International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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business model is to consume substantially all the economic benefits embodied in the
investment property over time, rather than through sale. The Interpretations Committee
has clarified that the presumption can be rebutted in other circumstances, provided that
sufficient evidence is available to support that rebuttal. However, the Committee neither
gave any indication of, nor placed any restriction on, what those other circumstances might
be.23 If the presumption is rebutted, the entity applies the normal requirements of IAS 12
for determining the manner of recovery of assets (see 8.4.1 to 8.4.5 above). [IAS 12.51C].
IAS 12 clarifies that these requirements are subject to the general restrictions on the
recognition of deferred tax assets (see 7.4 above). [IAS 12.51E].
8.4.8
Other assets and liabilities
In a number of areas of accounting IFRS effectively requires a transaction to be
accounted for in accordance with an assumption as to the ultimate settlement of that
transaction that may not reflect the entity’s expectation of the actual outcome.
For example, if the entity enters into a share-based payment transaction with an
employee that gives the employee the right to require settlement in either shares or cash,
IFRS 2 requires the transaction to be accounted for on the assumption that it will be
settled in cash, however unlikely this may be. IAS 19 may assert that an entity has a surplus
on a defined benefit pension scheme on an accounting basis, when in reality it has a deficit
on a funding basis. Similarly, if an entity issues a convertible bond that can also be settled
in cash at the holder’s option, IAS 32 requires the bond to be accounted for on the
assumption that it will be repaid, however probable it is that the holders will actually elect
for conversion. It may well be that such transactions have different tax consequences
depending on the expected manner of settlement, as illustrated in Example 29.29 below.
Example 29.29: Convertible bond deductible if settled
An entity issues a convertible bond for €1 million. After three years, the holders can elect to receive
€1.2 million or 100,000 shares of the entity. If the bond were settled in cash, the entity would receive a tax
deduction for the €200,000 difference between its original issue proceeds and the amount payable on
redemption. If the bond is converted, no tax deduction is available.
Under IAS 32, the bond would be accreted from €1 million to €1.2 million over the three year issue period.
The tax base remains at €1 million throughout, so that a deductible temporary difference of €200,000 emerges
over the issue period. It is assumed that the deferred tax asset relating to this difference would meet the
recognition criteria in IAS 12 (see 7.4 above).
For various reasons, it is extremely unlikely that the bond will be redeemed in cash.
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Example 29.29 raises the issue of whether any deferred tax asset should be recognised
in respect of the €200,000 temporary difference.
One view would be that no deferred tax asset should be recognised on the basis that
there is no real expectation that the transaction will be settled in cash, thus allowing the
entity to claim a tax deduction. The contrary view would be that the underlying
rationale of IAS 12 is that, in order for the financial statements to be internally
consistent, the tax effects of recognised assets and liabilities must also be recognised
(see 2.1 above). Accordingly, a deferred tax asset should be recognised.
8.4.9
‘Outside’ temporary differences relating to subsidiaries, branches,
associates and joint arrangements
In this section, an ‘outside’ temporary difference means a difference between the tax
base in the jurisdiction of the investor of an investment in a subsidiary, associate or
branch or an interest in a joint arrangement and carrying amount of that investment or
interest (or the net assets and goodwill relating to it) included in the financial statements.
Such differences, and the special recognition criteria applied to them by IAS 12, are
discussed in more detail at 7.5 above.
Where deferred tax is required to be recognised on such a temporary difference
(see 7.5.2 and 7.5.3 above), the question arises as to how it should be measured. Broadly
speaking, investors can realise an investment in one of two ways – either indirectly (by
remittance of retained earnings or capital) or directly (through sale of the investment to
a third party or by receiving residual assets upon liquidation of the associate). In many
jurisdictions, the two means of realisation have very different tax consequences.
Having determined that a temporary difference should be recognised, the entity should
apply the general rule (discussed in more detail above) that, where there is more than
one method of recovering an investment, the entity should measure any associated
deferred tax asset or liability by reference to the tax consequences associated with the
expected manner of recovery of the investment. [IAS 12.51A]. In other words, to the
extent that the investment is expected to be realised through sale, the deferred tax is
measured according to the tax rules applicable on sale, but to the extent that the
temporary difference is expected to be realised through a distribution of earnings or
capital, the deferred tax is measured according to the tax rules applicable on
distribution. In its decision in March 2015 not to take a question on this matter to its
agenda, the Interpretations Committee confirmed this view. Accordingly, if one part of
the temporary difference is expected to be received as dividends, and another part is
expected to be recovered upon sale or liquidation (for example, an investor has a plan
to sell the investment later and expects to receive dividends until the sale of the
investment), different tax rates would be applied to the parts of the temporary
difference in order to be consistent with the expected manner of recovery.24
Where the expected manner of recovery is through distribution, there may be tax
consequences for more than one entity in the group. For example, the paying company
may suffer a withholding tax on the dividend paid and the receiving company may suffer
income tax on the dividend received. In such cases, provision should be made for the
cumulative effect of all tax consequences. As discussed further at 10.3.3 below, a
withholding tax on an intragroup dividend is not accounted for in the consolidated
Income
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financial statements as a withholding tax (i.e. within equity), but as a tax expense in
profit or loss, since the group is not making a distribution but transferring assets from a
group entity to a parent of that entity.
8.4.10
‘Single asset’ entities
In many jurisdictions it is common for certain assets (particularly properties) to be
bought and sold by transferring ownership of a separate legal entity formed to hold the
asset (a ‘single asset’ entity) rather than the asset itself.
A ‘single asset’ entity may be formed for a number of reasons. For example, the insertion
of a ‘single asset’ entity between the ‘real’ owner and the property may limit the ‘real’
owner
’s liability for obligations arising from ownership of the property. It may also
provide shelter from tax liabilities arising on disposal of the property since, in many
jurisdictions, the sale of shares is taxed at a lower rate than the sale of property.
This raises the question whether, in determining the expected manner of recovery of
an asset for the purposes of IAS 12, an entity may have regard to the fact that an asset
held by a ‘single asset’ entity can be disposed of by selling the shares of the entity rather
than the asset itself.
The Interpretations Committee has discussed this matter on a number of occasions
since September 2011. In May 2012, the Committee noted the following significant
diversity in practice:25
• some preparers recognise deferred tax on both the asset within, and the shares of,
the ‘single asset’ entity;
• some preparers recognise tax on the shares only; and
• some preparers provide deferred tax on the difference between the asset within
the entity and the tax base of its shares, using the tax rate applicable to a disposal
of the shares.
The Interpretations Committee noted that IAS 12 requires the parent to recognise
deferred tax on both the asset within, and the shares of, the ‘single asset’ entity, if tax
law considers the asset and the shares as two separate assets and if no specific
exemptions in IAS 12 apply. At that time, the Committee asked its staff to undertake
more research with the possible outcome of an amendment to IAS 12 addressing this
specific type of transaction. Such an amendment would, in the Committee’s view, be
beyond the scope of the Annual Improvements project.26
Following further deliberations, the Interpretations Committee decided in July 2014 not to
take the issue onto its agenda but instead to recommend to the IASB that it should analyse
and assess the concerns raised about the current requirements in IAS 12 in its research
project on Income Taxes. In issuing its agenda decision, the Committee noted that:27
a) paragraph 11 of IAS 12 requires the entity to determine temporary differences in
the consolidated financial statements by comparing the carrying amounts of assets
and liabilities in the consolidated financial statements with the appropriate tax
base. In the case of an asset or a liability of a subsidiary that files separate tax
returns, this is the amount that will be taxable or deductible on the recovery
(settlement) of the asset (liability) in the tax returns of the subsidiary; and
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b) the requirement in paragraph 11 of IAS 12 is complemented by the requirement in
paragraph 38 of IAS 12 to determine the temporary difference related to the shares
held by the parent in the subsidiary by comparing the parent’s share of the net
assets of the subsidiary in the consolidated financial statements, including the
carrying amount of goodwill, with the tax base of the shares for purposes of the
parent’s tax returns.
The Interpretations Committee also noted that these paragraphs require a parent to
recognise both the deferred tax related to the asset inside and the deferred tax related
to the shares, if:28
a)
tax law attributes separate tax bases to the asset inside and to the shares;
b)
in the case of deferred tax assets, the related deductible temporary differences can
be utilised as specified in paragraphs 24 to 31 of IAS 12; and
c)
no specific exceptions in IAS 12 apply.
Accordingly, in determining the expected manner of recovery of an asset for the
purposes of IAS 12, the entity should have regard to both the asset itself and the shares.
8.4.11
Change in expected manner of recovery of an asset or settlement of a
liability
A change in the expected manner of recovery of an asset or settlement of a liability should
be dealt with as an item of deferred tax income or expense for the period in which the
change of expectation occurs, and recognised in profit or loss or in other comprehensive
income or movements in equity for that period as appropriate (see 10 below).
This may have the effect, in certain situations, that some tax consequences of a
disposal transaction are recognised before the transaction itself. For example, an
entity might own an item of PP&E which has previously been held for use but which
the entity now expects to sell. In our view, any deferred tax relating to that item of
PP&E should be measured on a ‘sale’ rather than a ‘use’ basis from that point, even
though the disposal itself, and any related current tax, will not be accounted for until
the disposal occurs. As noted at 7.4.8 above, which discusses the effect of disposals
on the recoverability of tax losses, the change in measurement will be required even
if the asset does not yet meet the criteria for being classified as held for sale in IFRS 5
(see Chapter 4 at 2.1.2). This is because those criteria set a higher hurdle for
reclassification (‘highly probable’) than the requirement in IAS 12 to use the entity’s
expected manner of recovery of an asset.
8.5
Different tax rates applicable to retained and distributed profits
In some jurisdictions, the rate at which tax is paid depends on whether profits are
distributed or retained. In other jurisdictions, distribution may lead to an additional
liability to tax, or a refund of tax already paid. IAS 12 requires current and deferred
taxes to be measured using the rate applicable to undistributed profits until a liability
to pay a dividend is recognised, at which point the tax consequences of that
dividend should also be recognised, as illustrated in Example 29.30 below.
[IAS 12.52A].
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Example 29.30: Different tax rates applicable to retained and distributed profits
An entity operates in a jurisdiction where income taxes are payable at a higher rate on undistributed profits
(50%) with an amount being refundable when profits are distributed. The tax rate on distributed profits is
35%. At the end of the reporting period, 31 December 2019, the entity does not recognise a liability for
dividends proposed or declared after the end of the reporting period. As a result, no dividends are recognised
in the year 2019. Taxable income for 2019 is €100,000. Net taxable temporary differences have increased
during the year ended 31 December 2019 by €40,000.
The entity recognises a current tax liability and a current income tax expense of €50,000 (€100,000 taxable
profit @ 50%). No asset is recognised for the amount potentially recoverable as a result of future dividends.
The entity also recognises a deferred tax liability and deferred tax expense of €20,000 (€40,000 @ 50%)
representing the income taxes that the entity will pay when it recovers or settles the carrying amounts of its
assets and liabilities based on the tax rate applicable to undistributed profits.
Subsequently, on 15 March 2020 the entity declares, and recognises as a liability, dividends of €10,000 from
previous operating profits. At that point, the entity recognises the recovery of income taxes of €1,500 (€10,000
@ [50% – 35%]), representing the refund of tax due in respect of the dividends recognised as a liabilit
y, as a
current tax asset and as a reduction of current income tax expense for the year ended 31 December 2020.
As discussed at 10.3.5 below, the tax benefit of €1,500 in the example above will be
recognised in profit or loss.
8.5.1 Effectively
tax-free
entities
In a number of jurisdictions certain types of entity, such as investment vehicles, are
generally exempt from corporate income tax provided that they fulfil certain criteria,
which generally include a requirement to distribute all, or a minimum percentage, of
their annual income as a dividend to investors. This raises the question of how such
entities should measure income taxes.
One view would be that, under the basic principle set out above, such an entity has a
liability to tax at the normal rate until the dividend for a year becomes a liability. The
liability for a dividend for an accounting period usually arises after the end of that period
(as in Example 29.30 above). Under this analysis, therefore, such an entity would be
required, at each period end, to record a liability for current tax at the standard corporate
rate. That liability would be released in full when the dividend is recognised as a liability
in the following period. This would mean that, on an ongoing basis, the income statement
would show a current tax charge or credit comprising:
• a charge for a full liability for the current period; and
• a credit for the reversal of the corresponding liability for the prior period.
In addition, deferred tax would be recognised at the standard tax rate on all temporary
differences.
A second view would be that the provisions of IAS 12 regarding different tax rates for
distributed and undistributed tax rates are intended to apply where the only significant
factor determining the differential tax rate is the retention or distribution of profit. By
contrast, the tax status of an investment fund often depends on many more factors than
whether or not profits are distributed, such as restrictions on its activities, the nature of
its investments and so forth. On this view, the analysis would be that such an entity can
choose to operate within one of two tax regimes (a ‘full tax’ regime or a ‘no tax’ regime),
rather than that it operates in a single tax regime with a dual tax rate depending on