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drawn up by the tax authorities under tax law, this liability would not be included, since
the relevant amount would, in the notional tax financial statements, have already been
taken to income.
An entity may have a liability of (say) €1,000 that will attract no tax deduction when it
is settled. In this case, the tax base is €1,000 (on the analogy with the rule in 6.1.1 above
that where, realisation of an asset will not be taxable, the tax base of the asset is equal
to its carrying amount). This applies irrespective of whether the liability concerned
arises from:
• a transaction already recognised in total comprehensive income and already
subject to a tax deduction on initial recognition (e.g. in most jurisdictions, the cost
of goods sold or accrued expenses);
• a transaction already recognised in total comprehensive income and outside the
scope of tax (e.g. non tax-deductible fines and penalties); or
• a transaction not affecting total comprehensive income at all (e.g. the principal of
a loan payable). [IAS 12.8].
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This is appropriate given that, in the first case, the liability represents a cost that has
already been deducted for tax purposes and, in the second and third cases, the liabilities
represent items that are outside the scope of tax.
6.1.3
Assets and liabilities whose tax base is not immediately apparent
IAS 12 indicates that where the tax base of an asset or liability is not immediately
apparent, it is helpful to consider the fundamental principle on which the standard is
based: an entity should, with certain limited exceptions, recognise a deferred tax
liability (asset) wherever recovery or settlement of the carrying amount of an asset or
liability would make future tax payments larger (smaller) than they would be if such
recovery or settlement were to have no tax consequences. [IAS 12.10]. In other words:
provide for the tax that would be payable or receivable if the assets and liabilities in the
statement of financial position were to be recovered or settled at book value.
The implication of this is that in the basic ‘equation’ of IAS 12, i.e.
carrying amount – tax base = temporary difference,
the true unknown is not in fact the temporary difference (as implied by the definitions
of tax base and temporary difference) but the tax base (as implied by paragraph 10).
It will be apparent from the more detailed discussion at 6.2 below that this clarification is
particularly relevant to determining the tax bases of certain financial liabilities, which often
do not fit the general ‘formula’ of carrying amount less amount deductible on settlement.
6.1.4
Tax base of items not recognised as assets or liabilities in financial
statements
Certain items are not recognised as assets or liabilities in financial statements, but may
nevertheless have a tax base. Examples may include:
• research costs (which are required to be expensed immediately by IAS 38 –
Intangible Assets – see Chapter 17);
• the cost of equity-settled share-based payment transactions (which under IFRS 2
– Share-based Payment – give rise to an increase in equity and not a liability –
see Chapter 30); and
• goodwill deducted from equity under previous IFRS or national GAAP.
Where such items are tax-deductible, their tax base is the difference between their carrying
amount (i.e. nil) and the amount deductible in future periods. [IAS 12.9]. This may seem
somewhat contrary to the definition of tax base, in which it is inherent that, in order for an
item to have a tax base, that item must be an asset or liability, whereas none of the items
above was ever recognised as an asset.8 The implicit argument is that all these items were
initially (and very briefly) recognised as assets before being immediately written off in full.
Local tax legislation sometimes gives rise to liabilities that have a tax base but no carrying
amount. For example, a subsidiary of the reporting entity may receive a tax deduction for
a provision that has been recognised in the individual financial statements of that
subsidiary prepared under local accounting principles. For the purposes of the entity’s
consolidated financial statements, however, the provision does not satisfy the recognition
requirements of IAS 37. In such situations we consider it appropriate to regard the tax
deduction received as giving rise to a deferred tax liability in the consolidated financial
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statements (by virtue of there being a provision with a tax base but no carrying amount)
in addition to the current tax income recorded for the subsidiary.
Similar situations may arise where local tax legislation permits deductions for certain
expenditure determined according to tax legislation without reference to any financial
statements. Again, in those cases where an equivalent amount of expenditure is likely
to be recognised in the financial statements at a later date, we would regard it as
appropriate to regard the tax deduction received as giving rise to a deferred tax liability
in the consolidated financial statements.
6.1.5
Equity items with a tax base
The definition of ‘tax base’ refers to the tax base of an ‘asset or liability’. This begs the
question of whether IAS 12 regards equity items as having a tax base and therefore
whether deferred tax can be recognised in respect of equity instruments (since deferred
tax is the tax relating to temporary differences which, by definition, can only arise on
items with a tax base – see above).
In February 2003 the Interpretations Committee considered this issue. It drew attention
to the IASB’s proposal at that time to amend the definition of ‘tax base’ so as to refer not
only to assets and liabilities but also equity instruments as supporting the view that
deferred tax should be recognised where appropriate on equity instruments. This was
effectively the approach proposed in the exposure draft ED/2009/2 (see 1.3 above).9
An alternative analysis might be that equity items do not have a tax base, but that any
tax effects of them are to be treated as items that are not recognised as assets or
liabilities but nevertheless have a tax base (see 6.1.4 above).
Given the lack of explicit guidance in the current version of IAS 12 either analysis may
be acceptable, provided that it is applied consistently. This is reflected in a number of
the examples in the remainder of this Chapter.
6.1.6
Items with more than one tax base
Some assets and liabilities have more than one tax base, depending on the manner in
which they are realised or settled. These are discussed further at 8.4 below.
6.1.7
Tax bases disclaimed or with no economic value
In some situations an entity may choose not to claim an available deduction for an item
as part of an overall tax planning strategy. In other cases, a deduction available as a
matter of tax law may have no real economic effect – for example because the
deduction will increase a pool of brought forward tax losses which the entity does not
expect to recover in the foreseeable future.
In our vie
w, the fact that the entity chooses not to take advantage of a potential tax
deduction, or that such a deduction would have no real economic effect in the
foreseeable future, does not mean that the asset to which the deduction relates has no
tax base. While such considerations will be relevant to determining whether a
deductible temporary difference gives rise to a recoverable deferred tax asset (see 7.4
below), the tax base of an asset is determined by reference to the amount attributed to
the item by tax law. [IAS 12.5].
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6.2
Examples of temporary differences
The following are examples of taxable temporary differences, deductible temporary
differences and items where the tax base and carrying value are the same so that there
is no temporary difference. They are mostly based on those given in IAS 12,
[IAS 12.17-20, 26, IE.A-C], but include several others that are encountered in practice. It will
be seen that a number of categories of assets and liabilities may give rise to either
taxable or deductible temporary differences.
A temporary difference will not always result in a deferred tax asset or liability being
recorded under IAS 12, since the difference may be subject to other provisions of the
standard restricting the recognition of deferred tax assets and liabilities, which are
discussed at 7 below. Moreover, even where deferred tax is recognised, it does not
necessarily create tax income or expense, but may instead give rise to additional goodwill
or bargain purchase gain in a business combination, or to a movement in equity.
6.2.1
Taxable temporary differences
6.2.1.A
Transactions that affect profit or loss
• Interest received in arrears
An entity with a financial year ending on 31 December 2019 holds a medium-term
cash deposit on which interest of €10,000 is received annually on 31 March. The
interest is taxed in the year of receipt. At 31 December 2019, the entity recognises
a receivable of €7,000 in respect of interest accrued but not yet received. The
receivable has a tax base of nil, since its recovery has tax consequences and no tax
deductions are available in respect of it. The temporary difference associated with
the receivable is €7,000 (€7,000 carrying amount less nil tax base).
• Sale of goods taxed on a cash basis
An entity has recorded revenue from the sale of goods of €40,000, together with
a cost of the goods sold of €35,000, since the goods have been delivered. However,
the transaction is taxed in the following financial year when the cash from the sale
is collected.
The entity will have recognised a receivable of €40,000 for the sale. The
receivable has a tax base of nil, since its recovery has tax consequences and no tax
deductions are available in respect of it. The temporary difference associated with
the receivable is €40,000 (€40,000 carrying amount less nil tax base).
There is also a deductible temporary difference of €35,000 associated with the
(now derecognised) inventory, which has a carrying amount of zero but a tax base
of €35,000 (since it will attract a tax deduction of €35,000 when the sale is taxed)
– see 6.2.2.A below.
• Depreciation of an asset accelerated for tax purposes
An entity has an item of PP&E whose cost is fully tax deductible, but with
deductions being given over a period shorter than the period over which the asset
is being depreciated under IAS 16 – Property, Plant and Equipment. At the
reporting date, the asset has been depreciated to £500,000 for financial reporting
purposes but to £300,000 for tax purposes.
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Recovery of the PP&E has tax consequences since, although there is no deduction
for accounting depreciation in the tax return, the PP&E is recovered through
future taxable profits. There is a taxable temporary difference of £200,000
between the carrying value of the asset (£500,000) and its tax base (£300,000).
• Capitalised development costs already deducted for tax
An entity incurred development costs of $1 million during the year ended
31 December 2019. The costs were fully deductible for tax purposes in the tax return
for that period, but were recognised as an intangible asset under IAS 38 in the
financial statements. The amount carried forward at 31 December 2019 is $800,000.
Recovery of the intangible asset through use has tax consequences since, although
there is no deduction for accounting amortisation in the tax return, the asset is
recovered through future profits which will be taxed. There is a taxable temporary
difference of $800,000 between the carrying value of the asset ($800,000) and its
tax base (nil). Although the expenditure to create the asset is tax-deductible in the
current period, its tax base is the amount deductible in future periods, which is nil,
since all deductions were made in the tax return for 2019.
A similar analysis would apply to prepaid expenses that have already been deducted
on a cash basis in determining the taxable profit of the current or previous periods.
6.2.1.B
Transactions that affect the statement of financial position
• Non-deductible and partially deductible assets
An entity acquires a building for €1 million. Any accounting depreciation of the
building is not deductible for tax purposes, and no deduction will be available for
tax purposes when the asset is sold or scrapped.
Recovery of the building, whether in use or on sale, nevertheless has tax
consequences since the building is recovered through future taxable profits of
€1 million. There is a taxable temporary difference of €1 million between the
carrying value of the asset (€1 million) and its tax base of zero.
A similar analysis applies to an asset which, when acquired, is deductible for tax
purposes, but for an amount lower than its cost. The difference between the cost
and the amount deductible for tax purposes is a taxable temporary difference.
• Deductible loan transaction costs
A borrowing entity records a loan at £9.5 million, being the proceeds received of
£10 million (which equal the amount due at maturity), less transaction costs of
£500,000, which are deducted for tax purposes in the period when the loan was
first recognised. For loans carried at amortised cost, IFRS 9 requires the costs,
together with interest and similar payments, to be accrued over the period to
maturity using the effective interest method.
Inception of the loan gives rise to a taxable temporary difference of £500,000, being
the difference between the carrying amount of the loan (£9.5 million) and its tax base
(£10 million). This tax base does not conform to the general definition of the tax base
of a liability – i.e. the carrying amount, less any amount that will be deductible for
tax purposes in respect of that liability in future periods (see 6.1.2 above).
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The easiest way to derive the correct tax base is to construct a notional statement of
financial position prepared by the tax authorities according to tax law. This would show
a liabil
ity for the full £10 million (since the amortisation of the issue costs that has yet
to occur in the financial statements has already occurred in the notional tax authority
financial statements). This indicates that the tax base of the loan is £10 million.
A far simpler analysis for the purposes of IAS 12 might have been that the
£9.5 million carrying amount comprises a loan of £10 million (with a tax base of
£10 million, giving rise to temporary difference of zero) offset by prepaid
transaction costs of £500,000 (with a tax base of zero, giving rise to a taxable
temporary difference of £500,000). However, this is inconsistent with the analysis
in IFRS 9 that the issue costs are an integral part of the carrying value of the loan.
The consequence of recognising a deferred tax liability in this case is that the tax
deduction for the transaction costs is recognised in profit or loss, not on inception
of the loan, but as the costs are recognised through the effective interest method
in future periods.
• Non-deductible loan transaction costs
As in the immediately preceding example, a borrowing entity records a loan at
£9.5 million, being the proceeds received of £10 million (which equal the amount
due at maturity), less transaction costs of £500,000. In this case, however, the
transaction costs are not deductible in determining the taxable profit of future,
current or prior periods. For loans carried at amortised cost, IFRS 9 requires the
costs to be accrued over the period to maturity using the effective interest method.
Just as in the preceding example (and perhaps rather counter-intuitively, given that
the costs are non-deductible) inception of the loan gives rise to a taxable
temporary difference of £500,000, being the difference between the carrying
amount of the loan (£9.5 million) and its tax base (£10 million). This is because a
notional statement of financial position prepared by the tax authorities according
to tax law would show a liability for the full £10 million, since the transaction costs
would never have been recorded (as they never occurred for tax purposes).
• Liability component of compound financial instrument
An entity issues a convertible bond for €5 million which, in accordance with the
requirements of IAS 32 – Financial Instruments: Presentation, is analysed as
comprising a liability component of €4.6 million and a residual equity component of