IAS 12 Deferred Tax

CareerDeal – IFRS
training
IAS 12 – Income taxes
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PwC
Introduction
Slide 3
July 2018IAS 12 - Income taxes

PwC
Introduction
• Accounting for tax expense can provide a number of challenges to the
accountancy profession
• The following areas will be addressed in the seminar:
- basic understanding of both current and deferred tax
- recognition and measurement of current tax
- recognition and measurement of deferred tax
- presentation and disclosure
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PwC
Current tax
Deferred tax+
Tax expense=
Accounting for tax under IFRS and GAPSME
• The following standards, or
sections, address accounting
for an entity’s tax expense:
- IFRS: IAS 12
- GAPSME: Section 16
• Both frameworks apply the
same conceptual approach to
the recognition and
measurement of tax balances
- Components of tax expense
include deferred tax under
both frameworks
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PwC
Understanding current and deferred
tax
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PwC
Accounting profit and taxable profit
• Accounting profit - the profit or loss for a period before deducting tax
expense
• Taxable profit (tax loss) - the profit (loss) for a period, determined in
accordance with the rules established by the taxation authorities,
upon which income taxes are payable (recoverable)
Financial statements Tax accounts
400 Gross profit 400
Costs:
(200) - salaries and wages (200)
(100) - general overheads (100)
(20) - donations -
80
Accounting profit /
Taxable profit 100
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PwC
Current tax
• Current tax - the amount of income taxes payable (recoverable) in
respect of the taxable profit (tax loss) for a period
€
Taxable profit 100
Current tax charge at 35% 35
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PwC
Deferred tax
• In simple terms:
- current tax is the amount of income tax currently due to the tax
authorities in respect of current year’s results
- deferred tax is a method of accounting for tax on an accruals basis,
In other words…
Deferred tax expense (income) is the amount of tax expense (income)
included in the determination of profit or loss for the period in
respect of changes in deferred tax assets and deferred tax liabilities
during the period.
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PwC
Tax expense
• Tax expense (tax income) - the aggregate amount included in the
determination of profit or loss for the period in respect of current tax
and deferred tax
€
Tax expense:
- current tax expense 35
- deferred tax expense 7
42
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PwC
Recognition and measurement of
current tax
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PwC
Current tax
• Current tax expense
- Current tax is the amount of tax payable or recoverable in respect
of the taxable profit or tax loss for the current period
• Current tax assets and liabilities
- If the amount already paid to the tax authorities (eg. through
provisional tax payments) exceeds the amounts due for those
periods, the excess should be recognised as an asset
- Unpaid taxes for current and prior periods should be recognised as
a liability and charged to profit or loss (or equity) as an expense
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PwC
Provisional tax payments
• Provisional tax payments are a series of advance tax payments in
anticipation of the current tax charge for the period
- if provisional tax payments exceed the current tax charge for the
year, then the excess will be recognised as an asset in the statement
of financial position
◦ a liability will be recognised if the current tax charge for the year
exceeds the provisional tax payments made
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PwC
Example
• Provisional tax payments were effected as follows:
- April: €200
- August: €300
- December: €500
• Current tax charge for the year is assessed at €850
- in this example, the company has paid €150 more than the current
tax charge for the year, and as a result will recognise a current tax
asset of €150
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PwC
Example: accounting entries
• As long as the accounting entries are recorded properly, it makes no
difference whether the provisional tax payments are initially
recorded in the statement of financial position or in profit of loss
• Taking the above figures from the example, the accounting entries
could be entered as follows:
- Recording tax payments in the statement of financial position:
◦ Dr Current tax asset €1,000
◦ Cr Cash €1,000
◦ Dr Current tax charge €850
◦ Cr Current tax asset €850
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PwC
Example: accounting entries - continued
• Recording tax payments in profit or loss:
- Dr Current tax charge €1,000
- Cr Cash €1,000
- Dr Current tax asset €150
- Cr Current tax charge €150
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PwC
Differences between accounting profit and taxable
profit
• Differences between accounting profit and taxable profit may give
rise to deferred tax implications
• Some common situations giving rise to differences are considered
below:
Area
Accounting
treatment Tax treatment
Deferred tax
implications?
Depreciation
of PPE
Depreciated to
residual value, over
useful life, using a
systematic basis
Generally
depreciated over
pre-defined life
using straight-line
basis
P/O
Leases of
motor
vehicles
Recognised as an
expense
Expense is capped if
the motor vehicle is
non-commercial
O
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PwC
profit - continued
Area
Accounting
Deferred tax
implications?
Provisions
for
impairment
of receivables
Movements
recognised in
profit or loss
Only deductible for
tax purposes if loss
is crystallised as
unrecoverable
P
Fair value
movements
on financial
assets at FV
through
profit or loss
Movements
recognised in
profit or loss
Unless trading, only
chargeable (or
deductible) if
realised upon a
disposal, and may
also be exempt
P/O
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PwC
profit - continued
Area
Accounting
Deferred tax
implications?
Fair
valuation of
investment
property
Recognised in
profit or loss
(under IFRS), or
reserve (under
GAPSME)
Only chargeable to
tax upon a disposal
P
Donations Recognised as an
expense
Disallowed for tax
purposes
O
Rental
income from
property
Income, and
expenses incurred
to generate the
income, recognised
in profit or loss
A maintenance
allowance at 20% of
rental income is
deductible for tax
purposes/ 15% FWT
O
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PwC
Recognition and measurement of
deferred tax
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PwC
Deferred tax assets and liabilities
• Deferred tax liabilities - the amounts of income taxes payable in
future periods in respect of taxable temporary differences
- eg. entity recognises an unrealised gain of 20 on fair valuation of a
financial investment, with the gain only becoming taxable upon an
eventual disposal of the investment
• Deferred tax assets - the amounts of income taxes recoverable in
future periods in respect of:
- deductible temporary differences,
- the carryforward of unused tax losses, and
- the carryforward of unused tax credits
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PwC
Temporary differences
• Temporary differences - differences between the carrying amount of
an asset or liability in the statement of financial position and its tax
base, i.e. its value for tax accounting purposes. Temporary
differences may be either:
- taxable temporary difference, or
- deductible temporary difference
• For example, for an item of PPE:
Carrying amount Tax base
100 Cost 100
(20) Accumulated depreciation (25)
80 Carrying amount / Tax base 75
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PwC
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 that will flow to an
entity when it recovers the carrying amount of the asset
• If those economic benefits are not taxable, the tax base of the asset is
equal to its carrying amount
• If no amount can be deductible for tax purposes, the tax base of the
asset is zero
Tax base of an asset
Tax base of an
asset
Carrying
amount
Taxable amount
arising from
recovery of the
asset
Deductible
amount arising
from use of the
asset
+-=
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PwC
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
• 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
Tax base of liability
Tax base of a
liability
Carrying
amount
Deductible
amount arising
from settlement
of liability
Taxable amount
arising from
settlement of
liability
+-=
Slide 24

PwC
Tax bases of assets and liabilities
“Short-cut” to work out the tax base
• A “short-cut” is to ask the following question:
- Is the asset/liability treated differently for tax than it is for
accounting purposes?
• If there is no difference in treatment, then the tax base will equal the
carrying amount
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PwC
• Where an asset has a higher book value than its tax base, the
temporary difference will be “taxable” because the entity will owe
additional current tax (as a proportion of accounting profit) when it
recovers the asset
- where the tax base exceeds the carrying amount the temporary
difference is “deductible”
• This works the other way round for liabilities in that a carrying
amount higher than the relevant tax base gives rise to a “deductible”
temporary difference, and where the carrying amount is below the
tax base a “taxable” temporary difference arises
• Deductible temporary differences result in deferred tax assets while
taxable temporary differences give rise to deferred tax liabilities
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PwC
Accounting entries for deferred tax
Movements in the statement of financial position
• Deferred tax assets or liabilities do not represent tax currently due or
receivable from the tax authorities
- it is merely an accruals basis of accounting for future tax
consequences of gains or losses already recognised in the
accounting records
• In accounting for deferred tax, the deferred tax balance in the
statement of financial position will be:
- debited (if there is an increase in a deferred tax asset or a decrease
in deferred tax liability), or
- credited (if there is a decrease in a deferred tax asset or an increase
in deferred tax liability)
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PwC
Accounting entries for deferred tax
Recognition of the charge or credit for the period
IAS 12 and Section 16 of GAPSME require an entity to account for the
tax consequences of transactions and other events in the same way that
it accounts for the transactions and other events that gave rise to the tax
consequence
Recognition of transaction
giving rise to deferred tax Recognition of deferred tax
Profit or loss Profit or loss
Directly in equity Directly in equity
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PwC
Other considerations
• Some items are not recognised as assets or liabilities in the statement
of financial position but their tax base may not be zero
- eg. under certain circumstances, development costs would be
expensed in accordance with the provisions of IFRS or GAPSME,
but recognised as an asset for tax accounting purposes
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PwC
Examples of temporary differences with deferred
tax implications
• Common examples of temporary
differences with deferred tax
implications include the
following
• Each one will be considered
separately
Provision
for
impairment
of
receivables
Unutilised
group relief
Unutilised
investment
tax credits
(BPA)
Fair
valuation of
investment
property
Property,
plant &
equipment
Unabsorbed
capital
allowances /
unutilised
tax losses Fair
valuation of
investments
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PwC
tax implications
Provision for impairment of receivables
• Provision for impairment of
receivables changes the carrying
amount but not the tax base of
the receivable
- i.e. any movement in the
provision is eliminated when
computing current tax
Provision
for
impairment
of
receivables
Unutilised
group relief
Unutilised
investment
tax credits
(BPA)
Fair
valuation of
investment
property
Property,
plant &
equipment
Unabsorbed
capital
allowances /
unutilised
tax losses Fair
valuation of
investments
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PwC
tax implications
Provision for impairment of receivables - continued
• Bad debts are deductible for
current tax purposes when they
are actually written off
• This creates a difference in
accounting and taxable profits,
thus giving rise to a temporary
difference
Provision
for
impairment
of
receivables
Unutilised
group relief
Unutilised
investment
tax credits
(BPA)
Fair
valuation of
investment
property
Property,
plant &
equipment
Unabsorbed
capital
allowances /
unutilised
tax losses Fair
valuation of
investments
Slide 32

PwC
tax implications
Provision for impairment of receivables: example
• Year 1
• Company A made an accounting profit of €100,000
• The accounting profit of €100,000 is stated after the creation of a
provision of €10,000 against impairment of an overdue receivable
• Taxable profit is €110,000
- the movement in the provision is disallowed for tax accounting
purposes
• In the tax computation:
- an increase in provision for impairment of receivables is always
added back to accounting profit in order to determine taxable
profit
- a decrease in provision is deducted from accounting profit
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PwC
tax implications
Provision for impairment of receivables: - continued
• Year 2
• The overdue debtor has gone into liquidation, and Company X will
only receive the €1,000 of the amount owed to it
• Company X therefore releases the provision (credit to profit or loss)
of €10,000 that it created in Year 1 and writes off the bad debt of
€9,000 (debit to profit or loss)
• Accounting profit in Year 2 is €80,000
• Taxable profit is €70,000
- the movement in provision is not deductible
- the bad debt write off is however deductible
Slide 34

PwC
tax implications
Financial statements Tax accounts
Year 1
110,000 Profit before mvmt in provision 110,000
(10,000) Mvmt in provision for impairment -
100,000 Accounting profit / Taxable profit 110,000
Year 2
79,000 Profit before mvmt in provision 79,000
10,000 Mvmt in provision for impairment -
(9,000) Impairment charge (9,000)
80,000 Accounting profit / Taxable profit 70,000
180,000Aggregate profit 180,000
Slide 35

PwC
tax implications
• The current tax charge will be:
Year 1 Year 2 Total
€ € €
Accounting profit 100,000 80,000 180,000
Movement in provision for impairment 10,000 (10,000) -
Taxable profit 110,000 70,000 180,000
Current tax charge @ 35% 38,500 24,500 63,000
Current tax charge as a % of accounting profit 38.5% 30.6% 35.0%
Slide 36

PwC
tax implications
• The provision gives rise to a deductible temporary difference, i.e. a
deferred tax asset
• The difference is temporary because the provision will be allowed for
current tax purposes at a later stage, i.e. when the loss materialises
Year 1 Year 2 Total
€ € €
Deferred tax (credit)/charge @ 35% (3,500) 3,500 -
Slide 37

PwC
tax implications
• The effect of recognising deferred tax is as follows:
Year 1 Year 2 Total
€ € €
Current tax charge 38,500 24,500 63,000
Deferred tax (credit)/charge (3,500) 3,500 -
Tax expense 35,000 28,000 63,000
Tax expense as a % of accounting profit 35.0% 35.0% 35.0%
Slide 38

PwC
Deferred tax case study
• In the case study we will consider a fictional company, Company X
• Company X made an accounting profit of €50,000 in each year under
consideration
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PwC
Provision for impairment of receivables
• Year 1
• The accounting profit of €50,000 is stated after the creation of a
provision of €1,000 against impairment of an overdue receivable
• Year 2
• Accounting profit is also €50,000. The overdue debtor has gone into
liquidation, and Company X will not receive the €1,000 owed to it
Slide 40

PwC
• The current tax charge will be:
Year 1 Year 2 Total
€ € €
Taxable profit 51,000 49,000 100,000
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PwC
• The deferred tax charge will be:
Year 1 Year 2 Total
€ € €
Deferred tax (credit)/charge @ 35% (350) 350 -
Slide 42

PwC
Year 1 Year 2 Total
€ € €
Deferred tax (credit)/charge (350) 350 -
Tax expense 17,500 17,500 35,000
Slide 43

PwC
tax implications
Property, plant & equipment
It is important to distinguish
between temporary differences
that:
• give rise to deferred tax
assets/liabilities
• do not give rise to deferred tax
assets/liabilities
Provision
for
impairment
of
receivables
Unutilised
group relief
Unutilised
investment
tax credits
(BPA)
Fair
valuation of
investment
property
Property,
plant &
equipment
Unabsorbed
capital
allowances /
unutilised
tax losses Fair
valuation of
investments
Slide 44

PwC
tax implications
Property, plant & equipment - continued
Temporary differences that give rise to deferred tax assets / liabilities:
• Depreciation for tax purposes (called “capital allowances”) is
calculated at specific rates as determined by the CIR
• These rates may be different from the accounting rates, thus giving
rise to a temporary difference
• The difference is temporary because, over the course of the asset’s
lifetime, the aggregate accounting and aggregate tax depreciation
charges will converge towards each other until both result in a fully
depreciated asset
Slide 45

PwC
tax implications
• In calculating the current tax charge, the accounting depreciation is
added back, and the capital allowances are taken as a charge against
profits
• Deferred tax is provided for at 35% on the resultant temporary
difference
• Similarly, when an item of PPE is disposed:
- the accounting profit/loss on disposal is added back to accounting
profit
- tax profit/loss (“balancing charge/allowance”) is taken instead
Slide 46

PwC
tax implications
Temporary differences that do not give rise to deferred tax assets /
liabilities:
• Specific criteria must be met for PPE to be allowed by the CIR for tax
(eg. necessarily incurred in income-generation, etc.)
• If the IRD recognition criteria is not met, then the depreciation for
tax purposes is NIL. In this case, the difference when compared to
accounting depreciation will not reverse over time, and the
accounting depreciation is added back to accounting profits with no
further consequence
• In the case of non-commercial vehicles, €14,000 of the value is
allowed by the IRD for depreciation purposes
Slide 47

PwC
tax implications
Property, plant & equipment: example 1
• Beginning of Year 1
• Company B purchases laptop computers costing €6,000
• Accounting depreciation rate is 33.3%
• Rate of capital allowances is 25%
• Years 1 - 4
• Accounting depreciation is €2,000 p.a. with the asset being fully
depreciated at the end of Year 3
• Capital allowances are €1,500 p.a. with the asset being fully
depreciated at end of Year 4
• Company B made a an accounting profit before tax of €20,000 p.a.
Slide 48

PwC
tax implications
Property, plant & equipment: example 1 - continued
Accounting Tax Diff
€ € €
Year 1
Purchase of asset 6,000 6,000 -
Depreciation charge at 33.3% / 25% (2,000) (1,500) (500)
Accounting NBV / tax WDV at end of year 4,000 4,500 (500)
Year 2
Accounting NBV / tax WDV at end of year 2,000 3,000 (1,000)
Year 3
Accounting NBV / tax WDV at end of year - 1,500 (1,500)
Year 4
Depreciation charge at 0% / 25% - (1,500) 1,500
Accounting NBV / tax WDV at end of year - - -
Slide 49

PwC
tax implications
• The current tax charge will be as follows:
Year 1 Year 2 Year 3 Year 4 Total
€ € € € €
Accounting profit 20,000 20,000 20,000 20,000 80,000
Add back a/cing dep'n 2,000 2,000 2,000 - 6,000
Less capital allowances (1,500) (1,500) (1,500) (1,500) (6,000)
Taxable profit 20,500 20,500 20,500 18,500 80,000
Current tax @ 35% 7,175 7,175 7,175 6,475 28,000
Current tax as a % of profit 35.9% 35.9% 35.9% 32.4% 35.0%
Slide 50

PwC
tax implications
• The deferred tax (credit)/charge will be as follows:
€ € € € €
Accounting net book value 4,000 2,000 - -
Tax written down value 4,500 3,000 1,500 -
Temporary difference (500) (1,000) (1,500) -
Mvmt in temporary difference (500) (500) (500) 1,500 -
Def tax (credit)/charge @ 35% (175) (175) (175) 525 -
Slide 51

PwC
tax implications
• The effect or recognising deferred tax is as follows:
€ € € € €
Current tax charge 7,175 7,175 7,175 6,475 28,000
Def tax (credit)/charge (175) (175) (175) 525 -
Tax expense 7,000 7,000 7,000 7,000 28,000
Tax as a % of profit 35.0% 35.0% 35.0% 35.0% 35.0%
Slide 52

PwC
• Company C purchased a non-commercial motor vehicle at a cost of
€28,000
• Both the accounting depreciation rate and the rate of capital
allowances are 20%
• Tax base of the vehicle is initially €14,000
• Years 1 - 4
• Accounting depreciation is €5,600 p.a.
• Capital allowances are €2,800 p.a.
• The above difference does not give rise to deferred tax
assets/liabilities
• Company C made an accounting profit before tax of €60,000 p.a.
Slide 53

PwC
Property, plant & equipment: example 2 -
continued
Accounting Tax Difference
€ € €
Year 1
Purchase of asset 28,000 14,000 14,000
Depreciation charge at 20% (5,600) (2,800) (2,800)
NBV / WDV at end of year 22,400 11,200 11,200
Year 2
Year 3
Year 4
Year 5
NBV / WDV at end of year - - -
Slide 54

PwC
continued
The above difference does not give rise to a deferred tax asset. Thus,
the effective rate of 36.6% is the final effective tax rate
Year 1 Year 2 Year 3 Year 4 Year 5 Total
€ € € € € €
Accounting profit 60,000 60,000 60,000 60,000 60,000 300,000
Add back a/cing dep'n 5,600 5,600 5,600 5,600 5,600 28,000
Less capital allowances (2,800) (2,800) (2,800) (2,800) (2,800) (14,000)
Taxable profit 62,800 62,800 62,800 62,800 62,800 314,000
Current tax @ 35% 21,980 21,980 21,980 21,980 21,980 109,900
Current tax as % of profit 36.6% 36.6% 36.6% 36.6% 36.6% 36.6%
Slide 55

PwC
• Company D purchased electronic equipment at a cost of €8,000
• Year 1
• Accounting depreciation is €2,667
• Capital allowances are €2,000
• Year 2
• Company D disposes of the asset at the beginning of the year for
proceeds of €5,000
• Company D made an accounting profit before tax of €10,000 p.a.
Slide 56

PwC
continued
Accounting Tax Diff
€ € €
Year 1
NBV / WDV at end of year 5,333 6,000 (667)
Year 2
Proceeds 5,000 5,000 -
Loss on disposal / Balancing allowance (333) (1,000) 667
Total impact on results
Depreciation charge / Capital allowances (2,667) (2,000) (667)
Loss on disposal / Balancing allowance (333) (1,000) 667
Aggregate impact on results (3,000) (3,000) -
Slide 57

PwC
continued
Year 1 Year 2 Total
€ € €
Add back dep'n / loss on disposal 2,667 333 3,000
Less capital allowances / bal allowance (2,000) (1,000) (3,000)
Taxable profit 10,667 9,333 20,000
Current tax as a % of accounting profit 37.3% 32.7% 35.0%
Slide 58

PwC
continued
Year 1 Year 2 Total
€ € €
Accounting net book value 5,333 -
Tax written down value 6,000 -
Temporary difference (667) -
Movement in temporary difference (667) 667 -
Slide 59

PwC
continued
Year 1 Year 2 Total
€ € €
Tax expense 3,500 3,500 7,000
Slide 60

PwC
Property, plant & equipment: scenario 1
• Company X purchases computer hardware costing €12,000
Slide 61

PwC
Property, plant & equipment: scenario 1 - continued
Accounting Tax Diff
€ € €
Year 1
Depreciation charge at 33.3% / 25% (4,000) (3,000) (1,000)
Year 2
Year 3
Accounting NBV / tax WDV at end of year - 3,000 (3,000)
Year 4
Depreciation charge at 0% / 25% - (3,000) 3,000
Accounting NBV / tax WDV at end of year - - -
Slide 62

PwC
€ € € € €
Add back a/cing dep'n 4,000 4,000 4,000 - 12,000
Less capital allowances (3,000) (3,000) (3,000) (3,000) (12,000)
Taxable profit 51,000 51,000 51,000 47,000 200,000
Current tax @ 35% 17,850 17,850 17,850 16,450 70,000
Current tax as a % of profit 35.7% 35.7% 35.7% 32.9% 35.0%
Slide 63

PwC
€ € € € €
Accounting net book value 8,000 4,000 - -
Tax written down value 9,000 6,000 3,000 -
Temporary difference (1,000) (2,000) (3,000) -
Mvmt in temporary difference (1,000) (1,000) (1,000) 3,000 -
Def tax (credit)/charge @ 35% (350) (350) (350) 1,050 -
Slide 64

PwC
• The effect or recognising deferred tax is as follows:
€ € € € €
Current tax charge 17,850 17,850 17,850 16,450 70,000
Def tax (credit)/charge (350) (350) (350) 1,050 -
Tax expense 17,500 17,500 17,500 17,500 70,000
Tax as a % of profit 35.0% 35.0% 35.0% 35.0% 35.0%
Slide 65

PwC
• Company X also purchases a non-commercial motor vehicle at a cost
of €21,000
• Both the accounting depreciation rate and the rate of capital
allowances are 20%
• Tax base of the vehicle is initially €14,000
Slide 66

PwC
Accounting Tax Difference
€ € €
Year 1
Purchase of asset 21,000 14,000 7,000
Year 2
Year 3
Year 4
Year 5
NBV / WDV at end of year - - -
Slide 67

PwC
Year 1 Year 2 Year 3 Year 4 Year 5 Total
€ € € € € €
Accounting profit 50,000 50,000 50,000 50,000 50,000 250,000
Add back a/cing dep'n 4,200 4,200 4,200 4,200 4,200 21,000
Less capital allowances (2,800) (2,800) (2,800) (2,800) (2,800) (14,000)
Taxable profit 51,400 51,400 51,400 51,400 51,400 257,000
Current tax @ 35% 17,990 17,990 17,990 17,990 17,990 89,950
Current tax as % of profit 36.0% 36.0% 36.0% 36.0% 36.0% 36.0%
Slide 68

PwC
• Company X also purchases electronic equipment at a cost of €4,000
• Year 2
• Company X disposes of the asset at the beginning of the year for
proceeds of €3,500
Slide 69

PwC
Accounting Tax Diff
€ € €
Year 1
NBV / WDV at end of year 2,667 3,000 (333)
Year 2
Proceeds 3,500 3,500 -
Profit on disposal / Balancing charge 833 500 333
Total impact on results
Depreciation charge / Capital allowances (1,333) (1,000) (333)
Profit on disposal / Balancing charge 833 500 333
Aggregate impact on results (500) (500) -
Slide 70

PwC
Year 1 Year 2 Total
€ € €
Add back dep'n / deduct gain on disposal 1,333 (833) 500
Less capital allowances / add bal charge (1,000) 500 (500)
Taxable profit 50,333 49,667 100,000
Slide 71

PwC
Year 1 Year 2 Total
€ € €
Accounting net book value 2,667 -
Tax written down value 3,000 -
Temporary difference (333) -
Movement in temporary difference (333) 333 -
Slide 72

PwC
Year 1 Year 2 Total
€ € €
Tax expense 17,500 17,500 35,000
Slide 73

PwC
Examples of temporary differences with deferred tax
implications
Unabsorbed cap. allowances/unutilised tax losses & group relief
• Unabsorbed capital allowances,
unutilised tax losses and
unutilised group relief represent
losses that can be offset against
future trading profits
• In future periods when trading
profits are registered by the
company, these tax benefits will
be deducted from the taxable
profits, i.e. tax rate will be
applied to the result after these
deductions
Provision
for
impairment
of
receivables
Unutilised
group relief
Unutilised
investment
tax credits
(BPA)
Fair
valuation of
investment
property
Property,
plant &
equipment
Unabsorbed
capital
allowances /
unutilised
tax losses Fair
valuation of
investments
Slide 74

PwC
tax implications
Unutilised tax losses
• The existence of unused tax losses is
strong evidence that future taxable
profit may not be available
• Deferred tax assets arising from
unused tax losses or tax credits are
recognised only to the extent that:
- the entity has sufficient taxable
temporary differences, or
- there is convincing other evidence
that sufficient taxable profit will
be available against which the
unused tax losses or unused tax
credits can be utilised by the
entity
Tax
planning
opportunities
Suitable taxable
temporary differences
available? (eg. right
timing, right character)
Sufficient
suitable taxable
profits
available?
Slide 75

PwC
tax implications
Unutilised tax losses - continued
• At the end of each reporting period, an entity re-assesses
unrecognised deferred tax assets
• The entity recognises a previously unrecognised deferred tax asset to
the extent that it has become probable that future taxable profit will
allow the deferred tax asset to be recovered, eg. an improvement in
trading conditions
Slide 76

PwC
Example
• Year 1
• Company E made an accounting loss of €10,000. There were no
temporary differences and the tax loss is also €10,000
• Year 2
• Company E made an accounting profit of €20,000. Taxable profit is
€10,000 (i.e. €20,000 accounting profit less €10,000 unutilised tax
losses brought forward)
Slide 77

PwC
Example - continued
Year 1 Year 2 Total
€ € €
Accounting and tax (loss)/profit (10,000) 20,000 10,000
Unutulised tax losses cf/(bf) 10,000 (10,000) -
Chargeable income - 10,000 10,000
Current tax charge @ 35% - 3,500 3,500
Current tax as a % of accounting (loss)/profit 0.0% 17.5% 35.0%
Slide 78

PwC
Example - continued
Year 1 Year 2 Total
€ € €
Unutilised tax losses (10,000) -
Movement in unutilised tax losses (10,000) 10,000 -
Deferred tax (credit)/charge @ 35% (3,500) 3,500 -
Slide 79

PwC
Example - continued
• The effect of recording deferred tax is as follows:
Year 1 Year 2 Total
€ € €
Accounting (loss)/profit (10,000) 20,000 10,000
Current tax charge - 3,500 3,500
Tax (income)/expense (3,500) 7,000 3,500
Tax (income)/expense as a % of profit 35.0% 35.0% 35.0%
Slide 80

PwC
Examples of temporary differences with deferred tax
implications
Unutilised investment tax credits (BPA)
• Tax credits are utilised to deduct
the tax charge itself (i.e. the
result of applying the tax rate to
the taxable income), rather than
to reduce the taxable income as
in the case of unutilised losses
• Tax credits therefore reduce the
effective tax rate applicable to
the company
• Similar considerations, with
respect to recognition, apply as
for unutilised tax losses
Deferred tax asset at 100%
Provision for
impairment
of
receivables
Unutilised
group relief
Unutilised
investment
tax credits
(BPA)
Fair
valuation of
investment
property
Property,
plant &
equipment
Unabsorbed
capital
allowances /
unutilised
tax losses Fair
valuation of
investments
Slide 81

PwC
Unutilised investment tax credits
Example
• Year 1
• Company F, which qualifies for investment tax credits, broke even in
Year 1. There were no temporary differences and tax results are also
break-even
• The company qualified for tax credits of €5,000, which remain
unutilised in view of not having taxable income
• Year 2
• Company F made an accounting profit of €30,000. Taxable profit is
also €30,000
• The company does have not any tax credits from Year 2 activity, but
has the €5,000 unutilised tax credits brought forward
Slide 82

PwC
Example (continued)
Year 1 Year 2 Total
€ € €
Accounting and tax profit - 30,000 30,000
Current tax charge @ 35% before tax credits - 10,500 10,500
Tax credits utilised - (5,000) (5,000)
Slide 83

PwC
Example (continued)
Year 1 Year 2 Total
€ € €
Unutilised investment tax credits (5,000) -
Movement in unutilised invetment tax credit (5,000) 5,000
Deferred tax (credit)/ charge @ 100% (5,000) 5,000
Slide 84

PwC
Example (continued)
• The effect of recording deferred tax is as follows:
• The effective tax rate in Year 2 is 35% because the company did not
have any expenditure that qualified for tax credits.
Year 1 Year 2 Total
€ € €
Accounting profit - 30,000 30,000
Tax expense (5,000) 10,500 5,500
Tax (income)/expense as a % of profit N/A 35.0% 18.3%
Slide 85

PwC
tax implications
Fair valuation of investment property
• When investment property is
fair valued, besides taking the
movement in fair value of the
investment property in profit or
loss, we should also adjust for
the tax liability that would be
incurred on its disposal
• The tax liability may vary, in
accordance with the local tax
legislation
Provision
for
impairment
of
receivables
Unutilised
group relief
Unutilised
investment
tax credits
(BPA)
Fair
valuation of
investment
property
Property,
plant &
equipment
Unabsorbed
capital
allowances /
unutilised
tax losses Fair
valuation of
investments
Slide 86

PwC
tax implications
Fair valuation of investment property - continued
The deferred tax liability on investment property follows the way an
eventual disposal would be charged to current tax. Current tax would
be charged as follows:
• if acquired prior to 1 January 2004: 10% of the proceeds on sale
• If acquired on or after 1 January 2004: 8% of the proceeds on sale
Slide 87

PwC
tax implications
Fair valuation of investment property: example
• Company G acquired investment property in 2002
• Carrying amount at commencement of current year is €240,000,
being the value determined from a valuation carried out in the
previous year
• At the end of the year, the fair value is established at €260,000
- fair value gain, credited to profit or loss, is therefore €20,000
• Deferred tax will be charged to profit or loss @ 10% of the fair value
gain of €20,000, i.e. €2,000
• The deferred tax liability, which stood at €24,000 at the
commencement of the current year (i.e. 10% of previous fair value of
€240,000) will now increase to €26,000
Slide 88

PwC
tax implications
Fair valuation of investment property: example - continued
Property value Deferred tax
€ €
Balance at 1 January 240,000 24,000
Fair value increase during the year 20,000 2,000
Balance at 31 December 260,000 26,000
Movement for the year:
Dr Deferred tax charge (P&L) 2,000
Cr Deferred tax liability (B/S) 2,000
Slide 89

PwC
tax implications
Fair valuation of investments
• If investments’ subsequent
disposal would be charged to
current tax, then deferred tax is
to be provided for
• If subsequent disposal would
not be charged to current tax,
then no timing difference arises
and therefore no deferred tax is
to be provided for
Provision
for
impairment
of
receivables
Unutilised
group relief
Unutilised
investment
tax credits
(BPA)
Fair
valuation of
investment
property
Property,
plant &
equipment
Unabsorbed
capital
allowances /
unutilised
tax losses Fair
valuation of
investments
Deferred tax asset/liability at 35%, or
no deferred tax
Slide 90

PwC
tax implications
Fair valuation of investments - continued
• Not chargeable/deductible for tax purposes:
- Gain/loss of a capital nature on investments quoted on the MSE
- Gain/loss of a capital nature on fixed income debt securities (eg.
MGS)
• Chargeable to current tax:
- Gain of a trading nature on quoted and unquoted investments
- Gain of a capital nature on unquoted investments
• Deductible against taxable income:
- Loss of a trading nature on quoted and unquoted investments
- Loss of a capital nature on unquoted investments
Slide 91

PwC
tax implications
• Year 1
• Company H acquires four securities during the year, each at a cost of
€100. The company does not trade in investments
• Security A is a bond that pays fixed rates of interest, Security B is a
bond that pays floating rates of interest, Security C is listed on the
Malta Stock Exchange, and Security D is listed on the Frankfurt Stock
Exchange
• Company H classifies the securities as Available-for-sale, with fair
value movements taken to an equity reserve
• At end of year, the values of the investments have changed as follows:
- A: €120; B: €85;
- C: €110; D: €115
Slide 92

PwC
tax implications
• The fair value movements will give rise to the following deferred tax:
• Deferred tax is recognised directly in the revaluation reserve
Bond Bond Frankfurt
(fixed) (floating) MSE Exchange Total
€ € € € €
Year 1
Balance at 1 January - - - - -
Cost on date of acquisition 100 100 100 100 400
FV movement during the year 20 (15) 10 15 30
Balance at 31 December 120 85 110 115 430
Disposal charged to current tax? O P O P
Def tax (credit)/charge @ 0% / 35% - (5) - 5 -
Slide 93

PwC
Deferred tax assets
Exemptions from calculating deferred tax
• A deferred tax asset or liability is not recognised if that deferred tax
arises from:
- the initial recognition of goodwill, or
- the initial recognition of an asset or liability in a transaction that:
◦ is not a business combination, and
◦ at the time of the transaction, affects neither accounting profit
nor taxable profit (tax loss)
Slide 94

PwC
Exemptions from calculating deferred tax
• Non-deductible goodwill
• Other exemptions
• Group accounting issues
Slide 95

PwC
Deferred tax
Selection of a tax rate
• The basic rule is that it should be the relevant rate that is enacted or
substantively enacted by the end of the reporting period
- this is consistent also with the tax rate to be used for current tax
purposes
• Sometimes the rate will depend on how the entity uses the asset, i.e.
does it recover the asset through use in the business or does it
assume settlement (disposal) at the end of the reporting period?
• Usually an entity recovers the value through use in the business and
therefore the income tax rate (corporation tax rate) is used
Slide 96

PwC
Deferred tax
Selection of a tax rate: common exceptions
• Companies might decide to revalue their property, plant and
equipment
- property, plant and equipment means tangible items that:
◦ are held for use in the production or supply of goods or services
or for administrative purposes
◦ are expected to be used during more than one period
• Under both IFRS and GAPSME, the revaluation surplus is recognised
directly in equity
- however to the extent that the revalued carrying amount is below
depreciated cost (and hence there exists an aggregate revaluation
deficit), the deficit is recognised in profit or loss
Slide 97

PwC
Deferred tax
Selection of a tax rate: common exceptions - continued
• Difficulties can arise when considering the appropriate tax rate for an
asset that is not depreciated for accounting purposes, e.g. land
- the carrying value of a non-depreciable asset is not recovered
through charges such as depreciation
• When land and buildings classified as property, plant and equipment
are revalued the revaluation should be split between:
- land, and
- buildings
Slide 98

PwC
Deferred tax
Land
• When a non-depreciable asset is revalued, the deferred tax arising
from that revaluation is determined based on the tax rate applicable
to the recovery of the asset through sale
- this applies even if the entity does not intend to sell the asset
- the rate to use will therefore depend on whether the land was
acquired prior to 1 January 2004 or otherwise
Slide 99

PwC
Deferred tax
Buildings
• The carrying amount of the building is assumed to be recovered
through own use and hence depreciated
- therefore, an entity will still depreciate the building component,
compute capital allowances and provide for deferred tax on the
temporary differences arising
• In fact the deferred tax on the building component is calculated at
35% of the revaluation surplus
Slide 100

PwC
Deferred tax
Background information:
• Immovable property acquired ten years ago
• Property is used by the company for administration purposes
• Cost of the property was €200,000
• Revaluation model adopted in current year and property revalued to
€280,000 at end of reporting period
- before considering accumulated depreciation on the buildings, the
surplus is therefore €80,000
- in accordance with applicable standards, this change in accounting
policy is applied prospectively
Slide 101

PwC
Deferred tax
Total
€
Cost at acquisition 200,000
Fair value at first revaluation date 280,000
Carrying amount (net of applicable dep'n) 190,000
Revaluation surplus 90,000
Deferred tax rate ?
Deferred tax liability ?
Slide 102

PwC
Deferred tax
Land Buidlings Total
€ € €
Cost at acquisition 150,000 50,000 200,000
Fair value at first revaluation date 220,000 60,000 280,000
Carrying amount (net of applicable dep'n) 150,000 40,000 190,000
Revaluation surplus 70,000 20,000 90,000
Deferred tax rate 10% 35%
Deferred tax liability 22,000 7,000 29,000
Slide 103

PwC
Measurement of deferred tax assets and liabilities
Can tax assets and liabilities be discounted or offset?
• IAS 12 and Section 16 of GAPSME do not permit:
- deferred tax assets or liabilities to be discounted
- the offsetting of tax assets and liabilities unless they relate to the
same tax authority and satisfy various other conditions
Slide 104

PwC
Presentation and disclosure
Slide 105

PwC
Presentation
• The tax expense (income) related to profit or loss from ordinary
activities shall be presented on the face of the income statement
Slide 106

PwC
Presentation
Offsetting
• An entity shall offset current tax assets and current tax liabilities if,
and only if, the entity:
- has a legally enforceable right to set off the recognised amounts;
and
- intends either to settle on a net basis, or to realise the asset and
settle the liability simultaneously.
Slide 107

PwC
Presentation
Offsetting – continued
• An entity shall offset deferred tax assets and deferred tax liabilities if,
and only if:
- the entity has a legally enforceable right to set off current tax assets
against current tax liabilities; and
- the deferred tax assets and the deferred tax liabilities relate to
income taxes levied by the same taxation authority on either:
◦ the same taxable entity; or
◦ different taxable entities which intend either to settle current tax
liabilities and assets on a net basis, or to realise the assets and
settle the liabilities simultaneously
Slide 108

PwC
Disclosure
Components of tax expense
• The major components of tax expense (income) shall be disclosed
separately
• Components of tax expense (income) may include, amongst others:
- current tax expense (income),
- any adjustments for current tax of prior periods,
- the amount of deferred tax expense (income) relating to
◦ the origination and reversal of temporary differences,
◦ changes in tax rates or the imposition of new taxes,
- the amount of the benefit arising from a previously unrecognised
tax loss, tax credit or temporary difference
Slide 109

PwC
Disclosure
Components of tax expense: illustrative examples
Slide 110

PwC
Disclosure
Tax reconciliation
• The following shall also be disclosed separately:
- an explanation of the relationship between tax expense (income)
and accounting profit in either or both of the following forms:
◦ a numerical reconciliation between tax expense (income) and
the product of accounting profit multiplied by the applicable tax
rate(s)
◦ a numerical reconciliation between the average effective tax rate
and the applicable tax rate
Slide 111

PwC
Disclosure
Other disclosures: illustrative examples - continued
Slide 112

PwC
Disclosure
Other disclosures - continued
- the aggregate current and deferred tax relating to items that are
charged or credited to equity
• The following shall also be disclosed separately in respect of each
type of temporary difference, and in respect of each type of unused
tax losses and unused tax credits:
- the amount of the deferred tax assets and liabilities recognised in
the statement of financial position for each period presented
- the amount of the deferred tax income or expense recognised in
the income statement, if this is not apparent from the changes in
the amounts recognised in the statement of financial position
Slide 113

PwC
Disclosure
Other disclosures: illustrative examples
Slide 114

PwC
Disclosure
- an explanation of changes in the applicable tax rate(s) compared to
the previous accounting period
- the amount (and expiry date, if any) of deductible temporary
differences, unused tax losses, and unused tax credits for which no
deferred tax asset is recognised in the statement of financial
position
- the aggregate amount of temporary differences associated with
investments in subsidiaries, branches and associates and interests
in joint ventures, for which deferred tax liabilities have not been
recognised
Slide 115

PwC
Disclosure
Slide 116

PwC
Disclosure
- in respect of discontinued operations, the tax expense relating to:
◦ the gain or loss on discontinuance, and
◦ the profit or loss from the ordinary activities of the discontinued
operation for the period, together with the corresponding
amounts for each prior period presented
- the amount of income tax consequences of dividends to
shareholders of the entity that were proposed or declared before
the financial statements were authorised for issue, but are not
recognised as a liability in the financial statements
Slide 117

PwC
Disclosure
Slide 118

PwC
Disclosure
• An entity shall disclose the amount of deferred tax asset and the
nature of the evidence supporting its recognition, when:
- the utilisation of the deferred tax asset is dependent on future
taxable profits in excess of the profits arising from the reversal of
existing taxable temporary differences, and
- the entity has suffered a loss in either the current or preceding
period in the tax jurisdiction to which the deferred tax asset relates
Slide 119

PwC
Tax reconciliation
Example
It is important to keep in mind that any item that:
• features in only one of accounting profit and tax profit, or
• features in both but is taxed at a rate other than 35%
will necessarily feature in the tax reconciliation unless it is charged to
deferred tax at 35%
Slide 120

PwC
Tax reconciliation
Example - continued
Taking Company X in Year 1:
• Accounting profit is €50,000
• An increase of €1,000 provision for impairment of receivables was
recognised
• Depreciation on computer hardware is of €4,000 whereas capital
allowances are €3,000. The temporary difference gives rise to
deferred tax implications
• Depreciation on motor vehicles is of €4,200 whereas capital
allowances are €2,800. The difference does not give rise to deferred
tax implications
• Depreciation on electronic equipment is of €1,333 whereas capital
allowances are €1,000
Slide 121

PwC
Tax reconciliation
Example - continued
• Fair value gains on investment property, credited to profit or loss,
amounted to €10,000
• Fair value movements on securities, credited to an equity reserve,
amounted to €100
• In addition, the following information also relates to Company X:
- Interest income of €5,000 was subject to final withholding tax @
15%
- Charitable donations amounting to €100 were made
- Disallowed motor vehicle lease expenditure of €300 was incurred
- Rental income of €5,000 was earned from the investment property
(assume that there is no ground rent payable, or administrative
expenses, related to the rental income that was generated)
Slide 122

PwC
€ € Deferred tax?
Accounting profit 50,000
Add back
Donations 100 O
Mvmt in prov for impairment of receivables 1,000 P
Depreciation on computer hardware 4,000 P
Depreciation on motor vehicle 4,200 O
Depreciation on office equipment 1,333 P
Disallowed lease expenditure 300 O
Less
Maintenance allowance (1,000) O
Fair value gains on investment property (10,000) P
Capital allowances on computer hardware (3,000) P
Capital allowances on motor vehicle (2,800) O
Capital allowances on office equipment (1,000) P
(6,867)
Tax profit 43,133
Chargeable @ 15%: €5,000 750 O
Chargeable @ 35%: €38,133 13,347
Current tax charge 14,097
Slide 123

PwC
Tax reconciliation
Example - continued
€ €
Deferred tax credits
Provision for impairment of receivables (350)
Computer hardware (350)
Office equipment (117)
Deferred tax charges
Fair value gains on investment property 1,000
Deferred tax charge 183
• The deferred tax charge for the year has been computed as follows:
Slide 124

PwC
Tax reconciliation
Example - continued
• The tax expense for the year is as follows:
• Through the tax reconciliation we will be explaining the difference between
the tax charge of €14,280 and the product of accounting profit of €50,000 *
35% = €17,500
€
Deferred tax charge 183
Tax expense 14,280
Tax expense as a percentage of accounting profit 28.6%
Slide 125

PwC
Tax reconciliation
Example - continued
• These reconciling items, although adjusted for in the current tax
computation, are charged to deferred tax
- as a result they do not feature in the tax reconciliation
Add back
Donations 100 O
Less
Slide 126

PwC
Tax reconciliation
Example - continued
• The fair value gains have been charged to deferred tax (since they are
only chargeable to current tax upon disposal of property). However,
the tax rate is 10%, resulting in a decrease in tax charge of (35% -
10%) * €10,000 = €2,500
Add back
Donations 100 O
Less
Slide 127

PwC
Add back
Donations 100 O
Less
Tax reconciliation
Example - continued
• In this particular instance, we saw earlier that the depreciation rate
and the rate of capital allowances are the same, and the above
temporary difference does not give rise to deferred tax implications.
This results in an additional tax charge of 35% * (€4,200 - €2,800) =
€490
Slide 128

PwC
Tax reconciliation
Example - continued
• The above expenditure, in line with tax legislation, is disallowed for
tax purposes. This results in an additional tax charge of 35% * (€100
+ €300) = €140
Add back
Donations 100 O
Less
Slide 129

PwC
Tax reconciliation
Example - continued
• Local tax legislation allows for 20% maintenance allowance on rental
income. This reduces the tax charge by 35% of €1,000 = €350
Add back
Donations 100 O
Less
Slide 130

PwC
Tax reconciliation
Example - continued
• Under local tax
legislation,
withholding tax (at
15%) on investment
income is final
• This reduces the tax
charge by (35% -
15%) * €5,000 =
€1,000
Add back
Donations 100 O
Less
(6,867)
Tax profit 43,133
Chargeable @ 15%: €5,000 750 O
Chargeable @ 35%: €38,133 13,347
Slide 131

PwC
Tax reconciliation
Example - continued
• The differences can be summarised as follows:
Fin. stats. @ 35% Tax Appl. tax Diff
€ € € € €
Profit before other items 45,933 16,077 45,933 16,077 -
Mvmt in provision * (1,000) (350) (1,000) (350) -
Depreciation * (9,533) (3,337) (8,133) (2,847) 490
Disallowed lease rentals (300) (105) - - 105
FV gains on inv prop * 10,000 3,500 10,000 1,000 (2,500)
Maintenance allowance - - (1,000) (350) (350)
Interest income 5,000 1,750 5,000 750 (1,000)
Donations (100) (35) - - 35
50,000 17,500 50,800 14,280 (3,220)
Slide 132

PwC
Tax reconciliation
Example - continued
The tax reconciliation is now complete:
€
Tax on profit at 35% 17,500
Tax effect of:
Income subject to reduced rates of tax (1,000)
Movement in deferred tax determined on the
basis applicable to tax rules (2,500)
Expenses not deductible for tax purposes 630
Other movements (350)
Tax charge 14,280
Slide 133

PwC
Tax reconciliation
Example - continued
€
Tax effect of:
Tax charge 14,280
Interest income: (35% - 15%) * €5,000 = €1,000
Slide 134

PwC
Tax reconciliation
Example - continued
€
Tax effect of:
Tax charge 14,280
Investment property: (35% - 10%) * €10,000 = €2,500
Slide 135

PwC
Tax reconciliation
Example - continued
€
Tax effect of:
Tax charge 14,280
Depreciation on non-qualifying asset: €1,400 * 35% = €490
Disallowed expenditure: 35% * (€100 + €300) = €140
Slide 136

PwC
€
Tax effect of:
Tax charge 14,280
Tax reconciliation
Example - continued
Maintenance allowance: 35% * €1,000 = €350
Slide 137

PwC
Tax reconciliation
Other items that may commonly feature in a tax
reconciliation
• Under or over provision in tax charge from prior years
• Movement in unrecognised deferred tax asset
• Capital gains or losses made on disposal of certain financial
investments
• Share of associates’ results accounted for using the equity method
• Differences arising from the application of the Flat Rate Foreign Tax
Credit (FRFTC)
Slide 138

PwC
Conclusion
Slide 139

PwC
Current tax recap
The nine-step approach
• Current tax can be broken down into a nine-step approach:
- Calculate accounting profit
- Identify reconciling items between accounting profit and taxable
profit
- Identify unabsorbed capital allowances, tax losses, and group relief
brought forward
- Calculate taxable profit
- Determine tax rates
- Identify tax credits
- Recognise current tax
- Presentation and offsetting
- Disclosure
Slide 140

PwC
Deferred tax recap
The nine-step approach
• Deferred tax can be broken down into a nine-step approach:
- Calculate current income tax
- Determine the tax base
- Calculate temporary differences
- Identify exceptions
- Review deductible temporary differences and tax losses
- Determine tax rates
- Recognise deferred tax
- Presentation and offsetting
- Disclosure
Slide 141

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IAS 12 Deferred Tax

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