Business Combination – Context of Ind AS 12

General

  • Generally, the identifiable assets acquired, and liabilities assumed in a business combination are recognised at their fair values at the acquisition date.
  • Temporary differences arise when the tax bases of the identifiable assets acquired, and liabilities assumed are not affected by the business combination or are affected differently.
  • For example, when the carrying amount of an asset is increased to fair value but the tax base of the asset remains at cost to the previous owner, a taxable temporary difference arises which results in a deferred tax liability.
  • In accordance with Ind AS 103, an entity should recognise any resulting deferred tax assets (to the extent that they meet the recognition criteria) or deferred tax liabilities as identifiable assets and liabilities at the acquisition date.
  • Consequently, those deferred tax assets and deferred tax liabilities affect the amount of goodwill or the bargain purchase gain the entity recognises. However, an entity does not recognise deferred tax liabilities arising from the initial recognition of goodwill.

Business Combination – example

  • For example, Company B merges with Company A wherein, Company A purchases net assets having carrying value of Rs. 1,000 crores (fair value Rs. 1,200 crores) for Rs. 1,500 crores.
  • Goodwill being the difference between the consideration paid and fair value was Rs. 300 crores (1,500 – 1,200 crores).
  • Company A recognizes Rs. 1,200 crores as new carrying values of the assets. Now, Company A will have to calculate deferred tax on the fair valued portion of Rs. 200 crores (1,200-1,000 crores), which is say 100 crores (assuming tax rate of 50%). These 100 crores will be added to goodwill and the total goodwill will be Rs. 400 crores (300 + 100 crores). The accounting entry would be:
Journal 1 1
  • As a result of a business combination, the probability of realising a pre-acquisition deferred tax asset of the acquirer could change. An acquirer may consider it probable that it will recover its own deferred tax asset that was not recognised before the business combination. F
  • or example, the acquirer may be able to utilize the benefit of its unused tax losses against the future taxable profit of the acquiree. Alternatively, as a result of the business combination it might no longer be probable that future taxable profit will allow the deferred tax asset to be recovered.
  • In such cases, the acquirer recognises a change in the deferred tax asset in the period of the business combination, but does not include it as part of the accounting for the business combination.
  • Therefore, the acquirer does not take it into account in measuring the goodwill or bargain purchase gain it recognises in the business combination.

Acquired deferred tax benefits

  • An entity shall recognise acquired deferred tax benefits that it realises after the business combination as follows:
  • Acquired deferred tax benefits recognised within the measurement period that result from new information about facts and circumstances that existed at the acquisition date shall be applied to reduce the carrying amount of any goodwill related to that acquisition.
  • All other acquired deferred tax benefits realised shall be recognised in profit or loss (or, if this Standard so requires, outside profit or loss).

Assets carried at fair value

  • Ind ASs permit or require certain assets to be carried at fair value or to be revalued (for example, Ind AS 16, Property, Plant and Equipment, Ind AS 38, Intangible Assets and Ind AS 109, Financial Instruments).
  • In some jurisdictions, the revaluation or other restatement of an asset to fair value affects taxable profit (tax loss) for the current period. As a result, the tax base of the asset is adjusted and no temporary difference arises.
  • In other jurisdictions, the revaluation or restatement of an asset does not affect taxable profit in the period of the revaluation or restatement and, consequently, the tax base of the asset is not adjusted. Nevertheless, the future recovery of the carrying amount will result in a taxable flow of economic benefits to the entity.
  • In such scenario, the amount that will be deductible for tax purposes will differ from the amount of those economic benefits. The difference between the carrying amount of a revalued asset and its tax base is a temporary difference and gives rise to a deferred tax liability or asset.
  • This is true even if:
  • the entity does not intend to dispose of the asset. In such cases, the revalued carrying amount of the asset will be recovered through use and this will generate taxable income which exceeds the depreciation that will be allowable for tax purposes in future periods; or
  • tax on capital gains is deferred if the proceeds of the disposal of the asset are invested in similar assets. In such cases, the tax will ultimately become payable on sale or use of the similar assets.
  • For example, Company A buys an asset worth Rs. 100 on April 1, 2020. The useful life of the asset is 5 years and the tax laws allow it to be depreciated over 4 years. One year later, on March 31, 2021, the Company revalues the asset to Rs. 120.
Working Journal 2 1
  • In the above case, the deferred tax liability created on revaluation on March 31, 2021, of Rs. 9 reverses in the subsequent periods. The accounting entry for the year 2021 would be:
Journal 2 1
  • Suppose on March 31, 2023, the Company decides to sell the asset at Rs. 70. In this case, there would be a gain of Rs. 10 as per the books of accounts. However, the tax books will show a gain of 45, thus offsetting the temporary difference of Rs. 35.
  • Ind AS 16 does not specify whether an entity should transfer each year from revaluation surplus to retained earnings an amount equal to the difference between the depreciation or amortisation on a revalued asset and the depreciation or amortisation based on the cost of that asset. If an entity makes such a transfer, the amount transferred is net of any related deferred tax. Similar considerations apply to transfers made on disposal of an item of property, plant or equipment.

Goodwill – Context of Ind AS 12

  • Many jurisdictions do not allow reductions in the carrying amount of goodwill as a deductible expense in determining taxable profit.
  • Moreover, in such jurisdictions, the cost of goodwill is often not deductible when a subsidiary disposes of its underlying business.
  • In such jurisdictions, goodwill has a tax base of nil.
  • Any difference between the carrying amount of goodwill and its tax base of nil is a taxable temporary difference.
  • However, Ind AS 12 does not permit the recognition of the resulting deferred tax liability because goodwill is measured as a residual and the recognition of the deferred tax liability would increase the carrying amount of goodwill.

Goodwill subsequent reductions

  • Subsequent reductions in a deferred tax liability that is unrecognised because it arises from the initial recognition of goodwill are also regarded as arising from the initial recognition of goodwill and are therefore not recognised.
  • For example, if in a business combination an entity recognises goodwill of Rs. 100 that has a tax base of nil, the Standard prohibits the entity from recognising the resulting deferred tax liability.
  • If the entity subsequently recognises an impairment loss of Rs. 20 for that goodwill, the resulting decrease in the value of the unrecognised deferred tax liability is also not recognised.

Goodwill – taxable temporary difference

  • Deferred tax liabilities for taxable temporary differences relating to goodwill are, however, recognised to the extent they do not arise from the initial recognition of goodwill.
  • For example, if in a business combination an entity recognises goodwill of Rs. 100 that is deductible for tax purposes at a rate of 20 per cent per year starting in the year of acquisition, the tax base of the goodwill is Rs. 100 on initial recognition and Rs. 80 at the end of the year of acquisition.
  • If the carrying amount of goodwill at the end of the year of acquisition remains unchanged at Rs. 100, a taxable temporary difference of Rs. 20 arises at the end of that year. Because that taxable temporary difference does not relate to the initial recognition of the goodwill, the resulting deferred tax liability is recognised.

Goodwill deferred tax asset

  • If the carrying amount of goodwill arising in a business combination is less than its tax base, the difference gives rise to a deferred tax asset.
  • The deferred tax asset arising from the initial recognition of goodwill shall be recognised as part of the accounting for a business combination to the extent that it is probable that taxable profit will be available against which the deductible temporary difference could be utilised.

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