International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

  7.4

  Restrictions on recognition of deferred tax assets

  There is an essential difference between deferred tax liabilities and deferred tax assets.

  An entity’s deferred tax liabilities will crystallise if the entity recovers its existing net

  assets at their carrying amount. However, in order to realise its net deferred tax assets

  in full, an entity must earn profits in excess of those represented by the carrying amount

  of its net assets in order to generate sufficient taxable profits against which the

  deductions represented by deferred tax assets can be offset. Accordingly IAS 12 restricts

  the recognition of deferred tax assets to the extent that it is probable that taxable profit

  will be available against which the underlying deductible temporary differences can be

  utilised. [IAS 12.27].

  7.4.1

  Restrictions imposed by relevant tax laws

  When an entity assesses whether a deductible temporary difference is capable of being

  utilised, it must consider whether tax law restricts the sources of taxable profits against

  which deductions for this type of temporary difference are permitted. If tax law imposes

  no such restrictions, an entity can assess a deductible temporary difference in

  combination with all its other deductible temporary differences. However, if tax law

  restricts the utilisation of losses to deduction against a specific type of income, the

  recovery of a deductible temporary difference is assessed in combination only with

  other deductible temporary differences of the appropriate type. [IAS 12.27A].

  7.4.2

  Sources of ‘probable’ taxable profit – taxable temporary differences

  Before considering forecasts of future taxable profits, an entity should look to the

  deferred tax liabilities it has already recognised at the reporting date as a source of

  probable taxable profits that would allow any deductible temporary differences to be

  utilised. IAS 12 states that it is ‘probable’ that there will be sufficient taxable profit if a

  deductible temporary difference can be offset against a taxable temporary difference

  (deferred tax liability) relating to the same tax authority and the same taxable entity

  which will reverse in the same period as the asset, or in a period into which a loss arising

  from the asset may be carried back or forward. In such circumstances, a deferred tax

  asset is recognised. [IAS 12.28].

  There is no need at this stage to estimate the future taxable profits of the entity. If there

  are sufficient taxable temporary differences to justify the recognition of a deferred tax

  asset for deductible temporary differences, then the asset is recognised. The only

  condition to apply, as noted at 7.4.1 above, is that any deferred tax liability used as the

  basis for recognising a deferred tax asset represents a future tax liability against which

  the deductible temporary difference can actually be offset under the relevant tax law.

  [IAS 12.27A]. For example, in a tax jurisdiction where revenue and capital items are

  treated separately for tax purposes, a deferred tax asset representing a capital loss

  cannot be recognised by reference to a deferred tax liability relating to tax allowances

  received on PP&E in advance of the related depreciation expense.

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  7.4.3

  Sources of ‘probable’ taxable profit – estimates of future taxable profits

  Estimates of future taxable profits are only required to justify the recoverability of those

  deductible temporary differences in excess of the amounts already ‘matched’ against

  deferred tax liabilities recognised at the reporting date in the manner described at 7.4.2

  above. Where there are insufficient taxable temporary differences relating to the same

  tax authority to offset deductible temporary differences, a deferred tax asset should be

  recognised to the extent that:

  • it is probable that in future periods there will be sufficient taxable profits:

  • relating to the same tax authority;

  • relating to the same taxable entity; and

  • arising in the same period as the reversal of the deductible temporary

  difference or in a period into which a loss arising from the deferred tax asset

  may be carried back or forward; or

  • tax planning opportunities are available that will create taxable profit in

  appropriate periods – see 7.4.4 below. [IAS 12.29].

  Where an entity has a history of recent losses it should also consider the guidance in

  IAS 12 for recognition of such losses (see 7.4.6 below). [IAS 12.31].

  7.4.3.A

  Ignore the origination of new future deductible temporary differences

  In assessing the availability of future taxable profits, an entity must ignore taxable

  amounts arising from deductible temporary differences expected to originate in future

  periods. This is because those new deductible differences will themselves require

  future taxable profit in order to be utilised. [IAS 12.29(a)(ii)].

  For example, suppose that in 2019 an entity charges £100 to profit or loss for which a tax

  deduction is not available until 2020, when the amount is settled. However, in 2020 a

  further £100 is expected to be charged to profit or loss, for which a deduction will be

  available in 2021, and so on for the foreseeable future. This will have the effect that,

  in 2019, the entity will pay tax on the £100 for which no deduction is made on the 2019

  tax return. In the tax return for 2020, there will be a deduction for that £100, but this will

  be offset by the add-back in the same tax return for the equivalent £100 charged for

  accounting purposes in 2020. If this cycle of ‘£100 deduction less £100 add-back’ is

  expected to be perpetuated in each tax return for the foreseeable future, there is never

  any real recovery of the tax paid on the £100 in 2019 and, in the absence of any other

  taxable profits, no deferred tax asset would be recognised.

  7.4.3.B

  Ignore the reversal of existing deductible temporary differences

  In 2016, the IASB added text to the standard to clarify that the estimate of probable

  future taxable profit should exclude the tax deductions resulting from the reversal of

  the deductible temporary differences that are themselves being assessed for recognition

  as an asset. [IAS 12.29(a)(i)]. This amendment was made following the IASB’s deliberations

  on the recognition of deferred tax assets for unrealised losses, as discussed at 7.4.5

  below. The effect of the amendment is to clarify that the measure of taxable profit used

  for assessing the utilisation of deductible temporary differences is different from the

  taxable profit on which income taxes are payable. [IAS 12.BC56].

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  The former is calculated before any allowances or deductions arising from the reversal of

  deductible temporary differences. The latter is the amount determined after the application

  of all applicable tax laws that gives rise to an entity’s liability to pay income tax. [IAS 12.5].

  7.4.4

  Tax planning opportunities and the recognition of deferred tax assets

  ‘Tax planning opportunities’ are actions that the entity would take in order to create or

  increase taxable income in a particular period before the expiry of a tax loss or tax

  cre
dit carryforward. IAS 12 notes that, in some jurisdictions, taxable profit may be

  created or increased by:

  • electing to have interest income taxed on either a received or receivable basis;

  • deferring the claim for certain deductions from taxable profit;

  • selling, and perhaps leasing back, assets that have appreciated but for which the

  tax base has not been adjusted to reflect such appreciation; and

  • selling an asset that generates non-taxable income (such as, in some jurisdictions,

  a government bond) in order to purchase another investment that generates

  taxable income.

  Where tax planning opportunities advance taxable profit from a later period to an

  earlier period, the utilisation of a tax loss or tax credit carryforward still depends on the

  existence of future taxable profit from sources other than future originating temporary

  differences. [IAS 12.30].

  The requirement to have regard to future tax planning opportunities applies only to the

  measurement of deferred tax assets. It does not apply to the measurement of deferred

  tax liabilities. Thus, for example, it would not be open to an entity subject to tax at 30%

  to argue that it should provide for deferred tax liabilities at some lower rate on the

  grounds that it intends to invest in assets attracting investment tax credits that will allow

  it to pay tax at that lower rate (see 8.4.1 below).

  IAS 12 describes tax planning opportunities as actions that the entity ‘would’ take – not

  those it ‘could’ take. In other words, they are restricted to future courses of action that

  the entity would actually undertake to realise such a deferred tax asset, and do not

  include actions that are theoretically possible but practically implausible, such as the

  sale of an asset essential to the ongoing operations of the entity. Only if such actions are

  both capable of being taken and are intended to be taken by the entity can it be said

  that the resulting tax planning would give rise to a ‘probable’ future taxable profit.

  Implementation of a tax planning opportunity may well entail significant direct costs or

  the loss of other tax benefits or both. Accordingly, any deferred tax asset recognised on

  the basis of a tax planning opportunity must be reduced by any cost of implementing

  that opportunity (measured, where applicable, on an after-tax basis).

  Moreover, IAS 12 regards tax planning opportunities as a component of future net

  taxable profits. Thus, where a tax planning opportunity exists, but the entity is expected

  to remain loss-making (such that the opportunity effectively will simply reduce future

  tax losses), we believe that such an opportunity does not generally form the basis for

  recognising a deferred tax asset, except to the extent that it will create net future taxable

  profits (see also 7.4.6 below).

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  7.4.5

  Unrealised losses on debt securities measured at fair value

  In January 2016, the IASB issued Recognition of Deferred Tax Assets for Unrealised

  Losses (Amendments to IAS 12). These amendments concluded deliberations started by

  the Interpretations Committee in May 2010 on the recognition of deferred tax assets for

  unrealised losses, for example on debt instruments measured at fair value. [IAS 12.BC1A].

  The Committee had been asked to provide guidance on how an entity determines whether

  to recognise a deferred tax asset under IAS 12 in the following circumstances: [IAS 12.BC37]

  (a) the entity has a debt instrument measured at fair value under IAS 39 and changes

  in market interest rates result in a decrease in the fair value of the debt instrument

  below its cost;

  (b) it is probable that the issuer of the debt instrument will make all the contractual

  payments;

  (c) the tax base of the debt instrument is its cost;

  (d) tax law does not allow a loss to be deducted on a debt instrument until the loss is

  realised for tax purposes;

  (e) the entity has the ability and intention to hold the debt instrument until the

  unrealised loss reverses (which may be at its maturity);

  (f) tax law distinguishes between capital gains and losses and ordinary income tax

  losses. While capital losses can only be offset against capital gains, ordinary losses

  can be offset against both capital gains and ordinary income; and

  (g) the entity has insufficient taxable temporary differences and no other probable taxable

  profits against which the entity can utilise those deductible temporary differences.

  The Interpretations Committee had identified diversity in practice because of

  uncertainty about the application of some of the principles in IAS 12, in particular in

  relation to the following:

  (a) The existence of a deductible temporary difference, when there are no tax

  consequences to the recovery of the principal on maturity; the holder of the debt

  instrument expects to hold it to maturity; and it is probable that the issuer will pay

  all the contractual cash flows. [IAS 12.BC38, BC39].

  (b) Whether it is appropriate for an entity to determine deductible temporary

  differences and taxable temporary differences on the basis of the asset’s carrying

  amount when at the same time it assumes that the asset is recovered for more than

  its carrying amount for the purposes of estimating probable future taxable profit

  against which deductible temporary differences are assessed for utilisation. This

  question is relevant when taxable profit from other sources is insufficient for the

  utilisation of the deductible temporary differences arising when the asset is

  measured at fair value. [IAS 12.BC38, BC47].

  (c) Whether the estimate of probable future taxable profit should include or exclude

  the effects of reversing the deductible temporary differences that are being

  assessed for recognition as an asset. [IAS 12.BC38, BC55].

  (d) The basis for assessing the recoverability of deductible temporary differences, i.e.

  for each deductible temporary difference separately, or in combination with other

  deductible temporary differences. This question is relevant, for example, when tax

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  law distinguishes capital gains and losses from other taxable gains and losses and

  capital losses can only be offset against capital gains. [IAS 12.BC38, BC57].

  Whilst the amendments to IAS 12 were framed around the above example of a fixed-rate

  debt instrument measured at fair value, the Board noted that the principle on which the

  amendments are based is not limited to any specific type or class of assets. [IAS 12.BC52].

  However, as noted at 7.4.5.B below, the IASB acknowledged the concerns raised by

  respondents that the amendments could be applied too broadly and highlighted the need

  for particular caution where assets are measured at fair value. In response to that concern,

  the Board noted that entities will need to have sufficient evidence on which to base their

  estimate of probable future taxable profit, including when that estimate involves the

  recovery of an asset for more than its carrying amount. [IAS 12.BC53].

  7.4.5.A

  The existence of a deductible temporary difference

  Because, in the case of many debt instruments, the collection of the principal on

  maturity does not give rise to a
ny liability for tax, some believed that the collection of

  the principal is a non-taxable event. Consequently, proponents of this view argued that

  a deductible temporary difference cannot exist when an entity asserts that the

  contractual payments will be received, because any difference between the debt

  instrument’s carrying amount and its higher tax base results from a loss that the entity

  expects never to realise for tax purposes. [IAS 12.BC40].

  The IASB rejected this argument. IAS 12 already states that a deductible temporary

  difference arises if the tax base of an asset exceeds its carrying amount. [IAS 12.20, 26(d)].

  The calculation of a temporary difference is based on the premise that the carrying

  amount of the asset will be recovered. [IAS 12.5]. The calculation of the temporary

  difference is not affected by possible future changes in the carrying amount of the asset.

  The Board considered that the economic benefit embodied in the related deferred tax

  asset results from the ability of the holder of the debt instrument to achieve future

  taxable gains in the amount of the deductible temporary difference without paying tax

  on those gains. This is the case where a previous impairment reverses, such that the

  entity recovers the original principal on the debt instrument. [IAS 12.BC42-44].

  Accordingly, the amendments add an example after paragraph 26 of IAS 12 to illustrate

  how a deductible temporary difference exists under paragraph 26(d).

  Example 29.21: Deductible temporary difference when the asset is valued below cost

  At the beginning of Year 1, Entity A purchases for $1,000 a debt instrument with a nominal value of $1,000

  payable at the end of Year 5 and with an interest rate of 2% payable at the end of each year. The effective

  interest rate is determined to be 2% and the debt instrument is measured at fair value.

  At the end of year 2, market interest rates have increased to 5%, causing the fair value of the debt instrument

  to decrease to $918. It is probable that Entity A will collect all the contractual cash flows if it continues to

  hold the debt instrument.

  Any gains or losses on the debt instrument are taxable or deductible only when realised. Gains or losses arising on

  the sale or maturity of the instrument are calculated for tax purposes as the difference between the amount collected

  and the original cost of the debt instrument. Accordingly, the tax base of the debt instrument is its original cost.