IAS 12 sets out the accounting for income taxes. It deals with the accounting for the current and future tax consequences of:

• Transactions and other events of the current period are recognized in the financial statements.
• The future recovery (settlement) of the carrying amount of assets (liabilities) recognized in an entity’s balance sheet.

The amount of tax payable on the taxable profits of a particular period might bear little relationship to the income and expenditure amounts in the financial statements. Tax laws and financial accounting standards recognize and measure income, expenditure, assets, and liabilities in different ways. The tax charge in the financial statements comprises current tax as well as deferred tax.

This chapter covers the accounting for taxation at the end of the reporting period. There are separate requirements in IAS 34 for determining the tax charge for an interim period.

Scope

IAS 12 applies to accounting for income taxes (that is, taxes based on taxable profit that is paid to the tax authorities). Income taxes include domestic and foreign income taxes, and some withholding taxes payable by a subsidiary, associate, or joint venture on distributions to the reporting entity. Taxable profit (or loss) is the profit (loss) for the period determined according to the tax rules. This is the profit on which income taxes are payable (or recoverable). ‘Taxable profit’ implies a net rather than a gross taxable amount.

For example, a tax based on gross revenue might not be an income tax. Management should consider the nature of tax payments made and whether they are, in substance, taxes on a measure of the net profit of the entity.

Income taxes – definition

IAS 12 deals with accounting for income taxes. The Standard defines income taxes as including “all domestic and foreign taxes which are based on taxable profits. Income taxes also include taxes, such as withholding taxes, that are payable by a subsidiary, associate, or joint arrangement on distributions to the reporting entity“.

Factors in the identification of an income tax The determination as to whether a tax is an ‘income tax’ is a matter requiring careful judgement based on the specific facts and circumstances. Factors to consider in making this determination include, but are not limited to, whether: the ‘starting point’ for determining the taxable amount is based on taxable profits rather than another metric (e.g. units of production); the tax is based on a ‘taxable profit’ notion, implying a net rather than a gross amount; the tax is based on actual income and expenses rather than a notional amount (e.g. on a tonnage capacity); the legal description or characteristics of the tax imply that the tax is calculated based on taxable profits; and there is any withholding related to the tax. The IFRIC (now the IFRS Interpretations Committee) referred to this topic in the March 2006 IFRIC Update. The IFRIC noted that the definition of taxable profit implies that not all taxes are in the scope of IAS 12, and that the requirement to disclose an explanation of the relationship between the tax expense and the accounting profit implies that taxable profit need not be the same as accounting profit. Taxes that are unlikely to meet the definition of an income tax include: sales taxes (because they are transactional taxes based on sales value rather than on taxable profits); production-based taxes; and ‘tonnage’ taxes. Care should be exercised in respect of taxes imposed in different jurisdictions that are referred to by common titles but for which the detailed application varies significantly between jurisdictions (such as ‘petroleum revenue taxes’). The determination as to whether such taxes are income taxes should be made on a case-by-case basis.

Levies

IFRIC 21 guides when to recognize a liability for a ‘levy’ imposed by a government; a levy is defined as “an outflow of resources embodying economic benefits that are imposed by governments on entities by legislation (ie laws and/or regulations), other than:

(a) those outflows of resources that are within the scope of other Standards (such as income taxes that are within the scope of IAS 12); and

(b) fines or other penalties that are imposed for breaches of the legislation“.

Therefore, any levy imposed by a government should be assessed to determine if it meets the definition of an income tax. If it does, it should be accounted for by IAS 12 rather than by IFRIC 21.

Whether margin taxes, hybrid taxes and tonnage taxes linked to tax expense are within the scope of IAS 12 Margin taxes Tax might be assessed, in some jurisdictions, by using a measure that is not directly linked to accounting income. For example, tax could be assessed on a ‘taxable margin’, which is calculated as revenue less specified costs. A specified tax rate is applied to such ‘taxable margin’ (an income tax structure). Such taxes are within IAS 12’s scope, since the tax (in the case of margin taxes) is an income tax in nature. These are different from systems that assess tax based on sales or gross receipts (a non-income tax structure). Hybrid taxes Some jurisdictions might specify a ‘minimum amount of tax that is payable’. For example, the minimum amount of tax could be the lower of a percentage of revenue and a percentage of revenue less expenses (that is, a ‘taxable margin’). These are often referred to as ‘hybrid taxes’. This is because they comprise two components: one that is based on a ‘gross’ amount, and the other that is based on a ‘net’ amount. The part that is based on a net amount generally has the features of an income tax and is within the scope of IAS 12. It is not appropriate to treat the entire hybrid tax as being within the scope of IAS 12. This is because part of it is not calculated based on taxable income. There are two approaches to determining the part that is within the scope of IAS 12. The first is to designate the amount based on the gross amount as an operating expense, and to treat any excess as the IAS 12 component. The alternative is to designate the amount based on the taxable margin as the IAS 12 component, and to treat any excess as an operating expense. An entity should choose one of the approaches as its accounting policy, and it should apply the policy consistently. Tonnage taxes Shipping entities, in some jurisdictions, can choose to be taxed on the basis of tonnage transported, tonnage capacity or a notional income, instead of the standard corporate income tax. Taxes on tonnage transported or tonnage capacity are based on gross rather than net amounts, and taxes on a notional income derived from tonnage capacity are not based on the entity’s actual income and expenses. Such tonnage taxes are not considered income taxes under IAS 12, and they are not presented as part of tax expense in the statement of comprehensive income.

Professional fees linked to tax expense An entity might incur expenses that are indirectly linked to the income tax expense (such as fees payable to tax consultants that are based on a percentage of savings made under a specific tax scheme). These fees are not an ‘income tax expense’.

Accounting treatment of indemnification of tax liabilities by a third party A third party can indemnify an entity for income tax liabilities. Typically, the acquirer would give such an indemnity in a business combination, but it can arise in other situations. An indemnity does not eliminate the entity’s tax charge in profit or loss. Income taxes are taxes based on taxable profit. An indemnification asset receivable from a third party in respect of a tax uncertainty is not within the scope of IAS 12. There might be subsequent changes in the asset’s value in addition to the income relating to the indemnification asset receivable from the third party. The asset usually changes in line with changes in the indemnified liability, depending on the terms of the arrangement. Movements in a third-party indemnification asset are not included in the income tax line item in the statement of comprehensive income; they are reported as part of pre-tax profits.

Withholding taxes

Certain withholding taxes are within the scope of IAS 12. Withholding taxes arise where some items of income are received net of taxes deducted at source, such as dividends and royalties. The tax paid on behalf of the recipient represents a tax on income of the receiving entity, instead of a tax on income of the paying entity.

Payments received for dividends, interest, and similar transactions should be recognized at an amount that includes withholding taxes paid to the tax authorities on behalf of the recipient (that is, gross including the amount of the withholding tax). The withholding tax paid should be recognized by the recipient as the tax expense.

Withholding taxes paid should also be recognized gross, and withholding tax paid on a dividend should be recognized in equity as part of the dividend.

When are withholding taxes within the scope of IAS 12? From the recipient’s perspective, withholding tax deducted at source would be within the scope of IAS 12 where the gross amount of income received is included in the calculation of taxable profit in the entity’s tax computation, and tax relief is given in respect of the amount deducted at source by the payer. The tax relief ensures that overall income taxes are based on the entity’s net profits. But, if no or limited tax relief is given for the amount of tax deducted at source, entities might consider that the withholding tax represents a tax on gross income, and so it is outside the scope of IAS 12. Entities need to determine whether the withholding tax is an income tax in nature (that is, a tax based on taxable profit that is paid to the tax authorities). The IFRS Interpretations Committee (IC) agenda decisions in March 2006 and May 2009 noted that IAS 12 defines income taxes as taxes that are based on taxable profits, and the term ‘taxable profit’ implies a notion of net rather than a gross amount. Amounts that are not based on taxable profits are not income taxes. In addition, the IC observed in its agenda decision in September 2017 on interest and penalties that entities do not have an accounting policy choice between applying IAS 12 and applying IAS 37, Where an entity has determined that the withholding tax is an income tax in nature, entities should present such withholding taxes within tax charges, and they are recognised, measured and disclosed under the requirements of IAS 12. Where an entity has determined this not to be the case, such withholding taxes are not presented as part of income taxes in the statement of comprehensive income, and they are recognised, measured and disclosed under the requirements of IAS 37. IAS 1 requires disclosure of the significant judgements that management has made in the process of applying the entity’s accounting policies. Therefore, disclosure of the entity’s determination of whether withholding taxes are an income tax in nature might be required where judgemental and significant.

Treatment of withholding tax on incoming dividends and other interest receivable Withholding tax is suffered by the recipient entity. Therefore, where the withholding tax on incoming dividends, interest and other income receivable falls within the scope of IAS 12, an entity should recognise such income in the income statement at an amount including any withholding taxes (that is, gross of the withholding tax that has been deducted at source by the payer on behalf of the recipient). IAS 12 is silent on the treatment of withholding taxes in the recipient’s financial statements, but this treatment mirrors the treatment for outgoing dividends.

Taxes payable by an entity’s shareholders An entity does not generally recognise income taxes payable by an entity’s shareholders. Shareholders or other group entities might pay income taxes on the entity’s behalf in some circumstances (for example, if there is a consolidated tax return, or if relief for one entity’s losses is transferred to another group entity). In such circumstances, the appropriate accounting is determined by examining the arrangement’s details and considering relevant tax legislation.

Distinguishing between underlying tax relief and withholding taxes In some jurisdictions, the recipient of a dividend receives a tax credit to acknowledge that the income from which the dividend is paid has been subject to tax in the entity paying the dividend. This is an imputed credit for underlying tax. This situation differs from one where a withholding tax is deducted at source and paid to the tax authorities on behalf of the recipient by the entity paying the dividend. Dividends or other income received should not be grossed up for tax relief for underlying tax. This is because the underlying tax is the liability of the payer of the dividend, and it is not tax that has been suffered by the recipient. The underlying tax is simply used by the entity’s tax authority to work out the relief (if any) that should be given to the recipient of the dividend for the tax already suffered by the payer. The only tax that the recipient suffers is the withholding tax, which is a ‘real tax’, as opposed to the underlying tax that, from the perspective of the recipient, is tax already suffered on the income by the payer.

Distinguishing between underlying tax relief and withholding taxes: unrelieved overseas tax A parent entity has a foreign subsidiary. The foreign subsidiary generated taxable profits equivalent to C100,000, on which it paid tax @ 35% amounting to C35,000. It distributed the remaining after-tax profit of C65,000 to the parent, after deducting 5% withholding tax amounting to C3,250. The parent received a cash dividend of C61,750. The parent’s rate of tax is 30%. The tax rules in the parent’s jurisdiction require it to pay tax on the grossed-up dividend, as illustrated below: Parent’s tax computation C C Cash dividend of C61,750 grossed up for overseas taxes (both underlying and withholding) 100,000 Tax @ 30% 30,000 Less double tax relief: Total overseas tax paid (C35,000 + C3,250) 38,250 Relief restricted to parent’s tax payable (30,000) (30,000) Unrelieved overseas tax* 8,250 Parent’s tax liability nil * It is assumed that no deferred tax asset can be recognised for the excess foreign tax paid. Parent’s separate income statement C Dividend received (grossed up for withholding tax) 65,000 Tax charge: Parent’s tax − Overseas tax paid (withholding tax) 3,250 Total tax charge 3,250 Profit after tax 61,750   Parent’s consolidated income statement C C Profit before tax 100,000 Tax charge: Tax 30,000 Less: double tax relief 30,000 − Overseas tax paid † 38,250 Total tax charge 38,250 Profit after tax 61,750   † Total tax charge is effectively tax of C30,000 plus unrelieved overseas tax of C8,250 = C38,250

Entities might receive government grants or tax credits. The standard guides accounting for temporary differences that arise from such grants or investment tax credits, but not on the accounting for the government grant or investment tax credit itself.

Tonnage tax In some jurisdictions, shipping entities can choose to be taxed by means of a ‘tonnage tax’ instead of under general corporate income tax regulations. Tonnage tax may be paid on the basis of tonnage transported, tonnage capacity or a notional profit. The IFRIC (now the IFRS Interpretations Committee) has considered tonnage taxes, as reported in the May 2009 IFRIC Update. The IFRIC noted that taxes based on tonnage transported or tonnage capacity are based on a gross rather than a net amount, and taxes on notional income are not based on the entity’s actual income and expenses. Such taxes should not be considered income taxes in accordance with IAS 12 and should not be presented as part of tax expense in the statement of comprehensive income. However, the IFRIC also noted that an entity subject to tonnage tax might present additional subtotals in the statement of comprehensive income if that presentation is relevant to an understanding of its financial performance.

Classification of interest and penalties assessed on underpayments or late payments of tax In many jurisdictions, interest and penalties are assessed on underpayments or late payments of income tax. In some circumstances, interest and penalties arise because the tax amount payable could not be agreed with the tax authority until significantly after the due date. Alternatively, interest and penalties may arise because the entity has made a deliberate choice not to make the appropriate tax payments before the due date. This topic has been discussed by the IFRS Interpretations Committee who, as reported in the September 2017 IFRIC Update, concluded that entities do not have an accounting policy choice between applying IAS 12 and applying IAS 37 to such amounts. Instead, judgement must be applied to determine whether a particular amount payable or receivable for interest and penalties is an income tax. When there is no significant uncertainty with respect to the overall amount of income tax payable and an entity deliberately delays payment of the amount, the resulting interest and penalties can be clearly distinguished from the assessed income tax. Accordingly, in such circumstances, the interest and penalties should not be presented as income tax in the financial statements, but should be presented separately according to their nature (i.e. either as a finance cost (interest) or operating expense (penalties)). However, in circumstances such as those described, when there is significant uncertainty regarding the amount of income tax to be paid, an entity may in the course of its discussions with the tax authorities delay making payment for the full amount of tax possibly payable (to avoid, for example, prejudicing a future appeal against the amount claimed as due by the tax authorities) and, by so doing, risk incurring interest and penalties. In such circumstances, possible interest and penalties can be seen as being part of the overall uncertain tax treatment and, as such, it is appropriate to consider them as part of tax expense (income). Information about material interest and penalties should be disclosed in accordance with IAS 12 (if considered part of income tax) or IAS 37 (if not). In addition, if the classification of interest and penalties is part of the entity’s judgements that had the most significant effect on the amounts recognised in the financial statements, this should be disclosed in accordance with IAS 1.

Hybrid taxes

Entities are sometimes subject to a tax that has different components. It is necessary to exercise careful judgment when determining whether each of the components meets the definition of an income tax under IAS 12.

Tax comprising both production- and profit-based components – example Company A is subject to a tax made up of two discrete components – a production-based component and a profit-based component. The production-based component is a fixed minimum amount per tonne of product sold. The total tax, however, may exceed the fixed minimum per tonne depending on the entity’s profitability. The production-based component of the tax should not be considered an income tax because it is based on the weight of product sold rather than taxable profits; it is, therefore, outside the scope of IAS 12. On the other hand, any amounts due as a result of the profit-based component should be considered an income tax and within the scope of IAS 12. The production-based component of the tax may be reported within either ‘cost of goods sold’ or ‘operating expenses’, though the former is preferable. In either case, the presentation should reflect the substance of the entity’s operations and should be applied consistently.

Petroleum revenue taxes In many jurisdictions, taxes are imposed on ‘petroleum revenue’; these taxes are generally designed to ensure that the tax authority benefits from ‘super profits’ generated by entities in certain resource sectors. Petroleum revenue taxes vary from jurisdiction to jurisdiction, but they are generally determined based on revenue from extraction activities reduced by specified items of deductible expenditure. The deductions are often limited to items relating to the extraction activities, but may also include other amounts such as administration expenses and deductions based on assets held in the industry. In addition, the amount of petroleum revenue tax paid will often itself be deductible when computing the entity’s ‘general’ income tax liability. The key characteristic that defines an income tax is that it is based on a measure of taxable profit. Whether a petroleum revenue tax in a particular jurisdiction is considered to be an income tax will depend on the tax rules in that specific jurisdiction and whether the basis for the tax is judged to be closer to a measure of revenue or a measure of net profit. The fact that the ‘taxable profit’ for the purposes of the petroleum revenue tax differs from ‘taxable profit’ for the purpose of a jurisdiction’s general income tax regime (e.g. because it relates to only part of the operations or because different deductions or allowances are available) is not in itself relevant because the basis for the petroleum revenue tax may still be considered to be a measure of net profit (albeit a different measure than that used as the basis for general income tax). If the petroleum revenue tax is allowed as a deduction when computing the entity’s general income tax liability, this does not preclude the petroleum revenue tax from being considered an income tax for the purposes of IAS 12. The reference in IAS 12 to ‘all’ domestic taxes indicates that there may be more than one form of income tax in a particular jurisdiction.

Investment tax credits IAS 12 states that the Standard does not deal with methods of accounting for government grants or investment tax credits. IAS 12 does not provide a definition for investment tax credits, which is a term used in many tax jurisdictions to describe a wide range of tax arrangements. Accordingly, in practice, the first step in accounting for an investment tax credit is to determine whether it is within the scope of IAS 12. Even if a tax benefit is referred to by a tax authority as an investment tax credit, it is important to consider the substance to determine whether the tax benefit is outside the scope of IAS 12. A tax credit (outside the scope of IAS 12) provides a reduction to taxes payable and can be distinguished from a tax deduction (within the scope of IAS 12) which is factored into the determination of taxable income. IAS 20 has a broad scope exemption, not just for investment tax credits, but also for “government assistance that is provided for an entity in the form of benefits that are available in determining taxable income or are determined or limited on the basis of income tax liability“. When a tax credit is determined to be an investment tax credit (and, consequently, outside the scope of IAS 12 and IAS 20), it is a matter of judgement under IAS 8 to determine the most appropriate accounting treatment. It may be appropriate to analogise to IAS 12 or IAS 20. Generally, if an approach similar to IAS 12 is adopted, a credit will be recognised in profit or loss, and the related asset in the statement of financial position, when the entity satisfies the criteria to receive the credit. If the substance of the arrangement is considered to be closer to a government grant, and an IAS 20 approach is adopted, the credit will be recognised in profit or loss over the periods necessary to match the benefit of the credit with the costs for which it is intended to compensate.

Refundable tax credits In some jurisdictions, tax credits may arise that have either or both of the following characteristics. The credit may be utilised to obtain a cash payment, rather than solely to reduce income tax payable in the year in which the credit is generated or to reduce income tax payable over a number of years. Therefore, the benefit is not dependent entirely on the entity having a future or past income tax liability against which the credit can be utilised (e.g. an entity may receive a full or partial cash payment despite being in a tax loss position). The credit may be utilised to receive a refund of a combination of income taxes and other non-income taxes paid during the year. For example, the tax credit may be offset first against income tax payable for the year, then against some other taxes (e.g. payroll taxes) incurred in the year, with any unused credit carried forward to subsequent years. Such credits are often referred to as ‘refundable’ tax credits. Whether refundable tax credits come within the scope of IAS 12 depends on the specific terms of the particular tax credits under consideration. The most appropriate accounting treatment for such refundable tax credits will be a matter of judgement to be determined under IAS 8. It will be necessary to look carefully at the substance of the particular credit, including the requirements that must be met in order to generate the credit and how the credit will be realised in practice. IAS 12 and IAS 20 are likely to provide the most appropriate references for the purpose of determining an appropriate accounting policy. For example, if the credit can be used to generate a cash payment and realisation is not dependent on any past or future income tax liability, then it may be reasonable to conclude that the credit is in the nature of a government grant and is not within the scope of IAS 12.

Additional tax deductions – example Entity A will receive an additional tax deduction if it invests in more than 25 per cent of an investee abroad and it meets a number of specified conditions. The deduction is granted to encourage investment in foreign entities. If the specified conditions are met, the additional tax deduction is 50 per cent of the cost of the investment. Entity A is permitted to use the deduction in the calculation of its current year’s tax liability; alternatively, it can defer claiming the deduction, but only for a maximum of five years. IAS 12 defines the tax base of an asset as “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” . In the circumstances described, the deduction is available independently of the recovery of the investment either through use or sale, and it is therefore not part of the tax base of the asset. The incentive is not directly linked to any underlying asset. If deferred, it represents an unused tax deduction and, in accordance with IAS 12, a deferred tax asset should be recognised to the extent that it is probable that future taxable profit will be available against which the unused tax deduction can be used.

Note that arrangements of the type described are sometimes referred to as investment tax credits; however, use of the term ‘investment tax credit’ in local tax legislation is not necessarily consistent with the term’s use in IAS 12 and it is necessary to review the detailed application of tax incentives referred to as investment tax credits to determine whether they are within the scope of IAS 12.

Classification of payments in a tax structuring transaction When implementing tax planning strategies, entities will often incur costs payable to the designer of the strategy. In determining whether such costs meet the definition of income tax or should be treated as an operating expense, the entity will need to have regard to whether the payment is to the designer, or whether it is paid to the designer to be paid to the tax authorities on the entity’s behalf. For example, Entity A has an effective domestic tax rate of 40 per cent. Entity A enters into a transaction with an investment bank which enables a portion of its activities (generating profit of CU1,000) to be taxed in a tax-haven jurisdiction rather than under Entity A’s domestic tax regime. The investment bank receives a 30 per cent fee based on total taxable profits before the transaction, of which it pays 10 per cent (CU30) over to the tax authorities in the tax-haven jurisdiction. The net result of the transaction on domestic tax is that tax is paid on 10 per cent of the original profit. The following table illustrates the effect of the transaction on taxable profits and tax payments. Before structuring  After structuring  CU  CU  Taxable profit before structuring 1,000 1,000 Fee payable to investment bank – (300) Domestic tax (40%) (400) (40) Profit after fee payable to investment bank and domestic tax 600 660 The fee payable by Entity A to the investment bank should not be classified as income tax expense. However, consideration should be given to whether the tax paid by the investment bank was paid on Entity A’s behalf. Only amounts that are ultimately paid to tax authorities on Entity A’s behalf should be considered as tax expenses. In the circumstances described, an evaluation needs to be performed as to whether, in substance, Entity A continues to bear the tax risk associated with the tax payment by the investment bank, or whether the bank makes the tax payment of CU30 on its own behalf. If Entity A retains substantially all of the tax risk associated with the tax payment by the investment bank, all direct and indirect payments to the tax authorities should be considered as a tax expense, resulting in the recognition of a tax expense of CU70 (CU40 domestic tax paid by Entity A and CU30 tax in the tax-haven jurisdiction paid on Entity A’s behalf by the investment bank). If the investment bank takes over substantially all the tax risk, the entire fee paid to the investment bank will be an operating expense and the tax expense will be only the domestic tax of CU40. In determining whether Entity A has retained the tax risk, the following factors should be considered: whether the tax authority has any power to demand payment from Entity A if the investment bank does not pay; and whether Entity A could be required to make further payments for the tax (or be entitled to refunds) if the onward payment proves to have been miscalculated.

Classification of payments to acquire tax losses In some jurisdictions, the tax authority requires each entity to file its tax return as if it is a stand-alone tax payer which is taxed and pays income tax separately. However, within a tax group (e.g. a group of entities under common control), tax losses may be transferred between entities and used to offset the taxable income in the purchasing entity. The price to be paid for the tax losses is determined by agreement between the seller and the purchaser. For example, Entity A and Entity B are both direct subsidiaries of Entity P. The tax rate in their jurisdiction is 30 per cent. Entity A acquires tax losses of CU100 from Entity B at an agreed price of CU50 and utilises the tax losses immediately. In this example, the payment of CU50 exceeds the tax benefit that Entity A has acquired (which is 30% × CU100 = CU30). The payment can only be considered a settlement of Entity A’s income tax liability to the extent of that tax benefit. Therefore, in its separate financial statements, Entity A should only offset CU30 of the payment against its tax liability. The accounting treatment for the excess payment of CU20 should reflect the substance of the transaction. In particular, it is necessary to consider whether Entity A has acquired anything else from Entity B that would correspond to the excess payment of CU20. If not, the substance of the transaction would seem to be that the excess payment of CU20 represents a distribution by Entity A which has been directed to Entity B in accordance with the wishes of their common parent, Entity P. Entity A should therefore recognise the CU20 as a distribution in equity. In practice, the losses will be included in the tax return and Entity A will have recognised a lower tax expense and tax liability on the basis of the amounts in the tax return. The entries to reflect the cash payment of CU50 will therefore be as follows. CU CU Dr Tax expense 30 Dr Distribution 20 Cr Cash 50