Chapter 3: Deferred tax

Most transactions and events recognized in the financial statements have a tax consequence. These consequences can be immediate or deferred. Future tax consequences cannot be avoided where transactions and events have occurred by the balance sheet date.

The tax effects of all income and expenditure, gains and losses, assets and liabilities are recognized in the same period in which the transactions are recognized, and not in the period in which they form part of taxable profit. This results in the recognition of deferred tax assets or liabilities. IAS 12 requires entities to recognize deferred taxes using the balance sheet liability method.

A step-by-step approach to determining deferred tax asset or liability

A deferred tax liability or asset is recognized if the recovery of the carrying amount of an asset or the settlement of liability will result in higher (or lower) tax payments in the future than if that recovery or settlement had no tax consequences.

A deferred tax liability or asset is recognized for all such tax consequences that have originated but have not been reversed by the balance sheet date, subject to certain exceptions. The approach to determining deferred tax can be summarised as follows:

• Calculate current income tax.
• Current tax payable to the taxation authorities is calculated based on the tax legislation in the relevant territory.
• Determine the tax base.

The tax base reflects the tax consequences arising from how management expects, at the balance sheet date, to recover or settle the carrying amount of an asset or liability.

The tax base of an asset is the future deductible amount when the asset’s carrying amount is recovered. A liability’s tax base is its carrying amount less future deductible amounts. If there are no tax consequences of recovery or settlement, there is no deferred tax.

• Calculate temporary differences. Temporary differences are the difference between an asset or liability’s carrying amount and its tax base.
• Consider the exceptions to recognizing deferred tax on temporary differences. There are three exceptions relating to temporary differences:
• Initial recognition of goodwill arising in a business combination (for deferred tax liabilities only).
• Initial recognition of an asset or liability in a transaction that is not a business combination and does not affect accounting profit or taxable profit.
• Investments in subsidiaries, branches, associates, and joint ventures, but only where certain criteria apply.
• Assess deductible temporary differences, tax losses, and tax credits for recoverability.

A deferred tax asset is recognized to the extent that it is probable that taxable profit will be available against which a deductible temporary difference or unused tax losses or tax credits can be utilized.

Determine the tax rate that is expected to apply when the temporary differences reverse; and calculate deferred tax. Deferred tax is measured at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, based on tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date.

Measurement of deferred tax reflects the tax consequences that follow from the manner that management expects, at the balance sheet date, to recover or settle the carrying amount of an asset or liability.

• Recognize deferred tax. Deferred tax is calculated by multiplying the temporary difference by the tax rate.
• Consider the presentation and offsetting of current and deferred tax.
• Disclose details of current and deferred tax.

Tax bases

The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. The tax base, as defined in the standard, is generally the amount shown as an asset or liability in a tax balance sheet (that is, using tax laws as a basis for accounting). There is also a specific definition of ‘tax base’ for assets and liabilities.

An asset or liability might have more than one tax base; this depends on how the entity intends to recover or settle the asset or liability. Temporary differences are differences between the tax base of an asset or liability and its carrying amount in the statement of financial position. The calculation of temporary differences depends on correctly identifying the tax base of each asset and liability in the entity’s balance sheet.

An entity recognizes a deferred tax liability (asset) whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (smaller) than if such recovery or settlement had no tax consequences. The definitions of the tax base can be difficult to apply.

The tax base of an asset

The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits flowing to an entity when it recovers the asset’s carrying amount. The asset’s tax base is equal to its carrying amount, and no deferred tax arises if those economic benefits will not be taxable.

An amount is ‘deductible for tax purposes’ if the deduction is allowed under the tax laws in determining taxable profits. The deduction might be for the full amount, a portion, or none of the asset’s cost. The deduction might be allowed in the period when the asset is acquired or over several periods. The asset’s tax base on initial acquisition is its cost if the tax laws allow an asset’s full cost on acquisition to be deductible.

The asset’s tax base is nil if the asset’s cost cannot be deducted in determining taxable profit, either over several periods or on disposal.

The formula to determine an asset’s tax base at the end of any reporting period is as follows:

The tax base of asset = Carrying amount − Future taxable amounts + Future deductible amounts

The future taxable amounts at the end of a reporting period will often be the same as the asset’s carrying amount; so, the first two terms in the formula will net to zero, leaving the future deductible amounts equal to the tax base at the end of the reporting period.

If the income generated by the asset is non-taxable, both the future taxable amounts and the future deductible amounts are nil; so, the tax base is equal to the carrying amount and there is no temporary difference.

Taxable economic benefits that flow to the entity in future periods are income earned from the asset’s use or proceeds arising from its disposal that are included in determining taxable profits. The standard does not require an entity to estimate the excess economic benefits that will be generated by the asset. IAS 12 focuses on the future tax consequences of recovering an asset only to the extent of the asset’s carrying amount at the balance sheet date.

Recovery of asset gives rise to both taxable and deductible amounts: tax base of inventory Inventory at the balance sheet date has a carrying amount of C1,000. The inventory will be deductible for tax purposes when sold. The amount that will be deductible for tax purposes if the inventory is sold is C1,000, which is its tax base. Applying the formula, we have: Carrying amount of asset − Future taxable amount + Future deductible amounts = Tax base C1,000 − C1,000 + C1,000 = C1,000 The temporary difference is C1,000 – C1,000 = C nil.

Recovery of asset gives rise to taxable amounts but not to deductible amounts: tax base of a foreign currency debtor A foreign currency debtor has a carrying amount of C1,150 after recognising an exchange gain of C50 in profit or loss. The original amount of C1,100 was included in taxable profit. Exchange gains are taxable only when realised. The original amount of C1,100 has already been included in taxable profit and, therefore, it will not be taxable in the future when the asset is recovered. So an element of the foreign currency debtor is not taxable. Where part of the carrying amount is not taxable, it is equivalent to a tax deduction being available for that amount. Applying the formula, we have: Carrying amount of asset − Future taxable amount + Future deductible amounts = Tax base C1,150 − C50 + C nil = C1,100 There is a taxable temporary difference of C50 (C1,150 − C1,100). The non-taxable element of the carrying amount (C1,100) forms part of the tax base (that is, the carrying amount of C1,150 less the future taxable amount of C50). Any deductible amounts to be received in the future should also be considered. There are none, in this case, and so the future deductible amount is Cnil.

Recovery of asset does not give rise to taxable amount but gives rise to deductible amounts: tax base of trade debtors A portfolio of trade debtors with similar credit risk characteristics has a carrying amount of C5,000, after recognising a bad debt provision of C250. The original amount of C5,250 has already been included in taxable profits. The provision for bad debt is not tax deductible, but it would be so when the individual assets are de-recognised. The first part of the definition of ‘tax base’ would suggest that the debtor’s tax base is C250, because that is the amount that will be deductible for tax purposes when the carrying amount of C5,000 is recovered. The second part of the definition would suggest that the tax base is equal to the carrying amount of C5,000, because the economic benefits are not taxable. But that is not the case since, applying the formula, we have: Carrying amount of asset − Future taxable amount + Future deductible amounts = Tax base C5,000 – C nil + C250 = C5,250 There is a deductible temporary difference of C250 (C5,000 − C5,250).

Recovery of asset does not give rise to either taxable or deductible amounts: tax base of trade debtors with specific bad debt provision Trade debtors have a carrying amount of C5,000 after recognising a specific provision of C250. The original amount of C5,250 has already been included in taxable profits. Specific provision of C250 is deductible for tax purposes when it is made. Applying the formula, we have: Carrying amount of asset − Future taxable amount + Future deductible amounts = Tax base C5,000 – C nil + C nil = C5,000 The temporary difference is C5,000 − C5,000 = C nil.

The tax base of a liability

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:

Tax base of liability = Carrying amount − Future deductible amounts + Future taxable amounts

The future taxable amount of liability is often nil because no part of a liability’s carrying amount (for example, a loan of C1,000) would normally be taxable or deductible when the liability is settled.

IAS 12 focuses on the future tax consequences of settling a liability at its carrying amount, as it does for assets. Management does not need to estimate the amount that might be payable on settlement, since the tax base of a liability begins with the carrying amount.

For example, where a premium is payable on redemption of a debt instrument, the tax base of the liability is calculated using the premium that has been accrued at the balance sheet date, and not the premium that would be payable on redemption.

Similarly, the tax base of a liability recognized at a discounted amount under IAS 37 is determined using that amount, and not the gross amount payable in the future (for example, where a tax deduction is available on settlement of a decommissioning liability).

Tax base of foreign currency loan payable A foreign currency loan payable has a carrying amount of C950, after recognising an exchange gain of C50 in profit or loss. Exchange gains are taxable only when realised. When the loan is repaid at its carrying amount at the balance sheet date, the amount that would be included in the future taxable amount is C50; and no part of the carrying amount would be deductible. Applying the formula, we have: Carrying amount of liability − Future deductible amounts + Future taxable amount = Tax base C950 – C nil + C50 = C1,000 There is a taxable temporary difference of C50 (C950 − C1,000).

Formula to determine tax base of revenue received in advance (contract liability) The formula for the tax base of a contract liability that is ‘revenue received in advance’ is consistent with the definition of tax base of a liability: Tax base = Carrying amount − Amount of revenue that will not be taxable in future periods Revenue might be taxed on a cash basis, and so ‘revenue received in advance’ recognised as a contract liability in accordance with IFRS 15 will not be taxed in the future period when it is recognised as revenue for accounting purposes. In this case (or if the revenue is not taxed at all), the tax base of the contract liability is zero. The tax base of a contract liability is equal to its carrying amount if the entire amount is taxed when subsequently recognised as revenue.

Applicability of the formulae where tax bases are not immediately apparent The formulae for determining the tax base of an asset and liability should give the correct result in most circumstances. There might be circumstances where the formulae cannot be readily applied, or where the tax base of an asset or liability is not immediately apparent. An entity should consider the fundamental principle of recognition of deferred tax: a deferred tax liability (asset) is recognised whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (smaller) than if such recovery or settlement had no tax consequences. Example C in IAS 12 illustrates how the fundamental principle is applied where the tax base of an asset or a liability depends on the expected manner of recovery or settlement.

Tax bases with no recognized carrying amounts

Some items might have a tax base but are not recognized as assets or liabilities on the balance sheet. A transaction during the reporting period might not give rise to an asset or liability on the balance sheet, but it might still affect taxable profits of future periods. The tax base is calculated using the amount that would affect taxable profits in future periods.

For example, expenditure incurred during the year might be written off for accounting purposes, but it is carried forward in the tax balance sheet at an amount that will be allowable as a deduction in future periods.

The difference between the tax base of the costs expensed and the carrying amount of nil is a deductible temporary difference that gives rise to a deferred tax asset.

Temporary differences

Temporary differences are defined as differences between the carrying amount of an asset or liability and its tax base. The term ‘temporary difference’ is used, because all differences between the carrying amounts of assets and liabilities and their tax bases will eventually reverse.

An entity might delay the reversal of temporary differences by delaying the events that give rise to those reversals (for example, it might defer indefinitely the sale of a revalued asset), but the temporary difference will eventually reverse.

Summary of temporary differences The relationship between the carrying amount and tax bases of assets and liabilities, and the resulting deferred tax assets and liabilities that arise, can be summarised as follows: Relationship For assets For liabilities Carrying amount is more than the tax base Taxable temporary difference Deductible temporary difference Deferred tax liability (DTL) Deferred tax asset (DTA) Carrying amount is less than the tax base Deductible temporary difference Taxable temporary difference Deferred tax asset (DTA) Deferred tax liability (DTL) Carrying amount = tax base None None

Temporary differences An item of income or expenditure is included in accounting profit of the period, but it is recognised in taxable profit in later periods. For example, income receivable might be accrued in the financial statements in one year, but it is taxed in the next year when received. Similarly, management might make provisions for restructuring costs in the financial statements in one period, but those costs would qualify for tax deduction in a later period when the expenditure is incurred. An item of income or expenditure is included in taxable profit of the period, but it is recognised in accounting profit in later years. For example, development expenditure might be tax deductible in the year in which it is incurred, but it is capitalised and amortised over a period for financial reporting purposes. Similarly, income received in advance might be taxed in the period of receipt, but it is treated in the financial statements as earned in a later period. Assets acquired and liabilities assumed in a business combination are generally recognised at their fair values; but no equivalent adjustment is made for tax purposes. Goodwill arises in a business combination. Assets are revalued and no equivalent adjustment is made for tax purposes. An asset or liability’s tax base on initial recognition differs from its initial carrying amount; for example, where an entity benefits from non-taxable government grants related to assets. The carrying amount of investments in subsidiaries, branches and associates or interests in joint ventures differs from the tax base of the investment or interest. An entity’s non-monetary assets and liabilities are measured in its functional currency, but the taxable profit or tax loss (and so the tax base of its non-monetary assets and liabilities) is determined in a different currency.

The carrying amounts of assets and liabilities used to calculate the temporary differences are determined from the entity’s balance sheet. The carrying amounts of assets are considered net of any provision for doubtful debts or impairment losses.

Similarly, the carrying amounts of liabilities, such as debts recognized at amortized cost, are considered net of any issue costs.

The carrying amounts of assets and liabilities in consolidated financial statements are obtained from the consolidated balance sheet. The tax base is determined by reference to a consolidated tax return in jurisdictions that require such a return; and by reference to the tax returns of each group entity in other jurisdictions.

Taxable temporary differences

Taxable temporary differences are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. Where the carrying amount of an asset exceeds its tax base, the amount of taxable economic benefits from recovering the asset will exceed the amount that is allowed as a deduction for tax purposes.

The same is true when the tax base of a liability exceeds its carrying amount. This difference is a taxable temporary difference, and the obligation to settle the resulting income taxes in future periods is a deferred tax liability.

Deferred tax liability relating to an asset An asset that cost C150 has a carrying amount of C100. Cumulative depreciation for tax purposes is C90 and the tax rate is 30%. Carrying amount Tax base Temporary difference C C C At acquisition 150 150 Accumulated depreciation 50 90 Net amount 100 60 40 Tax rate 30% Deferred tax liability 12 The tax base of the asset is C60 (cost of C150 less cumulative tax depreciation of C90). The entity will earn taxable income of C100 in recovering the carrying amount of C100, but it will only be able to deduct tax depreciation of C60. The entity will pay income tax on the excess. The difference between the carrying amount of C100 and the tax base of C60 is a taxable temporary difference of C40. The entity recognises a deferred tax liability of C12 (C40 × 30%), representing the income tax that it will pay when it recovers the asset’s carrying amount.

Deferred tax liability relating to a liability An entity has taken out a foreign currency loan of FC1,000 that is recognised at C625. At the reporting date, the carrying amount of the loan is C575. The unrealised exchange gain of C50 is included in profit or loss, but it will be taxable when the gain is realised on repayment of the loan. Carrying amount Tax base Temporary difference C C C At inception 625 625 Exchange gain 50 – Net amount 575 625 50 Tax rate 30% Deferred tax liability 15 The tax base of the loan is C625 (carrying amount of C575 plus the C50 of gain that will be taxable in future periods). The entity will make a gain of C50 in settling the liability at its carrying amount of C575, but it will not be able to deduct any amount for tax purposes. The entity will pay income tax of C15 (C50 × 30%) as a result of settling the carrying amount of the liability. The difference between the carrying amount of C575 and the tax base of C625 is a taxable temporary difference of C50. Therefore, the entity recognises a deferred tax liability of C15 (C50 × 30%), representing the income tax to be paid when the carrying amount of the loan is settled at an amount below the original proceeds.

Fair value of asset exceeds its carrying amount – impact when computing temporary difference Future tax consequences are always calculated based on the realisation of the asset at its carrying amount. In reality, an entity will often generate economic benefits in excess of the carrying amount through use or sale. For example, a property may have a market value that is substantially greater than its carrying amount. IAS 12 does not require an estimate of the benefits that will be generated by the asset. Rather, deferred tax is calculated on the assumption that those benefits will be equal to the carrying amount of the asset.

Example Tax base of an asset 1. A machine cost 100. For tax purposes, depreciation of 30 has already been deducted in the current and prior periods and the remaining cost will be deductible in future periods, either as depreciation or through a deduction on disposal. Revenue generated by using the machine is taxable, any gain on disposal of the machine will be taxable and any loss on disposal will be deductible for tax purposes. The tax base of the machine is 70. 2. Interest receivable has a carrying amount of 100. The related interest revenue will be taxed on a cash basis. The tax base of the interest receivable is nil. 3. Trade receivables have a carrying amount of 100. The related revenue has already been included in taxable profit (tax loss). The tax base of the trade receivables is 100. 4. Dividends receivable from a subsidiary have a carrying amount of 100. The dividends are not taxable. In substance, the entire carrying amount of the asset is deductible against the economic benefits. Consequently, the tax base of the dividends receivable is 100.a 5. A loan receivable has a carrying amount of 100. The repayment of the loan will have no tax consequences. The tax base of the loan is 100. aUnder this analysis, there is no taxable temporary difference. An alternative analysis is that the accrued dividends receivable have a tax base of nil and that a tax rate of nil is applied to the resulting taxable temporary difference of 100. Under both analyses, there is no deferred tax liability.

Example Tax base varies according to the expected manner of recovery of asset An item of property, plant and equipment with a cost of 100 and a carrying amount of 80 is revalued to 150. No equivalent adjustment is made for tax purposes. Cumulative depreciation for tax purposes is 30. If the item is sold for more than cost, the cumulative tax depreciation of 30 will be included in taxable income and the sale proceeds in excess of an inflation-adjusted cost of 110 will also be taxed. If the entity expects to recover the carrying amount by selling the item, the tax base is 80 (indexed cost of 110 less tax depreciation of 30). If the entity expects to recover the carrying amount of the item by using the asset, its tax base is 70 (100 less tax depreciation of 30).

Multiple tax consequences of recovering an asset – example Entity A acquires an intangible asset with a finite useful life (a licence) as part of a business combination. The carrying amount of the licence on initial recognition is CU100. Entity A intends to recover the carrying amount of the licence through use, and the expected residual value of the licence at expiry is CUnil. The applicable tax law prescribes two tax regimes: an income tax regime and a capital gains tax regime. Tax paid under both regimes meets the definition of income taxes in IAS 12. Recovering the licence’s carrying amount has the following tax consequences: under the income tax regime – Entity A will pay income tax on the economic benefits it receives from recovering the licence’s carrying amount through use, but receives no tax deductions in respect of amortisation of the licence (taxable economic benefits from use); and under the capital gains tax regime – Entity A will receive a tax deduction of CU100 when the licence expires (capital gain deduction). Entity A is prohibited from using the capital gain deduction to offset the taxable economic benefits from use when determining taxable profit. The fundamental principle upon which IAS 12 is based is that “an entity shall, with certain limited exceptions, recognise a deferred tax liability (asset) whenever 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“. The recovery of the asset’s carrying amount gives rise to two distinct tax consequences. It results in taxable economic benefits from use and a capital gain deduction that cannot be offset in determining taxable profit. Accordingly, applying the fundamental principle in IAS 12, Entity A should separately reflect the two distinct tax consequences of recovering the asset’s carrying amount. Entity A identifies temporary differences in a manner that reflects these distinct tax consequences by comparing: the portion of the asset’s carrying amount that will be recovered under one tax regime; to the tax deductions it will receive under that same tax regime (which are reflected in the asset’s tax base). Entity A identifies both of the following: a taxable temporary difference of CU100. Entity A will recover the licence’s carrying amount (CU100) under the income tax regime, but will receive no tax deductions under that regime (that is, none of the tax base relates to deductions under the income tax regime); and a deductible temporary difference of CU100. Entity A will not recover any part of the licence’s carrying amount under the capital gains tax regime, but will receive a deduction of CU100 upon expiry of the licence (that is, all of the tax base relates to deductions under the capital gains tax regime). Entity A applies the requirements in IAS 12 considering the applicable tax law in recognising and measuring deferred tax for the identified temporary differences. This conclusion was confirmed by the IFRS Interpretations Committee in the April 2020 IFRIC Update.

Taxable temporary difference arising on the initial recognition of non-tax deductible goodwill – example Company A acquires Company B for consideration of CU500. The fair value of the identifiable net assets of Company B at the acquisition date is CU400, resulting in goodwill of CU100. The goodwill is not tax deductible and, therefore, has a tax base of nil, but IAS 12 prohibits the recognition of the resulting deferred tax liability on the temporary difference of CU100. Subsequently, the goodwill is impaired by CU20 and, therefore, the amount of the taxable temporary difference relating to the goodwill is reduced from CU100 to CU80, with a resulting decrease in the value of the unrecognised deferred tax liability. The decrease in the value of the unrecognised deferred tax liability is also regarded as relating to the initial recognition of the goodwill and is not recognised.

Taxable temporary difference arising on goodwill that is wholly tax deductible – example The facts are as for previous FAQ, except that the goodwill is deductible for tax purposes at 20 per cent per year starting in the year of acquisition. Thus, the tax base of the goodwill is CU100 on initial recognition and CU80 at the end of the year of acquisition. If the carrying amount of goodwill at the end of the year of acquisition remains unchanged at CU100 (i.e. it has not been impaired), a taxable temporary difference of CU20 arises in that year. That taxable temporary difference does not relate to the initial recognition of the goodwill and, therefore, the resulting deferred tax liability is recognised. The temporary difference will reverse when the acquired business (including the goodwill) is sold or the goodwill is impaired.

Taxable temporary difference arising on goodwill that is partially tax deductible – example The facts are as for previous FAQ, except that CU80 of the goodwill is deductible for tax purposes at 25 per cent per year starting in the year of acquisition. The carrying amount of the goodwill that is non-tax deductible is CU20, and no deferred tax liability is initially recognised on this temporary difference of CU20. The tax rate is 30 per cent. At the end of the year of acquisition, the carrying amount of the total goodwill remains CU100 (i.e. it has not been impaired). No deferred tax liability is recognised for the initial temporary difference of CU20 in relation to the non-tax deductible goodwill. A deferred tax liability of CU6 (30% × CU20) is recognised for the temporary difference between the carrying amount (CU80) and the tax base (CU60) of the tax deductible goodwill because that taxable temporary difference does not relate to the initial recognition of the goodwill. The temporary difference will reverse when the acquired business (including the goodwill) is sold or the goodwill is impaired.

Tax deductible goodwill exceeds the carrying amount of goodwill – example Company A acquires Company B for consideration of CU500. The fair value of the identifiable net assets of Company B at the acquisition date is CU400, resulting in goodwill of CU100 (before any adjustment for a deferred tax asset arising on that goodwill). For tax purposes, a deduction of CU120 is available in respect of the goodwill. The tax rate is 30 per cent. Following the requirements of IAS 12, a deferred tax asset is recognised for the deductible temporary difference between the carrying amount and tax base of the goodwill, subject to the general recognition requirements of IAS 12. Because the carrying amount of goodwill is generally the residual purchase price over fair value of identifiable assets acquired and liabilities assumed (including deferred tax balances), a simultaneous equation (as illustrated below) is used to determine the final carrying amount of goodwill to be recognised in the business combination. CU  Consideration 500 Less: Fair value of identifiable net assets (400) Less: Deferred tax asset on goodwill (DTA) Goodwill (GW) 100 – DTA Equation 1 – Calculation of goodwill CU  Consideration 500 Less: Fair value of identifiable net assets (400) Less: Deferred tax asset on goodwill (DTA) Goodwill (GW) 100 – DTA Equation 2 – Calculation of deferred tax asset CU     Tax base of goodwill 120 Less: Carrying amount of goodwill (GW) Deductible temporary difference 120 – GW Tax rate 30% Deferred tax asset on goodwill (DTA) 0.3 × (120 – GW) Substituting Equation 2 into Equation 1 GW =100 – DTA = 100 – 0.3(120 – GW) = 100 – 36 + 0.3(GW) = 64 + 0.3(GW) Rearranged to 0.7(GW) = 64 ⇒ GW = CU91.43 The calculated goodwill figure is then used to determine the deferred tax asset. DTA = 0.3(120 – GW) = 0.3(120 – 91.43) = CU8.57 Therefore, the final goodwill calculation is as follows. CU  Consideration 500.00 Less: Fair value of identifiable net assets (400.00) Deferred tax asset   (8.57) Goodwill (GW)  91.43

Deferred tax liability arising on the recognition of an asset – asset depreciated at the same rate for tax and accounting purposes – example Company A purchases an asset for CU100,000 at the end of 20X0. Only CU60,000 is qualifying expenditure for tax purposes. The carrying amount of the asset will be recovered through use in taxable manufacturing operations. The asset is depreciated on a straight-line basis at 25 per cent for both tax and accounting purposes. Year Carrying amount CU Tax base CU Temporary difference CU Unrecognised temporary difference CU Recognised temporary difference CU Deferred tax liability CU A B A – B = C D* 20X0 100,000 60,000 40,000 40,000 – – 20X1 75,000 45,000 30,000 30,000 – – 20X2 50,000 30,000 20,000 20,000 – – 20X3 25,000 15,000 10,000 10,000 – – 20X4 – – – – – – *  The unrecognised temporary difference reflects the proportion of the asset’s carrying amount that represents the original unrecognised temporary difference, as reduced by subsequent depreciation. No deferred tax is ever recognised in respect of the original temporary difference.

Deferred tax liability arising on the recognition of an asset – different depreciation rates for tax and accounting purposes – example The facts are as per previous FAQ, but the asset is depreciated on a straight-line basis at 25 per cent for accounting purposes and 33 per cent for tax purposes. The tax rate is 30 per cent. Year Carrying amount CU Tax base CU Temporary difference CU Unrecognised temporary difference CU Recognised temporary difference CU Deferred tax liability CU A B A – B = C D* C – D = E** E × 30% 20X0 100,000 60,000 40,000 40,000 – – 20X1 75,000 40,000 35,000 30,000 5,000 1,500 20X2 50,000 20,000 30,000 20,000 10,000 3,000 20X3 25,000 – 25,000 10,000 15,000 4,500 20X4 – – – – – – * As per previous FAQ. ** The recognised temporary difference reflects the difference between cumulative tax and cumulative accounting depreciation on the original tax base of the asset.

Deferred tax liability arising on the recognition of an asset – asset subsequently revalued – example The facts are as per previous FAQ (i.e. depreciation on a straight-line basis at 25 per cent for both tax and accounting purposes), but the asset is revalued for accounting purposes to CU120,000 at the end of 20X1. The tax rate is 30 per cent. Year Carrying amount CU Tax base CU Temporary difference CU Unrecognised temporary difference CU Recognised temporary difference CU Deferred tax liability CU A B A – B = C D* C – D = E** E × 30% 20X0 100,000 60,000 40,000 40,000 – – 20X1 120,000 45,000 75,000 30,000 45,000 13,500 20X2 80,000 30,000 50,000 20,000 30,000 9,000 20X3 40,000 15,000 25,000 10,000 15,000 4,500 20X4 – – – – – – * As per previous FAQ. ** The recognised temporary difference is the amount by which the asset has been revalued upwards in comparison with the depreciated original cost (i.e. the difference between CU120,000 and CU75,000, being the carrying amount of the asset at the time of the revaluation), less depreciation of the revaluation uplift.

Available tax deductions exceeding the cost of the asset (‘super deductions’) – available when the asset is brought unto use – example On 31 December 20X0, Manufacturing Entity A enters into a capital expansion project that qualifies for tax deductions based on 150 per cent of the cost of new manufacturing assets (CU80,000). The deduction in excess of the cost of the assets (the additional tax deduction) is deductible in the determination of taxable income in the period when the assets are brought into use (20X1). The carrying amount of the assets will be recovered through use in taxable manufacturing operations. The cost of the assets is depreciated on a straight-line basis at 25 per cent for accounting purposes and 33 per cent for tax purposes. The tax rate is 30 per cent. Note that the tax deduction in excess of the cost of the assets (available when the assets are brought into use in 20X1) satisfies the conditions for the initial recognition exception under IAS 12 because the transaction (i.e. the incurrence of capital expenditure: is not a business combination; at the time of transaction, affects neither accounting nor taxable profit on initial recognition; and for entities that have adopted the May 2021 amendments, at the time of the transaction, does not give rise to equal taxable and deductible temporary differences. Year Carrying amount CU Tax base CU Temporary difference  CU  Unrecognised temporary difference  CU  Recognised temporary difference CU Deferred tax liability CU A B A – B = C D* C – D = E E × 30% 20X0 80,000 120,000 (40,000) (40,000) – – 20X1 60,000 53,333 6,667 – 6,667 2,000 20X2 40,000 26,667 13,333 – 13,333 4,000 20X3 20,000 – 20,000 – 20,000 6,000 20X4 – – – – – – * The unrecognised temporary difference represents the proportion of the additional tax deduction not yet claimed. The accounting treatment described results in a lower effective tax rate in 20X1 when the assets are brought into use (and the additional tax deduction of CU40,000 is claimed) and a constant effective tax rate from 20X2 to 20X4.

Deductible temporary differences

Deductible temporary differences are temporary differences that will result in deductible amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. The recognition of a liability implies that its carrying amount will be settled through an outflow of economic benefits from the entity in future periods.

These outflows might be deductible when the taxable profits of a later reporting period (that is, after the period when the liability is recognized) are determined. There is a difference between the carrying amount of the liability and its tax base when the outflow is deductible in the future.

A deferred tax asset arises concerning the income taxes that will be reduced or recoverable in future periods when the outflow is allowed as a deduction in determining taxable profit.

A deductible temporary difference also arises where an asset’s carrying amount is less than its tax base. The difference gives rise to a deferred tax asset to the extent that income taxes will be reduced or recoverable in future periods.

Deferred tax asset relating to a liability An entity recognises a liability of C1,000 for product warranty costs. For tax purposes, the warranty costs are deductible only when claims are made. Carrying amount Tax base Temporary difference C C C Accrued warranty cost 1,000 – 1,000 Tax rate 30% Deferred tax asset 300 The tax base of the warranty is nil (carrying amount of C1,000 less the amount of C1,000 that will be deductible in future periods when the claim is made). The entity obtains a deduction against taxable profits of the period in which the claim is made, and the liability is settled at its carrying amount of C1,000. The entity will pay less income tax of C300 (C1,000 × 30%) as a result of settling the carrying amount of the liability. The difference between the carrying amount of C1,000 and the nil tax base is a deductible temporary difference of C1,000. Therefore, the entity recognises a deferred tax asset of C300 (C1,000 × 30%), representing the income tax that will be recoverable (reduced) in the future.

Deferred tax asset relating to an asset An asset was acquired at a cost of C1,500. It has a carrying amount of C700 after an impairment write-down of C300 was recognised in the year. Cumulative depreciation for tax and accounting purposes amounted to C500 and the tax rate is 30%. Carrying amount Tax base Temporary difference C C C At acquisition 1,500 1,500 Accumulated depreciation 500 500 Impairment loss in year 300 – Net amount 700 1,000 300 Tax rate 30% Deferred tax asset 90 The tax base of the asset is C1,000 (cost of C1,500 less cumulative tax depreciation of C500). In recovering the carrying amount of C700, the entity will earn taxable income of C700, but will be able to deduct tax depreciation of C1,000. The entity will recover income tax. The difference between the carrying amount of C700 and the tax base of C1,000 is a deductible temporary difference of C300. So the entity recognises a deferred tax asset of C90 (C300 × 30%), representing the income tax that will be recovered (reduced) when it recovers the asset’s carrying amount.

Deferred tax asset where tax base exceeds the related asset’s carrying amount An entity purchases for C1,000, at the beginning of Year 1, a debt instrument with a nominal value of C1,000 payable on maturity in 5 years with an interest rate of 2% payable at the end of each year. The effective interest rate is 2%. The debt instrument is measured at fair value. At the end of Year 2, the fair value of the debt instrument has decreased to C918 as a result of an increase in market interest rates to 5%. It is probable that the entity will collect all of the contractual cash flows if it continues to hold the debt instrument. Any gains (losses) on the debt instrument are taxable (deductible) only when realised. The gains (losses) arising on the sale or maturity of the debt instrument are calculated for tax purposes as the difference between the amount collected and the original cost of the debt instrument. Accordingly, the tax base of the debt instrument is its original cost. The difference between the carrying amount of the debt instrument of C918 and its tax base of C1,000 gives rise to a deductible temporary difference of C82 at the end of Year 2, irrespective of whether the entity expects to recover the carrying amount of the debt instrument by sale or by use (that is, by holding it and collecting contractual cash flows, or a combination of both). This is because deductible temporary differences are differences between the carrying amount of an asset or liability and its tax base that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods, when the carrying amount of the asset or liability is recovered or settled. The entity obtains a deduction equivalent to the tax base of the asset of C1,000 in determining taxable profit (tax loss), either on sale or on maturity.

Liability expected to be settled for an amount that exceeds its carrying amount – impact when computing the tax base Future tax consequences are always calculated based on the settlement of the liability at its carrying amount. There may be occasions when the settlement of a liability is expected to exceed its current carrying amount (e.g. when a settlement premium is being accrued over the life of a debt instrument). IAS 12 does not require anticipation of the expected settlement amount. Instead, deferred tax is calculated on the assumption that the liability will be settled at its carrying amount.

Tax base for liability when settlement of liability at its carrying amount would have no tax consequences When settlement of the liability at its carrying amount would have no tax consequences, the tax base of the liability is equal to its carrying amount. This will be the case when either the transaction has no tax implications (e.g. accrual of fines and penalties that are not tax deductible), or when the accounting and tax implications occur in the same period (e.g. accrued wages in respect of which a tax deduction is allowed at the same time as the expense is recognised).

Example Tax base of a liability Current liabilities include accrued expenses with a carrying amount of 100. The related expense will be deducted for tax purposes on a cash basis. The tax base of the accrued expenses is nil. Current liabilities include interest revenue received in advance, with a carrying amount of 100. The related interest revenue was taxed on a cash basis. The tax base of the interest received in advance is nil. Current liabilities include accrued expenses with a carrying amount of 100. The related expense has already been deducted for tax purposes. The tax base of the accrued expenses is 100. Current liabilities include accrued fines and penalties with a carrying amount of 100. Fines and penalties are not deductible for tax purposes. The tax base of the accrued fines and penalties is 100.a A loan payable has a carrying amount of 100. The repayment of the loan will have no tax consequences. The tax base of the loan is 100. aUnder this analysis, there is no deductible temporary difference. An alternative analysis is that the accrued fines and penalties payable have a tax base of nil and that a tax rate of nil is applied to the resulting deductible temporary difference of 100. Under both analyses, there is no deferred tax asset.

Tax base of revenue received in advance – example On 31 December 20X1, Company A receives CU100 revenue in advance of performing services. The amount is recognised as deferred revenue in Company A’s statement of financial position and it will be recognised in profit or loss as services are performed during the 20X2 reporting period. The revenue is taxed on receipt. At 31 December 20X1, the carrying amount of the deferred revenue is CU100; the amount that will not be taxable in future periods is CU100 (because this has already been taxed). Therefore, the tax base of the deferred revenue is nil and a deductible temporary difference arises. A deferred tax asset is recognised in respect of this temporary difference subject to IAS 12’s general recognition criteria; the ‘initial recognition exception’ does not apply because the recognition of the revenue affected taxable profit.

Tax base of government grant recognised as deferred income – example Company B receives a government grant of CU150 to purchase a specified property. Company B recognises the government grant as deferred income in its statement of financial position, as permitted under IAS 20. If the government grant is taxed on receipt, the same analysis as set out applies, and a temporary difference equal to the carrying amount of the deferred income arises. A deferred tax asset is recognised in respect of this temporary difference subject to IAS 12’s general recognition criteria; the ‘initial recognition exception’ does not apply because the receipt of the grant affected taxable profit. If the government grant is taxed at the same time as it is recognised in profit or loss over the life of the related asset, all of the grant is taxable in future periods. Therefore, on initial recognition, the tax base will equal the carrying amount of the deferred income and no temporary difference arises. If the government grant is not taxable, either on receipt or when it is recognised in profit or loss over the useful life of the related property, applying the formula above will give a tax base of nil. Consequently, a deductible temporary difference arises. However, because this difference arises on the initial recognition of the deferred income and the conditions in IAS 12 are met, no deferred tax is recognised.

Recognizing deferred tax liabilities

All taxable temporary differences give rise to deferred tax liabilities and, with some exceptions, are recognized in the financial statements. Deferred tax liability is recognized, even if the entity expects to have a taxable loss in the future. A taxable temporary difference might be expected to reverse in a period in which a tax loss arises, and the entity might not have to pay any tax.

The entity will still suffer a sacrifice of future economic benefits. The benefit derived from the tax loss in future periods will be reduced by the amount of the reversing taxable temporary difference.

Deferred tax liability should be recognized for all taxable temporary differences, except a taxable temporary difference that arises from:

• The initial recognition of goodwill.
• The initial recognition of an asset or liability in a transaction which:
• is not a business combination; and
• at the time of the transaction, does not affect accounting profit or taxable profit (tax loss).
• Investment in subsidiaries, branches, and associates, and interests in joint ventures, where:
• the parent, investor, or venturer can control the timing of the reversal of the temporary difference; and
• probably, the temporary difference will not reverse in the foreseeable future.

The recognition of a taxable temporary difference depends on the nature of the transaction that led to the asset or liability being recognized initially. An entity does not recognize a deferred tax liability, either on initial recognition or subsequently, that arises from a transaction that is not a business combination and does not affect accounting profit or taxable profit.

Recognizing deferred tax assets for deductible temporary differences

Deductible temporary differences result in deductions from taxable profits in future periods when they reverse. The economic benefits of the tax deductions can only be realized if the entity earns sufficient taxable profits against which the deductions can be offset.

A deferred tax asset should be recognized for all deductible temporary differences to the extent that taxable profit will probably be available against which the deductible temporary difference can be utilized unless the deferred tax asset arises 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, does not affect accounting profit or taxable profit (tax loss).

An entity should also recognize a deferred tax asset for all deductible temporary differences associated with investments in subsidiaries, branches, and associates, and interests in joint ventures, to the extent that it is probable that:

• the temporary difference will reverse in the foreseeable future; and
• taxable profit will be available against which the temporary difference can be utilized.

The term ‘probable’ is not defined in IAS 12. However, IFRS 5 states: “For the purposes of IFRSs, probable is defined as ‘more likely than not”. A deferred tax asset should be recognised for the whole or the part of the temporary difference that is more likely than not to be recovered. An entity must do more than simply not make losses in future to recover a deferred tax asset; it would have to make sufficient taxable profits.

Considerations in assessing recoverability of deferred tax asset Taxable amounts arising from future deductible temporary differences are generally ignored in determining the sufficiency of taxable profits. Careful analysis is needed where losses cannot be carried forward indefinitely. A deferred tax asset could be recognised where an entity has tax planning opportunities that will create taxable profit in appropriate periods. This can mean that unused losses are recoverable out of taxable profits made available by deferring claims for deductions, because this creates a deductible temporary difference. A similar situation arises, without tax planning, where deductions are given under the relevant tax rules in later periods, as compared to the related accounting charge. Complexities arise where profit forecasts include the amounts relevant for tax purposes (rather than the accounting deductions) and where losses that would otherwise expire are only recoverable against taxable profits arising as a result of future deductible temporary differences. In such cases, those taxable profits can only be taken into account if the deferred tax assets relating to the future deductible temporary differences can also be recovered. A deferred tax asset is not recognised where it is only recoverable through the future creation of, or replacement with, a new unrecoverable deferred tax asset. But a deferred tax asset is recognised where an otherwise profitable entity has expiring unused losses that can be recovered by tax planning (or other deferral of deductions), and those losses create originating deductible temporary differences that are themselves recoverable. Taxable profits resulting from the reversal of deferred tax liabilities are excluded from the estimation of future taxable profits where they have been used to support the recognition of deferred tax assets to avoid double counting. A strong earnings history can provide objective evidence of future profitability in assessing the extent to which a deferred tax asset can be recognised. Hence, there would be less need for profitable entities to consider the pattern and timing of the reversals of existing temporary differences. Careful consideration is given to recoverability of a deferred tax asset, based on the entity’s projections, where there is a balance of favourable and unfavourable evidence. The amount of taxable profits considered more likely than not for each period is assessed. Management should have regard to any time limit on carry-forward of tax losses. The level of taxable profit might be more difficult to predict, the further into the future an assessment is required; but there should be no arbitrary cut-off in the time period over which such an assessment is made. Management should also ensure that the projections on which such assessments are based are broadly consistent with the assumptions made about the future in relation to other aspects of financial accounting (for example, impairment testing), except where relevant standards require a different treatment. Consideration should be given to the disclosures about key sources of uncertainty required by IAS 1. Some entities, by their nature, would not ordinarily recognise deferred tax assets that are not supported through reversals of existing temporary differences, such as development-stage enterprises and start-up businesses. The lack of a track record for profits means that a deferred tax asset is unlikely to be recognised. Evidence of future taxable profits might be assigned less weight in assessing whether a deferred tax asset should be recognised where there is other unfavourable evidence (such as actual trading losses).

Future reversals of existing taxable temporary differences

A deferred tax asset is recognized for deductible temporary differences to the extent that there are sufficient suitable deferred tax liabilities available. The future reversal of existing taxable temporary differences (the basis of a deferred tax liability) gives rise to an increase in taxable income. The deferred tax asset is recoverable to the extent that the taxable temporary difference:

• relates to the same taxable entity;
• is assessed by the same taxation authority; and
• reverses in the same period in which existing deductible temporary differences are expected to reverse, or in a period to which a tax loss arising from the reversal of the deductible temporary difference might be carried back or forward.

Recoverability is probable when there are suitable taxable temporary differences, whether or not the entity expects to make future taxable losses.

Recovery of deferred tax asset against deferred tax liabilities An entity has taxable temporary differences of C80,000 in respect of fair value adjustments in a business combination. The reversal of the temporary differences is expected to result in taxable income of C20,000 a year in years 1 to 4. The entity also has a warranty provision of C40,000, that is expected to be deductible for tax purposes, as follows: C30,000 in year 2; and C10,000 in year 3. In addition, the entity has unused tax losses of C60,000. A schedule of the reversal of temporary differences and the utilisation of tax losses carried forward is shown below: Year 1 Year 2 Year 3 Year 4 C C C C Taxable temporary differences – expected reversal profile Beginning of year 80,000 60,000 40,000 20,000 Recognised in taxable income (20,000) (20,000) (20,000) (20,000) End of year 60,000 40,000 20,000 – Deductible temporary differences – expected reversal profile (a) Warranty provisions Beginning of year 40,000 40,000 10,000 – Deducted for tax purposes – (30,000) (10,000) – End of year 40,000 10,000 – – (b) Tax losses Beginning of year 60,000 40,000 50,000 40,000 Increase (utilisation) in year (20,000) 10,000 (10,000) (20,000) End of year 40,000 50,000 40,000 20,000 Total deductible temporary differences 80,000 60,000 40,000 20,000 At the end of year 1, the entity recognises a deferred tax asset in respect of at least C60,000 of the deductible temporary differences and tax losses at the appropriate tax rate. This is because there are taxable temporary differences in respect of deferred tax liabilities of the same amount that are expected to be included in taxable income, and against which the expected reversal of deductible temporary differences and the tax losses can be utilised. For similar reasons, a deferred tax asset in respect of at least C40,000 of deductible temporary differences and tax losses would be recognised at the end of year 2, and C20,000 at the end of year 3, where circumstances remained the same at those dates. However, in order to recognise a deferred tax asset in any of years 1 to 4 with respect to the C20,000 of tax losses that remain un-utilised, the entity might need to look for sources of taxable profit other than reversals of temporary differences.

Future taxable profits

If there are insufficient taxable temporary differences against which the deductible temporary difference can be recovered, management should consider the likelihood that sufficient taxable profits of the appropriate type (for example, trading profit or capital gain) will arise in the same period(s) as the reversal of the deductible temporary differences (or in the periods to which a tax loss arising from reversal can be carried back or forward).

The future taxable profit must be available to the ‘taxable entity’ where the deductible temporary differences originate. The estimate of probable future taxable profit might include the recovery of some of an entity’s assets for more than their carrying amount if there is sufficient evidence that the entity will probably achieve this.

The meaning of ‘taxable entity’ and considerations for assessing recoverability of deferred tax assets in a group situation In various jurisdictions, entities can form ‘tax groups’, within which tax losses or other deductible temporary differences could be transferred between entities. This means that tax losses or other deductible temporary differences in an unprofitable entity could be used to reduce the taxable profits of another entity within the tax group, thus benefiting the group as a whole. The recoverability of deferred tax assets should be assessed with reference to the ‘taxable entity’. In our view, it is reasonable to interpret the ‘taxable entity’ to mean the wider group of entities in the same tax group. This means that taxable profits of all entities in the wider tax group could be taken into account in assessing whether a deferred tax asset should be recognised in consolidated financial statements. The question also arises whether a deferred tax asset should be recognised at the entity level, where tax losses or other deductible temporary differences are transferred within a tax group. The entity that generated the losses (or where the deductible temporary differences originated) might not itself have sufficient taxable profits to support recognising a deferred tax asset. In such cases, asset recognition at an entity level will depend on whether future economic benefit will flow to the entity; for example, the surrendering entity might have a contract in place to receive payment for transferring its tax benefits. This would indicate that an asset should be recognised at the entity level. In each case, the relevant facts and circumstances should be taken into account to determine the appropriate treatment.

Debt instruments measured at fair value At 31 December 20X1, an entity holds a portfolio of three debt instruments: Debt instrument Cost (C) Fair value (C) Contractual interest rate A 2,000,000 1,942,857 2.00% B 750,000 778,571 9.00% C 2,000,000 1,961,905 3.00% The entity acquired all of the debt instruments on issuance for their nominal value. The terms of the debt instruments require the issuer to pay the nominal value of the debt instruments on their maturity on 31 December 20X2. Interest is paid at the end of each year at the contractually fixed rate, which equalled the market interest rate when the debt instruments were acquired. At the end of 20X1, the market interest rate is 5%, which has caused the fair value of debt instruments A and C to fall below their cost, and the fair value of debt instrument B to rise above its cost. It is probable that the entity will receive all of the contractual cash flows if it continues to hold the debt instruments. At the end of 20X1, the entity expects that it will recover the carrying amounts of debt instruments A and B through use (that is, by continuing to hold them and collecting contractual cash flows) and debt instrument C by sale at the beginning of 20X2 for its fair value on 31 December 20X1. It is assumed that no other tax planning opportunity is available to the entity that would enable it to sell debt instrument B to generate a capital gain against which it could offset the capital loss arising from selling debt instrument C. The debt instruments are measured at fair value through other comprehensive income in accordance with IFRS 9. Tax law The tax base of the debt instruments is cost, which tax law allows to be offset either on maturity when principal is paid, or against the sale proceeds when the debt instruments are sold. Tax law specifies that gains (losses) on the debt instruments are taxable (deductible) only when realised. Tax law distinguishes ordinary gains and losses from capital gains and losses. Ordinary losses can be offset against both ordinary gains and capital gains. Capital losses can only be offset against capital gains. Capital losses can be carried forward for five years, and ordinary losses can be carried forward for 20 years. General On 31 December 20X1, the entity has, from other sources, taxable temporary differences of C50,000 and deductible temporary differences of C430,000, which will reverse in ordinary taxable profit (or ordinary tax loss) in 20X2. At the end of 20X1, it is probable that the entity will report to the tax authorities an ordinary tax loss of C200,000 for the year 20X2. This tax loss includes all taxable economic benefits and tax deductions for which temporary differences exist on 31 December 20X1 and that are classified as ordinary by tax law. These amounts contribute equally to the loss for the period according to tax law. The entity has no capital gains against which it can utilise capital losses arising in the years 20X1–20X2. Except for the information given in the previous paragraphs, there is no further information that is relevant to the entity’s accounting for deferred taxes in the period 20X1–20X2. Temporary differences At the end of 20X1, the entity identifies the following temporary differences: Debt instrument Carrying amount (C) Tax base (C) Taxable temporary differences (C) Deductible temporary differences (C) A 1,942,857 2,000,000 57,143 B 778,571 750,000 28,571 C 1,961,905 2,000,000 38,095 Other sources Not specified 50,000 430,000 – – –  – – The difference between the carrying amount of an asset or liability and its tax base gives rise to a deductible (taxable) temporary difference. This is because deductible (taxable) temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base, which will result in amounts that are deductible (taxable) in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. Utilisation of deductible temporary differences With some exceptions, deferred tax assets arising from deductible temporary differences are recognised to the extent that sufficient future taxable profit will be available against which the deductible temporary differences are utilised. IAS 12 identifies the sources of taxable profits against which an entity can utilise deductible temporary differences. They include: a. future reversal of existing taxable temporary differences; b. taxable profit in future periods; and c. tax planning opportunities. The deductible temporary difference that arises from debt instrument C is assessed separately for utilisation. This is because tax law classifies the loss resulting from recovering the carrying amount of debt instrument C by sale as capital, and it allows capital losses to be offset only against capital gains. The separate assessment results in not recognising a deferred tax asset for the deductible temporary difference that arises from debt instrument C, because the entity has no source of taxable profit available that tax law classifies as capital. In contrast, the deductible temporary differences that arise from debt instrument A and other sources are assessed for utilisation in combination with one another. This is because their related tax deductions would be classified as ordinary by tax law. The tax deductions represented by the deductible temporary differences related to debt instrument A are classified as ordinary, because tax law classifies the effect on taxable profit (tax loss) from deducting the tax base on maturity as ordinary. In assessing the utilisation of deductible temporary differences on 31 December 20X1, the following two steps are performed by the entity. Step 1: Utilisation of deductible temporary differences because of the reversal of taxable temporary differences The entity first assesses the availability of taxable temporary differences as follows: (C) Expected reversal of deductible temporary differences in 20X2 From debt instrument A 57,143 From other sources 430,000 Total reversal of deductible temporary differences 487,143 Expected reversal of taxable temporary differences in 20X2 From debt instrument B (28,571) From other sources (50,000) Total reversal of taxable temporary differences (78,571) Utilisation because of the reversal of taxable temporary differences (Step 1) 78,571 Remaining deductible temporary differences to be assessed for utilisation in Step 2 (487,143 – 78,571) 408,572 In Step 1, the entity can recognise a deferred tax asset in relation to a deductible temporary difference of C78,571. Step 2: Utilisation of deductible temporary differences because of future taxable profit In this step, the entity assesses the availability of future taxable profit as follows: (C) Probable future tax profit (loss) in 20X2 (on which income taxes are payable (recoverable)) (200,000) Add back: reversal of deductible temporary differences expected to reverse in 20X2 487,143 Less: reversal of taxable temporary differences (utilised in Step 1) (78,571) Probable taxable profit excluding tax deductions for assessing utilisation of deductible temporary differences in 20X2 208,572 Remaining deductible temporary differences to be assessed for utilisation from Step 1 8,57272 Utilisation because of future taxable profit (Step 2) 408,520 Utilisation because of the reversal of taxable temporary differences (Step 1) 78,571 Total utilisation of deductible temporary differences 287,143 The tax loss of C200,000 includes the taxable economic benefit of C2m from the collection of the principal of debt instrument A and the equivalent tax deduction, because it is probable that the entity will recover the debt instrument for more than its carrying amount (see IAS 12). The utilisation of deductible temporary differences is not, however, assessed against probable future taxable profit for a period on which income taxes are payable (see IAS 12). Instead, the utilisation of deductible temporary differences is assessed against probable future taxable profit that excludes tax deductions resulting from the reversal of deductible temporary differences. Assessing the utilisation of deductible temporary differences against probable future taxable profits without excluding those deductions would lead to double counting the deductible temporary differences in that assessment. In Step 2, the entity determines that it can recognise a deferred tax asset in relation to a future taxable profit, excluding tax deductions resulting from the reversal of deductible temporary differences, of C208,572. Consequently, the total utilisation of deductible temporary differences amounts to C287,143 (C78,571 (Step 1) + C208,572 (Step 2)). Measurement of deferred tax assets and deferred tax liabilities The entity presents the following deferred tax assets and deferred tax liabilities in its financial statements on 31 December 20X1: (C) Total taxable temporary differences 78,571 Total utilisation of deductible temporary differences 287,143 Deferred tax liabilities (78,571 at 30%) 23,571 Deferred tax assets (287,143 at 30%) 86,143 The deferred tax assets and the deferred tax liabilities are measured using the tax rate for ordinary gains of 30%, in accordance with the expected manner of recovery (settlement) of the underlying assets (liabilities). Allocation of changes in deferred tax assets between profit or loss and other comprehensive income Changes in deferred tax that arise from items that are recognised in profit or loss are recognised in profit or loss. Changes in deferred tax that arise from items that are recognised in other comprehensive income are recognised in other comprehensive income. The entity did not recognise deferred tax assets for all of its deductible temporary differences at 31 December 20X1 and, according to tax law, all of the tax deductions represented by the deductible temporary differences contribute equally to the tax loss for the period. Consequently, the assessment of the utilisation of deductible temporary differences does not specify whether the taxable profits are utilised for deferred tax items that are recognised in profit or loss (that is, the deductible temporary differences from other sources) or whether, instead, the taxable profits are utilised for deferred tax items that are recognised in other comprehensive income (that is, the deductible temporary differences related to debt instruments measured at fair value through other comprehensive income). For such situations, IAS 12 requires the changes in deferred taxes to be allocated to profit or loss and other comprehensive income, on a reasonable pro rata basis or by another method that achieves a more appropriate allocation in the circumstances.

Deductible temporary differences are compared with future taxable profit that excludes tax deductions resulting from the reversal of those deductible temporary differences.

This comparison shows the extent to which the future taxable profit is sufficient for the entity to deduct the amounts resulting from the reversal of those deductible temporary differences.

The impact of deductible temporary differences that are expected to originate in future periods is not taken into consideration in determining the availability of future taxable profits.

Deferred tax assets arising from those deductible temporary differences will require future taxable profits to be utilized.

Determining future taxable profits An entity has tax losses carried forward of C125, which expire after five years, and it is considering how much of this total can be recognised as a deferred tax asset. Profits before tax allowances for depreciation of plant are expected to be C25 for each of the next five years (that is, C125 in total), less tax deductions of C10 per annum; this would result in profits after tax allowances of C15 per annum for the five years (C75 in total). Profits after five years are expected to be nil; so, if the tax allowances are deferred, profits will not support their subsequent recovery. If the tax allowances are claimed in years 1 to 5, the taxable profits will be as follows: Years 1 to 5 Years 6 to 10 Total C C C Taxable profit before deduction 125 – 125 Tax deduction for plant (50) – (50) Taxable profit 75 – 75 Loss carry-forwards utilised (75) – (75) In this situation, C50 of the losses remain un-utilised. If the allowances are disclaimed in years 1 to 5 (so they are available for deduction in years 6 to 10), the taxable profit will be as follows: Years 1 to 5 Years 6 to 10 Total C C C Taxable profit before deduction 125 – 125 Tax deduction for plant – (50) (50) Taxable profit 125 (50) 75 Adjustment for disclaimed tax deductions (see below) (50) 50 – Taxable profit before utilisation of losses 75 – 75 The result of disclaiming the tax allowances is higher taxable profit, in years 1 to 5, of C125 in total; but the overall expected future taxable profits are still C75 in total. So the total tax deductions of C50 should be considered in determining the amount of taxable profit available for utilisation of the brought-forward losses. Thus, the amount of profit available for recovering the deferred tax asset will be C15 × 5 = C75, rather than C25 × 5 = C125, which would be the amount of profit if the tax deductions were not claimed. This is bcaeuse the entity only has an asset if it will gain future economic benefits from the item in question. There is no asset, in ‘net’ terms, where the entity can only gain those future economic benefits by deferring or waiving other future economic benefits due to the entity.

Interaction of losses and deductible temporary differences An entity has unused losses of C300, and it is assessing whether it can recognise a deferred tax asset. The losses expire in five years’ time. The entity is forecasting an accounting loss of C100 in year 1, but this is after recognising C400 for a loss on a loan. The tax deduction for the loan can be deferred, and the entity intends to claim this after year 5 (that is, in years 6 to 10). Accounting profits in years 2 to 5 are forecast to be nil, and in years 6 to 10 to be C600 in total. Years 1 to 5 Years 6 to 10 Total C C C Accounting result before loan loss 300 600 900 Loan loss (400) – (400) Accounting result (100) 600 500 Taxable profit before loan loss deduction 300 600 900 Loan loss deduction – (400) (400) Loss carry-forwards utilised (300) – (300) Taxable profit – 200 200 There are sufficient taxable profits (C900) to recover both the loss carry-forwards (C300) and the loan loss deduction (C400). A deferred tax asset in respect of the loss carry-forwards is recognised in the current year.

Tax planning opportunities

Entities might consider tax planning opportunities to ensure the recovery of deferred tax assets or to reduce future tax liabilities. An entity should consider whether it expects that tax planning opportunities will create suitable taxable profits to recover deductible temporary differences.

However, tax planning opportunities should only be considered to determine the extent to which an existing deferred tax asset will be realized. Tax planning opportunities cannot be utilized to reduce deferred tax liabilities or to create deferred tax assets.

The feasibility of the tax planning opportunity is assessed based on the individual facts and circumstances of each case.

Management should be capable of undertaking and implementing the tax planning strategy, and it should expect that it will implement the strategy if it is necessary to ensure that a deferred tax asset can be recovered.

Management should consider all of the economic consequences of the tax planning in assessing whether it would implement the strategy.

Recognition of expenses relating to implementing tax planning opportunities An entity might incur various expenses in implementing a tax planning opportunity. We believe that any deferred tax asset recognised as a result of implementing a tax planning opportunity should be recognised net of the tax effects of any expenses or losses expected to be incurred as a result of the opportunity; this is because that is the net amount by which future tax payments will be reduced as a result of implementing it. The same principles apply where a tax planning opportunity is used to support realisation of unused tax losses in a business combination. The benefit of any deferred tax asset recognised is also reduced by the tax effects of any expenses or losses incurred to implement a tax planning opportunity.

Expenses of tax planning opportunities An entity has gross deductible temporary differences of C1,000 in respect of a deferred tax asset that is not recognised in the balance sheet. The tax rate is 30%, and so the unrecognised deferred tax asset is C300. The entity expects to generate taxable profits of at least C1,000 as a result of implementing a tax planning opportunity. But the cost of implementing the opportunity is expected to be C200. Therefore, only C800 of future taxable profits would be available against which the deferred tax asset can be offset. A maximum deferred tax asset of C240 (C800 @ 30%) would qualify for recognition. The remaining C60 will remain unrecognised. That is, the deferred tax asset of C300 is reduced by C60, which is the tax benefit of the expenses that the entity expects to incur for implementing the tax planning opportunity.

A tax planning opportunity is an action that the entity would not normally take – except to prevent, say, an unused tax loss from expiring. Such actions could include:

• Accelerating taxable amounts or deferring claims for deductions to recover losses being carried forward (perhaps before they expire).

• Changing the character of taxable or deductible amounts from trading gains or losses to capital gains or losses, or vice versa.

• Switching from tax-free to taxable investments.

Sale of appreciated assets where operating losses are projected An entity has experienced operating losses over the last five years. Accumulated tax losses of C20 million have given rise to a potential unrecognised deferred tax asset of C6 million. Management is currently projecting that, for the next three years, it will experience losses of at least C1 million per year (and of approximately C5 million in total), based on its plans to introduce a new product line. Management then expects to ‘turn the corner’ and become profitable. The entity has an investment in a shopping centre property, which is now valued at approximately C500,000 more than the carrying amount in the balance sheet. This is because of appreciation in the property market. The entity proposes to recognise a deferred tax asset of C150,000 (C500,000 × 30%), based on a tax planning opportunity to sell the investment. The shopping centre property is not a ‘core’ asset of the entity; and management says that it would sell the property, if necessary, before it would permit the unused tax losses to expire. We believe that this tax planning opportunity does not justify recognising a deferred tax asset. A tax planning opportunity to sell appreciated assets constitutes a subset of the broader source of future taxable profit from operations. So a deferred tax asset is not recognised where the tax planning opportunity appears merely to reduce an expected future loss. In the above case, (a) the entity has a history of losses, (b) the entity has an unproven new product line, and (c) the entity does not anticipate being profitable for at least three years. This means that little significance can be assigned to the projected profitability. Therefore, there is no incremental tax benefit (at least for the foreseeable future), because the potential gain on the sale of the shopping centre property would only reduce what is otherwise a larger operating loss.

Acquisition of a profitable entity Question: An entity that has incurred losses for many years proposes a tax planning opportunity to support its deferred tax asset related to unused tax losses. The entity will use a portion of the cash balances received from a recent public share offering to acquire an entity that generates significant taxable profits. Could such a tax planning opportunity be considered to recognise the deferred tax asset? Solution: No. We believe that a proposed business combination and the accompanying availability of sufficient taxable profits should not be anticipated for the purpose of supporting a deferred tax asset. The acquirer needs the co-operation of others to make the tax planning opportunity effective, until the point at which the acquisition of the entity is irrevocable and there are no further statutory or regulatory impediments. That is, the acquirer does not control an essential part of the tax planning opportunity (the target entity). It would not be appropriate to use future taxable profits in the target entity to support recognising the acquirer’s tax losses, because the target entity does not form part of the group holding the tax losses, and it will not do so until the business combination occurs. As a result, the tax effects of an event such as the acquisition of an entity should not be recognised before the event has occurred. The acquirer can recognise a deferred tax asset as a credit to the tax charge once the acquisition has taken place.

Unused tax losses in an acquiree Entity B has unrecognised deferred tax assets related to unused tax losses. Entity C bought entity B in December 20X3. Entity C’s management intends to integrate entity B’s operations into entity C in the first quarter of 20X4, to take advantage of the tax losses. Entity C has a track record of generating taxable profits; and management expects this to continue for the foreseeable future. Management should recognise a deferred tax asset in respect of the unused tax losses in the consolidated financial statements for the period ended 31 December 20X3, if it is probable that management will carry out the integration, and also that entity C will generate enough taxable profit to absorb entity B’s unused tax losses. This will affect the goodwill calculation in the consolidated financial statements. This contrasts with the situation in previous FAQ, since both the newly acquired entity holding the losses (entity B) and the profitable entity (entity C) are part of the same group at the balance sheet date.

A tax planning opportunity might bring taxable profit from a later period to an earlier period. A tax loss or tax credit carry-forward can only be utilized where there is future taxable profit from sources other than future originating temporary differences.

Available tax deduction exceeding the cost of the asset (‘super deductions’) – available over several periods – example The facts are as per previous FAQ, except the additional tax deduction is claimed evenly over three years, commencing when the assets are brought into use in 20X1. Year Carrying amount CU Tax base CU Temporary difference  CU  Unrecognised temporary difference  CU  Recognised temporary difference CU Deferred tax liability CU A B A – B = C D* C – D = E E × 30% 20X0 80,000 120,000 (40,000) (40,000) – – 20X1 60,000 80,000 (20,000) (26,667) 6,667 2,000 20X2 40,000 40,000 – (13,333) 13,333 4,000 20X3 20,000 – (20,000) – 20,000 6,000 20X4 – – – – – – * The unrecognised temporary difference reflects the proportion of the additional tax deduction not yet claimed. The additional tax deduction is allowed over several periods, resulting in the reversal of the temporary difference that is subject to the initial recognition exception over time. This reduces the effective tax rate evenly throughout the period over which the tax deductions are realised.

Acquisition of investment property At the time of acquisition of an investment property, an entity should determine whether the acquisition is considered to be the acquisition of a single asset, or whether it is considered to be a business combination as defined in accordance with IFRS 3. The acquisition of a single asset is a transaction to which the initial recognition exception would generally apply and, if so, no deferred tax would be recognised for any taxable temporary difference at the date of acquisition. Conversely, the acquisition of assets in a business combination does not attract the initial recognition exception and, therefore, deferred tax would be recognised on any taxable temporary differences arising at the date of acquisition. In determining whether the acquisition of an investment property is a business combination, an entity should refer to the guidance in IAS 40. The deferred tax accounting for the acquisition will automatically follow the accounting determination as to whether the acquisition meets the definition of a business combination under IFRS 3; it is not an independent decision for the purposes of applying IAS 12.

Unused tax losses and unused tax credits

Trading losses

Tax losses that can be relieved against current tax liability for a previous year are recognized as assets. The tax relief is recoverable by a refund of the tax previously paid.

A deferred tax asset is recognized for the carry forward 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 utilized. Deferred tax assets cannot be recognized if it is not probable that taxable profits will be available against which deductible temporary differences, unused tax losses or unused tax credits can be utilized.

Entities are required to consider whether tax law restricts the sources of taxable profits available to utilize these deductible items. If tax law restricts the utilization of deductible temporary differences, unused tax losses, and unused tax credits to income of a specific type, the recognition of deferred tax assets is assessed in combination with deductible items of the appropriate type.

The criteria that should be considered, to determine whether a deferred tax asset in respect of unused tax losses or unused tax credits should be recognized, are:

• whether the entity has sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity;
• whether the entity will probably have taxable profits before the unused tax losses or unused tax credits will expire;
• whether the unused tax losses result from identifiable causes which are unlikely to recur; and
• whether there are tax planning opportunities available that will create taxable profit in the period in which the unused tax losses or unused tax credits can be utilized.

Convincing evidence that sufficient taxable profits will be available in the future is required to support the recognition of a deferred tax asset for losses carried forward where there are insufficient deferred tax liabilities.

This is because the existence of tax losses is strong evidence that future taxable profit might not be available. The amount of the deferred tax asset and the nature of the evidence supporting its recognition should be disclosed.

What is ‘convincing evidence’? There is no specific definition of ‘convincing evidence’. When an entity has a history of recent losses, management should exercise judgement to determine whether there is convincing evidence that sufficient taxable profit will be available against which tax losses and credits can be used. Tax losses with no expiry date may be more likely to be offset by future profits but the absence of an expiry date does not by itself provide convincing evidence that it is probable that sufficient taxable profits are available. It is not sufficient for an entity to simply discontinue making losses. Tax losses with short expiry dates should be subject to more critical review as there will be less time to generate sufficient profits before the losses expire. A forecast or budget in itself does not provide such convincing evidence. The forecast and the underlying assumptions used should be supported by reliable evidence and management should assess whether such evidence is convincing as required in IAS 12. In making this judgement, management should consider all relevant facts and circumstances and are expected to give more weight to evidence that is objectively verifiable than to evidence that is subjective. IAS 12 requires disclosure of the nature of evidence supporting the recognition of deferred tax assets in these circumstances. Management might consider the following factors when assessing whether its forecasts of taxable profit support the recognition of a deferred tax asset: Factors to consider when assessing whether a taxable profit forecast provides convincing other evidence that sufficient taxable profit will be available One off or nonrecurring items Is the history of recent losses a result of one off or non-recurring1 expenses, which if excluded, would result in a history of taxable profit? What is the evidence that these expenses are one off and will not recur? Have one off or non-recurring items of income recognised in prior periods been excluded from the taxable profit forecast? Strong earnings history Does the entity have a strong earnings history exclusive of the loss that created the unused tax losses? Is the history of recent losses as a result of losses arising from operations or activities that are expected to continue, for example low product demand or sales margins? If so, is there convincing objective evidence supporting any forecast turnaround? Accuracy of forecasting Does management have a robust forecasting process? If so, has management’s forecasting in the past been proven to be accurate/reliable or has it been prone to significant revision? Length of forecasting period Does recovery of the deferred tax asset require that management’s forecast cover a long period and, if so, what support exists for forecast profits in the later years? Unused tax losses and tax credits Has the entity historically been able to utilise carried forward tax losses and tax credits or is there evidence that losses and tax credits have lapsed unrecovered? Is the remaining carry forward period either indefinite or sufficiently long such that there might be less importance on which year or years the profit emerges? Sales contracts or firm commitments Is management’s forecast supported by the existence of legally binding contracts or firm sales backlog that will produce enough taxable profit to realise the deferred tax asset based on existing sales prices and cost structures? Have past sales backlogs actually been realised and therefore provide a reliable prediction of future sales? Have there been losses of major customers and/or significant contracts that cast doubt over the assumptions in management’s forecasts? Restructuring plan that will reduce costs Where costs are forecast to reduce as a result of a restructuring, has the restructuring been completed and is there recent actual data providing evidence that the forecast cost savings are achievable and sustainable? Where a forecast restructuring is based on a committed and approved plan, has the plan been fully costed and what evidence exists to support that the cost savings are achievable/sustainable and/or that the restructuring is not likely to affect future revenues/sales? Is there a history of restructuring without returning into profitability or emerging from a bankruptcy?   Acquisition and disposals Where profits from the acquisition of a business are included in the forecast, is this based on a transaction that has been completed? How has management assessed the accuracy of the acquiree’s profit forecasts? Have transaction costs and issues arising from due diligence been considered and reflected in the forecasts? Where the disposal of an unprofitable business is forecast, is this based on a transaction to which management is committed and for which the buyer has been identified? Where a disposal of valuable asset that has appreciated in value is forecast, is the asset readily saleable in an active market or is the asset bespoke and the forecast disposal based on a transaction to which management is committed and for which the buyer has been identified? Losses expected in the near term Are additional losses expected in the near term (for example because the entity is in start-up phase)? If so how are the forecast profits in the later years being supported by objectively verifiable data given it remains unknown whether the business activities will succeed and generate taxable profit? If the entity has recently begun operations and has a limited trading history how is it able to demonstrate that there is convincing objective evidence that it will be profitable? Convincing evidence would generally be more more than business plans or projections and would require for example: evidence in the form of a signed contract that ensures future revenues. Are there uncertainties such as a significant contingent liability that if unfavourably resolved would adversely affect future operations and profit levels on a recurring basis in future years? Is there uncertainty regarding going concern (for example due to liquidity problems)? New business opportunites Do new business opportunities that have been forecast depend on future market conditions that are outside the control of the entity? Are new business opportunities that have been forecast consistent with previously communicated strategies? Are new business opportunities that have been forecast supported by the registration of new patents/ received the necessary regulatory approvals? Convincing tax planning strategies Are the actions foreseen realistic, tax profitable and consistent with the entity’s business strategy? Have the forecast taxable profits been based on tax laws that have been substantively enacted and not those that are expected to be enacted? 1Examples of non-recurring expenses/losses might include a significant and unusual lawsuit; loss on disposal of a subsidiary where divestment is infrequent.

Tax legislation might prescribe a specific duration in which the tax losses or tax credits can be utilized. So it is essential to consider the availability of taxable profits before unused tax losses or unused tax credits expire.

Tax losses might result from identifiable causes. If those losses are likely to recur, it is unlikely that a deferred tax asset can be recognized.

Period of time to be considered for assessment of future taxable profits It might be difficult to place significant reliance on internal management projections where an entity has a limited record of profits in recent years. The entity will need to develop projections on which to measure the recoverable deferred tax asset if the future taxable profits are nonetheless considered probable. Projections become more subjective, the greater the period that is considered for sufficient taxable profits. One approach is to project income into the future, using the average annual income for a past period. However, this approach would ultimately need to be reconciled with the requirement to assess the probable future taxable profits. There should be no arbitrary cut-off in the time period over which an assessment of expected taxable profits is made (for example, the recoverability test should not be limited, using an arbitrary look-out  period, solely because budget information is not available after a certain number of years). Does the entity operate in a sector with a history of volatility in earnings and does the forecast factor in similar volatility in the future? The assessment should be broadly consistent with the assumptions used in other financial statement estimates for elements that are comparable, for example impairment testing, allowing for adjustments for the different time-frame (if the tax losses have expiry dates) and the different methods applied to other elements. Different methods include: Discounting (applied in IAS 36 but not IAS 12). Reflecting the risk/uncertainty inherent in the future in expected future taxable profits (IAS 12) rather than reflecting risk/uncertainty in the discount rate (IAS 36). Differences between a taxable reporting entity (IAS 12) and the cash generating unit (IAS 36). Taxable profit including the impact of future asset improvements under IAS 12 versus cash flows (IAS 36), and the impact of finance cost. It could be argued that the probability of taxable profits decreases over time; so there could be a point when taxable profits are no longer probable. Reliability might decrease the further out into the future the forecast extends as there is a greater risk of unforeseen events and circumstances outside of the entity’s control. (Entities should exercise caution when their planning period for deferred tax asset recognition purposes exceeds their normal planning cycle.) The longer the estimates/forecasts extend into the future the less reliable they are and therefore, entities should exercise caution when assessing the weight of positive and negative evidence. However, we consider that management should not generally assume, without specific facts (for example, significant contracts or patent rights terminating at a specific date), that no taxable profits are probable after a specified date. The calculation should include the maximum taxable profits that are more probable than not until the expiry of tax losses. This could result in lower estimates for years in the distant future, but it does not mean that those years should not be considered. Another issue is whether a limited look-out period might be acceptable for industries that historically have profit- and loss-making cycles. Management should not generally assume that the entity will not make taxable profits after a limited number of years of industrial upturn, based on the arguments described above. The cyclical downturns should be considered in determining the ‘probable’ future cash flows, but they should not be used to introduce an arbitrary cut-off date for the recoverability test. This approach should not lead to recognising only the full or a nil deferred tax asset (that is, an ‘all or nothing’ approach). An assessment should be made of future taxable profits, looking forward, without an arbitrary or specified cut-off period. A deferred tax asset is recognised to the extent that it is probable that there will be future taxable profits. That is, the probability criterion for recognising deferred tax assets should typically be applied to portions of the total amount of unused tax losses, and not just to the amount of unused tax losses taken as a whole. This is consistent with discussions by the IFRS IC that were finalised in June 2005.

Effect of going concern uncertainty on recognition of deferred tax asset Disclosure is required where management concludes that there is uncertainty regarding an entity’s ability to continue as a going concern for a reasonable period of time. The inclusion of such disclosure constitutes significant unfavourable evidence under IAS 12. Material uncertainties cast doubts on the entity’s ability to continue as a going concern; for example, liquidity problems will generally suggest that a deferred tax asset is not recoverable. In such circumstances, recognising all or a portion of a deferred tax asset would generally not be justified, unless realisation is assured by either (a) carry-back to prior tax years, or (b) reversals of existing taxable temporary differences. But there could be circumstances where the cause of the going concern uncertainty is not directly related to the entity’s profitability (for example, uncertainty about the renewal of an operating licence). In these situations, it might be appropriate to recognise a deferred tax asset, provided that it is probable that future taxable profits will be available. The specific facts and circumstances giving rise to the uncertainty should be considered in determining whether a deferred tax asset is recoverable. The absence of significant uncertainty regarding an entity’s ability to continue as a going concern does not, by itself, constitute favourable evidence that deferred tax assets will be realised.

Management can consider tax planning opportunities that could be undertaken in determining the entity’s future taxable profits to support the recognition of a deferred tax asset for tax losses.

A restructuring or exit plan is an ordinary part of running a business and therefore not a tax planning strategy. Such a plan might, however, be considered in the assessment of whether taxable profits will be available in future periods, depending on the likelihood of implementing the plan and its expected success.

Strategy to implement an exit plan Is the forecast consistent with relevant industry data/trends? An entity has a history of recent losses. Management has developed an exit plan in which a loss-making activity will be discontinued. Management intends to implement the measures from March 20X4. The current date is January 20X4 and the plan has not yet been made public. Management expects to return to profitability over the two years following the implementation of the exit plan, and it proposes to recognise a deferred tax asset in respect of the losses in the 31 December 20X3 financial statements, using the exit plan to justify the recognition of the deferred tax asset. A deferred tax asset should be recognised in respect of the losses to the extent that it is probable that future taxable profits will be available against which the unused tax losses can be utilised. The probability of future taxable profits should be assessed based on circumstances as at the balance sheet date. The following factors should be considered: The probability that management will implement the plan. Management’s ability to implement the plan (for example, obtaining concessions from labour unions or regulatory approval). The level of detailed analysis and sensitivity analysis that management has prepared. Judgement will be required to establish whether it is probable that the exit plan will go ahead and that taxable profits will be earned. It could be difficult to argue that it is more likely than not that the exit plan will be implemented if, at the balance sheet date, management has not finalised its decision to sell. In some cases, management will also need to assess the probability of the disposal at the balance sheet date for the purposes of IFRS 5. The fact that the disposal is considered ‘highly probable’ for the purposes of IFRS 5, and that a taxable profit is expected on the disposal, would strongly indicate that a deferred tax asset should be recognised in respect of the previously unrecognised losses.

Capital losses

Some jurisdictions have different tax rules for ‘ordinary’ and ‘capital’ income and losses. A ‘capital’ gain or loss would be defined by the relevant jurisdiction and often relates to a gain or loss incurred when a non-trading asset (for example, property plant and equipment or intangibles) is sold. The offset rules in tax legislation might mean that capital losses cannot be offset against trading profits.

A deferred tax asset for capital losses, or a deductible temporary difference for unrealized capital losses, will be recognized only if it can be offset against recognized deferred tax liabilities on unrealized capital gains, or there is convincing evidence that it will be recoverable against capital gains that are expected to arise in the future.

Capital gains might arise in the future as a result of temporary differences in existence at the balance sheet date, from generating future taxable profits, or through tax planning opportunities.

Re-assessment of recoverability

A deferred tax asset’s carrying amount should be reviewed at each balance sheet date. Management should assess whether a deferred tax asset recognized in the balance sheet is still recoverable. For example, an entity might have recognized a deferred tax asset in respect of tax losses in a previous period, based on information available at that time.

Circumstances might change so that it is no longer probable that sufficient future taxable profits will be available to absorb all of the tax benefits. The carrying amount of the asset should be reduced to the extent that it is not probable that sufficient taxable profits will be available.

If circumstances giving rise to the previous write-down no longer apply, or sufficient future taxable profits will probably be available, the reduction should be reversed.

Management should also consider at each balance sheet date whether some or all of an unrecognized deferred tax asset should now be recognized. For example, an improvement in trading conditions or the acquisition of a new subsidiary might make it probable that a previously unrecognized tax loss in the acquiring entity will be recovered.

The recognition of a previously unrecognized deferred tax asset is a change in estimate that should be reflected in the results for the year under IAS 8.

Exceptions to the Recognition Principles

Deferred tax liabilities and deferred tax assets (subject to the availability of future taxable profits) should be recognized for all temporary differences, subject to certain exceptions. The specific situations are:

• Initial recognition of goodwill arising in a business combination (for deferred tax liabilities only).
• Initial recognition of an asset or liability in a transaction that is not a business combination and does not affect accounting profit or taxable profit.
• Investments in subsidiaries, branches, associates, and joint ventures, but only where specified criteria apply

Taxable temporary difference on goodwill arising in a business combination

Goodwill arising from a business combination that is nondeductible for tax purposes has a tax base of nil. Reductions in the carrying amount of the goodwill for impairment are not allowed as a deductible expense in determining taxable profits, and the cost of the goodwill is not deductible when the subsidiary is sold.

Any difference between the carrying amount of the goodwill and its tax base of nil gives rise to a taxable temporary difference; this would usually result in a deferred tax liability.

IAS 12 does not permit recognition of this deferred tax liability. Goodwill is measured as a residual, and recognition of the deferred tax liability would increase the carrying amount of the goodwill.

The amount of the unrecognized taxable temporary difference (and the unrecognized deferred tax liability) on goodwill is reduced when an entity recognizes an impairment loss on the goodwill that is not tax deductible. This decrease in the value of the unrecognized deferred tax liability also relates to the initial recognition of the goodwill and is not recognized.

A taxable temporary difference and a deferred tax liability should be recognized where the goodwill arising in a business combination is deductible for tax purposes.

A deferred tax asset arising from a deductible temporary difference that results from the initial recognition of goodwill arising on a business combination is recognized to the extent that it is probable that sufficient future taxable profits will be available. The initial recognition exception does not apply in this case.

The deferred tax asset reduces, rather than increases, goodwill. The accounting for a deferred tax asset reflects the tax deduction that will be obtained in future periods.

An iterative process is required, to arrive at the carrying amount of the goodwill and deferred tax asset. This is because recognition of the deferred tax asset reduces the carrying value of the goodwill which, in turn, increases the deferred tax asset.

Initial recognition of an asset or liability

A deferred tax asset or liability is not recognized in respect of a temporary difference that arises on initial recognition of an asset or liability, in a transaction that is not a business combination, and the recognition does not affect accounting profit or taxable profit at the time of the transaction.

Initial recognition: cost of an asset is not deductible for tax purposes An entity acquired an intangible asset (a licence) for C100,000 that has a life of five years. The asset will be solely recovered through use. No tax deductions can be claimed as the licence is amortised or when the licence expires. No tax deductions are available on disposal. Trading profits from using the licence will be taxed at 30%. The tax base of the asset is nil, because the cost of the intangible asset is not deductible for tax purposes (either in use or on disposal). A temporary difference of C100,000 arises; prima facie a deferred tax liability of C30,000 should be recognised on this amount. However, no deferred tax is recognised on the asset’s initial recognition. This is because the temporary difference did not arise from a business combination and did not affect accounting or taxable profit at the time of the recognition. The asset will have a carrying amount of C80,000 at the end of year 1. The entity will pay tax of C24,000 through recovery of the asset by earning taxable amounts of C80,000. The deferred tax liability is not recognised, because it arises from initial recognition of an asset. Similarly, no deferred tax is recognised in later periods. It might appear imprudent not to recognise the deferred tax liability in these circumstances. However, this can be understood because the price paid by the entity in an arm’s length transaction would reflect the asset’s non-deductibility for tax purposes. It would not be appropriate to recognise a loss on the date of purchase. The above exception does not apply where the intangible asset was acquired in a business combination. The recognition of a deferred tax liability on acquisition increases goodwill, and it does not result in overstating the asset’s cost or recognising an expense.

Initial recognition: a proportion of the asset’s cost is deductible for tax purposes, and book and tax depreciation rates are different An asset might be depreciated at different rates for accounting and tax purposes. In such cases, we believe that the accounting depreciation should be allocated pro rata between the deductible and non-deductible portions of the asset. An entity acquired an asset for C120,000, which it expects to recover solely through use in the business. For tax purposes, only 60% of the asset is deductible when the asset’s carrying amount is recovered through use. The asset is depreciated at 25% for accounting purposes and 33⅓% per annum for tax purposes. The tax rate is 30%. Carrying amount Tax base Temporary difference Unrecognised temporary difference Recognised temporary difference Deferred tax C C C C C C On initial recognition 120,000 72,000 48,000 48,000 – – Book/tax depreciation 30,000 24,000 End of year 1 90,000 48,000 42,000 36,000 6,000 1,800 Book/tax depreciation 30,000 24,000 End of year 2 60,000 24,000 36,000 24,000 12,000 3,600 Book/tax depreciation 30,000 24,000 End of year 3 30,000 nil 30,000 12,000 18,000 5,400 Book/tax depreciation 30,000 – (18,000) (5,400) End of year 4 nil nil nil nil The asset’s carrying amount of C120,000 exceeds the tax base of C72,000; this gives a taxable temporary difference of C48,000. This amount is covered by the initial recognition exception (IRE), so no deferred tax is recognised. The asset is consumed at a rate of 25% per year (C30,000 accounting depreciation). So the amount of depreciation that relates to the temporary difference of C48,000 is C12,000 (48,000 × 25%). This amount is treated as a reversal of the temporary difference covered by the IRE. In addition, there is a new originating taxable temporary difference of C6,000. This results from the difference in depreciation rates used for book and tax – that is, between the remaining book depreciation (C18,000) and the tax deductions (C24,000). In summary, the overall reduction of C6,000 in the temporary difference comprises: Reversal of part of the temporary difference covered by the IRE (12,000) New originating temporary difference 6,000 Overall reduction in temporary difference (6,000) The same result is obtained by carrying out the analysis on the basis that the entity has acquired two assets. No deferred tax is recognised on the part of the asset costing C48,000 with a tax base of nil, because it arises on initial recognition. The other part of the asset costing C72,000 is subject to deferred tax accounting. The carrying amount of this part of the asset is C54,000 (after book depreciation of C18,000) at the end of year 1. The tax base is C48,000 (after tax depreciation of C24,000). The entity will have to earn taxable income of C54,000 to recover the carrying amount of C54,000, but it will only be able to deduct tax depreciation of C48,000. The difference between the carrying amount of C54,000 and the tax base of C48,000 gives rise to a taxable temporary difference of C6,000. The entity recognises a deferred tax liability of C1,800 (C6,000 @ 30%), representing the tax that it would pay when it recovers the asset’s carrying amount. Similar reasoning applies in years 2 and 3. Any deferred tax liability is reversed when the asset is fully depreciated at the end of year 4.

Initial recognition: subsequent revaluation of an asset An entity acquired an asset for C120,000, which it expects to recover solely through use in the business. For tax purposes, only 60% of the asset is deductible when the asset’s carrying amount is recovered through use. The asset is depreciated for both tax and accounting purposes at 25% per annum. The tax rate is 30%. Further, the asset is revalued to C100,000 at the beginning of year 3. Carrying amount Tax base Temporary difference Unrecognised temporary difference Recognised temporary difference Deferred tax @ 30% C C C C C C On initial recognition 120,000 72,000 48,000 48,000 – – Book/tax depreciation 30,000 18,000 End of year 1 90,000   54,000   36,000   36,000 – – Book/tax depreciation 30,000 18,000 End of year 2 60,000 36,000 24,000 24,000 – – Revaluation at beginning of year 3 40,000 100,000 36,000 64,000 24,000 40,000 12,000 Book/tax depreciation 50,000 18,000 End of year 3 50,000 18,000 32,000 12,000 20,000 6,000 Book/tax depreciation 50,000 18,000 (20,000) (6,000) End of year 4 nil nil – – nil nil No deferred tax is recognised on the initial temporary difference of C48,000 or in years 1 and 2. The asset is revalued to C100,000 at the beginning of year 3, but the asset’s tax base is C36,000. This gives rise to a temporary difference of C64,000. Only C24,000 of this amount arises on initial recognition. The remaining C40,000 arises on the asset’s subsequent revaluation. A deferred tax of C12,000 (C40,000 @ 30%) should be provided on this amount. The deferred tax liability that arises on the asset’s revaluation is recognised in the revaluation reserve. Half of the temporary difference reverses by the end of year 3, and this results in a corresponding reduction in the deferred tax liability to C6,000. The remaining temporary difference reverses when the asset is fully depreciated in year 4.

Initial recognition: deferred tax asset arising on initial recognition An example of a deferred tax asset that arises on an asset’s initial recognition is where an entity constructs a building costing C1 million in an enterprise zone that attracts 150% tax-deductible allowances on that building. The asset’s tax base on initial recognition is C1.5 million. The difference between the carrying amount of C1 million and the tax base of C1.5 million gives rise to a deductible temporary difference of C0.5 million, that would reduce future tax payable as the asset is recovered through use. IAS 12 does not permit a deferred tax asset to be recognised for the origination or reversal of such temporary difference. The resulting deferred tax asset is not immediately recognised in profit or loss. This approach would not allocate the tax income over the asset’s life. The deferred tax income is not deducted from the asset’s cost. It would be difficult to assess whether the consideration paid for the asset takes into account the tax treatment applied by the tax authorities.

Subsequent changes in an unrecognized deferred tax liability or asset

An entity has an unrecognized deferred tax liability or asset where the initial recognition exemption applies. The entity only reconsiders the recognition of a deferred tax asset or liability when there is a new temporary difference to be considered. The general principle is that deferred tax accounting should reflect changes in the underlying economics. The temporary difference in initial recognition arises because one element (carrying amount or tax base) exceeds the other.

An increase in this excess amount (that is, an increase of the larger element or a reduction of the smaller element) is treated as a new temporary difference; and deferred tax is recognized (subject to the criteria for deferred tax assets in IAS 12). However a reduction of this excess amount (due to a decrease in the larger element) is treated as a reversal of the unrecognized temporary difference, and no deferred tax arises.

For example, depreciation or amortization of an asset does not result in a new temporary difference that would give rise to deferred tax. The situation is more complex where a subsequent change increases the smaller element (and so reduces the temporary difference), and there might be diversity in practice.

Downwards accounting revaluation The facts are: Carrying amount Tax base Temporary difference Unrecognised temporary difference Recognised temporary difference Deferred tax liability/(asset)@ 30% C C C C C C Initial recognition 100,000 90,000 10,000 10,000 – – Devaluation (30,000) – (30,000) (3,000) (27,000) (8,100) 70,000 90,000 (20,000) 7,000 (27,000) (8,100) The accounting devaluation is similar to depreciation, and it reduces the asset’s carrying amount. The amount of devaluation that relates to the temporary difference of C10,000 is C3,000. This amount is treated as a reversal of the temporary difference covered by the initial recognition exception. The remaining devaluation of C27,000 is treated as a new deductible temporary difference; a deferred tax asset is recognised on this amount (provided that it meets the recognition criteria).

Upward accounting revaluation The facts are: Carrying amount Tax base Temporary difference Unrecognised temporary difference Recognised temporary difference Deferred tax liability/(asset)@ 30% C C C C C C Initial recognition 100,000 90,000 10,000 10,000 – – Revaluation gain 30,000 – 30,000 – 30,000 9,000 130,000 90,000 40,000 10,000 30,000 9,000 The revaluation of C30,000 increases the asset’s carrying amount and the temporary difference. This results in a new taxable temporary difference on which a deferred tax liability is recognised.

Tax devaluation The facts are: Carrying amount Tax base Temporary difference Unrecognised temporary difference Recognised temporary difference Deferred tax liability/(asset)@ 30% C C C C C C Initial recognition 100,000 90,000 10,000 10,000 – – Devaluation 30,000 – 30,000 – 30,000 9,000 100,000 60,000 40,000 10,000 30,000 9,000 The change of C30,000 reduces the asset’s tax base and increases the temporary difference. This represents a new taxable temporary difference on which a deferred tax liability is recognised.

Upward accounting revaluation The facts are: Carrying amount Tax base Temporary difference Unrecognised temporary difference Recognised temporary difference Deferred tax liability/(asset)@ 30% C C C C C C Initial recognition 90,000 100,000 (10,000) (10,000) – – Revaluation gain 30,000 – 30,000 – 30,000 9,000 120,000 100,000 20,000 (10,000) 30,000 9,000 The change of C30,000 reduces the deductible temporary difference (and changes it to a taxable temporary difference). But this is because of an increase in the carrying amount rather than a reduction in the tax base that gave rise to the unrecognised temporary difference. So, under the general principle, the C30,000 represents a new taxable temporary difference on which a deferred tax liability is recognised. There is an alternative acceptable view: an increase in the smaller component (that is, the asset’s carrying amount) reduces the previously unrecognised temporary difference. Under this view, C10,000 is a reversal of the temporary difference covered by the initial recognition exception. The remaining C20,000 is treated as a new taxable temporary difference.

Measurement of deferred taxes

Deferred tax is measured at the tax rates that are expected to apply when the asset is realized or the liability is settled. The tax rates are based on laws that have been enacted or substantively enacted at the balance sheet date.

Realizing an asset or settling a liability could take many years. An entity uses the rate that has been enacted or substantively enacted by the balance sheet date because tax rates are not usually known in advance. ‘Enacted’ means that the rate is part of tax law.

Accounting for changes in tax rates Question: How should changes in tax rates be considered in recognising deferred taxes? Solution: An entity’s tax rate might change as a result of new legislation. The impact of changes in rates depends on the nature and timing of the legislative changes. Any impact is recognised in accounting periods ending on or after the date of substantive enactment (and might be disclosable before that date). Changes in tax rates are often prospective, so there might be no impact on current tax assets and liabilities that arose before the change’s effective date. However, deferred tax balances are likely to be affected. This is because deferred tax assets and liabilities are required to be measured at the tax rates that are expected to apply to the period in which the asset is realised or the liability is settled. The impact of this reduction in tax rate might affect profit or loss, or other comprehensive income or equity. The change in tax rate might also require disclosure as a non-adjusting post-balance sheet event in accordance with IAS 10.

Change in tax rates A change in tax rate from 30% to 28% was substantively enacted on 26 June 20X7, with effect from 1 April 20X8. The change has no impact on current tax liabilities arising before its effective date. But the measurement of deferred tax assets and liabilities will be affected for accounting periods (including interim periods) ending on or after 26 June 20X7. Management needs to determine when the deferred tax balance is expected to reverse and what tax rate will apply in the reversal period. The reduction in tax rate will not affect deferred tax that is expected to reverse before 1 April 20X8, but it will affect later reversals. This will be complex for entities with a financial year that straddles 1 April 20X8. They will need to calculate an effective tax rate for reversals in the financial year in which the change takes effect.

Average rates

Management normally needs to calculate an average tax rate only if the enacted or substantively enacted tax rates are graduated (that is if different rates apply to different levels of taxable income). The average rate is the rate expected to apply to taxable profit (or loss) in the years in which management expects the temporary differences to reverse.

For example, the first C5 million of profit is taxed at 20%, and profit above that is taxed at 30%. Management needs to estimate the average rate at which it expects to earn an annual taxable profit of over C5 million in the future. Management determines the rate (which would be between 20% and 30%) by estimating future annual taxable profits, including reversing temporary differences. It is not usually necessary, in practice, to determine the net reversals of temporary differences for deferred tax assets and liabilities.

However, management should consider the effect of an abnormal level of taxable profit or any abnormally large temporary difference that could reverse in a single future year and distort the average rate.

Different tax rates applicable to different levels of income An entity operates in a country where different rates apply to different levels of taxable income. The net deductible temporary differences total C30,000 at 31 December 20X7. The temporary differences are expected to reverse over the next seven years. The average projected profit for the next seven years is C60,000. A deductible temporary difference relating to impairment of trade receivables of C25,000 is expected to fully reverse in 20X9, when the related expense will be deductible for tax purposes. The taxable profit for 20X9 will be C35,000 (that is, C60,000 – C25,000). The reversal of this large temporary difference will distort the average tax rate; so management should consider the impact of this separately when calculating the average rate that it will use for deferred tax assets and liabilities. An example of the calculation of the deferred tax assets and liabilities, assuming graduated tax rates, is: Range Tax Rate Profit Average Income tax Profit Year 20X9 Income C % C C C C 0 – 1,000 18 1,000 180 1,000 180 1,001 – 11,000 25 10,000 2,500 10,000 2,500 11,001 – 36,000 30 25,000 7,500 24,000 7,200 36,001 + 40 24,000 9,600 – – 60,000 19,780 35,000 9,880 Average rate 33% 28% Management uses a 28% tax rate in the 20X7 financial statements for the deferred tax asset relating to impairment of trade receivables; it uses a 33% rate for the remaining temporary differences.

The requirement to calculate an average tax rate applies to different levels of profit, but it is not used for different rates that are expected to apply to different types of taxable profit or in different tax jurisdictions. The rate used will reflect the nature of the temporary difference if different rates apply to different types of taxable profit (for example, trading profits and capital gains).

The rates used for measuring deferred tax arising in a specific tax jurisdiction will be the rates expected to apply in that jurisdiction. Management should consider tax in countries where state or provincial tax systems apply. Management should apply the appropriate rates for each state or province to the transactions in those states or provinces, and not an average rate for the country.

Expected manner of recovery or settlement of an asset or a liability

Entities should measure deferred tax assets and liabilities using the tax bases and tax rates that are consistent with how the entity expects, at the balance sheet date, to recover or settle the carrying amount of assets and liabilities. The tax consequences of recovering or settling the carrying amount of assets and liabilities might depend on how the asset is recovered or the liability is settled.

The tax base might be different depending on how the asset or liability is recovered or settled. The carrying amount of an asset is normally recovered through use, sale, or use and sale. The cumulative amount that is deducted for tax purposes if the asset is recovered through use might be different from the amount that would be deductible on the asset’s sale (for example, because of indexing the cost).

Expected manner of recovery based on use A parent entity acquired a subsidiary that owned a plant. The fair value of the plant was C10 million and it will be depreciated over 10 years to its residual value of nil. The accounting depreciation of C1 million charged in year 1 and later years is not deductible for tax purposes. The plant will be fully consumed, and it will have to be scrapped if the plant is used in the business for its full 10-year life. No tax deductions will be available for scrapping the asset. The cost of the asset to the subsidiary of, say, C8 million (after adjusting for inflation) is deductible on sale if the asset is sold. The tax rate is 30% for income and 25% for capital gains. The tax base is not immediately apparent in this example. It could be nil, if the asset is to be used; or it could be C8 million, if the asset is to be sold. Management needs to consider how it expects to recover the asset’s carrying amount. Management will use the plant for carrying out its business (supported by the fact that the asset is being depreciated to a nil residual value). The plant’s full carrying amount is expected to be recovered through use; and there are no tax consequences of scrapping the asset at the end of its life. The tax base that is consistent with the expected manner of recovery through use is nil. This is because no part of the carrying amount is deductible for tax purposes against the future economic benefits expected to flow from the plant’s use. A temporary difference arises of C10 million, which is the difference between the carrying amount on initial recognition and the tax base of nil. This temporary difference reduces to C9 million, because part of the carrying amount is recovered through depreciation in year 1. Management would provide a deferred tax liability of C3 million at the income tax rate of 30% on the date of the business combination. This deferred tax liability will have reduced to C2.7 million at the balance sheet date.

Different tax rates apply in some jurisdictions, depending on how the asset or liability is recovered or settled, such as a different rate for income and capital gains.

For example, an entity that expects to sell an asset should measure the related deferred tax liability at the capital gains rate if the transaction would be subject only to capital gains tax.

However, an entity that expects to retain the asset and recover its carrying amount through use should measure the deferred tax at the rate applicable to taxable income.

Single asset held within a corporate wrapper A group might hold a single asset within a corporate entity (or ‘corporate wrapper’), and it might expect to ultimately ‘recover’ the asset by selling the investment in the corporate entity. In our view, management should determine the asset’s expected manner of recovery (for the purpose of calculating the related deferred tax) on the basis of the asset’s recovery within the corporate entity, and not by reference to the expected manner of recovery of the investment in the corporate entity. This applies even where the group expects to recover its investment in the corporate entity without an impact on taxable profit (or with a lesser impact than from selling the asset itself). Deferred tax is recognised on temporary differences, and a temporary difference is defined as the difference between an asset’s carrying amount and its tax base. As it is the asset itself that is recognised in the group’s balance sheet (as opposed to the investment in the corporate entity in which the asset resides), the relevant tax base is that of the asset, and not that of the investment. There is debate over this approach to deferred tax accounting where corporate wrappers are used. This issue was referred to the IC in 2014, which noted that several concerns were raised with respect to the current requirements in IAS 12. However, analysing and assessing these concerns would require a broader project than the IC could perform on behalf of the IASB. Consequently, the IC decided not to take the issue onto its agenda, but it decided instead to recommend to the IASB that it should analyse and assess these concerns in its research project on income taxes.

Dual manner of recovery

An entity might plan to use an asset for several years and then sell it. The deferred tax should reflect this expected ‘dual manner of recovery’. Any deferred tax is recognized, based on normal income tax rules, for the portion of the asset’s carrying amount that is expected to be recovered through use; and it is recognized, using disposal tax rules, for the remainder of the asset’s carrying amount that is expected to be recovered through the sale.

Applicability of dual manner of recovery Assets, such as properties and intangible assets, will often be expected to have a ‘dual manner of recovery’. A residual value might indicate that the dual manner of recovery is applicable. The dual manner of recovery could still apply, even where there is no residual value – for example, where the asset is expected to be disposed of or abandoned (either during or at the end of its useful life) in order to recover any tax base available on disposal or abandonment. This might affect properties or intangibles with nil residual values or other types of assets such as mining assets. An asset with a nil residual value might appear to be recovered solely through use. However, it is likely that management will take the commercial decision to sell the asset at the end of its useful life, if this would recover the asset’s tax base. Proceeds are likely to be low (because the asset is at the end of its life); but the asset’s cost or indexed cost might be tax deductible and, therefore, the sale could generate a significant capital loss. A dual manner of recovery expectation would apply where there is a valid expectation that management would sell the asset.

Computing deferred tax where a dual manner of recovery applies Where a dual manner of recovery expectation applies, deferred tax is calculated as follows: Ascertain the expected manner of recovery of the asset’s carrying amount. For instance, depreciable assets (such as buildings) are expected to be held during their useful life, and a portion of the carrying amount is recovered through use. The residual amount (which might be nil) is recovered through a disposal at the end of the useful life. Land is not depreciable and it can only be recovered through ultimate disposal. Split the asset’s carrying amount between amounts to be recovered through use and through sale. The split might be based on the residual value determined for the purpose of depreciation under the cost model of IAS 16 or IAS 38. This residual value is the estimated value (in present prices at the balance sheet date) of the relevant asset in its expected state at the end of its useful life. But the split could arguably be based on a residual value measured on the same price basis as the carrying amount (that is, based on prices ruling at the date when the asset was acquired). Under the revaluation model in IAS 16, the residual value is likely to be measured on the same price basis as the carrying amount. Determine the expected period of recovery through use and the expected date of sale or abandonment. The expected period of recovery through use, for depreciable assets that are accounted for under the cost or revaluation model, is normally the asset’s useful life, as defined in IAS 16 or IAS 38. Determine the tax consequences of recovery through use and the temporary differences that will arise. The future taxable amount will be the portion of the carrying amount expected to be recovered through use. The tax consequences of recovering this amount through the receipt of operating income (that is, through use) are determined by considering any deductions available during the period of recovery. In a simple situation, this might mean just deducting the expected tax depreciation allowances (if any) from the amount expected to be recovered through use, to determine the resulting temporary difference. If an asset is expected to be recovered through use without any disposal, it might also be necessary to consider any capital gains tax consequences of abandoning the asset and any resulting temporary differences. If an asset is expected to be held and used for a period before disposal, it might be necessary to consider the income tax consequences of the disposal; these could affect tax depreciation allowances relating to the carrying amount that is expected to be recovered through use (for example, claw backs of, or additional, tax depreciation allowances based on the disposal proceeds, where applicable). Determine the tax consequences of recovery through sale and the temporary differences that will arise. The future taxable amount will be the portion of the carrying amount expected to be recovered through disposal. This will be the residual value or adjusted residual value (see the second bullet point above). The tax consequences will be the taxable gain arising on such disposal. Determine which of the temporary differences arising from recovery through use and through sale should be recognised. The temporary differences arising from the analysis in the above two steps should be considered separately (rather than determining a net temporary difference) where the tax liability (or asset) arising from use and the tax asset (or liability) arising from sale could not be offset. Such offset might not be possible where the amounts are taxed in a different manner (for example, if income tax losses cannot be fully offset against capital gains), or where they are taxed at a different time (for example, it might not be possible to offset a tax loss arising on the reversal of a deductible temporary difference against taxable income arising from the earlier reversal of a taxable temporary difference).

Impact of expected manner of recovery and residual values An entity acquired a property during a business combination before transition to IFRS. The total fair value on acquisition of the property was C3.5 million (that is, ‘cost’ to the entity); this was split between land of C1 million and buildings of C2.5 million. The property was revalued on transition to IFRS. A revaluation uplift of C2 million was recognised, and the revalued amount of C5.5 million is used as deemed cost. C0.8 million of this revaluation uplift related to the land element, and C1.2 million to the building element. There are no tax deductions for use, but the total cost (plus an adjustment for inflation) is deductible on sale. The tax rate is 30% throughout. Deferred tax on the land is calculated on a sale basis; but the expected manner of recovery for the buildings will have a significant impact on deferred tax. Expected manner of recovery based on use If the use basis alone is appropriate for the buildings: Land Buildings (use) C’000 C’000 Carrying amount 1,800 3,700 Tax base Cost 1,000 – Inflation adjustment (say) 200 – Total tax base 1,200 – Temporary difference – liability 600 3,700 The entity recognises a deferred tax liability on the land for the taxable temporary difference of C0.6 million, and a deferred tax liability on the buildings for the taxable temporary difference of C3.7 million, resulting in a total taxable temporary difference of C4.3 million @ 30%, giving a total deferred tax liability of C1.29 million. Dual manner of recovery with a residual value If a dual manner of recovery is appropriate for the buildings: Assume that C1.8 million of the buildings will be recovered through sale (residual value) and C1.9 million through use. Land Buildings (sale) Buildings (use) C’000 C’000 C’000 Carrying amount 1,800 1,800 1,900 Tax base Cost 1,000 2,500 – Inflation adjustment (say) 200 500 – Total tax base 1,200 3,000 – Temporary difference – liability (asset) 600 (1,200) 1,900 The deductible temporary difference on the sale element of the buildings can be recognised only if it is recoverable under IAS 12’s rules. In many jurisdictions, a deductible temporary difference calculated on a sale element cannot be offset against the taxable temporary difference on the use element, because capital losses cannot be offset against trading income. It is generally reasonable to assume that the land and buildings will be sold together. So, to the extent that the deductible temporary difference calculated on a capital (that is, sale) basis is covered by a taxable temporary difference on the related land that is also calculated on a capital basis, it can be offset against it. So the deferred tax liability recognised might relate only to the buildings’ use element. If C0.6 million of the deductible temporary difference is recognised against the C0.6 million taxable temporary difference on the land, the entity recognises a deferred tax liability on the buildings of C1.9 million @ 30% = C0.57 million. The remaining deferred tax asset (on deductible temporary difference of C0.6 million) can only be recognised if it meets the recognition criteria for assets. Dual manner of recovery with a nil residual value Land Buildings (sale) Buildings (use) C’000 C’000 C’000 Carrying amount 1,800 – 3,700 Tax base Cost 1,000 2,500 – Inflation adjustment (say) 200 500 – Total tax base 1,200 3,000 – Temporary difference – liability (asset) 600 (3,000) 3,700 There is a deductible temporary difference on the sale element of the buildings. To the extent that it is covered by a taxable temporary difference (calculated on a capital basis) on the related land, it can be offset against it. If C0.6 million of the deductible temporary difference is recognised against the C0.6 million taxable temporary difference on the land, the entity recognises a deferred tax liability on the buildings of C3.7 million @ 30% = C1.11 million. The remaining deferred tax asset (on deductible temporary difference of C2.4 million) can only be recognised if it meets the recognition criteria for assets. Comparison of methods The expected manner of recovery, the useful economic lives and the residual values attributed to the buildings need to reflect management’s expectations, because this is the basis of allocating the buildings’ carrying amount between the use and sale elements. This allocation, in turn, affects the deferred tax recognised on these elements. Consider the impact of the different manner of recovery expectations in the above scenarios: Use only Dual manner (with residual) Dual manner (with nil residual) C’000 C’000 C’000 Deferred tax liability on use element of buildings 1,110 570 1,110 Deferred tax liability on land 180 180 180 180 180 180 Deferred tax asset on sale element of buildings (offset against land) – (180) (180) Deferred tax liability recognised 1,290 570 1,110 Remaining deferred tax asset on sale element of buildings (available for recognition if IAS 12 criteria are met) – (180) (720) Reduction in net assets 1,290 390 390 A significant difference arises, between the outcome under the single use expectation and the dual manner of recovery expectation, where there is a residual value. In certain circumstances, the outcome under the dual manner of recovery might differ from that for single use, even where there is a nil residual value. Some of the deferred tax asset arising on sale of the buildings can be recognised under the dual manner of recovery expectation; this reduces the deferred tax liability on the land by C180,000. The difference between the outcomes under the dual manner of recovery and that for single use would be even greater if the taxable temporary difference on the land was larger. This is because more of the deferred tax asset arising on sale of the buildings could be recognised.

Dual manner of recovery and initial recognition exception An entity acquired a property for C3.5 million. This was split between land of C1 million and buildings of C2.5 million. On revaluation, the property’s residual value was revisited. This resulted in changes to the carrying amounts of the land and both elements of the buildings (that is, sale and use): Cost Revaluation Carrying amount C’000 C’000 C’000 Land 1,000 800 1,800 Buildings – recovered through sale 1,200 600 1,800 Buildings – recovered through use 1,300 600 1,900 Total 3,500 2,000 5,500 Expected manner of recovery for buildings solely through use The implications of the initial recognition exception (IRE) at the date of the property’s acquisition are: Land: taxable temporary difference of nil – carrying amount (cost of C1 million) less tax base (C1 million). Buildings: taxable temporary difference of C2.5 million – carrying amount (cost of C2.5 million) less tax base (nil) – deferred tax liability not recognised because of the IRE. After revaluation, if recovery solely through use is appropriate for the buildings: Land Buildings (use) C’000 C’000 Carrying amount 1,800 3,700 Tax base Cost 1,000 – Inflation adjustment (say) 200 – Total tax base 1,200 – Temporary difference 600 3,700 Covered by IRE – 2,500 New temporary difference 600 1,200 This example ignores depreciation (which reduces the original temporary difference covered by the IRE). The entity recognises a deferred tax liability on the land (taxable temporary difference of C0.6 million) and a deferred tax liability on buildings (taxable temporary difference of C1.2 million); that is, a total taxable temporary difference of C1.8 million @ 30%, giving a total deferred tax liability of C0.54 million. Dual manner of recovery with a residual value The implications of the IRE at the date of the property’s acquisition would be: Land: taxable temporary difference of nil – carrying amount (cost of C1 million) less tax base (C1 million). Buildings – sale element: deductible temporary difference of C1.3 million – carrying amount (allocated cost of C1.2 million) less tax base (C2.5 million) – deferred tax asset not recognised, because of the IRE. Buildings – use element: taxable temporary difference of C1.3 million – carrying amount (allocated cost of C1.3 million) less tax base (nil) – deferred tax liability not recognised, because of the IRE. After revaluation, if a dual manner of recovery is expected for the buildings: Land Buildings (sale) Buildings (use) C’000 C’000 C’000 Carrying amount 1,800 1,800 1,900 Tax base 1,000 Cost 200 2,500 – Inflation adjustment (say) 500 – Total tax base 1,200 3,000 – Temporary difference 600 (1,200) 1,900 Covered by IRE – 1,300 (1,300) New temporary difference 600 100 600 This example ignores depreciation (which reduces the original temporary difference covered by the IRE). After revaluation, the sale element of the buildings has a carrying amount (C1.8 million) that is less than its tax base (C3 million); thus, a deductible temporary difference of C1.2 million exists at the balance sheet date. On initial recognition, a deductible temporary difference of C1.3 million existed, but it was not recognised because of the IRE. So, the original deductible temporary difference has been reduced by C0.1 million as a result of the revaluation (C0.6 million), partly offset by indexation (C0.5 million). Under the IRE, the temporary difference resulting from the original carrying amount (and its subsequent depreciation, where applicable) and the original tax base are excluded from recognition. Any increases in the asset’s carrying amount or the tax base are considered separately for deferred tax purposes. A new revaluation event has occurred, producing an asset with an incremental carrying amount of C0.6 million and an incremental tax base of C0.5 million. This gives rise to a taxable temporary difference of C0.1 million. So, the entity recognises a deferred tax liability on land (taxable temporary difference of C0.6 million), a deferred tax liability on the sale element of the buildings (taxable temporary difference of C0.1 million) and a deferred tax liability on the use element of the buildings (taxable temporary difference of C0.6 million); that is, a total taxable temporary difference of C1.3 million @ 30%, giving a total deferred tax liability of C0.39 million. Dual manner of recovery with a nil residual value If nearly all of the buildings’ carrying amount is expected to be recovered through use, followed by disposal together with the related land, the implications of the IRE at the date of the property’s acquisition would be: Land: taxable temporary difference of nil – carrying amount (cost of C1 million) less tax base (C1 million). Buildings – sale element: deductible temporary difference of C2.5 million – carrying amount (allocated cost of Cnil) less tax base (C2.5 million) – deferred tax asset not recognised, because of the IRE. Buildings – use element: taxable temporary difference of C2.5 million – carrying amount (allocated cost of C2.5 million) less tax base (nil) – deferred tax liability not recognised, because of the IRE. After revaluation, if the dual manner of recovery is used for the buildings: Buildings (sale) Buildings (use) C’000 C’000 Carrying amount 1,800 – 3,700 Tax base Cost 1,000 2,500 – Inflation adjustment (say) 200 500 – Total tax base 1,200 3,000 – Temporary difference 600 (3,000) 3,700 Covered by IRE – 2,500 (2,500) New temporary difference 600 (500) 1,200 There is no revaluation of the sale element of the buildings for accounting purposes, because this is all attributed to the use element. But there is a revaluation (of C0.5 million) of the tax base, because of indexation allowance. Assuming that there is no restriction of the indexation allowance, the revaluation gives rise to a new deductible temporary difference (as explained above); to the extent that it is covered by a taxable temporary difference (capital basis) on the related land, it can be offset against this. If the deductible temporary difference of C0.5 million is recognised against the C0.6 million taxable temporary difference on the land, the entity recognises a deferred tax liability on the land (taxable temporary difference of C0.1 million) and buildings (taxable temporary difference of C1.2 million); that is, a total taxable temporary difference of C1.3 million @ 30%, giving a total deferred tax liability of C0.39 million. Comparison of methods Use only Dual manner (with residual) Dual manner (with nil residual) C’000 C’000 C’000 Deferred tax liability on use element of buildings 360 180 360 Deferred tax liability on land 180 180 180 Deferred tax liability/(asset) on sale element of buildings – 30 (150) Deferred tax liability recognised 540 390 390 The IRE reduces the difference between the single use and the dual method. But the difference can still be significant. Under both methods, deferred tax is recognised on the revaluation gains on the buildings. But the dual method also considers the effect of the inflation adjustment on calculating the sale element of the buildings. This reduces the deferred tax liability arising on the revaluation of that element (and could result in a deferred tax asset, subject to any restriction of the inflation adjustment); this might give rise to a smaller overall deferred tax liability than the single use method.

Implication of inflation adjustment in cases where dual manner of recovery exists Inflation adjustments for tax purposes can have a significant impact on the deferred tax calculation where there is a dual manner of recovery expectation. Inflation adjustments are generally an allowance relating to tax on capital gains (as opposed to taxes on trading income). Any adjustments to the tax base relating to inflation on the buildings are relevant only to the sale element of the buildings. Inflation adjustments are not allocated to the element of the buildings that will be used in the ongoing business. Instead, inflation adjustments on the buildings’ total cost are included in the calculation of deferred tax on the sale element of the property. Inflation adjustments are effectively a revaluation of the tax base, and they arise after initial recognition; hence, they are not subject to the initial recognition exception. The adjustments will increase the asset’s tax base and reduce the taxable temporary difference relating to the sale element of the buildings.

Impact of property devaluations on deferred taxes Downward revaluation of the use element of a building to an amount below its allocated original cost is accounted for similarly to depreciation of the building. Where the initial recognition exception applies, an entity does not recognise later changes in the unrecognised deferred tax liability as the asset is depreciated or devalued. The downward revaluation is a reversal of the originating temporary difference arising on the asset’s initial recognition, and it is not recognised in the deferred tax calculation. Downward revaluation of the sale element of a building to an amount below its allocated original cost increases the deductible temporary difference arising on the asset’s initial recognition. It is not a reversal of the originating temporary difference on initial recognition. The downward revaluation is a new temporary difference, and it is recognised in the deferred tax calculation. Any resulting deferred tax asset is recognised only where it can be offset against a deferred tax liability on the related land or where the IAS 12 recognition criteria are met in some other way.

Change in intention about the expected manner of recovery

Management’s expectation of how the entity will recover an asset’s carrying amount or settle a liability’s carrying amount might change. The change in the manner of recovery or settlement will affect the deferred tax balances already recognized for that asset or liability.

The deferred tax balances should be remeasured using the tax rates and tax bases that are consistent with the revised expected manner of recovery. Any adjustments resulting from the remeasurement should be recognized in profit or loss; or, if they relate to items previously recognized outside profit or loss, they should be recognized in other comprehensive income or directly in equity, as appropriate.

Change in intention on expected manner of recovery An entity acquired a piece of plant in a business combination on 1 January 20X6 at a cost of C800,000. The plant is fully deductible in use at a rate of 25% per annum. Accounting depreciation is charged at 10% per annum and the residual value is nil. If the plant is sold, any chargeable gain will be taxable at 40%. The chargeable gain will be the excess of proceeds over the original cost, adjusted for inflation, less any deductions already claimed. The rate for income and capital gains tax is 40%. Management intended initially to recover the asset in full through use. The asset would be scrapped at the end of its life and there would be no tax consequences. So, deferred tax is calculated on a use basis as at 31 December 20X6. The intention changes at the end of 20X7 and the plant is expected to be sold. Deferred tax is calculated on a sale basis as at 31 December 20X7. Carrying amount Tax base Temporary difference Deferred tax liability C C C C At 1 January 20X6 800,000 800,000 – – Depreciation/tax allowances (80,000) (200,000) 120,000 48,000 At 31 December 20X6 720,000 600,000 120,000 48,000 Depreciation/tax allowances (80,000) (200,000) 120,000 48,000 At 31 December 20X7 640,000 400,000 240,000 96,000 Change in expected manner of recovery Tax cost of plant − 800,000 800,000 320,000 Inflation adjustment (say) – 4,000 4,000 1,600 Claw-back of allowances claimed – (400,000) (400,000) (160,000) New temporary difference at 31 December 20X7 640,000 404,000 236,000 94,400 The adjustment to the deferred tax liability of C1,600 arises from the change in the manner of recovery; and this is credited to the profit or loss. The deferred tax balance of C94,400 reflects the tax consequences if the entity sold the plant at its carrying amount at the balance sheet date. The movement of C1,600 represents the tax effect of the inflation adjustment (C4,000 @ 40%).

Tax consequences of dividends

Measurement can be more complicated where distributed and undistributed income are taxed at different rates. Corporate taxes might be payable at a higher or lower rate if part or all of the net profit or retained earnings are distributed as dividends.

For example, undistributed profits might be taxed at 45% and distributed profits at 30%. In such situations, deferred tax assets and liabilities should be measured using the tax rates on undistributed profits (45% in the example).

Dividends that are proposed or declared after the end of the reporting period, but before the financial statements are authorized for issue, cannot be accrued. Any tax consequences of paying a dividend are recognized when the dividend is subsequently declared and recognized as a liability.

For example, consider a jurisdiction where undistributed profits are taxed at 45% and distributed profits at 30%, and tax is recoverable if the entity pays a dividend in the subsequent accounting period.

The entity recognizes the refundable part of income taxes (45% – 30% = 15%) as a current tax asset and a reduction of current tax expense when it recognizes the dividend. The entity continues to recognize deferred tax assets and liabilities using the undistributed rate.

Current tax liability and increase of current tax expense would be recognized, based on the incremental tax rate when the dividend was recognized, if the tax rate for distributed profits had been higher than that for undistributed profits.

Tax consequences of a dividend Question: A dividend of C400 was declared in February 20X4, payable on 31 March 20X4. No liability was recognised for the dividend at 31 December 20X3 in accordance with IAS 10. The profit before tax was C2,000. The tax rate is 30% for undistributed profits and 40% for distributed profits. Should the tax rate applicable to distributed profits be applied for the portion of net profit corresponding to dividends that are declared after the balance sheet date? Answer: No, the tax rate applicable to undistributed profits, should be applied because the tax rate for distributed profits is used only where the obligation to pay dividends has been recognised. The current income tax expense is C600 (C2,000 × 30%). During 20X4, a liability of C400 will be recognised for dividends payable. An additional tax liability of C40 (C400 × 10%) is also recognised as a current tax liability and an increase of the current income tax expense for 20X4.

An entity should recognize the income tax consequences of dividends, as defined in IFRS 9 when it recognizes a liability to pay a dividend. The income tax consequences of dividends are linked more directly to past transactions or events that generated distributable profits than to distributions to owners.

Therefore, the income tax consequences of dividends are recognized in profit or loss, in other comprehensive income, or equity, according to where the entity recognized those past transactions or events.

The income tax consequences of payments on financial instruments classified as equity that are not dividends should be recognized when the liability to make the payment is recognized. Such income tax consequences are recognized by the general principle in IAS 12, in profit or loss, except to the extent that they arise from transactions or events recognized outside profit or loss in the current or a previous period.

The standards do not provide further guidance on the distinction between dividends and other payments on financial instruments classified as equity. An entity might therefore need to apply judgment to determine this distinction. If the amounts payable are a withholding tax paid on behalf of the shareholders, the tax is charged directly to equity.

The recipients of the dividends in these circumstances would typically be entitled to a tax credit at least equal to the tax paid by the entity. The tax is levied on the shareholders and not on the entity

What should entities consider when determining whether payments on financial instruments classified as equity are distributions of profits? Entities need to apply judgement to determine whether payments on financial instruments classified as equity are distributions of profits (that is, dividends), and therefore the income tax consequences should be recognised in profit or loss. The following are among the factors that entities might consider when performing the determination: the source of the amounts being distributed, including whether sufficient distributable profits arising from profits in prior periods are required to make the payments (such a requirement might indicate that the payment is a dividend); whether the making of a payment is linked to distributions made to ordinary shareholders (for example, if a payment cannot be made unless a dividend payment to ordinary shareholders is also made, and/or a payment is required if a dividend payment to ordinary shareholders is made, this might indicate that the payment is a dividend); and how the amount is determined (for example, if the coupon payments are fixed or predetermined amounts that are not linked to earnings, this might indicate that the payment is not a dividend).

A parent that has a subsidiary operating in a dual-rate tax jurisdiction, and that does not meet the criteria to apply the exception for investments in subsidiaries, should measure the deferred taxes on temporary differences in the consolidated financial statements relating to the investment in the subsidiary at the rate that would apply to distributed profits.

This is on the basis that the undistributed earnings of the subsidiary are expected to be recovered through their distribution up the group, and the deferred tax should be measured by the expected manner of recovery.

Discounting of deferred tax assets and liabilities

Discounting of deferred tax assets and liabilities is prohibited.

Changes in the tax status of an entity or its shareholders

The current and deferred tax consequences of a change in an entity’s tax status should be dealt with in profit or loss unless they relate to transactions and events that result (in the same or a different period) in amounts recognized in other comprehensive income, or equity.

Tax consequences relating to amounts recognized in other comprehensive income are recognized in other comprehensive income. Tax consequences relating to direct changes in equity are charged or credited directly to equity.

An entity should identify the transactions and events that gave rise to current and deferred taxes. If transactions and events are recognized outside profit or loss (for example, asset revaluations), additional current and deferred tax consequences should also be recognized outside profit or loss.

The cumulative amount of tax recognized outside profit or loss would be the same amount that would have been recognized if the new tax status had been applied previously

Change in tax status of an entity Entity A changed its status from one type of entity to another on 31 August 20X2. It became subject to a higher income tax rate of 30% from the previous rate of 25%. The change in applicable tax rate applies to taxable income generated from 1 September 20X2. The tax rates applicable to a profit on sale of land also increased from 30% to 40%. The information below relates to temporary differences that exist at 1 January 20X2 and at 31 December 20X2 (the end of accounting period) and which will all reverse after 1 January 20X3. 1 Jan 20X2 31 Dec 20X2 Carrying amount Tax base Temporary difference Carrying amount Tax base Temporary difference Trade receivables 2,200 2,500 (300) 2,500 2,800 (300) Land (carried at revalued amount) 800 500 300 800 500 300 Plant and machinery 3,000 800 2,200 2,900 600 2,300 Warranty provisions (1,000) 0 (1,000) (1,000) 0 (1,000) Total 5,000 3,800 1,200 5,200 3,900 1,300 The tax consequences of the change in applicable tax rate should be included in profit or loss, unless they relate to items originally recognised outside profit or loss. The deferred tax at the opening and closing balance sheet dates is calculated as follows: Temporary difference Deferred tax Temporary difference Deferred tax   Trade receivables (300) (300) Plant and machinery 2,200 2,300 Warranty provisions (1,000) (1,000) Total 900 225 (900 × 25%) 1,000 300 (1,000 × 30%) Land (carried at revalued amount) 300 90 (300 × 30%) 300 120 (300 × 40%) The change in deferred tax relating to receivables, the plant and machinery and the warranty provision is included in profit or loss. The change in deferred tax relating to the land is recognised in other comprehensive income. This is because the revaluation of land itself is recognised in other comprehensive income.

Allocation of deferred taxes on items recognised outside profit or loss when an entity changes tax status The deferred tax effects of items recognised outside profit or loss might themselves have been determined on a pro rata basis. In that case, a change in tax status also affects those transactions and events. The tax effects of the change in tax status should, similarly, be allocated on a pro rata basis, unless the allocation can be made on a more appropriate basis.

Impact of change in tax status on balances that arose from a previous acquisition The tax consequences of a change in tax status could affect deferred tax balances that arose from a previous acquisition. Where the change in tax status arose in the period after acquisition, the tax effects of the change should be dealt with in profit or loss, and not as an adjustment against goodwill. But, where an entity’s tax status is changed because of its acquisition, the tax effects of the business combination should be measured in the acquirer’s consolidated financial statements, using the revised tax laws and rates which will also affect the goodwill.

Tax bases without an associated carrying amount Examples of items with a tax base but no carrying amount include the following: research costs recognised as an expense in determining accounting profit in the period in which they are incurred but for which a tax deduction is allowed in a later period; goodwill or other intangible assets recognised for local tax purposes, but not meeting the recognition criteria under IFRS Standards; and reserves in the local statutory books of the entity that will be taxable upon the occurrence of certain events (e.g. reclassification of the reserve, or upon liquidation of the entity). Such reserves are generally established upon receipt of a tax benefit. A temporary difference may also arise when a transaction has given rise to an asset or a liability in previous reporting periods that is no longer included in the statement of financial position, but will affect taxable income in future reporting periods (e.g. an asset that is fully depreciated for accounting purposes but for which tax depreciation may still be claimed). For example, an entity may incur pre-operating costs. Under IAS 38, these costs are required to be recognised as an expense when incurred. If local tax laws do not allow an immediate deduction, but do allow a future deduction, the difference between the tax base of the pre-operating costs (i.e. the amount that the tax authorities will permit as a deduction in future periods) and the carrying amount (nil) is a temporary difference.

Tax base generated as a result of intragroup transfer – example A group undertakes an internal restructuring whereby Subsidiary A sells an item of intellectual property with no carrying amount to Subsidiary B for CU100. Subsidiary B is able to claim a tax deduction for the amortisation of the purchased intangible asset over five years. IFRS 10 requires that intragroup profits be eliminated in full. Therefore, from the group perspective, the intellectual property has a carrying amount of nil and a tax base of CU100. Accordingly, a deductible temporary difference has arisen in respect of which a deferred tax asset should be recognised provided that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised. The corresponding gain should be recognised in profit or loss.

Alternative tax rates for use and disposal of an item of property, plant and equipment – example The carrying amount of an item of property, plant and equipment is CU400,000 (cost of CU500,000 less accumulated depreciation of CU100,000). The asset’s tax base is CU300,000 (tax depreciation of CU200,000 having been claimed to date). Income generated from the use of the asset is taxed at 25 per cent and, therefore, the tax depreciation will be recovered at 25 per cent. If the asset were sold, any excess of the disposal proceeds over the asset’s tax base would be taxed at 30 per cent. The taxable temporary difference is CU100,000. If the entity intends to continue to use the asset in its business, generating taxable income, the deferred tax liability is CU25,000 (CU100,000 at 25 per cent). If, instead, the entity intends to dispose of the asset, the deferred tax liability is CU30,000 (CU100,000 at 30 per cent).

Item of property, plant and equipment to be recovered partly through use and partly through sale – example The facts are as at previous FAQ, except that the entity intends to use the asset until its carrying amount is CU300,000 and its tax base is CU100,000. At that point, the entity will sell the asset, and will be taxed on the difference between the amount recovered through sale and the tax base. In accordance with the general principles of IAS 12, deferred tax is calculated on the assumption that the value of the asset will be recovered at its carrying amount. The entity will therefore recover another CU100,000 from the asset through its use, and receive CU200,000 of allowable deductions during that period. The entity will then recover CU300,000 from the sale of the asset, and receive CU100,000 of allowable deductions. In total, the entity expects to recover CU400,000 from the asset and receive CU300,000 of deductions. The tax rate applicable at the time the temporary difference reverses is 25 per cent in respect of use and 30 per cent in respect of sale. The entity must therefore use both tax rates in determining the deferred tax balance to take account of the fact that the temporary difference will reverse at different rates. Accordingly, the entity’s deferred tax liability in respect of the asset is calculated as follows. [(CU100,000 – CU200,000)] × 25% + [(CU300,000 – CU100,000)] × 30% = CU35,000

Recovery through sale and use subject to different income taxes A more complicated situation arises when, in a particular tax jurisdiction, the recovery of an asset through use is subject to one type of income tax and recovery through sale is subject to another type of income tax (potentially at a different rate). In such circumstances, it is often necessary to consider separately the tax bases and temporary differences arising from recovery through use and recovery through sale, particularly when the tax regime is such that there are effectively two distinct tax systems applicable to the recovery of the asset. Any deductible temporary differences need to be assessed for recognition in accordance with the usual requirements, separately from any taxable temporary difference arising. For example, Company D acquires machinery in a business combination. The machinery is initially recognised in the consolidated financial statements at its fair value at the date of acquisition of CU150. Company D is not entitled to claim any tax deductions if the machinery is used in its operations and, therefore, the machinery’s tax base for recovery through use is nil. Company D expects to use the asset for a number of years and then sell it for its currently estimated residual value of CU50. The income on sale of the machinery is subject to a different type of income tax and, when the machinery is sold, a tax deduction of CU100 (the original cost of the asset when purchased by the acquiree) will be available. Therefore, the asset’s tax base for recovery through sale is CU100. The tax rates expected to apply when the temporary differences reverse are 10 per cent in respect of use and 30 per cent in respect of sale. In the tax jurisdiction in which Company D operates, losses on sale of this type of property, plant and equipment can only be recovered against gains on disposal of similar assets and not against general operating profits. Company D should recognise deferred tax as follows. Carrying amount Tax base Taxable (deductible) temporary difference  Deferred tax liability (asset)   CU CU CU  CU   Recovery through use 100 Nil 100 10 Recovery through sale 50 100 (50) (15)* * The possible deferred tax asset that is expected to arise from the sale of the machinery must be assessed for recoverability. If it is not probable that suitable future taxable profit will be available against which the deductible temporary difference can be utilised, the deferred tax asset should not be recognised.

Non-depreciable asset – freehold land – example Company E holds freehold land and accounts for it on a revaluation basis under IAS 16. The carrying amount of the land is CU900,000, which is its current market value. The tax base on sale of the land will be its original cost of CU500,000. The land is used for the storage of Company E’s raw materials. The tax rate applicable to manufacturing income is 25 per cent but, on disposal of a capital asset, any proceeds in excess of cost are taxed at 30 per cent. There is currently no intention to sell the land. The taxable temporary difference between the carrying amount and the tax base of the freehold land is CU400,000. Although the asset is being used by Company E to generate manufacturing income, the carrying amount of the land is not being recovered in that way; the value of the land does not diminish over time through use. All of the value of the land will be recovered through its eventual sale and, therefore, the applicable tax rate is 30 per cent, and the deferred tax liability arising is CU120,000. If, for tax purposes, there was an indexation allowance on the land for the purposes of calculating the gain on disposal of the land, this indexed amount would be the tax base of the land.

Intangible asset with an indefinite useful life is not a non-depreciable asset An intangible asset that is considered to have an indefinite useful life (and therefore, in accordance with IAS 38, is not amortised) is not a ‘non-depreciable asset’ as envisaged by IAS 12. This is because a non-depreciable asset has an unlimited (or infinite) life and, as noted in IAS 38, ‘indefinite’ does not mean ‘infinite’. This conclusion was confirmed by the IFRS Interpretations Committee in its November 2016 IFRIC Update. As noted in IAS 38, the Board’s decision to require non-amortisation of indefinite-life intangible assets was not because the Board considered that there is no consumption of the future economic benefits embodied in the asset, but rather because amortisation over an arbitrary period would not be representationally faithful of that consumption. Hence, the general principles and requirements of IAS 12 (namely, that temporary differences will be recognised based on the expected manner of recovery), rather than the specific requirements of IAS 12, apply when measuring deferred tax on assets with indefinite useful lives.

Intangible asset with an indefinite useful life – determination of ‘expected manner of recovery’ – example Company F has a brand that is considered to have an indefinite useful life and, in accordance with the requirements of IAS 38:107, is not being amortised. The carrying amount of the brand is its original cost of CU900,000. Under local tax law, the brand is being amortised over 10 years. At 31 December 20X3, the tax base of the brand after three years’ tax amortisation is CU630,000. This tax base is either deductible over the life of the asset or upon sale. The tax rate applicable to trading profits is 25 per cent but, if the intangible asset were to be disposed of, the capital gain arising would be taxed at 20 per cent. There is currently no intention to dispose of the brand. In accordance with the general requirements of IAS 12, the measurement of deferred tax should reflect the tax consequences that would follow from the manner in which the entity expects to recover the asset. In the circumstances described, the brand is expected to be recovered (i.e. consumed) through use in Company F’s trading operations. On this basis, the taxable temporary difference between the carrying amount and the tax base of the brand is CU270,000. The applicable tax rate is 25 per cent and the deferred tax liability arising is CU67,500. The brand is not considered to be a non-depreciable asset for the purposes of IAS 12.

Rebuttal of presumption regarding the expected manner of recovery of investment property measured at fair value Provided that sufficient evidence is available to support the rebuttal, the presumption that the carrying amount of an investment property will be recovered through sale can be rebutted in circumstances other than those explicitly described in IAS 12. This conclusion was confirmed by the IFRS Interpretations Committee in November 2011. The Committee noted that a presumption is a matter of consistently applying a principle (or an exception) in IFRS Standards in the absence of acceptable reasons to the contrary and that it is rebutted when there is sufficient evidence to overcome the presumption. Because IAS 12 is expressed as a rebuttable presumption, and because the sentence explaining the rebuttal of the presumption does not express the rebuttal as ‘if and only if’, the Committee considered that the presumption could be rebutted in other circumstances, provided that sufficient evidence is available to support that rebuttal.

Example Investment property measured at fair value An investment property has a cost of 100 and fair value of 150. It is measured using the fair value model in IAS 40. It comprises land with a cost of 40 and fair value of 60 and a building with a cost of 60 and fair value of 90. The land has an unlimited useful life. Cumulative depreciation of the building for tax purposes is 30. Unrealised changes in the fair value of the investment property do not affect taxable profit. If the investment property is sold for more than cost, the reversal of the cumulative tax depreciation of 30 will be included in taxable profit and taxed at an ordinary tax rate of 30%. For sales proceeds in excess of cost, tax law specifies tax rates of 25% for assets held for less than two years and 20% for assets held for two years or more. Because the investment property is measured using the fair value model in IAS 40, there is a rebuttable presumption that the entity will recover the carrying amount of the investment property entirely through sale. If that presumption is not rebutted, the deferred tax reflects the tax consequences of recovering the carrying amount entirely through sale, even if the entity expects to earn rental income from the property before sale. The tax base of the land if it is sold is 40 and there is a taxable temporary difference of 20 (60 – 40). The tax base of the building if it is sold is 30 (60 – 30) and there is a taxable temporary difference of 60 (90 – 30). As a result, the total taxable temporary difference relating to the investment property is 80 (20 + 60). In accordance with IAS 12, the tax rate is the rate expected to apply to the period when the investment property is realised. Thus, the resulting deferred tax liability is computed as follows, if the entity expects to sell the property after holding it for more than two years: Taxable Temporary Difference Tax Rate Deferred Tax Liability Cumulative tax depreciation 30 30% 9 Proceeds in excess of cost 50 20% 10 Total 80 19 If the entity expects to sell the property after holding it for less than two years, the above computation would be amended to apply a tax rate of 25%, rather than 20%, to the proceeds in excess of cost. If, instead, the entity holds the building within a business model whose objective is to consume substantially all of the economic benefits embodied in the building over time, rather than through sale, this presumption would be rebutted for the building. However, the land is not depreciable. Therefore the presumption of recovery through sale would not be rebutted for the land. It follows that the deferred tax liability would reflect the tax consequences of recovering the carrying amount of the building through use and the carrying amount of the land through sale. The tax base of the building if it is used is 30 (60 – 30) and there is a taxable temporary difference of 60 (90 – 30), resulting in a deferred tax liability of 18 (60 at 30%). The tax base of the land if it is sold is 40 and there is a taxable temporary difference of 20 (60 – 40), resulting in a deferred tax liability of 4 (20 at 20%). As a result, if the presumption of recovery through sale is rebutted for the building, the deferred tax liability relating to the investment property is 22 (18 + 4).

Recognition of deferred tax for a single asset in a corporate wrapper In many jurisdictions, it is common for an investment property to be held within a corporate structure that holds only one material asset, the investment property itself. When the parent disposes of the property, it will dispose of it within that corporate shell because, in many cases, this will shield the parent entity from adverse tax consequences. IAS 12 requires temporary differences in the consolidated financial statements to be determined by comparing the carrying amounts of assets and liabilities in the consolidated financial statements with the appropriate tax base. These amounts are sometimes referred to as ‘inside basis differences’. In the case of an asset or a liability of a subsidiary that files separate tax returns, the tax base is the amount that will be taxable or deductible on the recovery (settlement) of the asset (liability) in the tax returns of the subsidiary. In addition, IAS 12 requires the determination of 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 the purposes of the parent’s tax returns. This amount is sometimes referred to as an ‘outside basis difference’. IAS 12 includes no exception to these requirements for single asset subsidiaries and, consequently, both components of deferred tax are required to be recognised in consolidated financial statements (subject to the requirements of IAS 12 limiting the recognition of outside basis differences, and the general recognition criteria in IAS 12 for any deferred tax assets) even if the parent expects to sell an investment property within a corporate shell. This conclusion was confirmed by the IFRS Interpretations Committee in July 2014.

Convertible instruments and derivative instruments over own equity – tax treatments depend on manner of settlement In some jurisdictions, the tax treatment for a convertible instrument may differ depending on whether the instrument is settled in cash or by the delivery of shares. It may also be the case that the tax treatment of a derivative instrument over own equity may differ depending on whether the instrument is settled in cash, in shares, or expires unexercised. Unlike IAS 32, IAS 12 require that the tax base and the rate used to determine the deferred tax assets and liabilities reflect the manner in which the entity expects to settle the instrument. When the manner of settlement of a financial instrument is within the control of the holder, the entity, as the issuer, will need to take into consideration factors that may influence the holder’s decision on settlement. In particular, the issuer should assume that the holder will act in an economically rational manner. Therefore, whilst the classification of the instrument as liability or equity may be a starting point in establishing how the instrument is expected to be settled, the issuer should also consider the economics of the various settlement options (e.g. an option that is deeply out of the money is unlikely to be exercised). Depending on facts and circumstances, other factors may also be relevant.

Tax base of a warrant when the future tax consequences depend on the manner of settlement – example On 1 January 20X1, Entity X issues a warrant (i.e. a written call option over own shares that will be gross physically settled) to Entity A which is exercisable from the issue date to 31 December 20X3. Entity X receives an option premium of CU100, which is the fair value of the warrant at the issue date. The terms of the warrant are such that it is classified as a derivative liability measured at fair value through profit and loss under IAS 32. The warrant has the following tax attributes: unrealised gains and losses on remeasurement of the warrant at fair value are not subject to tax; if the warrant is exercised, there are no tax consequences; and if the warrant expires unexercised, the option premium received by Entity X of CU100 is included in taxable income. As discussed, Entity X recognises and measures deferred tax on the warrant based on the expected manner of settlement. If Entity X expects that the warrant will be exercised, settlement will have no tax consequences. As a result, the tax basis of the warrant on 1 January 20X1 is CU100. As no temporary difference exists in this instance, no deferred tax is recognised. Any subsequent changes in the fair value of the warrant will not affect deferred tax since there are no tax consequences on settlement through exercise of the option (i.e. the tax basis is equal to its carrying amount). If instead, on initial recognition, Entity X expects that the warrant will expire unexercised, the tax base of the warrant on 1 January 20X1 is CU100. This is because the option premium of CU100 received is akin to deferred revenue such that, as explained in IAS 12, the tax basis of the derivative liability is its carrying amount less any amount of revenue that will not be taxable in future periods (CUnil in this case). Accordingly, no temporary difference exists on initial recognition. If, at any subsequent reporting date, Entity X expects that the warrant will expire unexercised, changes in the fair value of the warrant will give rise to a temporary difference (as the tax basis of the warrant remains CU100). A deferred tax liability or a deferred tax asset (if recoverable) will be recognised through profit or loss in accordance with IAS 12. If the warrant is unexpectedly exercised (or the expectation that the warrant will expire unexercised is no longer appropriate), any deferred tax amount previously recognised in respect of the warrant is reversed through profit or loss.

Tax base of a convertible bond when the future tax consequence depends on the manner of settlement – example On 1 January 20X1, Entity Y issues a convertible bond at par for total proceeds of CU1,000. The bond is not interest bearing and matures on 31 December 20X3. Bondholders can exercise the conversion option and receive shares at any date until 31 December 20X3 (the maturity of the bond). On 31 December 20X3, any remaining amount of the convertible bond is repayable at par. The terms of the conversion option are such that it is recognised separately from the host liability contract and classified as a derivative liability measured at fair value through profit and loss under IAS 32. On 1 January 20X1, the host liability component is determined to be CU751, and the fair value of the conversion option is determined to be CU249. The host liability component is subsequently measured at amortised cost. The convertible bond has the following tax attributes: accretion of the interest on the host liability component arising from the unwind of initial CU249 discount is not tax deductible; unrealised gains or losses on remeasurement of the conversion option at fair value are not subject to tax; if the conversion option is exercised, and the bond settled through the issuance of shares, there are no tax consequences; the repayment of the bond at par at maturity has no tax consequences; and if Entity Y redeems the convertible bond at above or below par before maturity (for example, redemption at fair value as a result of a renegotiation of its terms with the bondholders), the difference between par and the redemption amount is included in taxable income (if the redemption amount is less than par) or results in a tax deduction (if redemption is in excess of par). Because, for tax purposes, the host liability and the derivative instrument constitute a single instrument, and settlement of one of the instruments automatically triggers settlement of the other instrument, any temporary difference is assessed by looking at both the host liability and the derivative liability as a single liability (referred to herein as the combined liability). As discussed, Entity Y recognises and measures deferred tax on the convertible bond based on the expected manner of settlement. If Entity Y expects to settle the convertible bond by issuing shares (i.e. it expects the bond to be converted), no deferred tax is recognised on initial recognition or subsequently. This is because settlement in shares does not trigger any tax consequences. If instead, on initial recognition, Entity Y expects to settle the convertible bond in cash, the carrying amount of the combined liability and its tax base are CU1,000. This is because settlement in cash for CU1,000 does not trigger any tax consequences. Hence there is no temporary difference at the date of initial recognition. Subsequently, the remeasurement of the derivative liability at fair value and the accretion of interest on the host liability will result in the carrying amount of the combined liability being below or above the par amount of the liability. This will give rise to a temporary difference (as the tax basis of the combined liability remains CU1,000). A deferred tax liability or a deferred tax asset (if recoverable) will be recognised through profit or loss in accordance with IAS 12. If, contrary to expectation, the bond is converted (or Entity Y revises its expectation and now expects that the bond will be settled through conversion), any deferred tax amount previously recognised in respect of the convertible bond is reversed through profit or loss. As explained, the possibility that the convertible bond may be redeemed before maturity at fair value (for example, as a result of the renegotiation with the bondholders or purchase on the market) is ignored in assessing deferred tax. This is because the future tax consequences are always calculated based on the settlement of the liability at its carrying amount.

Change in management’s expectation as to the manner in which an asset will be recovered, or a liability settled When there is a change in management’s expectation as to the manner in which an asset will be recovered, or a liability settled, the change may affect the measurement of the related deferred tax balances. The deferred tax impact should be remeasured based on management’s revised intentions and the adjustment recognised in profit or loss or, to the extent that it relates to items previously recognised outside profit or loss, in other comprehensive income or directly in equity. Amounts reported in prior periods are not restated.

Rollover relief In some jurisdictions, an entity may be entitled to ‘rollover relief’ when it disposes of a capital asset for a profit and replaces it with an equivalent asset. In such circumstances, the gain on disposal may not have any impact for tax purposes until the replacement asset is disposed of, when it is taken into account via the ‘capital’ (or sale) tax base of the replacement asset. When the entity disposes of the replacement asset, it is required to pay the tax on the gain on disposal of the replacement asset together with the tax on the gain on disposal of the original asset. In many cases, the ‘rollover’ of the gain on the disposal of the original asset into the tax base of the replacement asset merely postpones, rather than eliminates, the payment of tax, and IAS 12 requires that a deferred tax liability be recognised. In some jurisdictions, the manner of recovery of the replacement asset will determine whether the rollover relief gives rise to a postponement of tax or to permanent relief. However, until the replacement asset is acquired, deferred tax should be recognised on the basis that rollover relief will give rise only to postponement of tax, i.e. the potential permanent relief should not be anticipated. If the original asset is sold and there is a time delay before the replacement asset is acquired, the entity should continue to recognise the deferred tax. If the replacement asset is recovered entirely through use, an entity should give careful consideration to the effect of rollover relief on the tax payments flowing from its recovery when determining the tax base of a replacement asset based on the expected manner of recovery.

Example Deductible temporary difference arising from asset carried at fair value Entity A purchases for CU1,000, at the beginning of Year 1, a debt instrument with a nominal value of CU1,000 payable on maturity in 5 years with an interest rate of 2% payable at the end of each year. The effective interest rate is 2%. The debt instrument is measured at fair value. At the end of Year 2, the fair value of the debt instrument has decreased to CU918 as a result of an increase in market interest rates to 5%. It is probable that Entity A will collect all the contractual cash flows if it continues to hold the debt instrument. Any gains (losses) on the debt instrument are taxable (deductible) only when realised. The gains (losses) arising on the sale or maturity of the debt instrument are calculated for tax purposes as the difference between the amount collected and the original cost of the debt instrument. Accordingly, the tax base of the debt instrument is its original cost. The difference between the carrying amount of the debt instrument in Entity A’s statement of financial position of CU918 and its tax base of CU1,000 gives rise to a deductible temporary difference of CU82 at the end of Year 2, irrespective of whether Entity A expects to recover the carrying amount of the debt instrument by sale or by use, ie by holding it and collecting contractual cash flows, or a combination of both. This is because deductible temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods, when the carrying amount of the asset or liability is recovered or settled. Entity A obtains a deduction equivalent to the tax base of the asset of CU1,000 in determining taxable profit (tax loss) either on sale or on maturity.

Use of the term ‘probable’ IAS 12 is silent with regard to the meaning of ‘probable’ in the context of IAS 12. IAS 37 defines the term ‘probable’ as ‘more likely than not’. The footnote to IAS 37 acknowledges that this definition is not necessarily applicable to other IFRS Standards. However, in the absence of any other guidance, the term ‘probable’ should be applied as ‘more likely than not’. In March 2009, the Board issued an exposure draft (ED) containing proposals for an IFRS Standard that would replace IAS 12. Although a replacement Standard was not finalised, the ED provides useful guidance on the meaning of ‘probable’ because it uses the term ‘more likely than not’ and notes in the Basis for Conclusions that this is consistent with the term ‘probable’ as used in IAS 37 and IFRS 3.