New on the Horizon: Deferred tax assets on unrealised losses, October 2014

17 Pages·2014·1.23 MB·English

IFRS
New on the Horizon:
Deferred tax assets
on unrealised losses
October 2014
kpmg.com/ifrs
Contents
A welcome step towards clarity 1
1 Proposals at a glance 2
2 What the proposals could mean for you 3
3 How does an entity determine the deductible
temporary difference? 4
4 How does an entity determine ‘future taxable
proft’ for the recognition test? 6
4.1 What is the formula? 6
4.2 Can an entity assume that it will recover
an asset for more than its carrying amount? 8
5 Are deductible temporary differences related to
unrealised losses assessed separately for
recognition? 10
About this publication 12
Acknowledgements 14
eN w on the oH rioz n : eD ef rred ta x assets on unrealised losses | 1
A welcome step towards clarity
Ansew rs to deef rred ta x uq estions are not alaw ys intuitive. uS ppose that you hold a debt instrument that is af lling in value,
iw thout a corresponding ta x deduction. uB t you nk o w that on the due date you iw ll receive the uf ll nominal amount, and there
iw ll be no ta x conseuq ences o f that repayment. oD you recognise a deef rred ta x asset on this unrealised loss ? Proposals 1
issued by the IA BS on 20 August 2014 attempt to bring clarity to this issue, hw ich emerged during the n� ancial crisis, and
suggest that the ansew r is yes – i f certain conditions are met.
Although the proposals stem rf om a uq estion about deef rred taex s on unrealised losses on debt instruments, they attempt to
address the much broader issue o f ho w to determine uf ture taax ble prot� of r the recognition test under IA S 12 Income Taxes.
hT ey maek one thing clear – it is not the bottom line on your ta x return. In addition, some aspects o f the proposals may have
broader implications on accounting of r deef rred taex s in general and they iw ll need to be assessed as part o f your response to
the IA.BS
eW hope that this publication iw ll help you to better understand the proposals. eW encourage you to oj in in the debate and
provide the IA BS iw th your comments by the deadline o f 1 8 eD cember 2014.
hT omas cS hmid
Anne cS hurbohm
aS nelo T mlinson
KPMG’s global IFRS income taxes leadership team
KPMG International Standards Group
1 2/DE 014 3/ Recognition of Deferred Tax Assets for Unrealised Losses – Proposed Amendments to IAS 12.
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2 | New on the Horizon: Deferred tax assets on unrealised losses
1 Proposals at a glance
The ED aims to clarify the accounting for deferred tax assets on unrealised losses for debt instruments
that are measured at fair value, and addresses the broader issue of how to determine future taxable
proft for the recognition test under IAS 12.
Through its proposals, the IASB is seeking to answer the following key questions. Each question is
further discussed in this publication under the sections listed.
Key questions Proposed answers Section
1. How does an entity determine the Based on the entity’s applicable tax law and 3
deductible temporary difference? its underlying principles
2. How does an entity determine
‘future taxable proft’ for the
recognition test?
●● What is the formula? Bottom line of the tax return 4.1
– Reversing taxable temporary differences
+ R eversing deductible temporary
differences
= Taxable proft for the recognition test
●● Can an entity assume that it will Yes – if certain conditions are met 4.2
recover an asset for more than its
carrying amount?
3. Are deductible temporary No – they are assessed on a combined basis 5
differences related to unrealised
losses assessed separately for
recognition?
Throughout this New on the Horizon, we use a simplifed example to illustrate how the proposals would
address each of those key questions.
The simplifed fact pattern
Company P bought a fxed-rate debt instrument with a nominal value of 1,000, and paid 1,000 for it.
The instrument’s fair value on 31 December 2014 is 900 due to a change in the market rate. P expects
to hold the instrument until its maturity on 31 December 2015, and to collect the full 1,000. In other
words, the loss on the debt instrument is unrealised and will reverse on maturity of the instrument.
P is loss-making, and expects that the bottom line of its tax return in 2015 will be a tax loss of 20. P also
has a taxable temporary difference of 30 that will reverse in 2015. P’s income tax rate is 25%.
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eN w on the oH rioz n : eD ef rred ta x assets on unrealised losses | 3
2 What the proposals could mean for you
hT e impact on your n� ancial statements ow uld depend on your ta x environment, ho w you currently
account of r deef rred taex s, and hw ether that accounting ow uld need to change.
oY u ow uld need to revie:w
●● ho w you treat transactions that are not recorded on a ta x return – e.g. the repayment o f a principal
amount related to a debt instrument – and hw ether any temporary dief f rences ow uld be identie� d on
those transactions based on the applicable ta x la;w
●● ho w you determine t‘ aax ble prot� ’ of r the recognition test, because under the proposals it ow uld not
be the bottom line on the ta x return ;
●● hw ether you recognise deef rred ta x assets i f you are lossm- aik ng – i.e. even i f the bottom line o f your
ta x return is epx ected to sho w a loss, you may still recognise deef rred ta x assets i f certain conditions
are met ; and
●● ho w you assess deductible temporary dief f rences of r recognition – i.e. on a separate or
combinedb� asis.
I f any o f these considerations ow uld lead to a change in the assessment about the recoverability o f
deef rred ta x assets – e.g. i f you ow uld be able to recognise an additional deef rred ta x asset – then this
may result in a oneo- f f decrease in your eef f ctive ta x rate.
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4 | New on the Horizon: Deferred tax assets on unrealised losses
3 How does an entity determine the
deductible temporary difference?
IAS 12.5(b) Under IAS 12, a ‘deductible temporary difference’ is the amount that an entity will deduct in determining
its taxable proft for future periods when it recovers an asset or settles a liability. An unrealised loss on a
debt instrument may not intuitively seem to ft this defnition if an entity does not expect to deduct this
loss for income tax purposes.
IAS 12.26(d) The IASB is not proposing to change the defnition of a deductible temporary difference, but to clarify
that a deductible temporary difference exists for such an instrument, even if:
●● the entity will hold the instrument until maturity and receive all of the contractual cash fows – i.e. no
loss is expected at maturity; and
●● tax law does not explicitly specify any tax consequences resulting from the full repayment of the
principal.
The ED proposes clarifying how to determine the deductible temporary difference by addressing the
following two questions.
●● What is the tax base of the debt instrument?
●● Does a deductible temporary difference exist?
Example
Existence of a deductible temporary difference
IAS 12.26(d) Consider the fact pattern introduced in Section 1. Under the tax law in Company P’s jurisdiction, taxable
proft (tax loss) includes the following.
Gains or losses arising Calculated as the difference between:
on the sale of the debt
●● the proceeds received; and
instrument
●● the original cost.
Losses that arise if Calculated as the difference between:
the issuer of the debt
instrument fails to pay the ●● the amount repaid on maturity; and
principal in full on maturity ●● the original cost.
However, Company P’s tax law does not explicitly specify any tax consequences resulting from the full
repayment of the principal.
What is the tax base of the debt instrument?
IAS 12.7 Under IAS 12, the tax base of an asset is the amount that will be deductible for tax purposes against
any taxable economic benefts that will fow to the entity when it recovers the carrying amount of
the asset. If those economic benefts will not be taxable, then the tax base of the asset is equal to its
carrying amount.
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eN w on the oH rioz n : eD ef rred ta x assets on unrealised losses | 5
Under the proposals, the ta x base o f Ps’ debt instrument is 1,000 because:
●●
it is irrelevant that the ta x la w does not epx licitly speciyf any ta x conseuq ences resulting rf om the
repayment o f the principal o f 1,000 ; and
●●
the applicable ta x la w is based on the principle that gains and losses arising on the sale or maturity
o f the debt instrument are determined as the dief f rence betew en the ino� w o f economic benet� s
and the original cost.
Does a deductible temporary difference exist?
IAS 12.5
Under the proposals, a deductible temporary dief f rence o f 100 eix sts of r Ps’ debt instrument, even
i f P epx ects to hold the instrument until its maturity and to collect the uf ll 1,000 – i.e. the deductible
temporary dief f rence iw ll reverse in uf ll and there iw ll be no actual deduction recorded in Ps’ ta x return.
Observations
At r� st glance, the proposals address only a very specic� instrument. oH ew ver, the rationale
supporting the analysis o f this narro w af ct pattern might have broader implications.
Entities would consider principles, not just rules, in tax law to determine tax base and
temporary difference
IAS 12 Objective, eB cause o f the reef rence to taax ble prot� in the den� ition o f a deductible temporary dief f rence,
IAS 12.5, 7, 26(d) some have argued that an entity need only consider the amounts that iw ll be included in a ta x return.
oH ew ver, under the proposals an entity ow uld also consider the principles in the ta x la,w hw ich might
have broader implications.
hT e proposals speciyf that, as a principle in the ta x la,w the repayment ow uld be deemed a taax ble
event iw th a corresponding deemed ta x deduction of r the purchase cost.
As such, there may be a temporary dief f rence in relation to unrealised gains or losses, even i:f
●●
they reverse over time ; and
●●
on the af ce o f it, there is no impact on a ta x return.
Although the IA BS is not proposing to change paragraph 5 o f IA S 12, this may present a ne w
perspective on the den� ition o f a deductible temporary dief f rence included in that paragraph.
Entities would consider economic beneft and its tax consequences to determine tax base
IAS 12.7(5),
eD ef rred ta x accounting is otf en analysed using a stepb- ys- tep approach. As a r� st step, an entity
ED.IAS 12.26(d)(Ex),
determines the ta x base.
ED.IAS 12.BC6–BC7
Paragraph 7 � o f IA1�S 2 states that i f economic benet� s o� iw ng to the entity iw ll not be taax ble, then the
ta x base o f an asset is euq al to its carrying amount. axE mple 5 � in paragraph 7 � o f IA1�S 2 illustrates ho w
to determine the ta x base o f a loan hw ose repayment iw ll have n‘ o ta x conseuq ences.’
nO this basis, some ow uld argue that, of r the ex� dr- ate debt instrument described in the eax mple
above, the ta x base is euq al to the carrying amount. Although the IA BS is not proposing to change
paragraph 7 � o f IA1�S 2, the proposals speciyf that any analysis should of cus on hw ether economic
benet� s rf om the debt instrument could be taax ble – rather than of cus on the af ct that the repayment
o f principal on maturity has no ta x conseuq ences.
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6 | New on the Horizon: Deferred tax assets on unrealised losses
4 How does an entity determine ‘future
taxable proft’ for the recognition test?
4.1 What is the formula?
IAS 12.29, An entity recognises deferred tax assets only if it is probable that it will have suffcient future taxable
ED.IAS 12.29(a) proft. A question then arises – what is the ‘future taxable proft’ against which the recognition of
deductible temporary differences is assessed? Some would argue that the most intuitive answer to this
question is the bottom line on the tax return – i.e. the amount on which income taxes are paid – but the
IASB does not share this view. Under the proposals, future taxable proft for the recognition test under
IAS 12 would be the amount before the reversal of any temporary differences.
The proposals attempt to clarify how an entity should calculate future taxable proft for the recognition
test. The following formula can be derived from the proposals.
Bottom line of tax return
-
Taxable temporary differences
+
Deductible temporary differences
=
Taxable profit for recognition test

Example
Determining future taxable proft
IAS 12.27–28 Consider the fact pattern introduced in Section 1. Under its applicable tax law, Company P determines
its future taxable proft for the recognition test as follows.
Step 1: Reversal of taxable temporary differences
Under the existing requirements of IAS 12, P considers whether it has a tax liability (from a
taxable temporary difference) that will support the recognition of the tax asset (from a deductible
temporary difference).
Deductible temporary difference 100
Reversing taxable temporary difference (30)
Remaining amount to be tested for recognition 70
In Step 1, P can recognise a deferred tax asset in relation to unrealised losses of 30 because of the
reversing taxable temporary difference of 30. This is the case even if P expects to be loss-making
in 2015.
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eN w on the oH rioz n : eD ef rred ta x assets on unrealised losses | 7
Step 2: Calculate future taxable proft
ED.IAS 12.29(a) hT e proposals speciyf ho w to perof rm tS ep 2, and suggest a of rmula to calculate uf ture taax ble
prot� of r the recognition test – i.e. the amount o f ta x prot� or loss beof re the reversal o f any
temporaryd� ief f rences.
pxE ected ta x loss per bottom line o f ta x return 2( 0)
Minus Reversing taax ble temporary dief f rence c( onsidered in tS ep1� ) 03( )
Plus Reversing deductible temporary dief f rence 100
aT ax ble prot� of r recognition test 05
Step 3: Add results of Step 1 and Step 2 and calculate tax
Under the proposals, P recognises a deef rred ta x asset o f 20, despite having an epx ected loss on its
ta x return. hT is amount is calculated as of llosw .
Deductible Deferred tax asset
temporary difference at 25%
Amount recognised because o f reversing taax ble
temporary dief f rence tS( ep 1) 03 .7 5
Amount recognised because o f uf ture taax ble prot�
tS( ep2� ) 05 12.5
oT tal 08 20.0
Observations
Single term ‘taxable proft’ describes two different concepts
IAS 12.5 Paragraph 5 o f IA S 12 includes a den� ition o f t‘ aax ble prot� t( a x loss ’) iw th a clear reef rence to the rules
established by the taax tion authorities, on hw ich current income taex s payable are calculated. oS me
ow uld argue that taax ble prot� is the bottom line on a ta x return. oH ew ver, the term t‘ aax ble prot� ’ is
also used as a recognition test of r deef rred ta x assets – but is a dief f rent amount under the proposals.
hT e logic behind the amount o f taax ble prot� of r the recognition test is that :
●●
taax ble income ecx ludes reversing taax ble temporary dief f rences because they have been
considered in tS ep 1 ; and
●●
tad- x eductible epx enses ecx lude reversing deductible temporary dief f rences because they ow uld
otheriw se be counted tiw ce.
vE en i f the rationale behind the proposals maek s sense overall, having one term of r tow dief f rent
concepts in IA S 12 might lead to some conuf sion and unepx ected conseuq ences.
Loss on bottom line of tax return does not automatically preclude recognition of deferred tax
asset
hT e proposals suggest the of rmula of r determining uf ture taax ble prot� of r the recognition test, hw ich
essentially aims to arrive at the amount o f ta x prot� or loss beof re the reversal o f any temporary
dief f rences – the obej ctive being to avoid double counting o f ta x income d( eductions ) related to
reversing taax ble d( eductible ) temporary dief f rences. vE en i f an entity epx ects the bottom line o f its
ta x return to be a loss, reversals o f temporary dief f rences could turn the loss into a prot� and provide a
basis to recognise a deef rred ta x asset. eN vertheless, the proposals are unliek ly to have much impact
in practice, because entities may already avoid double counting.
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8 | New on the Horizon: Deferred tax assets on unrealised losses
New concept may require further consideration
What is more challenging is that even if the repayment of the principal on a debt instrument has no
impact on the tax return, any reversing deductible temporary difference on the instrument would be
added back to determine the future taxable proft for the recognition test. This assessment would
be made with reference to the principles in the tax law. This is a new concept in IAS 12, which might
need further consideration.
Non-authoritative guidance could give rise to divergence in practice
The proposals include amendments to the body of the standard and a detailed illustrative example,
which does not form part of the authoritative guidance. The amendments focus on how to deal with
reversing deductible temporary differences when assessing future taxable proft. They need to be read
in conjunction with the illustrative example to get the full picture of the IASB’s proposals.
Some would argue that the IASB should have clarifed the overall approach in the amendments – i.e.
explicitly addressing the full formula for calculating future taxable proft as a test for recognition in the
standard. This is because the illustrative example would not be authoritative, which might give rise to
divergence in practice.
4.2 Can an entity assume that it will recover an asset for
more than its carrying amount?
ED.IAS 12.29A Deferred tax assets are recognised when an entity has suffcient probable future taxable proft.
However, a question then arises as to whether this estimate can include the recovery of an asset for
more than its current carrying amount. Under the proposals, the answer is yes – if certain conditions are
met. When making this assessment, an entity considers all of the relevant facts and circumstances.
The proposals provide the following examples:
ED.IAS 12.29A • recovery of an asset for more than its carrying amount is unlikely to be probable if, for example, it
was recently impaired; but
ED.IAS 12.29A • recovery of an asset for more than its carrying amount is likely to be probable if, for example, it is
measured at cost and used in a proftable operation.
Example
Recovery of an asset for more than its carrying amount
Inventories
ED.IAS 12.BC13 Company X is a manufacturing company. The carrying amount and tax base of X’s inventories are both
2,500 as at 31 December 2014. X expects to sell all of its inventories in 2015 for 3,000.
The question is whether X’s estimate of future taxable proft includes the recovery of inventory for
2,500 or 3,000.
When assessing its 2015 probable future taxable proft, X can assume that it will sell its inventories for
3,000 – i.e. more than their carrying amount.
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