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statements. Various approaches may be acceptable under IFRS for the
determination of how current and deferred tax is allocated between entities in the
tax-consolidated group. In Australia, where entities apply a standard virtually
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identical to IAS 12 in separate financial statements, three alternative approaches are
suggested as examples of acceptable allocation methods:39
• a ‘stand-alone taxpayer’ approach for each entity, as if it continued to be a taxable
entity in its own right.
• a ‘separate taxpayer within group’ approach for each entity, on the basis that the
entity is subject to tax as part of the tax-consolidated group. This method requires
adjustments for transactions and events occurring within the tax-consolidated
group that do not give rise to a tax consequence for the group or that have a
different tax consequence at the level of the group; and
• a ‘group allocation’ approach, under which the income tax amounts for the tax-
consolidated group are allocated among each entity in the group.
Nevertheless, there may be other methods that are also appropriate.
11.2 Payments for intragroup transfer of tax losses
Where one member of a group transfers tax losses to another member of the group, the
entity whose tax liability is reduced may be required, as matter of group policy, to pay
an amount of compensation to the member of the group that transfers the losses to it.
Such payments are known by different terms in different jurisdictions, but are referred
to in the discussion below as ‘tax loss payments’.
Tax loss payments are generally made in an amount equal to the tax saved by the paying
company. In some cases, however, payment may be made in an amount equal to the
nominal amount of the tax loss, which will be greater than the amount of tax saved. This
raises the question of how such payments should be accounted for.
The first issue is whether such payments should be recognised:
• in total comprehensive income; or
• as a distribution (in the case of a payment from a subsidiary to a parent) or a capital
contribution (in the case of a payment from a parent to a subsidiary).
The second issue is, to the extent that the payments are accounted for in total
comprehensive income, whether they should be classified as:
• income tax, allocated between profit or loss, other comprehensive income or
equity (see 10 above). The argument for this treatment is that the payments made
or received are amounts that would otherwise be paid to or received from (or
offset against an amount paid to) a tax authority; or
• operating income or expense in profit or loss (on the grounds that, as a matter of
fact, the payments are not made to or received from any tax authority).
IAS 12 is silent on these issues. However, there is a long-standing practice in many
jurisdictions that such payments are treated as if they were income taxes. We believe
that this practice is appropriate to the extent that the intragroup payment is for an
amount up to the amount of tax that would otherwise have been paid by the paying
company. Where a tax loss payment is made in excess of this amount, we consider that
it is more appropriate to account for the excess not as an income tax but as either:
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• a distribution or capital contribution (as applicable); or
• operating income or expense (as applicable).
In considering the applicable treatment, the legal and regulatory requirements in the
entity’s jurisdiction would also be relevant, for example if those local requirements
stipulate whether the excess payment is, in law, a distribution. The chosen treatment
should be applied consistently.
11.3 Recognition of deferred tax assets where tax losses are
transferred in a group
The ability of one member of a group to transfer its tax losses to another member of the
group that expects to have taxable profits against which those losses can be utilised is
an example of a tax planning opportunity ‘that will create taxable profit in appropriate
periods’. [IAS 12.29(b)]. Accordingly, it would be appropriate to recognise in the entity’s
consolidated financial statements a deferred tax asset in respect of unused tax losses
and unused tax credits that are expected to be utilised in this way. [IAS 12.29].
In the separate financial statements of the member of the group that holds the unused
losses and tax credits, it would only be appropriate to recognise an asset to the extent
that this entity expects to benefit itself from any transfer. Such benefits might be in the
form of payment for losses as discussed at 11.1 above, or as a result of taxable profits
otherwise created in the surrendering entity as a result of the transfer. If the
surrendering entity is not expected to receive any benefit in relation to the unused
losses and tax credits given up, then no asset should be recognised in the separate
financial statements of that entity.
12 BUSINESS
COMBINATIONS
Additional deferred tax arises on business combinations as a result of items such as:
• the application of IAS 12 to the assets and liabilities of the acquired business in the
consolidated financial statements, when it has not been applied in the separate
financial statements of that business;
• where the acquired entity already applies IAS 12 in its own financial statements,
the recognition in the fair value exercise of deferred tax in respect of assets and
liabilities of the acquired entity where no deferred tax is provided in those
financial statements. This may be the case where a temporary difference arose on
initial recognition of an asset or liability in the acquired entity’s own financial
statements. Deferred tax would then be recognised in the acquirer’s consolidated
financial statements, because, in those statements, the difference arises on initial
recognition in a business combination (see 7.2 above); and
• adjustments made to measure the assets and liabilities of the acquired business fair
value, with consequential changes in the temporary differences associated with
those assets and liabilities.
Any deferred tax assets or liabilities on temporary differences that arise on a business
combination affect the amount of goodwill or bargain purchase gain. [IAS 12.66].
Example 29.23 at 7.5.1 above illustrates the application of this principle.
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12.1 Measurement and recognition of deferred tax in a business
combination
IFRS 3 generally requires assets acquired and liabilities assumed in a business
combination to be:
• recognised only to the extent that they were assets or liabilities of the acquired
entity at the date of acquisition; [IFRS 3.10] and
• measured at fair value. [IFRS 3.18].
These provisions of IFRS 3 are discussed in more detail in Chapter 9 at 5. As exceptions
to this general principle, IFRS 3 requires an acquirer to:
• recognise and measure a deferred tax asset or liability arising from the assets
acquired and liabilities assumed in a business combination ‘in accordance with
IAS 12’; [IFRS 3.24] and
• account for the potential tax effects of temporary differences and carryforwards
of an acquiree that exist at the acquisition date or arise as a result of the acquisition
‘in accordance with IAS 12’. [IFRS 3.25].
There are essentially two reasons underlying these exceptions. The first is that IAS 12
does not purport to measure future tax at fair value, but at an amount based on a
prescribed model that takes no account of the time value of money. Secondly, and more
subtly, IAS 12 requires a number of questions of both recognition and measurement to
be resolved by reference to management’s plans and expectations – in particular, the
expected manner of recovery of assets (see 8.4 above) or the likelihood of recovering
deferred tax assets (see 7.4 above). The expectations and plans of the acquirer may well
differ from those of the acquired entity. For example, the acquired entity might have
assessed, for the purposes of IAS 12, that an asset would be recovered through use,
whereas the acquirer assesses it as recoverable through sale. The exceptions made by
IFRS 3 allow the deferred tax recognised in a business combination to reflect the
expectations of the acquirer rather than those of the acquiree.
Areas that give rise to particular difficulties of interpretation are:
• determining the manner of recovery of assets and settlement of liabilities at the
date of the business combination (see 12.1.1 below); and
• deferred tax assets (see 12.1.2 below).
12.1.1
Determining the manner of recovery of assets and settlement of
liabilities
As discussed at 8.4 above, IAS 12 requires deferred tax to be measured at an amount
that reflects the tax consequences that would follow from the manner in which the
entity expects to recover its assets or settle its liabilities. The expected manner of
recovery or settlement may affect both the tax base of an asset or liability and the tax
rate to be applied to any temporary difference arising.
As further noted above, the acquirer’s assessment of the manner of recovery for the
purposes of IAS 12 may well differ from that of the acquired entity. For example, the
acquired entity might have intended to recover an asset through use, whereas the
acquirer intends to sell it. In such a case, in our view, the requirement of IFRS 3 to
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recognise and measure deferred tax in accordance with IAS 12 has the effect that the
expectations of the acquirer are used to determine the tax base of an item and the
measurement of any deferred tax associated with the item.
12.1.1.A
Changes in tax base consequent on the business combination
In some jurisdictions, a business combination may provide the opportunity to revise the
tax base of an asset to an amount equal to the fair value assigned to it in accounting for the
business combination. Most significantly, this may include the ability to create a tax base
for an intangible asset or goodwill which may have had no tax base at all for the acquiree.
In some cases, the increase (as it generally is) in tax base may be more or less automatic.
In others, the taxpayer may be required to make a formal claim or election for the
increase to the tax authority. Sometimes further restructuring may be required – for
example, it may be necessary for the business of the acquired entity to be transferred
to another entity in the acquirer’s group in the same tax jurisdiction.
An increase in a tax base that requires action by the relevant entity after the acquisition
(such as making a claim or election or undertaking a restructuring) occurs after the business
combination. However, some hold the view that the ability to increase a tax base following
a business combination is a benefit that is taken into account by an informed buyer in
negotiating the purchase price. Accordingly, it is argued, the increase is most appropriately
reflected by adjusting the tax base of assets acquired as at the date of the business
combination as if the increase had occurred at that date. This reduces any deferred tax
liability and, therefore, reduces any goodwill (or increases any ‘bargain purchase’ gain).
Those who support this view note that, if the increase in tax base is accounted for only
when it legally occurs in the post-combination period, the net effect is to increase
goodwill and reduce post-combination tax expense when in reality the entity may have
done little more than fill in a form. It might also be difficult to sustain the higher carrying
amount of goodwill arising from this treatment.
We believe that it is generally appropriate to anticipate an increase to a tax base that
legally occurs following a business combination in accounting for the business
combination where the increase:
• is automatic or requires only a notification to the tax authority;
• requires an application to the tax authority that is not normally refused for
transactions of a comparable nature; or
• is contingent on some post-acquisition restructuring, where this can be done
without substantial difficulty.
Conversely, we believe that it would not generally be appropriate to account for an
increase in a tax base until it occurs where the increase:
• relies on ‘bespoke’ tax planning that may be challenged by the tax authority;
• requires an application to the tax authority that in practice is frequently and
successfully challenged for transactions of a comparable nature; or
• is contingent on some post-acquisition restructuring, where this will involve a
substantial process, such as obtaining approval from regulators, unions, pension
fund trustees etc.
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12.1.2
Deferred tax assets arising on a business combination
12.1.2.A
Assets of the acquirer
If, as a result of a business combination, the acquiring entity is able to recognise a
previously unrecognised tax asset of its own (e.g. unused tax losses), the recognition of
the asset is accounted for as income, and not as part of the accounting for the business
combination. [IAS 12.67].
12.1.2.B
Assets of the acquiree
It may be the case that deferred tax assets of an acquired entity do not meet the
recognition criteria of IAS 12 from the perspective of the acquired entity, but do meet
the criteria from the perspective of the acquirer. In such cases, the general principles of
IAS 12 require the acquirer’s perspective to be applied as at the date of the business
combination.
The potential benefit of the acquiree’s income tax loss carryforwards or other deferred
tax assets may not satisfy the criteria for separate recognition when a business
combination is initially accounted for but may be realised subsequently. Any changes
in recognised deferred tax assets of an acquired entity are accounted for as follows:
• Acquired deferred tax benefits recognised within the measurement period (see
Chapter 9 at 5.6.2) that result from new information about facts and circumstances
that existed at the acquisition date are applied to reduce the carrying amount of
any goodwill related to that acquisition. If the carrying amount of that goodwill is
zero, any remaining deferred tax benefits are recognised in profit or loss.
• All other acquired deferred tax benefits realised are recognised in profit or loss (or
outside profit or loss if IAS 12 so requires – see 10 above). [IAS 12.68].
12.1.3
Deferred tax liabilities of acquired entity
IAS 12 contains no specific provisions regarding the recognition of a deferred tax
liability of an acquired entity after the date of the original combination. The recognition
of such liabilities should therefore be accounted for in accordance with the normal rules
of IAS 12 (i.e. in the period in which the liability arises), unless either:
• the recognition of the liability occurs within the provisional measurement period
for the business combination and reflects new information about facts and
circumstances that existed at the acquisition date, in which case the acquisition
date value of the liability is retrospectively adjusted – see Chapter 9 at 12; or
• the failure to recognise the liability at the time of the combination was an error, in
which case the provisions of IAS 8 should be applied – see Chapter 3 at 4.6.
12.2 Tax deductions for replacement share-based payment awards in
a business combination
IFRS 3 contains some guidance on the treatment of tax deductions for share-based
payment transactions made by an acquirer as a replacement for awards made by the
acquired entity before the business combination. This is discussed in more detail
at 10.8.5 above.
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12.3 Apparent immediate impairment of goodwill created by
deferred tax
The requirement of IAS 12 to recognise deferred tax on all temporary differences
arising on net assets acquired in a business combination leads to the creation of goodwill
which, on a literal reading of IAS 36 may then be required to be immediately impaired,
as illustrated by Example 29.55 below.
Example 29.55: Apparent ‘day one’ impairment arising from recognition of
deferred tax in a business combination
Entity A, which is taxed at 40%, acquires Entity B for €100m in a transaction that is a business combination.
The fair values and tax bases of the identifiable net assets of Entity B are as follows:
Fair value
Tax base