MEMBERS' HANDBOOK

STATEMENT 2.112
STATEMENT OF STANDARD ACCOUNTING PRACTICE
INCOME TAXES

(Issued August 2002)

[August 2002 (Supp. No. 7/02)]

         
Contents

Paragraphs

OBJECTIVE  
SCOPE

1 - 4

DEFINITIONS

5 -11

Tax Base

7 - 11

RECOGNITION OF CURRENT TAX LIABILITIES AND CURRENT TAX ASSETS

12 - 14

RECOGNITION OF DEFERRED TAX LIABILITIES AND DEFERRED TAX ASSETS

15 - 45

Taxable Temporary Differences

15 - 23

  Business Combinations

19

  Assets Carried at Fair Value

20

  Goodwill

21

  Initial Recognition of an Asset or Liability

22

Deductible Temporary Differences

24 - 33

  Negative Goodwill

32

  Initial Recognition of an Asset or Liability

33

Unused Tax Losses and Unused Tax Credits

34 - 36

Re-assessment of Unrecognised Deferred Tax Assets

37

Investments in Subsidiaries, Branches and Associates and Interests in Joint Ventures

38 - 45

MEASUREMENT

46 - 56

RECOGNITION OF CURRENT AND DEFERRED TAX

57 - 58

Income Statement

58 - 60

Items Credited or Charged Directly to Equity

61 - 65A

Deferred Tax Arising from a Business Combination

66 - 68

PRESENTATION

69 - 78

Tax Assets and Tax Liabilities

69 - 76

  Off-set

71 - 76

Tax Expense

77 - 78

  Tax Expense (Income) Related to Profit or Loss from Ordinary Activities

77

  Exchange Differences on Deferred Foreign Tax Liabilities or Assets

78

DISCLOSURE

79 - 88

EFFECTIVE DATE

89 - 90

NOTES ON LEGAL REQUIREMENTS IN HONG KONG

91 - 96

APPENDICES:
A. Examples of Temporary Differences
B. Illustrative Computations and Presentation
C. Comparison of SSAP 12 with International Accounting Standards

STATEMENT OF STANDARD ACCOUNTING PRACTICE
INCOME TAXES

(Issued August 2002)

The standards, which have been set in bold italic type, should be read in the context of the background material and implementation guidance and in the context of the Foreword to Statements of Standard Accounting Practice, Interpretations and Accounting Guidelines. Statements of Standard Accounting Practice are not intended to apply to immaterial items (see paragraph 8 of the Foreword).

The explanatory guidance and illustrative examples set out in the boxes are to illustrate the application of the standards to assist in clarifying their meaning. They are for general guidance only and do not form part of the standards.
         

Objective

The objective of this Statement is to prescribe the accounting treatment for income taxes. The principal issue in accounting for income taxes is how to account for the current and future tax consequences of:
(a) the future recovery (settlement) of the carrying amount of assets (liabilities) that are recognised in an enterprise's balance sheet; and
(b) transactions and other events of the current period that are recognised in an enterprise's financial statements.
It is inherent in the recognition of an asset or liability that the reporting enterprise expects to recover or settle the carrying amount of that asset or liability. If it is probable that recovery or settlement of that carrying amount will make future tax payments larger (smaller) than they would be if such recovery or settlement were to have no tax consequences, this Statement requires an enterprise to recognise a deferred tax liability (deferred tax asset), with certain limited exceptions.

This Statement requires an enterprise to account for the tax consequences of transactions and other events in the same way that it accounts for the transactions and other events themselves. Thus, for transactions and other events recognised in the income statement, any related tax effects are also recognised in the income statement. For transactions and other events recognised directly in equity, any related tax effects are also recognised directly in equity. Similarly, the recognition of deferred tax assets and liabilities in a business combination affects the amount of goodwill or negative goodwill arising in that business combination.

This Statement also deals with the recognition of deferred tax assets arising from unused tax losses or unused tax credits, the presentation of income taxes in the financial statements and the disclosure of information relating to income taxes.
         

           
General Principles
  • This Statement deals with current taxes and deferred taxes. As its approach to deferred taxes is different from that contained in the superseded SSAP 12 "Accounting for deferred tax", some general principles relating to the treatment of deferred taxes in this Statement are set out below.
  • The future tax consequences of transactions and other events recognised in an enterprise's balance sheet give rise to deferred tax liabilities and assets, and are calculated in accordance with the following formulae:
             
    Carrying amounts of assets or liabilities - Tax bases of assets or liabilities = Taxable or deductible temporary differences
    Taxable or deductible temporary differences X Tax rates = Deferred tax liabilities or assets
  • Deferred tax assets also arise from unused tax losses that tax law allows to be carried forward, and are calculated in accordance with the following formula:
             
    Unused tax losses X Tax rates = Deferred tax assets
  • The notion of temporary differences is central to understanding the requirements of this Statement. A taxable temporary difference gives rise to a deferred tax liability. A deductible temporary difference gives rise to a deferred tax asset. A taxable or deductible temporary difference arises when the carrying amount of an asset or a liability differs from its tax base. The meaning of "tax base" is of key importance to applying the requirements of this Statement. Tax base is defined in paragraph 5 of this Statement and is generally the amount that would be shown as an asset or a liability in a balance sheet prepared for tax purposes. Unlike the practice in some other countries, it is not customary in Hong Kong for enterprises to prepare tax-based balance sheets. However, the notion of a tax-based balance sheet is relevant to this Statement and may be used as a basis for working papers developed for the purpose of implementing this Statement.
  • This Statement generally requires an enterprise to recognise the tax consequences of transactions and other events consistently with the way that it recognises the transactions and other events themselves. Thus, for transactions and other events recognised in net profit or loss for the period, any related tax effects are also recognised in net profit or loss for the period. For transactions and other events that are recognised as direct credits to equity (direct debits to equity), any related tax effects are generally recognised as direct debits to equity (direct credits to equity).
           
         

Scope

1. This Statement should be applied in accounting for income taxes.
2. For the purposes of this Statement, income taxes include all domestic and foreign taxes which are based on taxable profits. Income taxes also include taxes, such as withholding taxes, which are payable by a subsidiary, associate or joint venture on distributions to the reporting enterprise.
3. [Not used]
4. This Statement does not deal with the methods of accounting for government grants (see SSAP 35, Accounting for Government Grants and Disclosure of Government Assistance) or investment tax credits. However, this Statement does deal with the accounting for temporary differences that may arise from such grants or investment tax credits.

Definitions

5. The following terms are used in this Statement with the meanings specified:

Accounting profit is net 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 which income taxes are payable (recoverable).

Tax expense (tax income) is the aggregate amount included in the determination of net profit or loss for the period in respect of current tax and deferred tax.

Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.

Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences.

Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
  (a) deductible temporary differences;
  (b) the carryforward of unused tax losses; and
  (c) the carryforward of unused tax credits.
  Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax base. Temporary differences may be either:
  (a) taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or
  (b) deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.

The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.
6. Tax expense (tax income) comprises current tax expense (current tax income) and deferred tax expense (deferred tax income).
 
Tax Base
This section provides guidance for the calculation of tax base in different circumstances. The concept of tax base is of key importance in implementing the principles in this Statement. A difference between the carrying amount of an asset or a liability and the tax base of the asset or liability is a taxable temporary difference or a deductible temporary difference that gives rise to a deferred tax liability or asset, respectively.
7. The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an enterprise when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.

The tax base of an asset may be calculated as the asset's carrying amount, less any future taxable amounts plus any future deductible amounts that are expected to arise from recovering the asset's carrying amount as at the balance sheet date. For example, in the case of plant and equipment, the tax base is the tax written down value.
         
               
EXAMPLES


Examples of the calculation of the tax base of assets

1. A machine cost $100 and is expected to be ultimately disposed of for an amount that is equal to or less than cost. For tax purposes, depreciation of $30 has already been deducted in the current and prior periods and the remaining cost will be deductible in future periods, either as depreciation or through a deduction on disposal. Revenue generated by using the machine (that is, revenue generated from recovering the carrying amount of the machine) is taxable, any gain or loss on disposal will be subject to a balancing adjustment (such as for recouped depreciation) for tax purposes. The machine has been depreciated for accounting purposes by $20.

The tax base of the machine is:
  Carrying Amount   Taxable Amounts   Deductible Amounts   Tax Base
  $80 - $80 + $70 = $70
2. Leasehold land with a cost of $100 and a carrying amount of $90 is revalued to $150. For tax purposes, depreciation of $20 has been deducted in the current and prior periods and the remaining cost will be deductible in future periods through depreciation. Revenue generated from the use of the leasehold land is taxable and any gain or loss on disposal will be subject to a balancing adjustment for tax purposes.

The tax base of the leasehold land is:
  Carrying Amount   Taxable Amounts   Deductible Amounts   Tax Base
  $150 - $150 + $80 = $80
3. Freehold land with a cost of $100 is revalued to $150. For tax purposes, there is no depreciation. Revenue generated from the use of the freehold land is taxable. However, any gain on disposal of the land at the revalued amount will not be taxable.

The tax base of the freehold land is:
  Carrying Amount   Taxable Amounts   Deductible Amounts   Tax Base
  $150 - $150 + $100 = $100
4. Trade receivables has a carrying amount of $100 and is expected to be recovered through payments from debtors. There are no doubtful debts. The related revenue of $100 has already been included in the calculation of taxable profit (tax loss).

The tax base of the trade receivables is:
  Carrying Amount   Taxable Amounts   Deductible Amounts   Tax Base
  $100 - Nil + Nil = $100
5. Trade receivables has a carrying amount of $100, for which specific bad debt provisions amounting to $20 have been made. These provisions have already been deducted for tax purposes.

The tax base of the trade receivables is:
  Carrying Amount   Taxable Amounts   Deductible Amounts   Tax Base
  $100 - Nil + Nil = $100
6. Trade receivables has a carrying amount of $100, for which general bad debt provisions amounting to $20 have been made. These provisions have not yet been deducted for tax purposes but are expected to give rise to future deductible amounts.

The tax base of the trade receivables is:
  Carrying Amount   Taxable Amounts   Deductible Amounts   Tax Base
  $100 - Nil + $20 = $120
7. A loan receivable has a carrying amount of $100 and is expected to be recovered through payments from the borrower. The repayment of the carrying amount of the loan as at the reporting date will have no tax consequences.

The tax base of the loan is:
  Carrying Amount   Taxable Amounts   Deductible Amounts   Tax Base
  $100 - Nil + Nil = $100
8. Dividends receivable from a subsidiary have a carrying amount of $100. The dividends are not taxable.

The tax base of the dividends receivable is:
  Carrying Amount   Taxable Amounts   Deductible Amounts   Tax Base
  $100 - Nil + Nil = $100
9. An interest receivable has a carrying amount of $100. The related interest revenue will be taxed only when received.

The tax base of the interest receivable is:
  Carrying Amount   Taxable Amounts   Deductible Amounts   Tax Base
  $100 - $100 + Nil = Nil
               
         
8. The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods.

The tax base of a liability may be calculated as the liability's carrying amount as at the balance sheet date less any future deductible amounts, plus any future taxable amounts, that are expected to arise from settling the liability's carrying amount as at the balance sheet date. The tax base of a liability that is in the nature of "revenue received in advance", however, is calculated as the liability's carrying amount less any amount of the "revenue received in advance" that has been included in taxable amounts in the current or a previous reporting period.
         
               
EXAMPLES


Calculation of the tax base of liabilities

1. Current liabilities include accrued wages with a carrying amount of $100. The related expense has already been deducted for tax purposes on an accrued basis (that is, the wages were deducted for tax purposes in the same year in which they were recognised as an expense for accounting purposes).

The tax base of the accrued expenses is:
  Carrying Amount   Deductible Amounts   Taxable Amounts   Tax Base
  $100 - Nil + NIL = $100
2. Current liabilities include accrued fines and penalties with a carrying amount of $100. Fines and penalties are not deductible for tax purposes.

The tax base of the accrued fines and penalties is:
  Carrying Amount   Deductible Amounts   Taxable Amounts   Tax Base
  $100 - Nil + Nil = $100
3. A loan payable has a carrying amount of $100. The repayment of the carrying amount of the loan as at the reporting date will not give rise to taxable or deductible amounts.

The tax base of the loan is:
  Carrying Amount   Deductible Amounts   Taxable Amounts   Tax Base
  $100 - Nil + Nil = $100
4. Current liabilities include interest revenue received in advance, with a carrying amount of $100. The related interest revenue was taxed on a cash basis.

The tax base of the interest received in advance is:
  Carrying Amount   Amount of revenue received in advance that has increased taxable amount (or decreased tax loss)   Tax Base
  $100 - $100 = Nil
5. A foreign currency loan payable has a carrying amount on initial recognition of $100. Subsequently, the carrying amount is reduced to $90 to reflect the change in exchange rates (an unrealised foreign exchange gain). Exchange gains are only taxable when they are realised. The repayment of the $90 carrying amount of the loan will give rise to taxable amounts of $10.

The tax base of the loan is:
  Carrying Amount   Deductible Amounts   Taxable Amounts   Tax Base
  $90 - Nil + $10 = $100
6. An interest payable has a carrying amount of $100. The related interest will be deductible for tax purposes only when it is paid.

The tax base of the interest payable is:
  Carrying Amount   Deductible Amounts   Taxable Amounts   Tax Base
  $100 - $100 + Nil = Nil
               
         
9. Some items have a tax base but are not recognised as assets and liabilities in the balance sheet. For example, research costs are recognised as an expense in determining accounting profit in the period in which they are incurred but may not be permitted as a deduction in determining taxable profit (tax loss) until a later period. The difference between the tax base of the research costs, being the amount the taxation authorities will permit as a deduction in future periods, and the carrying amount of nil is a deductible temporary difference that results in a deferred tax asset.
10. Where the tax base of an asset or liability is not immediately apparent, it is helpful to consider the fundamental principle upon which this Statement is based: that an enterprise should, with certain limited exceptions, recognise a deferred tax liability (asset) whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (smaller) than they would be if such recovery or settlement were to have no tax consequences. Example C following paragraph 52 illustrates circumstances when it may be helpful to consider this fundamental principle, for example, when the tax base of an asset or liability depends on the expected manner of recovery or settlement.
11. In consolidated financial statements, temporary differences are determined by comparing the carrying amounts of assets and liabilities in the consolidated financial statements with the appropriate tax base. The tax base is determined by reference to a consolidated tax return in those jurisdictions in which such a return is filed. In other jurisdictions, the tax base is determined by reference to the tax returns of each enterprise in the group.
 

Recognition of Current Tax Liabilities and Current Tax Assets

12. Current tax for current and prior periods should, to the extent unpaid, be recognised as a liability. If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess should be recognised as an asset.
13. The benefit relating to a tax loss that can be carried back to recover current tax of a previous period should be recognised as an asset.
14. When a tax loss is used to recover current tax of a previous period, an enterprise recognises the benefit as an asset in the period in which the tax loss occurs because it is probable that the benefit will flow to the enterprise and the benefit can be reliably measured.
 

Recognition of Deferred Tax Liabilities and Deferred Tax Assets


Taxable Temporary Differences

15. A deferred tax liability should be recognised for all taxable temporary differences, unless the deferred tax liability arises from:
  (a) goodwill for which amortisation is not deductible for tax purposes; or
  (b) the initial recognition of an asset or liability in a transaction which:
    (i) is not a business combination; and
    (ii) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).
  However, for taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, a deferred tax liability should be recognised in accordance with paragraph 39.
16. It is inherent in the recognition of an asset that its carrying amount will be recovered in the form of economic benefits that flow to the enterprise in future periods. When the carrying amount of the asset exceeds its tax base, the amount of taxable economic benefits will exceed the amount that will be allowed as a deduction for tax purposes. This difference is a taxable temporary difference and the obligation to pay the resulting income taxes in future periods is a deferred tax liability. As the enterprise recovers the carrying amount of the asset, the taxable temporary difference will reverse and the enterprise will have taxable profit. This makes it probable that economic benefits will flow from the enterprise in the form of tax payments. Therefore, this Statement requires the recognition of all deferred tax liabilities, except in certain circumstances described in paragraphs 15 and 39.

             
The recovery of the carrying amount of many assets gives rise to taxable and deductible amounts. For example, an item of equipment may be used to produce goods that are in turn used to generate revenue, and therefore taxable amounts, and give rise to depreciation that is a deductible amount. When the carrying amount of the asset (equipment) exceeds its tax base, the amount of taxable economic benefits (taxable amounts) will exceed the amount that will be allowed as a deduction for tax purposes. This difference is a taxable temporary difference and the obligation to settle the resulting income taxes in future periods is a deferred tax liability. The example below illustrates a circumstance in which a deferred tax liability arises that is required to be recognised by this Statement.
             

EXAMPLE


An example of circumstances that give rise to a deferred tax liability that is required to be recognised

 
An asset that costs $150 has a carrying amount of $100. Cumulative depreciation for tax purposes is $90 and the tax rate is 30%.
    Carrying Amount   Tax Base   Temporary Difference
    $   $   $
At acquisition   150   150    
Accumulated Depreciation   50
____		   90
____		    
Net amount   100   60   40
Tax rate           30%
____
Deferred Tax Liability           12
The tax base of the asset is $60 (cost of $150 less cumulative tax depreciation of $90). In recovering the carrying amount of $100, the enterprise will derive taxable amounts of $100, but will only be able to deduct tax depreciation of $60. Consequently, the enterprise will pay income taxes of $12 (calculated as $40 x 30%) as a result of recovering the carrying amount of the asset. The difference between the carrying amount of $100 and the tax base of $60 is a taxable temporary difference of $40. Therefore, the enterprise recognises a deferred tax liability of $12 (calculated as $40 x 30%) representing the effect on income tax payable as a consequence of recovering the carrying amount of the asset.
17. Some temporary differences arise when income or expense is included in accounting profit in one period but is included in taxable profit in a different period. Such temporary differences are often described as timing differences. The following are examples of temporary differences of this kind which are taxable temporary differences and which therefore result in deferred tax liabilities:
  (a) interest revenue is included in accounting profit on a time proportion basis but may, in some jurisdictions, be included in taxable profit when cash is collected. The tax base of any receivable recognised in the balance sheet with respect to such revenues is nil because the revenues do not affect taxable profit until cash is collected;
  (b) depreciation used in determining taxable profit (tax loss) may differ from that used in determining accounting profit. The temporary difference is the difference between the carrying amount of the asset and its tax base which is the original cost of the asset less all deductions in respect of that asset permitted by the taxation authorities in determining taxable profit of the current and prior periods. A taxable temporary difference arises, and results in a deferred tax liability, when tax depreciation is accelerated (if tax depreciation is less rapid than accounting depreciation, a deductible temporary difference arises and results in a deferred tax asset); and
  (c) development costs may be capitalised and amortised over future periods in determining accounting profit but deducted in determining taxable profit in the period in which they are incurred. Such development costs have a tax base of nil as they have already been deducted from taxable profit. The temporary difference is the difference between the carrying amount of the development costs and their tax base of nil.
18. Temporary differences also arise when:
  (a) the cost of a business combination that is an acquisition is allocated to the identifiable assets and liabilities acquired by reference to their fair values but no equivalent adjustment is made for tax purposes (see paragraph 19);
  (b) assets are revalued and no equivalent adjustment is made for tax purposes (see paragraph 20);
  (c) goodwill or negative goodwill arises on consolidation (see paragraphs 21 and 32);
  (d) the tax base of an asset or liability on initial recognition differs from its initial carrying amount, for example when an enterprise benefits from non-taxable government grants related to assets (see paragraphs 22 and 33); or
  (e) the carrying amount of investments in subsidiaries, branches and associates or interests in joint ventures becomes different from the tax base of the investment or interest (see paragraphs 38 - 45).
 
Business Combinations
19. In a business combination that is an acquisition, the cost of the acquisition is allocated to the identifiable assets and liabilities acquired by reference to their fair values at the date of the exchange transaction. Temporary differences arise when the tax bases of the identifiable assets and liabilities acquired are not affected by the business combination or are affected differently. For example, when the carrying amount of an asset is increased to fair value but the tax base of the asset remains at cost to the previous owner, a taxable temporary difference arises which results in a deferred tax liability. The resulting deferred tax liability affects goodwill (see paragraph 66).
 
Assets Carried at Fair Value
20. Statements of Standard Accounting Practice permit certain assets to be carried at fair value or to be revalued (see, for example, SSAP 13, Accounting for investment properties, SSAP 17, Property, plant and equipment, SSAP 29, Intangible Assets and SSAP 24, Accounting for investments in securities.) In some jurisdictions, the revaluation or other restatement of an asset to fair value affects taxable profit (tax loss) for the current period. As a result, the tax base of the asset is adjusted and no temporary difference arises. In other jurisdictions, the revaluation or restatement of an asset does not affect taxable profit in the period of the revaluation or restatement and, consequently, the tax base of the asset is not adjusted. Nevertheless, the future recovery of the carrying amount will result in a taxable flow of economic benefits to the enterprise and the amount that will be deductible for tax purposes will differ from the amount of those economic benefits. The difference between the carrying amount of a revalued asset and its tax base is a temporary difference and gives rise to a deferred tax liability or asset. This is true even if:
  (a) the enterprise does not intend to dispose of the asset. In such cases, the revalued carrying amount of the asset will be recovered through use and this will generate taxable income which exceeds the depreciation that will be allowable for tax purposes in future periods; or
  (b) tax on capital gains is deferred if the proceeds of the disposal of the asset are invested in similar assets. In such cases, the tax will ultimately become payable on sale or use of the similar assets.
Goodwill
21. Goodwill is the excess of the cost of an acquisition over the acquirer's interest in the fair value of the identifiable assets and liabilities acquired. Many taxation authorities do not allow the amortisation of goodwill as a deductible expense in determining taxable profit. Moreover, in such jurisdictions, the cost of goodwill is often not deductible when a subsidiary disposes of its underlying business. In such jurisdictions, goodwill has a tax base of nil. Any difference between the carrying amount of goodwill and its tax base of nil is a taxable temporary difference. However, this Statement does not permit the recognition of the resulting deferred tax liability because goodwill is a residual and the recognition of the deferred tax liability would increase the carrying amount of goodwill.
Initial Recognition of an Asset or Liability1
22. A temporary difference may arise on initial recognition of an asset or liability, for example if part or all of the cost of an asset will not be deductible for tax purposes. The method of accounting for such a temporary difference depends on the nature of the transaction which led to the initial recognition of the asset:
  (a) in a business combination, an enterprise recognises any deferred tax liability or asset and this affects the amount of goodwill or negative goodwill (see paragraph 19);
  (b) if the transaction affects either accounting profit or taxable profit, an enterprise recognises any deferred tax liability or asset and recognises the resulting deferred tax expense or income in the income statement (see paragraph 59);
  (c) if the transaction is not a business combination, and affects neither accounting profit nor taxable profit, an enterprise would, in the absence of the exemption provided by paragraphs 15 and 24, recognise the resulting deferred tax liability or asset and adjust the carrying amount of the asset or liability by the same amount. Such adjustments would make the financial statements less transparent. Therefore, this Statement does not permit an enterprise to recognise the resulting deferred tax liability or asset, either on initial recognition or subsequently (see example below). Furthermore, an enterprise does not recognise subsequent changes in the unrecognised deferred tax liability or asset as the asset is depreciated.

_________________________

1 In accordance with SSAP 1 paragraph 23, management could consider IAS 32, Financial Instruments: Disclosure and Presentation, when accounting for a compound financial instrument. Under IAS 32, the issuer of a compound financial instrument (for example, a convertible bond) classifies the instrument's liability component as a liability and the equity component as equity. In some jurisdictions, the tax base of the liability component on initial recognition is equal to the initial carrying amount of the sum of the liability and equity components. The resulting taxable temporary difference arises from the initial recognition of the equity component separately from the liability component. Therefore, the exception set out in paragraph 15(b) of this Statement does not apply. Consequently, an enterprise recognises the resulting deferred tax liability. In accordance with paragraph 61 of this Statement, the deferred tax is charged directly to the carrying amount of the equity component. In accordance with paragraph 58 of this Statement, subsequent changes in the deferred tax liability are recognised in the income statement as deferred tax expense (income).
 
Example illustrating paragraph 22(c)

An enterprise intends to use an asset which cost $1,000 throughout its useful life of five years and then dispose of it for a residual value of nil. The tax rate is 40%. Depreciation of the asset is not deductible for tax purposes. On disposal, any capital gain would not be taxable and any capital loss would not be deductible.

As it recovers the carrying amount of the asset, the enterprise will earn taxable income of $1,000 and pay tax of $400. The enterprise does not recognise the resulting deferred tax liability of $400 because it results from the initial recognition of the asset.

In the following year, the carrying amount of the asset is $800. In earning taxable income of $800, the enterprise will pay tax of $320. The enterprise does not recognise the deferred tax liability of $320 because it results from the initial recognition of the asset.
23. [Not used]
 
Deductible Temporary Differences
24. A deferred tax asset should be recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised, unless the deferred tax asset arises from:
  (a) negative goodwill which is treated as deferred income in accordance with SSAP 30, Business combinations; or
  (b) the initial recognition of an asset or liability in a transaction which:
    (i) is not a business combination; and
    (ii) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).
  However, for deductible temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, a deferred tax asset should be recognised in accordance with paragraph 44.
25. It is inherent in the recognition of a liability that the carrying amount will be settled in future periods through an outflow from the enterprise of resources embodying economic benefits. When resources flow from the enterprise, part or all of their amounts may be deductible in determining taxable profit of a period later than the period in which the liability is recognised. In such cases, a temporary difference exists between the carrying amount of the liability and its tax base. Accordingly, a deferred tax asset arises in respect of the income taxes that will be recoverable in the future periods when that part of the liability is allowed as a deduction in determining taxable profit. Similarly, if the carrying amount of an asset is less than its tax base, the difference gives rise to a deferred tax asset in respect of the income taxes that will be recoverable in future periods.
             
Provisions such as guarantees, product warranties or employee entitlements (including long service payments) made for accounting purposes on an estimated basis may be deducted in determining accounting profit in the reporting period in which the liability for such items arises, but deducted in determining taxable profit when paid. The example below illustrates a circumstance in which a deferred tax asset arises.
 
EXAMPLE

An example of circumstances that give rise to a deferred tax asset

An enterprise recognises a liability of $100 for accrued product warranty costs. For tax purposes, the product warranty costs will not be deductible until the enterprise meets claims. The tax rate is 30%.
   

Carrying Amount

Tax Base

Temporary Difference

   

$

$

$

Accrued Warranty Costs  

100

Nil

100

Tax rate  

30%
____

Deferred Tax Asset  

30

The tax base of the liability is nil (carrying amount of $100, less the deductible amount of $100 in respect of that liability in future periods). In settling the liability for its carrying amount, the enterprise will reduce its future taxable amount by $100 and, consequently, reduce its future tax payments by $30 (calculated as $100 x 30%). The difference between the carrying amount of $100 and the tax base of nil is a deductible temporary difference of $100. Therefore, the enterprise recognises a deferred tax asset of $30 (calculated as $100 x 30%), provided that it is probable that the entity will earn sufficient taxable amounts in future periods to benefit from a reduction in tax payments.
             
26. The following are examples of deductible temporary differences which result in deferred tax assets:
  (a) retirement benefit costs may be deducted in determining accounting profit as service is provided by the employee, but deducted in determining taxable profit either when contributions are paid to a fund by the enterprise or when retirement benefits are paid by the enterprise. A temporary difference exists between the carrying amount of the liability and its tax base; the tax base of the liability is usually nil. Such a deductible temporary difference results in a deferred tax asset as economic benefits will flow to the enterprise in the form of a deduction from taxable profits when contributions or retirement benefits are paid;
  (b) research costs are recognised as an expense in determining accounting profit in the period in which they are incurred but may not be permitted as a deduction in determining taxable profit (tax loss) until a later period. The difference between the tax base of the research costs, being the amount the taxation authorities will permit as a deduction in future periods, and the carrying amount of nil is a deductible temporary difference that results in a deferred tax asset;
  (c) in a business combination that is an acquisition, the cost of the acquisition is allocated to the assets and liabilities recognised, by reference to their fair values at the date of the exchange transaction. When a liability is recognised on the acquisition but the related costs are not deducted in determining taxable profits until a later period, a deductible temporary difference arises which results in a deferred tax asset. A deferred tax asset also arises where the fair value of an identifiable asset acquired is less than its tax base. In both cases, the resulting deferred tax asset affects goodwill (see paragraph 66); and
  (d) certain assets may be carried at fair value, or may be revalued, without an equivalent adjustment being made for tax purposes (see paragraph 20). A deductible temporary difference arises if the tax base of the asset exceeds its carrying amount.
27. The reversal of deductible temporary differences results in deductions in determining taxable profits of future periods. However, economic benefits in the form of reductions in tax payments will flow to the enterprise only if it earns sufficient taxable profits against which the deductions can be offset. Therefore, an enterprise recognises deferred tax assets only when it is probable that taxable profits will be available against which the deductible temporary differences can be utilised.
28. It is probable that taxable profit will be available against which a deductible temporary difference can be utilised when there are sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity which are expected to reverse:
  (a) in the same period as the expected reversal of the deductible temporary difference; or
  (b) in periods into which a tax loss arising from the deferred tax asset can be carried back or forward.
  In such circumstances, the deferred tax asset is recognised in the period in which the deductible temporary differences arise.
29. When there are insufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, the deferred tax asset is recognised to the extent that:
  (a) it is probable that the enterprise will have sufficient taxable profit relating to the same taxation authority and the same taxable entity in the same period as the reversal of the deductible temporary difference (or in the periods into which a tax loss arising from the deferred tax asset can be carried back or forward). In evaluating whether it will have sufficient taxable profit in future periods, an enterprise ignores taxable amounts arising from deductible temporary differences that are expected to originate in future periods, because the deferred tax asset arising from these deductible temporary differences will itself require future taxable profit in order to be utilised; or
  (b) tax planning opportunities are available to the enterprise that will create taxable profit in appropriate periods.

Example illustrating paragraph 29(a)

An enterprise has a tax loss of $1000 which can be carried forward for 5 years. The estimated cumulative taxable profits for the next five years are $600. It is estimated that $400 of the tax loss will expire unused. The tax rate is 30%.

The enterprise recognises a deferred tax asset of $180 ($600 x 30%)

Suppose the enterprise expects to buy a machine that costs $300 with a useful life for accounting purposes of 2 years, and a useful life for the purpose of calculating tax depreciation of 3 years. In year 1, a deductible temporary difference of $50 (representing the tax base of $200 less the carrying amount of $150) will arise corresponding to taxable income of $50 and a further deductible amount (and taxable income) of $50 will arise in year 2. These differences will reverse (with a reduction of $100 in taxable profit) in year 3.

The enterprise ignores the taxable income of $50 in years 1 and 2 when evaluating whether there is sufficient taxable profit to utilise the tax loss carried forward. This is because it merely creates another deductible temporary difference, which itself needs to be tested for recoverability.
30. Tax planning opportunities are actions that the enterprise would take in order to create or increase taxable income in a particular period before the expiry of a tax loss or tax credit carryforward. For example, in some jurisdictions, taxable profit may be created or increased by:
  (a) electing to have interest income taxed on either a received or receivable basis;
  (b) deferring the claim for certain deductions from taxable profit;
  (c) selling, and perhaps leasing back, assets that have appreciated but for which the tax base has not been adjusted to reflect such appreciation; and
  (d) selling an asset that generates non-taxable income (such as, in some jurisdictions, a government bond) in order to purchase another investment that generates taxable income.
  Where tax planning opportunities advance taxable profit from a later period to an earlier period, the utilisation of a tax loss or tax credit carryforward still depends on the existence of future taxable profit from sources other than future originating temporary differences.
31. When an enterprise has a history of recent losses, the enterprise considers the guidance in paragraphs 35 and 36.
         
  Negative Goodwill
32. This Statement does not permit the recognition of a deferred tax asset arising from deductible temporary differences associated with negative goodwill which is treated as deferred income in accordance with SSAP 30, Business Combinations, because negative goodwill is a residual and the recognition of the deferred tax asset would increase the carrying amount of negative goodwill.
         
  Initial Recognition of an Asset or Liability
33. One case when a deferred tax asset arises on initial recognition of an asset is when a non-taxable government grant related to an asset is deducted in arriving at the carrying amount of the asset but, for tax purposes, is not deducted from the asset's depreciable amount (in other words its tax base); the carrying amount of the asset is less than its tax base and this gives rise to a deductible temporary difference. Government grants may also be set up as deferred income in which case the difference between the deferred income and its tax base of nil is a deductible temporary difference. Whichever method of presentation an enterprise adopts, the enterprise does not recognise the resulting deferred tax asset, for the reason given in paragraph 22.
         
Unused Tax Losses and Unused Tax Credits
34. A deferred tax asset should be recognised for the carryforward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised.
35. The criteria for recognising deferred tax assets arising from the carryforward of unused tax losses and tax credits are the same as the criteria for recognising deferred tax assets arising from deductible temporary differences. However, the existence of unused tax losses is strong evidence that future taxable profit may not be available. Therefore, when an enterprise has a history of recent losses, the enterprise recognises a deferred tax asset arising from unused tax losses or tax credits only to the extent that the enterprise has sufficient taxable temporary differences or there is convincing other evidence that sufficient taxable profit will be available against which the unused tax losses or unused tax credits can be utilised by the enterprise. In such circumstances, paragraph 82 requires disclosure of the amount of the deferred tax asset and the nature of the evidence supporting its
recognition.
36. An enterprise considers the following criteria in assessing the probability that taxable profit will be available against which the unused tax losses or unused tax credits can be utilised:
  (a) whether the enterprise has sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, which will result in taxable amounts against which the unused tax losses or unused tax credits can be utilised before they expire;
  (b) whether it is probable that the enterprise will have taxable profits before the unused tax losses or unused tax credits expire;
  (c) whether the unused tax losses result from identifiable causes which are unlikely to recur; and
  (d) whether tax planning opportunities (see paragraph 30) are available to the enterprise that will create taxable profit in the period in which the unused tax losses or unused tax credits can be utilised.
  To the extent that it is not probable that taxable profit will be available against which the unused tax losses or unused tax credits can be utilised, the deferred tax asset is not recognised.
         
Re-assessment of Unrecognised Deferred Tax Assets
37. At each balance sheet date, an enterprise re-assesses unrecognised deferred tax assets. The enterprise recognises a previously unrecognised deferred tax asset to the extent that it has become probable that future taxable profit will allow the deferred tax asset to be recovered. For example, an improvement in trading conditions may make it more probable that the enterprise will be able to generate sufficient taxable profit in the future for the deferred tax asset to meet the recognition criteria set out in paragraphs 24 or 34. Another example is when an enterprise re-assesses deferred tax assets at the date of a business combination or subsequently (see paragraphs 67 and 68).
         
Investments in Subsidiaries, Branches and Associates and Interests in Joint Ventures
38. Temporary differences arise when the carrying amount of investments in subsidiaries, branches and associates or interests in joint ventures (namely the parent or investor's share of the net assets of the subsidiary, branch, associate or investee, including the carrying amount of goodwill) becomes different from the tax base (which is often cost) of the investment or interest. Such differences may arise in a number of different circumstances, for example:
  (a) the existence of undistributed profits of subsidiaries, branches, associates and joint ventures;
  (b) changes in foreign exchange rates when a parent and its subsidiary are based in different countries; and
  (c) a reduction in the carrying amount of an investment in an associate to its recoverable amount.
  In consolidated financial statements, the temporary difference may be different from the temporary difference associated with that investment in the parent's separate financial statements if the parent carries the investment in its separate financial statements at cost or revalued amount.
39. An enterprise should recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint ventures, except to the extent that both of the following conditions are satisfied:
  (a) the parent, investor or venturer is able to control the timing of the reversal of the temporary difference; and
  (b) it is probable that the temporary difference will not reverse in the foreseeable future.
40. As a parent controls the dividend policy of its subsidiary, it is able to control the timing of the reversal of temporary differences associated with that investment (including the temporary differences arising not only from undistributed profits but also from any foreign exchange translation differences). Furthermore, it would often be impracticable to determine the amount of income taxes that would be payable when the temporary difference reverses. Therefore, when the parent has determined that those profits will not be distributed in the foreseeable future the parent does not recognise a deferred tax liability. The same considerations apply to investments in branches.
41.  An enterprise accounts in its own currency for the non-monetary assets and liabilities of a foreign operation that is integral to the enterprise's operations. Where the foreign operation's taxable profit or tax loss (and, hence, the tax base of its non-monetary assets and liabilities) is determined in the foreign currency, changes in the exchange rate give rise to temporary differences. Because such temporary differences relate to the foreign operation's own assets and liabilities, rather than to the reporting enterprise's investment in that foreign operation, the reporting enterprise recognises the resulting deferred tax liability or (subject to paragraph 24) asset. The resulting deferred tax is charged or credited in the income statement (see paragraph 58).
42. An investor in an associate does not control that enterprise and is usually not in a position to determine its dividend policy. Therefore, in the absence of an agreement requiring that the profits of the associate will not be distributed in the foreseeable future, an investor recognises a deferred tax liability arising from taxable temporary differences associated with its investment in the associate. In some cases, an investor may not be able to determine the amount of tax that would be payable if it recovers the cost of its investment in an associate, but can determine that it will equal or exceed a minimum amount. In such cases, the deferred tax liability is measured at this amount.
43. The arrangement between the parties to a joint venture usually deals with the sharing of the profits and identifies whether decisions on such matters require the consent of all the venturers or a specified majority of the venturers. When the venturer can control the sharing of profits and it is probable that the profits will not be distributed in the foreseeable future, a deferred tax liability is not recognised.
44. An enterprise should recognise a deferred tax asset for all deductible temporary differences arising from investments in subsidiaries, branches and associates, and interests in joint ventures, to the extent that, and only to the extent that, it is probable that:
  (a) the temporary difference will reverse in the foreseeable future; and
  (b) taxable profit will be available against which the temporary difference can be utilised.
45. In deciding whether a deferred tax asset is recognised for deductible temporary differences associated with its investments in subsidiaries, branches and associates, and its interests in joint ventures, an enterprise considers the guidance set out in paragraphs 28 to 31.
 

Measurement

46. Current tax liabilities (assets) for the current and prior periods should be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been enacted or substantively enacted by the balance sheet date.
47. Deferred tax assets and liabilities should be measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the balance sheet date.
48. Current and deferred tax assets and liabilities are usually measured using the tax rates (and tax laws) that have been enacted. However, in some jurisdictions, announcements of tax rates (and tax laws) by the government have the substantive effect of actual enactment, which may follow the announcement by a period of several months. In these circumstances, tax assets and liabilities are measured using the announced tax rate (and tax laws).
49. When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are measured using the average rates that are expected to apply to the taxable profit (tax loss) of the periods in which the temporary differences are expected to reverse.
50. [Not used]
51. The measurement of deferred tax liabilities and deferred tax assets should reflect the tax consequences that would follow from the manner in which the enterprise expects, at the balance sheet date, to recover or settle the carrying amount of its assets and liabilities.
         
More...