IAS 12 – Recognition of deferred tax assets for unrealised losses

Date recorded:

Agenda papers 2 and 2A present proposed draft amendments to IAS 12 Income Taxes to clarify the accounting for deferred tax assets for unrealised losses on debt instruments measured at fair value, and analyse whether the proposed clarifications might result in unintended consequences for non-financial assets measured at fair value.

A Committee member noted that she was happy with the direction of the proposed draft amendments, but had a number of comments on items she believed were not clear in the paper:

  • Although accurate, she noted that paragraphs 29A and B were extremely difficult to understand, and asked whether the paragraphs could be better worded, and, in particular, the new concept being introduced made clearer (i.e. that the utilisation of deductible temporary differences is assessed against probable future taxable profit that excludes tax deductions resulting from the reversal of deductible temporary differences).
  • With respect to the example, she noted that there were some assumptions missing, and that there was no explanation of how the $100,000 ordinary tax loss was calculated.
  • She noted that where the paper discussed that, in applying paragraphs 28 and 29 of IAS 12, a two-step approach must be applied, the example did not work through the two steps, and went straight to the second step without explaining why the first step had not been performed
  • She also noted that the deductible temporary differences relating to the type C instrument had been excluded on the basis that the entity would not be able to utilise these, and therefore, no deferred tax assets were recognised, adding that there needed to be an assumption in the paper to explain that the entity was not going to generate capital gains in 2016 through 2020.
  • In the table on pages 10–11 of the paper, a tax rate of 30% was applied when measuring deferred tax assets and deferred tax liabilities. She acknowledged that this was because the assumption had been made that holding the asset until maturity resulted in the entity falling into the ordinary tax rate category rather than the tax rate applicable on capital gains and losses. She noted that it is not obvious in the example, and that it needed to be explained why 30% and not 10% was being used in the example.
  • She noted that, with respect to allocation of changes in deferred taxes between profit or loss and OCI (on page 11 of the paper), more illustration would be helpful.

Another Committee member noted that he agreed with the comments made by the previous Committee member. He also highlighted some further concerns with the proposed example.

  • He noted that the three investments were described as instruments of type A, type B, and type C, which could be read as if there were multiple type A instruments, multiple type B instruments, and multiple type C instruments. He noted that this overcomplicated things, and opened up the possibility that there may be some type A instruments valued above cost and others below cost, in which case these should not be lumped together in the analysis, as had been done in the paper. He noted that accordingly, it should be made clear in the example that there is only one instrument in each category.
  • He noted that, speaking of the type A instrument, the difference would reverse over the next five years as the fair value moved back up towards cost as it got closer to maturity, yet it had been assumed in the calculations in the example that the entire temporary difference reversed in 2020, which is not what would actually happen. He questioned why the calculation was performed as if the $100,000 tax loss in 2020 was calculated with the entire temporary difference reversing in 2020, and suggested that it may be that the example was saying that in 2016 through 2019 it created a net operating loss carry forward, which would then be utilised in 2020 — but noted that this was not stated in the paper, and accordingly, that it was difficult to determine what had been done.

He agreed that the example was what was needed, and agreed with the previous member that paragraph 29A(i) was difficult to read, but that the example helped provide clarity, so noted that he was not as concerned about the language in this paragraph.

Another Committee member agreed that the wording was challenging, but pointed out that IAS 12 is challenging. He noted that he liked the example; however, expressed the same concerns as previous Committee members with respect to the $100,000 and what it means in 2020.

Another Committee member agreed with the previous comments made, noting that the basis for the $100,000 tax loss needed explanation and questioned why it was being assumed that the entire deductible temporary difference reverses in year five when it is happening progressively over the five years. He noted that he did not know why the example did not show the offset against taxable temporary differences first before going to the next stage (the availability of suitable future taxable profits). Overall, he noted that he would like to see a far simpler example, noting that there are a small number of key points that need to be explained about the existence of a deductible temporary difference and the basis upon which recoverability of that deductible temporary difference is assessed; and that the example was trying to bring other issues into play.

The Committee member referred to the final sentence in the amendment to paragraph 29, that stated that ‘In estimating future taxable profit, an entity assumes to recover an asset, including an asset to which a deductible temporary difference is related, for more than its carrying amount in the statement of financial position, if such a recovery is probable’. He noted that in this case, economically, the entity was not recovering the asset for more than its carrying amount, it simply held the asset and the discount unwound over the holding period. So, from an economic point of view, the entity did not recover any more than the carrying amount and that sentence seemed to introduce guidance on the basis on which future taxable profits are estimated into IAS 12 when IAS 12 was generally silent in this area, and questioned the necessity of the sentence.

The Project Manager noted that this issue arose out of comment letters. He highlighted that the question raised was whether, in the case where an entity only has this debt instrument, it could assume to recover the asset for the whole amount so that it could deduct its whole tax base, or would it need to assume when estimating probable future taxable profit that it could only recover it for the carrying amount, in which case the entity would not have taxable profits beyond the carrying amount and so there would not be anything the entity could offset the tax deductions represented by the deductible temporary difference against.

The Committee member noted that there was no inconsistency in this example between the measurement and the future assumptions about future tax profit because both were simply allowing the discount rate to unwind, and this sentence could be taken as an invitation to introduce an inconsistency between the measurement of the asset and the future projection of taxable profit.
Another Committee member noted that it was an invitation. He noted that in the example in the paper, the instrument had a fair value of $1.7m and the entity believed it is going to recover it for $2m, and the sentence stated that the $300k in profit must be factored into the entity’s estimate of future taxable profit. He noted that the sentence was not needed because it was obvious because the entity was forecasting future profits, so it must mean that the entity expected to sell the asset for more than it was on the books for, otherwise there would be no profits. He added that he would have left this notion only for the Basis for Conclusions, noting that the standard already stated that one could forecast if that is what they believed would happen.

Another Committee member noted that he agreed with the conclusion reached, but shared the comments raised by other members, noting specifically that the example is too complex and difficult for the uninitiated to understand. He suggested the Committee should consider what the question actually asked was — ie ‘should these instruments be looked at in isolation or should they be considered together with all the other deductible temporary differences?’ and suggested that the Committee should focus the answer on the question asked. He noted that it was self-evident in the standard that one has to assume recovery of assets for more than their carrying amount; otherwise an entity would never be projecting any future taxable profits, and accordingly, the sentence at the end of paragraph 29 was redundant. He noted that it was also evident that an entity had to forecast taxable profits before the reversal of deductible temporary differences, otherwise it would inevitably need twice as much future profit as it had deductible temporary differences to get them reversed. He noted that he found this confusing in the analysis and recommended leaving it out. He further noted that, based on his experience, he had never seen anyone forecast taxable profit for recoverability purposes including the reversal of deductible differences, because it had to be done first otherwise it would not work. He then noted that the reference to tax planning should be left out (this can be assumed) because it is detracting from the underlying principle which is 1) Does one look at instruments in isolation? No, and 2) Can one assume they are going to recover for face value? He noted that if this was done, the example would be much simpler, and the points that the Committee were trying to get across would not get lost.

Another Committee member commented noting that he had similar comments to those that had already been expressed by other Committee members. He noted that, with respect to the last sentence in paragraph 29 that talked about recovering an asset for more than its carrying value, this sentence would be better placed in the Basis for Conclusions because inherently, if an entity had a non-financial asset carried at fair value, it may not be a fair assumption that the entity was going to recover that asset for more than its carrying value, which in turn highlighted that the sentence might be better placed elsewhere.

Another Committee member noted, in response to the previous comments about the deductible temporary difference reversing over a period of time that this was not necessarily true. She noted that she actually thought the example was too simplified and noted that there were a number of possible scenarios that have not been considered.

Another Committee member noted that he agreed overall with the staff proposal, and with other comments made by other Committee members. He noted that the example should illustrate the progression of the reversal over the life of the instrument rather than assume that the reversal is in the final year, noting that this adds to the confusion on the interaction with the taxable profit in the final year. He noted that the example also needed to show an assessment of the recovery against taxable temporary differences first, as that is the sequence required under paragraph 28 of IAS 12. With respect to the final sentence of paragraph 29, he stated that he believed this sentence was required (although could be included in the Basis for Conclusions) because that was the direct result of one of the issues raised in the comment letters, which was that the objective of IAS 12 seems to imply that when recognising deferred tax, one should assume recovery of the assets and liabilities at their carrying amount.

The Chairman summarised the discussion, and proposed a plan for moving forward. He noted that:

  • There was general support for the analysis.
  • The example was over-engineered in some areas, and under-engineered in others.
  • There were no objections from Committee members with respect to the basic message.
  • The example needed reworking.
  • The staff should circulate a revised example to the Committee members, and that the Committee members respond directly to the staff with any comments they may have.

The Committee members all agreed with this plan forward.

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