Deferred Tax 102

I trust my previous publication, “Deferred tax 101” duly introduces you to the basics of deferred taxes. I trust you wouldn’t shy away from subsequent deferred tax discussions by the end of this article, after which a solid foundation would have been built, hopefully. This is not an invitation to treat, remember the carlill v carbolic smoke ball case, Lol. Enjoy the meal as usual!

We have agreed from my previous article that deferred taxes arise from timing differences. We also concluded that both the accounting and tax implication of an element of financial statement will be the same only that it is a matter of time, hence timing difference; Pls. re-read the previous article for clarity on this.

Brethren, the timing difference is the difference between carrying amount of an asset or liability and its tax base. Tax base here is the amount of an asset or liability that would be ascribed to tax.

For an asset that cost N100m, useful life of 4 years depreciable on straight line. Capital allowance is assumed at 20%. At the end of year carrying amount would be N75m (N100m-(100m/4yrs) but the amount we will ascribe to tax as far as this asset is concerned is after applying what tax relates with, the language tax understands; which is the capital allowance rate. So tax base becomes, N80m.

Forget it, at every point in time, to determine the tax base of an asset or liability, one should ask oneself what amount would be ascribed or attributed to tax as far as the asset or liability is concerned. One’s answer is the tax base. You might want to recheck your mind hasn’t shown you lagoon sha. LOL!

Deferred tax liability

You would have a deferred tax liability where there is a timing difference that is taxable. A taxable temporary difference here implies that you would have taxable amounts while determining taxable profit of future periods when the asset or liability is recovered or settled. English, yeah? Chillax, we are going practical as usual.

Imagine you made sales of N200m, N50m was credit sales; you obviously have an asset in an expectation account as you didn’t receive the N50m in cash, hence Receivable of N50m. If the tax law in your jurisdiction taxes income on cash basis, it then means there would be a temporary difference of N50m. your mind is asking, how naa? I read mind, LOL!

Recall that temporary difference is the difference between the carrying amount of an asset (interest receivable of N50m) and the tax base of 0. The tax base is 0 because as far as the receivable is concerned, there is no portion of it that is taxable in the current year, it becomes taxable at a later date when the receivable would have been realized and becomes nothing. I only hope this makes sense to you.

What inference can we draw from this scenario and how does it give rise to a deferred tax liability? Obviously, we know we have a temporary difference, the question is whether it tax now taxable, which gives rise to deferred tax liability. Here is the logic, it means that I wouldn’t be obliged to pay the tax consequence of the N50m today but unavoidably when the N50m is realized in cash (in the future), I become obliged to settle the tax implication of the N50m difference. Meaning that the N50m is a difference that would give rise to taxable amount while determining taxable profit or future periods (the date the N50m turned cash and hence taxable). Re-read please, there is sense in it. LOL!

A funny analogy here is for you “aunty potential bride”, better raise the bar while making your choice of man, because you will get married to someone from a different background and become part of the person (timing difference as of today), so you have to be sure, today’s love and affection for the person does not result into severe burdens (taxable temporary difference, hence deferred tax liability) in the future because of the decision you are making today.

Deferred tax asset

A deferred tax asset arises from a deductible temporary difference, carry-forward of unused tax losses and tax credits.

E be like sey, assets own much right? But, yeah, no much thinking is required, just give me your heart (only girls should o, guys, dey your dey!) LOL!!!

IAS 12 espouses that timing difference is said to be deductible, if the difference results in to amounts that are deductible from future taxable profit when the asset or liability are realized or settled. Let us go to the practical lab as always.

You accrued for N10m rent, but paid N8m. it means you have a payable of N2m to the landlord. If the tax law allows only expenses that are cash-backed, there is a timing difference of the N2m obviously. This N2m is the carrying amount of the liability; accrued rent while the tax base is 0 as there is no portion of the N2m that could be attributed to tax in the current period. The 2m would have been disallowed as a reduction to taxable profit, meaning you would have paid more tax today but there is solace; the comfort here is that the N2m becomes deductible or allowable as it were, against any future taxable profit, when the liability is settled. Makes sense?

Away from deductible difference, where an entity has an unused tax losses or credits that could be carried forward against future profit (which obviously seems to have passed the deductible difference presumption or logic), a deferred tax may be recognized.

Recognition of deferred tax asset is quite strict because it is an asset of course. So, entities do not use this to boost their net assets value unnecessarily, IAS 12 has clear requirement for recognition. Deferred taxes are recognized to the extent that it is highly probable the asset would be recovered. How? To the extent that it is probable that deductible differences would be recouped by future taxable profit and that the unused tax losses and credits can be utilized. I leave you and your company’s auditors to battle this out, LOL!

Accounting for deferred taxes

Accounting here is straight forward, a first time deferred tax liability is credited to deferred tax liability account (as the name implies of course) and then debited to income tax expense (meaning, It increases your  current tax expense in profit or loss). It is worthy of notes here that where the temporary difference arises from an OCI item like revaluation surplus, deferred tax adjustment is taken to the extent.

A reverse entry is what goes to a deferred tax asset, debit deferred tax asset, credit income tax expense in the statement of profit or loss.

Please note that deferred tax asset/liability is calculated as --- deductible difference/taxable difference X applicable tax rate.

Hmmmm, the tax rate is another discussion. But let me just say in very brief summary that it is the tax rate based on relevant tax laws at reporting date and must reflect the expected manner of recovery or settlement of your timing difference. If my intention is to sell an asset, I would rather use the capital gains tax rate than use income tax rate which would have been tenable, if I want to keep using the asset and realize by depreciating.

The story is long this time, but I hope you enjoyed it. I hope this piece convinces you that IAS 12’s deferred tax isn’t even as “indaboskious” let alone be a “liquid metal” as we have perceived.

Esteemed readers, please keep staying safe from Covid-19, this time shall pass by God’s limitless grace.

Your, IFRS Pal,

Sobur ‘Lekan Bello.