Ind AS 12 – Income Taxes – Introduction
Balance sheet approach
- Ind AS 12, as the name suggests, prescribes the accounting treatment for income taxes. Under the accounting standards, the relevant corresponding standard is AS 22 Taxes on Income.
- AS 22 required entities to account for deferred taxes using the income statement approach. Ind AS 12, on the other hand, requires the balance sheet approach to be followed for accounting for income taxes.
- The income statement approach focuses on timing differences, whereas the balance sheet approach focuses on temporary differences.
- Timing differences are differences between taxable profit and accounting profit that originate in one period and reverse in one or more subsequent periods.
- Temporary differences are differences between the tax base of an asset or liability and its carrying amount in the statement of financial position.
- The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. All timing differences are temporary differences.
Accounting challenges
- The principal issue in accounting for income taxes is how to account for the current and future tax consequences of:
- the future recovery (settlement) of the carrying amount of assets (liabilities) that are recognised in an entity’s statement of financial position; and
- transactions and other events of the current period that are recognized in an entity’s financial statements.
- It is inherent in the recognition of an asset or liability that the reporting entity expects to recover or settle the carrying amount of that asset or liability.
- If it is probable that recovery or settlement of that carrying amount will result in future tax payments/ (exemptions), this Standard requires an entity to recognize a deferred tax liability (deferred tax asset), with certain limited exceptions.
- An entity should account for the tax consequences of transactions and other events in the same way that it accounts for the transactions and other events themselves.
- Thus, for transactions and other events recognised in profit or loss, any related tax effects are also recognised in profit or loss. For transactions and other events recognised outside profit or loss (either in other comprehensive income or directly in equity), any related tax effects are also recognised outside profit or loss (either in other comprehensive income or directly in equity, respectively).
- Similarly, the recognition of deferred tax assets and liabilities in a business combination affects the amount of goodwill arising in that business combination or the amount of the bargain purchase gain recognized.
Scope
- For the purposes of this Standard, income taxes include all domestic and foreign taxes which are based on taxable profits.
- Income taxes also include taxes, such as withholding taxes, which are payable by a subsidiary, associate or joint arrangement on distributions to the reporting entity.
Key Concepts of Ind AS 12
Temporary differences
- Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. Temporary differences may be either:
- taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or
- deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.
Tax base
- The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.
- In simple terms, the numbers appearing in a tax balance sheet (assuming one is prepared based on tax laws of relevant country/ies) is termed as ‘tax base’.
- This tax base will be compared with the carrying amount of assets and liabilities in the books of accounts.
- Deferred tax will be calculated on the difference so calculated.
Example
- For example – if a provision for an expense is allowed on cash basis under tax laws, no expense would have been booked on accrual basis for tax purposes. Hence, no corresponding liability would exist as per tax books i.e. tax base is nil.
- On the other hand, a provision for the expense will be accounted for in the books of accounts.
- The difference in carrying amount of the provision/ liability is regarded as a temporary difference under the balance sheet approach.
- Since this will be deductible for tax purpose in future, it will be classified as a deductible temporary difference.
- Deductible temporary difference multiplied by the applicable tax rate would result in deferred tax asset.
Carrying amount
- Tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.
Examples of tax base
- A machine cost 100. For tax purposes, depreciation of 30 has already been deducted in the current and prior periods and the remaining cost will be deductible in future periods, either as depreciation or through a deduction on disposal. Revenue generated by using the machine is taxable, any gain on disposal of the machine will be taxable and any loss on disposal will be deductible for tax purposes. The tax base of the machine is 70.
- Interest receivable has a carrying amount of 100. The related interest revenue will be taxed on a cash basis. The tax base of the interest receivable is nil.
- Trade receivables have a carrying amount of 100. The related revenue has already been included in taxable profit (tax loss). The tax base of the trade receivables is 100.
- Dividends receivable from a subsidiary of 100. The dividends are not taxable. In substance, the entire carrying amount of the asset is deductible against the economic benefits. Consequently, the tax base of the dividends receivable is 100. (Note: If the economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.) Under this analysis, there is no taxable temporary difference. An alternative analysis is that the accrued dividends receivable have a tax base of nil and that a tax rate of nil is applied to the resulting taxable temporary difference of 100. Under both analyses, there is no deferred tax liability.
- A loan receivable has a carrying amount of 100. The repayment of the loan will have no tax consequences. The tax base of the loan is 100.
Tax base of a liability
- The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue, which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods.
Examples
- Current liabilities include accrued expenses with a carrying amount of 100. The related expense will be deducted for tax purposes on a cash basis. The tax base of the accrued expenses is nil.
- Current liabilities include interest revenue received in advance, with a carrying amount of 100. The related interest revenue was taxed on a cash basis. The tax base of the interest received in advance is nil.
- Current liabilities include accrued expenses with a carrying amount of 100. The related expense has already been deducted for tax purposes. The tax base of the accrued expenses is 100.
- Current liabilities include accrued fines and penalties with a carrying amount of 100. Fines and penalties are not deductible for tax purposes. The tax base of the accrued fines and penalties is 100. Under this analysis, there is no deductible temporary difference. An alternative analysis is that the accrued fines and penalties payable have a tax base of nil and that a tax rate of nil is applied to the resulting deductible temporary difference of 100. Under both analyses, there is no deferred tax asset.
- A loan payable has a carrying amount of 100. The repayment of the loan will have no tax consequences. The tax base of the loan is 100.
Items not recognised as assets and liabilities
- Some items have a tax base but are not recognised as assets and liabilities in the statement of financial position.
- For example, research costs are recognised as an expense in determining accounting profit in the period in which they are incurred but may not be permitted as a deduction in determining taxable profit (tax loss) until a later period.
- The difference between the tax base of the research costs, being the amount the taxation authorities will permit as a deduction in future periods, and the carrying amount of nil is a deductible temporary difference that results in a deferred tax asset.
- In consolidated financial statements, temporary differences are determined by comparing the carrying amounts of assets and liabilities in the consolidated financial statements with the appropriate tax base.
- The tax base is determined by reference to a consolidated tax return in those jurisdictions in which such a return is filed. In other jurisdictions, the tax base is determined by reference to the tax returns of each entity in the group.
