Income Taxes (IAS 12)

Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.

Accounting:

• Current tax expense/income for the period is recognised in P/L (unless the tax arises from a transaction recognised directly in equity or OCI — see below)
• Any unpaid current tax at the period end is recognised as a current tax liability; any overpayment is a current tax asset
• Measured at the amount expected to be paid to (recovered from) the tax authorities, using tax rates and tax laws enacted or substantively enacted by the reporting date

"Substantively enacted": A change in tax rate is substantively enacted when the legislative process is effectively complete and the rate will apply unless overturned by an unlikely event. In the UK, this typically means Royal Assent has been granted OR (for Finance Bills) the House of Commons has approved the resolution with Provisional Collection of Taxes Act authority.

Accounting profit vs taxable profit: These differ because of:

• Permanent differences: Items that affect accounting profit but never affect taxable profit, or vice versa (e.g., UK disallowable expenses like entertaining; income that is permanently tax-exempt). Permanent differences do NOT give rise to deferred tax.
• Temporary differences: Items that affect accounting profit and taxable profit in DIFFERENT PERIODS — they create deferred tax (see below).

Presentation of current tax: Current tax liabilities/assets are presented separately in the statement of financial position. Current tax assets and liabilities can be offset only if: (a) the entity has a legally enforceable right to set off, AND (b) the entity intends either to settle on a net basis or realise the asset and settle the liability simultaneously.

Why deferred tax? The objective of IAS 12 is to ensure that the tax consequences of transactions are recognised in the same period as the underlying transaction. Without deferred tax, there would be a "mismatch" — a transaction recognised in one period for accounting but taxed in a different period.

Classic example: Property, plant, and equipment. Accounting depreciates an asset over its useful economic life. Tax authorities typically allow capital allowances at a different (often faster) rate. In early years, capital allowances > accounting depreciation → taxable profit < accounting profit → current tax is LOW. But this is only a TIMING difference — in later years, capital allowances fall while depreciation continues, reversing the difference. Deferred tax captures this future reversal.

The balance sheet liability method (IAS 12 approach):

1. Compare the carrying amount of each asset/liability with its tax base
2. The difference is a temporary difference
3. Multiply by the tax rate expected to apply when the difference reverses
4. Result: deferred tax liability (DTL) or deferred tax asset (DTA)

Temporary difference = Carrying amount − Tax base

The tax base is the amount attributed to an asset or liability for tax purposes.

Tax base of an asset: The amount that will be deductible for tax purposes against any taxable economic benefits that will flow to the entity when it recovers the carrying amount.

• Depreciable asset: Tax base = cost − cumulative capital allowances claimed to date
• Trade receivables: Tax base = amount of the future economic benefits that will be tax-deductible (usually equal to the accounting carrying amount if revenue has already been taxed)
• Interest receivable (taxed on accruals basis): Tax base = carrying amount (already taxed). Temporary difference = 0.
• Interest receivable (taxed on cash basis): Tax base = 0 (the future cash receipt will be taxed in full). Temporary difference = carrying amount.

Tax base of a liability: Carrying amount less any amount that will be deductible for tax purposes in respect of that liability in future periods. For revenue received in advance (tax base = carrying amount less any amount that won't be taxed in future).

• Accrued expenses (tax-deductible when paid): Tax base = 0 (carrying amount = CA, expense will be deducted when paid). Temporary difference = carrying amount → DTA.
• Warranty provisions: Tax base = 0 (assuming warranties are tax-deductible when paid, not when accrued). Temporary difference = carrying amount → DTA.
• Tax already-paid provisions: E.g., a revenue received in advance that is taxed when received. Tax base = CA (no future tax deduction). Temporary difference = 0.

Quick test: Ask — "What happens for tax purposes when this asset is recovered / this liability is settled?" The tax base reflects the amount that will be deductible (for assets) or not yet taxed (for liabilities) at that future point.

Deferred tax liabilities (DTLs): Recognised for ALL taxable temporary differences, EXCEPT:

• Goodwill initial recognition: Although goodwill is usually not tax-deductible (creating a taxable temporary difference), DTL is NOT recognised — this would create a circular calculation (more goodwill → more DTL → more goodwill)
• Initial recognition exception: DTL NOT recognised on initial recognition of an asset/liability that is NOT a business combination and does NOT affect accounting or taxable profit at the time (e.g., the initial recognition of a government grant)
• Investments in subsidiaries, branches, associates, and JVs where: (a) the parent/investor controls the timing of reversal AND (b) it is probable the difference will not reverse in the foreseeable future (e.g., retained earnings of a subsidiary where the parent does not plan to distribute them)

Deferred tax assets (DTAs): Recognised for ALL deductible temporary differences, unused tax losses, and unused tax credits, to the extent that it is PROBABLE that future taxable profits will be available against which they can be utilised.

• The recoverability test is strict — DTAs are recognised only when realisation is probable
• Evidence supporting recognition: history of profitability, existing taxable temporary differences that will reverse in the same period, tax planning opportunities
• Same initial recognition exception applies
• The "outside basis" exception for investments applies if the reversal is not probable in the foreseeable future AND it will not be utilised
• Reassessment: At each reporting date, unrecognised DTAs are reviewed for possible recognition (if now probable) and recognised DTAs are reviewed for continued recoverability

Unused tax losses and credits: A DTA is recognised for carry-forward tax losses and tax credits only if it is probable that future taxable profits will be available. For entities with a history of recent losses, strong evidence is needed — mere expectations of future profitability are not sufficient.

Measurement: Deferred tax is measured at the tax rates expected to apply in the period when the temporary difference reverses, using the rates enacted or substantively enacted at the reporting date.

• If the tax rate is changing in the future: apply the NEW rate to reversals after the change date
• Deferred tax is NOT discounted — this contrasts with financial liabilities (PV). The rationale: discounting would require detailed scheduling of temporary differences which is often impractical

Expected manner of recovery: The measurement reflects how the entity expects to recover the carrying amount:

• For most assets: through use (recovering via income from operations — usually taxed at standard corporation tax rate)
• For some assets: through sale (may be subject to different tax rules — e.g., chargeable gains rate, indexation, rollover reliefs)
• For investment property measured at fair value: there is a rebuttable presumption that the carrying amount will be recovered through sale — unless the property is held to earn rental income and there is no intention to sell
• For revalued non-depreciable assets: the carrying amount will be recovered through sale (so use the chargeable gains tax rate if different)

Backwards tracing: The tax effect of a transaction should be recognised in the same component of total comprehensive income or equity as the transaction itself.

Change in tax rate: When tax rates change after initial recognition of a deferred tax balance, the effect of the change is allocated to P/L, OCI, or equity depending on where the original transaction was recognised — using backwards tracing to locate the original source.

Deferred tax on business combinations:

• Fair value adjustments to the acquired assets and liabilities (e.g., revaluing property, recognising identifiable intangibles) often have no tax base change — creating temporary differences
• Deferred tax on these adjustments is recognised as part of the acquisition and adjusts goodwill
• Example: Subsidiary's land has tax base £1m but fair value is £3m. Recognise the land at £3m in the consolidated accounts. DTL on the £2m uplift (at the chargeable gains rate) is recognised and increases goodwill
• The initial recognition exception does NOT apply to business combinations
• BUT no DTL is recognised on goodwill itself (goodwill exception)

"Outside basis" temporary differences — investments in subsidiaries, associates, branches, and JVs:

• Temporary differences arise when the carrying amount of an investment (in consolidated accounts, the parent's share of net assets including post-acquisition retained earnings) differs from the tax base (typically the original cost to the investor)
• DTL exemption: NO DTL recognised if the parent/investor controls the timing of reversal AND it is probable the difference will not reverse in the foreseeable future. For subsidiaries, the parent typically controls dividend policy → if no plan to distribute, no DTL
• For associates and JVs: the investor typically does NOT control dividend policy → DTL generally recognised (unless the investor-investee agreement prevents distributions)
• DTA for deductible outside basis differences: recognised to the extent it is probable the difference will reverse in the foreseeable future AND taxable profits will be available

Presentation:

• Deferred tax assets and liabilities are classified as non-current in the statement of financial position (regardless of when the temporary differences are expected to reverse)
• Current tax assets and liabilities are presented separately from deferred tax
• Offsetting DTAs and DTLs: Offset only when: (a) there is a legally enforceable right to set off current tax assets against current tax liabilities, AND (b) DTAs and DTLs relate to income taxes levied by the same taxation authority on either: the same taxable entity, OR different taxable entities that intend to settle on a net basis

Key disclosures required (IAS 12):

• Major components of tax expense (current tax, deferred tax on temporary differences, deferred tax on rate changes, etc.)
• A tax reconciliation: either (a) numerical reconciliation between tax expense and (accounting profit × applicable tax rate), or (b) numerical reconciliation between the average effective tax rate and the applicable tax rate
• For each type of temporary difference (and each type of unused loss/credit): the amount of DTAs/DTLs recognised and the amount recognised in P/L
• Evidence supporting recognition of a DTA when the entity has suffered a loss in either the current or preceding period
• Unrecognised DTAs (deductible differences, unused losses/credits) and their expiry dates
• DTL not recognised on investments in subsidiaries (aggregate amount)