profit measure. Another practical disadvantage is that the future rate of the element
accounted for as income tax is unpredictable, as it will depend on the level of profit in
future periods. Suppose for example that an entity is required to pay tax at 30% on its
taxable profit, but subject to a minimum tax of €100,000 per year. No income tax relief
is available for the minimum tax. If its taxable profits were €1 million, it would pay tax
of €300,000 (€1,000,000 at 30%). Under the first approach, this €300,000 would be
accounted for as comprising a minimum (non-income) tax of €100,000 and income tax
of €200,000. The effective rate of tax accounted for as income tax would be 22%
[€200,000 / (€1,000,000 – €100,000)]. If, however, the entity’s taxable profits were
€2,000,000 it would pay tax of €600,000 (€2,000,000 at 30%). In this case, this
€600,000 would be accounted for as comprising a minimum (non-income) tax of
€100,000 and income tax of €500,000. The effective rate of tax accounted for as
income tax would be 26.3% [€500,000 / (€2,000,000 – €100,000)]. This illustrates that,
in order to calculate deferred income taxes for the purposes of IAS 12, any future
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income tax rate would be subject to constant re-estimation, even if the ‘headline’
enacted rate had not changed.
In our view, either of these broad approaches can be adopted so long as it is applied
consistently to all taxes of a similar nature in all periods. We would generally expect a
common approach to be applied to the same tax in the same jurisdiction.
4.2
Withholding and similar taxes
As noted at 4.1 above, IAS 12 also includes in its scope those taxes, such as withholding
taxes, which are payable by a subsidiary, associate or joint arrangement on distributions
to the reporting entity. [IAS 12.2]. This gives rise to further questions of interpretation.
The most basic issue is what is meant by a ‘withholding tax’. This is discussed at 10.3.2
and 10.3.4 below.
A second issue is whether the scope of IAS 12 covers only taxes on distributions from a
subsidiary, associate or joint arrangement, or whether it extends to tax on distributions
from other entities in which the reporting entity has an investment. Such an investment
is typically accounted for at fair value under IFRS 9 – Financial Instruments.
The rationale for the treatment as income taxes of taxes payable by a subsidiary,
associate or joint arrangement on distributions to the investor is discussed further at 7.5
below. Essentially, however, the reason for considering withholding taxes within the
scope of income tax accounting derives from the accounting treatment of the
investments themselves. The accounting treatment for such investments – whether by
full consolidation or the equity method – results in the investor recognising profit that
may be taxed twice: once as it is earned by the investee entity concerned, and again as
that entity distributes the profit as dividend to the investor. IAS 12 ensures that the
financial statements reflect both tax consequences.
Some argue that this indicates a general principle that an entity should account for all
the tax consequences of realising the income of an investee as that income is
recognised. On this analysis withholding taxes suffered on any investment income
should be treated as income taxes. Others argue that the reference in IAS 12 to
distributions from ‘a subsidiary, associate or joint arrangement’ should be read
restrictively, and that no wider general principle is implied. In addition, because the
amount of the tax relates to a single component of the investor entity’s income, it can
be argued that (without the specific reference to a ‘withholding tax’) such amounts are
not within the scope of IAS 12 because they are not ‘based on taxable profits’, [IAS 12.2],
(see 4.1 above).
We believe that judgement is required to decide whether a tax deducted from investment
income at the source of the income is a withholding tax in the scope of IAS 12. As well as
the considerations noted above, the decision requires consideration of all the relevant
facts and circumstances of the jurisdiction that levies the tax, especially the national tax
legislation and the design of the investor entity. If it is determined that the tax withheld
from investment income is within the scope of IAS 12, any non-refundable portion of such
withholding taxes is recognised as a tax expense in the statement of comprehensive
income. In addition, the entity should apply all the provisions of IAS 12 for current and
deferred taxes, including recognition, measurement, presentation and disclosure.
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Accordingly, an entity may determine that it should treat as income taxes the
withholding taxes that could potentially be suffered on distributions from all
investments, not just subsidiaries, associates and joint arrangements. Whether or not
any tax liability is recognised will depend on an analysis of the facts and circumstances
in each particular case, in particular whether the investment concerned is expected to
be recovered through receipt of dividend income or through sale (see 8.4 below).
4.3
Investment tax credits
Investment tax credits are not defined in IAS 12, but for the purposes of the following
discussion they are taken to comprise government assistance and incentives for specific
kinds of business activity and investment delivered through the tax system. Investment
tax credits can take different forms and be subject to different conditions. Sometimes a
tax credit is given as a deductible expense in computing the entity’s tax liability, and
sometimes as a deduction from the entity’s tax liability, rather than as a deductible
expense. In some cases, the value of the credit is chargeable to income taxes and in
others it is not.
Entitlement to receive investment tax credits can be determined in a variety of ways.
Some investment tax credits may relate to direct investment in property, plant and
equipment. Other entities may receive investment tax credits relating to research and
development or other specific activities. Some credits may be realisable only through
a reduction in current or future income taxes payable, while others may be settled
directly in cash if the entity does not have sufficient income taxes payable to offset
the credit within a certain period. Access to the credit may be limited according to
total taxes paid (i.e. including taxes such as payroll and sales taxes remitted to
government in addition to income taxes). There may be other conditions associated
with receiving the investment tax credit, for example with respect to the conduct and
continuing activities of the entity, and the credit may become repayable if ongoing
conditions are not met.
As noted at 4 above, IAS 12 states that it does not deal with the methods of accounting
for government grants or investment tax credits although any temporary differences
that arise from them are in the scope of the Standard. [IAS 12.4]. At the same time,
government assistance that is either provided by way of a reduction in taxable income,
or determined or
limited according to an entity’s income tax liability, is excluded from
the scope of IAS 20. That Standard lists income tax holidays, investment tax credits,
accelerated depreciation allowances and reduced income tax rates as examples of such
benefits. [IAS 20.2]. Accordingly, if government assistance is described as an investment
tax credit, but it is neither determined nor limited by reference to an entity’s liability to
income taxes, it falls within the scope of IAS 20 and should therefore be accounted for
as a government grant (see Chapter 25 at 2.3.1).
The fact that both IAS 20 and IAS 12 use the term ‘investment tax credits’ to describe
items excluded from their scope requires entities to carefully consider the nature of
such incentives and the conditions attached to them in order to determine which
standard the particular tax credit is excluded from and, therefore, whether they fall in
the scope of IAS 12 or IAS 20.
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In our view, such a judgement would be informed by reference to the following factors
as applied to the specific facts and circumstances relating to the incentive:
Feature of credit
Indicator of IAS 12 treatment
Indicator of IAS 20
treatment
Method of realisation
Only available as a reduction in
Directly settled in cash
income taxes payable (i.e. benefit is
where there are insufficient
forfeit if there are insufficient
taxable profits to allow
income taxes payable). However,
credit to be fully offset, or
the longer the period allowed for
available for set off against
carrying forward unused credits, the
payroll taxes, sales taxes or
less relevant this indicator becomes.
amounts owed to
government other than
income taxes payable.
Number of conditions not related
None or few
Many
to tax position (e.g. minimum
employment, manner of ongoing
use of purchased assets)
Restrictions as to nature of
Broad criteria encompassing
Highly specific
expenditure required to receive
many different types of qualifying
the grant
expenditure
Tax status of grant income
Not taxable
Taxable
In group accounts, in which entities from a number of different jurisdictions may be
consolidated, it may be desirable that all ‘investment tax credits’ should be consistently
accounted for, either as an IAS 12 income tax or as a government grant under IAS 20.
However, the judgment as to which standard applies is made by reference to the nature
of each type of investment tax credit and the conditions attached to it. This may mean
that the predominant treatment in a particular jurisdiction for a specific type of
investment tax credit has evolved differently from consensus in another jurisdiction for
what could appear to be a substantially similar credit. We believe that, in determining
whether the arrangement is of a type that falls within the scope of IAS 12 or IAS 20, an
entity should consider the following factors in the order listed below:
• the predominant local determination as to whether a specific credit in the relevant
tax jurisdiction falls within the scope of IAS 12 or IAS 20;
• if there is no predominant local consensus, the group-wide approach to
determining the standard that applies to such a credit should be applied; and
• in the absence of a predominant local treatment or a group-wide approach to making
the determination, the indicators listed in the table above should provide guidance.
This may mean that an entity operating in a number of territories adopts different
accounting treatments for apparently similar arrangements in different countries, but it
at least ensures a measure of comparability between different entities operating in the
same tax jurisdiction. Similar considerations apply in determining the meaning of
‘substantively enacted’ legislation in different jurisdictions (see 5.1 below).
Where a tax credit is determined to be in the nature of an income tax, the incentive
should be recognised as an asset and a reduction in current income tax (up to the
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amount of the incentive that has already been used) in the period in which it is probable
that the benefit will flow to the entity and the benefit can be reliably measured. This
approach applies the same recognition criteria as for tax losses used to recover current
tax of a previous period. [IAS 12.14].
A deferred tax asset will be recognised for any unused tax credits (up to the amount of
incentive that has already been made available) to the extent that it is probable that
future taxable profit will be available against which the unused tax losses and unused
tax credits can be utilised. [IAS 12.34].
For incentives related to the initial recognition of assets (i.e. not relating to items
expensed for accounting purposes), it would also be acceptable, as an alternative to
immediate recognition in profit or loss, to treat the tax credit as an adjustment to the
tax base of the asset. If this alternative approach is taken, the initial recognition
exception would apply to prohibit recognition of the excess of the tax base over the
accounting carrying value. The subsequent accounting would then be similar to the
accounting followed for a super-deductible asset. The treatment of super-deductible
assets is discussed further at 7.2.6 below.
4.4
Interest and penalties
Many tax regimes require interest and/or penalties to be paid on late payments of tax.
This raises the question of whether or not such penalties fall within the scope of IAS 12.
The answer can have consequences not only for the presentation of interest and
penalties in the income statement; but also for the timing of recognition and on the
measurement of amounts recognised. If such penalties and interest fall within the scope
of IAS 12, they are presented as part of tax expense and measured in accordance with
the requirements of that Standard. Where uncertainty exists as to whether interest and
penalties will be applied by the tax authorities, IFRIC 23 on uncertain tax treatments
would be relevant in determining how much should be recognised and when (see 9.1
below). If interest and penalties do not fall within the scope of IAS 12, they should be
included in profit before tax, with recognition and measurement determined in
accordance with another accounting standard, most likely to be IAS 37.
Some argue that penalties and interest have the characteristics of an income tax – they
are paid to the tax authorities under specific tax legislation that has already been
deemed to give rise to an IAS 12 income tax and therefore should be treated
consistently. Others contend that penalties and interest are distinct from the main
income tax liability, are not ‘based on taxable profits’ as required in paragraph 5 of the
Standard and should not therefore form part of tax expense. Those who hold this view
would point out, for example, that under I
FRS the unwinding of the discount on
discounted items is generally accounted for separately from the discounted expense.
The Interpretations Committee considered this issue most recently in 2017, as a result
of comments received from respondents regarding the scope of what is now IFRIC 23.
Notwithstanding their decision to exclude a specific reference to interest and penalties
in IFRIC 23 and their decision in September 2017 not to add a project on interest and
penalties to its agenda, the Committee observed that:5
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(a) the determination of whether IAS 12 or IAS 37 should be applied is not an
accounting policy choice. Instead, if an entity determines that a particular amount
payable or receivable for interest and penalties is an income tax, then the entity
applies IAS 12 to that amount. If an entity does not apply IAS 12 to interest and
penalties, then it applies IAS 37 to those amounts;
(b) paragraph 79 of IAS 12 requires an entity to disclose the major components of tax
expense (income); for each class of provision, and paragraphs 84 and 85 of IAS 37
require a reconciliation of the carrying amount at the beginning and end of the
reporting period as well as various other pieces of information. Accordingly,
regardless of whether an entity applies IAS 12 or IAS 37 when accounting for
interest and penalties related to income taxes, the entity would disclose
information about those interest and penalties if it is material; and
(c) paragraph 122 of IAS 1 requires disclosure of the judgements that management has
made in the process of applying the entity’s accounting policies and that have the
most significant effect on the amounts recognised in the financial statements.
The Committee also observed that it had previously published agenda decisions
discussing the scope of IAS 12 in March 2006 and May 2009 (as noted at 4.1 above).
The Interpretations Committee did not give any specific guidance as to how one might
decide whether interest and penalties should be regarded as an IAS 12 income tax.
In our view, the judgement of whether IAS 12 or IAS 37 applies should be determined on
a country-by-country and a tax-by-tax basis. The agenda decision is clear that this is not
an accounting policy choice whereby an entity has ‘free rein’ to arbitrarily choose that
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 469
