International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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a whole is not impaired, and indeed its fair value at 31 December 2019 is €660 million.
If, in its separate financial statements, H accounts for its investment at cost of
€600 million, there would be no temporary difference associated with S in H’s separate
financial statements, since the carrying amount and tax base of S would both be
€600 million.
If, however, in its separate financial statements, H accounts for its investment at its fair
value of €660 million, there would be a taxable temporary difference of €60 million
(carrying amount €660m less tax base €600m) associated with S in H’s separate
financial statements. Whether or not any deferred tax is required to be provided for on
this difference is determined in accordance with the principles discussed at 7.5.2 and
at 7.5.3 below. Any tax provided for would be allocated to profit or loss, other
comprehensive income or equity in accordance with the general provisions of IAS 12
(see 10 below). Irrespective of whether provision is made for deferred tax, H would be
required to make disclosures in respect of this difference (see 14.2.2 below).
IAS 27 also allows entities to use the equity method as described in IAS 28 –
Investments in Associates and Joint Ventures – to account for investments in
subsidiaries, joint ventures and associates in their separate financial statements.
[IAS 27.10(c)]. Where the equity method is used, dividends from those investments are to
be recognised as a reduction from the carrying value of the investment. [IAS 27.12].
The same principles apply as those discussed above. Any difference between the carrying
value of the entity’s interest in its subsidiaries, joint ventures and associates, in this case
determined using the equity method, and the tax base in the investor’s jurisdiction gives rise
to a temporary difference. Whether or not any deferred tax is required to be recognised on
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this difference is determined in accordance with the principles discussed at 7.5.2 below.
Any tax provided for would be allocated to profit or loss, other comprehensive income or
equity in accordance with the general provisions of IAS 12 (see 10 below).
7.5.2
Taxable temporary differences
IAS 12 requires a deferred tax liability to be recognised for all taxable temporary
differences associated with investments (both domestic and foreign) in subsidiaries,
branches and associates or interests in joint arrangements, unless:
(a) the parent, investor joint venturer or joint operator is able to control the timing of
the reversal of the temporary difference; and
(b) it is probable that the temporary difference will not reverse in the foreseeable
future. [IAS 12.39].
IAS 12 does not currently define the meaning of ‘probable’ in this context. However, we
consider that, as in other IFRSs, it should be taken to mean ‘more likely than not’. IAS 12
also does not elaborate on the meaning of ‘foreseeable’. In our view, the period used
will be a matter of judgement in individual circumstances.
What this means in practice is best illustrated by reference to its application to the
retained earnings of subsidiaries, branches and joint arrangements on the one hand, and
those of associates on the other.
In the case of a subsidiary or a branch, the parent is able to control when and whether
the retained earnings are distributed. Therefore, no provision need be made for the tax
consequences of distribution of profits that the parent has determined will not be
distributed in the foreseeable future. [IAS 12.40]. In the case of a joint arrangement,
provided that the joint venturer or joint operator can control the distribution policy,
similar considerations apply. [IAS 12.43].
In the case of an associate, however, the investor cannot control the distribution policy.
Therefore provision should be made for the tax consequences of the distribution of the
retained earnings of an associate, except to the extent that there is a shareholders’
agreement that those earnings will not be distributed.
Some might consider this a counter-intuitive result. In reality, it is extremely unusual
for any entity (other than one set up for a specific project) to pursue a policy of full
distribution. To the extent that it occurs at all, it is much more likely in a wholly-owned
subsidiary than in an associate; and yet IAS 12 effectively treats full distribution by
associates as the norm and that by subsidiaries as the exception. Moreover, it seems to
ignore the fact that equity accounting was developed as a regulatory response to the
perceived ability of investors in associates to exert some degree of control over the
amount and timing of dividends from them.
In some jurisdictions, some or all of the temporary differences associated with such
investments in subsidiaries, branches and associates or interests in joint arrangements
are taxed on disposal of that investment or interest. Clearly, where the entity is
contemplating such a disposal, it would no longer be able to assert that it is probable
that the relevant temporary difference will not reverse in the foreseeable future.
The measurement of any deferred tax liability recognised is discussed at 8.4.9 below.
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7.5.3
Deductible temporary differences
IAS 12 requires a deferred tax asset to be recognised for all deductible temporary
differences associated with investments in subsidiaries, branches and associates or
interests in joint arrangements, only to the extent that it is probable that:
(a) the temporary difference will reverse in the foreseeable future; and
(b) taxable profit will be available against which the temporary difference can be
utilised. [IAS 12.44].
IAS 12 does not define the meaning of ‘probable’ in this context. However, we consider
that, as in other IFRS, it should be taken to mean ‘more likely than not’.
The guidance discussed at 7.4 above is used to determine whether or not a deferred tax
asset can be recognised for such deductible temporary differences. [IAS 12.45].
Any analysis of whether a deductible temporary difference gives rise to an asset must
presumably make the same distinction between controlled and non-controlled entities
as is required when assessing whether a taxable temporary difference gives rise to a
liability (see 7.5.2 above). This may mean, in practical terms, that it is never possible to
recognise a deferred tax asset in respect of a non-controlled investment (such as an
associate), unless either the investee entity is committed to a course of action that would
realise the asset or, where the asset can be realised by disposal, that it is probable that
the reporting entity will undertake such a disposal.
The measurement of any deferred tax asset recognised is discussed at 8.4.9 below.
7.5.4
Anticipated intragroup dividends in future periods
Under IAS 10, a dividend may be recognised as a liability of the paying entity and
revenue of the receiving entity only when it has been declared by the paying entity.
This raises the question of when a reporting entity should account for the tax
consequences of a dividend expected to be paid by a subsid
iary out of its retained
profits as at the reporting date.
7.5.4.A
Consolidated financial statements of receiving entity
In our view, IAS 12 requires the group to make provision for the taxes payable on the
retained profits of the group as at each reporting date based on the best evidence
available to it at the reporting date. In other words, if in preparing its financial
statements for 31 December 2019, an entity believes that, in order to meet the dividend
expectations of its shareholders in 2020 and 2021, it will have to cause the retained
earnings of certain overseas subsidiaries (as included in the group accounts at
31 December 2019) to be distributed, the group should provide for any tax
consequences of such distributions in its consolidated financial statements for the
period ended 31 December 2019.
It is not relevant that such dividends have not yet been recognised in the separate
financial statements of the relevant members of the group. Indeed, such intragroup
dividends will never be recognised in the group financial statements, as they will be
eliminated on consolidation. What IAS 12 requires is a best estimate of the taxes
ultimately payable on the net assets of the group as at 31 December 2019. However, for
this reason it would not be appropriate to recognise any liability for the tax anticipated
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to be paid out of an intragroup dividend in a future period that is likely to be covered
by profits made in future periods, since such profits do not form part of the net assets
of the group as at 31 December 2019.
7.5.4.B
Separate financial statements of paying entity
Irrespective of whether a provision is made in the consolidated financial statements for
the tax effects of an expected future intragroup dividend of the retained earnings of a
subsidiary, the paying subsidiary would not recognise a liability for the tax effects of
any distribution in its individual or separate financial statements until the liability to pay
the dividend was recognised in those individual or separate financial statements.
7.5.5
Unpaid intragroup interest, royalties, management charges etc.
It is common for groups of companies to access the earnings of subsidiaries not only through
distribution by way of dividend, but also by levying charges on subsidiaries such as interest,
royalties or general management charges for central corporate services. In practice, such
charges are often not settled but left outstanding on the intercompany account between the
subsidiary and the parent. In some jurisdictions such income is taxed only on receipt.
This has led some to argue that, where settlement of such balances is within the control
of the reporting entity, and it can be demonstrated that there is no foreseeable intention
or need to settle such balances, such balances are economically equivalent to unremitted
earnings, so that there is no need to provide for the tax consequences of settlement.
In February 2003 the Interpretations Committee considered the issue and indicated
that it believes that the exemption from provision for deferred taxes on ‘outside’
temporary differences arising from subsidiaries, branches, associates and interests in
joint arrangements is intended to address the temporary differences arising from the
undistributed earnings of such entities. The exception does not apply to the ‘inside’
temporary differences that exist between the carrying amount and the tax base of
individual assets and liabilities within the subsidiary, branch, associate or interest in a
joint arrangement. Accordingly, the Interpretations Committee concluded that a
deferred tax liability should be provided for the tax consequences of settling unpaid
intragroup charges.19
7.5.6
Other overseas income taxed only on remittance
In May 2007 the Interpretations Committee considered the more general issue of
whether deferred taxes should be recognised in respect of temporary differences
arising because foreign income is not taxable unless it is remitted to the entity’s
home jurisdiction.
The Interpretations Committee resolved not to add this issue to its agenda, but to draw
it to the attention of the IASB. This decision reflected the status of the IASB’s project
on income taxes at that time – particularly the Board’s decision to eliminate the notion
of a ‘branch’.20
7.6 ‘Tax-transparent’
(‘flow-through’) entities
In many tax jurisdictions certain entities are not taxed in their own right. Instead the income
of such entities is taxed in the hands of their owners as if it were income of the owners.
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An example might be a partnership which does not itself pay tax, but whose partners each
pay tax on their share of the partnership’s profits. Such entities are sometimes referred to
as ‘tax-transparent’ or ‘flow-through’ entities.
The tax status of such an entity is of no particular relevance to the accounting treatment,
in the investor’s financial statements, of the current tax on the income of the entity. An
investor in such an entity will determine whether the entity is a subsidiary, associate, joint
arrangement, branch or a financial asset investment and account for it accordingly. The
investor then accounts for its own current tax payable as it arises in the normal way.
The investor will also determine whether the basis on which the investment has been
accounted for (e.g. through consolidation or equity accounting) has led to the
recognition of assets or liabilities which give rise to temporary differences and
recognise deferred tax on these in the normal way.
Finally, the investor will also determine whether there are ‘outside’ temporary
differences associated with the investment as a whole and account for these as above.
Examples 29.24 and 29.25 illustrate the accounting treatment for, respectively, a
consolidated and an equity-accounted tax-transparent entity.
Example 29.24: Tax-transparent entity (consolidated)
An entity (A) acquires 60% of a tax-transparent partnership (P) for $100 million in a transaction accounted
for as a business combination. The aggregate fair value of the identifiable net assets of the partnership is
$80 million and their tax base is $60m. A is directly liable to tax at 25% on 60% of the taxable profits of the
partnership, in computing which it is entitled to offset 60% of the tax base of the assets. A elects to measure
the non-controlling interest at its proportionate share of the net assets of the partnership.
The accounting entry to record the business combination is:
$m
$m
Net assets
80
Goodwill (balancing figure)
55
Consideration paid
100
Deferred tax* 3
Non-controlling interest† 32
*
In recovering the carrying value of the net assets ($80m), A will pay tax on 60% of $20m ($80m
– $60m) = $12m at 25% = $3m.
† 40%
of
$80m.
By contrast, if the partnership were a tax-paying entity, the accounting entry would be:
$m
$m
Net assets
80
Goodwill (balancing figure)
55
Consideration paid
100
Deferred tax*
5
Non-controlling interest†
30
*
In recovering the carrying value of the net assets ($80m), P will pay tax on $20m ($80m – $60m)
at 25% = $5m.
†
40% of $75m (net assets excluding deferred tax $80m less deferred tax (as above) $5m).
Example 29.25: Tax-transparent entity (equity-accounted)
The facts are the same as in Example 29.24 above, except that, due to an agreement between A and the
other partners, P is a jointly-controlled entity, rather than a subsidiary, of A, which accounts for P using
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the equity method. In this case it is less clear how to account for the deferred tax liability, which, it must
be remembered, is not a liability of P, but of A and therefore does not form part of the net assets and
goodwill underlying A’s investment in P.
One analysis might be that the deferred tax relates to a temporary difference arising on the initial recognition of the
investment in P in a transaction that gives rise to no accounting or taxable profit, and therefore is not recognised
under the initial recognition exception (see 7.2.3 above). On this view, the initial accounting entry is simply:
$m
$m
Investment in P
100
Consideration 100
Another analysis might be that the true cost of the investment in P comprises both the consideration paid to
the vendor and the assumption by A of the deferred tax liability associated with its share of the underlying
assets (other than goodwill) of the investment. On this view the initial accounting entry is:
$m
$m
Investment in P
103
Deferred tax (see Example 29.24 above)
3
Consideration 100
This second method has the merit that it results in the same implied underlying goodwill as arises on full
consolidation in Example 29.24 above: $103m – $48m [60% of $80m] = $55m. However, it does raise the
issue of an apparent ‘day one’ impairment, as discussed in more detail at 12.3 below.