For Additional Reading
IAS 12 Income Taxes
What is the objective of IAS 12?
The objective of IAS 12 is to prescribe the accounting treatment for income taxes.
The main issue here is how to account for the current and future consequences of
• The future recovery (settlement) of the carrying amount of assets (liabilities)
recognized in the entity’s financial statements.
Here, if the future recovery or settlement will make future tax payments larger or smaller
than they would be if such recovery or settlement were to have no tax consequences, then
an entity must recognize deferred tax liability or asset.
• Transactions and other events of the current period recognized in the entity’s financial
statements.
IAS 12 requires accounting for current and deferred income tax from certain transaction
or event exactly in the same way as the transaction or event itself.
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Understand the differences
Almost in every country the accounting rules differ from the tax laws and regulations.
Sometimes, these differences are really significant and accountants must make lots of
adjustments to their accounting profit in order to arrive to the basis for calculation of income tax.
In order to understand the meaning and the rules of IAS 12 fully, you need to understand the
meaning of and differences between
• Accounting profit and taxable profit, and
• Current income tax and deferred income tax.
I. Accounting versus taxable profit
Accounting profit is profit or loss for a period before deducting tax expense. Please note that
IAS 12 defines accounting profit as a before-tax figure (not after tax as we normally do) in order
to be consistent with the definition of a taxable profit.
Taxable profit (tax loss) is the profit (loss) for a period determined in accordance with the rules
established by the taxation authorities upon which income taxes are payable (recoverable).
You can clearly see here that these 2 numbers can differ significantly because accounting and tax
rules are not the same. A number of differences can pop out between accounting profit and
taxable profit you have to make the following adjustments to your accounting profit:
• Add back the expenses recognized but non-deductible for tax purposes
• Add income not recognized but included under tax regulations
• Deduct expenses not recognized but deductible for tax purposes
• Deduct income recognized but not taxable under tax regulations.
II. Current tax versus deferred tax
Current income tax is the amount of income tax that you actually need to pay to your tax office.
Deferred income tax is an accounting measure used to match the tax effect of transactions with
their accounting impact and thereby produce less distorted results.
I have outlined the other differences between current and deferred income tax in the following
scheme:
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Current income tax
Current tax is the amount of income tax payable (recoverable) in
respect of the taxable profit (loss) for a period.
Measurement of current tax liabilities (assets) is very straightforward. We need to use the tax
rates that have been enacted or substantively enacted by the end of the reporting period and apply
these rates to the taxable profit (loss).
Current income tax expense shall be recognized directly to profit or loss in most cases.
However, If the current tax arises from a transaction or event recognized outside profit or loss,
either in other comprehensive income or directly in equity, then current income tax shall be
recognized in the same way.
Deferred income tax
Deferred income tax is the income tax payable (recoverable) in future periods in respect of the
temporary differences, unused tax losses and unused tax credits.
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Deferred tax liabilities result from taxable temporary differences and deferred tax assets result
from deductible temporary differences, unused tax losses and unused tax credits.
We can calculate deferred tax as temporary difference multiplied with the applicable tax rate.
Before you dig deeper in the concept of temporary differences, you need to understand the tax
base first.
What is a tax base?
Tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.
In my opinion, this definition does not say that much, so let’s explain it in a greater detail:
Tax base of an asset
Tax base of an asset is the amount that will be deductible for tax purposes against any taxable
economic benefits that will flow to an entity when it recovers the carrying amount of the asset.
For example, when you have an interest receivable and interest revenue is taxed on a cash basis,
then the tax base of interest receivable is 0. Why? Because when you actually receive the cash
and remove the interest receivable from your books, you will need to include full amount of cash
received into your tax return. At the same time you cannot deduct anything from this amount for
tax purposes.
Tax base of a liability
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.
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For example, when you accrue some expenses that will be deductible when paid, then the tax
base of a liability from accrued expenses is 0.
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Tax base
The tax base of an asset is the amount that will be deductible for tax purposes against any
taxable economic benefits that will flow to an entity when it recovers the carrying amount of the
asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its
carrying amount.
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The tax base of a liability is its carrying amount, less any amount that will be deductible for tax
purposes in respect of that liability in future periods. In the case of revenue which is received in
advance, the tax base of the resulting liability is its carrying amount, less any amount of the
revenue that will not be taxable in future periods.
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Temporary differences
Temporary differences are differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base.
When the carrying amount of an asset or a liability is greater than its tax base, then there is a
taxable temporary difference and it gives rise to deferred tax liability.
In the opaque situation, when the carrying amount of an asset or a liability is lower than its tax
base, then there is a deductible temporary difference and it gives rise to deferred tax asset.
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Important note: This applies to both assets and liabilities, if you view the assets with PLUS and
liabilities with MINUS. So for example:
• Example of an asset: Let’s say your asset has a carrying amount of 100, and the tax base
of 0 => then, its carrying amount is greater than the tax base, and taxable temporary
difference arises.
• Example of a liability: Let’s say you made a provision of 500 that will be tax deductible
in the future. Its carrying amount is MINUS 500 (since it is a liability), its tax base is
zero, therefore as the carrying amount is smaller than the tax base, deductible temporary
difference arises.
Deferred tax liability
You need to recognize deferred tax liability for all taxable temporary differences you discovered,
except for the following situations:
• No deferred tax liability shall be recognized from initial recognition of goodwill
• No deferred tax liability shall be recognized from initial recognition of asset or liability in
a transaction that is not a business combination and at the time of the transaction it affects
neither accounting nor taxable profit (loss).
The most common examples of taxable temporary differences giving rise to deferred tax
liabilities are:
1. Timing differences
Timing difference arises when the recognition of certain item in the financial statements
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occurs in a different time than its recognition in tax return, for example, interest received
is taxed deductible only when cash is received.
2. Business combinations
In a business combination identifiable assets and liabilities can be revalued upwards to
fair value at the acquisition date, but no adjustment is made for tax purposes. As a result,
taxable temporary difference arises.
3. Assets carried at fair valueWhen a company applies policy of revaluation (for example,
revaluation model for property, plant and equipment in line with IAS 16) and some assets
are revalued upwards to their fair value, taxable temporary difference arises.
4. Initial recognition of an asset / liabilityWhen an asset or liability are initially recognized
in the financial statements, part or all of it could be tax-non-deductible or not taxable. In
this case, deferred tax liability is recognized based on the specific situation.
Deferred tax asset
While you need to recognize deferred tax liability for all taxable temporary differences, here the
situation is different.
A deferred tax asset shall be recognized for all deductible temporary differences to the extent
that it is probable that taxable profit will be available against which the deductible temporary
difference can be utilized.
No deferred tax asset shall be recognized from initial recognition of asset or liability in a
transaction that is not a business combination and at the time of the transaction it affects neither
accounting nor taxable profit (loss).
The most common examples of deductible temporary differences giving rise to deferred tax
assets are:
1. Timing differences
Timing difference arises when the recognition of certain item in the financial statements
occurs in a different time than its recognition in tax return, for example, accrued expenses
are tax deductible only when paid.
2. Business combinations
In a business combination identifiable assets and liabilities can be revalued downwards to
fair value at the acquisition date, but no adjustment is made for tax purposes. As a result,
deductible temporary difference arises.
3. Assets carried at fair value
When a company applies policy of revaluation (for example, revaluation model for
property, plant and equipment in line with IAS 16) and some assets are revalued
downwards to their fair value, deductible temporary difference arises.
4. Initial recognition of an asset / liability
When an asset or liability are initially recognized in the financial statements, part or all of
it could be tax-non-deductible or not taxable. In this case, deferred tax asset is recognized
based on the specific situation.
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Unused tax losses and tax credits
A deferred tax asset shall be recognized for the unused tax losses carried forward 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.
Investments in subsidiaries, branches and associates and interests in joint ventures
Except for various kinds of temporary differences mentioned above, a number of them can arise
at business combinations. This issue is even more complicated that it looks because temporary
difference may be different in the consolidated financial statements from temporary difference in
the individual parent’s financial statements.
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Such differences arise in number of circumstances:
• Undistributed profits of subsidiaries, branches, associates and joint arrangements
• Changes in foreign exchange rates when a parent and its subsidiary are based in different
countries
• Reduction in the carrying amount of an investment in an associate to its recoverable
amount.
Here, 2 essential rules for recognition of deferred tax apply:
1. An entity shall recognize a deferred tax liability for all taxable temporary differences
associated with investments in subsidiaries, branches and associates, and interests in joint
arrangements, except to the extent that both of the following conditions are satisfied:
o the parent, investor, joint venturer or joint operator is able to control the timing of
the reversal of the temporary difference; and
o it is probable that the temporary difference will not reverse in the foreseeable
future.
2. An entity shall recognize a deferred tax asset for all deductible temporary differences
arising from investments in subsidiaries, branches and associates, and interests in joint
arrangements, to the extent that it is probable that:
o the temporary difference will reverse in the foreseeable future; and
o taxable profit will be available against which the temporary difference can be
utilized.
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Measurement of deferred tax
In measuring deferred tax assets / liabilities you need to apply the tax rates that are expected to
apply to the period when the asset is realized or the liability is settled. However, these expected
rates need to be based on tax rates or tax laws that have been enacted or substantively enacted by
the end of the reporting period.
So please, don’t use some estimates of the future tax rates, as this is not allowed.
Let me also point out that the measurement of deferred tax should reflect the tax consequences
that would follow from the manner of expected recovery or settlement.
So for example, if in your country, sales of property are taxed at 35% and other income at 30%,
then for calculation of deferred tax on your property you need to apply the tax rate based on your
expected way of property’s recovery – if you plan to sell it, then measure your deferred tax at
35% and if you plan to use it and then remove it, then measure your deferred tax at 30%.
How to recognize deferred taxes
In almost all situations you would recognize deferred tax as an income or an expense in profit or
loss for the period. There are just 2 exceptions of this rule:
• if a deferred tax arose from a transaction or even recognized outside profit or loss, then
you need to recognize deferred tax in the same way (in other comprehensive income or
directly in equity)
• if a deferred tax arose in a business combination, deferred tax affects goodwill or bargain
purchase gain.
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How to present income taxes
The principal issue in presenting income taxes is offsetting. Can you present current or deferred
income tax assets and liabilities as one net amount? Or do you need to show them separately?
Offsetting the current income tax
You can offset current income tax assets and liabilities if 2 conditions are fulfilled:
1. You have a legally enforceable right to set off the recognized amounts; and
2. You intend either to settle on a net basis or to realize the asset and settle the liability
simultaneously.
Offsetting the deferred income tax
You can offset deferred income tax assets and liabilities if 2 conditions are fulfilled:
1. You have a legally enforceable right to set off the current income tax assets against
current income tax liabilities (see above when it happens); and
2. The deferred tax assets and the deferred tax liabilities relate to income taxed levied by the
same taxation authority on either
o the same taxable entity; or
o different taxable entities which intend to settle current tax liabilities and assets on
a net basis or realize the assets and settle the liabilities simultaneously, in each
future period in which significant amounts of deferred tax liabilities or assets are
expected to be settled or recovered.
Just be careful when making consolidated financial statements because often you just cannot
simply combine deferred tax assets of a parent with deferred tax liabilities of a subsidiary and
present them as 1 net amount.
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