Deferred tax—tax base of assets and liabilities (Agenda Paper 12B)

Background

The IFRS Interpretations Committee (the Committee) received a submission about the recognition of deferred tax in relation to leases (when a lessee recognises an asset and a liability at the lease commencement) and decommissioning obligations (when an entity recognises a liability and includes the decommissioning costs in the cost of the item of PPE). The submitted fact pattern assumed that lease payments and decommissioning costs were deductible for tax purposes when paid and identified different approaches in practice.

The Committee discussed the submission at its meetings in March and June 2018 and observed that, in some situations, offsetting temporary differences arise on initial recognition of assets and liabilities related to leases or decommissioning obligations. The Committee then discussed whether an entity (i) recognises deferred tax for these temporary differences or (ii) applies the initial recognition exemption in IAS 12 Income Taxes.

Staff analysis

The staff analysed how an entity applies the requirements of IAS 12. The entity first considers whether temporary differences arise on initial recognition of a lease asset and lease liability. If the entity attributes tax deductions to the lease asset and future interest accrual, temporary differences do not arise on initial recognition of the lease asset and lease liability and the initial recognition exemption does not apply. If the entity attributes tax deductions to the repayment of the principal amount of the lease liability and the future interest accrual temporary differences arise on initial recognition.

In this latter situation the staff think the entity applies the initial recognition exemption and thus does not recognise a deferred tax asset or liability on initial recognition of the lease asset and lease liability. This is because an entity applies the initial recognition exemption separately to the asset and liability recognised in the statement of financial position.

At the Committee’s March 2018 meeting, some Committee members said the diversity in reporting methods result from differing interpretations of the requirements in IAS 12 and in particular the application of the initial recognition exemption and that, in their view, resolving the matter would require standard-setting.

In exploring possible standard-setting options the staff analysed the effects of applying (or not applying) the initial recognition exemption to the subsequent accounting of income taxes and the purpose of the initial recognition exemption and whether it is necessary in the fact pattern described in the submission.

Committee’s discussions and recommendation

The Committee explored two possible standard-setting options to address the matter: develop a narrow-scope amendment to IAS 12 so that the initial recognition exemption would not apply to the fact pattern described in the submission; or develop an Interpretation on how an entity applies the requirements in IAS 12 to the fact pattern described in the submission.

The Committee recommended that the International Accounting Standards Board propose a narrow-scope amendment to IAS 12 so that the initial recognition exemption would not apply to transactions that give rise to both taxable and deductible temporary differences to the extent the amounts recognised for the temporary differences are the same.

Question for the Board

The Board has been asked if it agrees with the Committee’s recommendation.

Discussion

The key concepts in IAS 12 were recapped using the slides included within Agenda Paper 12C.

It was clarified that the initial recognition exemption is a mandatory one, rather than optional.

There was some concern that the impact of the proposed amendment would not be material for most entities and that the cost of implementing would outweigh the benefits. Along with the implication of adopting IFRS 16 Leases there were concerns that there would be a lot of work required and a Board member asked whether there would be ways to simplify the process.

It was also noted that currently there is diversity in practice and that it was desirable to address this. It was also noted that entities would currently have to separately identify items that are covered by the exemption from those that are not so there would be some cost and time saving realised from no longer having to perform this exercise.

A Board member noted that in some jurisdictions the tax rules are made to follow the accounting rules. However under IFRS 16 tax receipts for the authorities will decrease initially as the lessee benefits from higher tax-deductible expenses earlier in the lease period while the lessor’s taxable income is received on a straight-line basis. Consequently the tax laws may not harmonise with the accounting issues. Whilst this is not very significant currently, there is the potential to be significant in the future if, for example, interest rates increase.

Following a query, the staff confirmed that their proposal would be to permit early application of the amendment to allow entities to take advantage of matching up the amendment with the adoption of IFRS 16.

A comment was made that whilst one of the proposed responses to the issue was for the Committee to provide an Interpretation of how tax bases should be assessed, this could have cast doubt on the treatment previously adopted by entities. By making an amendment to IAS 12 this would allow any previous treatment to remain unchallenged and for this change to effectively confirm what the correct treatment is going forward.

A suggestion was made to expand the proposed amendment by clarifying that the initial recognition exemption assessment would also apply to any deferred tax asset not recognised initially due to recoverability issues, i.e. that an assessment for applying the initial recognition exemption would be performed first followed by any impairment test on the recoverability of a deferred tax asset. This would avoid any asymmetrical issues arising between the deferred tax asset and deferred tax liability recognised and subsequently measured.

The staff clarified that when both deferred tax assets and deferred tax liabilities were recognsied following the amendment, the specific rules of offsetting in IAS 12 would then apply in relation to disclosure. The staff noted that in several cases they would likely meet the criteria for offsetting.

Decision

All Board members agreed with the recommendation and the staff confirmed they would explore the recoverability of the deferred tax asset issue raised.