1 INTRODUCTION
1.1
The nature of taxation
Taxation has certain characteristics which set it apart from other business expenses and
which might justify a different treatment, in particular:
• tax payments are not typically made in exchange for goods or services specific to
the business (as opposed to access to generally available national infrastructure
assets and services); and
• the business has no say in whether or not the payments are to be made.
1.2 Allocation
between
periods
The most significant accounting question which arises in relation to taxation is how to
allocate tax expense between accounting periods. The recognition of transactions in
the financial statements in a particular period is governed by the application of IFRS.
However, the timing of the recognition of transactions for the purposes of measuring
the taxable profit is governed by the application of tax law, which sometimes prescribes
a treatment different from that used in the financial statements. The generally accepted
view is that it is necessary for the financial statements to seek some reconciliation
between these different treatments.
Accordingly IFRS requires an entity to recognise, at each reporting date, the tax
consequences expected to arise in future periods in respect of the recovery of its
assets and settlement of its liabilities recognised at that date. Broadly speaking, those
tax consequences that are legal assets or liabilities at the reporting date are referred
to as current tax. The other consequences, which are expected to become, or (more
strictly) form part of, legal assets or liabilities in a future period, are referred to as
deferred tax.
This is illustrated by Example 29.1, which considers the treatment of tax deductions
received against the cost of property, plant and equipment (PP&E), and the further
discussion in 1.2.1 and 1.2.2, below.
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Example 29.1: PP&E attracting tax deductions in advance of accounting
depreciation
An item of equipment is purchased on 1 January 2019 for €50,000 and is estimated to have a useful life of
five years, at the end of which it will be scrapped. There is no change to the estimated residual amount of
zero over the life of the equipment. The depreciation charge will therefore be €10,000 per year for five years.
The entity is tax-resident in a jurisdiction where the corporate tax rate is 30%. No tax deductions are given
for depreciation charged in the financial statements. Instead, the cost may be deducted from taxes payable in
the year that the asset is purchased. The entity’s profit before tax, including the depreciation charge, for each
of the five years ended 31 December 2019 to 31 December 2023 is €100,000. All components of pre-tax
profit, other than the accounting depreciation, are taxable or tax-deductible.
The entity’s tax computations for each year would show the following (all figures in €s)1:
2019
2020
2021
2022
2023
Accounting profit
100,000
100,000
100,000
100,000
100,000
Accounting
10,000
10,000
10,000
10,000
10,000
depreciation
Tax depreciation
(50,000)
–
–
–
–
Taxable profit 60,000
110,000
110,000
110,000
110,000
Tax payable @ 30%
18,000
33,000
33,000
33,000
33,000
1.2.1
No provision for deferred tax (‘flow through’)
If the entity in Example 29.1 above were to account only for the tax legally due in respect
of each year (‘current tax’), it would report the amounts in the table below in profit or loss.
Accounting for current tax only is generally known as the ‘flow through’ method.
€s
2019
2020
2021
2022
2023 Total
Profit before tax
100,000
100,000
100,000
100,000
100,000
500,000
Current tax
18,000
33,000
33,000
33,000
33,000
150,000
Profit after tax
82,000
67,000
67,000
67,000
67,000
350,000
Effective tax rate (%)
18
33
33
33
33
30
The ‘effective tax rate’ in the last row of the table above is the ratio, expressed as a
percentage, of the profit before tax to the charge for tax in the financial statements, and
is regarded as a key performance indicator by many preparers and users of financial
statements. As can be seen from the table above, over the full five-year life of the asset,
the entity pays tax at the statutory rate of 30% on its total profits of €500,000, but with
considerable variation in the effective rate in individual accounting periods.
The generally held view is that simply to account for the tax legally payable as above is
distortive, and that the tax should therefore be allocated between periods. Under IAS 12 –
Income Taxes – this allocation is achieved by means of deferred taxation (see 1.2.2 below).
However, the flow-through method attracts the support of a number of commentators.
They argue that the tax authorities impose a single annual tax assessment on the entity
based on its profits as determined for tax purposes, not on accounting profits. That
assessment is the entity’s only liability to tax for that period, and any tax to be assessed
Income
taxes
2345
in future years is not a present obligation and therefore not a liability as defined in the
IASB’s Conceptual Framework. Supporters of flow-through acknowledge the distortive
effect of transactions such as that in Example 29.1 above, but argue that this is better
remedied by disclosure than by creating what they see as an ‘imaginary’ liability for
deferred tax.
1.2.2
Provision for deferred tax (the temporary difference approach)
The approach currently required by IAS 12 is known as the temporary difference
approach, which focuses on the difference between the carrying amount of an asset or
liability in the financial statements and the amount attributed to it for tax purposes,
known as its ‘tax base’.
In Example 29.1 above, the carrying value of the PP&E in the financial statements at the
end of each reporting period is:
€s
2019
2020
2021
2022
2023
PP&E 40,000
30,000
20,000
10,000
–
If the tax authority were to prepare financial statements based on tax law rather than
IFRS, it would record PP&E
of nil at the end of each period, since the full cost of €50,000
was written off in 2019 for tax purposes. There is therefore a difference, at the end of
2019, of €40,000 between the carrying amount of €40,000 of the asset in the financial
statements and its tax base of nil. This difference is referred to as a ‘temporary’ difference
because, by the end of 2023, the carrying value of the PP&E in the financial statements
and its tax base are both nil, so that there is no longer a difference between them.
As discussed in more detail later in this Chapter, IAS 12 requires an entity to recognise a
liability for deferred tax on the temporary difference arising on the asset (at 30%), as follows.
€s
2019
2020
2021
2022
2023
Net book value
40,000
30,000
20,000
10,000
–
Tax base
–
–
–
–
–
Temporary difference
40,000
30,000
20,000
10,000
–
Deferred tax
12,000
9,000
6,000
3,000
–
Movement in deferred
tax in period
12,000
(3,000)
(3,000)
(3,000)
(3,000)
IAS 12 argues that, taking the position as at 31 December 2019 as an example, the
carrying amount of the PP&E of €40,000 implicitly assumes that the asset will
ultimately be recovered or realised by a cash inflow of at least €40,000. Any tax that
will be paid on that inflow represents a present liability. In this case, the entity pays tax
at 30% and will be unable to make any deduction in respect of the asset for tax purposes
in a future period. It will therefore pay tax of €12,000 (30% of [€40,000 – nil]) as the
asset is realised. This tax is as much a liability as the PP&E is an asset, since it would be
internally inconsistent for the financial statements simultaneously to represent that the
asset will be recovered at €40,000 while ignoring the tax consequences of doing so.
[IAS 12.16].
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The deferred tax liability is recognised in the statement of financial position and any
movement in the deferred tax liability during the period is recognised as deferred tax
income or expense in profit or loss, with the following impact:
€s
2019
2020
2021
2022
2023 Total
Profit before tax
100,000
100,000
100,000
100,000
100,000
500,000
Current tax
18,000
33,000
33,000
33,000
33,000
150,000
Deferred tax
12,000
(3,000)
(3,000)
(3,000)
(3,000)
–
Total tax
30,000
30,000
30,000
30,000
30,000
150,000
Profit after tax
70,000
70,000
70,000
70,000
70,000
350,000
Effective tax rate (%)
30
30
30
30
30
30
It can be seen that the effect of accounting for deferred tax is to present an effective tax
rate of 30% in profit or loss for each period. As will become apparent later in the
Chapter, there is some tension in practice between the stated objective of IAS 12 (to
recognise the appropriate amount of tax assets and liabilities in the statement of
financial position) and what many users and preparers see as the real objective of IAS 12
(to match the tax effects of a transaction with the recognition of its pre-tax effects in
the statement of comprehensive income or equity).
This tension arises in part because earlier methods of accounting for income tax, which
explicitly focused on tax income and expense (‘income statement approaches’) rather
than tax assets and liabilities (‘balance sheet approaches’), remain part of the
professional ‘DNA’ of many preparers and users. Moreover, as will be seen later in the
Chapter, a number of aspects of IAS 12 are difficult to reconcile to the purported
balance sheet approach of the standard, because, in reality, they are relics of the now
superseded income statement approaches.
1.3
The development of IAS 12
The current version of IAS 12 was published in October 1996, and has been amended by a
number of subsequent pronouncements. IAS 12 is based on the same principles as the US
GAAP guidance (FASB ASC Topic 740 – Income Taxes). However, there are important
differences of methodology between the two standards which can lead to significant
differences between the amounts recorded under IAS 12 and US GAAP. Some of the main
differences between the standards are noted at relevant points in the discussion below.
In July 2000, the SIC issued an interpretation of IAS 12, SIC-25 – Income Taxes –
Changes in the Tax Status of an Entity or its Shareholders (see 10.9 below).2
In March 2009 the IASB issued an exposure draft (ED/2009/2 – Income Tax) of a
standard to replace IAS 12. This was poorly received by commentators and there is no
prospect of a new standard in this form being issued in the foreseeable future.
Nevertheless, the IASB continues to consider possible limited changes to IAS 12 with
the aim of improving it or clarifying its existing provisions.
Income
taxes
2347
In December 2010, the IASB issued an amendment to IAS 12 – Deferred Tax:
Recovery of Underlying Assets. The amendment addressed the measurement of
deferred tax associated with non-depreciable revalued property, plant and
equipment and investment properties accounted for at fair value (see 8.4.6
and 8.4.7 below). Recognition of Deferred Tax Assets for Unrealised Losses
(Amendments to IAS 12) – was issued in January 2016 in relation to the recognition
of deferred tax assets for unrealised losses, for example on debt securities
measured at fair value and related clarifications to the guidance on determining
future taxable profits. It has been applied since annual periods beginning on or after
1 January 2017 (see 7.4.5 below).
In June 2017 the Interpretations Committee issued IFRIC 23 – Uncertainty over
Income Tax Treatments, on the recognition and measurement of uncertain tax
treatments. Annual Improvements to IFRS Standards 2015–2017 Cycle, issued in
December 2017, clarifies that the income tax consequences of distributions relating
to equity instruments should always be allocated to profit or loss, other
comprehensive income or equity according to where the entity originally
recognised the past transactions or events that generated distributable profits, and
not only in situations where differential tax rates apply to distributed or
undistributed earnings. This will require adjustment by those entities that previously
allocated the related income tax to equity on the basis that it was linked more
directly to the distribution to owners. Both changes are mandatory for annual
periods beginning on or after 1 January 2019, with earlier application permitted,
provided that this is disclosed. [IFRIC 23.B1, IAS 12.98I]. The treatment of uncertain tax
positions is discussed at 9 below, with the allocation of tax on equity distributions
set out at 10.3.5 below.
1.3.1
References to taxes in standards other than IAS 12
There are numerous references in other standards and interpretations to taxes, the
more significant of which are noted later in this Chapter. The requirements of IFRS
for accounting for income taxes in interim financial statements are discussed in
Chapter 37 at 9.5. Other standards and interpretations also refer to taxes that are
not necessarily income taxes within the scope of IAS 12. In some cases such taxes
are clearly outside the scope of IAS 12, such as sales taxes, payroll taxes and other
taxes related to specific items of expenditure. These taxes often fall within the
scope of IAS 37 – Provisions, Contingent Liabilities and Contingent Assets – and, in
particular, IFRIC 21 – Levies, or by reference to the accounting standard most
closely related to the item subject to such a non-income tax (such as IAS 19 –
Employee Benefits, in the case of payroll taxes). In other cases, judgement is
required to determine whether such taxes fall in the scope of IAS 12, as discussed
at 4 below.
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2
OBJECTIVE AND SCOPE OF IAS 12
2.1 Objective
The stated objective of IAS 12 is ‘to prescribe the accounting treatment for income
taxes. The principal issue in accounting for income taxes is how to account for the
current and future tax consequences of:
(a) the future recovery (settlement) of the carrying amount of assets (liabilities) that
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