7 Taxation in Company Accounts

Question 1

Tax rates set by law are known as…

Answer 1

… Statutory Tax Rates (STR)

Question 2

Whats the current income tax? How does it relate to companies?

1.
2.
3.
4.

Answer 2

• in financial accounting, this is the corporation tax related to a given accounting period
• current income tax = STR * taxable profit
• amount reported in financial statements is an estimate, so its potentially exposed to subsequent adjustments or audits
• reason is that taxable profit is not disclosed in financial statements, but is included in the tax return filed by corporation

Question 3

What is…

1. Tax Avoidance?
2. Tax Evasion?

Answer 3

1. manipulation of one´s affair within the laws as to reduce liability -> it is LEGAL
2. illegal manipulation of business affairs to escpae taxation

Problem: hard to distinguish sometimes; e.g. relocating the business to tax heavens and creating subsidiaries there / use of shareable donations where tax relieve is allowed to the donor and its a way to encourage donations, except that the system has been manipulated as a form of tax evasion

Question 4

What is the current tax liability?

1.
2.

Whats a Current Tax Asset?

1.

Answer 4

• its the amount of current tax that is payable at the end of the period
• the label used can vary
• when a firm has overpaid income tax, it recognises a current tax asset

Question 5

How are these recorded?

1. Current income tax expense; 2 million
2. Cash; 1.2 million
3. Current Tax Liability; 0.8 million

Answer 5

1. Current income tax expense goes down so DEBIT
2. Cash: Current asset; goes down so CREDIT
3. Current Tax liability; goes up to CREDIT

Question 6

What is the problem when we take our current tax expense from the tax accounts that are not public?

And what cam we do to remedy this problem?

Answer 6

• informativenenss compromised, because investor would expect a tax expense of something different
• by recording another income (deferred tax income) that reduces current tax expense to what you expect

Question 7

What are the differences: Income Tax vs Deferred Income Tax

1. substance
2. basis
3. timing

Answer 7

1. C: payable to tax office; D: accounting measure
2. C: taxable profit (loss); D: temporary differences
3. C: current period; D: future periods

Question 8

Whats the Difference between accounting profit and Taxable profit?

Answer 8

• AP: profit before tax; recorded in SoCI; measured according to financial accounting rules (GAAP), e.g. IFRS, may include items that are non tax deductible, based on this we determine income tax expense
• TP: based on the tax code; reported in the tax return (not in financial statements), measured accoridng to tax authority rules, based on this we determinde current tax expense

Question 9

What causes differences between accounting profit (GAAP) and taxable profit (tax return)?

Answer 9

• permanent differences and timing differences

Question 10

What are…

Permanent Differences?

1. eg
2. acc vs tax
3. come from where and why?
4. income tax exp?

Answer 10

1. like non taxable income (e.g. government grants) and non tax deductible expenses (e.g. fines and penalties)
2. items where accounting profit includes income or expenses that are not included in the taxable profit
3. often result of regulations meant to promote/ discourage certain economic activities
4. are excluded when computing income tax expense

Question 11

What are….

Timing Differences?

1.
2.
3.

And what are typical causes of timing differences?

4.
5.

Answer 11

1. income/ expense included in accounting profit in ONE period, but is included in taxable profit in a DIFFERENT period
2. timing differences reverse and disappear over time
3. they exist for a limited period of time only (after than indefinitely)
4. taxable profit based on Cash Flow (accounting vs accrual basis; e.g. pension contribution vs expense)
5. economic policy driven decisions, e.g. accelerated depreciation schedules

Question 12

If tax rules would prevail over GAPP rules, then….

Answer 12

… our tax expense would be the same as the current expense
…. there wouldn´t be deferred taxes at all

Question 13

When a timing presence is difference is present, then…

Answer 13

… IFRS requires utilising the GAAP measurements to compute the tax expense
-> this choice results in deferred taxation

Question 14

1. if current tax < tax expense
2. if current tax > tax expense

Answer 14

1. deferred tax expense (need to add)
2. deferred tax income (need to decrease)

Question 15

Tax expense must be presented in….

Answer 15

in the P&L as a seperate item (except for tax relating to transactions recognised in OCI or directly in equity, in this case the tax must be recognised in OCI or directly in equity, e.g. gains on revaluation of PP&E)

Question 16

According to IAS12…

Answer 16

… deferred tax must be recognised whenever temporary differences arise, i.e. differences betweem carrying amount of an asset / liability in SoFP and its tax base

Balance Sheet oriented

Question 17

Temporary Differences

1. Taxable TD
2. Deductible TD

Answer 17

1. TD that will result in taxable amounts in determining taxable profit (tax loss) of future periods; when carrying amount of asset / liability is recovered or settled -> deferred tax liabilities (DTL)
2. TD that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods; when carrying amount of the asser or liability is recovered or settled -> deferred tax assets (DTA)

Question 18

Whats tax planning?

Answer 18

has the purpose to save money regarding tax expenditures under legal conditions

Question 19

TD: When the carrying amount is 40 and the tax base is 30, this implies….

Answer 19

… that in future periods the amount deductible when computing taxable profits will be lower than the amount deductible when computing accounting profits
-> taxable TD
-> resulting in deferred tax liability (DTL)

Question 20

What are the main Differences between permanent and timing differences?

1. Permanent
2. Timing

Answer 20

1. differences between accounting profit and taxable profit that never reverse over time; PD do not create deferred tax bc they will never affect taxable income
2. TD: differences that happen now but will reverse in the future; create deferred tax bc they will impact taxable income in future periods

Question 21

When timing differences are present: Should tax expense be computed based on accounting profit or taxable profit? Why?

Answer 21

• tax expense should be computed based on accounting profit, as required by IFRS (IAS 12)
• Why?: accounting profit is determined based on standards like IFRS or GAAP, whilst taxable profit is calculated based on tax rules

Question 22

What would be the consequence if tax rules prevail over GAAP rules?

1.
2.
3.

Answer 22

1. less financial transparency: financial statements would reflect tax driven figures rather than economic reality, making it harder for investors and stakeholders to assess a companys true performance
2. inconsistent comparability: because tax rules differ across countries and change sometimes, this makes it hard to compare
3. misleading profitability metrics: tax rules may allow to aggressively deduct, distrorting profitability of a company

TIM

Question 23

What is a taxable temporary Difference?

Answer 23

• TD that results in taxable amounts in determining taxable profit (loss) of future periods
• happens when an asset or liability is valued higher in the accounting records (carrying amount) than for tax purposes
• this means the company will have to pay more tax in the future when the difference reserves
• results in deferred tax liability

Question 24

What is a deductible temporary difference?

Answer 24

• TD that will result in amounts that are deductible in determining taxable profit (loss) of future periods
• happens when asset or liability is values lower in the accounting records than for tax purposes
• this means the company will pay less tax in the future, leading to potential tax savings
• result is a deferred tax asset

Question 25

Deferred tax assets and deferred tax liabilites must be presented….

UNLESS…

Answer 25

…. as seperate items in the SoFP

… unless the amounts presented are netted (if the DTAs and DTLs relate to tax charged by the same authority and if the entity has a legal right to offset current tax assets against current tax liabilities)

Question 26

Whats….

1. Current Tax?
2. Deferred Tax?
3. Tax Expense?

Answer 26

1. tax payable for current accounting period (STR*taxable profit)
2. tax arising from temporary differences between acconting prfoit and taxable prfoit, creating DTAs and DTLs
3. the total tax reported in the I/S (tax expense = current tax +- deferred tax)

Question 27

Whats…

1. Accounting Profit?
2. Taxable profit?

Answer 27

1. profit before tax, calculated according to financial accounting rules (IFRS/ GAAP)
2. profit calculated according to tax rules, used to determine taxes payable

Question 28

Whats….

1. permanent differences?
2. timing differences?

Answer 28

1. differences between accounting prfoit and taxable prfoit that do not reverse over time (eg non deductible expenses like fines) -> no deferred tx is created here
2. differences between accounting and taxable profit that reverse over time/ differences in timing for recognizing income or expense in accounting vs tax rules (eg depreciation methods)

Question 29

When does it occur?

1. Taxable temporary differences occur when… and result in…
2. Deductible Temporary Differences occur when…. and result in…

Answer 29

1. when accounting profit is higher than taxable profit; result in deferred tax liabilities because the company will pay more tax in the future
2. occur when accounting profit is lower than taxable profit; result in deferred tax assets because the company will pay less tax in the future