IAS 12 – Income Taxes

IAS 12 – Income Taxes describes how an entity should deal with the accounting treatment for income taxes. Income taxes includes:

• current income tax, and
• deferred income tax.

Income taxes include all domestic and foreign taxes that are based on taxable profits and all countries will provide tax provisions according to their respective country tax rules and regulations.

Current and prior periods unpaid amounts should be recognised as a liability while overpayment of current tax is recognised as an asset.

New Amendments effective from 1 January 2023

The IASB has issued amendments to IAS 12 in May 2021 which are effective from 1 January 2023 and Paragraphs 15 and 24 of this IAS were amended to include an additional condition where the initial recognition exemption is not applied. According to the amended guidance, a temporary difference that arises on initial recognition of an asset or liability is not subject to the initial recognition exemption if that transaction gave rise to equal amounts of taxable and deductible temporary differences.

These changes may significantly impact on those who have substantial balances of right-of-use assets, lease liabilities and decommissioning and will be resulted in recognition of additional deferred tax assets and liabilities.

Important Definitions

• Accounting profit are profit or loss for a period before deducting tax expense.
• Taxable profit (tax loss) is the profit (loss) for a period determined in accordance with the rules established by the taxation authorities upon whom income taxes are payable or recoverable.
• The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

Formula

Current income taxes = taxable profit (loss) * tax rate (%)

Another important factor in calculation of income taxes is calculation of deferred tax.

What is deferred tax?

Please note that accounting profit / (loss) may differ from taxable profit / (loss). The differences between book income and tax income give rise to either permanent or temporary differences. The temporary tax difference arises from the timing differences with regard to reporting of income or deducting of expenses that are the difference between the carrying amount of an asset and liability and its tax base. These temporary differences create a deferred tax liability.

This concept is bit complicated but we will try to make it simple. Before going further, we will see what are the common factors which initiate temporary differences.

Temporary Differences

Timing difference arises when the recognition of certain item in the financial statements occurs in a different time than its recognition in tax return.

Usually, they originate in one period and reverse in subsequent period(s).

Examples are

• depreciation method applied by entity and tax authorities may differ, for example tax authorities may use straight line method of depreciation while entity using reducing balance method so depreciation expense will be different in books and tax calculation.
• depreciation rates applied by business and tax authorities may different on non current assets. If company’s depreciation expense in its income statement, calculated using its own accounting policy is 2,500, However, the depreciation expense allowable by tax authorities is 3,000. This leads to a temporary difference of 500 for the period.
• interest received is tax deductible only when cash is received.
• Some foreign tax jurisdictions allow for the tax bases of assets and liabilities to be indexed to inflation rates for tax purposes while the book bases of such assets do not change with inflation.

Measurement of deferred tax

Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, based on tax rates/laws that have been enacted or substantively enacted by the end of the reporting period.

Formula

Deferred income taxes = temporary difference * tax rate (%)

Permanent Differences:

Permanent differences are those that are done and dusted, nothing in the future will change them. They relate to income and expenditure that has been included in the financial statements profit before tax figure, but will never be included in the calculation of taxable profits. Examples are:

• All those expenses charged to accounting profit and loss but not accepted by tax authorities as an expense like donation to non approved charities and all other disallowed expenses by tax authorities.

Deferred tax is provided in full for all temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements, except when the temporary difference arises from:

• initial recognition of goodwill (for deferred tax liabilities only);
• initial recognition of an asset or liability in a transaction that is not a business combination and that affects neither accounting profit nor taxable profit; and
• investment in subsidiaries, and joint ventures, but only where certain criteria apply.

Recognition of deferred tax liabilities

The general principle in IAS 12 is that a deferred tax liability is recognized for all taxable temporary differences.

Current tax

Current tax for the current and prior periods is recognized as a liability to the extent that has not yet been settled, and as an asset to the extent that the amounts already paid exceeds the amount due.

How to recognize income tax for the period?

Current and deferred tax is recognized as an income or an expense and included in profit or loss for the period.

Offsetting

• Current tax assets and current tax liabilities can only be offset in the statement of financial position if the entity has the legal right and the intention to settle on a net basis.
• Deferred tax assets and deferred tax liabilities can only be offset in the statement of financial position if the entity has the legal right to settle current tax amounts on a net basis and the deferred tax amounts are levied by the same taxing authority on the same entity or different entities that intend to realize the asset and settle the liability at the same time.
• The amount of tax expense (or income) related to profit or loss is required to be presented in the statement(s) of profit or loss and other comprehensive income.

Disclosure

Please review complete disclosure requirements here: https://www.ifrs.org/issued-standards/list-of-standards/ias-12-income-taxes/

Review my blog on GCC Corporate tax here: https://accountingblogger.com/uae-corporate-tax/

Review my blog on GCC VAT here: https://accountingblogger.com/uae-value-added-tax-vat/

Review my blog on FBR tax here: https://accountingblogger.com/tax-on-deemed-income-fbr-pakistan/

ABOUT THE AUTHOR

Humayun Atif | CMA, CPA, CA (FIN), MS-IT, CA Articles from Big 4

                                                    Certified Forensic Accountant, USA, Six Sigma & Oracle Certified

Atif is passionate about Business, Tech, and the written word. He is the author of the book ‘IFRS Made Easy’. He is a tax and IFRS coach and the founder of accountingblogger.com