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IAS 12 Deferred tax Why deferred tax arises? Accounting is on the basis of substance. Substance means the economic reality, who is actually taking the benefits. Who is taking the risk and rewards? The one who is taking the risk and rewards accounting will be done according to him. The best example is IAS 17 finance lease. According to finance lease on the very first day ownership of the asset is not transferred to you. But risk and rewards are transferred. On the basis of these risk and rewards you include this asset into your SFP and depreciate it. However the ownership is not transferred to you. Everything we are doing here is on the basis of substance. This shows that the Profit in the SOCI is also on the basis of substance and hence the tax figure. When we talk about taxation authorities one thing that blinks is that tax authorities do not calculate tax on ACCOUNTING PROFIT, but they calculate it on TAXABLE PROFIT. They convert accounting profit into taxable profit and calculate tax. Due the differences in accounting profit and taxable profit the amount of tax differs. This is the point where deferred tax arises.

Due to the rules of tax authorities we may pay higher amount of tax or lower amount of tax. Today’s saving of tax results in more payment of tax in future or today’s more payment of tax results in future less payment of tax. E.g. 100 % (FYA) First year allowance in the first year on capital expenditure. From 2nd year tax authorities add back the amount of depreciation. Which results in the increase of profit and hence the tax increases. Due to FYA we save the tax in the first year in which we incurred the capital expenditure. But this saving results into the more payment of tax into the next year due to add back of depreciation. This saving of tax or more payment of tax is only because of the rules of the tax authorities. We have not done any effort to make it more or less. Example: Car 	cost	$1000,000 Life		5 years St.line Dep	$200,000 Gross Profit	$2000,000 Our Calculation: SOCI		Depreciation	$200,000	(profit will be reduced by the same amount.) SFP		NBV		$800,000 Tax		$2000,000-$200,000= $1800,000×0.3= $540,000

Tax Authorities calculation: Accounting profit		$2000,000 +Depreciation			 $200,000 Net Profit			$2200,000 Tax Rate			         30% TAX				 $660,000 Tax authorities add back depreciation and provide 100% FYA. Due to FYA we will be exercising the benefit of deducting expense of $800,000 e.g. 100% FYA 									$2000,000 Less Depreciation (that we were already deducting in the first year>         ( $200,000) Available expense in the first year					               $800,000

Once we have exercised this benefit of deducting $800,000 from the profit, we save the tax in this year. This saving will result in the more payment of tax in the future when tax authorities add back depreciation. The point is that we pay the same amount of tax sooner of later. The difference is only because of the time, this difference gets eliminated with the period of time. This difference is temporary. This is why IAS 12 deals with temporary differences not with permanent differences. It doesn’t mean that permanent differences don’t exist. IAS 12 deals with permanent differences in the way of exceptions. Temporary differences are of two types: 1. Taxable temporary differences 2. Deductable temporary differences •	Taxable temporary differences TTD × Tax Rate = DTL Why this results in liability? Organization must have saved tax due to the rules of tax authorities. Saving of today creates liability in future. In short it shows that in future we will pay the tax.

•	Deductable temporary difference DTD × Tax Rate = DTA Why this results in asset? Organization must have paid more tax due to the rules of the tax authorities. It shows that in the future tax will be saved.

How we will come to know that we have saved the tax or we will pay more tax in the future. The tool that will tell us TTD or DTD is TAX BASE.

TAX BASE means value assigned by taxation authorities to your assets and to your liabilities.

Tax Base of Asset Assets are of two types:

1. CASH Category Assets 2. SOCI Category Assets

Cash Category

•	All receivable are cash category assets.

•	Abnormally bad debts written off become cash category assets. But normally they are SOCI category.

•	Tax Base:

Related Future receipts on which no tax will be paid.

Rule (1). Any income which is taxable on accrual basis the same amount is tax base.

Rule (2). Any income which is taxable on cash or receipt basis the tax base is NIL.

Rule(3). Any income which is tax exempt same amount is the tax base. SOCI Category

•	All Depreciable assets are SOCI category assets. They become CASH category assets when we sell them. •	Tax Base: Related expense that will be allowed in future by tax authorities as expense. Example: Plant 	$2M Tax Depreciation	Y1	50% Y2	40% Y3	10% Tax Base will be: Y1		50%		$1M Y2		10%	        $0.2M Y3		Nil		 Nil

Easy Method: •	Calculate NBV of asset of the year tax base is required. •	That depreciation will relate to tax authorities.

Exceptions: LAND In case of freehold land acquisition cost of land is the tax base, because tax authorities do not believe in revaluation. If taxation authorities accept revaluation then revalued amount will be the tax base. INVESTMENT In case of investment the tax base will be acquisition cost/purchase cost/original cost of the investment. Unrealized gains on investment are not acceptable. DEBTORS In case of debtors tax base will be the gross amount. I.e. if provision for bad debt is already deducted from debtors then we have to add it back. Tax authorities do not accept provisions. E.g. 	P&L/SOCI		DR Allowance/Provision	CR (not acceptable for Tax authorities) DIVIDEND RECEIVABLE All receivables are cash category assets. Any income which is tax exempt, same amount is the tax base. Note: Any asset which is 100% tax deductable in first year then tax base would be NIL. No doubt it is SOCI category asset and tax base for it should be the amount of the expense to be allowed in the future. But once the whole 100% FYA is given, no amount of expense will be allowed in the future. Tax Base of Liability

Nature of liability: 1. Income Nature liability 2. Expense nature liability

1.	Income Nature Liability: Examples: 	Revenue received in advance. 	Govt. Grant < Deferred income treatment> When govt grants fund due to the asset, there are two treatments of govt grant: I.	Cost of the asset – Govt grant II. Treat the grant as liability and amortize it by the passage of time by transferring it to P&L. In this way it becomes your income. So the deferred income is the income nature liability. We have two examples of income nature liability: a. Money received in advance. b. Govt grant  2. Expense Nature Liability: Rest of the liabilities except above two income nature liabilities are expense nature of liabilities. Examples are; fine imposed on company or penalty due to environmental provision. Tax base of income nature liability = CA – any amount on which no tax will be paid in the future. Tax base of expense nature liability = CA – any amount that will be allowed in future by taxation authorities as expense. Note: If nothing is mentioned about any asset or liability the whole amount is its tax base. Relationships of IAS 12 Deferred tax Asset (DTA) CA	↑	Tax Base	↓	=	Taxable temporary difference CA	↓	Tax Base	↑	=	Deductable temporary difference

Example: Company has debtors of $55m and provision for doubtful debts is $5m. Solution: If doubtful debtors become bad debt DTA will arise. Tax base for provisions is NIL. Accounting SOCI – Provision for doubtful debts	$5m Tax SOCI – tax authorities do not accept provisions. Tax calculation: CA		Tax Base		Temp.Diff 50 ↓		55 ↑			5 DTD × TR = DTA Deferred tax Liability (DTL) Opposite of ASSET. If tax is saved in the current year due to the rules of tax authorities more tax will be paid in the future. Book DTL. CA	↑	Tax Base	↓	=	Deductable temporary difference CA	↓	Tax Base	↑	=	Taxable temporary difference

Example: Company has a plant costing $10m has a useful life of 5 years. Plant is depreciated on straight line basis. Solution: Accounting SOCI --	Depreciation per year $2m Tax SOCI	    --	Depreciation expense $10m (First year allowance) By accepting FYA expense will be increased by $8m ($10m - $2m). This will result in the saving of tax in the current year and hence the DTL of ($8m×TR) will be booked. Exam calculation: CA			Tax Base	Temp.Diff Cost			$10m Depreciation		($2m) $8m			Nil		$8m $8m × TR = DTL Exceptions Handout Point number 8. 1. Goodwill which impairment is not tax deductable will not result in any deferred tax liability (DTL). E.g.				CA		TB		Temp.Diff Goodwill (purchased) 	12 Impairment (Y1)		(2) 10		NIL		10×TR =DTL (NOTE 1) Impairment (Y2)		(3) 07		NIL		07×TR =DTL NOTE 1. It is an exception so we are not booking any liability. (Commentary: Above accounting is not acceptable for tax authorities. They do not allow deducting goodwill impairment from CA. Neither should it be deducted from the books of subsidiary nor in the form of reduction in liability). 2. The initial recognition of an asset or liability in a transition which: I.	Is not a business combination; and II. At the time of the transaction, affects neither accounting nor taxable profit (tax loss). Example (1): if your company is going to receive commission income in the future. You record this transaction as: DR	Commission receivable CR	Commission income This transaction neither resulting in business combination nor affecting taxable profit (because tax authorities do not accept this income, which is not received yet). But this do affects accounting profit at the time of transaction. This is not an exception.

Example (2): Company received govt grant and treated it as deferred income. Tax authorities are not going to tax this grant. Journal entry for the grant received or to be received: DR	Cash/Receivable CR	Govt grant This is not a business combination. Neither it is hitting taxable profit nor accounting profit at the time of transaction. Neither cash nor govt grant goes to P&L. This is an exception. Handout Point number 9. 3. 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 ventures, except to the extent that both of the following conditions are satisfied: I.	The parent, investor or venturer is able to control the timing of reversal of the temporary difference; and II. It is probable that the temporary difference will not reverse in the foreseeable future (next 12 months). Example: A & B are two separate companies, having 40% and 60% holdings in XYZ ltd respectively. At the end of the year XYZ ltd declared dividend. According to the holding XYZ ltd is an associate of company A; and at the same time it is subsidiary of company B. A can not force XYZ not to declare dividend because it is not controlling XYZ. A is just an investor. While B’s decision can affect XYZ ltd. B is the parent having the control over the timing of reversal of the temporary difference; but it will not reverse it in the foreseeable future. Exam Tip: In exception 3, part is important. Examiner will state that parent is not receiving dividend. Summary: 1. Goodwill no impairment is deductable. 2. Initial recognition of asset

It should not be business combination		  neither should it hit accounting profit nor taxable profit. 3. Investments in subsidiary /associates/joint ventures

Control over the	It is probable that reversal of timing 	difference will not of difference		reverse in foreseeable future Bonds: Tax base of debt is gross amount. Explanation: When company issues bonds to raise finance say $100m: DR	Cash/Bank	$100m CR	Bond		$100m This involves issue cost also; DR	Bond/Issue cost	$5m CR	Cash/Bank		$5m Practically the bonds will be booked at the amount of $95m (100-5). Redemption will occur after 5 years. Bonds will be redeemed at $100m. This difference of $5m will be amortized over the period of 5 yrs. Not on the basis of straight line. From accounting perspective the Journal entry will be at the end of each year; DR	SOCI	$1m CR	Bond	$1m (this will increase the CA of bond each year) Tax authorities allow the whole amount of $5m one time in the year in which bonds are issued. Overall difference will be $4m ($5m - $1m). Carrying amount of the asset will be (100 – 4 = $96m) This $4m will increase the expense and profit will be reduced by the same and tax will be saved in the first year. This will increase the liability in the future and DTL will be booked. Commentary: When the bonds are redeemed at more than par certain amount of premium is paid. This premium on redemption is technically interest. Interest is the part of SOCI so the amount of premium on redemption is not allowed by the tax authorities as expense because the interest has already been deducted from the SOCI.

Fines Payable: Fine payable is not a provision of any kind. This arises when company couldn’t follow the law. Fine never saves tax. If org thinks that late payment of tax saves tax it is making a big mistake. Fines payable is expense nature liability. It is not income nature liability. Tax base will be the amount that will be allowed as expense in the future. In future no amount will be allowed as expense. Provision is a liability where expense will be allowed in the future where as fine payable is a liability for which no amount of expense will be allowed as expense. If the both were same there would have been no difference between them.

Rent Received in advance: Rent received in advance is income nature liability. Accounting for unearned income: Dr	Cash Cr	Unearned income when income is earned: Dr	Unearned income Cr	Income Tax authorities do not accept this treatment. According to them unearned income is taxable when it is received. Actually you are receiving the cash at present so the whole amount is taxable in the current year. This means you are paying tax on liability. But when the income will be earned no tax is paid by the company. Today’s payment of tax is saving in future. This will arise the Deductable temporary difference hence DTA (asset).