Deferred Tax Liabilities
When deferred tax is being provided for, a full provision method is used under IAS 12.
To do this, the temporary difference is multiplied by the applicable enacted tax rate at the end of the reporting period.
An item in the financial statements may not be liable for tax until another financial period, or unless it is sold or disposed of.
Say, for example, if the revaluation of a machine increases its value by €100,000, the company may have to pay capital gains tax on this, but only if it sells the asset.
The tax won’t be payable on just a book gain, which is what we call an unrealised gain.
We still must note what the tax consequences of this would be however, this is what we called deferred tax.
Deferred tax is the amount of tax that will or may become payable in another financial period.
Probable Outflow of Cash
Deferred tax meets the definition of a liability under the IASB Conceptual Framework because it represents an obligation where a probable outflow of cash will be required.
Deferred tax is therefore shown as a liability in the statement of financial position.
This could also happen for interest receivable.
If the bank pays the company interest after the reporting period, the interest may be recognised in the reporting period because of the accruals concept.
The tax payable on this interest may not be payable until actually received, so the entity should create a deferred tax liability for the amount of tax payable on the interest received after the reporting period.
Capital Allowances
For an asset with capital allowances that are different to the depreciation, the deferred tax will be settled at a later date when the temporary difference is nil, this happens once the capital allowances and depreciation catch up with each other.
Unless the tax rates for the future periods until this happens have already been announced or enacted by the government, the current tax rate will serve as an approximation.
Any deferred tax liability should be updated each year as any changes to the tax rates are made.
Deferred Tax Expense
When creating a deferred tax liability in the statement of financial position, the expense is charged to either profit or loss for the period or to other comprehensive income for the period.
This will depend on how the item of income or expense to which the deferred tax liability relates to was charged.
Discounting
Normally if a liability will become payable in a few years, it would be discounted back to present value.
IAS 12 prohibits this, and any deferred tax asset or liability must be presented in full.
Deferred Tax Assets
Sometimes a temporary difference can result in a deferred tax asset.
This occurs with things like tax losses, where the entity can use the tax losses against taxable profits in the future.
Deferred tax assets must only be recognised to the extent that it is probable taxable profit will be available against which the deductible temporary difference can be used.
If there will be no future taxable profit to use, no deferred tax asset should be recognised.
Working Example
- Bantry Limited made a trading loss last year of €100,000 due to supplier problems.
- It expects to make a profit this year and in future accounting periods.
- It expects corporation tax will be payable in these future periods.
The trading loss carried forward will result in less tax payable in future periods when the company returns to profit.
This trading loss of €100,000 is a temporary difference which will result in a deferred tax asset.
If the rate of corporation tax is 12.5%, the deferred tax asset should be recognised as €12,500 (12.5% × €100,000).