€400,000. If the entity were to settle the liability for €4.6 million it would be liable to
tax on €400,000 (€5 million less €4.6 million). Therefore the tax base of the liability is
€5 million and there is a taxable temporary difference of €400,000 between this and
the carrying amount of the liability component. This is discussed further at 7.2.8 below.
6.2.1.C Revaluations
• Financial assets and property carried at valuation
An entity holds investments, accounted for at fair value through profit or loss, with
a carrying amount of CHF2 million and an original cost (and tax base) of
CHF1.3 million. There is a taxable temporary difference of CHF700,000
2374 Chapter 29
associated with the investments, being the amount on which the entity would pay
tax if the investments were realised at their carrying value.
A similar analysis would apply to investment property or PP&E carried at a value
that exceeds cost, where no equivalent adjustment is made for tax purposes.
6.2.1.D Tax
re-basing
• Withdrawal of tax depreciation for classes of PP&E
An entity holds buildings with a carrying amount of £15 million and a tax base of
£12 million, giving rise to a taxable temporary difference of £3 million. As part of
a general fiscal reform package introduced by the government, future tax
deductions for the buildings (their tax base) are reduced to £1 million. This
increases the taxable temporary difference by £11 million to £14 million.
6.2.1.E Business
combinations and consolidation
• Fair value adjustments
Where the carrying amount of an asset is increased to fair value in a business
combination, but no equivalent adjustment is made for tax purposes, a taxable
temporary difference arises just as on the revaluation of an asset (see 6.2.1.C above).
• Non-deductible or partially-deductible goodwill
Where goodwill is not deductible, or only partially deductible, in determining
taxable profit there will be a taxable temporary difference between the carrying
amount of the goodwill and its tax base, similar to that arising on a non-deductible
or partially-deductible asset (see 6.2.1.B above).
• Intragroup transactions
Although intragroup transactions are eliminated in consolidated financial
statements, they may give rise to temporary differences. An entity in a group (A)
might sell inventory with a cost and tax base of £1,000 to another group entity (B)
for £900, which becomes the cost and tax base to B. If the carrying value in the
consolidated financial statements remains £1,000 (i.e. the inventory is not actually
impaired, notwithstanding the intragroup sale at a loss), a new taxable temporary
difference of £100 emerges in the consolidated financial statements between the
carrying value of £1,000 and the new tax base of £900.
• Undistributed earnings of group investments
A parent entity P holds an investment in subsidiary S. Retained earnings of
$1 million relating to S are included in the consolidated financial statements of P.
S must pay a non-refundable withholding tax on any distribution of earnings to P.
There is therefore a taxable temporary difference in the consolidated financial
statements of $1 million associated with the net assets representing the retained
earnings, since their recovery (in the form of distribution to the parent) has tax
consequences, with no offsetting tax deductions.
Similar temporary differences may arise on the retained earnings of branches,
associates and joint arrangements.
Income
taxes
2375
6.2.1.F
Foreign currency differences
• Translation of foreign subsidiary to presentation currency
A UK entity acquires the equity of a French entity, which therefore becomes its
subsidiary, for €10 million. For UK tax purposes, the tax base of the investment is
£8 million (the spot-rate equivalent of €10 million at the date of acquisition). The
presentation currency of the UK entity’s consolidated financial statements is sterling.
Between the date of acquisition and the first reporting date, the French entity makes
no gains or losses, such that its net assets and goodwill as included in the consolidated
financial statements, expressed in euros, remain €10 million. However, the exchange
rate has moved, so that the sterling equivalent of €10 million at the reporting date,
included in the consolidated statement of financial position, is £9 million.
This gives rise to a £1 million taxable temporary difference between the £9 million
carrying value of the investment and its £8 million tax base.
• Functional currency different from currency used to compute tax
On 1 January 2019 an entity which, under IAS 21 – The Effects of Changes in Foreign
Exchange Rates, has determined its functional currency as US dollars (see Chapter 15),
purchases plant for $1 million, which will be depreciated to its estimated residual value
of zero over 10 years. The entity is taxed in the local currency LC, and is entitled to
receive tax deductions for the depreciation charged in the financial statements. The
exchange rate is $1=LC2 at 1 January 2019 (so that the cost of the asset for local tax
purposes is LC2 million). The exchange rate at 31 December 2019 is $1=LC2.5.
At 31 December 2019 there is a taxable temporary difference of $180,000, being the
difference between the net book value of the plant of $900,000 (cost $1,000,000
less depreciation $100,000) and its tax base of $720,000 (cost LC2,000,000 less
depreciation LC200,000 = LC1,800,000 translated at year end rate of $1=LC2.5).
6.2.1.G Hyperinflation
A taxable temporary difference (similar to those in 6.2.1.F above) arises when non-
monetary assets are restated in terms of the measuring unit current at the end of the
reporting period under IAS 29 – Financial Reporting in Hyperinflationary Economies –
but no equivalent adjustment is made for tax purposes.
6.2.2
Deductible temporary differences
6.2.2.A
Transactions that affect profit of loss
• Expenses deductible for tax on cash basis
An entity records a liability of €1 million for retirement benefit costs which are tax
deductible only when paid. The tax base of the liability is zero, being its carrying
amount (€1 million) less the amount deductible for tax purposes when the liability is
settled (also €1 million). There is therefore a deductible temporary difference of
€1 million (€1 million carrying amount less zero tax base) associated with the liability.
• Depreciation of an asset delayed for tax purposes
An entity has an item of PP&E that originally cost £1 million. The cost is fully tax
deductible, with deductions being given over a period longer than the period over
2376 Chapter 29
which the asset is being depreciated under IAS 16. At the reporting date, the asset
has been depreciated to £300,000 for financial reporting purposes but to only
£500,000 for tax purposes.
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 recover
ed through future
taxable profits of £300,000. There is a deductible temporary difference of £200,000
between the carrying value of the asset (£300,000) and its tax base (£500,000).
• 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.
There is 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).
There is also a taxable temporary difference of €40,000 associated with the
receivable (see 6.2.1.A above).
• Write-down of asset not deductible for tax purposes until realised
An entity purchases inventory for $1,000, which is also its tax base. The inventory is
later written down to a net realisable value of $800. However, no loss is recognised
for tax purposes until the inventory is sold. There is a deductible temporary difference
of $200 between the $800 carrying amount of the inventory and its $1,000 tax base.
• Deferred income taxed on receipt
In the year ended 31 December 2016, an entity received €2 million, being 5 years’
rent of an investment property received in advance. In the statement of financial
position as at 31 December, €1,800,000 is carried forward as deferred income.
However, the whole €2 million is taxed in the tax return for the period.
There is a deductible temporary difference of €1,800,000 associated with the
deferred income, being its carrying amount (€1,800,000), less its tax base of zero,
computed as the carrying amount (€1,800,000) less the amount not taxable in
future periods (also €1,800,000 since the income has already been taxed).
• Deferred non-taxable income
An entity receives a non-taxable government grant of £1 million, of which £700,000
is carried forward in the statement of financial position as at the period end.
There is a deductible temporary difference of £700,000 associated with the
deferred income, being its carrying amount (£700,000), less its tax base of zero,
computed as the carrying amount (£700,000) less the amount of income not
taxable in future periods (also £700,000 since the income is tax free). In this case,
while there is a deductible temporary difference, no deferred tax asset would be
recognised, as discussed in Example 29.7 at 7.2.3. [IAS 12.24, 33].
Income
taxes
2377
6.2.2.B
Transactions that affect the statement of financial position
• Asset deductible for more than cost
An entity invests NOK10 million in PP&E for which tax deductions of
NOK13 million may be claimed. There is a deductible temporary difference of
NOK3 million between the NOK10 million carrying value of the PP&E and its tax
base of NOK13 million.
6.2.2.C Revaluations
• Financial assets and property carried at valuation
An entity holds investments, accounted for at fair value through profit or loss, with
a carrying amount of CHF2 million and an original cost (and tax base) of
CHF2.5 million. There is a deductible temporary difference of CHF500,000
associated with the investments, being the amount for which the entity would
receive a tax deduction if the investments were realised at their carrying value.
A similar analysis would apply to investment property or PP&E carried at a value
below cost, where no equivalent adjustment is made for tax purposes.
6.2.2.D Tax
re-basing
• Indexation of assets for tax purposes
An entity acquires land for $5 million, which is also its tax base at the date of
purchase. A year later, as part of a general fiscal reform package introduced by the
government, future tax deductions for the land (its tax base) are increased to
$6 million. This creates a deductible temporary difference of $1 million in respect
of the land.
6.2.2.E Business
combinations and consolidation
• Fair value adjustments
Where a liability is recognised at fair value in a business combination, but the
liability is deductible for tax purposes only on settlement, a deductible temporary
difference arises similar to that arising on the initial recognition of a liability for an
expense deductible for tax on a cash basis (see 6.2.2.A above).
• Intragroup transactions
Although intragroup transactions are eliminated in consolidated financial
statements, they may give rise to deductible temporary differences. An entity
in a group (A) might sell inventory with a cost and tax base of £1,000 to another
group entity (B) for £1,200, which becomes the cost and tax base to B. Since
the carrying value in the consolidated financial statements remains £1,000, a
new deductible temporary difference of £200 emerges in the consolidated
financial statements between the carrying value of £1,000 and the new tax base
of £1,200.
2378 Chapter 29
6.2.2.F
Foreign currency differences
• Translation of foreign subsidiary to presentation currency
A UK entity acquires the equity of a French entity, which therefore becomes its
subsidiary, for €10 million. For UK tax purposes, the tax base of the investment is
£8 million (the spot-rate equivalent of €10 million at the date of acquisition). The
presentation currency of the UK entity’s consolidated financial statements is sterling.
Between the date of acquisition and the first reporting date, the French entity makes
no gains or losses, such that its net assets and goodwill as included in the consolidated
financial statements, expressed in euros, remain €10 million. However, the exchange
rate has moved, so that the sterling equivalent of €10 million at the reporting date,
included in the consolidated statement of financial position, is £7 million.
This gives rise to a £1 million deductible temporary difference between the
£7 million carrying value of the investment and its £8 million tax base.
• Functional currency different from currency used to compute tax
On 1 January 2019 an entity which, under IAS 21 has determined its functional
currency as US dollars (see Chapter 15), purchases plant for $1 million, which will
be depreciated to its estimated residual value of zero over 10 years. The entity is
taxed in the local currency LC, and is entitled to receive tax deductions for the
depreciation charged in the financial statements. The exchange rate is $1=LC2 at
1 January 2019 (so that the cost of the asset for local tax purposes is LC2 million).
The exchange rate at 31 December 2019 is $1=LC1.8.
At 31 December 2019 there is a deductible temporary difference of $100,000, being
the difference between the net book value of the plant of $900,000 (cost $1,000,000
less depreciation $100,000) and its tax base of $1,000,000 (cost LC2,000,000 less
depreciation LC200,000 = LC1,800,000 translated at year end rate of $1=LC1.8).
6.2.3
&n
bsp; Assets and liabilities with no temporary difference (because tax base
equals carrying amount)
• Liability for expense already deducted for tax
An entity accrues £200,000 for electricity costs in the year ended 31 March 2016.
The expense is deductible for tax in that period. The temporary difference
associated with the liability is zero. This is calculated as the carrying amount of
£200,000 less the tax base of £200,000, being the carrying amount (£200,000)
less amount deductible for tax in future periods (zero).
• Liability for expense never deductible for tax
An entity accrues €400,000 for a fine for environmental pollution, which is not
deductible for tax. The temporary difference associated with the liability is zero. This
is calculated as the carrying amount of €400,000 less the tax base of €400,000, being
the carrying amount (€400,000) less amount deductible for tax in future periods (zero).
• Loan repayable at carrying amount
An entity borrows $2 million. This is the carrying amount of the loan on initial
recognition, which is the same as the amount repayable on final maturity of the loan.
The temporary difference associated with the liability is zero. This is calculated as
Income
taxes
2379
the carrying amount of $2 million less the tax base of $2 million, being the carrying
amount ($2 million) less amount deductible for tax in future periods (zero).
• Receivable for non-taxable income
In its separate financial statements an entity records a receivable for a £1 million
dividend due from a subsidiary accounted for at cost. The dividend is not taxable.
Accordingly it gives rise to a temporary difference of zero, since the tax base of
any asset, the recovery of the carrying amount of which is not taxable, is taken to
be the same as its carrying amount.
7
DEFERRED TAX – RECOGNITION
7.1
The basic principles
7.1.1
Taxable temporary differences (deferred tax liabilities)
IAS 12 requires a deferred tax liability to be recognised in respect of all taxable
temporary differences except those arising from:
• the initial recognition of goodwill; or
• the initial recognition of an asset or liability in a transaction that:
• is not a business combination; and
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 473
