International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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When an asset is revalued for tax purposes and that revaluation is related to an
accounting revaluation of an earlier period, or to one that is expected to be carried out
in a future period, the tax effects of both the asset revaluation and the adjustment of the
tax base are credited or charged to equity in the periods in which they occur.
However, if the revaluation for tax purposes is not related to an accounting revaluation
of an earlier period, or to one that is expected to be carried out in a future period, the
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tax effects of the adjustment of the tax base are recognised in profit or loss. [IAS 12.65].
For example, when tax law gives additional deductions to reflect the indexation of
assets for tax purposes (see 6.2.2.D above) the tax base of the asset changes without any
corresponding change to the asset’s carrying amount in the financial statements.
Because the carrying amount has not changed, there is no gain or loss in relation to
indexation in profit and loss or in other comprehensive income. Accordingly, the effect
of the change in tax base is recorded in profit or loss. [IAS 12.65].
10.1.1
Non-monetary assets with a tax base determined in a foreign
currency
Another example arises when the tax base of a non-monetary asset is determined in a
foreign currency. This can be the case in oil and gas producing entities that have a
functional currency of US dollars but operate (and are accountable for income taxes) in
various local jurisdictions under different currencies (see Chapter 39 at 9.1).
IAS 12 notes that in this situation the entity measures its non-monetary asset using its
functional currency as at the date of purchase. Where the non-monetary asset is also a
non-current asset, the tax base (denominated in local currency) is retranslated to
determine the temporary difference (on a functional currency basis) as at each reporting
date. Because this retranslation has no effect on carrying values recognised in the financial
statements, there is no corresponding gain or loss against which the tax can be allocated.
As a result, the movement in deferred tax is recorded in profit or loss. [IAS 12.41].
In 2015, the Interpretations Committee considered a submission that requested
confirmation as to whether deferred taxes arising from the effect of exchange rate
changes on the tax bases of such non-current assets are recognised through profit or
loss. The Committee completed its deliberations in January 2016 and, in noting the
requirement in paragraph 41 of IAS 12, determined that:36
• deferred tax does not arise from a transaction or event that is recognised outside
profit or loss and is therefore charged or credited to profit or loss in accordance
with paragraph 58 of IAS 12;
• such a deferred tax charge or credit would be presented with other deferred taxes,
instead of with foreign exchange gains or losses, in the statement of profit or loss; and
• paragraph 79 of IAS 12 requires the disclosure of the major components of tax
expense (income). When changes in the exchange rate are the cause of a major
component of the deferred tax charge or credit, an explanation of this in
accordance with paragraph 79 of IAS 12 would help explain the tax expense
(income) to the users of the financial statements.
In the light of the existing IFRS requirements the Interpretations Committee determined
that neither an Interpretation nor an amendment to a Standard was necessary.37
10.2 Retrospective restatements or applications
IAS 8 requires retrospective restatements or retrospective applications arising from
corrections of errors and changes in accounting policy to be accounted for by adjusting
the amounts presented in the financial statements of comparative periods and restating
the opening balances of assets, liabilities and equity for the earliest prior period presented.
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Because IAS 12 requires tax relating to an item that has been recognised outside profit
or loss to be treated in the same way, any tax effect of a retrospective restatement or
retrospective application on the opening comparative statement of financial position is
dealt with as an adjustment to equity also. [IAS 12.58].
However, the fact that IAS 12 states that tax arising in a different period, but relating to
a transaction or event arising outside profit or loss should also be recognised in other
comprehensive income or equity (as applicable) is taken by some to mean that any
subsequent remeasurement of tax originally recognised in equity as part of a prior year
adjustment should be accounted for in equity also. In our view, such an assertion fails
to reflect the true nature of retrospective application, which is defined in IAS 8 as the
application of a new accounting policy ‘to transactions, other events or conditions as if
that policy had always been applied’ (our emphasis). [IAS 8.5]. This is illustrated by
Example 29.37 below.
Example 29.37: Remeasurement of deferred tax liability recognised as the result
of retrospective application
An entity’s date of transition to IFRS was 1 January 2004. As a result of the adoption of IAS 37, its first IFRS
financial statements (prepared for the year ended 31 December 2005) showed an additional liability for
environmental rectification costs of €5 million as an adjustment to opening reserves, together with an
associated deferred tax asset at 40% of €2 million.
The environmental liability does not change substantially over the following accounting periods, but during
the year ended 31 December 2019 the tax rate falls to 30%. This requires the deferred tax asset to be
remeasured to €1.5 million giving rise to tax expense of €500,000. Should this expense be recognised in
profit or loss for the period or in equity?
If read in isolation, IAS 12 could be construed as requiring this expense to be accounted
for in equity, as being a remeasurement of an amount originally recognised in equity.
However, as discussed above, IAS 8 defines retrospective application as the application
of a new accounting policy ‘to transactions, other events or conditions as if that policy
had always been applied’. If the entity had presented comparative information for all
periods since it first commenced business, rather than present a single ‘catch up’
adjustment at the start of the earliest period presented, the charge for environmental
costs (and all the related deferred tax) would have been reflected in profit or loss in
previous periods. It is therefore clear that the tax relates to a transaction which would
have been recognised in profit or loss on a full retrospective application of IFRS, and
that the tax expense arising from a change in tax rate should be treated in the same way.
10.3 Dividends and transaction costs of equity instruments
10.3.1
Dividend subject to differential tax rate
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. This is discussed further at 8.5 above.
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Where taxes are remeasured on recognition of a liability to pay a dividend, the
difference should normally be recognised in profit or loss rather than directly in equity,
even though the dividend itself is recognised directly in equity under IFRS. IAS 12 takes
the view that any additional (or lower) tax liability relates to the original profit now
being distributed rather than to the distribution itself. Where, however, the dividend is
paid out of profit arising from a transaction that was originally recognised in other
comprehensive income or equity, the adjustment to the tax liability should also be
recognised in other comprehensive income or equity. [IAS 12.57A].
10.3.2
Dividend subject to withholding tax
Where dividends are paid by the reporting entity subject to withholding tax, the
withholding tax should be included as part of the dividend charged to equity. [IAS 12.65A].
It is noteworthy that there may be little economic difference, from the paying entity’s
perspective, between a requirement to pay a 5% ‘withholding tax’ on all dividends and
a requirement to pay an additional 5% ‘income tax’ on distributed profit. Yet, the
accounting treatment varies significantly depending on the analysis. If the tax is
considered a withholding tax, it is treated as a deduction from equity in all
circumstances. If, however, it is considered as an additional income tax, it will generally
be treated as a charge to profit or loss (see 10.3.1 above). This distinction therefore relies
on a clear definition of withholding tax, which IAS 12 unfortunately does not provide.
IAS 12 describes a withholding tax as a ‘portion of the dividends [paid] to taxation
authorities on behalf of shareholders’. [IAS 12.65A]. However, it is not clear whether the
determination of whether or not the tax is paid ‘on behalf of shareholders’ should be
made by reference to the characterisation of the tax:
• in the paying entity’s tax jurisdiction – in which case, there is the problem noted
above that one jurisdiction’s ‘additional distribution tax’ may be economically
identical to another jurisdiction’s ‘withholding tax’; or
• in the receiving entity’s tax jurisdiction – in which case there would be the
problem that the tax on a dividend paid to one shareholder is a ‘withholding tax’
(because credit is given for it on the shareholder’s tax return) but the tax on a
dividend paid to another shareholder the same time is not (because no credit is
given for it on that shareholder’s tax return).
This distinction is also relevant in accounting for dividend income that has been subject
to withholding tax, as discussed at 10.3.4 below.
10.3.3
Intragroup dividend subject to withholding tax
Where irrecoverable withholding tax is suffered on intragroup dividends, the withholding
tax does not relate to an item recognised in equity in the consolidated financial statements
(since the intragroup dividend to which it relates has been eliminated in those financial
statements). The tax should therefore be accounted for in profit or loss for the period.
10.3.4 Incoming
dividends
IAS 12 does not directly address the treatment of incoming dividends on which tax has
been levied (i.e. whether they should be shown at the amount received, or gross of
withholding tax together with a corresponding tax charge). As discussed at 4.2 above, we
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believe that judgement is required to determine 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 discussed at 4.2 above, it is noted at 10.3.2 above that an
entity paying dividends that are subject to withholding tax would record the gross value
of the distribution in equity, on the basis that the withholding tax is regarded as an amount
paid to the tax authorities ‘on behalf of shareholders’. [IAS 12.65A]. If it is determined from
the point of view of the recipient of the dividend that a particular withholding tax is an
income tax in the scope of IAS 12, it would therefore be consistent with this treatment to
show dividends (and other investment income subject to withholding taxes) gross of
withholding taxes and to recognise any non-refundable portion of such withholding taxes
as a tax expense in the statement of comprehensive income.
Some jurisdictions also give tax deductions for the ‘underlying’ tax suffered on
dividends received. This is based on the concept that the dividend has been paid out of
profits already subject to tax, so that to tax the full amount received again would amount
to a punitive double taxation of the underlying profits. In our view, such underlying tax
(which would form part of the tax charge, not the dividend, of the paying company) is
not directly paid on behalf of the shareholder, and accordingly incoming dividends
should not be grossed up for underlying tax.
10.3.5
Tax benefits of distributions and transaction costs of equity
instruments
IAS 32 as originally issued required distributions to shareholders and transaction costs
of equity instruments to be accounted for in equity net of any related income tax benefit
(see Chapter 43 at 8.2). However, as discussed below, the ‘default’ allocation for income
tax on equity distributions is now to profit or loss, with the tax consequences of
transaction costs relating to equity instruments still being taken to equity, provided that
the related costs are also recognised in equity.
Annual Improvements to IFRSs 2009-2011 Cycle, issued in May 2012, amended IAS 32
so as to remove the reference to income tax benefit. This means that all tax effects of
equity transactions are allocated in accordance with the general principles of IAS 12.
Unfortunately, IAS 12 was not entirely clear as to how the tax effects of certain equity
transactions should be dealt with, as illustrated by Example 29.38 below.
Example 29.38: Tax deductible distribution on equity instrument
An entity paying tax at 25% has issued €25 million 4% preference shares at par value that are treated as
equity instruments for accounting purposes (because coupon payments are subject to an equity dividend
blocker and are therefore discretionary). The preference shares are treated as debt for tax purposes (i.e. all
coupon payments are deductible in determining taxable profit). The entity makes a payment of €1 million
and is able to claim a tax deduction of €250,000. There are no restrictions on the recoverability of that
deduction for tax purposes.
Some would have allocated the tax deduction to equity on the basis that it relates to the
coupon payment, which was accounted for in equity. Others would have considered
the distribution as being sourced from an accumulation of retained earnings originally
accounted for in profit or loss and, therefore, have allocated the tax deduction for the
dividend payment in profit or loss. The cause of this divergence was paragraph 52B of
IAS 12, which stated the following:
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‘In the circumstances described in paragraph 52A, the income tax consequences of
dividends are recognised when a liability to pay the dividend is recognised. The income
tax consequences of dividends are more directly linked to past transactions or events
than to distributions to owners. Therefore, the income tax consequences of dividends
are recognised in profit or loss for the period as required by paragraph 58 except to the
extent that the income tax consequences of dividends arise from the circumstances
described in paragraph 58(a) and (b).’ [IAS 12 (2018).52A].
Those who believed that the tax deduction should be accounted for in equity argued
that paragraph 52B of IAS 12 only applies ‘in the circumstances described in
paragraph 52A’ and the example does not include differential tax rates for retained and
distributed profits. Those who argued that the tax deduction should be credited to profit
or loss considered that the reference in paragraph 52A of IAS 12 to taxes ‘payable at a
higher or lower rate’, should be interpreted as including a higher or lower effective rate,
as well as a higher or lower headline rate.
The Interpretations Committee observed that the circumstances to which the
requirements in paragraph 52B of IAS 12 apply were unclear and decided that a limited
amendment to IAS 12 was required to clarify that the requirements in paragraph 52B of
IAS 12 apply to all payments on financial instruments classified as equity that are
distributions of profits, and are not limited to the circumstances described in
paragraph 52A of IAS 12.38
In December 2017, the IASB published – Annual Improvements to IFRS Standards –
2015-2017 Cycle, which moves the text in paragraph 52B to paragraph 57A, thereby
relating it more closely to the general requirements for the allocation of tax set out
at 10 above, and removes any reference to the specific circumstances when there are
different tax rates for distributed and undistributed profits. Accordingly, the tax benefits
of equity distributions will be recognised in profit or loss, unless it can be demonstrated
that the profits being distributed were previously generated in transactions recognised in
other comprehensive income or equity. These amendments are mandatory for annual