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IAS 12 – Recognition of deferred tax for a single asset in a corporate wrapper

Date recorded:

Agenda Papers 3 and 3A analyse whether IAS 12 Income Taxes should be amended in a limited scope project.

The Committee received a request to clarify the accounting for deferred tax in the consolidated financial statements of the parent, when the subsidiary has only one single asset within it and the parent expects to recover the carrying amount of that asset by selling the shares in the subsidiary. Concerns were raised by commentators, and in response to the concerns raised, the staff analysed whether the requirements of IAS 12 should be amended in a limited scope project. The staff concluded that the concerns raised could not be addressed in a limited scope project to amend IAS 12, and recommended that the Committee should not take this issue onto its agenda, and provided proposed wording for the tentative agenda decision.

A Committee member noted that she had significant concerns with the paper and the conclusion arrived at by the staff. She noted that she did not believe the description of the fact pattern was necessarily accurate — pointing to paragraph 12(b) in the paper which stated that in most of these cases… “the parent and the subsidiary are two separate entities and file separate tax returns.” She noted that she did not believe this was always the case and that there had been no assessment of a situation where entities did not file separate tax returns, and what the implications of filing separate returns would be. She also pointed to paragraph 12(f) in the paper, which stated that “… acquisitions and resales of investment properties in the short term by this type of parent do occur, but they are not usual”, noting that such transactions were more common than one would think, and further noted that she did not believe these points were good reasons for the Committee not to look at the issue.

She referred to paragraph 29 of the paper, which listed three concerns raised by commentators on the requirements in IAS 12, noting that she would add a fourth concern relating to the interactions with fair value measurement questioning how fair value should be determined (considering tax effects), how this would interact with the measurement of deferred taxes and, in particular whether this would create day 2 gains and losses. She noted that this was more applicable in business combination accounting because this results in a deferred tax liability that creates mechanical goodwill that has no meaning.

She also noted that an area she believed had not been researched sufficiently was whether, when there was an asset wrapped up in a legal entity, that the legal entity was always a subsidiary. She questioned whether there could be cases where it could be said that the legal entity has no substance and, in effect, there was an asset (and the legal entity was ignored), noting that this linked with the unit of account questions that had been investigated on this issue. She noted that in the case where there was a legal entity that just carried the asset and did nothing more (ie existed solely for tax purposes), looking at the substance might result in reaching a different conclusion. She concluded by stating that she had fundamental concerns with the recommendation that the Committee does nothing further on this issue and that the answer was clear that one must have deferred tax liabilities at each level (subsidiary and investor), noting that in many cases this would not provide faithful representation of the economics of the transaction, and accordingly, she disagreed with the staff recommendation.

Another Committee member noted that he understood the concerns expressed by the previous Committee member; however, he noted that these concerns were beyond the scope of what the Committee had been asked. He added that the staff analysis captured what IAS 12 currently required (to look at the inside basis difference and the outside basis difference and account for appropriately), and accordingly, he noted that he supported the conclusion arrived at by the staff.

Another Committee member noted that the paper and tentative agenda decision were reflective of the current requirements in IAS 12. He noted that the assumptions needed to be made that there was a subsidiary that held a single asset, and that it had a separate identity for tax purposes to move this issue forward. He noted that the question of when a subsidiary was not a subsidiary was far too broad for the Committee on this issue. He concluded that he supported the staff position, and had minor drafting suggestions on the tentative agenda decision.

Another Committee member also noted that he shared the concerns expressed by the first Committee member, but agreed with other Committee members that the tentative agenda decision was consistent with what IAS 12 currently stated. He also noted that he had minor drafting edits on the tentative agenda decision.

Another Committee member noted that she agreed with the comments of the first Committee member, adding that she thought the possible solutions in the paper created more problems. She noted that there was a question about relevant information for investors, but that investors in investment property entities like this understood inside / outside basis differences and that this could be explained through disclosures and other information, for example, non-GAAP measures. She noted that creating other problems was a worse result and therefore she agreed with the staff conclusion, but she noted that this did not produce the most economically relevant information in the consolidated results, but it may in the separate results.

Another Committee member noted that he also agreed with the conclusion arrived at by the staff and supported the wording in the tentative agenda decision because he believed the project was too broad to have as an interpretation or amendment.

Another Committee member noted that he shared the concerns raised by the first Committee member with respect to issues that arose upon acquisition and the interaction with the initial recognition exception and the day 2 accounting issues because the asset inside may be at fair value on an ongoing basis. He noted that he believed the issue has a number of different aspects to it that were not covered in the paper, but would need to be addressed; and he noted that he did not disagree with the staff’s analysis of the requirements of IAS 12.

Another Committee member made a comment in relation to the remark made by a previous Committee member who had suggested that it could be helpful to include appropriate disclosures, including non-GAAP measures to help investors understand. She noted that ESMA had been publishing some papers about non-GAAP measures and that there were questions about what type of non-GAAP measures should be allowed inside and outside financial statements. She noted that she recalled that in the Committee’s previous meeting, the Committee had said that no additional information should be included in financial statements that would contradict what was in the standards, and asked the Committee member who had made the comment, where she would expect to see this information disclosed.

The Committee member responded, noting that she believed that if management felt that the financial statements did not clearly explain the economics, it would not be unreasonable to explain the economics to an outside investor in a different way (i.e. through non-GAAP measures outside the financial statements), as long as that explanation was performed consistently over time.

The Chairman of the Committee called a vote. The overwhelming majority of the Committee members agreed to proceed with the staff’s recommendation, subject to wording changes to the tentative agenda decision.

One Committee member did not vote in favour of the staff recommendation.

The Chairman asked the Senior Director, Technical Activities to provide an update on the status of the research project on income taxes.

The Senior Director, Technical Activities responded, noting that the project was on the agenda, but on the longer term agenda, adding that the staff had signalled that there would not be any Board time dedicated to the project in the next 3 years. He noted that the staff had identified two national standard setters who were willing to do some work on the project and had identified a staff member who could be the focal point for that. He emphasised that this was a significant project, and noted that the Board had tried unsuccessfully with the FASB to try and get the models closer together.

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