Share-Based Payment: Questions & Answers

IAS 12 Handout 1

Essentials Deferred Tax

A. Examples basic concepts

Example 1 – Tax base of an asset

A machine cost Shs 200,000. For tax purposes, wear & tear of Shs 50,000 has already been deducted and the remaining cost will be deductible in future periods. Revenue generated by using the machine (that is, recovering the carrying amount of the machine) is taxable. The machine has been depreciated for accounting purposes by Shs 40,000. What is the tax base of the machine?

An entity has a US dollar receivable, recognized initially at Shs 100,000. At year-end the entity recognized an unrealized exchange loss of Shs 10,000, valuing the receivable at Shs 90,000. The unrealized loss was not allowed as tax deductible, but will be once realized. What is the tax base of the receivable?

A bank has loans receivable of Shs 1 billion. The bank has booked specific provisions for impairment losses totalling Shs 80 million, and a portfolio provision for impairment losses of Shs 20 million (net carrying value = Shs 900 million). The specific provision has been treated as tax deductible, but the portfolio provision has not. What is the tax base of the loans receivable?

Example 4 – Tax base of a liability

An entity has trade creditors of Shs 60,000. What is the tax base of the liability?

The entity has recognised a provision of Shs 5,000,000 related to the settlement of a law suit. The payment will not be deductible for tax purposes. What is the tax base of the provision?

The entity has provided for termination payments of Shs 6,000,000 under a restructuring scheme. The amounts will be tax deductible only when paid. What is the tax base of the liability?

Example 7 – Applicable tax rate

The income tax rate in Country A for 20X4 is 30%. At 31 October 20X4, the parliament of Country A approved a tax cut which will result in an income tax rate of 25%. The new tax rate will be effective beginning for years beginning 1 January 20X5.

If the company prepares the financial statements for the year ended 31 December 20X4, which tax rate should be used to calculate deferred income taxes at the year end?

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Example 8 – Applicable tax rate

An EPZ company has been granted a tax holiday until 31 December 2007. Thereafter it will have to pay income tax at the concessionary rate of 25% for the next 10 years. At 31 December 2005 the company has a taxable temporary difference of Shs 10 million relating to its plant & machinery. Of this temporary difference, Shs 2 million is expected to reverse by 31 December 2007. Calculate its deferred tax liability at 31 December 2005.

B. Questions - Specific issues

Question 1 – Consolidated accounts

Entity A manufactures and sells products to a foreign subsidiary (B Ltd), who in turn sells them to third parties. Tax rate of Entity A is 30%, whilst the tax rate of B Ltd is 40%. During the year Entity A has sold products to B Ltd for Shs 200,000, recording a profit of Shs 20,000 in its own books. At the end of 20X4, the unsold inventory is stated in the Group’s consolidation balance sheet at Shs 90,000, i.e. net of the unrealised profits of Shs 10,000. No equivalent adjustment to inventory is made for tax purposes.

What is the amount of the deferred tax asset/liability related to this transaction at the end of 20X4?

Question 2 – Initial recognition exemption

At 14 June 20X4, entity A purchases a luxury car from a car producer. The car is for the use of the company’s chief executive officer. The purchase price of the car is Shs 5,000,000. The car will be depreciated over 5 years for accounting purposes. The cost of the car that can be depreciated for tax purposes is restricted to Shs 1,000,000. The income tax rate is 30%.

Carrying amount of the car 5,000,000 Tax base of the car 1,000,000

What amount of deferred income tax should be recognised at 14 June 20X4?

Question 3 - Assets carried at fair value

Entity A buys the following on 1 January 2004:  Freehold land for shs 10 million  An industrial building for Sha 102 million  An office building for Shs 51 million.

At 31 December 2004 the carrying values were:  Freehold land – Shs 10 million  Industrial building – Shs 100 million  Office building – Shs 50 million.

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Tax allowances, including an investment deduction, were claimed on the industrial building and the residual value for tax purposes at 31 December 2004 was Shs 40 million. The income tax rate is 30%. There is no capital gains tax.

The company revalued its assets on 1 January 2005 to:  Freehold land – Shs 15 million  Industrial building – Shs 120 million  Office building – Shs 65 million.

Compute the deferred tax liability to be recognised in entity A’s balance sheet relating to each asset at 1 January 2004, 31 December 2004, and 1 January 2005.

On 2 January 2005, 100% of the issued shares of entity A were acquired by entity B. The valuation amounts above were considered to be the fair values of the assets on the acquisition of the business.

Compute the deferred tax liability that entity B should recognise in respect of the above assets for the purposes of determining the goodwill on acquisition.

Question 4 – Strategy to implement an exit plan

An entity has a history of recent losses. Management has developed an exit plan in which a loss- making activity will be discontinued. Management intend to implement the measures from March 20X5.

Management expects to reverse the losses over the two years following the implementation of the exit plan, and proposes that a deferred tax asset is recognised in respect of the losses incurred using the exit plan to justify the recognition of the deferred tax asset.

Management is preparing the 31 December 20X4 financial statements. The current date is January 20X5 and the plan has not yet been made public.

Can management recognise a deferred tax asset based on a strategy to implement an exit plan?

Question 5 – Recognition of deferred tax asset

In 20X4, a company has taxable temporary differences of Shs 40,000, which result in a deferred tax liability, that are expected to reverse in 20X8. The company also has deductible temporary differences of Shs 60,000, which would result in a deferred tax asset, that are expected to reverse in 20X8. The management of the company expects that the company will have a taxable gain for the first time in its history in 20X8. No business plan is available for this period. No tax planning opportunities are available to create taxable profits.

The company's tax rate is 30%. Assume that the company has the right to offset deferred tax assets and liabilities.

What is the amount of deferred tax asset and deferred tax liability before netting, and what amount should be included in the company’s balance sheet at 31 December 20X4?

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Question 6 – proof of tax

C Ltd’s tax computation for the year ended 31 December 2004 is as follows:

Shs Shs Accounting profit 56,783,000

Add back: Depreciation of office building 2,000,000 Depreciation of industrial building 3,000,000 Depreciation of plant and machinery 2,500,000 Depreciation of saloon car* 1,500,000 Unrealised exchange losses (trading items) 300,000 Donations 1,000,000 Fines 700,000 11,000,000 67,783,000 Less: Industrial building allowance 2,000,000 Wear & Tear allowances 2,100,000 Dividend from subsidiary 5,000,000 9,100,000

Taxable profit 58,683,000

Tax at 30% 17,604,900

*The saloon car cost Shs 6,000,000 and was restricted to Shs 1,000,000 for tax purposes.

Based on the above information, what would you expect the tax expense to be after adjusting for the deferred tax movement?