15 Taxation Flashcards
Current tax is…
Current tax is the amount payable to the tax authorities in relation to the trading activities of the period
You would calculate the amount of tax due to be paid on the company’s taxable profits and with this amount you would:
DEBIT Tax charge (statement of profit or loss) CREDIT Tax liability (statement of financial position)
Define: Accounting profit; Taxable profit (tax loss); Tax expense (tax income);Current tax
Accounting profit. Net profit or loss for a period before deducting tax expense. Taxable profit (tax loss). The profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable). Tax expense (tax income). The aggregate amount included in the determination of net profit or loss for the period in respect of current tax and deferred tax. Current tax. The amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.
What is the difference between current tax and Deffered tax
(a) Current tax is the amount actually payable to the tax authorities in relation to the trading activities of the entity during the period. (b) Deferred tax is an accounting measure, used to match the tax effects of transactions with their accounting impact and thereby produce less distorted results.
Recognition of current tax liabilities and assets IAS 12 requires any unpaid tax in respect of the current or prior periods to be recognised as a liability. Conversely, any excess tax paid in respect of current or prior periods over what is due should be recognised as an asset. True/ False
Recognition of current tax liabilities and assets IAS 12 requires any unpaid tax in respect of the current or prior periods to be recognised as a liability. Conversely, any excess tax paid in respect of current or prior periods over what is due should be recognised as an asset.
Recognition of current tax Normally, current tax is recognised as income or expense and included in the net profit or loss for the period, except in two cases:
(a) Tax arising from a business combination is treated differently (tax assets or liabilities of the acquired subsidiary will form part of the goodwill calculation). (b) Tax arising from a transaction or event which is recognised directly in equity (in the same or a different period).
Presentation In the statement of financial position, tax assets and liabilities should be shown separately from other assets and liabilities. Current tax assets and liabilities can be offset, but this should happen only when certain conditions apply.
(a) The entity has a legally enforceable right to set off the recognised amounts. (b) The entity intends to settle the amounts on a net basis, or to realise the asset and settle the liability at the same time. The tax expense (income) related to the profit or loss from ordinary activities should be shown in the statement of profit or loss.
Define defered tax
Deferred tax is an accounting measure used to match the tax effects of transactions with their accounting impact. It is quite complex.
What happens if that recovery or settlement is likely to make future tax payments larger (or smaller) than they would otherwise have been if the recovery or settlement had no tax consequences?
In these circumstances, IAS 12 requires companies to recognise a deferred tax liability (or deferred tax asset).
Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
Deductible temporary differences The carry forward of unused tax losses The carry forward of unused tax credits
Explain what causes the temporary differences
Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. Temporary differences may be either: Taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled Deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled
What is a tax base?
The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.
IAS 12 gives the following examples of circumstances in which the carrying amount of an asset or liability will be equal to its tax base and no temporary difference will arise.
Accrued expenses which have already been deducted in determining an entity’s current tax liability for the current or earlier periods A loan payable which is measured at the amount originally received and this amount is the same as the amount repayable on final maturity of the loan Accrued expenses which will never be deductible for tax purposes Accrued income which will never be taxable
You may have found the definition of temporary differences somewhat confusing. Remember that accounting profits form the basis for computing taxable profits, on which the tax liability for the year is calculated; however, accounting profits and taxable profits are different. There are two reasons for the differences.
(a) Permanent differences. These occur when certain items of revenue or expense are excluded from the computation of taxable profits (for example, entertainment expenses may not be allowable for tax purposes). (b) Temporary differences. These occur when items of revenue or expense are included in both accounting profits and taxable profits, but not for the same accounting period. For example, an expense which is allowable as a deduction in arriving at taxable profits for 20X7 might not be included in the financial accounts until 20X8 or later. In the long run, the total taxable profits and total accounting profits will be the same (except for permanent differences) so that timing differences originate in one period and are capable of reversal in one or more subsequent periods. Deferred tax is the tax attributable to temporary differences. The distinction made in the definition between taxable temporary differences and deductible temporary differences can be made clearer by looking at whether the difference will cause more or less tax to be paid in future periods.
Summarise the section on deferred tax
Deferred tax is an accounting device. It does not represent tax payable to the tax authorities. The tax base of an asset or liability is the value of that asset or liability for tax purposes. You should understand the difference between permanent and temporary differences. Deferred tax is the tax attributable to temporary differences.
The rule to remember here is that: ‘All taxable temporary differences give rise to a deferred tax liability.’ T/F
The rule to remember here is that: ‘All taxable temporary differences give rise to a deferred tax liability.’
Transactions that affect the statement of profit or loss: where are these included: Interest revenue Sale of goods revenue Depreciation Development costs Prepaid expenses
Transactions that affect the statement of profit or loss (a) Interest revenue received in arrears and included in accounting profit on the basis of time apportionment. It is included in taxable profit, however, on a cash basis. (b) Sale of goods revenue is included in accounting profit when the goods are delivered, but only included in taxable profit when cash is received. (c) Depreciation of an asset is accelerated for tax purposes. When new assets are purchased, allowances may be available against taxable profits which exceed the amount of depreciation chargeable on the assets in the financial accounts for the year of purchase. (d) Development costs which have been capitalised will be amortised in the statement of profit or loss, but they were deducted in full from taxable profit in the period in which they were incurred. (e) Prepaid expenses have already been deducted on a cash basis in determining the taxable profit of the current or previous periods.
Transactions that affect the statement of financial position:
Transactions that affect the statement of financial position (a) Accounting depreciation of an asset is not deductible for tax purposes. Deduction for tax purposes will be allowed through tax depreciation.
(b) A borrower records a loan at proceeds received (amount due at maturity) less transaction costs. The carrying amount of the loan is subsequently increased by amortisation of the transaction costs against accounting profit. The transaction costs were, however, deducted for tax purposes in the period when the loan was first recognised.
Fair value adjustments and revaluations :
Current investments and name one more
Fair value adjustments and revaluations (a) Current investments or financial instruments are carried at fair value. This exceeds cost, but no equivalent adjustment is made for tax purposes. (b) Property, plant and equipment can be revalued by an entity (under IAS 16), but no equivalent adjustment is made for tax purposes. This also applies to long-term investments. As the tax base remains at the original value, there will be a difference between the carrying amount and the tax base, leading to an increase in the deferred tax provision.
Try to understand the reasoning behind the recognition of deferred tax liabilities on taxable temporary differences
(a) When an asset is recognised, it is expected that its carrying amount will be recovered in the form of economic benefits that flow to the entity in future periods. (b) If the carrying amount of the asset is greater than its tax base, then taxable economic benefits will also be greater than the amount that will be allowed as a deduction for tax purposes. (c) The difference is therefore a taxable temporary difference and the obligation to pay the resulting income taxes in future periods is a deferred tax liability. (d) As the entity recovers the carrying amount of the asset, the taxable temporary difference will reverse and the entity will have taxable profit. (e) It is then probable that economic benefits will flow from the entity in the form of tax payments, and so the recognition of deferred tax liabilities is required by IAS 12.
Timing differences Some temporary differences are often called timing differences, when income or expense is included in accounting profit in one period, but is included in taxable profit in a different period. The main types of taxable temporary differences which are timing differences and which result in deferred tax liabilities are
Interest received which is accounted for on an accruals basis, but which for tax purposes is included on a cash basis Accelerated depreciation for tax purposes Capitalised and amortised development costs
Summarise DTA & DTL
Taxable temporary differences give rise to a deferred tax liability. Many taxable temporary differences are timing differences. Timing differences arise when income or an expense is included in accounting profit in one period, but in taxable profit in a different period.
Transactions that affect the statement of profit or loss
Retirement benefit costs (pension costs) are deducted from accounting profit as service is provided by the employee. They are not deducted in determining taxable profit until the entity pays either retirement benefits or contributions to a fund. (This may also apply to similar expenses
(b) Accumulated depreciation of an asset in the financial statements is greater than the accumulated depreciation allowed for tax purposes up to the end of the reporting period. (c) The cost of inventories sold before the end of the reporting period is deducted from accounting profit when goods/services are delivered, but is deducted from taxable profit when the cash is received. (d) The NRV of inventory, or the recoverable amount of an item of property, plant and equipment falls and the carrying value is therefore reduced, but that reduction is ignored for tax purposes until the asset is sold. (e) Research costs (or organisation/other start-up costs) are recognised as an expense for accounting purposes but are not deductible against taxable profits until a later period. (f) Income is deferred in the statement of financial position, but has already been included in taxable profit in current/prior periods.
Recognition of deductible temporary differences Let us lay out the reasoning behind the recognition of deferred tax assets arising from deductible temporary differences.
(a) When a liability is recognised, it is assumed that its carrying amount will be settled in the form of outflows of economic benefits from the entity in future periods. (b) When these resources flow from the entity, part or all may be deductible in determining taxable profits of a period later than that in which the liability is recognised. (c) A temporary tax difference then exists between the carrying amount of the liability and its tax base. (d) A deferred tax asset therefore arises, representing the income taxes that will be recoverable in future periods when that part of the liability is allowed as a deduction from taxable profit. (e) Similarly, when the carrying amount of an asset is less than its tax base, the difference gives rise to a deferred tax asset in respect of the income taxes that will be recoverable in future periods.
IAS 12 states that a deferred tax asset may be recognised in such circumstances to the extent that it is probable future taxable profit will be available against which the unused tax losses/credits can be utilised. t/f
IAS 12 states that a deferred tax asset may be recognised in such circumstances to the extent that it is probable future taxable profit will be available against which the unused tax losses/credits can be utilised.
IAS 12 adopts the full provision method of accounting for deferred tax. The full provision method has the advantage that it recognises that each timing difference at the end of the reporting period has an effect on future tax payments. If a company claims an accelerated tax allowance on an item of plant, future tax assessments will be bigger than they would have been otherwise. Future transactions may well affect those assessments still further, but that is not relevant in assessing the position at the end of the reporting period. T/F
IAS 12 adopts the full provision method of accounting for deferred tax. The full provision method has the advantage that it recognises that each timing difference at the end of the reporting period has an effect on future tax payments. If a company claims an accelerated tax allowance on an item of plant, future tax assessments will be bigger than they would have been otherwise. Future transactions may well affect those assessments still further, but that is not relevant in assessing the position at the end of the reporting period.
Where the corporate rate of income tax fluctuates from one year to another, a problem arises in respect of the amount of deferred tax to be credited (debited) to the statement of profit or loss in later years. IAS 12 requires deferred tax assets and liabilities to be measured at the tax rates expected to apply in the period when the asset is realised or liability settled, based on tax rates and laws enacted (or substantively enacted) at the end of the reporting period. In other words, IAS 12 requires the liability method to be used. T/F
Where the corporate rate of income tax fluctuates from one year to another, a problem arises in respect of the amount of deferred tax to be credited (debited) to the statement of profit or loss in later years. IAS 12 requires deferred tax assets and liabilities to be measured at the tax rates expected to apply in the period when the asset is realised or liability settled, based on tax rates and laws enacted (or substantively enacted) at the end of the reporting period. In other words, IAS 12 requires the liability method to be used.
IAS 12 states that deferred tax assets and liabilities should not be discounted because of the complexities and difficulties involved. Discounting is applied to other non-current liabilities such as provisions and deferred payments. T/F
IAS 12 states that deferred tax assets and liabilities should not be discounted because of the complexities and difficulties involved. Discounting is applied to other non-current liabilities such as provisions and deferred payments.
The carrying amount of deferred tax assets should be reviewed at the end of each reporting period and reduced where appropriate (insufficient future taxable profits). Such a reduction may be reversed in future years. T/F
The carrying amount of deferred tax assets should be reviewed at the end of each reporting period and reduced where appropriate (insufficient future taxable profits). Such a reduction may be reversed in future years.
As with current tax, deferred tax should normally be recognised as income or an expense and included in the net profit or loss for the year in the statement of profit or loss. Current and deferred tax will together make up the tax charge. The exception is where the tax arises from a transaction or event which is recognised (in the same or a different period) directly in equity such as a revaluation where the surplus is credited to the revaluation surplus. The figures shown for deferred tax in the statement of profit or loss will consist of two components:
a) Deferred tax relating to timing differences (b) Adjustments relating to changes in the carrying amount of deferred tax assets/liabilities (where there is no change in timing differences), eg changes in tax rates/laws, reassessment of the recoverability of deferred tax assets, or a change in the expected recovery of an asset
Deferred tax (and current tax) should be charged/credited directly to equity if the tax relates to items also charged/credited directly to equity (in the same or a different period). Examples of IASs which allow certain items to be credited/charged directly to equity include:
(a) Revaluations of property, plant and equipment (IAS 16) (b) The effect of a change in accounting policy (applied retrospectively) or correction of a material error (IAS 8)
Why do we recognise deferred tax?
(a) Adjustments for deferred tax are made in accordance with the accruals concept and in accordance with the definition of a liability in the Conceptual Framework, ie a past event has given rise to an obligation in the form of increased taxation which will be payable in the future. The amount can be reliably estimated. A deferred tax asset similarly meets the definition of an asset. (b) If the future tax consequences of transactions are not recognised, profit can be overstated, leading to overpayment of dividends and distortion of share price and EPS.
Taxation in the statement of profit or loss The tax on profit on ordinary activities is calculated by aggregating:
a) Income tax on taxable profits (b) Transfers to or from deferred taxation (c) Any under provision or overprovision of income tax on profits of previous years
Presentation of tax assets and liabilities These should be presented separately from other assets and liabilities in the statement of financial position. Deferred tax assets and liabilities should be distinguished from current tax assets and liabilities. In addition, deferred tax assets/liabilities should not be classified as current assets/liabilities, where an entity makes such a distinction. There are only limited circumstances where current tax assets and liabilities may be offset. This should only occur if two things apply:
(a) The entity has a legally enforceable right to set off the recognised amounts. (b) The entity intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.
