Deferre d taxes an d effec tive tax ra te reconcilia tion — Approach under Ind AS

Computation of deferred taxes using the balance-sheet approach

Deferred taxes under Ind AS are computed using the balance-sheet approach. While in principle, the concept of deferred tax is similar to Indian GAAP, the approach adopted for computation is different. This approach is based on the principle that each asset and liability has a value for tax purposes, considered the tax base. Differences between the carrying amount of an asset/liability and its tax base are temporary differences. Deferred tax assets/liabilities are computed using the substantially enacted tax rate on such temporary differences which are either taxable or deductible in the future periods, subject to specific exemptions under Ind AS 12.

Temporary differences are either taxable temporary differences or deductible temporary differences. A taxable temporary difference results in the payment of tax when the carrying amount of an asset or liability is settled. This means that a deferred tax liability will arise when the carrying value of an asset is greater than its tax base, or the carrying value of a liability is less than its tax base. Deductible temporary differences are differences that result in amounts being deductible in determining taxable profit or loss in future periods when the carrying value of an asset or liability is recovered or settled. When the carrying value of a liability is greater than its tax base or the carrying value of an asset is less than its tax base, a deferred tax asset may arise.

Summary of accounting for deferred tax

In summary, the approach for computing deferred tax under Ind AS is as follows:

•  Determine the tax base of the assets and liabilities
• Compare the carrying amounts in the balance sheet with the tax base, and identify all taxable/ deductible temporary differences apart from the specific exceptions under Ind AS
• Apply the tax rate to the temporary differences to determine the value of deferred tax assets/ liabilities to be recorded. 

Case study

Given below is the balance sheet of an entity as at 31 December 20X2

The first step is to determine the tax base of the above assets and liabilities

Note 1: Land

Consider that under the entity’s tax jurisdiction the indexed cost of land is considered as the cost of land while calculating the profit on sale of such land. Hence the indexed cost of land (tax base) will exceed the book value of land by the indexation benefit provided each year resulting in a deductible temporary difference.

Note 2: Plant and equipment

The original cost of plant and equipment is assumed to be INR 20mn purchased on 1 January 20X2 having an estimated useful life of four years. Depreciation in the books is provided on a straight-line basis. The depreciation rate for tax purposes is 50% and is calculated on a written-down value method. Accordingly, at the end of year 1, the accounting base of Property, Plant and Equipment is INR 15mn and the tax base is INR 10mn resulting in a taxable temporary difference of INR 5mn.

Note 3: Dividend receivable

One of the entity investees has declared a dividend of INR 10mn and the entity has recognised a receivable in its financial statements. In the jurisdiction of the entity, dividends are tax-exempt. In this case, no deferred tax liability is recognised, following either of these analyses:

• The tax base of the receivable is zero and therefore there is a temporary difference of INR 10mn; however, the tax rate that will apply is zero when the cash is received. Therefore, no deferred tax liability is recognised.
• The tax base of the receivable is INR 10mn since, in substance; the full amount will be tax deductible (i.e., the economic benefits are not taxable). Therefore, no deferred tax liability is recognised as the tax base is equal to the carrying amount of the asset.

Note 4: Trade receivables

The entity has net debtors of INR 6mn after recognising a bad debt provision of INR 2mn in the books. In the jurisdiction of the entity, tax does not allow a deduction for provision of bad debts and allows a deduction only in the year the company records a bad debt write-off. Hence, the tax base for trade receivables is INR 8mn. This results in a deductible temporary difference which will reverse when the debtor is actually written off in the books and tax allows a deduction.

Note 5: Interest receivable

The entity has accrued interest receivable of INR 5 mn, which will be considered as income for tax purposes only when it receives it in cash. Hence the tax base of the receivable equals zero. This difference results in a taxable temporary difference because the amount will be taxed in a future period i.e., when the cash is received.

Note 6: Loan

The entity has taken a loan of INR 12 mn on 31 December 20X2 and has incurred an upfront loan processing fee (transaction cost) of INR 1 mn. As per Ind AS 39, the entity records the loan value, net of the processing fee as INR 11mn. Consider that under the entity’s tax jurisdiction, such costs are allowed as a deduction in the year when they are incurred. Hence the tax base of the loan is INR 12 mn leading to a taxable temporary difference of INR 1 mn. In the future years, there will be a reversal of this difference as and when the transactions costs are charged to the income statement as per the effective interest rate method under Ind AS 39.

Note 7: Business loss

Consider that the entity has incurred book losses during the current period of INR 4 mn. The tax loss of the current year amounts to INR 21.3 mn. These losses can be carried forward for a period of eight years and claimed as a set-off against tax profits earned in the future. The loss during the current year is on account of an identifiable cause that is unlikely to occur in the future periods. The entity determines that it is probable that future tax profits will be available to recover the deferred tax asset recognised on these losses. In this case, there is an asset tax base of INR 21.3 mn while the accounting base is nil leading to a deductible temporary difference.

Thus the deferred tax computation under the balance sheet approach is as shown in table on previous page:

Effective tax rate reconciliation

One of the mandatory disclosures required by Ind AS 12 is the disclosure of the effective tax rate reconciliation. Effective tax rate reconciliation is explained under Ind AS 12 as a numeric reconciliation between the actual tax expense/income i.e., sum of the current and deferred tax; and the expected tax expense/income i.e., product of accounting profit multiplied by the applicable tax rate. There are two approaches to disclose this reconciliation — reconcile the effective tax rate percentage to the actual tax rate percentage or reconcile the absolute actual income tax expense to the expected tax expense. We have adopted the second approach in the illustration below. Continuing the case study above, consider that the computation of taxable income/loss for the entity is as under:

All temporary differences not considered as part of the deferred tax computations since they are neither deductible, nor taxable in future periods (for example, donations and penalties or dividends) or considered additionally under the deferred tax computations, but will impact taxable income in future periods (for example, land indexation) will form part of the effective tax rate reconciliation.

The approach under Ind AS 12 for computing deferred taxes and related effective tax rate disclosure ensures that all possible tax impacts to be recorded in the financial statements have been determined. It also helps the reader of the financial statements correlate the tax and account-ing position of the company leading to better understanding of the financial statements.