at cost. The dividend is not taxable. Accordingly it gives rise to a temporary difference of zero, since the tax base of any asset, the recovery of the carrying amount of which is not taxable, is taken to be the same as its carrying amount.

7.1.1 Taxable temporary differences (deferred tax liabilities)

IAS 12 requires a deferred tax liability to be recognised in respect of all taxable temporary differences except those arising from:

• the initial recognition of goodwill; or
• the initial recognition of an asset or liability in a transaction that:
  • is not a business combination; and
  • at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).

These exceptions to the recognition principles do not apply to taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, which are subject to further detailed provisions of IAS 12 (see 7.5 below). [IAS 12.15].

Examples of taxable temporary differences are given in 6.2.1 above.

7.1.2 Deductible temporary differences (deferred tax assets)

IAS 12 requires a deferred tax asset to be recognised in respect of all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference will be utilised except those arising from the initial recognition of an asset or liability in a transaction that:

• is not a business combination; and
• at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss). [IAS 12.24].

IAS 12 does not define ‘probable’ in this context. However, it is generally understood that, for example in IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations – and IAS 37, it should be taken to mean ‘more likely than not’. [IFRS 5 Appendix A, IAS 37.23]. The exposure draft ED/2009/2 (see 1.3 above) effectively clarified that this is the intended meaning.¹⁰

These exceptions to the recognition principles do not apply to deductible temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, which are subject to further detailed provisions of IAS 12 (see 7.5 below).

Examples of deductible temporary differences are given in 6.2.2 above.

7.1.3 Interpretation issues

7.2.1 Acquisition of tax losses

The initial recognition exception applies only to deferred tax relating to temporary differences. It does not apply to tax assets, such as purchased tax losses, that do not arise from deductible temporary differences. The definition of ‘deferred tax assets’ (see 3 above) explicitly distinguishes between deductible temporary differences and unused losses and tax credits. [IAS 12.5]. There is therefore no restriction on the recognition of acquired tax losses other than the general criteria of IAS 12 for recognition of tax assets (see 7.4 below).

Under the general principles of IAS 12, acquired tax losses are initially recognised at the amount paid, subsequently re-assessed for recoverability (see 7.4.6 below) and re-measured accordingly (see 8 below). Changes in the recognised amount of acquired tax losses are generally recognised in profit or loss, on the basis that, as acquired losses, they do not relate to any pre-tax transaction previously accounted for by the entity (see 10 below). However, in some limited circumstances, changes to tax losses acquired as part of a business combination are required to be treated as an adjustment to goodwill (see 12.1.2 below).

7.2.2 Initial recognition of goodwill

7.2.3 Initial recognition of other assets and liabilities

Where a temporary difference arises on initial recognition of an asset or liability, its treatment depends on the circumstances which give rise to the recognition of the asset or liability.

If the temporary difference arises as the result of a business combination, deferred tax is recognised on the temporary difference with a corresponding adjustment to goodwill or any bargain purchase gain.

If the temporary difference arises in a transaction that gives rise to an accounting or taxable profit or loss, deferred tax is recognised on the temporary difference, giving rise to deferred tax expense or deferred tax income.

If the temporary difference arises in any other circumstances (i.e. neither in a business combination nor in a transaction that gives rise to an accounting or taxable profit or loss) no deferred tax is recognised. [IAS 12.22].

The application of the initial recognition exception to assets and liabilities is illustrated in Examples 33.4 to 33.7 below.

7.2.4 Changes to temporary differences after initial recognition

The initial recognition exception applies only to temporary differences arising on initial recognition of an asset or liability. It does not apply to new temporary differences that arise on the same asset or liability after initial recognition. When the exception has been applied to the temporary difference arising on initial recognition of an asset or liability, and there is a different temporary difference associated with that asset or liability at a subsequent date, it is necessary to analyse the temporary difference at that date between:

• any amount relating to the original temporary difference (on which no deferred tax is recognised); and
• the remainder, which has implicitly arisen after initial recognition of the asset or liability (on which deferred tax is recognised).

IAS 12 does not set out comprehensive guidance to be followed in making this analysis, but it does give a number of examples, from which the following general principles may be inferred:

• the new temporary difference is treated as part of the temporary difference arising on initial recognition to the extent that any change from the original temporary difference is due to:
  • the write-down (through depreciation, amortisation or impairment) of the original carrying amount of an asset with no corresponding change in the tax base (see 7.2.4.A below); or
  • the increase in the original carrying amount of a liability arising from the amortisation of any discount recognised at the time of initial recognition of that liability, with no corresponding change in the tax base (see 7.2.4.A below);
• the new temporary difference is regarded as arising after initial recognition to the extent that any change from the original temporary difference is due to:
  • a change in the carrying value of the asset or liability, other than for the reasons set out above (see 7.2.4.B below); or
  • a change in the tax base due to items being recorded on the tax return (see 7.2.4.C below); and
• where the change in the temporary difference results from a change in the tax base due to legislative change, IAS 12 provides no specific guidance, and more than one treatment may be possible (see 7.2.4.D below).

7.2.5 Intragroup transfers of assets with no change in tax base

In many tax jurisdictions the tax deductions for an asset are generally related to the cost of that asset to the legal entity that owns it. However, in some jurisdictions, where an asset is transferred between members of the same group within that jurisdiction, the tax base remains unchanged, irrespective of the consideration paid.

Therefore, where the consideration paid for an asset in such a case differs from its tax base, a temporary difference arises in the acquiring entity's separate financial statements on transfer of the asset. The initial recognition exception applies to any such temporary difference. A further complication is that the acquiring entity acquires an asset that, rather than conforming to the fiscal norms of being either deductible for its full cost or not deductible at all, is deductible, but for an amount different from its cost. The treatment of such assets in the context of the initial recognition exception is discussed more generally at 7.2.6 below.

In the consolidated financial statements of any parent of the buying entity, however, there is no change to the amount of deferred tax recognised provided that the tax rate of the buying and selling entity is the same. Where the tax rate differs, the deferred tax will be remeasured using the buying entity's tax rate.

Where an asset is transferred between group entities and the tax base of the asset changes as a result of the transaction, there will be deferred tax income or expense in the consolidated financial statements. This is discussed further at 8.7 below.

7.2.6 Partially deductible and super-deductible assets

In many tax jurisdictions the tax deductions for an asset are generally based on the cost of that asset to the legal entity that owns it. However, in some jurisdictions, certain categories of asset are deductible for tax but for an amount either less than the cost of the asset (‘partially deductible’) or more than the cost of the asset (‘super-deductible’).

IAS 12 provides no specific guidance on the treatment of partially deductible and super-deductible assets acquired in a transaction to which the initial recognition exception applies. The issues raised by such assets are illustrated in Examples 33.16 and 33.17 below.

However, this approach cannot be said to be required by IAS 12 and other methodologies could well be appropriate, provided that they are applied consistently in similar circumstances.

In specific cases, the additional tax deductions might have sufficient characteristics of a government grant (e.g. if it were subject to conditions more onerous that those normally associated with tax deductions in the jurisdiction concerned) to allow application of the principles of IAS 20 which results in the allocation of the additional tax deductions over the life of the asset (see 4.3 above). However, such circumstances are rare.

Again, as in Example 33.16 above, no single approach can be said to be required by IAS 12 and other methodologies could well be appropriate, provided that they are applied consistently in similar circumstances.

7.2.7 Transactions involving the initial recognition of an asset and liability

As noted at 7.2 above, the initial recognition exception is essentially a pragmatic remedy to avoid accounting problems that would arise without it, particularly in transactions where one asset is exchanged for another (such as the acquisition of PP&E for cash).

However, experience has shown that the exception creates new difficulties of its own. In particular, it does not deal adequately with transactions involving the initial recognition of an equal and opposite asset and liability which subsequently unwind on different bases. Examples of such transactions include:

• recording a liability for decommissioning costs, for which the corresponding debit entry is an increase in PP&E (see 7.2.7.A below); and
• the commencement of a finance lease by a lessee, which involves the recording of an asset and a corresponding financial liability (see 7.2.7.B below).

In these circumstances there are three alternative approaches seen in practice:

1. apply the initial recognition exception. Recognise nothing in respect of temporary differences arising at the time the asset and liability are first recognised. No deferred tax arises for any changes in those initial temporary differences;
2. recognise deferred tax on initial recognition – consider the asset and the liability separately. The entity recognises a deferred tax liability for any taxable temporary differences related to the asset component and a deferred tax asset for any deductible temporary differences related to the liability component. On initial recognition, the taxable temporary difference and the deductible temporary differences are equal and offset to zero. Deferred tax is recognised on subsequent changes to the taxable and deductible temporary differences; or
3. recognise deferred tax on initial recognition – consider the asset and the liability as in-substance linked to each other. Consider any temporary differences on a net basis and recognise deferred tax on that net amount. In this approach, the non-deductible asset and the tax-deductible liability are regarded as being economically the same as a tax deductible asset that is acquired on deferred terms (where the repayment of the loan does not normally give rise to tax). On this basis, the net carrying value of the asset and liability is zero on initial recognition, as is the tax base. There is therefore no temporary difference and the initial recognition exception does not apply. Deferred tax is recognised on subsequent temporary differences that arise when the net asset or liability changes from zero.

These three approaches are illustrated in Example 33.18 below.

As can be seen below, applying the initial recognition exception results in significant fluctuations in effective tax rates reported in the periods over which the related asset is depreciated and the finance cost on the liability is recognised. In addition, it fails to reflect the economic reality that all expenditure is ultimately expected to be eligible for tax deductions at the standard tax rate. Indeed, it could be argued that the result of applying the initial recognition exception in these circumstances makes the financial statements less transparent, contrary to the stated reason in IAS 12 for requiring the exception to be applied. [IAS 12.22(c)].

It has been argued that the Initial Recognition Exception (IRE) does not apply as paragraphs 15 and 24 of IAS 12 refer to the recognition of ‘an asset or liability’, but do not explicitly consider the simultaneous recognition of ‘an asset and a liability’. Arguably a more informative result is achieved when the initial recognition exception is disregarded, as in the second and third approaches set out above. Both of these approaches eliminate the volatility in the reported effective tax rate, as demonstrated by Approach 2 and Approach 3 in Example 33.18 below. All three approaches give a result that is consistent with the implied intention of the initial recognition exception (that the reporting entity should provide for deferred tax on initial recognition unless to do so would create an immediate net tax expense or credit in the statement of comprehensive income).

As noted at 7.2.7.B below, in June 2018 the Interpretations Committee acknowledged the three approaches currently applied in the circumstances noted above and decided to recommend that the Board should develop a narrow-scope amendment to IAS 12.¹¹ In July 2019, the Board issued its Exposure Draft, ED/2019/5 – Deferred Tax related to Assets and Liabilities arising from a Single Transaction: Proposed amendments to IAS 12. The proposed amendments would require an entity to recognise deferred tax on initial recognition of particular transactions to the extent that the transaction gives rise to equal amounts of deferred tax assets and liabilities. The proposed amendments would apply to particular transactions for which an entity recognises both an asset and a liability, such as leases and decommissioning obligations.¹² The comment period for the Exposure Draft ends in November 2019.

Notwithstanding that this recommendation would result in an approach that is similar to the second treatment above being required, we believe that any of the approaches described above continue to be acceptable until such an amendment is issued by the Board in its final form.

7.2.8 Initial recognition of compound financial instruments by the issuer

IAS 32 requires ‘compound’ financial instruments (those with both a liability feature and an equity feature, such as convertible bonds) to be accounted for by the issuer using so-called split accounting. This is discussed in more detail in Chapter 47 at 6, but in essence an entity is required to split the proceeds of issue of such an instrument (say €1 million) into a liability component, measured at its fair value based on real market rates for non-convertible debt rather than the nominal rate on the bond (say €750,000), with the balance being treated as an equity component (in this case €250,000).

Over the life of the instrument, the €750,000 carrying value of the liability element will be accreted back up to €1,000,000 (or such lower or higher sum as might be potentially repayable), so that the cumulative income statement interest charge will comprise:

1. any actual cash interest payments made (which are tax-deductible in most jurisdictions); and
2. the €250,000 accretion of the liability from €750,000 to €1,000,000 (which is not tax-deductible in most jurisdictions).

Where such an instrument is issued, IAS 12 requires the treatment in Example 33.19 to be adopted. [IAS 12 IE Example 4].

This treatment causes some confusion in practice because it appears to contravene the prohibition on recognition of deferred tax on temporary differences arising on the initial recognition of assets and liabilities (other than in a business combination) that do not give rise to accounting or taxable profit or loss. [IAS 12.15(b)]. IAS 12 states that this temporary difference does not arise on initial recognition of a liability but as a result of the initial recognition of the equity component as a result of the requirement in IAS 32 to separate the instrument between its equity and liability components. [IAS 12.23].

7.2.9 Acquisition of subsidiary that does not constitute a business

Occasionally, an entity may acquire a subsidiary which is accounted for as the acquisition of an asset rather than as a business combination. This will most often be the case where the subsidiary concerned is a ‘single asset entity’ holding a single item of property, plant and equipment which is not considered to constitute a business. Where an asset is acquired in such circumstances, the initial recognition exception applies, as illustrated by the following example.

Having determined that the acquisition does not constitute a business combination, the initial recognition exception applies to the entire $6 million difference between the carrying value of the property in the financial statements of P of $10 million and its tax base of $4 million, in exactly the same way as if the property had been legally acquired as a separate asset rather than through acquisition of the shares of S. [IAS 12.15(b)]. Therefore, no deferred tax is recognised by P in respect of the property at the time of its acquisition.

This conclusion was confirmed by the Interpretations Committee in March 2017. The Committee considered an example similar to Example 33.20 above and where the fair value of the property had been higher than the transaction price for the shares in S because of the associated deferred tax liability. Even in those circumstances, the Committee concluded that in a transaction that does not meet the definition of a business combination:¹⁶

1. the entire purchase price is allocated to the investment property; [IFRS 3.2(b)] and
2. no deferred tax liability is recognised by virtue of the initial recognition exception. [IAS 12.15(b)].

7.2.10 Acquisition of an investment in a subsidiary, associate, branch or joint arrangement

The initial recognition exception does not apply to temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, which are subject to further detailed provisions of IAS 12 (see 7.5 below). [IAS 12.15, 24].

7.4.1 Restrictions imposed by relevant tax laws

When an entity assesses whether a deductible temporary difference is capable of being utilised, it must consider whether tax law restricts the sources of taxable profits against which deductions for this type of temporary difference are permitted. If tax law imposes no such restrictions, an entity can assess a deductible temporary difference in combination with all its other deductible temporary differences. However, if tax law restricts the utilisation of losses to deduction against a specific type of income, the recovery of a deductible temporary difference is assessed in combination only with other deductible temporary differences of the appropriate type. [IAS 12.27A].

7.4.2 Sources of ‘probable’ taxable profit – taxable temporary differences

Before considering forecasts of future taxable profits, an entity should look to the deferred tax liabilities it has already recognised at the reporting date as a source of probable taxable profits that would allow any deductible temporary differences to be utilised. IAS 12 states that it is ‘probable’ that there will be sufficient taxable profit if a deductible temporary difference can be offset against a taxable temporary difference (deferred tax liability) relating to the same tax authority and the same taxable entity which will reverse in the same period as the asset, or in a period into which a loss arising from the asset may be carried back or forward. In such circumstances, a deferred tax asset is recognised. [IAS 12.28].

There is no need at this stage to estimate the future taxable profits of the entity. If there are sufficient taxable temporary differences to justify the recognition of a deferred tax asset for deductible temporary differences, then the asset is recognised. The only condition to apply, as noted at 7.4.1 above, is that any deferred tax liability used as the basis for recognising a deferred tax asset represents a future tax liability against which the deductible temporary difference can actually be offset under the relevant tax law. [IAS 12.27A]. For example, in a tax jurisdiction where revenue and capital items are treated separately for tax purposes, a deferred tax asset representing a capital loss cannot be recognised by reference to a deferred tax liability relating to tax allowances received on PP&E in advance of the related depreciation expense.

7.4.3 Sources of ‘probable’ taxable profit – estimates of future taxable profits

Estimates of future taxable profits are only required to justify the recoverability of those deductible temporary differences in excess of the amounts already ‘matched’ against deferred tax liabilities recognised at the reporting date in the manner described at 7.4.2 above. Where there are insufficient taxable temporary differences relating to the same tax authority to offset deductible temporary differences, a deferred tax asset should be recognised to the extent that:

• it is probable that in future periods there will be sufficient taxable profits:
  • relating to the same tax authority;
  • relating to the same taxable entity; and
  • arising in the same period as the reversal of the deductible temporary difference or in a period into which a loss arising from the deferred tax asset may be carried back or forward; or
• tax planning opportunities are available that will create taxable profit in appropriate periods – see 7.4.4 below. [IAS 12.29].

Where an entity has a history of recent losses it should also consider the guidance in IAS 12 for recognition of such losses (see 7.4.6 below). [IAS 12.31].

7.4.4 Tax planning opportunities and the recognition of deferred tax assets

‘Tax planning opportunities’ are actions that the entity would take in order to create or increase taxable income in a particular period before the expiry of a tax loss or tax credit carryforward. IAS 12 notes that, in some jurisdictions, taxable profit may be created or increased by:

• electing to have interest income taxed on either a received or receivable basis;
• deferring the claim for certain deductions from taxable profit;
• selling, and perhaps leasing back, assets that have appreciated but for which the tax base has not been adjusted to reflect such appreciation; and
• selling an asset that generates non-taxable income (such as, in some jurisdictions, a government bond) in order to purchase another investment that generates taxable income.

Where tax planning opportunities advance taxable profit from a later period to an earlier period, the utilisation of a tax loss or tax credit carryforward still depends on the existence of future taxable profit from sources other than future originating temporary differences. [IAS 12.30].

The requirement to have regard to future tax planning opportunities applies only to the measurement of deferred tax assets. It does not apply to the measurement of deferred tax liabilities. Thus, for example, it would not be open to an entity subject to tax at 30% to argue that it should provide for deferred tax liabilities at some lower rate on the grounds that it intends to invest in assets attracting investment tax credits that will allow it to pay tax at that lower rate (see 8.4.1 below).

IAS 12 describes tax planning opportunities as actions that the entity ‘would’ take – not those it ‘could’ take. In other words, they are restricted to future courses of action that the entity would actually undertake to realise such a deferred tax asset, and do not include actions that are theoretically possible but practically implausible, such as the sale of an asset essential to the ongoing operations of the entity. Only if such actions are both capable of being taken and are intended to be taken by the entity can it be said that the resulting tax planning would give rise to a ‘probable’ future taxable profit.

Implementation of a tax planning opportunity may well entail significant direct costs or the loss of other tax benefits or both. Accordingly, any deferred tax asset recognised on the basis of a tax planning opportunity must be reduced by any cost of implementing that opportunity (measured, where applicable, on an after-tax basis).

Moreover, IAS 12 regards tax planning opportunities as a component of future net taxable profits. Thus, where a tax planning opportunity exists, but the entity is expected to remain loss-making (such that the opportunity effectively will simply reduce future tax losses), we believe that such an opportunity does not generally form the basis for recognising a deferred tax asset, except to the extent that it will create net future taxable profits (see also 7.4.6 below).

7.4.5 Unrealised losses on debt securities measured at fair value

In January 2016, the IASB issued Recognition of Deferred Tax Assets for Unrealised Losses (Amendments to IAS 12). These amendments concluded deliberations started by the Interpretations Committee in May 2010 on the recognition of deferred tax assets for unrealised losses, for example on debt instruments measured at fair value. [IAS 12.BC1A].

The Committee had been asked to provide guidance on how an entity determines whether to recognise a deferred tax asset under IAS 12 in the following circumstances: [IAS 12.BC37]

1. the entity has a debt instrument measured at fair value under IAS 39 – Financial Instruments: Recognition and Measurement – and changes in market interest rates result in a decrease in the fair value of the debt instrument below its cost;
2. it is probable that the issuer of the debt instrument will make all the contractual payments;
3. the tax base of the debt instrument is its cost;
4. tax law does not allow a loss to be deducted on a debt instrument until the loss is realised for tax purposes;
5. the entity has the ability and intention to hold the debt instrument until the unrealised loss reverses (which may be at its maturity);
6. tax law distinguishes between capital gains and losses and ordinary income tax losses. While capital losses can only be offset against capital gains, ordinary losses can be offset against both capital gains and ordinary income; and
7. the entity has insufficient taxable temporary differences and no other probable taxable profits against which the entity can utilise those deductible temporary differences.

The Interpretations Committee had identified diversity in practice because of uncertainty about the application of some of the principles in IAS 12, in particular in relation to the following:

1. The existence of a deductible temporary difference, when there are no tax consequences to the recovery of the principal on maturity; the holder of the debt instrument expects to hold it to maturity; and it is probable that the issuer will pay all the contractual cash flows. [IAS 12.BC38, BC39].
2. Whether it is appropriate for an entity to determine deductible temporary differences and taxable temporary differences on the basis of the asset's carrying amount when at the same time it assumes that the asset is recovered for more than its carrying amount for the purposes of estimating probable future taxable profit against which deductible temporary differences are assessed for utilisation. This question is relevant when taxable profit from other sources is insufficient for the utilisation of the deductible temporary differences arising when the asset is measured at fair value. [IAS 12.BC38, BC47].
3. Whether the estimate of probable future taxable profit should include or exclude the effects of reversing the deductible temporary differences that are being assessed for recognition as an asset. [IAS 12.BC38, BC55].
4. The basis for assessing the recoverability of deductible temporary differences, i.e. for each deductible temporary difference separately, or in combination with other deductible temporary differences. This question is relevant, for example, when tax law distinguishes capital gains and losses from other taxable gains and losses and capital losses can only be offset against capital gains. [IAS 12.BC38, BC57].

Whilst the amendments to IAS 12 were framed around the above example of a fixed-rate debt instrument measured at fair value, the Board noted that the principle on which the amendments are based is not limited to any specific type or class of assets. [IAS 12.BC52]. However, as noted at 7.4.5.B below, the IASB acknowledged the concerns raised by respondents that the amendments could be applied too broadly and highlighted the need for particular caution where assets are measured at fair value. In response to that concern, the Board noted that entities will need to have sufficient evidence on which to base their estimate of probable future taxable profit, including when that estimate involves the recovery of an asset for more than its carrying amount. [IAS 12.BC53].

7.4.6 Unused tax losses and unused tax credits

A deferred tax asset should be recognised for the carryforward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised. [IAS 12.34].

The criteria for recognition are essentially the same as those for deductible temporary differences, as set out in 7.4.1 to 7.4.4 above, in particular that it is ‘probable’ that there will be sufficient taxable profit against which a deductible temporary difference can be utilised when there are sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity which are expected to reverse in the same period as the asset, or in a period into which a loss arising from the asset may be carried back or forward. [IAS 12.28].

However, IAS 12 emphasises that the existence of unused tax losses is strong evidence that taxable profits (other than those represented by deferred tax liabilities) may not be available. Therefore, an entity with a history of recent losses recognises a deferred tax asset arising from unused tax losses or tax credits only to the extent that: [IAS 12.35]

• it has sufficient taxable temporary differences; or
• there is other convincing evidence that sufficient taxable profit will be available against which the unused tax losses or unused tax credits can be utilised by the entity.

In May 2014, the Interpretations Committee confirmed that the consideration of available reversing taxable temporary differences is made independently of the assessment of an entity's expectations of future tax losses. Accordingly, a deferred tax asset is recognised for the carryforward of unused tax losses to the extent of the existing taxable temporary differences, of an appropriate type, that reverse in an appropriate period. The reversal of those taxable temporary differences enables the utilisation of the unused tax losses and justifies the recognition of deferred tax assets.¹⁷

In addition to the question noted above, the Interpretations Committee was asked to clarify how the guidance in IAS 12 is applied when tax laws limit the extent to which tax losses brought forward can be recovered against future taxable profits. In the tax systems considered for this issue, the amount of tax losses brought forward that can be recovered in each tax year is limited to a specified percentage of the taxable profits of that year.

In these circumstances, the Committee noted that the amount of deferred tax assets recognised from unused tax losses as a result of suitable existing taxable temporary differences should be restricted as specified by the tax law. This is because when the suitable taxable temporary differences reverse, the amount of tax losses that can be utilised by that reversal is reduced as specified by the tax law. Also, the Committee noted that in this case future tax losses are not considered.¹⁸

Consequently, the availability of future taxable profits is only required to be considered if the unused tax losses exceed the amount of suitable existing taxable temporary differences (after taking into account any restrictions). The Interpretations Committee also confirmed in May 2014 that an additional deferred tax asset is recognised only to the extent that the following requirements are met:¹⁹ [IAS 12.36]

• whether the entity has sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, which will result in taxable amounts against which the unused tax losses or unused tax credits can be utilised before they expire;
• whether the entity will have taxable profits before the unused tax losses or unused tax credits expire;
• whether the unused tax losses result from identifiable causes which are unlikely to recur; and
• whether tax planning opportunities (see 7.4.4 above) are available to the entity that will create taxable profit in the period in which the unused tax losses or unused tax credits can be utilised.

To the extent that it is not probable that taxable profit will be available against which the unused tax losses or unused tax credits can be utilised, a deferred tax asset is not recognised. [IAS 12.36]. Additional disclosures are required when an entity recognises a deferred tax asset on the assumption that there will be future taxable profits available in excess of the amount of existing taxable temporary differences, and the entity has suffered a loss in either the current or preceding period in the tax jurisdiction to which the deferred tax asset relates (see 14.3 below). [IAS 12.35].

Some have suggested that the IASB should set time limits on the foresight period used. We consider that such generalised guidance would be inappropriate, particularly in the context of an international standard, which must address the great variety of tax systems that exist worldwide, and which impose a wide range of restrictions on the carryforward of tax losses or tax credits. In any event, it may well be the case that a deferred tax asset recoverable in twenty years from profits from a currently existing long-term supply contract with a creditworthy customer may be more robust than one recoverable in one year from expected future trading by a start-up company.

7.4.7 Re-assessment of deferred tax assets

An entity must review its deferred tax assets, both recognised and unrecognised, at each reporting date.

7.4.8 Effect of disposals on recoverability of tax losses

In consolidated financial statements, the disposal of a subsidiary may lead to the derecognition of a deferred tax asset in respect of tax losses because either:

• the entity disposed of had incurred those tax losses itself; or
• the entity disposed of was the source of probable future taxable profits against which the tax losses of another member of the group could be offset, allowing the group to recognise a deferred tax asset.

It is clear that, once the disposal has been completed, those tax losses will no longer appear in the disposing entity's statement of financial position. What is less clear is whether those tax losses should be derecognised before the disposal itself is accounted for – and if so, when. IAS 12 does not give any explicit guidance on this point, beyond the general requirement to recognise tax losses only to the extent that their recoverability is probable (see 7.4 above).

In our view, three broad circumstances need to be considered:

• the entity has recognised a deferred tax asset in respect of tax losses of the subsidiary to be disposed of, the recoverability of which is dependent on future profits of that subsidiary (see 7.4.8.A below);
• the entity has recognised a deferred tax asset in respect of tax losses of a subsidiary that is to remain in the group, the recoverability of which is dependent on future profits of the subsidiary to be disposed of (see 7.4.8.B below); and
• the entity has recognised a deferred tax asset in respect of tax losses of the subsidiary to be disposed of, the recoverability of which is dependent on future profits of one or more entities that are to remain in the group (see 7.4.8.C below).

7.5.1 Calculation of ‘outside’ temporary differences

As noted above, ‘outside’ temporary differences arise in both consolidated and separate financial statements and may well be different, due to the different bases used to account for subsidiaries, branches and associates or interests in joint arrangements in consolidated and separate financial statements. [IAS 12.38]. This is illustrated by Example 33.23 below.

7.5.2 Taxable temporary differences

IAS 12 requires a deferred tax liability to be recognised for all taxable temporary differences associated with investments (both domestic and foreign) in subsidiaries, branches and associates or interests in joint arrangements, unless:

1. the parent, investor joint venturer or joint operator is able to control the timing of the reversal of the temporary difference; and
2. it is probable that the temporary difference will not reverse in the foreseeable future. [IAS 12.39].

IAS 12 does not currently define the meaning of ‘probable’ in this context. However, we consider that, as in other IFRSs, it should be taken to mean ‘more likely than not’ (see 7.1.2 above). IAS 12 also does not elaborate on the meaning of ‘foreseeable’. In our view, the period used will be a matter of judgement in individual circumstances.

What this means in practice is best illustrated by reference to its application to the retained earnings of subsidiaries, branches and joint arrangements on the one hand, and those of associates on the other.

In the case of a subsidiary or a branch, the parent is able to control when and whether the retained earnings are distributed. Therefore, no provision need be made for the tax consequences of distribution of profits that the parent has determined will not be distributed in the foreseeable future. [IAS 12.40]. In the case of a joint arrangement, provided that the joint venturer or joint operator can control the distribution policy, similar considerations apply. [IAS 12.43].

In the case of an associate, however, the investor cannot control the distribution policy. Therefore provision should be made for the tax consequences of the distribution of the retained earnings of an associate, except to the extent that there is a shareholders’ agreement that those earnings will not be distributed.

Some might consider this a counter-intuitive result. In reality, it is extremely unusual for any entity (other than one set up for a specific project) to pursue a policy of full distribution. To the extent that it occurs at all, it is much more likely in a wholly-owned subsidiary than in an associate; and yet IAS 12 effectively treats full distribution by associates as the norm and that by subsidiaries as the exception. Moreover, it seems to ignore the fact that equity accounting was developed as a regulatory response to the perceived ability of investors in associates to exert some degree of control over the amount and timing of dividends from them.

In some jurisdictions, some or all of the temporary differences associated with such investments in subsidiaries, branches and associates or interests in joint arrangements are taxed on disposal of that investment or interest. Clearly, where the entity is contemplating such a disposal, it would no longer be able to assert that it is probable that the relevant temporary difference will not reverse in the foreseeable future.

The measurement of any deferred tax liability recognised is discussed at 8.4.9 below.

7.5.3 Deductible temporary differences

IAS 12 requires a deferred tax asset to be recognised for all deductible temporary differences associated with investments in subsidiaries, branches and associates or interests in joint arrangements, only to the extent that it is probable that:

1. the temporary difference will reverse in the foreseeable future; and
2. taxable profit will be available against which the temporary difference can be utilised. [IAS 12.44].

IAS 12 does not define the meaning of ‘probable’ in this context. However, we consider that, as in other IFRS, it should be taken to mean ‘more likely than not’ (see 7.1.2 above).

The guidance discussed at 7.4 above is used to determine whether or not a deferred tax asset can be recognised for such deductible temporary differences. [IAS 12.45].

Any analysis of whether a deductible temporary difference gives rise to an asset must presumably make the same distinction between controlled and non-controlled entities as is required when assessing whether a taxable temporary difference gives rise to a liability (see 7.5.2 above). This may mean, in practical terms, that it is never possible to recognise a deferred tax asset in respect of a non-controlled investment (such as an associate), unless either the investee entity is committed to a course of action that would realise the asset or, where the asset can be realised by disposal, that it is probable that the reporting entity will undertake such a disposal.

The measurement of any deferred tax asset recognised is discussed at 8.4.9 below.

7.5.4 Anticipated intragroup dividends in future periods

Under IAS 10, a dividend may be recognised as a liability of the paying entity and revenue of the receiving entity only when it has been declared by the paying entity. This raises the question of when a reporting entity should account for the tax consequences of a dividend expected to be paid by a subsidiary out of its retained profits as at the reporting date.

7.5.5 Unpaid intragroup interest, royalties, management charges etc.

It is common for groups of companies to access the earnings of subsidiaries not only through distribution by way of dividend, but also by levying charges on subsidiaries such as interest, royalties or general management charges for central corporate services. In practice, such charges are often not settled but left outstanding on the intercompany account between the subsidiary and the parent. In some jurisdictions such income is taxed only on receipt.

This has led some to argue that, where settlement of such balances is within the control of the reporting entity, and it can be demonstrated that there is no foreseeable intention or need to settle such balances, such balances are economically equivalent to unremitted earnings, so that there is no need to provide for the tax consequences of settlement.

In February 2003 the Interpretations Committee considered the issue and indicated that it believes that the exemption from provision for deferred taxes on ‘outside’ temporary differences arising from subsidiaries, branches, associates and interests in joint arrangements is intended to address the temporary differences arising from the undistributed earnings of such entities. The exception does not apply to the ‘inside’ temporary differences that exist between the carrying amount and the tax base of individual assets and liabilities within the subsidiary, branch, associate or interest in a joint arrangement. Accordingly, the Interpretations Committee concluded that a deferred tax liability should be provided for the tax consequences of settling unpaid intragroup charges.²⁰

7.5.6 Other overseas income taxed only on remittance

In May 2007 the Interpretations Committee considered the more general issue of whether deferred taxes should be recognised in respect of temporary differences arising because foreign income is not taxable unless it is remitted to the entity's home jurisdiction.

The Interpretations Committee resolved not to add this issue to its agenda, but to draw it to the attention of the IASB. This decision reflected the status of the IASB's project on income taxes at that time – particularly the Board's decision to eliminate the notion of a ‘branch’.²¹

8.1.1 Changes to tax rates and laws enacted before the reporting date

Deferred tax should be measured by reference to the tax rates and laws, as enacted or substantively enacted by the end of the reporting period. [IAS 12.47]. This requirement for substantive enactment is clear. Changes that have not been enacted by the end of the reporting period are ignored, but changes that are enacted before the reporting date must be applied, even in circumstances when complex legislation is substantively enacted shortly before the end of an annual or interim reporting period.

In cases where the effective date of any enacted changes is after the end of the reporting period, deferred tax should still be calculated by applying the new rates and laws to the deductible and taxable temporary differences that are expected to reverse in those later periods. [IAS 12.47]. When the effective date of any rate changes is not the first day of the entity's annual reporting period, deferred tax would be calculated by applying a blended rate to the taxable profits for each year.

In implementing any amendment to enacted tax rates and laws there will be matters to consider that are specific to the actual changes being made to the tax legislation. However, the following principles from IAS 12 and other standards are relevant in all cases where new tax legislation has been enacted before the end of the reporting period.

8.1.2 Changes to tax rates and laws enacted after the reporting date

The requirement for substantive enactment as at the end of the reporting period is clear. IAS 10 identifies the enactment or announcement of a change in tax rates and laws after the end of the reporting period as an example of a non-adjusting event. [IAS 10.22(h)]. For example, an entity with a reporting period ending on 31 December issuing its financial statements on 20 April the following year would measure its tax assets and liabilities by reference to tax rates and laws enacted or substantively enacted as at 31 December even if these had changed significantly before 20 April and even if those changes have retrospective effect. However, in these circumstances the entity would have to disclose the nature of those changes and provide an estimate of the financial effect of those changes if the impact is expected to be significant (see 14.2 below). [IAS 10.21].

8.4.1 Tax planning strategies to reduce liabilities are not anticipated

As discussed at 7.4.4 above, IAS 12 allows tax planning strategies to be taken into account in determining whether a deductible temporary difference as at the reporting date can be recognised as a deferred tax asset, provided that the entity will create taxable profit in appropriate periods. [IAS 12.29(b)]. This raises the question of the extent to which tax planning strategies may be taken into account more generally in applying IAS 12.

For example, some jurisdictions may offer incentives in the form of a significantly reduced tax rate for entities that undertake particular activities, or invest in particular plant, property and equipment, or create a certain level of employment.

Some have argued that, where an entity has the ability and intention to undertake transactions in the future that will lead to its being taxed at a lower rate, it may take this into account in measuring deferred tax liabilities relating to temporary differences that exist at the reporting date and will reverse in future periods when the lower rate is expected to apply.

We believe that this is not appropriate. IAS 12 only allows entities to consider tax planning opportunities available to the entity that will create taxable profits in appropriate periods for the purpose of determining whether deferred tax assets qualify for recognition. [IAS 12.29(b)]. However, entities are not permitted to take into account future tax planning opportunities in relation to the measurement of deferred tax liabilities as at the reporting date, nor are entities allowed to anticipate future tax deductions that are expected to become available. Such opportunities do not impact on the measurement of deferred tax until the entity has undertaken them, or is at least irrevocably committed to doing so.

8.4.2 Carrying amount

IAS 12 requires an entity to account for the tax consequences of recovering an asset or settling a liability at its carrying amount, and not, for example, the tax that might arise on a disposal at the current estimated fair value of the asset. This is illustrated by the example below.

If the goodwill were disposed of for its current fair value of €3 million, tax of €200,000 would arise. However, the entity recognises no deferred tax liability at the end of 2020, since IAS 12 requires the entity to recognise the tax (if any) that would arise on disposal of the goodwill for its carrying amount of zero. If the asset were sold for zero, a tax loss of €2.5 million would arise but, in accordance with the general provisions of IAS 12 discussed at 7.4 above, a deferred tax asset could be recognised in respect of this deductible temporary difference only if there were an expectation of suitable taxable profits sufficient to enable recovery of the asset.

This may mean that any deferred tax asset or liability recognised under IAS 12 will reflect the expected manner of recovery or settlement, but not the expected amount of recovery or settlement, where this differs from the current carrying amount.

8.4.3 Assets and liabilities with more than one tax base

IAS 12 notes that, in some jurisdictions, the manner in which an entity recovers (settles) the carrying amount of an asset (liability) may affect either or both of:

1. the tax rate applicable when the entity recovers (settles) the carrying amount of the asset (or liability); and
2. the tax base of the asset (or liability).

In such cases, an entity should measure deferred tax assets and liabilities using the tax rate and the tax base that are consistent with the expected manner of recovery or settlement. [IAS 12.51A]. Assets which are treated differently for tax purposes depending on whether their value is recovered through use or sale are commonly referred to as ‘dual-based assets’. The basic requirements of IAS 12 for dual-based assets can be illustrated with a simple example.

8.4.4 Determining the expected manner of recovery of assets

Example 33.27 above, like the various similar examples in IAS 12, assumes that an asset will either be used in the business or sold. In practice, however, many assets are acquired, used for part of their life and then sold before the end of that period. This is particularly the case with long-lived assets such as property. We set out below the approach which we believe should be adopted in assessing the manner of recovery of:

• depreciable PP&E, investment properties and intangible assets (see 8.4.5 below);
• non-depreciable PP&E, investment properties and intangible assets (see 8.4.6 and 8.4.7 below); and
• other assets and liabilities (see 8.4.8 below).

8.4.5 Depreciable PP&E and intangible assets

Depreciable PP&E and investment properties are accounted for in accordance with IAS 16. Amortisable intangibles are accounted for in accordance with IAS 38. IAS 16 and IAS 38, which are discussed in detail in Chapters 17 and 18, require the carrying amount of a depreciable asset to be separated into a ‘residual value’ and a ‘depreciable amount’.

‘Residual value’ is defined as:

• ‘… the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and condition expected at the end of its useful life’

and ‘depreciable amount’ as:

• ‘… the cost of an asset, or other amount substituted for cost, less its residual value’. [IAS 16.6, IAS 38.8].

It is inherent in the definitions of ‘residual value’ and ‘depreciable amount’ that, in determining residual value, an entity is effectively asserting that it expects to recover the depreciable amount of an asset through use and its residual value through sale. If the entity does not expect to sell an asset, but to use and scrap it, then the residual value (i.e. the amount that would be obtained from sale) must be nil.

Accordingly, we believe that, in determining the expected manner of recovery of a depreciable asset for the purposes of IAS 12, an entity should assume that, in the case of an asset accounted for under IAS 16 or IAS 38, it will recover the residual value of the asset through sale and the depreciable amount through use. This view is reinforced by the Basis for Conclusions on IAS 12 which notes that ‘recognition of depreciation implies that the carrying amount of a depreciable asset is expected to be recovered through use to the extent of its depreciable amount, and through sale at its residual value’. [IAS 12.BC6].

Such an analysis is also consistent with the requirement of IAS 8 to account for similar transactions consistently (see Chapter 3 at 4.1.4). This suggests that consistent assumptions should be used in determining both the residual value of an asset for the purposes of IAS 16 and IAS 38 and the expected manner of its recovery for the purposes of IAS 12.

The effect of this treatment is as follows.

We acknowledge that this is not the only interpretation of IAS 12 adopted in practice. However, any alternative approach should be consistent with:

• the requirement of IAS 12 to have regard to the expected manner of recovery of the asset in determining its tax base; and
• the overall objective of IAS 12 to ‘account for the current and future tax consequences of … the future recovery (settlement) of the carrying amount of assets (liabilities) that are recognised in an entity's statement of financial position’ (see 2.1 and 8.4.2 above).

The principle of ‘expected manner of recovery’ and its importance in the determination of the appropriate measurement of deferred tax was reinforced by the Interpretations Committee in its agenda decision on indefinite-life intangible assets, as discussed at 8.4.6.B below.

8.4.6 Non-depreciable PP&E and intangible assets

During 2009 and 2010 the IASB received representations from various entities and bodies that it was often difficult and subjective to determine the manner of recovery of certain categories of asset for the purposes of IAS 12. This was particularly the case for investment properties accounted for at fair value under IAS 40 which are often traded opportunistically, without a specific business plan, but yield rental income until disposed of. In many jurisdictions rental income is taxed at the standard rate, while gains on asset sales are tax-free or taxed at a significantly lower rate. The principal difficulty was that the then extant guidance (SIC‑21 – Income Taxes – Recovery of Revalued Non-Depreciable Assets) effectively required entities to determine what the residual amount of the asset would be if it were depreciated under IAS 16 rather than accounted for at fair value,²² which many regarded as resulting in nonsensical tax effect accounting.

To deal with these concerns, in December 2010 the IASB amended IAS 12 so as to give more specific guidance on determining the expected manner of recovery for non-depreciable assets measured using the revaluation model in IAS 16 (see 8.4.6.A below) and for investment properties measured using the fair value model in IAS 40 (see 8.4.7 below). As noted at 8.4.6.B below, an indefinite-life intangible asset (that is not amortised because its useful economic life cannot be reliably determined) is not the same as a non-depreciable asset to which this amendment would apply.

8.4.7 Investment properties

IAS 40 allows investment properties to be accounted for at fair value (see Chapter 19 at 6). IAS 12 requires any deferred tax asset or liability associated with such a property to be measured using a rebuttable presumption that the carrying amount of the investment property will be recovered through sale. [IAS 12.51C]. The same rebuttable presumption is used when measuring any deferred tax asset or liability associated with an investment property acquired in a business combination if the entity intends to adopt the fair value model in accounting for the property subsequently. [IAS 12.51D].

The presumption is rebutted if the investment property is depreciable and the entity's business model is to consume substantially all the economic benefits embodied in the investment property over time, rather than through sale. The Interpretations Committee has clarified that the presumption can be rebutted in other circumstances, provided that sufficient evidence is available to support that rebuttal. However, the Committee neither gave any indication of, nor placed any restriction on, what those other circumstances might be.²⁴ If the presumption is rebutted, the entity applies the normal requirements of IAS 12 for determining the manner of recovery of assets (see 8.4.1 to 8.4.5 above). [IAS 12.51C].

IAS 12 clarifies that these requirements are subject to the general restrictions on the recognition of deferred tax assets (see 7.4 above). [IAS 12.51E].

8.4.8 Other assets and liabilities

In a number of areas of accounting IFRS effectively requires a transaction to be accounted for in accordance with an assumption as to the ultimate settlement of that transaction that may not reflect the entity's expectation of the actual outcome.

For example, if the entity enters into a share-based payment transaction with an employee that gives the employee the right to require settlement in either shares or cash, IFRS 2 requires the transaction to be accounted for on the assumption that it will be settled in cash, however unlikely this may be. IAS 19 may assert that an entity has a surplus on a defined benefit pension scheme on an accounting basis, when in reality it has a deficit on a funding basis. Similarly, if an entity issues a convertible bond that can also be settled in cash at the holder's option, IAS 32 requires the bond to be accounted for on the assumption that it will be repaid, however probable it is that the holders will actually elect for conversion. It may well be that such transactions have different tax consequences depending on the expected manner of settlement, as illustrated in Example 33.29 below.

Example 33.29 raises the issue of whether any deferred tax asset should be recognised in respect of the €200,000 temporary difference.

One view would be that no deferred tax asset should be recognised on the basis that there is no real expectation that the transaction will be settled in cash, thus allowing the entity to claim a tax deduction. The contrary view would be that the underlying rationale of IAS 12 is that, in order for the financial statements to be internally consistent, the tax effects of recognised assets and liabilities must also be recognised (see 2.1 above). Accordingly, a deferred tax asset should be recognised.

8.4.9 ‘Outside’ temporary differences relating to subsidiaries, branches, associates and joint arrangements

In this section, an ‘outside’ temporary difference means a difference between the tax base in the jurisdiction of the investor of an investment in a subsidiary, associate or branch or an interest in a joint arrangement and carrying amount of that investment or interest (or the net assets and goodwill relating to it) included in the financial statements. Such differences, and the special recognition criteria applied to them by IAS 12, are discussed in more detail at 7.5 above.

Where deferred tax is required to be recognised on such a temporary difference (see 7.5.2 and 7.5.3 above), the question arises as to how it should be measured. Broadly speaking, investors can realise an investment in one of two ways – either indirectly (by remittance of retained earnings or capital) or directly (through sale of the investment to a third party or by receiving residual assets upon liquidation of the associate). In many jurisdictions, the two means of realisation have very different tax consequences.

Having determined that a temporary difference should be recognised, the entity should apply the general rule (discussed in more detail above) that, where there is more than one method of recovering an investment, the entity should measure any associated deferred tax asset or liability by reference to the tax consequences associated with the expected manner of recovery of the investment. [IAS 12.51A]. In other words, to the extent that the investment is expected to be realised through sale, the deferred tax is measured according to the tax rules applicable on sale, but to the extent that the temporary difference is expected to be realised through a distribution of earnings or capital, the deferred tax is measured according to the tax rules applicable on distribution. In its decision in March 2015 not to take a question on this matter to its agenda, the Interpretations Committee confirmed this view. Accordingly, if one part of the temporary difference is expected to be received as dividends, and another part is expected to be recovered upon sale or liquidation (for example, an investor has a plan to sell the investment later and expects to receive dividends until the sale of the investment), different tax rates would be applied to the parts of the temporary difference in order to be consistent with the expected manner of recovery.²⁵

Where the expected manner of recovery is through distribution, there may be tax consequences for more than one entity in the group. For example, the paying company may suffer a withholding tax on the dividend paid and the receiving company may suffer income tax on the dividend received. In such cases, provision should be made for the cumulative effect of all tax consequences. As discussed further at 10.3.3 below, a withholding tax on an intragroup dividend is not accounted for in the consolidated financial statements as a withholding tax (i.e. within equity), but as a tax expense in profit or loss, since the group is not making a distribution but transferring assets from a group entity to a parent of that entity.

8.4.10 ‘Single asset’ entities

In many jurisdictions it is common for certain assets (particularly properties) to be bought and sold by transferring ownership of a separate legal entity formed to hold the asset (a ‘single asset’ entity) rather than the asset itself.

A ‘single asset’ entity may be formed for a number of reasons. For example, the insertion of a ‘single asset’ entity between the ‘real’ owner and the property may limit the ‘real’ owner's liability for obligations arising from ownership of the property. It may also provide shelter from tax liabilities arising on disposal of the property since, in many jurisdictions, the sale of shares is taxed at a lower rate than the sale of property.

This raises the question whether, in determining the expected manner of recovery of an asset for the purposes of IAS 12, an entity may have regard to the fact that an asset held by a ‘single asset’ entity can be disposed of by selling the shares of the entity rather than the asset itself.

The Interpretations Committee has discussed this matter on a number of occasions since September 2011. In May 2012, the Committee noted the following significant diversity in practice:²⁶

• some preparers recognise deferred tax on both the asset within, and the shares of, the ‘single asset’ entity;
• some preparers recognise tax on the shares only; and
• some preparers provide deferred tax on the difference between the asset within the entity and the tax base of its shares, using the tax rate applicable to a disposal of the shares.

The Interpretations Committee noted that IAS 12 requires the parent to recognise deferred tax on both the asset within, and the shares of, the ‘single asset’ entity, if tax law considers the asset and the shares as two separate assets and if no specific exemptions in IAS 12 apply. At that time, the Committee asked its staff to undertake more research with the possible outcome of an amendment to IAS 12 addressing this specific type of transaction. Such an amendment would, in the Committee's view, be beyond the scope of the Annual Improvements project.²⁷

Following further deliberations, the Interpretations Committee decided in July 2014 not to take the issue onto its agenda but instead to recommend to the IASB that it should analyse and assess the concerns raised about the current requirements in IAS 12 in its research project on Income Taxes. In issuing its agenda decision, the Committee noted that:²⁸

1. paragraph 11 of IAS 12 requires the entity to determine temporary differences in the consolidated financial statements by comparing the carrying amounts of assets and liabilities in the consolidated financial statements with the appropriate tax base. In the case of an asset or a liability of a subsidiary that files separate tax returns, this is the amount that will be taxable or deductible on the recovery (settlement) of the asset (liability) in the tax returns of the subsidiary; and
2. the requirement in paragraph 11 of IAS 12 is complemented by the requirement in paragraph 38 of IAS 12 to determine the temporary difference related to the shares held by the parent in the subsidiary by comparing the parent's share of the net assets of the subsidiary in the consolidated financial statements, including the carrying amount of goodwill, with the tax base of the shares for purposes of the parent's tax returns.

The Interpretations Committee also noted that these paragraphs require a parent to recognise both the deferred tax related to the asset inside and the deferred tax related to the shares, if:²⁹

1. tax law attributes separate tax bases to the asset inside and to the shares;
2. in the case of deferred tax assets, the related deductible temporary differences can be utilised as specified in paragraphs 24 to 31 of IAS 12; and
3. no specific exceptions in IAS 12 apply.

Accordingly, in determining the expected manner of recovery of an asset for the purposes of IAS 12, the entity should have regard to both the asset itself and the shares (subject to the exemption relating to investments in subsidiaries in paragraph 39 of the Standard (see 7.5.2 above)).

8.4.11 Change in expected manner of recovery of an asset or settlement of a liability

A change in the expected manner of recovery of an asset or settlement of a liability should be dealt with as an item of deferred tax income or expense for the period in which the change of expectation occurs, and recognised in profit or loss or in other comprehensive income or movements in equity for that period as appropriate (see 10 below).

This may have the effect, in certain situations, that some tax consequences of a disposal transaction are recognised before the transaction itself. For example, an entity might own an item of PP&E which has previously been held for use but which the entity now expects to sell. In our view, any deferred tax relating to that item of PP&E should be measured on a ‘sale’ rather than a ‘use’ basis from that point, even though the disposal itself, and any related current tax, will not be accounted for until the disposal occurs. As noted at 7.4.8 above, which discusses the effect of disposals on the recoverability of tax losses, the change in measurement will be required even if the asset does not yet meet the criteria for being classified as held for sale in IFRS 5 (see Chapter 4 at 2.1.2). This is because those criteria set a higher hurdle for reclassification (‘highly probable’) than the requirement in IAS 12 to use the entity's expected manner of recovery of an asset.

8.5.1 Effectively tax-free entities

In a number of jurisdictions certain types of entity, such as investment vehicles, are generally exempt from corporate income tax provided that they fulfil certain criteria, which generally include a requirement to distribute all, or a minimum percentage, of their annual income as a dividend to investors. This raises the question of how such entities should measure income taxes.

One view would be that, under the basic principle set out above, such an entity has a liability to tax at the normal rate until the dividend for a year becomes a liability. The liability for a dividend for an accounting period usually arises after the end of that period (as in Example 33.30 above). Under this analysis, therefore, such an entity would be required, at each period end, to record a liability for current tax at the standard corporate rate. That liability would be released in full when the dividend is recognised as a liability in the following period. This would mean that, on an ongoing basis, the income statement would show a current tax charge or credit comprising:

• a charge for a full liability for the current period; and
• a credit for the reversal of the corresponding liability for the prior period.

In addition, deferred tax would be recognised at the standard tax rate on all temporary differences.

A second view would be that the provisions of IAS 12 regarding different tax rates for distributed and undistributed tax rates are intended to apply where the only significant factor determining the differential tax rate is the retention or distribution of profit. By contrast, the tax status of an investment fund often depends on many more factors than whether or not profits are distributed, such as restrictions on its activities, the nature of its investments and so forth. On this view, the analysis would be that such an entity can choose to operate within one of two tax regimes (a ‘full tax’ regime or a ‘no tax’ regime), rather than that it operates in a single tax regime with a dual tax rate depending on whether profits are retained or distributed.

The IASB previously appeared to regard IAS 12 as favouring the first analysis, while accepting that the resulting accounting treatment – a cycle of raising full tax provisions and then reversing them – does not reflect economic reality. Accordingly, the exposure draft ED/2009/2 proposed that the measurement of tax assets and liabilities should include the effect of expected future distributions, based on the entity's past practices and expectations of future distributions.³⁰ Following the withdrawal of the exposure draft, the IASB intends to consider this issue further. However, no formal decision has been taken, nor proposals issued for comment.

8.5.2 Withholding tax or distribution tax?

In practice, it is sometimes difficult to determine whether a particular transaction should be accounted for under the provisions of IAS 12 relating to different tax rates for distributed and undistributed profits, or in accordance with the provisions of the standard relating to withholding taxes.

The classification can significantly affect tax expense, because IAS 12 requires a withholding tax to be accounted for as a deduction from equity, whereas a higher tax rate for distributed profits is usually accounted for as a charge to profit or loss.

This issue is discussed further at 10.3 below.

8.7.1 Intragroup transfers of goodwill and intangible assets

It is common in some jurisdictions to sell goodwill and intangible assets from one entity in a group to another in the same group, very often in order either to increase tax deductions on an already recognised asset or to obtain deductions for a previously unrecognised asset. This raises the issue of how the tax effects of such transactions should be accounted for in the financial statements both of the individual entities concerned and in the consolidated financial statements, as illustrated by Example 33.33 below.

9.1.1 Business combinations

The Committee considered whether the Interpretation should address the accounting for tax assets and liabilities acquired or assumed in a business combination when there is uncertainty over income tax treatments. It noted that IFRS 3 applies to all assets acquired and liabilities assumed in a business combination and concluded that on this basis the Interpretation should not explicitly address tax assets and liabilities acquired or assumed in a business combination. [IFRIC 23.BC23].

Nonetheless, IFRS 3 requires an entity to account for deferred tax assets and liabilities that arise as part of a business combination by applying IAS 12. [IFRS 3.24]. Accordingly, the Interpretation applies to such assets and liabilities when there is uncertainty over income tax treatments that affect deferred tax. [IFRIC 23.BC24].

9.5.1 The expiry of a taxation authority's right to examine or re-examine a tax treatment

As noted above, the expiry of a taxation authority's right to examine or re-examine a tax treatment is one example of a change in facts and circumstances cited in the guidance to IFRIC 23. Where this right expires between the end of the reporting period and the date when the financial statements are authorised for issue, the entity should apply the guidance in IAS 10 to determine whether the change is an adjusting or non-adjusting event. [IFRIC 23.14].

IAS 10 defines adjusting events as ‘those that provide evidence of conditions that existed at the end of the reporting period’. Non-adjusting events are ‘those that are indicative of conditions that arose after the reporting period’. [IAS 10.3].

If the right of the tax authority to examine or re-examine a tax treatment does not expire until a date falling after the end of the reporting period, it is clearly indicative of conditions that arose after the reporting period and would therefore be regarded as a non-adjusting event. In addition, because the Interpretation requires an entity to reflect the effect of a change in facts and circumstances or of new information as a change in accounting estimate applying IAS 8, [IFRIC 23.14], the effect of such a change would be recognised prospectively in the period of the change, with no restatement of any estimates made as at the end of the (previous) reporting period. [IAS 8.36].

9.9.1 First-time adopters

The Interpretation includes a consequential amendment to IFRS 1 – First-time Adoption of International Financial Reporting Standards – that provides relief for first-time adopters whose date of transition to IFRSs is before 1 July 2017, such that they do not have to present in their first IFRS financial statements comparative information that reflects IFRIC 23. In this case, the entity would recognise the cumulative effect of applying IFRIC 23 as an adjustment to the opening balance of equity at the beginning of its first IFRS reporting period. [IFRS 1.E8, 39AF].

10.1.1 Non-monetary assets or liabilities with a tax base determined in a different currency

Another example arises when the tax base of a non-monetary asset or liability is determined in a different currency to the entity's functional currency for accounting purposes. This can be the case in oil and gas producing entities that have a functional currency of US dollars but operate (and are accountable for income taxes) in various local jurisdictions under different currencies (see Chapter 43 at 9.1).

IAS 12 notes that in this situation the entity measures its non-monetary asset or liability using its functional currency as at the date of initial recognition, as required by IAS 21. However, if the tax base of its non-monetary assets and liabilities is determined in a different currency, changes in the exchange rate will give rise to temporary differences that result in a recognised deferred tax liability or deferred tax asset (if recoverable). Because this retranslation has no effect on carrying values recognised in the financial statements, there is no corresponding gain or loss against which the tax can be allocated. As a result, the movement in deferred tax is recorded in profit or loss. [IAS 12.41].

In 2015, the Interpretations Committee considered a submission that requested confirmation as to whether deferred taxes arising from the effect of exchange rate changes on the tax bases of such non-current assets are recognised through profit or loss. The Committee completed its deliberations in January 2016 and, in noting the requirement in paragraph 41 of IAS 12, determined that:³⁹

• deferred tax does not arise from a transaction or event that is recognised outside profit or loss and is therefore charged or credited to profit or loss in accordance with paragraph 58 of IAS 12;
• such a deferred tax charge or credit would be presented with other deferred taxes, instead of with foreign exchange gains or losses, in the statement of profit or loss; and
• paragraph 79 of IAS 12 requires the disclosure of the major components of tax expense (income). When changes in the exchange rate are the cause of a major component of the deferred tax charge or credit, an explanation of this in accordance with paragraph 79 of IAS 12 would help explain the tax expense (income) to the users of the financial statements.

In the light of the existing IFRS requirements the Interpretations Committee determined that neither an Interpretation nor an amendment to a Standard was necessary.⁴⁰

10.3.1 Dividend subject to differential tax rate

In some jurisdictions, the rate at which tax is paid depends on whether profits are distributed or retained. In other jurisdictions, distribution may lead to an additional liability to tax, or a refund of tax already paid. IAS 12 requires current and deferred taxes to be measured using the rate applicable to undistributed profits until a liability to pay a dividend is recognised, at which point the tax consequences of that dividend should also be recognised. This is discussed further at 8.5 above.

Where taxes are remeasured on recognition of a liability to pay a dividend, the difference should normally be recognised in profit or loss rather than directly in equity, even though the dividend itself is recognised directly in equity under IFRS. IAS 12 takes the view that any additional (or lower) tax liability relates to the original profit now being distributed rather than to the distribution itself. Where, however, the dividend is paid out of profit arising from a transaction that was originally recognised in other comprehensive income or equity, the adjustment to the tax liability should also be recognised in other comprehensive income or equity. [IAS 12.57A].

10.3.2 Dividend subject to withholding tax

Where dividends are paid by the reporting entity subject to withholding tax, the withholding tax should be included as part of the dividend charged to equity. [IAS 12.65A].

It is noteworthy that there may be little economic difference, from the paying entity's perspective, between a requirement to pay a 5% ‘withholding tax’ on all dividends and a requirement to pay an additional 5% ‘income tax’ on distributed profit. Yet, the accounting treatment varies significantly depending on the analysis. If the tax is considered a withholding tax, it is treated as a deduction from equity in all circumstances. If, however, it is considered as an additional income tax, it will generally be treated as a charge to profit or loss (see 10.3.1 above). This distinction therefore relies on a clear definition of withholding tax, which IAS 12 unfortunately does not provide.

IAS 12 describes a withholding tax as a ‘portion of the dividends [paid] to taxation authorities on behalf of shareholders’. [IAS 12.65A]. However, it is not clear whether the determination of whether or not the tax is paid ‘on behalf of shareholders’ should be made by reference to the characterisation of the tax:

• in the paying entity's tax jurisdiction – in which case, there is the problem noted above that one jurisdiction's ‘additional distribution tax’ may be economically identical to another jurisdiction's ‘withholding tax’; or
• in the receiving entity's tax jurisdiction – in which case there would be the problem that the tax on a dividend paid to one shareholder is a ‘withholding tax’ (because credit is given for it on the shareholder's tax return) but the tax on a dividend paid to another shareholder the same time is not (because no credit is given for it on that shareholder's tax return).

This distinction is also relevant in accounting for dividend income that has been subject to withholding tax, as discussed at 10.3.4 below.

10.3.3 Intragroup dividend subject to withholding tax

Where irrecoverable withholding tax is suffered on intragroup dividends, the withholding tax does not relate to an item recognised in equity in the consolidated financial statements (since the intragroup dividend to which it relates has been eliminated in those financial statements). The tax should therefore be accounted for in profit or loss for the period.

10.3.4 Incoming dividends

IAS 12 does not directly address the treatment of incoming dividends on which tax has been levied (i.e. whether they should be shown at the amount received, or gross of withholding tax together with a corresponding tax charge). As discussed at 4.2 above, we believe that judgement is required to determine whether a tax deducted from investment income at the source of the income is a withholding tax in the scope of IAS 12.

As well as the considerations discussed at 4.2 above, it is noted at 10.3.2 above that an entity paying dividends that are subject to withholding tax would record the gross value of the distribution in equity, on the basis that the withholding tax is regarded as an amount paid to the tax authorities ‘on behalf of shareholders’. [IAS 12.65A]. If it is determined from the point of view of the recipient of the dividend that a particular withholding tax is an income tax in the scope of IAS 12, it would therefore be consistent with this treatment for the recipient to show dividends (and other income subject to withholding taxes) gross of withholding taxes and to recognise any non-refundable portion of such withholding taxes as a tax expense in the statement of comprehensive income.

Some jurisdictions also give tax deductions for the ‘underlying’ tax suffered on dividends received. This is based on the concept that the dividend has been paid out of profits already subject to tax, so that to tax the full amount received again would amount to a punitive double taxation of the underlying profits. In our view, such underlying tax (which would form part of the tax charge, not the dividend, of the paying company) is not directly paid on behalf of the shareholder, and accordingly incoming dividends should not be grossed up for underlying tax.

10.3.5 Tax benefits of distributions and transaction costs of equity instruments

IAS 32 as originally issued required distributions to shareholders and transaction costs of equity instruments to be accounted for in equity net of any related income tax benefit (see Chapter 47 at 8.2). However, as discussed below, the ‘default’ allocation for income tax on equity distributions is now to profit or loss, with the tax consequences of transaction costs relating to equity instruments still being taken to equity, provided that the related costs are also recognised in equity.

Annual Improvements to IFRSs 2009‑2011 Cycle, issued in May 2012, amended IAS 32 so as to remove the reference to income tax benefit. This means that all tax effects of equity transactions are allocated in accordance with the general principles of IAS 12. Unfortunately, IAS 12 was not entirely clear as to how the tax effects of certain equity transactions should be dealt with, as illustrated by Example 33.38 below.

Some would have allocated the tax deduction to equity on the basis that it relates to the coupon payment, which was accounted for in equity. Others would have considered the distribution as being sourced from an accumulation of retained earnings originally accounted for in profit or loss and, therefore, have allocated the tax deduction for the dividend payment in profit or loss. The cause of this divergence was paragraph 52B of IAS 12, which stated the following:

‘In the circumstances described in paragraph 52A, the income tax consequences of dividends are recognised when a liability to pay the dividend is recognised. The income tax consequences of dividends are more directly linked to past transactions or events than to distributions to owners. Therefore, the income tax consequences of dividends are recognised in profit or loss for the period as required by paragraph 58 except to the extent that the income tax consequences of dividends arise from the circumstances described in paragraph 58(a) and (b).’ [IAS 12 (2018).52A].

Those who believed that the tax deduction should be accounted for in equity argued that paragraph 52B of IAS 12 only applies ‘in the circumstances described in paragraph 52A’ and the example does not include differential tax rates for retained and distributed profits. Those who argued that the tax deduction should be credited to profit or loss considered that the reference in paragraph 52A of IAS 12 to taxes ‘payable at a higher or lower rate’, should be interpreted as including a higher or lower effective rate, as well as a higher or lower headline rate.

The Interpretations Committee observed that the circumstances to which the requirements in paragraph 52B of IAS 12 apply were unclear and decided that a limited amendment to IAS 12 was required to clarify that the requirements in paragraph 52B of IAS 12 apply to all payments on financial instruments classified as equity that are distributions of profits, and are not limited to the circumstances described in paragraph 52A of IAS 12.⁴¹

In December 2017, the IASB published – Annual Improvements to IFRS Standards – 2015‑2017 Cycle, which moves the text in paragraph 52B to paragraph 57A, thereby relating it more closely to the general requirements for the allocation of tax set out at 10 above, and removes any reference to the specific circumstances when there are different tax rates for distributed and undistributed profits. Accordingly, the tax benefits of equity distributions will be recognised in profit or loss, unless it can be demonstrated that the profits being distributed were previously generated in transactions recognised in other comprehensive income or equity. These amendments are mandatory for annual periods beginning on or after 1 January 2019. When an entity first applies these amendments, it applies them to the income tax consequences of dividends recognised on or after the beginning of the earliest comparative period. [IAS 12.98I].

The Board concluded that entities would have sufficient information to apply the amendments in this way, which will enhance comparability of reporting periods. [IAS 12.BC70].

10.4.1 Debt instrument measured at fair value through OCI under IFRS 9

IFRS 9 requires an entity to recognise a loss allowance for expected credit losses (ECLs) on financial assets that are debt instruments measured at fair value through other comprehensive income (FVOCI). [IFRS 9.5.5.1].

Under the general approach, at each reporting date, an entity recognises a loss allowance based on either 12-month expected credit losses or lifetime expected credit losses, depending on whether there has been a significant increase in credit risk on the financial instrument since initial recognition. [IFRS 9.5.5.3, 5.5.5].

The Standard states that these expected credit losses do not reduce the carrying amount of the financial assets in the statement of financial position, which remains at fair value. Instead, an amount equal to the allowance that would arise if the asset was measured at amortised cost is recognised in other comprehensive income as the ‘accumulated impairment amount’. [IFRS 9.4.1.2A, 5.5.2, Appendix A].

The accounting treatment (ignoring the accounting for any tax) and journal entries for debt instruments measured at FVOCI are illustrated in Chapter 51 at 9.1 by the following example, based on Illustrative Example 3 in the Implementation Guidance for the standard. [IFRS 9 IG Example 13, IE78-IE81].

As noted at 9.1 in Chapter 51, this means that in contrast to financial assets measured at amortised cost, there is no separate allowance for credit losses but, instead, impairment gains or losses are accounted for as an adjustment of the revaluation reserve accumulated in other comprehensive income, with a corresponding charge to profit or loss (which is then reflected in retained earnings).

Assume that, for tax purposes, current tax does not arise until the asset is recovered. In Example 33.40 above, the asset revaluation creates a temporary difference as the carrying value is now different to its original cost (being its tax base). The asset revaluation is first accounted for in OCI, therefore, the related tax is recorded in OCI. [IAS 12.61A].

As regards the recognition of the ECLs, and as noted above, there is no further change to the carrying value of the asset. Impairment gains or losses are accounted for as an adjustment of the revaluation reserve accumulated in other comprehensive income, with a corresponding charge to profit or loss. Under the general principal in IAS 12, the entity would transfer the related deferred tax out of OCI and into profit or loss in respect of the ECLs reallocated out of OCI. A similar transfer would be made in respect of any earlier revaluation entries that are recycled to profit or loss on derecognition of the debt instrument. [IAS 12.61A]. Accordingly, if the applicable rate of tax is 20%, the tax-effected journals in Example 33.40 above would be as follows:

10.4.2 Recognition of expected credit losses with no change in fair value

Consider an example where there has been no change to the asset's fair value since its acquisition, but an expected credit loss has been determined. Current tax is charged on realisation of the asset only.

As discussed above, the ECLs are accounted for as an adjustment (credit) to the revaluation reserve accumulated in other comprehensive income, with a corresponding charge to profit or loss. However, in this case, there is no change to the carrying amount of the asset. Prima facie, therefore, there is no temporary difference associated with the asset. However, the treatment discussed at 7.2.4.D above would support a conclusion that this temporary difference of nil should in fact be analysed into:

• a deductible temporary difference arising on the ECLs that affect accounting profit; and
• a taxable temporary difference of an equal amount arising on the amount reflected in OCI, which is effectively an upward revaluation to restore the asset back to its fair value.

This analysis indicates it would be appropriate to recognise a deferred tax asset for amounts recognised for ECLs in profit or loss [IAS 12.58] and to recognise the tax effect of the ‘item that is recognised outside profit or loss’ (i.e. the credit to OCI) in other comprehensive income. [IAS 12.61A].

This approach is illustrated in Example 33.42 below:

The entity in Example 33.42 above could have determined that the recognition of the expected credit loss does not generate a temporary difference because neither the carrying amount nor the tax base of the asset has changed. However, this determination can have unwanted consequences as the debt instrument is later revalued and realised, in particular with respect to variability in the effective tax rate reported in both profit or loss and in other comprehensive income.

10.7.1 Tax on refund of pension surplus

In some jurisdictions, a pension fund may be permitted or required to make a refund to the sponsoring employee of any surplus in the fund not required to settle the known or anticipated liabilities of the fund. It may be that such a refund is subject to tax. IFRIC 14 – IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction – requires any asset recorded in respect of such a refund to be shown net of any tax other than an income tax (see Chapter 35). In determining whether such a tax is an income tax of the entity, the general principles at 4.1 above should be applied. Relevant factors may include:

• whether tax is levied on the pension fund or the sponsoring entity; and
• whether tax is levied on the gross amount of the refund in all cases, or has regard to the sponsoring entity's other taxable income, or the amount of tax deductions received by the sponsoring entity in respect of contributions to the fund.

10.8.1 Allocation of tax deduction between profit or loss and equity

Where the amount of any tax deduction (or estimated future tax deduction) exceeds the amount of the related cumulative remuneration expense, the current or deferred tax associated with the excess should be recognised directly in equity. [IAS 12.68C]. This treatment is illustrated by Example 33.49 below.

Example 33.49 above is based on Example 5 in the illustrative examples accompanying IAS 12 (as inserted by IFRS 2). However, the example included in IAS 12 states that the cumulative tax income is based on the number of options ‘outstanding’ at each period end. This would be inconsistent with the methodology in IFRS 2 (see Chapter 34), which requires the share-based payment expense during the vesting period to be based on the number of options expected to vest (as that term is defined in IFRS 2), not the total number of options outstanding, at the period end. It would only be once the vesting period is complete that the number of options outstanding becomes relevant. We assume that this is simply a drafting slip by the IASB.

IAS 12 asserts that the allocation of the tax deduction between profit or loss and equity illustrated in Example 33.49 is appropriate on the basis that the fact that the tax deduction (or estimated future tax deduction) exceeds the amount of the related cumulative remuneration expense ‘indicates that the tax deduction relates not only to remuneration expense but also to an equity item.’ [IAS 12.68C].

The treatment required by IFRS 2 seems to have been adopted for consistency with US GAAP. However, as the IASB acknowledges, while the final cumulative allocation of tax between profit or loss and equity is broadly consistent with that required by US GAAP, the basis on which it is measured and reported at reporting dates before exercise date is quite different. [IFRS 2.BC311-BC329].

10.8.2 Determining the tax base

IAS 12 does not specify exactly how the tax base of a share-based payment transaction is to be determined. However, Example 5 in the illustrative examples accompanying IAS 12 (the substance of which is reproduced at 10.8.1 above) calculates the tax base as:

• the amount that would be deductible for tax if the event triggering deduction occurred at the end of the reporting period; multiplied by
• the expired portion of the vesting period at the end of the reporting period.

IFRS 2 treats certain share-based payment awards as, in effect, a parcel of a number of discrete awards, each with a different vesting period. This may be the case where an award is subject to graded vesting, has been modified, or has separate equity and liability components (see Chapter 34). In order to determine the tax base for such an award, it is necessary to consider separately the part, or parts, of the award with the same vesting period, as illustrated in Example 33.50 below.

10.8.3 Allocation when more than one award is outstanding

As noted above, IAS 12 requires that, ‘where the amount of any tax deduction … exceeds the amount of the related cumulative remuneration expense, the current or deferred tax associated with the excess should be recognised directly in equity’. Some have therefore argued that, as drafted, IAS 12 requires the cumulative expense for all outstanding share schemes to be compared in aggregate with the aggregate tax deduction for all share schemes. Others argue that the comparison should be made for each scheme separately. The effect of each treatment is illustrated in Example 33.51 below.

In our view, the comparison must be made on a discrete scheme-by-scheme basis. As noted at 10.8.2 above, it is clear from IAS 12 and the Basis for Conclusions to IFRS 2 that the IASB's intention was to exclude from profit or loss any tax deduction that is effectively given for the growth in fair value of an award that accrues after grant date. [IAS 12.68C, IFRS 2.BC311‑BC329]. This can be determined only on an award-by-award basis. Moreover, IAS 12 requires the amount of any tax deduction to be accounted for in equity when it ‘exceeds the amount of the related cumulative remuneration expense’. In Example 33.51 above, the tax deduction on Scheme B cannot, in our view, be said to be ‘related’ to the remuneration expense for Scheme A. Accordingly, the expense relating to Scheme A is not relevant for determining the amount of tax income relating to Scheme B that is required to be accounted for in equity.

It may also be that what is regarded as a single scheme may need to be further sub-divided for the purposes of the comparison for reasons such as the following:

• where the same award is made to regular employees and also to top management, the fair value of the options granted to each population may nevertheless be different for the purposes of IFRS 2 given different exercise behaviours (see Chapter 34 at 8.5.2.A);
• an award is made to employees which attracts tax deductions in more than one tax jurisdiction; or
• an award is made in the same tax jurisdiction to employees in different entities, not all of which are able to recognise a deferred tax asset.

10.8.4 Staggered exercise of awards

The example in IAS 12, the substance of which is included in Example 33.49 at 10.8.1 above, addresses a situation in which all vested awards are exercised simultaneously. In practice, however, vested awards are often exercised at different dates.

Once an award under a given scheme has vested, and different awards in that scheme are exercised at different times, the question arises as to whether the ‘cap’ on recognition of the tax benefit in profit or loss should be calculated by reference to the cumulative expense recognised in respect of the total number of awards vested, or in respect only of as yet unexercised vested awards. In our view, where a tax deduction is received on exercise, the calculation must be undertaken by reference to the cumulative expense recognised for outstanding unexercised options. This is illustrated by Example 33.52 below.

10.8.5 Replacement awards in a business combination

IFRS 3 contains some detailed provisions on the treatment of share-based payment awards issued by an acquirer to replace awards made by the acquired entity before the business combination occurred. These are discussed in Chapter 34 at 11.

IFRS 3 amended IAS 12 to include an illustrative example for the treatment of tax deductions on such replacement awards, the substance of which is reproduced as Example 33.53 below. [IAS 12 IE Example 6].

10.8.6 Share-based payment transactions subject to transitional provisions of IFRS 1 and IFRS 2

IFRS 1 and IFRS 2 provide, respectively, first-time adopters and existing IFRS preparers with some transitional exemptions from accounting for share-based payment transactions. The accounting treatment of the tax effects of transactions to which these exemptions have been applied is discussed in Chapter 5 at 7.3.2. Whilst that discussion specifically addresses the tax effects of transactions subject to the exemption for first-time adopters of IFRS, it is equally applicable to the tax effects of transactions subject to the exemptions in IFRS 2 for existing IFRS preparers.

12.1.1 Determining the manner of recovery of assets and settlement of liabilities

As discussed at 8.4 above, IAS 12 requires deferred tax to be measured at an amount that reflects the tax consequences that would follow from the manner in which the entity expects to recover its assets or settle its liabilities. The expected manner of recovery or settlement may affect both the tax base of an asset or liability and the tax rate to be applied to any temporary difference arising.

As further noted above, the acquirer's assessment of the manner of recovery for the purposes of IAS 12 may well differ from that of the acquired entity. For example, the acquired entity might have intended to recover an asset through use, whereas the acquirer intends to sell it. In such a case, in our view, the requirement of IFRS 3 to recognise and measure deferred tax in accordance with IAS 12 has the effect that the expectations of the acquirer are used to determine the tax base of an item and the measurement of any deferred tax associated with the item.

12.1.2 Deferred tax assets arising on a business combination

12.1.3 Deferred tax liabilities of acquired entity

IAS 12 contains no specific provisions regarding the recognition of a deferred tax liability of an acquired entity after the date of the original combination. The recognition of such liabilities should therefore be accounted for in accordance with the normal rules of IAS 12 (i.e. in the period in which the liability arises), unless either:

• the recognition of the liability occurs within the provisional measurement period for the business combination and reflects new information about facts and circumstances that existed at the acquisition date, in which case the acquisition date value of the liability is retrospectively adjusted – see Chapter 9 at 12; or
• the failure to recognise the liability at the time of the combination was an error, in which case the provisions of IAS 8 should be applied – see Chapter 3 at 4.6.

13.1.1 Offset

14.2.1 Tax (or tax rate) reconciliation

IAS 12 explains that the purpose of the tax reconciliation required by (c) above is to enable users of financial statements to understand whether the relationship between tax expense (or income) and accounting profit is unusual and to understand the significant factors that could affect that relationship in the future. The relationship may be affected by the effects of such factors as:

• revenue and expenses that are outside the scope of taxation;
• tax losses; and
• foreign tax rates. [IAS 12.84].

Accordingly, in explaining the relationship between tax expense (or income) and accounting profit, an entity should use an applicable tax rate that provides the most meaningful information to the users of its financial statements.

Often, the most meaningful rate is the domestic rate of tax in the country in which the entity is domiciled. In this case, the tax rate applied for national taxes should be aggregated with the rates applied for any local taxes which are computed on a substantially similar level of taxable profit (tax loss). However, for an entity operating in several jurisdictions, it may be more meaningful to aggregate separate reconciliations prepared using the domestic rate in each individual jurisdiction. [IAS 12.85]. Where this latter approach is adopted, the entity may need to discuss the effect of significant changes in either tax rates, or the mix of profits earned in different jurisdictions, in order to satisfy the requirement of IAS 12 to explain changes in the applicable tax rate(s) compared to the previous accounting period – see item (d) at 14.2 above.

Example 33.56 illustrates how the selection of the applicable tax rate affects the presentation of the numerical reconciliation.

14.2.2 Temporary differences relating to subsidiaries, associates, branches and joint arrangements

IAS 12 requires an entity to disclose the gross temporary differences associated with subsidiaries, associates, branches and joint arrangements for which a deferred tax liability is not recognised, as opposed to the unrecognised deferred tax on those temporary differences – see (f) under 14.2 above.

IAS 12 clarifies that this approach is adopted because it would often be impracticable to compute the amount of unrecognised deferred tax. Nevertheless, where practicable, entities are encouraged to disclose the amounts of the unrecognised deferred tax liabilities because financial statement users may find such information useful. [IAS 12.87].