Deferred Tax Scenarios

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Deferred Tax Scenarios

So as we saw in the introductory section, deferred tax is all about matching.

If the accounts show the income, then they must also show any related tax.

This is normally not a problem as both the accounts and taxman often charge amounts in the same period.

The problem occurs when they don’t.

We saw how the accounts may show income when the performance occurs, while the taxman only taxes it (tax base) when the money is received.

In this case, as financial reporters we must make sure we match the income and related expense.

So this was a case of the accounts showing ‘more income’ than the tax man in the current year (he will tax it the following year when the money is received).

So we had to bring in ‘more tax’ ourselves by creating a deferred tax liability.

So, basically deferred tax is caused simply by timing differences between IFRS rules and tax rules.

Therefore IFRS demands that matching should occur i.e.

Difference between IFRS and Tax base Tax adjustment needed for matching to occur Deferred Tax  Double entry
More Income in I/S More tax needed Liability Dr Tax (I/S)
Cr Def Tax Liability (SFP)

Hopefully you can see then that the opposite  also applies:

Difference between IFRS and Tax base Tax adjustment needed for matching to occur Deferred Tax  Double entry
More expense in I/S Less tax needed Asset Dr Def tax asset
Cr tax (I/S)

In fact, the following table all applies:

Difference Tax effect Difference
1 More Income More tax Liability
2 Less income Less tax Asset
3 More expense Less tax Asset
4 Less expense More tax Liability

Remember this “more income etc.” is from the point of view of IFRS. I.e. The accounts are showing more income, as the taxman does not tax it until next year.


We will now look at each of these 4 cases in more detail.

Case 1

Difference Tax effect Deferred Tax
1 More Income More tax Liability

Issue

IFRS shows more income than the taxman has taken into account.

Example
Royalties receivable above.

Double entry required:
Dr Tax (I/S)
Cr Deferred tax Liability (SFP)


Case 2

Difference Tax effect Deferred Tax
2 Less Income Less tax Asset

     

Issue

IFRS shows less income than the taxman has taken into account.

Example
Taxman taxes some income which IFRS states should be deferred such as upfront receipts on a long term contract.

Double entry required:
Dr Deferred Tax Asset (SFP)
Cr Tax (I/S)

This will have the effect of eliminating the tax charge for now, so matching the fact that IFRS is not showing the income yet either.
Once the income is shown, then the tax will also be shown by:

Dr Tax (I/S)
Cr Deferred tax asset (SFP)


Case 3

Difference Tax effect Deferred Tax
3 More Expense Less tax Asset

Issue

IFRS shows more expense than the taxman has taken into account.

Example

IFRS depreciation is more than Tax depreciation (WDA or CA).

Double entry required:
Dr Deferred Tax Asset (SFP)
Cr Tax (I/S)

Illustration

                                 

IFRS

TAX

Asset Cost 1,0001,000
Depreciation (400) (300)
NBV 600700


Simply compare 700-600 =100

100 x tax rate = deferred tax asset


Case 4

Difference Tax effect Deferred Tax
4 Less Expense More tax Liability

     

Issue

IFRS shows less expense than the taxman has taken into account.

Example

IFRS depreciation is less than Tax depreciation (WDA or CA).

Double entry required:
Dr Tax I/S
Cr Deferred Tax Liability

Illustration

                                 

IFRS

TAX

Asset Cost 1,0001,000
Depreciation (300) (400)
NBV 700600

Simply compare 700-600 =100

100 x tax rate = deferred tax liability

Then multiply this by the tax rate (e.g. 30%) = 100 x 30% = 30


NOTE

In actual fact, the standard refers to assets and liabilities rather than more income and more expense etc. Simply use the above tables and substitute the word asset for income and expense for liability.

Difference Tax effect Difference
1 More Asset More tax Liability
2 Less Asset Less tax Asset
3 More Liability Less tax Asset
4 Less Liability More tax Liability

Possible Examination examples of Case 1& 4

Accelerated capital allowances (accelerated tax depreciation) - see above.

Interest revenue - some interest revenue may be included in profit or loss on an accruals basis, but taxed when received.

Development costs - capitalised for accounting purposes in accordance with IAS 38 while being deducted from taxable profit in the period incurred.

Revaluations to fair value

In some countries the revaluation does not affect the tax base of the asset and hence a temporary difference occurs which should be provided for in full based on the difference between its carrying value and tax base.

NOTE: Double entry here is:
Dr Revaluation Reserve with the tax (as this is where the “income” went)
Cr Deferred tax liability

Fair value adjustments on consolidation
IFRS 3/ IAS 28 require assets acquired on acquisition of a subsidiary or associate to be brought in at their fair value rather than carrying amount.

The deferred tax effect is a consolidation adjustment - this is more assets (normally) so a deferred tax liability. The other side would be though to increase goodwill. And vice-versa.

Undistributed profits of subsidiaries, branches, associates and joint ventures

No deferred tax liability if Parent controls the timing of the dividend.


Possible Examination examples of Case 2 & 3

Provisions - may not be deductible for tax purposes until the expenditure is incurred.

Losses - current losses that can be carried forward to be offset against future taxable profits result in a deferred tax asset.

Fair value adjustments
liabilities recognised on business combinations result in a deferred tax asset where the expenditure is not deductible for tax purposes until a later period.

A deferred tax asset also arises on downward revaluations where the fair value is less than its tax base.
NOTE: Here, the deferred tax asset here is another asset of S at acquisition and so reduces goodwill.

Unrealised profits on intragroup trading
the tax base is based on the profits of the individual company who has made a realised profit.

THERE IS NO DEFERRED TAX EFFECT ON INITIAL GOODWILL.


How much deferred tax?

Deferred tax is measured at the tax rates expected to apply to the period when the asset is realised or liability settled, based on tax rates (and tax laws) that have been enacted by the end of the reporting period.

No Discounting

Deferred tax assets are only recognised to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be used.

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