The IASB has issued amendments to IAS 12 Deferred Tax related to Assets and Liabilities arising from a Single Transaction, effective for annual reporting periods beginning on or after January 1, 2023
The amendments express themselves primarily with reference to accounting for leases under IFRS 16, but they also apply to decommissioning obligations, and perhaps in other situations too. Prior to the amendments, IAS 12.15 requires recognizing a deferred tax liability for all taxable temporary differences, except to the extent that the deferred tax liability arises from the initial recognition of goodwill; or from the initial recognition of an asset or liability in a transaction which isn’t a business combination and which at the time of the transaction affects neither accounting profit nor taxable profit or loss. The standard explains that in the absence of this exemption, an entity would recognize the resulting deferred tax liability or asset and (to make it work) adjust the carrying amount of the originating asset or liability by the same amount, thus making the financial statements “less transparent” (this was required under old Canadian GAAP).
A jurisdiction will likely allow tax deductions when a company makes lease payments, but not when it recognizes depreciation and interest expense arising from the mechanics of IFRS 16. IFRS doesn’t prescribe whether these tax deductions should be regarded as applying to the lease asset or to the lease liability, leaving the assessment to the issuer’s judgment based on the local tax laws and other relevant factors. If the issuer determines that the tax deductions relate to the lease asset, then no temporary differences arise – the asset amount to be depreciated for accounting purposes will equal the amount to be charged for tax purposes, and the repayment of the liability will have no tax consequences. However, if the tax deductions relate to the lease liability, then neither of those statements is true, and temporary differences do arise. However, if the initial recognition exemption applies, then the deferred tax consequences of these temporary differences needn’t be recognized. The IASB identified differences in practice on whether the exemption was considered to apply or not.
The amendments make clear that the exemption doesn’t apply in this case, primarily by amending the passage cited above to apply to the initial recognition of an asset or liability in a transaction which isn’t a business combination, which at the time of the transaction affects neither accounting profit nor taxable profit or loss, and, at the time of the transaction, does not give rise to equal taxable and deductible temporary differences. A new paragraph specifies:
- A transaction that is not a business combination may lead to the initial recognition of an asset and a liability and, at the time of the transaction, affect neither accounting profit nor taxable profit. For example, at the commencement date of a lease, a lessee typically recognizes a lease liability and the corresponding amount as part of the cost of a right-of-use asset. Depending on the applicable tax law, equal taxable and deductible temporary differences may arise on initial recognition of the asset and liability in such a transaction. The exemption provided by paragraphs 15 and 24 does not apply to such temporary differences and an entity recognizes any resulting deferred tax liability and asset.
The exposure draft mused on the example of a a decommissioning liability which might be settled (and on which a tax deduction might arise) only after the end of the related asset’s useful life. In this case, a portion of the temporary difference related to the corresponding asset might reverse in periods for which no conclusion can be drawn about the existence of sufficient taxable temporary differences, limiting the recognition of the deferred tax asset. But to recognize a deferred tax liability greater than a corresponding deferred tax asset could avoid having an initial impact on profit and loss only by adjusting the carrying amount of the related asset as the other side of the entry, thus resulting, the exposure draft noted, in the outcome the recognition exemption was designed to prevent. Consequently, the exposure draft proposed in such situations that the amount of the deferred tax liability should not exceed the amount of the deferred tax asset. In response to the comments received, the Board removed this item from the final standard, concluding that it would be complex and burdensome to apply, and observing:
- Removing the capping proposal might result in an entity recognizing unequal amounts of deferred tax assets and liabilities on initial recognition of a transaction. In such cases, an entity would recognize any difference in profit or loss…For example, an entity would recognize an income tax loss if, on initial recognition, it recognizes a deferred tax liability but is unable to recognize an equal and offsetting deferred tax asset. The Board concluded that this accounting appropriately reflects the entity’s expectation that it will be unable to benefit fully from the tax deductions available when it settles the liability, but that it is nonetheless required to make future tax payments as it recovers the asset.
Maybe someone else could think of a snappy ending to that summary. But I’m afraid I couldn’t…
The opinions expressed are solely those of the author