If the temporary difference arises as the result of a business combination, deferred tax
is recognised on the temporary difference with a corresponding adjustment to goodwill
or any bargain purchase gain.
If the temporary difference arises in a transaction that gives rise to an accounting or
taxable profit or loss, deferred tax is recognised on the temporary difference, giving rise
to deferred tax expense or deferred tax income.
If the temporary difference arises in any other circumstances (i.e. neither in a business
combination nor in a transaction that gives rise to an accounting or taxable profit or
loss) no deferred tax is recognised. [IAS 12.22].
The application of the initial recognition exception to assets and liabilities is illustrated
in Examples 29.4 to 29.7 below.
Example 29.4: Non-deductible PP&E
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 demolished.
Recovery of the building, whether in use or on sale, 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 €1 million carrying value of the asset and its tax base of zero.
Under the initial recognition exception, no deferred tax liability is provided for. The non-deductibility of the
asset is reflected in an effective tax rate higher than the statutory rate (assuming that all other components of
pre-tax profit are taxed at the statutory rate) as the asset is depreciated in future periods.
If the asset had been acquired as part of a larger business combination, the initial recognition would not have
applied. Deferred tax of would have been provided for, with a corresponding increase in goodwill. As the
asset is depreciated, the deferred tax liability is released to deferred tax income in the income statement, as
illustrated in Example 29.1 above. This results in an effective tax rate equal to the statutory rate (assuming
that all other components of pre-tax profit are taxed at the statutory rate).
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Example 29.5: Inception of loan with tax-deductible issue 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 is first recognised. For financial reporting purposes, under IFRS 9 the costs, together
with interest and similar payments, are 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 analysis is explained in
more detail at 6.2.1.B above.
Initial recognition of the transaction costs gives rise to no accounting loss (because they are included in the
carrying amount of the loan). However, there is a tax loss (since the costs are included in the tax return for
the period of inception). Accordingly, the initial recognition exception does not apply and a deferred tax
liability is recognised on the taxable temporary difference of £500,000.
Example 29.6: Inception of loan with non-deductible issue 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 not deductible for tax purposes
either in the period when the loan is first recognised or subsequently. For financial reporting purposes, under
IFRS 9 the costs, together with interest and similar payments, are 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 analysis is explained in
more detail at 6.2.1.B above.
Initial recognition of the transaction costs gives rise to no accounting loss (because they are included in the
carrying amount of the loan) or tax loss (because in this case there is no deduction for the issue costs).
Accordingly, the initial recognition exception applies and no deferred tax liability is recognised.
If the same loan (including the unamortised transaction costs) had been recognised as part of a larger business
combination, the initial recognition exception would not have applied. Deferred tax would have been
recognised on the taxable temporary difference of £500,000, with a corresponding increase in goodwill (or
decrease in any bargain purchase gain).
Example 29.7: Purchase of PP&E subject to tax-free government grant
An entity acquires an item of PP&E for €1 million subject to a tax free government grant of €350,000. The asset is
also fully-tax deductible (at €1 million). IAS 20 permits the grant to be accounted for either as deferred income or
by deduction from the cost of the asset. Whichever treatment is followed, a deductible temporary difference arises:
• If the grant is accounted for as deferred income, there is a deductible temporary difference between the
liability of €350,000 and its tax base of nil (carrying amount €350,000 less amount not taxed in future
periods, also €350,000).
• If the grant is accounted for as a reduction in the cost of the PP&E, there is a deductible temporary
difference between the carrying amount of the PP&E (€650,000) and its tax base (€1 million).
IAS 12 emphasises that the initial recognition exception applies, and no deferred tax asset should be
recognised. [IAS 12.33].
7.2.4
Changes to temporary differences after initial recognition
The initial recognition exception applies only to temporary differences arising on
initial recognition of an asset or liability. It does not apply to new temporary
differences that arise on the same asset or liability after initial recognition. When the
exception has been applied to the temporary difference arising on initial recognition
of an asset or liability, and there is a different temporary difference associated with
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that asset or liability at a subsequent date, it is necessary to analyse the temporary
difference at that date between:
• any amount relating to the original temporary difference (on which no deferred
tax is recognised); and
• the remainder, which has implicitly arisen after initial recognition of the asset or
liability (on which deferred tax is recognised).
IAS 12 does not set out comprehensive guidance to be followed in making this analysis,
but it does give a number of examples, from which the following general principles may
be inferred:
• the new temporary difference is treated as part of the temporary difference arising
on initial recognition to the extent that any change from the original temporary
difference is due to:
• the write-down (through depreciation, amortisation or impairment) of the
original carrying amount of an asset with no corresponding change in the tax
base (see 7.2.4.A below); or
• the increase in the original
carrying amount of a liability arising from the
amortisation of any discount recognised at the time of initial recognition of that
liability, with no corresponding change in the tax base (see 7.2.4.A below);
• the new temporary difference is regarded as arising after initial recognition to the
extent that any change from the original temporary difference is due to:
• a change in the carrying value of the asset or liability, other than for the
reasons set out above (see 7.2.4.B below); or
• a change in the tax base due to items being recorded on the tax return
(see 7.2.4.C below); and
• where the change in the temporary difference results from a change in the tax base
due to legislative change, IAS 12 provides no specific guidance, and more than one
treatment may be possible (see 7.2.4.D below).
7.2.4.A
Depreciation, amortisation or impairment of initial carrying value
The following are examples of transactions where the initial temporary difference
changes as the result of the amortisation of the original carrying amount, so that the
adjusted temporary difference is regarded as part of the temporary difference arising
on initial recognition, rather than a new difference.
Example 29.8: Impairment of non-deductible goodwill
Goodwill of £10 million (not tax-deductible) arose on a business combination in 2008. In accordance with
IAS 12 no deferred tax liability was recognised on the taxable temporary difference of £10 million that arose
on initial recognition of the goodwill. During the year ended 31 December 2019, following an impairment
test, the carrying amount of the goodwill is reduced to £6 million.
No deferred tax is recognised on the new temporary difference of £6 million, because it is part of the
temporary difference arising on the initial recognition of the goodwill. [IAS 12.21A].
Example 29.9: Depreciation of non-deductible PP&E
During the year ended 31 March 2019 an entity acquires an item of PP&E for €1 million which it intends to use
for 20 years, with no anticipated residual value. No tax deductions are available for the asset. In accordance with
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IAS 12 no deferred tax liability was recognised on the taxable temporary difference of €1 million that arises on
initial recognition of the PP&E.
The entity’s accounting policy is to charge a full year’s depreciation in the year of purchase, so that the carrying
amount of the asset at 31 March 2019 is €950,000. No deferred tax is recognised on the current temporary difference
of €950,000, because it is part of the temporary difference arising on the initial recognition of the PP&E. [IAS 12.22(c)].
Example 29.10: Amortisation of non-deductible loan issue 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 not deductible for tax purposes
either in the period when the loan is first recognised or subsequently. For financial reporting purposes, under
IFRS 9 the costs, together with interest and similar payments, are 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 analysis is explained in
more detail at 6.2.1.B above.
In accordance with IAS 12, no deferred tax liability was recognised on the taxable temporary difference of
£10 million that arose on initial recognition of the loan.
One year later, the carrying amount of the loan is £9.7 million, comprising the proceeds received of
£10 million (which equal the amount due at maturity), less unamortised transaction costs of £300,000. This
gives rise to a new temporary difference of £300,000. No deferred tax is recognised on the current temporary
difference, because it is part of the temporary difference arising on the initial recognition of the loan.
7.2.4.B
Change in carrying value due to revaluation
As illustrated in Example 29.4 at 7.2.3 above, a temporary difference arises when a non
tax-deductible asset is acquired. Where the asset is acquired separately (i.e. not as part of
a larger business combination) in circumstances giving rise to neither an accounting nor a
taxable profit or loss, no deferred tax liability is recognised for that temporary difference.
If such an asset is subsequently revalued, however, deferred tax is recognised on the
new temporary difference arising as a result of the revaluation, since this does not arise
on initial recognition of the asset, as illustrated in Examples 29.11 and 29.12.
Example 29.11: Revaluation of non-deductible asset (1)
On 1 January 2019 an entity paying tax at 30% acquires a non tax-deductible office building for €1,000,000
in circumstances in which IAS 12 prohibits recognition of the deferred tax liability associated with the
temporary difference of €1,000,000.
Application of IAS 16 results in no depreciation being charged on the building.
On 1 January 2019 the entity revalues the building to €1,200,000. The temporary difference associated with the
building is now €1,200,000, only €1,000,000 of which arose on initial recognition. Accordingly, the entity
recognises a deferred tax liability based on the remaining temporary difference of €200,000 giving deferred tax
expense at 30% of €60,000. This tax expense would be recognised in other comprehensive income (see 10 below).
Example 29.12: Revaluation of non-deductible asset (2)
On 1 January 2018 an entity paying tax at 30% acquires a non tax-deductible office building for €1,000,000
in circumstances in which IAS 12 prohibits recognition of the deferred tax liability associated with the
temporary difference of €1,000,000. The building is depreciated over 20 years at €50,000 per year to a
residual value of zero. The entity’s financial year ends on 31 December.
At 1 January 2020, the carrying amount of the building is €900,000, and it is revalued upwards by €450,000
to its current market value of €1,350,000. As there is no change to the estimated residual value of zero, or to
the life of the building, this will be depreciated over the next 18 years at €75,000 per year.
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Following the revaluation, the temporary difference associated with the building is €1,350,000. Of this
amount, only €900,000 arose on initial recognition, since €100,000 of the original temporary difference of
€1,000,000 arising on initial recognition of the asset has been eliminated through depreciation of the asset
(see 7.2.4.A above). The carrying amount (which equals the temporary difference, since the tax base is zero)
and depreciation during the year ended 31 December 2020 may then be analysed as follows.
Total
Arising on
Arising on
carrying
initial
revaluation
amount
recognition
€ € €
1 January 2020
1,350,000
900,000
450,000
Depreciation1 75,000
50,000
25,000
31 December 2020
1,275,000
850,000
425,000
The depreciation is allocated pro-rata to the cost element and revalued element of the total carrying amount.
On 1 January 2020 the entity recognises a deferred tax liability based on the temporary difference of €450,000
arising on the revaluation (i.e. after initial recognition) giving a deferred tax expense of €135,000 (€450,000 @
30%), recognised in other comprehensive income (see 10 below). This has the result that the effective tax rate
shown in the financial statements for the revaluation is 30% (€450,000 gain with deferred tax expense of €135,000).
As can be seen from the table above, as at 31 December 2020, €425,000 of the total temporary difference arose
after initial recognition. The entity therefore provides for deferred tax of €127,500 (€425,000 @ 30%), and deferred
tax income of €7,500 (the reduction in the liability from €135,000 to €127,500) is recognised in profit or loss.
The deferred tax income can be explained as the tax effect at 30% of the €25,000 depreciation relating to the
revalued element of the building (see table above).
7.2.4.C
Change in tax base due to deductions in tax return
The following are examples of transactions where a new temporary difference emerges
after initial recognition as the result of claiming tax deductions.
Example 29.13: Tax deduction for land
An entity that pays tax at 35% acquires land with a fair value of €5 million. Tax deductions of €100,000 per
year may be claimed for the land for the next 30 years (i.e. the tax base of the land is €3 million). In
accordance with IAS 12, no deferred tax liability is recognised on the taxable temporary difference of
€2 million that arises on initial recognition of the land.
In the period in which the land is acquired, the entity claims the first €100,000 annual tax deduction, and the
original cost of the land is not depreciated or impaired. The taxable temporary difference at the end of the
period is therefore €2.1 million (cost €5.0 million less tax base €2.9 million). Of this, €2 million arose on
initial recognition and no deferred tax is recognised on this. However, the remaining €100,000 of the gross
temporary difference arose after initial recognition. Accordingly the entity recognises a deferred tax liability
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 475
