The IFRS for SMEs

Topic 3.2 Section 29 Income Tax

2011 IFRS Foundation

This PowerPoint presentation was prepared by IFRS Foundation education staff as a convenience for others. It has not been approved by the IASB. The IFRS Foundation allows individuals and organisations to use this presentation to conduct training on the IFRS for SMEs. However, if you make any changes to the PowerPoint presentation, your changes should be clearly identifiable as not part of the presentation prepared by the IFRS Foundation education staff and the copyright notice must be removed from every amended page . This presentation may be modified from time to time. The latest version may be downloaded from: http://www.ifrs.org/IFRS+for+SMEs/SME+Workshops.htm The accounting requirements applicable to small and medium-sized entities (SMEs) are set out in the International Financial Reporting Standard (IFRS) for SMEs, which was issued by the IASB in July 2009. The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise.
2011 IFRS Foundation

Section 29 Introduction

Section 29 is based on the IASBs March 2009 Exposure Draft, Income Tax. Same temporary difference approach as in IAS 12 Simpler explanation Fewer exceptions

2011 IFRS Foundation

Section 29 Scope and definitions

Income tax defined Income tax: All domestic and foreign tax based on taxable profit Taxable profit = taxable income minus deductible amounts (a net amount) Tax based on revenue income tax Sales tax, VAT, tax on capital, and social security tax income tax Income tax = tax rate x taxable profit
2011 IFRS Foundation

Section 29 Other definitions

Current tax: Amount of income tax payable/refundable based on taxable profit/loss for the current period or past periods Deferred tax: Tax payable/recoverable in the future period as a result of past transactions

2011 IFRS Foundation

Section 29 Other definitions

Tax basis: Measurement of asset, liability, or equity under the tax law Temporary difference: Difference in carrying amount of asset, liability, or other item in the financial statements and its tax basis if entity expects the item will affect future taxable profit

2011 IFRS Foundation

Section 29 Steps in accounting for income tax

1. Recognise current tax 2. Identify which assets and liabilities would affect taxable profit if recovered or settled for their carrying amounts 3. Determine tax basis of items in (2) plus other items that have a tax basis although not recognised (eg borrowing cost or R&D that is capitalised for tax purposes) 4. Compute temporary differences, unused tax losses, unused tax credits
2011 IFRS Foundation

Section 29 Steps in accounting for income tax

5. Recognise deferred tax assets or liabilities arising from temporary differences 6. Measure deferred tax assets and liabilities Use substantively enacted tax rates Consider possible outcomes of a review by tax authorities 7. Valuation allowance against deferred tax assets (probable recovery) 8. Allocate current and deferred tax to related components of P&L, OCI, equity
2011 IFRS Foundation

Section 29 Recognition of current tax

Current Tax Liability for any tax payable on current or prior taxable profit Asset if overpayment is recoverable Measure using tax law enacted or substantively enacted at reporting date Current period expense or income, but if current tax relates to an item of OCI, that tax is presented as part of OCI
2011 IFRS Foundation

Section 29 Recognition of current tax

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Example: Calculate Current Tax Accounting profit 150,000, tax rate 15% 20,000 royalty income is tax exempt 5,000 meals expense is not deductible Bad debt expense 2,500 included 500 estimate not deductible until write-off Tax depreciation (accelerated) is 43,000, book depreciation is 35,000. What is current tax expense? continued...
2011 IFRS Foundation

Section 29 Recognition of current tax

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Example: Calculate Current Tax (contd) Taxable profit: Accounting profit 150,000 Less nontaxable royalty (20,000) Plus nondeductible meals 5,000 Plus nondeductible bad debts 500 Less addl tax depreciation (8,000) Taxable Profit 127,500 Current tax = 15% x 127,500 = 19,125
2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Deferred tax Based on difference between amounts in balance sheet and tax basis of those items If recovery of asset/liability will not affect taxable profit, no deferred tax Tax basis = amount that would be deductible if asset were sold (or liability were settled) at end of reporting period

2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Deferred tax Measure using enacted (or substantively enacted) tax rates But use the rate based on expected income at the time of reversal of the temporary difference to calculate the expected effective tax rate

2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Example: Calculate Deferred Tax Accounting profit 150,000, tax rate 15% 20,000 royalty income is tax exempt 5,000 meals expense is not deductible Bad debt expense 2,500 included 500 estimate not deductible until write-off Tax depreciation (accelerated) is 43,000, book depreciation is 35,000. What is deferred tax expense? continued...
2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Example: Calculate Deferred Tax (contd) Deferred tax asset nondeductible bad debt: 500 x 15% = 75 Deferred tax liability accelerated deprec: 8,000 x 15% = 1,200 Same jurisdiction, right of offset Deferred tax expense = 1,200 75 = 1,125 Deferred tax liability = 1,125 Total tax expense 19,125 + 1,125 = 20,250
2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Example: Journal entry (reflects the last two examples)

Income tax expense Taxes currently payable Deferred tax liability 20,250 19,125 1,125

2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Example: Graduated tax rates

Temporary difference arises 7,500 in 20X1, expected to reverse in 20X3 Tax rate 15% on first 500,000 of profit, 25% on excess over 500,000 Taxable profit 20X1 = 400,000 Expected taxable profit 20X3 = 600,000 Effective tax rate 20X3 = (500,000 x 15%) + (100,000 x 25%) = 100,000/600,000 = 16.67% Deferred tax liability 20X1 = 16.67% x 7,500 = 1,250
2011 IFRS Foundation

Section 29 Temporary differences

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Temporary differences Can arise on initial recognition of an asset or liability Can arise after initial recognition because income/expense is recognised in P&L in one period and in taxable profit in a different period Can arise when tax basis of asset or liability changes but changes will never affect the carrying amount
2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Recognise (a few exceptions next slide): Deferred tax liability for all temporary differences that will increase taxable profit in the future Deferred tax asset for all temporary differences that will reduce taxable profit in the future Deferred tax asset for tax loss and tax credit carryforwards
2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Exceptions to recognition: No deferred tax for temporary differences associated with unremitted earnings of foreign sub, associate, JV No deferred tax for temporary difference associated with initial recognition of goodwill

2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Example: 25% owned associate, equity method used for books, ordinary tax rate 30%, capital gains tax rate 0% Cost 10,000 Equity method income year 1 = 1,000 Temporary difference = 1,000 Deferred tax liability = 0% x 1,000 = 0 Taxable dividend received = 200 Current tax expense = 30% x 200 = 60 End of year 1 carrying amount = 10,800
2011 IFRS Foundation

Section 29 Recognition of deferred tax

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Changes in deferred tax liabilities / assets: Recognised in P&L (or in OCI if it relates to an item of OCI) Example using data in slide 14: Tax rate now increases to 20%, deferred tax asset and liability not yet reversed. Deferred tax liability is 1,125 Def tax liab should be 20% x 7,500 = 1,500 Tax expense charged to P&L = 375
2011 IFRS Foundation

Section 29 Measurement of deferred tax

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Use tax rate that has been enacted or substantively enacted If different rates apply to different types of income, use rate the entity expects to pay Valuation allowance against tax assets: Net carrying amount = probable recovery Review carrying amount each period

2011 IFRS Foundation

Section 29 Measurement of deferred tax

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Example: Valuation allowance

31/12/X1 temporary differences of 120 available to reduce future taxable profit Cannot be carried back Of the 120, based on forecasts of future profits, only 30 has > 50% likelihood to be utilised Tax rate 20%
Journal entry at 31/12/X1 Deferred tax asset [120 x 20%] Valuation allowance [(120 - 30) x 20%] Income tax benefit deferred tax (P&L)
2011 IFRS Foundation

Debit 24

Credit 18 6

Section 29 Measurement of deferred tax

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Do not discount current or deferred taxes Uncertainty in measuring both deferred tax assets and liabilities: Use probability-weighted average amount of all possible outcomes, assuming tax authorities know all facts If different tax rates apply to undistributed and distributed income, accrue at undistributed rate initially Adjust through P&L when distributed
2011 IFRS Foundation

Section 29 Presentation

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Classification: All deferred tax assets and liabilities as non-current Offsetting: Do not offset current tax assets and liabilities or deferred tax assets and liabilities unless entity has legal right to offset and it intends either to settle net or simultaneously
2011 IFRS Foundation

Section 29 Disclosure

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Disclose major components of tax expense: Current tax expense (income) Adjustments to current tax of prior periods Deferred tax expense (income) relating to: New or reversing temporary differences Changes in tax rates or new taxes Effects of changes in uncertainty Changes in valuation allowance Tax expense relating to changes in accounting policies or errors
2011 IFRS Foundation

Section 29 Disclosure

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Other disclosures: Current and deferred tax relating to items of OCI Explanation of significant differences in amounts in P&L and amounts reported to tax authorities Changes in tax rates
continued next slide...
2011 IFRS Foundation

Section 29 Disclosure

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Other disclosures (continued): For each type of temporary difference and unused tax loss and tax credit:
Amount of deferred tax and valuation allowance at end of period Analysis of changes in deferred tax and valuation allowance during period

Expiry date of temporary differences and unused tax losses and tax credits Explanation if payment of undistributed earnings will have a tax impact
2011 IFRS Foundation