IAS 12

INCOME TAXES
Compiled by: Murtaza Quaid, ACA
IAS 12: Income Taxes
In this Part:
 Objective of IAS 12

 Accounting Profit / Loss & Taxable Income / Loss

 Current Tax

 Deferred Tax

 Carrying Amount & Tax Base

 Temporary Difference

 Measurement – Deferred Tax

 Recognition – Deferred Tax

 Difference between current tax and deferred tax

 Special Circumstances
 Objective of IAS 12
 To prescribe accounting treatment for the income taxes

 Incomes taxes payable / recoverable in respect of

Current Tax the current period’s taxable profit / loss

 Income taxes payable / recoverable in respect of

Deferred Tax
future periods
 Accounting Profit / Loss and Taxable Income / Loss

Accounting  Profit or loss for the period before deducting XXXX

Profit / Loss tax expense

Add. Expenses recognized, but non-deductible for tax purposes XXXX

Add. Income not recognized, but included under tax laws XXXX
Less. Expenses not recognized, but deductible for tax purposes (XXX)
Less. Income recognized, but not under tax laws (XXX)

Taxable  Profit or loss for the period determined in

Income / Loss accordance with applicable tax rules XXXX
 Current Tax
Current tax is income tax payable / recoverable in respect of current
period’s taxable profit / loss

Taxable Income / Loss X Tax Rate %

Debit: Current Tax Expense – P/L XXXX

Credit: Provision for Tax XXXX

Deferred Tax
Income tax payable (recoverable) in future periods in respect of the
temporary differences, unused tax losses and unused tax credits

 Temporary difference
 Unused Tax Losses X Tax Rate %
 Unused Tax Credits
 Temporary Difference

Temporary Difference = Carrying Amount – Tax Base

Asset: Carrying amount > Tax base Asset: Carrying amount < Tax base
Liability: Carrying amount < Tax base Liability: Carrying amount > Tax base

Taxable Temporary difference Deductible Temporary difference

Deferred Tax Liability Deferred Tax Asset

Carrying Amount  Amount attributed to asset / liability as per IAS & IFRS

Tax Base  Amount attributed to asset / liability for tax purposes

 Recognition – Deferred Tax

Deferred Tax Liabilities Deferred Tax Assets

Recognize to extent probable that

future taxable profit will be
Recognize in full
available against which deductible
temporary differences can be used
 Measurement – Deferred Tax

Measurement should reflect the type of income and the manner in which the
asset will be recovered, or the liability settled

Enacted or substantively enacted Rate expected to apply when assets

rates and laws by the reporting date are realized / liabilities are settled

Deferred taxes are not discounted

 Recognition – Deferred Tax

Deferred tax is recognized in the same place as the

underlying transaction or events (i.e. item) to which it relates

Item recognized in profit or loss Item recognized in OCI / equity

Deferred tax recognized in Deferred tax recognized in

profit or loss OCI / equity

OCI Equity

 Fair valuation of financial  Correction of prior period

asset at FVOCI errors
 Upward revaluation of  Retrospective adjustment of
property, plant & equipment change in accounting policy
 Difference between current tax and deferred tax

CURRENT TAX DEFERRED TAX

Accounting measure to avoid

Amount payable to tax authorities
mismatch

Incomes taxes payable in respect of Income taxes payable / recoverable

current period’s taxable profit in respect of future periods

Temporary Difference
Taxable profit / loss Unused Tax losses
Unused Tax Credits
 Deferred Tax Implications of Gains or Losses on Financial Assets
 Gains/(losses) on financial assets held at fair
value should be recognised in profit or loss or
in other comprehensive income
 If the gain is not taxable until the financial
asset is sold, the gain is ignored for tax
purposes until the sale and the tax base of the
asset does not change. A taxable temporary
difference arises generating a deferred tax
liability.
 Similarly, losses on financial assets that are not tax deductible until they are
sold generate a deferred tax asset.
 The deferred tax is recognised in the same section of the statement of profit
or loss and other comprehensive income as the gain/loss on the financial
asset.
 Deferred Tax and Convertible Bonds
 IAS 32: Financial instruments: Presentation requires that on initial recognition of a
compound instrument, for example a convertible bond, the credit entry must be split
into the two component parts, equity and liability.
 In many jurisdictions the tax base of the convertible bond would be the amount
borrowed. Therefore, split accounting results in the origination of a taxable temporary
difference (being the difference between the carrying amount of the liability and its tax
base).
 An entity must recognise the resultant deferred tax liability. The temporary difference
arises on initial recognition because the equity portion of the bond is recognised in
equity. Therefore, the other side of the double entry to establish the deferred tax liability
is also recognised in equity (where it is netted off against the equity component.
 Over the life of the bond its carrying value is adjusted
to the amount borrowed. Therefore, the taxable
temporary difference and the resultant deferred tax
liability falls over the bond’s life. These changes in the
deferred taxation liability are due differences in the
annual effective rate used to value the initial liability
and the cash interest. Therefore, the movement in
deferred tax is recognised in the statement of profit or
loss.
 Deferred Tax Implications of Equity Settled Share-Based Payment
Accounting for share option schemes involves recognising an annual remuneration expense in
profit or loss throughout the vesting period. Whereas, tax deduction is not normally granted until
the share options are exercised.
The amount of tax deduction granted is based on the intrinsic value of the options (the difference
between the market price of the shares and the exercise price of the option) on the exercise date.
This delayed tax deduction means that equity-settled share-based payment schemes give rise to a
deductible temporary difference. Consequently, deferred tax asset is recognized.
Measurement
The deferred tax asset temporary difference is measured as:
Carrying amount of share-based payment expense ---
Less. Tax base of share-based payment expense (estimated amount tax authorities will
(XXX)
permit as a deduction in future periods, based on year end information)
Deductible Temporary Difference (XXX)
Deferred Tax Asset at Tax Rate % XXX
If the amount of the tax deduction (or estimated future tax deduction) exceeds the amount of the
related cumulative share-based payment expense, this indicates that the tax deduction relates
partly to the remuneration expense and partly to equity.
The excess is therefore recognised directly in equity (Note, it is not reported in other
comprehensive income)
 Deferred Tax Implications of Equity Settled Share-Based Payment
The expected future tax benefit should be allocated between the income statement and equity.
The excess of the total tax benefit over the tax effect of the related cumulative remuneration
expense is recognized in equity.
The accounting is illustrated below.

Estimated tax deduction

as determined by tax
regulations
< Cumulative SBP Expense
recognized in P/L
Tax benefit is recognized
in P/L

Tax benefit upto the SBP

Expense (P/L) is
recognized in P/L
Estimated tax deduction
as determined by tax
regulations
> Cumulative SBP Expense
recognized in P/L
The excess tax benefit is
recognized in Equity
 Deferred Tax: Group Financial Statements
 There are some temporary differences which only arise
in a business combination.
 IFRS 3 requires assets acquired and liabilities assumed on
acquisition of a subsidiary to be brought into the
consolidated financial statements at their fair value rather
than their carrying amount.
 However, this change in fair value is not usually reflected
in the tax base. The tax bases of assets and liabilities in
the consolidated financial statements are determined by
reference to the applicable tax rules.
 Usually tax authorities calculate tax on the profits of the individual entities (not group
profit), so the relevant tax bases to use will be those of the individual entities.
 Therefore, temporary difference arises.
 Deferred tax calculation
Carrying amount of asset/liability (in consolidated statement of financial position) XX / (XX)
Tax base (usually subsidiary’s tax base) (XX) / XX
Temporary Difference XX / (XX)
Deferred Tax (Liability)/Asset (XX) / XX
 Deferred Tax: Group Financial Statements
 The accounting entries to record the resulting deferred tax are:
(a) Deferred tax liability due to fair value gain: reduces the fair value of the net assets of
the subsidiary and therefore increases goodwill:
Debit Goodwill XXX
Credit Deferred tax liability XXX
(b) Deferred tax asset due to fair value loss: increases the fair value of the net assets of
the subsidiary and therefore reduces goodwill:
Debit Deferred tax asset XXX
Credit Goodwill XXX
 Unrealised Profits on Intragroup Trading
 When a group entity sells goods to
another group entity, the selling entity
recognises the profit made in its
individual financial statements.
 If the related inventories are still held by
the group at the year end, the profit is
unrealised from the group perspective
and adjustments are made in the group
accounts to eliminate it.
 The same adjustment is not usually made
to the tax base of the inventories (as tax is usually calculated on the
individual entity profits, and not group profits) and a temporary difference
arises.
 IAS 12 requires that deferred tax on such temporary difference would be
provided at the buyer’s rate of tax.
 Unrealised Profits on Intragroup Trading - Example
 P sells goods costing $150 to its overseas subsidiary S for $200. At the year end, S still holds the inventories.
In the jurisdictions in which P and S operate, tax is charged on individual entity profits.
 P’s rate of tax is 40%, whereas S’s rate of tax is 50%.
 P pays tax of $20 ($50 × 40%) on the profit generated by the sale.
 S is entitled to a future tax deduction for the $200 paid for the inventories. The tax base of the inventories
is therefore $200 from S’s perspective.
 From the perspective of the P group, the profit of $50 generated by the sale is unrealised. In the
consolidated financial statements, the unrealised profit is eliminated, so the carrying amount of the
inventories from the group perspective is $150.
 Deferred tax is calculated as: $
Carrying amount (in the group financial statements) 150
Tax base (cost of inventories to S) (200)
Temporary difference (group unrealised profit) (50)
Deferred tax asset (50 × 50% (S’s tax rate)) 25

 S’s tax rate is used to calculate the deferred tax asset because S will receive the future tax deduction related
to the inventories.
 In the consolidated financial statements a deferred tax asset of $25 should be recognised:
Debit Deferred tax asset (in consolidated statement of financial position) $25
Credit Deferred tax (in consolidated statement of profit or loss) $25
 Investments in Subsidiaries, Branches, Associates
and Interests in Joint Arrangements
 When a company invests in a subsidiary, branch, associate or interests in joint
arrangements, it acquires a right to receive dividends out of its accumulated profits.
 The carrying amount of an investment in a subsidiary, branch, associate or interests
in joint arrangements (e.g the parent’s/investor’s share of the net assets plus
goodwill) can be different from the tax base (often the cost) of the investment.
 This can happen when, for example, the subsidiary has undistributed profits. The
subsidiary’s profits are recognised in the consolidated financial statements, but if the
profits are not taxable until they are remitted to the parent as dividend income, a
temporary difference arises.
 IAS 12 requires that a deferred tax liability be recognised for these undistributed
earnings, because they will attract tax when the dividends are paid to the parent in
the future.
 A temporary difference in the consolidated financial statements may be different
from that in the parent’s separate financial statements if the parent carries the
investment in its separate financial statements at cost or revalued amount.
 Investments in Subsidiaries, Branches, Associates
and Interests in Joint Arrangements
 An entity should recognise a deferred tax liability for all temporary differences
associated with investments in subsidiaries, branches, associates or joint ventures
unless:
(a) The parent, investor or venturer is able to control the timing of the reversal of
the temporary difference (eg by determining dividend policy); and
(b) It is probable that the temporary difference will not reverse in the foreseeable
future.
 In practice, it is unusual to see companies recognising deferred tax liability for
undistributed profits of a subsidiary because of the above rule.
 The situation for investments in associates is different because the parent is unlikely
to control the timing of the reversal of the temporary difference. Recognition of
deferred tax liability for undistributed profits of associates is quite common.
 ICAP Technical Release 27 - Income subject to Final Taxation
 Deferred tax accounting does not apply to
those companies whose entire income is
subject to final taxation as there will be no
temporary differences.
 For companies that have portion of income
subject to final taxation, the company is
required to make a reasonable estimate of
future sales subject to normal taxation and
sales subject to final taxation and recognize
deferred tax accordingly.
 However, if it is not practicable to develop a reasonable estimate for
calculation of deferred tax liability / asset then an entity should evaluate
the expectation of future turnover by taking into consideration the
turnover trend of at-least three years (including the current year) and
recognize and provide deferred tax liability accordingly.
ICAP Technical Release 27 – Tax Losses and Turnover Tax (Minimum Tax)
 In case current tax liability is calculated u/s
113 (Minimum tax) due to taxable loss, the
effect of temporary differences should be
calculated and deferred tax asset should be
recognized.
 Deferred tax asset should be recognized for
the carry forward of unused tax losses &
unused tax credits (as allowed under
Income Tax Ordinance, 2001) to the extent
that it is probable that future taxable profit
will be available against which the unused
tax losses & unused tax credits can be
utilized.
 ICAP Technical Release 30 - Income subject to Final Tax at Import Stage
 Where an entity is taxed under FTR at import stage under ITO-
2001 and a portion of the imported goods remains unsold at the
balance sheet date (held and carried forward as inventory), the
final tax paid at import stage be recognized as expense as and
when the goods are sold and the related profits are earned.
 Under ITO-2001, although tax is paid at import stage, but the tax is
on the income of the importer from imports and hence, till the
time the income does not so arise, it merely is a pre-payment of
tax in relation to such income. Despite, the tax is final and is not
refundable but in substance the tax paid at import stage entitles the
tax payer to future tax benefit or relief in the shape of no further
outflow in the form of taxation of profits that maybe earned from
the selling of imported goods.
 In short, tax paid at import stage under FTR should be recognized as tax expense in the period in
which related goods are sold. Accordingly, portion of tax paid that pertains to unsold inventory
should be carried forward in balance sheet as pre-paid tax, subject to following conditions:
a) it is probable that the sale of imported goods would result in sufficient future taxable profits;
b) the carry forward of tax shall not relate to the inventories written down to net realizable
value in accordance with IAS 2 “ Inventories”;
c) the tax to be carried forward as explained above shall not constitute value of inventories;
 If above conditions are not met, tax paid under FTR at import stage shall be fully recognized as a tax
expense in the period in which the goods are imported and such tax is paid.