Cover Paper (Agenda Paper 13)

The objective of the Equity Method project is to assess whether application questions with the equity method, as set out in IAS 28, can be addressed in consolidated and individual financial statements by identifying and explaining principles in IAS 28.

The purpose of this meeting is to decide:

• How to answer the application question: Does an investor recognise a deferred tax asset (or liability) on the difference between its share of the fair value and the tax base of the associate’s identifiable assets and liabilities?
• Whether to move the Equity Method research project to its standard-setting work plan and work towards publishing an exposure draft as the next due process step

For this purpose, the staff prepared two papers, one for each topic.

Initial recognition of an investment in an associate—deferred taxes (Agenda Paper 13A)

This agenda paper was originally posted for the March 2023 IASB meeting as Agenda Paper 13D but was not discussed.

The purpose of this session was to discuss the application question: Does an investor recognise deferred tax assets or liabilities on the differences between the fair value and the tax base of its share of the associate’s identifiable assets and liabilities?

The equity method is applied from the date on which an investment becomes an associate or a joint venture. On obtaining significant influence, an investor applies IAS 28:32 and recognises its share of the net fair value of the investee’s identifiable assets and liabilities. This may require the investor to adjust the carrying amounts of investee’s assets and liabilities—for the purpose of this paper these adjustments are referred to as fair value adjustments.

The application question is asking if the investor should recognise deferred tax assets or liabilities on the fair value adjustments. For example: an investor purchases a 25% interest in an entity and obtains significant influence. The investor determines that the fair value of an item of equipment is 400CU. The tax basis and the carrying amount in the investee’s financial statements is 300CU. Does the investor recognise a deferred tax liability relating to its share of the fair value adjustment of 100CU?

Staff recommendation

The staff recommended that the IASB proposes the following answer to the application question:

“An investor recognises deferred tax assets or liabilities on the differences between the fair value and the tax base of its share of the associate’s identifiable assets and liabilities.”

IASB discussion

Several IASB members agreed with the staff recommendation but asked for the rationale for the conclusion to be updated. It was clarified that IAS 12 is not being directly applied in order to recognise deferred tax on acquisition of an associate but that only the method within IAS 12 is applied by IAS 28 to calculate the deferred tax. This is similar to the concept of the method of IFRS 3, in allocating the purchase price, being applied by IAS 28 and it was agreed that the purchase price could not be allocated without also including deferred tax. 

One IASB member clarified that the deferred tax recognised is only the fair value adjustment, e.g. the difference between the fair value recognised by the investor and the carrying amount in the investee. The recommendation states that the deferred tax is recognised ‘on the differences between the fair value and the tax base’. However, this will only be the case when the investees tax base and carrying amount are the same.

One IASB member highlighted that deferred tax should only be calculated on the date of obtaining significant influence when the purchase price is allocated, not if there there are subsquent changes in an interest in an associate.

IASB decision

All IASB members voted in favour of the staff recommendation subject to the change in rationale suggested.

Moving the research project to the standard-setting work plan (Agenda Paper 13B)

The purpose of this paper was to ask the IASB whether to move the Equity Method project to its standard-setting work plan, work towards publishing an exposure draft (ED), set up a consultative group and update the project’s objectives to reflect the progress made.

In relation to the proposal to move the Equity Method project to the standard-setting work plan the staff highlighted that the due process criteria have been met as deficiencies in financial reporting standards have been identified. These have been demonstrated to be of importance to users and the issues are pervasive. Additionally, the preliminary analysis from staff indicated that the benefits of improvements to financial reporting are likely to outweigh the costs.

An ED, rather than a discussion paper, is proposed, given that the questions to be asked are based on tentative decisions reached by the IASB and do not change the requirements of IAS 28 (except for the tentative decision that an investor would recognise a full gain or loss on all transactions with its associate, for which it would itself be a simplification in the equity method).

A consultative group is not recommended given that the topic is not a specialist area and the existing consultative groups and targeted outreach will be sufficient for the project.

Staff recommendation

The staff recommended that the IASB:

• Moves the Equity Method research project to its standard-setting work plan
• Works towards publishing an ED as the next due process step
• Continues to use the expertise of its advisory bodies instead of establishing a consultative group
• Updates the project’s objective

IASB discussion

The majority of IASB members supported the staff recommendation.

One IASB member highlighted that they would prefer a discussion paper if the rationale for some views included conceptual arguments that were not derived from the principles in IAS 28. The IASB member noted agreement with the decisions made by the IASB previously and these could be supported without additional conceptual arguments that would require a discussion paper.

Some IASB members noted that they were surprised that the implications of decisions taken by the IASB on joint ventures had not been considered prior to moving the project to a standard-setting project. However, it was agreed that this would be part of standard-setting and it was important to maintain the momentum of the project.

Some IASB members highlighted that it was important not to overstate the usefulness of the information being considered in the project to users, but instead to see the benefits of the project as removing costs and solving conflicts.

IASB decision

13 of 14 IASB members supported the staff recommendation to produce an ED.

All IASB members supported the remaining staff recommendations.