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Income taxes — Key differences between U.S. GAAP and IFRSs

Under U.S. GAAP, ASC 740 is the primary source of guidance on accounting for income taxes.

Under IFRSs, IAS 12, Income Taxes, is the primary source of guidance on accounting for income taxes.

In general, the income tax accounting frameworks under both U.S. GAAP and IFRSs consist of the same basic principle concerning the basis of deferred tax assets and liabilities: the recognition of temporary differences between the carrying amount and tax basis of assets and liabilities in the financial statements.

The table below summarizes these differences and is followed by a detailed explanation of each difference.1

SubjectU.S. GAAPIFRSs
Classification of deferred tax assets and liabilities Classification is split between current and noncurrent components on the basis of either (1) the underlying asset or liability or (2) the expected reversal of items not related to an asset or liability. There is no split between current and noncurrent. All deferred tax assets and liabilities are classified as noncurrent.
Recognition of deferred tax assets Deferred tax assets are recognized in full and then reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax assets will not be recognized. No valuation allowance concerning deferred tax assets. Deferred tax assets are only recognized if it is probable (more likely than not) that they will be used.
Tax rate for measuring deferred tax assets and liabilities Enacted tax rates are used. Enacted or "substantively" enacted tax rates are used.
Uncertain tax positions ASC 740 prescribes a two-step recognition and measurement approach to determining the amount of tax benefit to recognize in the financial statements. IAS 12 does not specifically address the accounting for tax uncertainties. The recognition and measurement provisions of IAS 37 are relevant because an uncertain tax position may give rise to a liability of uncertain timing and amount. Recognition is based on whether it is probable that an outflow of economic resources will occur. Probable is defined as more likely than not. Measurement is based on the entity's best estimate of the amount of the tax benefit.
Tax consequences of intercompany sales Tax expense from intercompany sales is deferred until the related asset is sold or disposed of, and no deferred taxes are recognized for the purchaser's change in tax basis. Tax expense from intercompany sales is recognized, and the buyer's tax rate is used to recognize deferred taxes for the change in tax basis.
Deferred taxes on foreign nonmonetary assets/liabilities remeasured from local currency to functional currency No deferred tax is recognized on the remeasurement from local currency to functional currency. Deferred tax is recognized on the remeasurement from local currency to functional currency.
Other exceptions to the basic principle that deferred tax is recognized for all temporary differences

(1) Leveraged lease exemption — no deferred tax is recognized under ASC 740. See ASC 840-30 for information about the tax consequences of leveraged leases.

(2) No similar exception under U.S. GAAP.

(1) No similar exception under IFRSs.

(2) "Initial recognition" exemption — deferred tax is not recognized for taxable or deductible temporary differences that arise from the initial recognition of an asset or liability in a transaction that (a) is not a business combination and (b) at the time of the transaction does not affect accounting profit or taxable profit. Changes in this unrecognized deferred tax asset or liability are not subsequently recognized.
Special deductions (special deductions provide tax benefits under specific tax jurisdictions for unique industries or governmental purposes) Special-deduction tax benefits should not be anticipated by offsetting a deferred tax liability. Instead, such tax benefits should be recognized for financial reporting purposes no earlier than the year in which they are available to reduce taxable income on the entity's tax returns. In addition, the future tax effects of special deductions may nevertheless affect (1) the average graduated tax rate to be used in measuring deferred tax assets and liabilities when graduated tax rates are a significant factor and (2) the need for a valuation allowance for deferred tax assets. No similar guidance in IAS 12.
Share-based compensation Deferred tax is computed on the basis of share-based compensation expense recognized. Deferred tax is computed on the basis of the hypothetical tax deduction for the share-based payment in every period under the applicable tax law (i.e., intrinsic value).
Subsequent changes in deferred taxes that were originally charged or credited to equity (backward tracing) Backward tracing is generally prohibited. Subsequent changes to deferred taxes originally charged or credited to equity are generally allocated to continuing operations, not to equity. As with the initial treatment, IAS 12 requires that the resulting change in deferred taxes also be charged or credited back directly to equity.
Reconciliation of actual and expected tax rate

Required for public companies only; expected tax expense is computed by applying the domestic federal statutory rates to pretax income from continuing operations.

Nonpublic companies must disclose the reconciling nature of the reconciling items but not the amounts.
Required for all entities applying IFRSs; expected tax expense is computed by applying the applicable tax rate(s) to accounting profit, disclosing also the basis on which any applicable tax rate is computed.
Undistributed earnings on investments Deferred tax is recognized on all undistributed earnings, arising after 1992, of domestic subsidiaries and joint ventures. No deferred tax is recognized on undistributed earnings of foreign subsidiaries and corporate joint ventures if the duration of such earnings is considered permanent. Deferred tax is recognized on the undistributed earnings of any form of investee unless (1) the parent is able to control the timing of the reversal of the temporary difference and (2) it is probable that the temporary difference will not reverse in the foreseeable future.

Classification of Deferred Tax Assets and Liabilities

Under U.S. GAAP, ASC 740-10-45-4 states, "Deferred tax liabilities and assets shall be classified as current or noncurrent based on the classification of the related asset or liability for financial reporting." In addition, if the deferred tax is unrelated to an asset or liability (e.g., an operating loss carryforward), the classification on the balance sheet should be based on the expected reversal of the underlying temporary difference.

Under IFRSs, paragraph 56 of IAS 1 states, "When an entity presents current and non-current assets, and current and non-current liabilities, as separate classifications in its statement of financial position, it shall not classify deferred tax assets (liabilities) as current assets (liabilities)." Therefore, on the balance sheet (i.e., the balance sheet showing current and noncurrent assets and liabilities), all deferred tax assets and liabilities are classified as noncurrent.

Recognition of Deferred Tax Assets

Under U.S. GAAP, ASC 740-10-30-5(e) states that deferred tax assets are recognized in full and then reduced "by a valuation allowance if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50 percent) that some portion or all of the deferred tax assets will not be realized." The valuation allowance will "reduce the deferred tax asset to the [net] amount that is more likely than not to be realized."

Under IFRSs, deferred tax assets are only recognized to the extent that realizing them is probable (akin to U.S. GAAP's more-likely-than-not threshold). Therefore, there is no need for a deferred tax asset valuation allowance.

Tax Rate for Measuring Deferred Tax Assets and Liabilities

Under U.S. GAAP, deferred tax liabilities (assets) are measured at the enacted tax rates only. ASC 740-10-10-3 states that "the objective is to measure a deferred tax liability or asset using the enacted tax rate(s) expected to apply to taxable income in the periods in which the deferred tax liability or asset is expected to be settled or realized."

Under IFRSs, deferred tax liabilities (assets) should be measured at the tax rates that are expected to apply when the liability is settled or the asset is realized, on the basis of tax rates and laws that have been enacted or substantively enacted by the balance sheet date. Paragraph 48 of IAS 12 states, in part:

Current and deferred tax assets and liabilities are usually measured using the tax rates (and tax laws) that have been enacted. However, in some jurisdictions, announcements of tax rates (and tax laws) by the government have the substantive effect of actual enactment, which may follow the announcement by a period of several months. In these circumstances, tax assets and liabilities are measured using the announced tax rate (and tax laws).

Uncertain Tax Positions

Under U.S. GAAP, an entity cannot recognize a tax benefit in its financial statements unless it concludes that it is "more likely than not" that the benefit will be sustained on audit by the taxing authority solely on the basis of the technical merits of the associated tax position. Accordingly, an entity must assume that the position will be (1) examined by a taxing authority that has full knowledge of all relevant information and (2) resolved in the court of last resort. If the recognition threshold is not met, no benefit can be recognized, even when the entity believes that some amount of benefit will ultimately be realized.

If the recognition threshold is met, the tax benefit recognized is measured at the largest amount of the tax benefit that, in the entity's judgment, is more than 50 percent likely to be realized. The analysis should be based on the amount the taxpayer would ultimately accept in a negotiated settlement with the taxing authority. To compute the amount that is more than 50 percent likely to be realized, an entity must perform a cumulative-probability assessment of the possible outcome(s). Assigning probabilities in measuring a recognized tax position requires a high degree of judgment and should be based on all relevant facts, circumstances, and information.

Under IFRSs, no formal guidance yet exists concerning uncertain tax positions. Since IAS 12 does not specifically address accounting uncertainties, the recognition and measurement criteria of IAS 37, Provisions, Contingent Liabilities and Contingent Assets, are relevant because an uncertain tax position may give rise to a liability of uncertain timing and amount. Recognition is based on whether it is probable that an outflow of economic resources will occur. Probable is defined as more likely than not. Measurement is based on the entity's best estimate of the amount of the tax benefit.

Tax Consequences of Intercompany Sales

Under U.S. GAAP, when accounting for the tax consequences of intercompany sales between different tax jurisdictions, an entity should use the seller's tax rate to eliminate intercompany profit on the internal transaction. The FASB has concluded that an entity's income statement should not reflect a tax consequence for intercompany sales that are eliminated in consolidation. The current tax paid or payable from the sale (of inventory or other assets) is deferred upon consolidation (as a prepaid income tax) and is not recorded until the inventory or other asset is sold to an unrelated party. In addition, under U.S. GAAP, the buyer is prohibited from recognizing a temporary difference between the book carrying amount and the asset's tax base.

Under IFRSs, the deferred tax effect must be recognized on consolidation for intercompany sales. For example, an intercompany sale creates a temporary difference between the book carrying amount of the asset and its tax base. When intercompany entities operate in different tax jurisdictions, are subject to different tax rates,or both, the rate used is that at which the temporary difference is expected to reverse, which generally is that of the buyer's tax jurisdiction. If the buyer's tax rate is different from the seller's tax rate, the deferred tax recognized may not entirely offset the taxes payable from the sale in consolidation.

Deferred Taxes on Foreign Nonmonetary Assets/Liabilities Remeasured From Local Currency to Functional Currency

Under U.S. GAAP, ASC 740 prohibits recognition of deferred tax consequences for differences that arise from changes in exchange rates or indexing for tax purposes for those foreign subsidiaries that are required to use historical rates to remeasure nonmonetary assets and liabilities from the local currency into the functional currency. Although this basis difference technically meets the definition of a temporary difference under ASC 740, the FASB has concluded that to account for it as a temporary difference is to effectively recognize deferred taxes on exchange gains and losses that are not recognized in the income statement under ASC 830.

Under IFRSs, deferred taxes are recognized. Paragraph 41 of IAS 12 states:

The non-monetary assets and liabilities of an entity are measured in its functional currency (see IAS 21, The Effects of Changes in Foreign Exchange Rates). If the entity's taxable profit or tax loss (and, hence, the tax base of its non-monetary assets and liabilities) is determined in a different currency, changes in the exchange rate give rise to temporary differences that result in a recognised deferred tax liability or (subject to paragraph 24) asset. The resulting deferred tax is charged or credited to profit or loss (see paragraph 58).

Other Exceptions to the Basic Principle That Deferred Tax Is Recognized for All Temporary Differences

Leveraged Leases

Under U.S. GAAP, an exemption is made in applying the basic principles of ASC 740 for leveraged leases. Under ASC 840-30, the tax consequences of leveraged leases are incorporated directly into the lease accounting measurements; therefore, no temporary differences are recognized.

IFRSs do not include a concept of leveraged leases.

Initial Recognition

Under IFRSs, deferred tax is not provided on temporary differences that arise from the initial recognition of an asset or liability in a transaction that (1) is not a business combination and (2) does not affect accounting profit or taxable profit. In addition, changes in this unrecognized deferred tax asset or liability are not subsequently recognized. For example, in some tax jurisdictions, certain assets may not be deductible for tax purposes. That is, an asset's book basis is greater than its tax basis of zero. In this situation, even though the difference between the asset's book basis and tax basis represents an initial temporary difference, IFRSs do not permit the recognition of the deferred taxes on the basis of the "initial recognition" exemption. IFRSs state that the recognition of deferred tax in this case would simply gross up the balance sheet and make the financial statements less "transparent."

Unlike IFRSs, U.S. GAAP do not contain an "initial recognition" exemption.

Special Deductions

Under U.S. GAAP, tax benefits of special deductions for financial reporting purposes are recognized no earlier than the year in which they are available to reduce taxable income on the tax return. Although anticipation of future special deductions in the measurement of deferred liabilities is not permitted, the future tax effects of special deductions may nevertheless affect (1) the average graduated tax rate used for measuring deferred tax assets and liabilities when graduated tax rates are a significant factor and (2) the need for a valuation allowance for deferred tax assets. In those circumstances, implicit recognition is unavoidable because those special deductions are one of the determinants of future taxable income, and future taxable income is used to determine the average graduated tax rate and may affect the need for a valuation allowance.

There is no guidance on "special deductions" under IFRSs.

Share-Based Compensation

Under U.S. GAAP, the deferred tax recorded on share-based compensation is computed on the basis of the expense recognized in the financial statements. Therefore, changes in an entity's share price do not affect the deferred tax asset recorded on the entity's financial statements.

Under IFRSs, the deferred tax is computed on the basis of the tax deduction for the share-based payments in every period under the applicable tax law (i.e., intrinsic value). Therefore, changes in share price do affect the deferred tax asset at period-end and result in adjustments to the deferred tax asset.

Subsequent Changes in Deferred Taxes That Were Originally Charged or Credited to Equity (Backward Tracing)

Under U.S. GAAP, subsequent-period changes in deferred tax items that were originally charged or credited to shareholders' equity or comprehensive income are allocated to the income tax provision related to continuing operations and not directly charged or credited to shareholders' equity or to other comprehensive income. For example, the effect of a change in the subsequent tax rate on recorded deferred tax would be charged or credited to the current income tax provision of continuing operations even if such a tax effect was originally recorded in shareholders' equity. (Note that there are limited exceptions to the above in ASC 740-10-45-20 and ASC 740-20-45-11(c)–11(f).)

Under IFRSs, however, subsequent-period changes in deferred taxes that were originally charged or credited to shareholders' equity are also allocated to shareholders' equity. Paragraph 61A of IAS 12 states, "Current tax and deferred tax shall be recognised outside profit or loss if the tax relates to items that are recognised, in the same or a different period, outside profit or loss." For example, a deferred tax item originally recognized by a charge or credit to shareholders' equity may change either from changes in assessments of recovery of deferred tax assets or from changes in tax rates, laws, or other measurement attributes. In a manner consistent with the original treatment, IFRSs require that the resulting subsequent change in deferred taxes be charged or credited directly to equity as well.

Reconciliation of Actual and Expected Tax Rate

Under U.S. GAAP, all public entities must disclose a reconciliation by using percentages or dollars between (1) the reported amount of income tax expense attributable to continuing operations and (2) the amount of income tax expense that would have resulted from applying domestic federal statutory rates to pretax income from continuing operations. The amount and nature of each significant reconciling item should be disclosed as well. For nonpublic entities, a numerical reconciliation is not required; however, the nature of all significant reconciling items between (1) and (2) above should be disclosed.

Under IFRSs, paragraph 81(c) of IAS 12 states that all entities must disclose a numerical reconciliation in either or both of the following forms:

  1. The reported "tax expense (income) and the product of accounting profit multiplied by the applicable tax rate(s) disclosing also the basis on which [any] applicable tax [rate is] computed."
  2. "The average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed."

Undistributed Earnings on Investments

Under U.S. GAAP, a deferred tax is generally required on undistributed earnings arising after 1992 that relate to a domestic subsidiary or a domestic joint venture. However, no deferred tax is recognized on the undistributed profits of an investment in a foreign subsidiary or foreign corporate joint venture if such foreign investments are considered permanent in duration.

Similarly to U.S. GAAP, IFRSs require recognition of a deferred tax for all undistributed earnings associated with any form of investee except to the extent that (1) the parent is able to control the timing of the reversal of the temporary difference and (2) it is probable that the temporary difference will not reverse in the foreseeable future. Under IFRSs, however, there is no distinction between domestic and foreign investments.

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1 Differences are based on comparison of authoritative literature under U.S. GAAP and IFRSs and do not necessarily include interpretations of such literature.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.