IAS 12 / NAS 09 : Income Taxes IAS 12: Income Taxes

1. Objective The objective of IAS 12 is to prescribe the accounting treatment for income taxes. The principal issue is how to account for the current and future tax consequences of: (a) the future recovery (or settlement) of the carrying amount of assets (or liabilities) that are recognised in an entity's balance sheet, and (b) transactions and other events of the current period that are recognised in an entity's financial statements The items below reveal more about the requirements of IAS 12. a. Deferred tax The carrying amount of assets and liabilities may be recovered or settled at an amount, or under a timing, different from that considered for tax purposes. In such cases, IAS 12 requires an entity to recognise a deferred tax liability or a deferred tax asset (with certain limited exceptions), so as to recognise the deferred tax effects in the current financial statements as if those differences did not exist. The deferred tax liability (or asset) subsequently reverses as the differences between tax and accounting treatment reduce, and ultimately disappears. b. Where to account for the tax IAS 12 requires an entity to account for the tax consequences of transactions and other events in the same way that it accounts for the transactions and other events themselves, i.e: in the income statement in equity, or in calculation of goodwill c. IAS 12 also deals with... IAS 12 also addresses: the recognition of deferred tax assets arising from unused tax losses or unused tax credits the presentation of income taxes in the financial statements, and the disclosure of information relating to income taxes

2. The scope of IAS 12 IAS 12 should be applied in accounting for income taxes. Income taxes include: all domestic and foreign taxes that are based on taxable profits taxes, such as withholding taxes, payable by a subsidiary, associate or joint venture on distributions to the reporting entity IAS 12 does not address: methods of accounting for government grants (see IAS 20, Accounting for Government Grants and Disclosure of Government Assistance), or investment tax credits However, it does address accounting for temporary differences that may arise from such grants or investment tax credits. 3. Key definitions

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IAS 12 / NAS 09 : Income Taxes

a. Accounting profit Accounting profit is profit or loss for a period before deducting tax expense.

b. Taxable profit (or tax loss) Taxable profit (or tax loss) is the profit (or loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which it will be determined whether income taxes are payable (or recoverable). This is the profit or loss, as calculated by the tax authorities, at the end of a financial period based on the income and expenses that are included or excluded for tax purposes (e.g. accounting depreciation versus tax depreciation). c. Tax expense (or tax income) Tax expense (tax income) is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax. i.e. Tax expense (or tax income) = current tax + deferred tax

d. Current tax Current tax is the amount of income taxes payable (or recoverable) in respect of the taxable profit (or tax loss) for a period. i.e. Current tax = taxable profit (or tax loss) x tax rate It is the amount of tax due to or from the tax authorities for a period.

e. Tax base The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes, i.e. the value of an asset or liability in terms of the tax laws.

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IAS 12 / NAS 09 : Income Taxes

For example: an asset has a cost of 100, depreciation to date is 20 but tax depreciation is 25.

Therefore: Carrying amount = 80 (accounting value) Tax base = 75 (tax value) f. Temporary differences Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax base, i.e. the difference between the accounting value (carrying amount) and the tax authority amount (tax base) due to the differences in treatment between the relevant tax legislation and the accounting policies of the entity. Temporary differences may be either: (a) taxable temporary differences - temporary differences that will result in taxable amounts in determining taxable profit (or tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled or (b) deductible temporary differences - temporary differences that will result in amounts that are deductible in determining taxable profit (or tax loss) of future periods, when the carrying amount of the asset or liability is recovered or settled g. Deferred tax liabilities Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. i.e. Deferred tax liabilities = taxable temporary differences x tax rate

h. Deferred tax assets Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: (a) deductible temporary differences (b) the carryforward of unused tax losses, and (c) the carryforward of unused tax credits i.e. deferred tax assets = deductible temporary differences * tax rate + unused tax losses * tax rate and tax credits

4. Tax versus accounting treatment A key element of understanding IAS 12 is to understand the differences between accounting profit (or loss) versus taxable profit (or loss) and current tax versus deferred tax.

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IAS 12 / NAS 09 : Income Taxes

a. Accounting Profit (Or Loss) Versus Taxable Profit (Or Loss) Accounting profit/loss is the profit/loss before tax in the income statement of a business for a financial period. However, due to tax legislation, certain items that are recognised for accounting purposes are disallowed in the computation of taxable profit (or loss). Tax profit/loss = basis on which current tax is calculated. You can calculate tax profit/loss from accounting profit by performing the following reconciliation: Accounting profit/loss Add: expenses not deductible under tax laws but recognised for accounting purposes; income included under tax laws but not recognised for accounting purposes Deduct: expenses deductible under tax laws but not recognised for accounting purposes; income not included under tax laws but recognised for accounting purposes = Tax profit/loss

b. Current Tax Versus Deferred Tax Current tax is the tax to be paid to (or received from) the tax authority - it relates to the tax profit/loss generated during that financial period. i.e. Current tax = tax profit/loss x tax rate The difference in timing for tax and accounting purposes (such as different accounting depreciation versus tax depreciation rates) will give rise to a temporary difference that will reverse over time. i.e. Temporary difference = carrying amount - tax base The temporary difference will result in deferred tax. Deferred tax is tax that relates to differences between the carrying amount of an asset or a liability and its tax base, and that is payable (or recoverable) in future periods when the asset or liability is recovered or settled. i.e. Deferred tax = temporary differences x tax rate

5. Current tax liabilities and assets Current tax liabilities Current tax for current and prior periods should, to the extent unpaid, be recognised as a liability. For example: Dr Tax expense (Income statement) Cr Tax Authority (Balance sheet) A current tax asset is recognised when: the excess of the amount already paid exceeds the amount due for those periods (i.e. companies pay estimated taxes or incur unexpected losses resulting in tax assets) it is probable that the benefit will flow to the enterprise and the benefit can be reliably measured

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IAS 12 / NAS 09 : Income Taxes

Section 2 Practical Problem 2.1 Calculating current tax The calculation of current tax can be summarised as: Current tax = Tax profit/loss x Tax rate For a basic example on calculating tax profit or loss, refer to the image shown, and remember: Accounting profit/loss Add: expenses not deductible under tax laws but recognised for accounting purposes (e.g. accounting depreciation, provisions and fines) Add: income included under tax laws but not recognised for accounting purposes Deduct: expenses deductible under tax laws but not recognised for accounting purposes (e.g. tax depreciation allowed, profit on the legal sale of an asset that cannot be recognised under IAS 18) Deduct: income not included under tax laws but recognised for accounting purposes (e.g. remeasurement of certain assets at fair value) = Tax profit/loss 2.2 Tax Base 2.2.1 The tax base of an asset The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. The tax base of an asset is equal to: the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount (and therefore there is no temporary difference or deferred tax). 2.2.2 The tax base of a liability is: its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods In the case of revenue which is received in advance, the tax base of the resulting liability is: its carrying amount, less any amount of the revenue that will not be taxable in future periods. 2.2.3 Exceptions There are some additional circumstances in which tax bases may or may not be recognised under IAS 12. a. Tax base where there is no asset or liability in the balance sheet Some items have a tax base but are not recognised as assets and liabilities in the balance sheet. Example: Research costs of 100 are recognised as an expense in determining accounting profit for the period in which they are incurred but are only allowed as a deduction in determining taxable profit (or tax loss) in a later period.

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IAS 12 / NAS 09 : Income Taxes

Carrying amount = 0 Tax base = 100 (the amount the taxation authorities will permit as a deduction in future periods) b. Tax base is not immediately apparent

If the tax base of an asset or liability is not immediately apparent, consider the fundamental principle upon which IAS 12.10 is based: that an entity should, with certain limited exceptions, recognise a deferred tax liability (or asset) whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (or smaller) than they would be if such recovery or settlement were to have no tax consequences i.e. where there is a difference in treatment between accounting policies and tax laws affecting tax payments made, a deferred tax asset or liability is likely to exist. c. Consolidated annual financial statements In consolidated financial statements: Temporary differences = carrying amounts of assets and liabilities in the consolidated financial statements appropriate tax base The tax base is determined by either: reference to a consolidated tax return in those jurisdictions in which such a return is filed, or by reference to the tax returns of each entity in the group (in all other jurisdictions) 2.3 Taxable Vs Deducible Temporary differences Temporary differences may be either: (a) taxable temporary differences - temporary differences that will result in deferred tax liabilities, i.e. taxable amounts in determining taxable profit (or tax loss) of future periods or (b) deductible temporary differences - temporary differences that will result in deferred tax assets, i.e. amounts that are deductible in determining taxable profit (or tax loss) of future periods a. Temporary differences Temporary differences arise when an income or expense item is included in accounting profit in one period but is included in taxable profit in a different period. The images shown represent examples of temporary differences which are taxable temporary differences and therefore result in deferred tax liabilities. The table shown summarises the classification of temporary differences. E.g:

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IAS 12 / NAS 09 : Income Taxes

i. Interest revenue is included in accounting profit on a time proportion basis (as earned) but may, in some jurisdictions, be included in taxable profit only when the cash is collected. Example: Interest receivable as per balance sheet = 350. Tax base = 0 (interest revenues do not affect taxable profit until cash is collected) Carrying amount = 350 Taxable temporary difference = 350 (350 - 0) Deferred tax liability (30%) = 105 (350 x 30%)

ii. Depreciation used in determining taxable profit (or tax loss) may differ from that used in determining accounting profit. Example: Asset cost = 500, accounting depreciation = 200, tax depreciation = 250. Carrying amount = 300 Tax base = 250 Taxable temporary difference = 50 (300 - 250) Deferred tax liability (30%) = 15 (50 x 30%)

iii. Development costs may form part of the cost of an internally generated intangible asset that is amortised over future periods in determining accounting profit but deducted in determining taxable profit in the period in which they are incurred. Example: Original cost of development costs = 4,500, with a carrying amount of = 3,500. Carrying amount = 3,500 Tax base = 0 Taxable temporary difference = 3,500 (3,500 - 0) Deferred tax liability (30%) = 1,050 (3,500 x 30%) Compiled by Rakesh Prajapati Page 7 of 28

IAS 12 / NAS 09 : Income Taxes 2.4 Other causes of temporary differences Temporary differences also arise when... i. the cost of a business combination that is an acquisition is allocated to the identifiable assets and liabilities acquired by reference to their fair values but no equivalent adjustment is made for tax purposes. Example: Plant originally costs 500, tax base = 500. Due to acquisition in a business combination the plants carrying amount is now 700. Carrying amount = 700 Tax base = 500 Taxable temporary difference = 200 ii. there is a revaluation of assets When assets are revalued and no equivalent adjustment is made for tax purposes, this gives rise to a temporary difference. Example: A building originally cost 500, tax base = 500. Due to the implementation of IAS 40: Investment Property the building is revalued to 800. Carrying amount = 800 Tax base = 500 Taxable temporary difference = 300 iii. there is goodwill When goodwill arises on consolidation, due to tax authorities not allowing reductions (e.g. impairments) in the carrying amount of goodwill as a deductible expense, a taxable temporary difference may arise however: IAS 12.21 does not permit the recognition of the resulting deferred tax liability because goodwill is a residual and the recognition of the deferred tax liability would increase the carrying amount of goodwill. iv. the tax base of an asset or liability differs from its carrying amount on initial recognition If the tax base of an asset or liability differs from its carrying amount on initial recognition, the entity does not recognise the resulting deferred tax under IAS 12.15(b)(ii) and IAS 12.24(b). v. the carrying amount of investments in subsidiaries, branches, associates and joint ventures differ from their tax base If the carrying amount of investments in subsidiaries, branches and associates or interests in joint ventures becomes different from the tax base of the investment or interest, a temporary difference will arise. This is covered in another Coach me session: Investments in subsidiaries, branches and associates or interests in joint ventures.

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IAS 12 / NAS 09 : Income Taxes Example 1 Calculating Current Tax Jones Inc Jones Inc. has an accounting profit of 10,000 for the year ended 31 December 2005. During the year the company paid fines of 300, and 1,200 dividends were received (both are disallowed by the tax laws of the jurisdiction in which Jones Inc. operates). The company recognised a depreciation expense of 450 for the year whereas the tax allowance was 600. Jones Inc. recognised a provision for a bonus of 775 in 2005 (2004: 625) - these amounts are tax deductible when they are paid. The 2004 bonus of 625 was paid during the 2005 financial year. There are no other items in the accounts with a tax effect. The tax rate is 30%. Accounting profit/loss: 10,000 Add - Expenses not deductible under tax laws but recognised for accounting purposes: Fines: 300 Depreciation: 450 Provision 2005: 775 Deduct - expenses allowed under tax laws but not recognised for accounting purposes: Tax allowance on assets: (600) Provision 2004: (625) Deduct - Income not recognised under tax laws but recognised for accounting purposes: Dividends: (1,200) = Tax profit/loss: 9,100 Current Tax @ 30%: 2,730 2. Taxable temporary differences On 1 January 2005, Pyramids Ltd purchases an item of plant for 120,000. This plant has an expected useful life of four years with a zero residual value. The company depreciates on a straight-line basis. The tax authorities allow a three- year amortisation period as shown in the diagram. The tax rate is 30%. Recovery of an asset: the underlying principle behind the recovery of an asset is that: its carrying amount will be recovered in the form of future benefits that flow into the entity (either through use (by generating income from using the asset) or through sale). at least the carrying amount will be recovered (120,000)

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IAS 12 / NAS 09 : Income Taxes

This point is made to illustrate that even through use the asset will have an effect on accounting current and future profits. When the carrying amount is greater than tax base (e.g. in 2005), this means that the amount available to offset against future accounting profit (90,000) is greater than the amount to be offset against future taxable profit (80,000). This means that in the future there will be taxes payable in excess of what one would normally project from the carrying amount of the asset (90,000). These excess taxes payable in the future (10,000) (taxable temporary differences) need to be recognised as a liability (i.e. a deferred tax liability 3,000). 3. Deductible temporary differences On 1 January 2005, Osiris Ltd purchases an item of plant for 120,000. This plant has an expected useful life of four years with a zero residual value. The company depreciates on a straight-line basis. The tax authorities allow a five year amortisation period. The tax rate is 30%. The image shows the deferred tax calculation for Osiris Ltd.

Where the carrying amount is less than the tax base, the amounts available for offset against accounting profit are less than amounts to be offset against taxable profit. Therefore in the future there will be less tax Compiled by Rakesh Prajapati Page 10 of 28

IAS 12 / NAS 09 : Income Taxes payable (as tax authorities owe a future deduction equal to what has been deducted for accounting purposes) than what one would normally project from the carrying amount of the asset. This tax benefit in the future (deductible temporary difference) needs to be recognised as an asset (i.e. a deferred tax asset), provided that it is probable that the entity will have sufficient taxable profit against which the deductible temporary difference can be utilised.

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IAS 12 / NAS 09 : Income Taxes Section 3 3.1 Calculation of Deferred Tax Step 1: Determine the tax base Step 2: Calculate the temporary difference (if any) Step 3: Identify if the temporary difference is deductible (i.e. will lead to a deferred tax asset) or taxable (i.e. will lead to a deferred tax liability) Step 4: Are any exemptions to the recognition of deferred tax applicable? Step 5: Calculate the deferred tax by applying the correct tax rate Step 6: Is the movement recognised in the income statement, equity or goodwill? 3.2 Step 1: Determine the tax base

Tax base of an asset = future deductible amounts Therefore for Property, Plant and Equipment these amounts are the original cost less tax depreciation (Note 1 Management Accounts) as the balance will be deductible in the future. Land (200,000 - 0) = 200,000 Building 1 (363,636 -109,091) = 254,545 Building 2 (437,383 - 87,477) = 349,906 Plant (333,433 - 66,687) = 266,746 Machinery (250,000 - 100,000) = 150,000 Trademarks tax base is also the original cost less tax depreciation (Note 2.2 - Management Accounts): (2,000,000 - 1,600,000) = 400,000 Product development costs were deducted when the expense was incurred and therefore none are deductible in the future = 0 Inventories writedowns (Note 5 Management Accounts) are not deductible for tax purposes, so the full inventory balance plus the writedown is deductible in the future (as cost of sales): (250,000 + 31,021) = 281,021 Compiled by Rakesh Prajapati Page 12 of 28

IAS 12 / NAS 09 : Income Taxes Receivables impairment (Note 6 Management Accounts) are only 25% deductible for tax purposes and therefore the entire receivables plus 75% of the impairment, is deductible in the future: (435,078+(75% x 44,922) = 468,770 Prepayments (Note7 Management Accounts), 300,000 is deductible in the current year and the balance is deductible in the future = 477,115 The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods. Trade and other payables, no amounts are deductible for tax purposes in respect of that liability in future periods therefore tax base equals carrying amount = 3,935,396 Provision (Note 8 Management Accounts), carrying amount (207,973), less any amount that will be deductible for tax purposes in respect of that liability in future periods (137,973) = 70,000 Step 2: Calculate the temporary difference This step is straightforward, provided you have completed Step 1 correctly: Temporary Difference for an asset = Tax Base Carrying Amount Temporary Difference for a liability = Carrying Amount - Tax Base

Step 3: Is it deductible or taxable?

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IAS 12 / NAS 09 : Income Taxes

Youre applying the following rules correctly: when an assets carrying amount is greater than its tax base, a taxable temporary difference arises when an assets carrying amount is less than its tax base, a deductible temporary difference arises when a liability's carrying amount is greater than its tax base, a deductible temporary difference arises when a liability's carrying amount is less than its tax base, a taxable temporary difference arises

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IAS 12 / NAS 09 : Income Taxes Section 4 Exceptions 1. Taxable temporary differences and exceptions Introduction A deferred tax liability should be recognized for all taxable temporary differences, including those arising from: business combinations assets carried at fair value split accounting of financial instruments unless the deferred tax liability arises from the initial recognition of goodwill or the initial recognition of an asset or liability in a transaction which: is not a business combination, and at the time of the transaction, affects neither accounting profit nor taxable profit (or tax loss) This Coach me explores the situations where a deferred tax liability is or is not recognised on taxable temporary differences. a. Business combinations The cost of a business combination is allocated to the identifiable assets and liabilities acquired by reference to their fair values at the date of the exchange transaction. Temporary differences arise when the tax bases of the identifiable assets and liabilities acquired are not affected by the business combination or are affected differently. The image shows an example. Buckley Inc. acquires Sugar Ltd. The cost of the plant of Sugar Ltd is 800, and its fair value is 1,000. Buckley Inc. recognises the asset at fair value. Carrying amount = 1,000 Tax base = 800 Taxable temporary difference = 200 Deferred tax liability (@30%) = 60 The resulting deferred tax liability affects goodwill (also covered in this Coach me) i.e. the journal entry is: Dr Goodwill Cr Deferred tax liability

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IAS 12 / NAS 09 : Income Taxes b. Assets carried at fair value IFRS permit certain assets to be carried at fair value or to be revalued. For example refer to: IAS 16: Property, Plant and Equipment IAS 38: Intangible Assets IAS 39: Financial Instruments: Recognition and Measurement IAS 40: Investment Property IAS 41: Agriculture If the tax authorities recognize the revaluation or fair value adjustment for tax purposes (i.e. adjust the tax base), there will be no difference between the carrying amount and tax base, and hence no temporary difference. However if the revaluation or restatement of an asset does not affect taxable profit in the period of the revaluation or restatement, then the tax base of the asset is not adjusted. Due to the future recovery of the carrying amount resulting in a taxable flow of economic benefits to the entity, the amount that will be deductible for tax purposes will differ from the amount of those economic benefits. This is true even if: (a) the entity doesn't intend to dispose of the asset (recovery will be through use and this will generate taxable income which exceeds the depreciation that will be allowable for tax purposes in future periods), or (b) tax on capital gains is deferred (as permitted by many tax authorities) if the proceeds of the disposal of the asset are invested in similar assets. In such cases, the tax will ultimately become payable on sale or use of the similar assets. c. Initial recognition of an asset or liability A temporary difference may arise on initial recognition of an asset or liability, for example if part or all of the cost of an asset will not be deductible for tax purposes. The method of accounting for such a temporary difference depends on the nature of the transaction which led to the initial recognition of the asset or liability: (a) in a business combination, an entity recognises any deferred tax liability or asset from temporary differences and this affects the amount of goodwill (b) if the transaction affects either accounting profit or taxable profit, an entity recognises any deferred tax liability or asset and recognises the resulting deferred tax expense or income in the income statement. Business combinations If the transaction is not a business combination, and affects neither accounting profit nor taxable profit, then an entity would, in theory, need to recognise the resulting deferred tax liability or asset and adjust the carrying amount of the asset or liability by the same amount. However, such adjustments would make the financial statements complex and less transparent. Therefore, IAS 12 does not permit an entity to recognise a deferred tax liability or asset arising on initial recognition of an asset or liability acquired other than in a business combination, where the transaction affects neither accounting profit nor taxable profit (loss).

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IAS 12 / NAS 09 : Income Taxes

In accordance with IAS 32: Financial Instruments: Disclosure and Presentation, the issuer of a compound financial instrument classifies the instrument in two parts: the liability component as a liability, and the equity component as equity. In some jurisdictions, the tax base of the liability component on initial recognition is equal to the initial carrying amount of the sum of the liability and equity components. The resulting taxable temporary difference arises from the initial recognition of the equity component separately from the liability component (and not the initial recognition of an asset or liability). Therefore the exemption does not apply and any resulting deferred tax liability should be recognised. The deferred tax is charged directly to the carrying amount of the equity component. Subsequent changes in the deferred tax liability are recognised in the income statement as deferred tax expense (or income). Business combinations d. Goodwill Many taxation authorities do not allow the amortisation of goodwill as a deductible expense in determining taxable profit or the cost of goodwill to be deducted when a subsidiary disposes of its underlying business. These tax rules lead to taxable temporary differences. However, IAS 12 does not permit the recognition of the resulting deferred tax liability because goodwill is a residual and the recognition of the deferred tax liability would increase the carrying amount of goodwill. Note further: a) 12.21A - Subsequent reductions in deferred tax liability that is unrecognised because it arises from the initial recognition of goodwill are also not recognised (this is in line with the treatment of initial recognition). b) 12.21B - Deferred tax liabilities for taxable temporary differences relating to goodwill are however recognised to the extent that they do not arise from the initial recognition of goodwill (eg. tax laws allow write-off of the balance). Summary Compiled by Rakesh Prajapati Page 17 of 28

IAS 12 / NAS 09 : Income Taxes

2. Deductible temporary differences and exceptions Deductible temporary differences A deferred tax asset should be recognised for all deductible temporary differences to the extent that: it is probable that taxable profit will be available against which the deductible temporary difference can be utilised unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction which: is not a business combination, and at the time of the transaction, affects neither accounting profit nor taxable profit (or tax loss)

2.1 Deductible temporary differences resulting in deferred tax assets Retirement benefit costs may be recognised in determining accounting profit as service is provided by the employee, but only deducted in determining taxable profit either when contributions are paid to a fund by the entity or when retirement benefits are paid by the entity. A deductible temporary difference exists between the carrying amount of the liability and its tax base because the tax base is usually nil (calculated as the carrying amount of the liability less the amount that will be deductible in the future). A deferred tax asset therefore exists. Compiled by Rakesh Prajapati Page 18 of 28

IAS 12 / NAS 09 : Income Taxes Example: Retirement benefit costs (4,500) Carrying amount Liability = 4,500 Tax base = 0 (4,500 less amount that will be deductible in the future i.e. 4,500) Deductible temporary difference = 4,500 Deferred tax asset (@30%) = 1,350 (4,500 x 30%) Research costs are recognised as an expense in determining accounting profit in the period in which they are incurred but may not be permitted as a deduction in determining taxable profit (or tax loss) until a later period. Example: Research costs (6,000) Carrying amount asset = 0 (as was expensed immediately) Tax base = 6,000 Deductible temporary difference = 6,000 Deferred tax asset (@30%) = 1,800 The cost of a business combination is allocated to the assets and liabilities recognised, by reference to their fair values at the date of the transaction. Example: A liability of 4,000 was recognised on the acquisition but the related costs were not deducted in determining taxable profits until a later period. Carrying amount liability = 4,000 Tax base = 0 (4,000 less amount that will be deductible in the future i.e. 4,000) Deductible temporary difference = 4,000 Deferred tax asset (@30%) = 1,200 The resulting deferred tax asset affects goodwill. Therefore the journal entry is: Dr Deferred tax asset, Cr Goodwill Certain assets may be carried at fair value, or may be revalued at amounts lower than the amount attributed to them for tax purposes Example: Plant with a tax base and previous carrying amount of 55,000 was impaired to its recoverable amount of 35,000. Carrying amount of asset = 35,000 Tax base = 55,000 Deductible temporary difference = 20,000 (55,000 - 35,000) Deferred tax asset (@30%) = 6,000 (20,000 x 30%) Initial recognition of an asset or liability - example A non-taxable government grant (200) related to a harvester (600) was given to Hilly Farms Ltd. For tax purposes, the grant is not taxable. The tax rate is 35%. Deferred tax calculation: Compiled by Rakesh Prajapati Page 19 of 28

IAS 12 / NAS 09 : Income Taxes Carrying amount of harvester = 400 (600 less 200 grant that was offset against cost of the asset according to one of the alternatives under IAS 20) Tax base = 600 Deductible temporary difference = 200 However the entity does not recognise the resulting deferred tax asset, because the initial recognition of an asset or liability in a transaction was not a business combination, and at the time of the transaction, affected neither accounting profit nor taxable profit. As the temporary difference in the above case is somewhat permanent, we can identify that the IAS 12 exemption on initial recognition applies. Government grants may also be recognised as deferred income under the other alternative in IAS 20, in which case the difference between the deferred income and its tax base of nil is a deductible temporary difference. However the entity does not recognise the resulting deferred tax asset, because the initial recognition of an asset or liability in a transaction was not a business combination, and at the time of the transaction, affected neither accounting profit nor taxable profit. As the temporary difference in the above case is somewhat permanent, we can identify that the IAS 12 exemption on initial recognition applies. 3. Calculating deferred tax Deferred tax Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. Deferred tax liability = taxable temporary difference x tax rate Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: deductible temporary differences the carryforward of unused tax losses, and the carryforward of unused tax credits Deferred tax asset = (deductible temporary difference and carryforward of unused tax losses) x tax rate and unused tax credits Example Muggins Health Shop had the following balances at the end of 2005 (tax rate = 30%): Taxable temporary difference = 56,000 Assessed Loss carried forward = 30,000 Deferred tax calculation: Deferred tax liability = 16,800 (56,000 x 30%) Deferred tax asset = 9,000 (30,000 x 30%) TOTAL deferred tax liability for 2005 = 7,800 (16,800 9,000) Compiled by Rakesh Prajapati Page 20 of 28

IAS 12 / NAS 09 : Income Taxes 4. Recognition of deferred tax assets limitations The reversal of deductible temporary differences means that there will be deductions in determining taxable profits of future periods. However, these deductions are allowable only if it is probable that taxable profits will be available against which the deductible temporary differences can be utilised (i.e. when the entity earns sufficient taxable profits against which the deductions can be offset). There are criteria that help to assess whether the recognition of deferred tax assets is probable. Probability It is probable that taxable profit will be available against which a deductible temporary difference can be utilised when there are sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity which are expected to reverse: in the same period as the expected reversal of the deductible temporary difference, or in periods into which a tax loss arising from the deferred tax asset can be carried back or forward If these criteria are met, the deferred tax asset is recognised in the period in which the deductible temporary differences arise. Insufficient taxable temporary differences When there are insufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, the deferred tax asset is recognised to the extent that: 1) it is probable that the entity will have sufficient taxable profit relating to the same taxation authority and the same taxable entity in the same period as the reversal of the deductible temporary difference or in the periods in which the tax loss arising from the deferred tax asset can be carried back or forward. (Note: in assessing this, the taxable amounts arising from other deductible temporary differences that are expected to originate in future periods are ignored) and 2) tax planning opportunities are available to the entity that will create taxable profit in appropriate periods Tax planning opportunities Tax planning opportunities are actions that the entity could take in order to create or increase taxable income in a particular period before the expiry of a tax loss or tax credit carryforward. For example, taxable profit may be created or increased by: electing to have interest income taxed on either a received or receivable basis deferring the claim for certain deductions from taxable profit Unused tax losses and unused tax credits A deferred tax asset should be recognised for: the carryforward of unused tax losses, and the carryforward of unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised. Compiled by Rakesh Prajapati Page 21 of 28

IAS 12 / NAS 09 : Income Taxes

The criteria for recognising deferred tax assets arising from the carryforward of unused tax losses and unused tax credits are the same as the criteria for recognising deferred tax assets arising from deductible temporary differences. However, the existence of unused tax losses is strong evidence that future taxable profit may not be available. So, the entity recognises a deferred tax asset arising from unused tax losses or tax credits only to the extent that the entity has sufficient taxable temporary differences, or there is convincing other evidence that sufficient taxable temporary differences will be available against which the unused tax losses or tax credits can be utilised Disclosure of the amount of the deferred tax asset and the nature of the evidence supporting its recognition is required by IAS 12.

Consider these criteria in assessing the probability that taxable profit will be available. Whether: 1) the entity has sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity which will result in taxable amounts against which the unused tax losses/credits can be utilised before they expire 2) it is probable that the entity will have taxable profits before the unused tax losses/credits expire 3) the unused tax losses result from identifiable causes which are unlikely to recur, and 4) tax planning opportunities are available to the entity that will create taxable profit in the period in which the unused tax losses/credits can be utilised. To the extent that it is not probable that taxable profit will be available against which the unused tax losses/credits can be utilised, the deferred tax asset is not recognised.

At each balance sheet date, an entity re-assesses unrecognised deferred tax assets. The entity recognises a previously unrecognised deferred tax asset to the extent that it has become probable that future taxable profit will allow the deferred tax asset to be recovered. For example: an improvement in trading conditions or an entity re-assesses deferred tax assets at the date of a business combination or subsequently and it becomes probable that the entity will be able to generate sufficient taxable profit in the future for the deferred tax asset to meet the recognition criteria. 5. Subsidiaries, branches and associates, and joint ventures

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IAS 12 / NAS 09 : Income Taxes

5.1 When do temporary differences arise? Temporary differences arise when the carrying amount of investments in subsidiaries, branches and associates or interests in joint ventures (i.e. the net assets including the carrying amount of goodwill) becomes different from the tax base (which is often cost). Such differences may arise in a number of different circumstances, for example: the existence of undistributed profits of subsidiaries, branches and associates or joint ventures changes in foreign exchange rates when a parent and its subsidiary are based in different countries having different currencies a reduction in the carrying amount of an investment in an associate to its recoverable amount (due to impairment) 5.2 Recognition of deferred tax liabilities Recognise all deferred tax liabilities associated with investments in subsidiaries, branches and associates, and interests in joint ventures, except to the extent that both of the following conditions are satisfied: 1) the parent, investor or venturer is able to control the timing of the reversal of the temporary difference, 2) it is probable that the temporary difference will not reverse in the foreseeable future. Further issues: Control of timing Foreign operations Investments in associates Joint ventures Control of timing As a parent controls the dividend policy of its subsidiary (and branch operations) it therefore controls the timing of the reversal of temporary differences associated with that investment, including: the temporary differences arising from undistributed profits, and any foreign exchange translation differences Also, it would often be impracticable to determine the amount of income taxes that would be payable when the temporary difference reverses. Therefore, when the parent has determined that those profits will not be distributed in the foreseeable future the parent does not recognise a deferred tax liability. Compiled by Rakesh Prajapati Page 23 of 28

IAS 12 / NAS 09 : Income Taxes Foreign operations The non-monetary assets and liabilities of an entity are measured in its functional currency (see IAS 21:The Effects of Changes in Foreign Exchange Rates). If the entitys taxable profit or tax loss (and, hence, the tax base of its non-monetary assets and liabilities) is determined in a different currency, changes in the exchange rate give rise to temporary differences that result in a recognised deferred tax liability or asset. The resulting deferred tax is charged or credited to profit or loss. Because such temporary differences relate to the foreign operation's own assets and liabilities, rather than to the reporting entity's investment in that foreign operation, the reporting entity recognises the resulting deferred tax liability or deferred tax asset Investments in associates An investor in an associate: 1. does not control that entity, and 2. is usually not in a position to determine its dividend policy Therefore, in the absence of an agreement requiring that the profits of the associate will not be distributed in the foreseeable future, an investor recognises a deferred tax liability arising from taxable temporary differences associated with its investment in the associate. In some cases, an investor may not be able to determine the amount of tax that would be payable if it recovers the cost of its investment in an associate, but can determine that it will equal or exceed a minimum amount. In such cases, the deferred tax liability is measured at this minimum amount Joint ventures The arrangement between the parties to a joint venture usually deals with the sharing of the profits. When: the venturer can control the sharing of profits, and it is probable that the profits will not be distributed in the foreseeable future a deferred tax liability is not recognised. 5.3 Recognition of deferred tax assets An entity should recognise a deferred tax asset for all deductible temporary differences arising from investments in subsidiaries, branches and associates, and interests in joint ventures only to the extent that it is probable that: the temporary difference will reverse in the foreseeable future, and taxable profit will be available against which the temporary difference can be utilised You should use the same criteria on 'Limitations in recognition of deferred tax assets'. for determining a deferred tax asset.

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IAS 12 / NAS 09 : Income Taxes Recognition & Measurement 1. Recognition: income statement, equity or goodwill? 1.1. Accounting for current and deferred tax effects Accounting for the current and deferred tax effects of a transaction should be the same as the accounting for the transaction or event itself. I.e. If the accounting transaction affects the income statement (e.g. temporary difference between depreciation for accounting and for tax purposes), so will the tax transaction. For example: Dr Tax expense - Income statement Cr Deferred tax liability

1.2. Recognition in Income Statement; When to recognise Current and deferred tax should be recognised as income or an expense and included in the profit or loss for the period, except to the extent that the tax arises from: a transaction or event which is recognised directly in equity, or a business combination Changes; The carrying amount of deferred tax may change even though there is no change in the amount of the related temporary differences. For example, when there is a: change in tax rates or tax laws re-assessment of the recoverability of deferred tax assets, or Compiled by Rakesh Prajapati Page 25 of 28

IAS 12 / NAS 09 : Income Taxes change in the expected manner of recovery of an asset the resulting deferred tax is recognised in the income statement, except to the extent that it relates to items previously charged or credited to equity. 1.3. Equity recognition Current tax and deferred tax should be charged or credited directly to equity if the tax relates to items that are credited or charged, in the same or a different period, directly to equity. Detailed below are circumstances where the charge is to be taken to equity. Items to be charged directly to equity IFRS require or permit certain items to be credited or charged directly to equity. For example: a change in carrying amount arising from the revaluation of property, plant and equipment (see IAS 16) an adjustment to the opening balance of retained earnings resulting from either a change in accounting policy that is applied retrospectively or the correction of an error (see IAS 8: Accounting Policies, Change in Accounting Estimates and Errors) exchange differences arising on the translation of the financial statements of a foreign operation (see IAS 21), and amounts arising on initial recognition of the equity component of a compound financial instrument (see IAS 32) Revaluation of an asset - example 1 Here's an example of where the impact on the tax is recognised where an entity may recognise a revaluation of an asset in accordance with IAS 16 (revaluation recognised in equity). Tax rate 30%. Accounting entry: Dr Asset 1,000 Cr Revaluation reserve (Equity) 1,000 ...to recognise the revaluation of an asset under IAS 16 Deferred tax: Dr Revaluation reserve (Equity) 300 (30% x 1,000) Cr Deferred tax liability 300 ...to recognise the tax effect associated with the revaluation Note: The recognition of deferred tax follows accounting for the initial transaction. Revaluation of an asset - example 2 Here's an example of where the impact on the tax is recognised where an entity may recognise a revaluation of an asset in accordance with IAS 40 (fair value movement recognised in the income statement). Tax rate 30%. Accounting entry: Dr Asset 1,000 Compiled by Rakesh Prajapati Page 26 of 28

IAS 12 / NAS 09 : Income Taxes Cr Fair value adjustment - (Income statement) 1,000 ...to recognise the revaluation under IAS 40 Deferred tax: Dr Tax expense - (Income statement) 300 (30% x 1,000) Cr Deferred tax liability 300 ...to recognise the associated tax effect Note: The recognition of deferred tax follows the accounting for the initial transaction. 2. Deferred tax arising from a business combination Business combinations Temporary differences may arise in a business combination. In accordance with IFRS 3: Business Combinations an entity recognises any resulting deferred tax assets (to the extent that they meet the recognition criteria) or deferred tax liabilities as identifiable assets and liabilities at the date of the acquisition. Consequently, those deferred tax assets and liabilities affect goodwill. However, an entity does not recognise deferred tax liabilities arising from the initial recognition of goodwill. Recognition of a deferred tax asset As a result of a business combination, an acquirer may consider it probable that it will recover its own deferred tax asset that was not recognised before the business combination. For example, the acquirer may be able to utilise the benefit of its unused tax losses against the future taxable profit of the acquiree. In such cases, the acquirer recognises a deferred tax asset, but does not include it as part of the accounting for the business combination, and therefore does not take it into account in determining the goodwill or the amount of any excess of the acquirers interest in the net fair value of the acquirees identifiable assets, liabilities and contingent liabilities over the cost of the combination. Initial non-recognition of a deferred tax asset An acquirer may consider it improbable at the date of acquisition that it will recover the acquirees potential benefit arising from tax loss carry-forwards or other deferred tax assets but at a later date the possibility may become probable. 3. Presentation 3.1 Current tax Current tax assets and liabilities can be offset only if there is: a legally enforceable right to set off the recognised amounts, and an intention either to settle on a net basis, or to realise the asset and settle the liability simultaneously Criteria for legally enforceable rights

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IAS 12 / NAS 09 : Income Taxes There will normally be a legally enforceable right to set off when current taxes relate to income tax levied by the same taxation authority, and the taxation authority permits the entity to make or receive a single net payment. Therefore although current tax assets and liabilities are separately recognised and measured, they can usually be offset in the balance sheet of a single entity. Consolidated annual financial statements In consolidated financial statements, a current tax asset of one entity in a group is offset against a current tax liability of another entity in the group only if the entities concerned have a legally enforceable right to make or receive a single net payment, and the entities intend to make or receive such a net payment or to recover the asset and settle the liability simultaneously. Therefore the offset of current tax assets and liabilities in a group is more difficult. 3.2 Deferred tax Deferred tax should be offset only when the same criteria as for current tax are met in each future period in which significant amounts of deferred tax liabilities or assets are expected to be settled or recovered. In certain circumstances, detailed scheduling may be required.

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