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IAS 12 TAXATION
Taxation is a major expense for business entities. IAS 12 Income Taxes notes that there are two
elements to tax that an entity must deal with:

Current tax – the amount payable to the tax authorities in relation to the trading activities of
the current period.

Deferred tax – an accounting measure used to match the tax effects of transactions with their
accounting treatment. It is not a tax that is levied by the government that needs to be paid, but
simply an application of the accruals concept.

Tax expense = current tax +/– movement in deferred tax

Current Tax

Accounting for current tax

Current tax is the amount expected to be paid to the tax authorities by applying the tax laws
and tax rates in place at the reporting date.

Current tax is recognised in the financial statements by posting the following entry:

Dr Tax expense (P/L)

Cr Provision of Current Tax (SFP)

Current tax accounting is often based on estimates, and the final amount payable is often not
finalised until after the financial statements have been authorised for issue:

If the eventual amount paid is less than the estimate recognised in the current period's financial
statements then this will reduce the current tax expense in the next accounting period

If the eventual amount paid is more than the estimate recognised in the current period's
financial statements then this will increase the current tax expense in the next accounting
period.
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Deferred Tax

Basic principles - The need to provide for deferred tax

There are generally differences between accounting standards (such as IFRS Standards) and the
tax rules of a particular jurisdiction. This means that accounting profits are normally different
from taxable profits.

Some differences between accounting and tax treatments are permanent:

Fines, political donations and entertainment costs would be expensed to the statement of
profit or loss but are normally disallowed by the tax authorities. Therefore, these costs are
eliminated ('added back') in the company's tax computation.

Some differences between accounting and tax treatments are temporary:

Temporary differences arise when income or expenditure is recognised in the financial

statements in one year, but is charged or allowed for tax in another. Deferred tax needs to be
provided for o these items.
A temporary difference is the difference between the carrying amount of an asset or liability
and its tax base.

The tax base is the 'amount attributed to an asset or liability for tax purposes' (IAS 12, para 5).

Examples of temporary differences

Temporary differences include (but are not restricted to):

 The most important temporary difference is that between depreciation charged in the
financial statements and capital allowances in the tax computation. In practice capital
allowances tend to be higher than depreciation charges, resulting in accounting profits
being higher than taxable profits. This means that the actual tax charge (known as current
tax) is too low in comparison with accounting profits. However, these differences even
out over the life of an asset, and so at point in the future the accounting profits will be
lower than the taxable profits, resulting in a relatively high current tax charge.
 Development costs are capitalised and amortised to profit or loss in future periods, but
were deducted for tax purposes as incurred.

 Assets are revalued upwards in the financial statements, but no adjustment is made for
tax purposes.
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 The cost of granting share options to employees is recognised in profit or loss, but no tax
deduction is obtained until the options are exercised.

 Intra-group profits in inventory that are unrealised for consolidation purposes yet taxable
in the computation of the group entity that made the unrealised profit.

 Losses reported in the financial statements but the related tax relief is only available by
carry forward against future taxable profits.

According to the accruals concept, the tax effect of a transaction should be reported in the
same accounting period as the transaction itself. Therefore, an adjustment to the tax charge
may be required. This gives rise to deferred tax. Deferred tax only arises on temporary
differences. It is not accounted for on permanent differences.

There are many ways that deferred tax could be calculated. IAS 12 states the liability method
should be used. This provides for the tax on the difference between the carrying value of an
asset (or liability) and its tax base. The tax base is the value given to an asset (or liability) for tax
purposes. The deferred tax charge (or credit) in the income statement is the increase (or
decrease) in the provision reported in the statement of financial position.

These differences are misleading for investors who value companies on the basis of their post -
tax profits (by using EPS for example). Deferred tax adjusts the reported tax expenses for these
differences. As a result the reported tax expense ( the current tax for the period plus the
deferred tax) will be comparable to the reported profits, and in the statement of financial
position a provision is built up for the expected increase in the tax charge in the future.
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Example
Julian recognized a deferred tax liability for the year and 31 December 20X3 which related solely
to accelerated tax depreciation on property, plant and equipment at a rate 30%. The net book
value of the property, plant and equipment at that date was $310,000 and the tax written down
value was $230,000.
The following data relates to the year ended 31 December 20X4:
(i) At the end of the year the carrying of property, plant and equipment was $460,000 and
their tax written down value was $270,000. During the year some items were revalued by
$90,000. No items had previously required revaluation. In the tax jurisdiction in which
Julian operates revaluations of assets do not affect he tax base of an asset or taxable
profit. Gains due to revaluations are taxable on sale.

(ii) Julian began development of a new product during the year and capitalized $60,000 in
accordance with IAS 38. The expenditure was deducted for tax purposes as it was
incurred. Nome of the expenditure had been amortized by the year end.

(iii) Julian’s income statement showed interest income receivable of $55,000 but only
$45,000 of this had been received by the year end. Interest income is taxed on a receipt
basis.

(iv) During the year, Julian made a provision of $40,000 to cover an obligation to clean up
some damage caused by an environmental accident. None of the provision had been used
by the year and. The expenditure will be tax deductible when paid.

The corporate income tax rate recently enacted for the following year is 30% (unchanged from
the previous year).

The current tax charge was calculated for the year as $45,000.

Current tax is settled on a net basis with the national tax authority.

Required:
(a) Prepare a table showing the carrying values, tax bases and temporary differences for the
items above at 31 December 20X4.
(b) Prepare the income statement and statement of financial position notes to the financial
relating to deferred tax for the year ended 31 December 20X4.
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Deferred tax implications – IAS 16 (PPE Depreciation & Tax Allowance)

Bowtock purchased an item of plant for $2,000,000 on 1 October 20X0. It had an estimated life
of eight years and an estimated residual value of $400,000.
The plant is depreciated on a straight-line basis.
The tax authorities do not allow depreciation as a deductible expense. Instead a tax expense of
40% of the cost of this type of asset can be claimed against income tax in the year of purchase
and 20% per annum (on a reducing balance basis) of its tax base thereafter.
The rate of income tax can be taken as 25%.
Required

In respect of the above item of plant, calculate the deferred tax charge/credit in Bowtock’s
income statement for the year to 30 September 20X1, 20X2 and 20X3 and the deferred tax
balance in the statement of financial position at that date.
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Deferred tax implications – IAS 16 (PPE Revaluation)

Example

An entity, Dodge, owns property, plant and equipment that cost $100,000 when purchased.
Depreciation of $40,000 has been charged up to the reporting date of 31 March 20X1. The
entity has claimed total tax allowances on the asset of $50,000. On 31 March 20X1, the asset is
revalued to $90,000. The tax rate is 30%.

Explain the deferred tax implications of this situation.

Solution

The carrying amount of the asset is $90,000 and the tax base is $50,000
($100,000 – $50,000). The carrying amount exceeds the tax base by
$40,000 ($90,000 – $50,000).

This temporary difference will give rise to a deferred tax liability of $12,000
($40,000 × 30%).

Prior to the revaluation, the carrying amount of the asset was $60,000.
The asset was then revalued to $90,000. Therefore, $30,000 ($90,000 –
$60,000) of the temporary difference relates to the revaluation.

Revaluation gains are recorded in other comprehensive income and so the deferred tax charge
relating to this gain should also be recorded in other comprehensive income. This means that
the tax charged to other comprehensive income is $9,000 ($30,000 × 30%).

The following accounting entry is required:

Dr Other comprehensive income $9,000

Dr Profit or loss (bal. fig.) $3,000
Cr Deferred tax liability $12,000

The balance on the revaluation reserve within other components of equity will be $21,000
($30,000 revaluation gain – $9,000 deferred tax).
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Deferred tax implications – IFRS 2

Issue
An entity may receive a tax deduction that differs from related cumulative related cumulative
remuneration expenses, and may arise in a later accounting period.
e.g. an entity recognizes an expenses for share options granted under IFRS 2, but does not receive
a tax deduction until the options are exercised and receives the tax deduction at the share price
on the exercise date.
Measurement
The deferred tax asset temporary difference is measured as:
Carry amount of share-based payment expense 0
Less: Tax Base
(intrinsic value = Estimated amount tax authorities will permit as a deduction
in future periods, based on year end information) (X)
Temporary difference (X)
Deferred tax asset of X% X
If the amount of the tax deduction (or estimated future tax deduction) exceeds the amount of
the related cumulative remuneration expense, this indicates that the tax deduction relates also
to an equity item.
The excess is therefore recognized directly in equity (and reported in other compressive income).
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Example
On 1 January 20X2, an entity granted 5,000 share options to an employee vesting two years later
on 31 December 20X3. The fair value of each option measured at the grant date was $3.
Tax law in the jurisdiction in which the entity operates allows a tax deduction of the intrinsic
value of the options on exercise. The intrinsic value of the share options was $1.20 at 31
December 20X2 and $3.40 at 31 December 20X3 on which date the options were exercised.
Assume a tax rate of 30%.
Required
Show the deferred tax accounting treatment of the above transaction at 31 December 20X2. 31
December 20X3 (before exercise), and on exercise.

Solution
Under IFRS 2 Share based payment the company recognizes an expense for the employee
services received in return for the share options granted over the vesting period. The related
tax deduction does not arise until the share options are exercised. Therefore a deferred tax
asset arises, based on the difference between the intrinsic value of the options and their
carrying amount (normally zero).

IFRS 2 – Share Option

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IAS 12 – Deferred Tax Implications

Vesting Date – Option Exercise/Lapse

There is no longer a deferred tax asset because the options have been exercised or lapsed.
Therefore the deferred tax asset is no longer required.
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Self-Test

An entity, Splash, established a share option scheme for its four directors. This scheme
commenced on 1 July 20X8. Each director will be entitled to 25,000 share options on condition
that they remain with Splash for four years, from the date the scheme was introduced.

Information regarding the share options is provided below:

Fair value of option at grant date $10

Exercise price of option $5
The fair value of the shares at 30 June 20X9 was $17 per share.
A tax deduction is only given for the share options when they are exercised. The allowable
deduction will be based on the intrinsic value of the options. Assume a tax rate of 30%.

Required:
Calculate and explain the amounts to be included in the financial statements of Splash for the
year ended 30 June 20X9, including explanation and calculation of any deferred tax implications.
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Solution

The expense recognised for an equity-settled share-based payment scheme is calculated based
on the fair value of the options at the grant date. This expense is spread over the vesting
period. At each reporting date, the entity should reassess the number of options expected to
vest.

The expense for the scheme in the year ended 30 June 20X9 is $250,000
(4 × 25,000 × $10 × 1/4).

For tax purposes, tax relief is allowed based on the intrinsic value of the options at the date
they are exercised.

At the reporting date, the shares have a market value of $17 but the options allow the holders
to purchase these shares for $5. The options therefore have an intrinsic value of $12 ($17 – $5).

The deferred tax asset is calculated as follows:

$ $
Carrying value of share-based payment Nil
Tax base of the share-based payment
(4 × 25,000 × ($17 – $5) × 1/4)
(300,000)
–––––––
× Tax rate 30% (300,000)
–––––––
Deferred tax asset 90,000
–––––––

Where the amount of the estimated future tax deduction exceeds the accumulated
remuneration expense, this indicates that the tax deduction relates partly to the remuneration
expense and partly to equity.

In this case, the estimated future tax deduction is $300,000 whereas the accumulated
remuneration expense is $250,000. Therefore, $50,000 of the temporary difference is deemed
to relate to an equity item, and the deferred tax relating to this should be credited to equity.

The following entry is required:

Dr. Deferred tax asset $90,000

Cr. Equity ($50,000 × 30%) $15,000
Cr. Profit or loss ($250,000 × 30%) $75,000

If the deferred tax asset is to be recognised, it must be regarded as recoverable.

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Deferred tax implications – IFRS 16 Lessee Accounting

Issue

Under a lease, the lessee recognises a right-of-use asset and a corresponding lease liability. This
net figure represents the carrying amount.
If an entity is granted tax relief as lease rentals are paid, a temporary difference arises, as the
tax base of the lease is zero.

This results in a deferred tax asset. Tax deductions are allowed on the lease rental payment
made, which, at the beginning of the lease, is lower than the combined depreciation expense
and finance cost recognised for accounting. Therefore, the future tax saving on the additional
accounting deduction is recognised now in order to apply the accruals concept.

Measurement

The deferred tax asset temporary difference is measured as:

Carrying amount:
Right-of-use asset (carrying amount) X
Lease liability (X)
(X)
Tax base 0
Temporary difference (X)
Deferred tax asset at x% X
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Example

On 1 January 20X1, Heggie leased a machine under a five year lease. The useful life of the asset
to Heggie was four years and there is no residual value.

The annual lease payments are $6 million payable in arrears each year on 31 December. The
present value of the lease payments was $24 million using the interest rate implicit in the lease
of approximately 8% per annum. At the end of the lease term legal title remains with the lessor.
Heggie incurred $0.4 million of direct costs of setting up the lease.

The directors have not leased an asset before and are unsure how to account for it and whether
there are any deferred tax implications.

The company can claim a tax deduction for the annual lease payments and lease set-up costs.
Assume a tax rate of 20%.

Required
Discuss, with suitable computations, the accounting treatment of the above transaction in
Heggie's financial statements for the year ended 31 December 20X1. Work to the nearest $0.1
million.
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Solution

Calculation
$m $m
Carrying amount:
Right-of-use asset ($24.4m – ($24.4m/4 years)) 18.3
Lease liability (W1) (19.9)
(1.6)
Tax base 0.0
Temporary difference (1.6)
Deferred tax asset (20%) 0.3

Working: Lease liability

$m
b/d at 1 January 20X1 24
Interest (24  8%) 1.9
Instalment in arrears (6.0)
c/d at 31 December 20X1 19.9

Explanation

Lease accounting

A right-of-use asset of $24.4m should be recognised in Heggie's financial statements. This

comprises the $24m present value of lease payments not paid at the 1 January 20X1
commencement date plus the 'initial direct costs' incurred in setting up the lease of $0.4m.
The asset should be depreciated from the commencement date (1 January 20X1) to the earlier
of the end of the asset's useful life (4 years) and the end of the lease term (5 years) unless the
legal title reverts to the lessee at the end of the lease term. Here, as the legal title remains with
the lessor, the asset should be depreciated over 4 years, giving an annual depreciation charge
of $6.1m
($24.4m/4 years) and a carrying amount of $18.3m at 31 December 20X1.
A lease liability should initially be recognised on 1 January 20X1 at the present value of lease
payments not paid at the commencement date. This amounts to $24m. An annual finance cost
of
8% of the carrying amount should be recognised in profit or loss and added to the liability. The
first lease instalment on 31 December 20X1 is then deducted from the liability, giving a carrying
amount of (Working) $19.9m at 31 December 20X1.
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Deferred tax

The carrying amount in the financial statements will be the net of the right-of-use asset and
lease liability.
As tax relief is granted on a cash basis, ie when lease payments and set-up costs are paid, the
tax base is zero, giving rise to a temporary difference.
This results in a deferred tax asset and additional credit to tax in profit or loss of $0.3m (see
below).
The tax deduction is based on the lease rental and set-up costs which is lower than the
combined depreciation expense and finance cost. The future tax saving of $0.3m on the
additional accounting deduction is recognised now in order to apply the accruals concept.
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Deferred tax implications – IAS 37 Provision for warranty

Pargathi Co recognizes a liability of £10,000 for accrued products warranty costs on 31 December
20X7. Assume that these product warranty costs will not be deductible for tax purposes until the
entity pays claims. The tax rate is 25%.
Requirement:
State the deferred tax implications of this situation.
Solution
The carrying amount of the liability is (£10,000).
The tax base of the liability is nil (carrying amount of £10,000 less the amount that will be
deductible for tax purposes in respect of the liability in future periods).
When the liability is settled for its carrying amount, the entity’s future taxable profit will be
reduced by £10,000 and so its future tax payments by £10,000 x 25% = £2,500.
The carrying amount of (£10,000) is less than the tax base of nil and therefore the difference of
£10,000 is a deductible temporary difference.
The entity should therefore recognize a deferred tax asset of £10,000 x 25% = £2,500 provided
that it is probable that the entity will earn sufficient taxable profits in future periods to benefits
from a reduction in tax payments.
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Deferred tax implications – Tax Rate Change with IAS 10

Brick is a company with a reporting date of 30 April 20X4. The company obtains tax relief for
research and development expenditure on a cash paid basis. The recognition of a material
development asset during the year, in accordance with IAS 38, created a significant taxable
temporary difference as at 30 April 20X4.
The tax rate for companies as at the reporting period was 22%. On 6 June 20X4, the
government passed legislation to lower the company tax rate to 20% from 1 January 20X5.

Required:
Explain which tax rate should have been used to calculate the deferred tax liability for inclusion
in the financial statements for the year ended 30 April 20X4.

Solution

Deferred tax liabilities and assets should be measured using the tax rates expected to apply
when the asset is realised. This tax rate must have been enacted or substantively enacted by
the end of the reporting period.
The government enacted the 20% tax rate after the period end. Therefore, it should not be
used when calculating the deferred tax liability for the year ended 30 April 20X4. The current
22% rate should be used instead. Per IAS 10, changes in tax rates after the end of the reporting
period are a non-adjusting event. However, if the change in the tax rate is deemed to be
material then Brick should disclose this rate change and an estimate of the financial impact.
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Deferred tax assets

A deferred tax asset must satisfy the recognition criteria given in IAS-12.
These state that a deferred tax asset should only be recognized to the extent that it is probable
that taxable profit will be available against which it can be utilized.
This is an application of prudence
Future taxable profits???
When can we be sure that sufficient taxable profit will be available against which a deductible
temporary difference can be utilized.
IAS-12 states that this is assumed when:

• There are sufficient taxable temporary differences, and

• The taxable temporary differences and deductible temporary differences relate
o to the same entity and same tax authority and:
o In the same time period as the deductible temporary differences, or

Insufficient taxable temporary differences

Where there are insufficient taxable temporary differences, a deferred tax asset may only be
recognized to the extent that:

• It is probable that taxable profits will be sufficient in the same period as the
reversal of the deductible temporary difference.
• Tax planning opportunities exist that will allow the entity to create taxable profit in
the appropriate periods.
If an entity has a history of recent losses, then this is evidence that future taxable profit may not
be available.
Reassessment of unrecognized deferred tax assets
For all unrecognized deferred tax assets, at each reporting date an entity should reassess the
availability of future taxable profits and whether part or all of any unrecognized deferred tax
assets should now be recognized. This may be due to an improvement in trading conditions which
is expected to continue.
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Presentation
Deferred tax assets and liabilities can only be offset if:

(a) The entity has sufficient taxable temporary differences which will result in taxable
amounts against which the losses / credits can be used;
(b) It is probable that the entity will have taxable profits before the losses / credits expire;
(c) The unused tax losses result from identifiable causes which are unlikely to recur;
(d) Tax planning opportunities are available which will create taxable profits against which
the losses / credits can be used.

UNUSED TAX LOSSES /UNSUED TAX CREDITS/CARRY FORWARD LOSSES

TAXABLE INCOME - TAX PAYMENT

TAXABLE LOSS - FUTURE TAXABLE INCOME ADJUST (IF ALLOWOED BY TAX AUTHORITY) -
FUTURE TAX SAVINGS - FUTURE BENEFIT - DEFEREED TAX ASSET - IF FUTURE TAXABLE INCOME
IS EXPECTED

A deferred tax asset is recognised for the carryforward unused tax losses or credits to the extent
that it is probable that the future taxable profit will be available against which the unused tax
losses and credits can be used.

Factors to considered (about the probability of future taxable profit)include whether:

1- Sufficient Taxable Temporary Differences

2- Taxable loss arose (eg COVID 19), unlikely to reoccur
3- Probable sufficient taxable profit before unused tax losses/credits become expire.
4- Tax Planning opportunities are available.
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Example
Barcino Co made tax losses of $230,000 in the year ended 31 December 20X1. Local tax rules
state that losses can be carried forward for two calendar years to reduce future tax bills before
they expire. Barcino recognized a deferred tax asset at 30% in 20X1 on the grounds that it was
probable that the company would make sufficient taxable profits before the tax losses expired,
and continued to hold this expectation at the 20X2 year end. No corporate income tax was
payable in 20X1.

In the accounting regime in which Barcino operates, taxable profits are measured based on profit
before tax adjusted for disallowable.

Results for the three years ended 31 December 20X3 were:

20X1 20X2 20X3

$ $ $

(Loss)/profit before tax (234,000) 47,000 135,500

Disallowable expenses 4,000 3,000 4,000

Taxable (loss)/profit) (230,000) 50,000 139,500

Required
Show relevant extracts from the financial statements of Barcino Co illustrating the effects of the
tax losses over the three years ended 31 December 20X3.
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SBR Exam Alert – Specimen 2 Q1 (B)

Hill has made a loss in the year ended 30 September 20X6, as well as in the previous two financial years.
In the consolidated statement of financial position it has recognised a material deferred tax asset in
respect of the carry-forward of unused tax losses. These losses cannot be surrendered to other group
companies. On 30 September 20X6, Hill breached a covenant attached to a bank loan which is due for
repayment in 20X9. The loan is presented in non-current liabilities on the statement of financial position.
The loan agreement terms state that a breach in loan covenants entitles the bank to demand immediate
repayment of the loan. Hill and its subsidiaries do not have sufficient liquid assets to repay the loan in full.
However, on 1 November 20X6 the bank confirmed that repayment of the loan would not be required
until the original due date. Hill has produced a business plan which forecasts significant improvement in
its financial situation over the next three years as a result of the launch of new products which are
currently being developed.

Required:

Discuss the proposed treatment of Hill’s deferred tax asset and the financial reporting issues raised by its
loan covenant breach. (9 marks)

Solution

Deferred tax (5 Marks)

According to IAS 12 Income Taxes, an entity should recognise a deferred tax asset in respect of the carry-
forward of unused tax losses to the extent that it is probable that future taxable profit will be available
against which the losses can be utilised. IAS 12 stresses that the existence of unused losses is strong
evidence that future taxable profit may not be available. For this reason, convincing evidence is required
about the existence of future taxable profits.

IAS 12 says that entities should consider whether the tax losses result from identifiable causes which are
unlikely to recur. Hill has now made losses in three consecutive financial years, and therefore significant
doubt exists about the likelihood of future profits being generated.

Although Hill is forecasting an improvement in its trading performance, this is a result of new products
which are currently under development. It will be difficult to reliably forecast the performance of these
products. More emphasis should be placed on the performance of existing products and existing
customers when assessing the likelihood of future trading profits.

Finally, Hill breached a bank loan covenant and some uncertainty exists about its ability to continue as a
going concern. This, again, places doubts on the likelihood of future profits and suggests that recognition
of a deferred tax asset for unused tax losses would be inappropriate.

Based on the above, it would seem that Hill is incorrect to recognise a deferred tax asset in respect of its
unused tax losses.
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Covenant breach (2 Marks)

Hill is currently presenting the loan as a non-current liability. IAS 1 Presentation of Financial Statements
states that a liability should be presented as current if the entity:

– settles it as part of its operating cycle, or

– is due to settle the liability within 12 months of the reporting date, or
– does not have an unconditional right to defer settlement for at least 12 months after the
reporting date.
Hill breached the loan covenants before the reporting date but only received confirmation after the
reporting date that the loan was not immediately repayable. As per IAS 10 Events after the Reporting
Period, the bank confirmation is a non-adjusting event because, as at the reporting date, Hill did not have
an unconditional right to defer settlement of the loan for at least 12 months. In the statement of financial
position as at 30 September 20X6 the loan should be reclassified as a current liability.

Going concern (2 Marks)

Although positive forecasts of future performance exist, management must consider whether the breach
of the loan covenant and the recent trading losses place doubt on Hill’s ability to continue as a going
concern. If material uncertainties exist, then disclosures should be made in accordance with IAS 1.
 Page 23 of 27

Tax base Definition by IAS 12

TAX BASE – ASSET
We can expand on the definition given above by stating that the tax base of an asset is the
amount that will be deductible for tax purposes against any taxable economic benefits that will
flow to the enterprise when it recovers the carrying value of the asset. Where those economic
benefits are not taxable, the tax base of the asset is the same as its carrying amount.
RULES FOR TAX BASE
ASSET

Profit and loss category Cash Category

Eg: Depreciable NCA, Eg: Interest Receivable,

Prepaid Expenses Loan Receivable, Land,
and Investment in Shares

Tax Base = Future Allowable Tax Base = Amount Not Taxable in

Expenses Future
Question:
State the tax base of each of the following assets.

(a) A machine cost $10,000. For tax purposes, depreciation of $3,000 has already been
deducted in the current and prior periods and he remaining cost will be deductible in
future periods, either as depreciation or through a deduction disposal. Revenue
generated by using the machine is taxable, any gain on disposal of the machine will be
taxable and any loss on disposal will be deductible for tax purposes.
(b) Interest receivable has a carrying amount of $1,000. The related interest revenue will be
taxed on a cash basis.
(c) Trade receivables have a carrying amount of $10,000. The related revenue already been
included in taxable profit (tax loss).
(d) A loan receivable has a carrying amount of $1m. The repayment of the loan will have no
tax consequences.
Answer:
(a) The tax base of the machine is $7,000.
(b) The tax base of the interest receivable is nil.
(c) The tax base of the trade receivables is $10,000.
(d) The tax base of the loan is $1m
 Page 24 of 27

Tax base Definition by IAS 12

TAX BASE – LIABILITY
In the case of a liability, tax base will be its carrying amount, less any amount that will be deducted
for tax purposes in relation to the liability in future periods. For revenue 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.
RULES FOR TAX BASE
LIABILTY

Advance Income All others Liabilities

Eg: Advance Income Eg: Provisions, Accrued

Expenses

Tax Base
Tax Base
Carrying Amount
Carrying Amount
(-) Liability Not Taxable in Future
(-) Future Allowable Expense
Question:
State the tax base of each of the following liabilities.

(a) Current liabilities include accrued expenses with a carrying amount of $1,000. The related
expense will be deducted for tax purposes on a cash basis.
(b) Current liabilities include interest revenue received in advance, with a carrying amount of
$10,000. The related interest revenue was taxed on a cash basis.
(c) Current liabilities include accrued expensed with a carrying amount of $20,000. The
related expense has already been deducted for tax purposes.
(d) Current liabilities include accrued fines and penalties with a carrying amount of $100.
Fines and penalties are not deductible for tax purposes.
(e) A loan payable has a carrying amount of $1m. The repayment of the loan will have no tax
consequences.
Answer:
(a) The tax base of the accrued expenses is nil
(b) The tax base of the interest received in advance is nil
(c) The tax base of the accrued expenses is $2,000
(d) The tax base of the accrued fines and penalties is $100
(e) The tax base of the loan is $1m
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More Examples: Tax Base

Scenario 1 – An entity’s current assets include insurance premiums paid in advance of £20,000,
for which a tax deduction will be allow in future periods.
The tax base of the insurance premiums is £20,000, because the whole carrying amount will be
deductible for tax purposes in future periods.
Scenario 2 – An entity has recognized a current liability of £400,000 in respect of income received
in advance, which will be taxed in future periods.
The tax base of the liability is its £400,000 carrying amount.
Scenario 3 – An entity has recognized a defined benefit liability of £500,000 in respect of a
defined benefits retirement plan, but no tax deduction is allowed until contributions are paid into
the plan.
The tax base of the liability is nil, because the whole carrying amount will be deductible for tax
purposes in future periods.
Scenario 4 – Two years ago, an entity recognized a non-current asset at its £1 million cost. Tax
depreciation is allowed on the full cost at 15% per annum on a straight-line basis.
The tax base of the non-current asset is £700,000. 15% of cost has been allowed for tax purposes
in each of the two years, the tax base in therefore the 70% of cost which will be deductible for tax
purposes in future periods.
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IAS 12 – EXCEPTION PARAGRAPH - INITIAL RECOGNITION

Temporary differences with no deferred tax impact
A deferred tax liability or asset should be recognized for all taxable and deductible temporary
differences unless (EXCEPTION) they arise from:
The initial recognition of goodwill, or
The initial recognition of an asset or liability in a transaction which
- Is not a business combination (Group Accounts), and
- At the time of the transaction (INITIAL RECOGNITION), affects neither accounting nor
taxable profit
Examples of initial recognition of assets or liabilities in a transaction which does not affect either
accounting for taxable profit at the time of the transaction are:
1. An intangible asset with a finite life which attracts no tax allowances. In this case, taxable
profit is never affected, and amortization is only charged to accounting profit after the
transaction.
2. A non-taxable government grant related to an asset which is deducted in arriving at the
carrying amount of the asset. For tax purposes it is not deducted from the tax basis.

Although a deductible temporary difference arises in both cases (on initial recognition in the
second case, and subsequently in the first case), this is not permitted to be recognized as a
deferred tax asset as it would make the financial statements less transparent.
Worked example: initial recognition
As another example of the principles behind initial recognition, suppose Petros Co intends to use
an asset which cost £10,000 in 20X7 throughout its useful life of five years. Its residual value
would then be nil. The tax rate is 40%. Any capital gain on disposal would not be taxable (and any
capital loss not deductible). Depreciation of the asset is not deductible for tax purposes.
Requirements
State the deferred tax consequences in each of the years 20X7 and 20X8.
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Solution
20X7
To recover the carrying amount of the asset, Petros will earn taxable income of £10,000 and pay
tax of £4,000. The resulting deferred tax liability of £4,000 would not be recognized because it
results from the initial recognition of the asset.

20X8
The carrying value of the asset is no £8,000. In earning taxable income of £8,000. Petros will pay
tax of £3,200. Again the resulting deferred tax liability of £3,200 is not recognized it results from
the initial recognition of the asset.

Past Exam Questions

Specimen 2 – Q1 – B – Deferred Tax Asset
December 2018 – Q4
March/June 2019 Q2 - Deferred Tax Asset
September/December 2019 – Q2 - Deferred Tax Asset