IAS 12, INCOME TAXES

By Graham Holt
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IAS 12, Income Taxes, deals with taxes on income, both current tax and
deferred tax. Income tax accounting is comlex, and rearers and users find
some asects difficult to understand and aly. !hese difficulties arise from
excetions to the rinciles in the current standard, and from areas where the
accounting does not reflect the economics of the transactions.
!he current tax exense for a eriod is based on the taxable and deductible
amounts that will be shown on the tax return for the current year. "urrent tax
assets and liabilities for the current and rior eriods are measured at the
amount exected to be aid to or reco#ered from the tax authorities, using the
tax rates and tax laws that ha#e been enacted or substanti#ely enacted by the
date of the financial statements.
A mismatch can occur because International $inancial %eorting Standards
&I$%S' recognition criteria for items of income and exense are different from
the treatment of items under tax law. (eferred taxation accounting attemts to
deal with this mismatch. !he IAS 12 standard is based on the temorary
differences between the tax base of an asset or liability and its carrying amount
in the financial statements.
!he tax base of an asset or liability is the amount attributed to it for tax
uroses, based on the exected manner of reco#ery. IAS 12 focuses on the
future tax conse)uences of reco#ering an asset only to the extent of its carrying
amount at the date of the financial statements. $uture taxable amounts arising
from reco#ery of the asset will be caed at the asset*s carrying amount.
$or examle, a roerty may be re#alued uwards but not sold, creating a
temorary difference because the carrying amount of the asset in the financial
statements is greater than the tax base of the asset. !he tax conse)uence is a
deferred tax liability.
(eferred tax is ro#ided in full for all temorary differences arising between the
tax bases of assets and liabilities and their carrying amounts in the financial
statements. !here are excetions where the temorary difference arises from+
, Initial recognition of goodwill.
, Initial recognition of an asset or liability in a transaction that is not a business
combination and that affects neither accounting rofit nor taxable rofit.
, In#estments in subsidiaries, branches, associates and -oint #entures where
certain criteria aly.
(eferred tax assets and liabilities are measured at the tax rates that are
exected to aly to the eriod when the asset is realised or the liability is
settled and discounting of deferred tax assets and liabilities is not ermitted.
!he measurement of deferred tax liabilities and deferred tax assets reflects the
tax conse)uences of the manner in which the entity exects to reco#er or settle
the carrying amount of its assets and liabilities. !he exected manner of
reco#ery for land with an unlimited life is always through sale, but for other
assets the manner in which management exects to reco#er the asset, either
through use or sale or both, should be considered at each date of the financial
statements.
A deferred tax asset is recognised to the extent that it is robable that taxable
rofit will be a#ailable against which the deductible temorary difference can be
used. !his also alies to deferred tax assets for unused tax losses carried
forward. "urrent and deferred tax is recognised in rofit or loss for the eriod,
unless the tax arises from a business combination or a transaction or e#ent that
is recognised outside rofit or loss, either in other comrehensi#e income or
directly in e)uity in the same or different eriod.
$or examle, a change in tax rates or tax laws, a reassessment of the
reco#erability of deferred tax assets or a change in the exected manner of
reco#ery of an asset ha#e tax conse)uences that are recognised in rofit or loss,
excet to the extent that they relate to items re#iously charged or credited
outside rofit or loss.
!hat, at least, is the current osition on current and deferred taxation under
I$%S. !he roosed amendments to IAS 12 issued in .arch 2//0 would ha#e
made significant changes. Howe#er, after considering the unenthusiastic
feedbac1, the International Accounting Standards Board &IASB' has decided not
to roceed with its roosals but to focus on ractical issues with the existing
standard. !he IASB and the $inancial Accounting Standards Board &$ASB' will
consider fundamentally re#iewing the accounting for income taxes some time in
the future. In the meantime, the IASB is underta1ing a limited2scoe ro-ect to
see which issues can be addressed in the shorter term.
!he ro-ect aims to resol#e roblems without changing the fundamental
aroach under IAS 12, and without increasing differences with 3S GAA4. !he
ro-ect will co#er the following+
, deferred tax arising from roerty remeasurement at fair #alue5
, uncertain tax ositions5
, introduction of a ste to consider whether the reco#ery of an asset or
settlement of a liability will affect taxable rofit5
, recognition of a deferred tax asset in full and an offsetting #aluation allowance
to the extent necessary5
, guidance on assessing the need for a #aluation allowance5
, guidance on substanti#e enactment of tax laws5 and
, allocation of current and deferred taxes within a grou that files a consolidated
tax return.
In Setember 2/1/, an IASB exosure draft roosed an excetion to the
existing rincile for measuring deferred tax assets or liabilities arising on
certain non2financial assets measured at fair #alue. !he excetion alies to+
, in#estment roerty measured using the fair #alue model in IAS 6/5
, roerty, lant and e)uiment or intangible assets measured using the
re#aluation model in IAS 17 or IAS 895 and
, in#estment roerty, roerty, lant and e)uiment or intangible assets
initially measured at fair #alue in a business combination if the fair #alue
or re#aluation model was used when the underlying asset was
subse)uently measured.
(eferred tax assets and liabilities are currently measured on the basis of+
, the exected manner of reco#ery &asset' or settlement &liability'5 and
, the tax rate exected to aly when the underlying asset &liability' is
reco#ered &settled'.
!he exected manner of reco#ery or settlement may affect the calculation of the
tax base or the alicable tax rate or both. In such cases management*s
intentions are 1ey in determining the amount of deferred tax to recognise.
!he issue is that it can be difficult and sub-ecti#e to determine the exected
manner of reco#ery. !he IASB*s roosed excetion to this measurement
rincile alies to in#estment roerty, roerty, lant and e)uiment, and
intangible assets measured using the fair #alue or re#aluation model in
accordance with rele#ant I$%Ss. 3nder this excetion, the measurement of
deferred tax assets and liabilities reflects a rebuttable resumtion that the
carrying amount of the underlying asset will be reco#ered entirely through sale.
!he resumtion could be rebutted only when there is clear e#idence that the
underlying asset*s economic benefits will be consumed by the entity throughout
the asset*s economic life.!he IASB has roosed this excetion to the
measurement rincile that disregards management*s intention unless there is
clear e#idence to suort consumtion through use. It will affect entities holding
in#estment roerty, roerty, lant and e)uiment or intangible assets
measured at fair #alue where the caital gains tax rate is different from the
income tax rate, and:or the tax base from sale is different from tax base from
use. !he deferred tax liability will be reduced significantly where there is no
caital gains tax. ;udgment will be re)uired to determine whether clear e#idence
exists. SI" 21, Income Taxes - Recovery of Revalued Non-Depreciable Assets,
will be withdrawn by the amendment.
Assets measured at cost, or other assets measured at fair #alue such as financial
instruments, are not in the scoe of the IASB*s exosure draft. Howe#er, it is
unclear why the same rinciles do not aly to these assets. !he result is that
there will be a different aroach to deferred tax accounting by entities with
identical assets and tax rates but different accounting olicies.
!he IASB*s exosure draft re)uires full retrosecti#e alication, with early
adotion ermitted. "omlexities might therefore arise if the underlying assets
were ac)uired in a business combination.
E*a&%le
An entity has in#estment roerty o#erseas that is currently out on rental. !he
entity has decided that it may sell the roerty. !he roerty is measured at fair
#alue under IAS 6/. In the o#erseas country, there are different tax rates
deending on whether an entity reco#ers an asset through use &8/<' or sale
&2/<'. !he entity anticiates that it will reco#er 6/< of the roerty*s economic
benefits through use. !he fair #alue:carrying amount of the roerty is =>m,
=2.>m of which is the land #alue. !he tax base is =8m, which is slit e)ually
o#er land and buildings.

Te&%orary
di!!erence
Ta* rate
$e!erred
ta*
lia"ility
?and =1m 2/< =2//,///
Building 2 reco#er
through use
=6//,/// 8/< =12/,///
Building 2 reco#er
through sale
=7//,/// 2/< =12/,///
!otal =2m =66/,///

Solution
Gi#en that the entity has a dual intention of use and sale with resect to the
reco#ery of the asset, the deferred tax calculation could reflect that dual
intention. 4art of the buildings may be reco#ered through usage, in which case
the deferred tax liability for that art would be calculated using a 8/< tax rate.
@ote that the exected manner of reco#ery for land with an unlimited life is
always through sale.
Howe#er, the exosure draft roosals ha#e a rebuttable resumtion that the
carrying amount of the roerty will be reco#ered through sale, so the deferred
tax liability would be calculated in total as =&>28'm A 2/<, i.e. =6//,///. !he
entity could use the tax rate alicable for reco#ery through use of 8/< only to
the extent it had clear e#idence that it would reco#er the carrying amount of the
in#estment roerty through usage.
It is clear that the exosure draft roosals could result in a significant change
in the deferred tax calculation. A series of iecemeal changes to IAS 12 could
ha#e a significant imact on deferred taxation balances.
+raha& ,olt is an e*a&iner !or ACCA and e*ecutie head o! the
accounting and !inance diision at Manchester Metro%olitan -niersity
.usiness School