Multiple tax consequences – but only one headache!

I don’t dive into the technicalities of deferred tax too often in this space, because, you know, it’s nice to keep at least a handful of readers… 

But let’s make an exception today, courtesy of this fact pattern recently considered by IFRIC:

  • an entity acquires an intangible asset with a finite useful life (a licence) as part of a business combination. The carrying amount of the licence at initial recognition is CU100. The entity intends to recover the carrying amount of the licence through use, and the expected residual value of the licence at expiry is nil.
  • the applicable tax law prescribes two tax regimes: an income tax regime and a capital gains tax regime. Tax paid under both regimes meets the definition of income taxes in IAS 12. Recovering the licence’s carrying amount through use has both of the following tax consequences:
    • under the income tax regime—the entity pays income tax on the economic benefits it receives from recovering the licence’s carrying amount through use, but receives no tax deductions in respect of amortization of the licence (taxable economic benefits from use); and
    • under the capital gains tax regime—the entity receives a tax deduction of CU100 when the licence expires (capital gain deduction).
  • the applicable tax law prohibits the entity from using the capital gain deduction to offset the taxable economic benefits from use in determining taxable profit.

The tax base of an asset, you’ll recall, 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.” So how does the entity determine the tax base in this situation? It might seem relatively straightforward (by tax accounting standards) – CU100 of tax deductions will ultimately be received, and so the tax base is CU100. But on the other hand, this approach wouldn’t reflect the IAS 12 concept of recognizing a deferred tax liability (asset) whenever recovery or settlement of an asset or liability’s carrying amount would make future tax payments larger (smaller) than they would be if the recovery or settlement were to have no tax consequences, This leads IFRIC to the following conclusion:

  • In the fact pattern described in the request, the Committee concluded that the entity identifies both:
  1. a taxable temporary difference of CU100—the entity will recover the licence’s carrying amount (CU100) under the income tax regime, but will receive no tax deductions under that regime (that is, none of the tax base relates to deductions under the income tax regime); and
  2. a deductible temporary difference of CU100—the entity will not recover any part of the licence’s carrying amount under the capital gains tax regime, but will receive a deduction of CU100 upon expiry of the licence (that is, all of the tax base relates to deductions under the capital gains tax regime).
  • The entity then applies the requirements in IAS 12 considering the applicable tax law in recognizing and measuring deferred tax for the identified temporary differences.

IFRIC concluded that IAS 12 as it stands provides an adequate basis for arriving at this analysis, and that the issue needn’t be added to its standard setting agenda. The comment letters yielded a lively collection of suggested clarifications and enhancements though. To name just one, the accounting firm Mazar’s observed that the fact pattern, specified as relating to a business combination, excludes a license acquired separately, for which an exemption exists from recognizing a deferred tax asset or liability on initial recognition. They suggested a couple of ways of dealing with that issue, if it’s an issue that needs to be dealt with, which I don’t know if it is or not.

But then, readers (if I have any left by now) may have been wondering that about the entire topic. As I’ve said in the past, it seems unlikely that many users can obtain much specific value from the numbers attaching to deferred tax or from what’s disclosed about them – rather:

  • …the main value of the exercise, it seems to me, is really in avoiding the distortion that would result if the accounting for taxes were based solely on what’s payable for any particular period (whereby, for example, an entity’s reported tax rate might fluctuate materially based on what proportion of its expenditures from one period to the next is subject to accelerated treatment for tax purposes, regardless that all profits are ultimately taxable at the same rate). To that perhaps necessary but not inherently very exciting end, I expect the majority of us should be truly grateful to those brave practitioners who spend their lives immersing themselves in the technicalities of IAS 12, so that the rest of us don’t have to.

The last time I addressed this topic, I found myself wondering whether even this weak defense might have been more than the IAS 12 model deserved. Still, for the foreseeable future, those brave practitioners I mentioned will continue to plug away, defending the integrity of temporary differences as if the financial statements depended on it. I dedicate this blog post to their sacrifice…

The opinions expressed are solely those of the author

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