International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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Example 29.53 below. [IAS 12 IE Example 6].
Example 29.53: Deferred tax on replacement share-based awards in a business
combination
On 1 January 2019 Entity A acquired Entity B. A paid cash consideration of €400 million to the former owners of
B. At the acquisition date B had outstanding fully-vested employee share options with a fair value of €100 million.
As part of the business combination B’s outstanding share options are replaced by fully vested share options of A
(replacement awards) with a market-based measure of €100 million and an intrinsic value of €80 million. In
accordance with IFRS 3, the replacement awards are part of the consideration transferred for B (see Chapter 30 at 11).
A tax deduction will be given only when the options are exercised, based on the intrinsic value of the options
at that date. A’s tax rate is 40%.
A recognises a deferred tax asset of €32 million (intrinsic value of €80m × 40%) on the replacement awards
at the acquisition date (see 10.8.1 above). IAS 12 does not indicate the calculation if only part of the fair
value of the award were regarded as part of the consideration transferred. However, it would be consistent
with the general approach indicated at 10.8.2 above to calculate the tax base of the award by adjusting the
intrinsic value by the ratio of the expired vesting period at acquisition to the total vesting period of the award
(as determined for the purposes of IFRS 3 – see Chapter 30 at 11).
A measures the identifiable net assets obtained in the business combination (excluding deferred tax assets
and liabilities) at €450 million, with a combined tax base of €300 million, giving rise to a taxable temporary
difference at the acquisition date of €150 million, on which deferred tax at 40% of €60 million is recognised.
Goodwill is calculated as follows:
€m
Cash consideration
400
Replacement options
100
Total consideration
500
Identifiable net assets (excluding deferred tax)
(450)
Deferred tax asset
(32)
Deferred tax liability
60
Goodwill 78
Reductions in the carrying amount of goodwill are not deductible for tax purposes. In accordance with the initial
recognition exception in IAS 12 (see 7.2 above), A recognises no deferred tax liability for the taxable temporary
difference associated with the goodwill recognised in the business combination. The accounting entry for the
business combination is therefore as follows:
Debit
Credit
€m
€m
Goodwill 78
Identifiable net assets
450
Deferred tax asset
32
Cash 400
Equity 100
Deferred tax liability
60
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On 31 December 2019 the intrinsic value of the replacement awards is €120 million, in respect of
which A recognises a deferred tax asset of €48 million (€120 m at 40%). This gives rise to deferred
tax income of €16 million (€48 million recognised at 31 December 2019 less €32 million arising on
acquisition). IAS 12 notes, somewhat redundantly, that this amount is credited to ‘deferred tax
income’, but with no indication as to whether the amount should be recognised in profit or loss or in
equity. In our view, the general principles of IAS 12 regarding tax deductions on share-based payment
transactions suggest that the entire amount is recognised in equity. This is because the consolidated
financial statements of A have never recognised any expense for the award in profit or loss (since it
is attributed fully to the consideration transferred). Therefore none of the tax deductions can be
recognised in profit or loss either.
10.8.6
Share-based payment transactions subject to transitional provisions
of IFRS 1 and IFRS 2
IFRS 1 and IFRS 2 provide, respectively, first-time adopters and existing IFRS preparers
with some transitional exemptions from accounting for share-based payment
transactions. The accounting treatment of the tax effects of transactions to which these
exemptions have been applied is discussed in Chapter 5 at 7.3.2. Whilst that discussion
specifically addresses the tax effects of transactions subject to the exemption for first-
time adopters of IFRS, it is equally applicable to the tax effects of transactions subject
to the exemptions in IFRS 2 for existing IFRS preparers.
10.9 Change in tax status of entity or shareholders
Sometimes there is a change in an entity’s tax assets and liabilities as a result of a change
in the tax status of the entity itself or that of its shareholders. SIC-25 clarifies that the
effect of such a change should be recognised in profit or loss except to the extent that
it involves a remeasurement of tax originally accounted for in other comprehensive
income or in equity, in which case the change should also be dealt with in, respectively,
other comprehensive income or equity. [SIC-25.4].
10.10 Previous revaluation of PP&E treated as deemed cost on
transition to IFRS
In some cases IFRS 1 allows an entity, on transition to IFRS, to treat the carrying amount
of property, plant, and equipment (PP&E) revalued under its pre-transition GAAP as a
deemed cost for the purposes of IFRS (see Chapter 5 at 5.5).
Where an asset is carried at deemed cost on transition to IFRS, but the tax base of the
asset remains at original cost (or an amount based on original cost), the pre-transition
revaluation will give rise to a temporary difference (often, a taxable temporary
difference) associated with the asset. IAS 12 requires deferred tax to be recognised on
any such temporary difference at transition.
If, after transition, the deferred tax is required to be remeasured (e.g. because of a
change in tax rate, or a re-basing of the asset for tax purposes), and the asset concerned
was revalued outside profit or loss under pre-transition GAAP, the question arises as to
whether the resulting deferred tax income or expense should be recognised in, or
outside, profit or loss. This is discussed in Chapter 5 at 7.3.1.
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10.11 Disposal of an interest in a subsidiary that does not result in a
loss of control
Under IFRS 10 – Consolidated Financial Statements – a decrease in a parent’s
ownership interest in a subsidiary that does not result in a loss of control is accounted
for in the consolidated financial statements as an equity transaction, i.e. a transaction
with owners in their capacity as owners. [IFRS 10.23]. In these circumstances, the carrying
amounts of the controlling and non-controlling interests are adjusted to reflect the
changes in their relative interests in the subsidiary. ‘The entity shall recognise directly
in equity any difference between the amount by which the non-controlling interests are
adjusted and the fair value of the consideration paid or received, and attribute it to the
owners of the parent.’ [IFRS 10.B96]. In other words, no changes in a subsidiary’s assets
(including goodwill) and liabilities are recognised in a transaction in which a parent
increases or decreases its ownership interest in a sub
sidiary that it already controls.
[IFRS 10.BCZ173]. Increases or decreases in the ownership interest in a subsidiary do not
result in the recognition of a gain or loss. Accounting for disposals of interests that do
not result in a loss of control is discussed in Chapter 7 at 3.3.
As the transaction is accounted for as an equity transaction, which does not affect profit
or loss in the consolidated financial statements, one might assume that the full amount
of any tax effect should also be recognised in equity. [IAS 12.58(a)]. However, this is not
the case to the extent that any adjustment to non-controlling interests relates to the
post acquisition profit of the subsidiary, which was previously recognised in the
consolidated income statement, as illustrated in Example 29.54 below.
Example 29.54: Tax effect of a disposal of an interest in a subsidiary that does
not result in a loss of control
A parent owns 100% of the equity shares of a subsidiary and presents the investment at a cost of $1,000,000
in its separate financial statements. To date, the parent had not recognised deferred taxation, as it considered
it probable that the temporary difference would not reverse in the foreseeable future. At the end of the
reporting period, the subsidiary’s post acquisition profit and net asset value recognised in the parent’s
consolidated financial statements are $500,000 and $1,500,000 respectively. The parent agrees to dispose of
a 20% interest in the subsidiary for a cash consideration of $1,400,000 (the ‘Transaction’).
It is assumed that the tax base of the investment in the subsidiary is the same as its original cost of $1,000,000.
The taxable gain is calculated on the same basis as the gain recognised in the separate financial statements
and the applicable tax rate is 25%.
The parent recognises a gain of $1,200,000 (i.e. $1,400,000 – [$1,000,000 × 20%]) in its separate financial
statements and is liable for a current tax of $300,000 (i.e. $1,200,000 × 25%).
The Transaction does not result in the parent losing control of the subsidiary and it is accounted for in equity
in the consolidated financial statements of the parent. The parent recognises non-controlling interests of
$300,000 (i.e. $1,500,000 × 20%) and credits equity for $1,100,000, being the difference between the
consideration of $1,400,000 and the non-controlling interests of $300,000, in the consolidated financial
statements of the parent.
What are the current and deferred tax effects in the consolidated financial statements if:
(a) the transaction is not completed until after the end of the reporting period; or
(b) the transaction is completed at the end of the reporting period?
If the transaction is not completed until after the end of the reporting period, no current
tax is recognised. However, as the parent intends to recover 20% of its investment in
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the subsidiary through sale, it must recognise a deferred tax liability for the temporary
difference associated with its investment in the subsidiary that is expected to reverse in
the foreseeable future. [IAS 12.39]. Its carrying value in the consolidated financial
statements is $1,500,000 and its tax base is $1,000,000. Accordingly, deferred tax of
$25,000 (i.e. [$1,500,000 – $1,000,000] × 20% × 25%) should be recognised in profit or
loss in the consolidated financial statements. This deferred tax would reverse through
profit or loss upon disposal, because it relates to the post acquisition profit recognised
in an earlier period. [IAS 12.58].
If the transaction is completed at the end of the reporting period, the consolidated
financial statements would include a current tax charge of $300,000 on the taxable gain
on sale recorded by the subsidiary. Whilst the transaction is recorded in equity, because
there is no loss of control, the entity does not recognise all of this tax directly in equity
because only $1,100,000 out of the total taxable gain of $1,200,000 was taken to non-
controlling interests in equity. [IAS 12.58(a)]. Therefore, $275,000 (i.e. $1,100,000 × 25%) is
recognised directly in equity because it arises from the equity transaction. [IAS 12.61A(b)].
The remaining current tax of $25,000 (i.e. [$1,500,000 – $1,000,000] × 20% × 25%) relates
to the post acquisition profit of the subsidiary, and is recognised in the consolidated
income statement.
11 CONSOLIDATED
TAX
RETURNS AND OFFSET OF
TAXABLE PROFITS AND LOSSES WITHIN GROUPS
In some jurisdictions one member of a group of companies may file a single tax return
on behalf of all, or some, members of the group. Sometimes this is a mandatory
requirement for a parent entity and its eligible subsidiaries operating in the same tax
jurisdiction; and sometimes adoption is elective. In other jurisdictions, it is possible for
one member of a group to transfer its tax losses to one or more other members of the
group in order to reduce their tax liabilities. In some groups a company whose tax
liability is reduced by such an arrangement may be required to make a payment to the
member of the group that pays tax on its behalf, or transfers losses to it, as the case may
be. In other groups no such charge is made.
Such transactions raise the question of the appropriate accounting treatment in the
separate financial statements of the group entities involved – in particular, whether the
company benefiting from such an arrangement should reflect income (or more likely a
capital contribution) from another member of the group equal to the tax expense
mitigated as a result of the arrangement.
Some argue that the effects of such transactions should be reflected in the separate
financial statements of the entities involved, as is required by some national standards
(e.g. those of the US and Australia). Others argue that, except to the extent that a
management charge is actually made (see 11.1 below), there is no need to reflect such
transactions in the separate financial statements of the entities involved. Those that take
this view point out that it is inconsistent to require companies to show a capital
contribution for tax losses ceded to them without charge, unless all other intragroup
transactions are also restated on arm’s-length terms – which would be somewhat
radical. Moreover, IAS 24 – Related Party Disclosures – merely requires disclosure of
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the actual terms of such transactions, not that they be remeasured, either for financial
reporting or disclosure purposes, on the same basis as a similar notional arm’s length
transaction (see Chapter 35).
IAS 12 is silent on the issue and, in our view, no single approach can be said to either
be prohibited or required. Accordingly, a properly considered approach may be
adopted, provided that it is applied on a consistent basis and the related judgements
are disclosed where their impact is believed to be material. In arriving at an
appropriate judgement, the discussion at 4.1 and 4.4 above is relevant in considering
whether entities should apply IAS 12 or another standard (such as IAS 37). Any
judgement should be based on the particular facts and circumstances relating to the
legislation giving rise to tax-consolidation, the nature of the obligations and right
s of
entities in the group and local company law. As noted at 4.4 above, where there is a
predominant local consensus in evidence or specific guidance issued by regulators
in the relevant tax jurisdiction, then we believe that the entity should apply this
consensus or guidance.
11.1 Examples of accounting by entities in a tax-consolidated group
In a typical tax-consolidation arrangement, a single consolidated annual tax return is
prepared for the tax-consolidated group as a whole. Transactions between the
entities in the tax-consolidated group are eliminated, and therefore ignored for tax
purposes. A single legal entity in the group (usually the parent) is primarily liable for
the current income tax liabilities of that group. Each entity in the group would be
jointly and severally liable for the current income tax liability of the group if the
parent entity defaults. There might also be a legally binding agreement between the
entities in the group which establishes how tax assets and liabilities are allocated
within the group.
As noted above, IAS 12 is silent on the issue and there is diversity in practice where
these arrangements exist. Some entities apply IAS 37 principles to the recognition,
measurement and allocation of current tax assets and liabilities to individual entities
in the group, on the basis that tax is determined on the basis of the taxable profits
of the group as a whole and not on the profits of the individual entities themselves.
In that case current tax assets and liabilities are allocated on the basis of each
entity’s legal or constructive obligations to the tax authorities (for example where
joint and several liability is determined to exist) or to other entities in the tax-
consolidated group (including where formal agreements are implemented for the
funding and sharing or tax liabilities and assets). Deferred tax is not accounted for
in separate financial statements in these circumstances. Other entities apply the
recognition and measurement principles of IAS 12 on the basis that tax is still
determined on the basis of the taxable profits of each entity in the group on the
obligations of each entity to the tax authorities. When IAS 12 is deemed to apply,
entities will account for both current and deferred tax in their separate financial