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Case Study 8
Wiley lFRS: Practical Implementation Guide and Workbook
Facts
An entity purchases plant and equipment for $2 million. In the tax jurisdiction, there are no tax al–
lowances available for the depreciation of this asset; neither are any profits or losses on disposal taken
into account for taxation purposes. The entity depreciates the asset at 25% per annum. Taxation is 30%.
Required
Explain the deferred tax position of the plant and equipment on initial recognition and at the first year–
end after initial recognition.
Solution
The asset would have a tax base of zero on initial recognition, and this would normally give rise to a
deferred tax liability of $2 million
@
30%, or $600,OOO.This would mean that an immediate tax expense
has arisen before the asset was used. lAS 12 prohibits the recognition of this expense. This could be
classified as a permanent difference.
At the date of the first accounts, the asset would have been depreciated by, say, 25% of $2 million, or
$500,000. As the tax base is zero, this would normally cause a deferred tax liability of $1.5
@
30%, or
$450,000. However, this liability has arisen from the initial recognition of the asset and therefore is not
provided for.
6.5 A further temporary difference not recogni zed relates to investment s in subsidiaries , associ–
ates, and joint ventures. Normally deferred tax assets and liabi lities should be recognized on these
investments. Such temp orary differenc es often will be as a resu lt of the undi stributed profits of
such entities. However , where the parent or the inves tor can control the timing of the reversa l of a
taxable temp orary difference and it is probable that the temporary difference will not reverse in the
foreseeable future, then a deferred tax liabil ity should not be recog nized. Th is would be the case
where the parent is abl e to contro l when and if the reta ined profits of the subsidiary are to be dis–
tributed.
6.6 Similarly, a deferred tax asset should not be recognized if the temporary difference is ex–
pected to continue into the fore seeable future and there are no tax able profits available against
which the temporary difference can be offset.
6.7 In the case of a joint venture or an associate, norm ally a deferred tax liab ility would be rec–
ognized, because normally the investor cannot control the dividend policy. However , if there is an
agreement between the parti es that the profits will not be distributed , then a deferred tax liabil ity
would not be provided for.
7. DEFERRED TAX ASSETS
7.1
Dedu ctibl e temporary differences give rise to deferred tax assets. Examples of this are tax
losses carried forward or temporary differences arising on provisions that are not allowable for
taxation until the future.
7.2 These deferred tax assets can be recognized if it is prob able that the asse t will be realized.
7.3 Realization of the asset will depend on whether there are sufficient taxa ble profits ava ilab le in
the future .
7.4 Suffi cient taxable profits can arise from three different sources:
( I) They can arise from existing taxable temporary differences. In principle, these differences
should reverse in the same acco unting period as the reversal of the dedu ctible temporary
differenc e or in the per iod in which a tax loss is expec ted to be used .
(2) If there are insufficient taxabl e temp orary differences, the entity may recognize the
deferred tax asse t where it fee ls that the re will be future taxable profit s, other than those
arisi ng from taxabl e temporary differences. Th ese profits should relate to the same taxable
authority and enti ty.
(3) The entity may be able to prove that it ca n create tax plann ing opportunities whereby the
deductible temp orary differenc es can be utilized.