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IAS 12: Income Tax

Examples of Temporary Difference – Deductible Temporary Differences

The following are examples of deductible temporary differences that result in deferred tax assets:

(a) retirement benefit costs may be deducted in determining accounting profit as service is provided by the employee, but deducted in determining taxable profit either when contributions are paid to a fund by the entity or when retirement benefits are paid by the entity. A temporary difference exists between the carrying amount of the liability and its tax base; the tax base of the liability is usually nil. Such a deductible temporary difference results in a deferred tax asset as economic benefits will flow to the entity in the form of a deduction from taxable profits when contributions or retirement benefits are paid;

(b) preliminary expenses are recognised as an expense in determining accounting profit in the period in which they are incurred but may not be permitted as a deduction in determining taxable profit (tax loss) until a later period(s). The difference between the tax base of the preliminary expenses, being the amount permitted as a deduction in future periods under taxation laws, and the carrying amount of nil is a deductible temporary difference that results in a deferred tax asset;

(c) with limited exceptions, an entity recognises the identifiable assets acquired and liabilities assumed in a business combination at their fair values at the acquisition date. When a liability assumed is recognised at the acquisition date but the related costs are not deducted in determining taxable profits until a later period, a deductible temporary difference arises which results in a deferred tax asset. A deferred tax asset also arises when the fair value of an identifiable asset acquired is less than its tax base. In both cases, the resulting deferred tax asset affects goodwill; and

(d) certain assets may be carried at fair value, or may be revalued, without an equivalent adjustment being made for tax purposes. A deductible temporary difference arises if the tax base of the asset exceeds its carrying amount.

Example:

An entity recognises a liability of Rs. 100 for gratuity and leave encashment expenses by creating a provision for gratuity and leave encashment. For tax purposes, any amount with regard to gratuity and leave encashment will not be deductible until the entity pays the same. The tax rate is 25%.

The tax base of the liability is nil (carrying amount of Rs. 100, less the amount that will be deductible for tax purposes in respect of that liability in future periods). In settling the liability for its carrying amount, the entity will reduce its future taxable profit by an amount of Rs. 100 and, consequently, reduce its future tax payments by Rs. 25 (Rs. 100 at 25%). The difference between the carrying amount of Rs. 100 and the tax base of nil is a deductible temporary difference of Rs. 100. Therefore, the entity recognises a deferred tax asset of Rs. 25 (Rs. 100 at 25%), provided that it is probable that the entity will earn sufficient taxable profit in future periods to benefit from a reduction in tax payments.

When there are insufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, the deferred tax asset is recognised to the extent that:

(a) it is probable that the entity will have sufficient taxable profit relating to the same taxation authority and the same taxable entity in the same period as the reversal of the deductible temporary difference (or in the periods into which a tax loss arising from the deferred tax asset can be carried back or forward). In evaluating whether it will have sufficient taxable profit in future periods, an entity ignores taxable amounts arising from deductible temporary differences that are expected to originate in future periods, because the deferred tax asset arising from these deductible temporary differences will itself require future taxable profit in order to be utilised; or

(b) tax planning opportunities are available to the entity that will create taxable profit in appropriate periods


Sale and Leaseback Transactions (IFRS 16)

A sale and leaseback transaction involves the transfer of an asset by an entity (the seller-lessee) to another entity (the buyer-lessor) and the leaseback of the same asset by the seller-lessee. Because IFRS 16 requires lessees to recognise most leases on the balance sheet (i.e., all leases except for leases of low-value assets and short-term leases depending on the lessee’s accounting policy election), sale and leaseback transactions no longer provide lessees with a source of off-balance sheet financing. Another key change is that both the seller-lessee and the buyer-lessor are required to apply IFRS 15 to determine whether to account for a sale and leaseback transaction as a sale and purchase of an asset

An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (ie an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset

Goods and services are assets, even if only momentarily, when they are received and used (as in the case of many services). Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset.

The benefits of an asset are the potential cash flows (inflows or savings in outflows) that can be obtained directly or indirectly in many ways, such as by:

(a) Using the asset to produce goods or provide services (including public services);

(b) Using the asset to enhance the value of other assets;

(c) Using the asset to settle liabilities or reduce expenses;

(d) Selling or exchanging the asset;

(e) Pledging the asset to secure a loan; and

(f) Holding the asset.

When evaluating whether a customer obtains control of an asset, an entity shall consider any agreement to repurchase the asset.

Existence of a leaseback, in isolation, does not preclude a sale. This is because a lease is different from the sale or purchase of an underlying asset, as a lease does not transfer control of the underlying asset. Instead, it transfers the right to control the use of the underlying asset for the period of the lease. However, if the seller-lessee has a substantive repurchase option for the underlying asset (i.e., a right to repurchase the asset), no sale has occurred because the buyer-lessor has not obtained control of the asset.

A lessee that has an option to extend a lease for substantially all of the remaining economic life of the underlying asset is, economically, in a similar position to a lessee that has an option to purchase the underlying asset. Therefore, when the renewal price is not fair value at the time the renewal option is exercised, the renewal option would prohibit sale accounting

If the transfer of an asset by the seller-lessee satisfies the requirements of IFRS 15 to be accounted for as a sale of the asset:

(a) The seller-lessee shall measure the right-of-use asset arising from the leaseback at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee. Accordingly, the seller-lessee shall recognise only the amount of any gain or loss that relates to the rights transferred to the buyer-lessor.

(b) The buyer-lessor shall account for the purchase of the asset applying applicable Standards, and for the lease applying the lessor accounting requirements in this Standard.

If the fair value of the consideration for the sale of an asset does not equal the fair value of the asset, or if the payments for the lease are not at market rates, an entity shall make the following adjustments to measure the sale proceeds at fair value:

(a) Any below-market terms shall be accounted for as a prepayment of lease payments; and

(b) Any above-market terms shall be accounted for as additional financing provided by the buyer-lessor to the seller-lessee.

The entity shall measure any potential adjustment on the basis of the more readily determinable of:

(a) The difference between the fair value of the consideration for the sale and the fair value of the asset; and

(b) The difference between the present value of the contractual payments for the lease and the present value of payments for the lease at market rates.

Example— Sale and leaseback transaction

An entity (Seller-lessee) sells a building to another entity (Buyer-lessor) for cash of $2,000,000. Immediately before the transaction, the building is carried at a cost of $1,000,000. At the same time, Seller-lessee enters into a contract with Buyer-lessor for the right to use the building for 18 years, with annual payments of $120,000 payable at the end of each year. The terms and conditions of the transaction are such that the transfer of the building by Seller-lessee satisfies the requirements for determining when a performance obligation is satisfied in IFRS 15 Revenue from Contracts with Customers. Accordingly, Seller-lessee and Buyer-lessor account for the transaction as a sale and leaseback. This example ignores any initial direct costs.

The fair value of the building at the date of sale is $1,800,000. Because the consideration for the sale of the building is not at fair value Seller-lessee and Buyer-lessor make adjustments to measure the sale proceeds at fair value. The amount of the excess sale price of $200,000 ($2,000,000 — $1,800,000) is recognised as additional financing provided by Buyer-lessor to Seller-lessee.

The interest rate implicit in the lease is 4.5% per annum, which is readily determinable by Seller-lessee. The present value of the annual payments (18 payments of $120,000, discounted at 4.5% per annum) amounts to $1,459,200, of which $200,000 relates to the additional financing and $1,259,200 relates to the lease—corresponding to 18 annual payments of $16,447 and $103,553, respectively.

Buyer-lessor classifies the lease of the building as an operating lease.

Seller-lessee

At the commencement date, Seller-lessee measures the right-of-use asset arising from the leaseback of the building at the proportion of the previous carrying amount of the building that relates to the right-of-use retained by Seller-lessee, which is $699,555. This is calculated as: $1,000,000 (the carrying amount of the building) ÷ $1,800,000 (the fair value of the building) x $1,259,200 (the discounted lease payments for the 18-year right-of-use asset).

Seller-lessee recognises only the amount of the gain that relates to the rights transferred to Buyer-lessor of $240,355 calculated as follows. The gain on sale of building amounts to $800,000 ($1,800,000 – $1,000,000), of which:

(a) $559,645 ($800,000 ÷ $1,800,000 x $1,259,200) relates to the right to use the building retained by Seller-lessee; and

(b) $240,355 ($800,000 ÷ $1,800,000 x ($1,800,000 - $1,259,200)) relates to the rights transferred to Buyer-lessor.

After the commencement date, Buyer-lessor accounts for the lease by treating $103,553 of the annual payments of $120,000 as lease payments. The remaining $16,447 of annual payments received from Seller-lessee are accounted for as (a) payments received to settle the financial asset of $200,000 and (b) interest revenue.

At the commencement date, Seller-lessee accounts for the transaction as follows.

Cash $2,000,000

Right-of-use asset $699,555

Building $1,000,000

Financial liability $1,459,200

Gain on rights transferred $240,355

Buyer-lessor

At the commencement date, Buyer-lessor accounts for the transaction as follows.

Building $1,800,000

Financial asset $200,000 (18 payments of $16,447, discounted at 4.5%)

Cash $2,000,000

After the commencement date, Buyer-lessor accounts for the lease by treating $103,553 of the annual payments of $120,000 as lease payments. The remaining $16,447 of annual payments received from Seller-lessee are accounted for as (a) payments received to settle the financial asset of $200,000 and (b) interest revenue

Transfer of the asset is not a sale

If the transfer of an asset by the seller-lessee does not satisfy the requirements of IFRS 15 to be accounted for as a sale of the asset:

(a) The seller-lessee shall continue to recognise the transferred asset and shall recognise a financial liability equal to the transfer proceeds. It shall account for the financial liability applying IFRS 9.

(b) The buyer-lessor shall not recognise the transferred asset and shall recognise a financial asset equal to the transfer proceeds. It shall account for the financial asset applying IFRS 9.


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