Initial recognition of an asset or liability – Ind AS 12
Table Of Contents
General
- A temporary difference may arise on initial recognition of an asset or liability, for example if part or all of the cost of an asset will not be deductible for tax purposes. The method of accounting for such a temporary difference depends on the nature of the transaction that led to the initial recognition of the asset or liability:
- in a business combination, an entity recognises any deferred tax liability or asset and this affects the amount of goodwill or bargain purchase gain it recognises (see above)
- if the transaction affects either accounting profit or taxable profit, an entity recognises any deferred tax liability or asset and recognises the resulting deferred tax expense or income in profit or loss;
- if the transaction is not a business combination, and affects neither accounting profit nor taxable profit, an entity would recognise the resulting deferred tax liability or asset and adjust the carrying amount of the asset or liability by the same amount. Such adjustments would make the financial statements less transparent. Therefore, this Standard does not permit an entity to recognise the resulting deferred tax liability or asset, either on initial recognition or subsequently (see example below). Furthermore, an entity does not recognise subsequent changes in the unrecognised deferred tax liability or asset as the asset is depreciated.
Example
- An entity intends to use an asset which cost Rs. 1,000 throughout its useful life of five years and then dispose of it for a residual value of nil. The tax rate is 40%. Depreciation of the asset is not deductible for tax purposes. On disposal, any capital gain would not be taxable and any capital loss would not be deductible.
- As it recovers the carrying amount of the asset, the entity will earn taxable income of Rs. 1,000 and pay tax of Rs. 400. The entity does not recognise the resulting deferred tax liability of Rs. 400 because it results from the initial recognition of the asset.
- In the following year, the carrying amount of the asset is Rs. 800. In earning taxable income of Rs. 800, the entity will pay tax of Rs. 320. The entity does not recognise the deferred tax liability of Rs. 320 because it results from the initial recognition of the asset.
Compound financial instrument
- In accordance with Ind AS 32, Financial Instruments: Presentation, the issuer of a compound financial instrument (for example, a convertible bond) classifies the instrument’s liability component as a liability and the equity component as equity. In some jurisdictions, the tax base of the liability component on initial recognition is equal to the initial carrying amount of the sum of the liability and equity components.
- The resulting taxable temporary difference arises from the initial recognition of the equity component separately from the liability component. Consequently, an entity recognises the resulting deferred tax liability.
- The deferred tax is charged directly to the carrying amount of the equity component. Subsequent changes in the deferred tax liability are recognised in profit or loss as deferred tax expense (income).
- One case when a deferred tax asset arises on initial recognition of an asset is when a non-taxable government grant related to an asset is set up as deferred income in which case the difference between the deferred income and its tax base of nil is a deductible temporary difference. In this case, the entity does not recognise the resulting deferred tax asset.
Investments in subsidiaries, branches and associates and interests in joint arrangements
Temporary differences arise when the carrying amount of investments in subsidiaries, branches and associates or interests in joint arrangements (namely the parent or investor’s share of the net assets of the subsidiary, branch, associate or investee, including the carrying amount of goodwill) becomes different from the tax base (which is often cost) of the investment or interest. Such differences may arise in a number of different circumstances, for example:
- the existence of undistributed profits of subsidiaries, branches, associates and joint arrangements;
- changes in foreign exchange rates when a parent and its subsidiary are based in different countries; and
- a reduction in the carrying amount of an investment in an associate to its recoverable amount.
- In consolidated financial statements, the temporary difference may be different from the temporary difference associated with that investment in the parent’s separate financial statements if the parent carries the investment in its separate financial statements at cost or revalued amount.
- An entity shall recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, except to the extent that both of the following conditions are satisfied:
- the parent, investor, joint venturer or joint operator is able to control the timing of the reversal of the temporary difference; and
- it is probable that the temporary difference will not reverse in the foreseeable future.
- As a parent controls the dividend policy of its subsidiary, it is able to control the timing of the reversal of temporary differences associated with that investment (including the temporary differences arising not only from undistributed profits but also from any foreign exchange translation differences).
- Furthermore, it would often be impracticable to determine the amount of income taxes that would be payable when the temporary difference reverses.
- Therefore, when the parent has determined that those profits will not be distributed in the foreseeable future the parent does not recognise a deferred tax liability. The same considerations apply to investments in branches.
Investment in associate
- An investor in an associate does not control that entity and is usually not in a position to determine its dividend policy.
- Therefore, in the absence of an agreement requiring that the profits of the associate will not be distributed in the foreseeable future, an investor recognises a deferred tax liability arising from taxable temporary differences associated with its investment in the associate.
- In some cases, an investor may not be able to determine the amount of tax that would be payable if it recovers the cost of its investment in an associate, but can determine that it will equal or exceed a minimum amount. In such cases, the deferred tax liability is measured at this amount.
Joint arrangement
- The arrangement between the parties to a joint arrangement usually deals with the distribution of the profits and identifies whether decisions on such matters require the consent of all the parties or a group of the parties.
- When the joint venturer or joint operator can control the timing of the distribution of its share of the profits of the joint arrangement and it is probable that its share of the profits will not be distributed in the foreseeable future, a deferred tax liability is not recognised.
- The non-monetary assets and liabilities of an entity are measured in its functional currency (see Ind AS 21, The Effects of Changes in Foreign Exchange Rates). If the entity’s taxable profit or tax loss (and, hence, the tax base of its non-monetary assets and liabilities) is determined in a different currency, changes in the exchange rate give rise to temporary differences that result in a recognised deferred tax liability or asset. The resulting deferred tax is charged or credited to profit or loss.
Land – Ind AS 12
- Land is a non-depreciable asset which is also eligible for indexation benefit as per tax laws of the land. This indexed cost of land (i.e. its tax base) will exceed the book value of land by the indexation benefit provided. Hence, a deferred tax asset will have to be created on this difference.
- If a deferred tax liability or deferred tax asset arises from a non-depreciable asset measured using the revaluation model in Ind AS 16, the measurement of the deferred tax liability or deferred tax asset shall reflect the tax consequences of recovering the carrying amount of the non-depreciable asset through sale, regardless of the basis of measuring the carrying amount of that asset.
- Accordingly, if the tax law specifies a tax rate applicable to the taxable amount derived from the sale of an asset that differs from the tax rate applicable to the taxable amount derived from using an asset, the former rate is applied in measuring the deferred tax liability or asset related to a non-depreciable asset.
- When an asset is revalued for tax purposes and that revaluation is related to an accounting revaluation of an earlier period, or to one that is expected to be carried out in a future period, the tax effects of both the asset revaluation and the adjustment of the tax base are recognised in other comprehensive income in the periods in which they occur.
- However, if the revaluation for tax purposes is not related to an accounting revaluation of an earlier period, or to one that is expected to be carried out in a future period, the tax effects of the adjustment of the tax base are recognised in profit or loss.
Share-based payment transactions – Ind AS 12
- In some tax jurisdictions, an entity receives a tax deduction (ie an amount that is deductible in determining taxable profit) that relates to remuneration paid in shares, share options or other equity instruments of the entity.
- The amount of that tax deduction may differ from the related cumulative remuneration expense and may arise in a later accounting period.
- For example, in some jurisdictions, an entity may recognise an expense for the consumption of employee services received as consideration for share options granted, in accordance with Ind AS 102, Share-based Payment, and not receive a tax deduction until the share options are exercised, with the measurement of the tax deduction based on the entity’s share price at the date of exercise.
- The difference between the tax base of the employee services received to date (being the amount permitted as a deduction in future periods under taxation laws), and the carrying amount of nil, is a deductible temporary difference that results in a deferred tax asset.
- If the amount permitted as a deduction in future periods under taxation laws is not known at the end of the period, it shall be estimated, based on information available at the end of the period. For example, if the amount permitted as a deduction in future periods under taxation laws is dependent upon the entity’s share price at a future date, the measurement of the deductible temporary difference should be based on the entity’s share price at the end of the period.
- If the amount of the tax deduction (or estimated future tax deduction) exceeds the amount of the related cumulative remuneration expense, this indicates that the tax deduction relates not only to remuneration expense but also to an equity item. In this situation, the excess of the associated current or deferred tax should be recognised directly in equity.
Deferred tax on consolidation
- IAS 12 requires re-calculation of deferred tax at consolidated level. In-effect, an entity will have to calculate deferred tax impact on inter-company transactions.
- For example – Company H, the holding company, sells goods costing Rs. 1,000 to Company S, the subsidiary company, for Rs. 1,200. The goods are lying in the closing stock of Company S. Assume tax rate 0f 50%. Then entry in the consolidated books is as follows:

- Here, the deferred tax asset is created because the profit element of Rs. 200 (1,200-1,000) is not eliminated in the tax books i.e. the consolidated books has an inventory of Rs. 1,000 but the tax books of Company’ S has an inventory of Rs. 1,200.
- Please note: the tax rate used in this case would be the rate applicable to the Company S, since the deduction will be available to Company S.