ICAEW REPRESENTATION 169/14

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ICAEW REPRESENTATION

169/14

RECOGNITION OF DEFERRED TAX ASSETS FOR UNREALISED LOSSES

ICAEW welcomes the opportunity to comment on the exposure draft (ED), Recognition of Deferred Tax Assets for Unrealised Losses: Proposed Amendments to IAS 12, published by the

International Accounting Standards Board (IASB) on 20 August 2014, a copy of which is available from this link.

This response of 18 December 2014 has been prepared on behalf of ICAEW by the Financial Reporting Faculty. Recognised internationally as a leading authority on financial reporting, the Faculty, through its Financial Reporting Committee, is responsible for formulating ICAEW policy on financial reporting issues and makes submissions to standard setters and other external bodies on behalf of ICAEW. The Faculty provides an extensive range of services to its members including providing practical assistance with common financial reporting problems.

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ICAEW members operate across a wide range of areas in business, practice and the public sector. They provide financial expertise and guidance based on the highest professional, technical and ethical standards. They are trained to provide clarity and apply rigour, and so help create long-term sustainable economic value.

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ICAEW representation 169/14 Recognition of deferred tax assets for unrealised losses

MAJOR POINTS

Support for the initiative

1. We welcome the IASB’s initiative in proposing amendments to deal with uncertainties that

have arisen in applying IAS 12, Income Taxes, to the possible recognition of deferred tax assets for certain types of unrealised losses. In general, we support the proposed

amendments, which we believe correctly apply the principles of IAS 12 to the issues that have arisen, but have some significant concerns about the drafting of the proposed amendments and how far they will be understood. We make suggestions in our responses to specific questions as to how these problems should be addressed.

RESPONSES TO SPECIFIC QUESTIONS

Existence of a deductible temporary difference

Q1 The IASB proposes to confirm that decreases in the carrying amount of a fixed-rate debt instrument for which the principal is paid on maturity give rise to a deductible temporary difference if this debt instrument is measured at fair value and if its tax base remains at cost. This applies irrespective of whether the debt instrument’s holder expects to recover the carrying amount of the debt instrument by sale or by use, ie by holding it to maturity, or whether it is probable that the issuer will pay all the contractual cash flows.

Do you agree with the proposed amendment? Why or why not? If not, what alternative do you propose?

2. We agree with the objective of the proposed amendment, which in our view is consistent with the principles in IAS 12, but are doubtful whether the proposed new example illustrating paragraph 26(d) is worded clearly enough so as to avoid continuing uncertainty of interpretation.

3. The example is intended to address the question, identified in the Introduction to the ED, whether a deductible temporary difference can arise on a fair valued fixed-rate debt instrument if the instrument’s holder expects to recover the carrying amount of the asset by holding it to maturity and if it is probable that the issuer will pay all the contractual cash flows. It is stated at the top of the second page of the example that whether the debt instrument will be held to maturity is irrelevant to whether a deductible temporary difference arises. But it is also stated at the end of paragraph 2 of the example that ‘It is probable that Entity A will receive all the contractual cash flows if it holds the debt instrument until maturity’, which gives the impression that this is relevant information. Perhaps this sentence should be omitted or it should be added at this point that the information is irrelevant, as discussed in paragraph BC6 of the ED.

Recovering an asset for more than its carrying amount

Q2 The IASB proposes to clarify the extent to which an entity’s estimate of future taxable profit (paragraph 29) includes amounts from recovering assets for more than their carrying amounts.

4. We agree with the intention of the proposed amendment, which in our view is consistent with the principles in IAS 12, but we consider that the wording of new paragraph 29A needs to be improved. One problem with the proposed wording is that it refers to ‘recovery of an asset for more than its carrying amount’ (and similar wording). The meaning of ‘recovery of an asset’ is unclear. Elsewhere, IAS 12 refers to ‘recovery of the carrying amount’ (rather than ‘recovery of the asset’), which is well understood, and we suggest that similar wording should be used in the new paragraph 29A.

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should assume in relation to recovery of the carrying amounts of particular assets when estimating probable future taxable profits against which deductible temporary differences are assessed for utilisation. However, while it is therefore understandable that new paragraph 29A should refer to recoverable amount assessments relating to particular assets, in our

experience companies generally do not estimate future taxable profits asset by asset. As a result, it is possible that the new paragraph will appear irrelevant to most companies. Indeed, it may well appear relevant only to those whose misunderstanding of IAS 12 is based on an asset-by-asset approach. It would therefore be useful to clarify that an asset-by-asset approach to estimating future taxable profits is not required.

6. We suggest that the wording of the penultimate sentence of the example illustrating paragraph 26(d) should be changed. At the moment, it says that ‘Tax law is based on the principle that gains and losses arising on the sale of or on maturity of the debt instruments are determined as the difference between the inflow of economic benefits and the tax base.’ This is stated as a universal rule, but it is not clear what the evidence is for such a definitive statement.

Probable future taxable profit against which deductible temporary differences are assessed for utilisation

Q3 The IASB proposes to clarify that an entity’s estimate of future taxable profit (paragraph 29) excludes tax deductions resulting from the reversal of deductible temporary differences. Do you agree with the proposed amendment? Why or why not? If not, what alternative do you propose?

7. We broadly agree with the proposed amendment, which in our view is consistent with the principles in the existing IAS 12, but we have some concerns about the precise wording proposed, and we believe that the meaning of the amendment may not always be understood unless it is accompanied by a clearly explained example, which forms part of the standard. We acknowledge that examples are not usually included in standards, but the IASB is proposing to include an example to explain paragraph 26(d), and the case for including an example that explains the amended paragraph 29 seems to us to be just as strong. While it may not be necessary to include the whole of the new Example 7 in the standard, we believe that the standard should at least include an example clearly explaining how the ‘Adjusted taxable profit (tax loss) for assessing utilisation of deductible temporary differences’ is arrived at. This could cross-refer to the full Example 7, which would be, as envisaged in the ED, an illustrative example outside the standard.

8. Our concern about the wording of the proposed paragraph 29(a)(i) relates to the use of ‘taxable profit’, which, bearing in mind the example provided, we are not sure is being used in the same way as defined at paragraph 5 of the standard, ie, ‘the profit (loss) for a period … upon which income taxes are payable (recoverable)’. The proposed wording of paragraph 29(a)(i) refers to ‘taxable profit that excludes tax deductions resulting from the reversal of …

deductible temporary differences’ (emphasis added). This seems to imply that deductible temporary differences would otherwise be included in taxable profit, which would not

necessarily be the case. Including in the standard a simplified version of the new Example 7, as suggested above, could serve to illustrate the two apparently different uses of the term ‘taxable profit’. We return to this point at paragraph 11 below.

Combined versus separate assessment

Q4 The IASB proposes to clarify that an entity assesses whether to recognise the tax effect of a deductible temporary difference as a deferred tax asset in combination with other deferred tax assets. If tax law restricts the utilisation of tax losses so that an entity can only deduct tax losses against income of a specified type or specified types (eg if it can deduct capital losses only against capital gains), the entity must still assess a deferred tax asset in combination with other deferred tax assets, but only with deferred tax assets of the

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ICAEW representation 169/14 Recognition of deferred tax assets for unrealised losses

9. We agree in principle with the proposed amendment, but the proposed wording for new paragraph 27A might usefully specify some of the different ways in which tax law can restrict the utilisation of losses to income of a specific type. To do this, a new sentence along the following lines could be added after the first sentence of paragraph 27A: ‘It might, for example, restrict relief to taxable profits arising in the same jurisdiction, in the same entity or from the same activity.’

Transition

Q5 The IASB proposes to require limited retrospective application of the proposed

amendments for entities already applying IFRS. This is so that restatements of the opening retained earnings or other components of equity of the earliest comparative period

presented should be allowed but not be required. Full retrospective application would be required for first-time adopters of IFRS.

10. We agree with the proposed amendment, which we believe avoids imposing unduly onerous transition arrangements.

OTHER POINTS

Definitions

11. We have questioned whether the term ‘taxable profit’ is being used in a consistent way in the

proposed amendments and the existing definition at paragraph 5 of the standard. This may indicate a need to change either the proposed amendments or the definition at paragraph 5. It may also be sensible to review the examples included in the definitions of ‘tax base’ at

paragraphs 7 and 8 of the standard, given that the ED’s proposed amendments would clarify the meaning of ‘tax base’ where there are unrealised losses. It would be useful, for instance, to amplify the information given for example 5 at paragraph 7 and to supplement it with an

example of a loan where, although the payment of the loan will have no tax consequences, the carrying amount and the tax base are not the same.

Assets carried at fair value

12. We also suggest that paragraph 20 of the standard, ‘Assets carried at fair value’, should be

reviewed, as it ought to tie in more clearly with the rest of the standard as amended. For example, the wording at 20(a) appears to be intended to apply to depreciation in the context of plant and equipment. It would be helpful to add some wording that would also be applicable to financial instruments.