ACCOUNTING FOR TAXATIONLearning objectivesAccount for current taxation in accordance with relevant accounting standards.Record entries relating to income tax in the accounting recordsExplain the effect of taxable temporary differences on accounting and taxable profits
Introduction:Companies are normally responsible for collection and payment of three types of taxes namely:Pay as you earn( PAYE) – This is a payroll tax paid by the employees on their salaries and wages and other benefits and is collected and paid by the company on the employees’ behalf.Corporation Tax – This is paid by corporations based on their profits.Income Tax (IAS 12)A Company is a legal person and therefore is liable for income tax on its profits made for the year. The income tax is assessable and payable on the taxable income which is regulated by the tax laws in place not on the profits as reported in the statement of comprehensive income.
Definitions:Accounting profit- Net profit or loss for a period before deducting tax expense.Taxable profit(Tax loss) The profit(loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payableTax expense(Tax Income) The aggregate amount included in the determination net profit or loss for the period in respect of current tax and deferred taxCurrent tax– is the amount of income taxes payable (recoverable) in respect of the taxable profit(Tax loss) for a period.
Recognition of current tax liabilities and assets
IAS 12 requires anyunpaid taxin respect of the current or prior periods to be recognised as aliabilityAnyexcess taxpaid in respect of current or prior periods over what is due should be recognised as anassetExample:In 2012 Dalton co had taxable profits of N$120,000. In the previous year (2011) income tax on 2011 profits had been estimated as N$30,000Required:Assuming 30%tax rate, calculate tax payable and the charge for 2012 if the tax due on 2011 profits was subsequently agreed with the tax authorities as:(a) 35,000 or(b) 25,000Any under or over payments are not settled until the following years tax payment is due
SOLUTIONTax due on 2012 profits (120,000 x 30% = 36,000Underpayment for 20115,000Tax Charge and liability41,000Tax due on 2012 profits .................Overpayment for 2011 .................Tax charge and liability .................
IAS 12 also requires recognition as an asset of the benefit relating to any tax loss that can becarried backto recover current tax of a previous period. This is acceptable because it is probable that the benefit will flow to the entity and it can be reliably measured.Example: Tax losses carried back.In 2011 Erasmus Co paid N$50,000 in tax on its profits In 2012 the company made tax losses of N$24,000. The local tax authority rules allow losses to be carried back to offset against current tax of prior years.Required:Show the tax charge and tax liability for 2012.
The repayment due on tax losses = 30% x24,000 = N$7,200The double entry will be:DEBIT Tax receivable( SOFP) N$ 7,200CREDIT Tax repayment (SOCI) N$ 7,200The tax receivable will be shown as an asset until the repayment is received from the tax authorities.
PRESENTATION:In the statement of financial position, tax assets and liabilities should be shown separately from other assets and liabilities.Current tax assets and liabilities can beoffsetbut this should happen only when certain conditions apply.The entity has a legally enforceable right to set off the recognised amountsThe entity tends to settle the amount on a net basis or to realise the asset and settle the liability at the same time.
WHAT IS DEFERRED TAX?Deferred tax is:• the estimated future tax consequences of transactions and events recognised in the financial statements of the current and previous periods.Deferred taxation is a basis of allocating tax charges to particular accounting periods.The key to deferred taxation lies in the two quitedifferent concepts of profit:The accounting profit (or the reported profit), which is the figure of profit before tax, reported to the shareholders in the published accountsThe taxable profit, which is the figure of profit on which the taxation authorities base their tax calculations
Accounting profit and taxable profitThe difference between accounting profit and taxable profit is caused by:• Permanent differences.• Temporary differences.Permanent differences are:• one off differences between accounting and taxable profits caused by certain items not being taxable/allowable.• differences which only impact on the tax computation of one period.• differences which have no deferred tax consequences whatsoeverAn example of a permanent difference isclient entertaining expenses.
Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base (the amount attributed to that asset or liability for tax purposes).Deferred tax is the tax attributable totemporary differenceswhich are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base.These can be either:a) Taxable temporary differences- results in taxable amounts in determining taxable profit of future periods when the carrying amount of the asset or liability is recovered or settled. Taxable temporary differences give rise todeferred tax liabilitiesb) Deductible temporary differences- result in amounts that are deductible in determining taxable profit of future periods when the carrying amount of the asset or liability is recovered or settled. Deductible temporary differences give rise todeferred tax assets
Before we move on let uslook at these definitionsTax base of an asset.The tax base of an asset is the amount that will be deductible for taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset.Tax base of a liability.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 infuture periodsThe difference between the carrying amount and tax base is called TEMPORARY DIFFERENCE.The temporary difference multiplied by the tax rate will give:The deferred tax balance in the statement of financial position.
Example:A non –current asset costing NS 2000 was acquired at the start of year 1. it is being depreciated straight line over 4 years, resulting in annual depreciation charges of N$500. Thus a total of N$2000 of depreciation is being charged. The capital allowances granted on this asset are:N$Year 1 800Year 2 600Year 3 360Year 4240Total capital allowances 2000Required : Calculate the taxable temporary differences for years 1-4 and the deferred tax including the movement in the deferred tax liability assuming 25% tax rate.
Year Carrying amount Tax base Temporary difference1 1500 1200 3002 1000 600 4003 500 240 2604 nilnilnil
Deferred taxYear 1 = 300 x 25% = 75Year 2 = 400 x 25 = 100Year 3 = 260 x 25% = 65Year 4 = Nil since carrying amount = tax base
Year 1Dr Tax expense ( P& L) 75Cr Deferred tax liability (sofp) 75Year 2Dr Tax expense 25Cr Deferred tax liability 25Year 3Dr Deferred tax liability 35Cr Tax expense 35
The movement in the liability are recorded in the income statement as part of the taxation charge
The movement in the deferred tax liability in the year is recorded in the income statement where:An increase in the liability, increases the tax expenseA decrease in the liability decreases the tax expenseThe Closing figures are reported in the statement of financial position as the deferred tax liability
Continuing with the previous example, suppose that the profit before tax of the entity for each of years 1-4 is N$ 10000( After charging depreciation) since the tax rate is 25% it would be logical to expect the tax expense for each year to be N$ 2500. HOWEVER INCOME TAX IS BASED ON TAXABLE PROFITS NOT ON ACCOUNTING PROFITS.
The taxable profits and so the actual tax liability for each year could be calculated as follows:
AS we have seen in the example, accounting for deferred tax then results in a further increase or decrease in the tax expense. Therefore the final tax expense for each year reported in the income statement would be as below
MEASUREMENT OF DEFERRED TAX.
There are two methods of measuring deferred tax, although IAS 12 only refers to one.The income statement approach ;andBalance Sheet approachThe latest version of IAS 12 refers only to the Balance sheet method and therefore the Income Statement method will not be amplified in this study.
TheBalance sheet method requires deferred tax to be measured based on the difference between :The carrying amount of the entity’s assets and liabilities, andThe Tax base of each of the entity’s assets and liabilitiesThe SOFP approach thus requires that we compare thecarrying amountof each of the assets and liabilities with itstax base .Thecarrying amountof an asset or liability is thebalancerecognised in the statement of financial position based in International financial reporting standards.The tax base of an asset or liability is the balance calculated based on Tax legislation.
The definition of a tax base of an asset refers to two types of assetsAn asset that represents a future inflow of economic benefits that will be taxable.( e.g) plant earning taxable profitsAn asset that represent a future inflow of economic benefits that will not be taxable( e.g an Investment earning exempt dividend income
If the inflow will be taxable, the tax base is the future deductionsIf the inflow will not be taxable the tax base will be its carrying amount.
The definition of a tax base of a liability refers to two types of a liabilityLiabilities that represent income received in advanceLiabilities that represent expenses
If the liability is income received in advance,the tax base will its carrying amount less the portion that wont be taxable in the future.In the case of any other liabilityThe tax base will be its carrying amount less any portion that represents future deductions(i.e the portion of the carrying amount that will not be allowed as a tax deduction inthe future.
Useful format for calculating deferred Tax using the balance sheet approach
TEST YOUR UNDERSTANDING.
QUESTION 2 . JULIAN
SOLUTION TO QUESTION 2
ASSETSIf the carrying amount is greater than the tax base then it’s a tax liabilityLIABILITIESIfthe carrying amount is greater than the tax base then it’s a tax asset