The second approach to deferred tax focuses on the statement of fi nancial position impact of the differences and calculates the tax that would have been paid if the net assets of the entity were realised at book value at the end of the reporting period. A temporary differ- ence is the difference between the carrying amount of an asset or liability in the statement of fi nancial position and its tax base (its value for tax purposes).
It is this approach that is adopted by IAS 12 for the recognition and measurement of deferred tax assets and liabilities and therefore we will concentrate on this approach for the remainder of the chapter.
Example 6.D
Let us use the information from Example 6.B:
An item of plant and machinery is purchased by U in 20X0 for $300,000. The asset’s estimated useful life is 6 years, following which it will have no residual value. Plant and machinery is depreciated on a straight-line basis. Tax depreciation for this item is given at 25% on a straight-line basis for the fi rst 4 years.
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The fi gures for accounting and for taxation purposes would be as follows (from Example 6B):
20X0 20X1 20X2 20X3 20X4 20X5
$’000 $’000 $’000 $’000 $’000 $’000 Financial statements
Opening carrying value 300 250 200 150 100 50 Accounting depreciation charge 50 50 50 50 50 50 Carrying value (end of the reporting period) 250 200 150 100 50 0 Tax computation
Carrying value 300 225 150 75 0 0 Tax depreciation 75 75 75 75 0 0 Tax written down value 225 150 75 0 0 0 Taxable temporary differences
Carrying value (per accounts) 250 200 150 100 50 0 Tax written down value 225 150 75 0 0 0 Temporary difference 25 50 75 100 50 0 The provision for deferred tax under the temporary difference method is based on what tax would become payable if the assets were realised at book value at the end of the reporting period. We compare the carrying value of the item per accounts with the tax base, which is the value of the item for tax purposes (which in the case of fi xed assets is usually the tax written down value).
Example 6.E
Using data in Example 6.D to illustrate the deferred tax impact.
The asset purchased above by U is sold at the end of 20X2 for $180,000 when the carrying value of the asset is $150,000 and the tax written down value is $75,000. The taxable profi t and resulting tax charge are calculated as follows:
Accounting profi t $’000 Tax computation $’000 Proceeds 180 Proceeds 180 Carrying value 20X2 150 Tax written down value 20X2 75 Accounting profi t 30 Profi t per tax computation 105 Tax on profi t at 30% 9 Tax on profi t at 30% 31.5 Based on the accounting records, we would expect to earn $30,000 profi t on sale of the asset. However, due to accelerated tax depreciation, the tax written down value is considerably lower than the book value and so the gain on sale that would be recognised for tax purposes is $31,500. The additional $22,500 ($31,500 $9,000) tax that would be payable if the asset was sold, must be provided for under the tempo- rary differences method.
The table below shows the movement on the deferred tax liability account in the statement of fi nancial position and the charge/(release) to the profi t or loss in each of the 6 years of the asset’s useful life.
20X0 20X1 20X2 20X3 20X4 20X5
$’000 $’000 $’000 $’000 $’000 $’000 Temporary differences
Carrying value (per accounts) 250 200 150 100 50 0 Tax written down value 225 150 75 0 0 0 Temporary difference 25 50 75 100 50 0 Deferred tax provision required (at a rate of 30%) 7.5 15 22.5 30 15 0
The provision for deferred tax increases in the fi rst 4 years of the asset’s life. This is the period that tax depreci- ation is applied which causes differences between the statement of fi nancial position carrying value and the tax written down value. This taxable temporary difference then reduces in the last 2 years as the book value reduces to the asset’s residual value of nil.
The deferred tax provision required is calculated at the tax rate (in this case 30%). This provision represents the additional tax the entity would pay on the gain if the asset was sold any time within its useful life, based on the tax written down value as opposed to the asset’s book value.
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Tax base
IAS 12 states that a temporary difference is the difference between the carrying value of an asset or liability and its tax base. The tax base is the amount attributed to that asset or liability for tax purposes. Consider the four scenarios below:
1. Non-current assets. The detailed illustration above dealt with a tax-deductible non-current asset. Its tax base was the tax written down value at the end of the reporting period. This is normally the case for non-current assets.
2. Revalued non-current assets. The temporary difference is defi ned as the difference between the carrying value of an asset and its tax base. As the tax base will remain the same, an upwards revaluation of a non-current asset will result in an increase in the deferred taxation provision.
3. Accrued interest. An entity has recorded accrued interest receivable of $5,000 in its accounts to 31 December 20X1. The interest receivable will only be taxed, however, when it is received. At 31 December 20X1, the asset has a tax base of nil and a carrying value (the value included in receivables in the statement of fi nancial position) of $5,000. At 31 December 20X1, a temporary difference of $5,000 occurs. A deferred tax provi- sion is required in respect of this difference of $1,500 ($5,000 at a rate of 30%).
4. Pension costs. In the year ended 30 June 20X3, an entity made provision for unfunded pension costs of $400,000. Tax relief on this item will be given when the retirement benefi ts are actually paid. The carrying value of the liability is $400,000 at 30 June 20X3; however, the tax base of the liability at that date is nil. It has no amount attrib- uted to it for tax purposes until the liability is settled (when the benefi ts are actually paid). This creates a deductible temporary difference at 30 June 20X3 and a deferred tax asset must be recognised in the accounts. Assuming a rate of 30%, the deferred tax asset of $120,000 would be included in the statement of fi nancial position.