Deferred tax calculation guidelines
The deferred tax calculation shows the amount of income tax payable or recoverable in future periods in respect of temporary differences and unused tax losses. Temporary differences are differences between the accounting and tax values of assets and liabilities. Temporary differences will often exist in relation to non-current assets and provisions.
The calculation of deferred tax on non-current assets, such as property, plant and equipment, is usually the most complicated part of the deferred tax calculation. The calculation would generally start with the asset values shown in the balance sheet and the value shown in the tax fixed asset register. However, adjustments will typically be required for buildings, land and goodwill. Adjustments may also be required for items recognised outside of the tax fixed asset register.
The calculation of deferred tax on building assets depends on the tax depreciation rate, the date of initial recognition, and whether the entity expects to recover the value of the asset by use or sale.
Building classified as property, plant and equipment
For most buildings classified as property, plant and equipment, the entity would be expecting to recover the asset value by use, rather than sale. As a result, the deferred tax in relation to these assets should generally be calculated based on the difference between the accounting value of the asset and its tax base. The tax base of an asset is the amount that will be deductible for tax purposes.
The removal of tax depreciation on buildings has reduced the tax base of certain building assets to zero. This has resulted in the recognition of additional deferred tax liabilities for many entities. However, in general, this additional liability only applies to building costs subject to 0% tax depreciation and recognised prior to 21 May 2010. In the deferred tax calculation, the tax book value of these assets should be deducted from the value shown in the tax fixed asset register. In general, this adjustment should remain unchanged from year to year, unless the asset is sold or is expected to be sold.
For building costs subject to 0% tax depreciation but recognised after 21 May 2010, the initial recognition exemption will generally apply, and no deferred tax will be recognised on the difference between the accounting value and the tax base. For these assets, deferred tax would not generally be recognised until the asset is revalued, and then only on the revaluation adjustment. Technically, both the cost-based accounting book value and the tax book value of these assets should be removed from the deferred tax calculation. However, in many cases, it may be acceptable to simply make no adjustment for these assets, as the book values for both tax and accounting should be very similar, at least initially.
For assets that are not subject to 0% tax depreciation, deferred tax is calculated based on the difference between tax and accounting book value. No adjustments are required to the values shown in the fixed asset registers. This would apply to building fit-out assets and certain structures (e.g. wharves, runways).
Buildings held for sale and investment property buildings
If the entity expects to recover the building value by sale, the deferred tax should be calculated based on the tax consequences of selling the asset at its carrying amount. This would apply to buildings held for sale and to investment properties, unless presumption of recovery by sale has been rebutted.
As any capital gain on sale will generally be exempt from tax, the deferred tax liability in relation to these assets would generally be calculated based on the amount of any tax depreciation recovery.
In the deferred tax calculation, both the accounting and tax values could be removed, and replaced with the amount of any tax depreciation recovery. Alternatively, the capital gain amount could be deducted from the accounting value.
If the presumption of recovery by sale has been rebutted, the deferred tax in relation to the investment property should be calculated on the same basis as buildings classified as property, plant and equipment.
The deferred tax associated with a non-depreciable asset, such as land, should reflect the tax consequences of selling the asset at its carrying amount. In most cases, the capital gain on sale of land will be exempt from tax. As a result, there will generally be no deferred tax liability associated with the revaluation of land.
Both the accounting and tax values for land, including investment property land, should be removed from the deferred tax calculation, unless the land has been acquired for resale. No adjustment is required for land acquired for resale, as the gain on sale would be subject to tax.
Deferred tax is not recognised on the initial recognition of goodwill. In the deferred tax calculation, the balance of goodwill should be deducted from the accounting value of intangible assets. Goodwill would no typically be included in the tax fixed asset register, but if it is, the amount included should also be deducted from the tax value.
Capital work in progress
If capital work in progress is included in the accounting values but not included in the tax values, either deduct capital work in progress from the accounting values or add capital work in progress to the tax values. If the tax value of capital work in progress differs from the accounting value, the tax value of capital work in progress
should be added to the tax column. The accounting and tax values of capital work in progress will generally be the same. However, differences could occur if the balance includes capitalised interest, assets purchased from overseas, or assets funded by government grants.
Adjustments may also be required for certain asset-related deductions claimed for tax purposes. Common examples include capital grants, customer contributions, expensed assets, internal profits and capitalised interest. Some entities calculate the tax depreciation impact of these items in a separate spreadsheet instead of reducing the cost values in the tax fixed asset register. If this is the case, the net value of these items will need to be deducted from the tax book value.
Adjustments may also be required if the tax fixed assets register includes revaluation gains or other non-depreciable balances.
In some cases, temporary differences will exist in relation to derivative financial instruments. The most common example is interest rate swaps. These derivatives may have a value for accounting purposes, but no value for tax purposes.
Provisions and adjustments
Most deferred tax calculations would include temporary differences associated with provisions, such as annual leave and doubtful debts. It may also include temporary differences for other tax calculation adjustments, such as work in progress or retentions receivable. The temporary differences for these items should generally agree to the closing balances shown in the current tax calculation.
In some cases, the deferred tax calculation will include tax losses carried forward. The figure for tax losses usually comes from the current tax calculation. It includes losses brought forward, losses for the current year, and losses from excess imputation credits, but it excludes any losses transferred to other entities.
Deferred tax on other comprehensive income
The movement in deferred tax for the year is generally charged to tax expense, unless it relates to items recognised in other comprehensive income.
Revaluations of fixed assets (other than land) typically result in a significant increase in deferred tax liability. The deferred tax expense associated with a revaluation gain should be recognised in other comprehensive income, and should be charged to the revaluation reserve, not retained earnings.
In most cases, deferred tax should also be recognised against hedge gains and losses shown in other comprehensive income.
Any deferred tax adjustment associated with a change in tax rates should also be recognised in other comprehensive to the extent that it relates to tax charged to reserves in prior periods.
Deferred tax assets
A deferred tax asset in relation to temporary differences or tax losses can only be recognised if it is probable that the entity will generate sufficient taxable profits against which the temporary differences or tax losses can be utilised.
If an entity has a deferred tax liability in relation to temporary differences, it can recognise a deferred tax asset in relation to losses to offset the deferred tax liability. However, if the deferred tax asset exceeds the deferred tax liability, the entity needs convincing evidence of future taxable income to be able to recognise a net deferred tax asset.
It would be unusual to see holding companies or local authorities with net deferred tax assets, as these entities usually generate tax losses, rather than taxable profits. However, at a group level, unrecognised tax losses in one company can be recognised to offset deferred tax liabilities in another company, provided that the losses can be transferred between these entities.
Any unrecognised temporary differences or tax losses should be separately disclosed in the tax note. However, this should exclude any losses that have been recognised as deferred tax assets.
The differential reporting framework provided a partial exemption from NZ IAS 12. Qualifying entities were allowed to account for income tax using the taxes payable method, and basically ignore deferred tax.
However, the differential reporting framework is being phased out, and the new accounting standards framework for public benefit entities (PBEs) and for-profit entities does not include a similar exemption from accounting for deferred tax.
Most entities that have applied the differential reporting framework will qualify to apply the Tier 2 reduced disclosure regime (RDR). RDR eliminates certain tax-related disclosure requirements but unlike differential reporting it has no recognition or measurement concessions. As a result, deferred tax will need to be recognised under RDR.
The new accounting standards for PBEs apply for reporting periods beginning on or after 1 July 2014. This includes PBE IAS 12, which is essentially the same as NZ IAS 12. As a result, a PBE with a June balance date would need to recognise deferred tax in their 2015 accounts.
For-profit entities cannot apply differential reporting for reporting periods beginning on or after 1 April 2015. For example, a for-profit entity with a June balance date would need to recognise deferred tax in their 2016 accounts.
In general, this change will require the calculation of comparative and opening deferred tax balances, and a restatement of the accounts (similar to transition to IFRS).
Some PBEs will qualify to apply the public sector PBE Tier 3 simple format accrual standard. This standard does not deal with the accounting for income tax. In our view, tax paying entities will need to account for current tax under this standard, but will not be required to account for deferred tax.
Page last updated: 18 March 2015Source: www.auditnz.govt.nz