IFRS for SMEs:
Income tax
Definitions
- Income tax is a direct tax based on taxable profits.
- Taxable profit/loss is the profit/loss for a period determined in accordance with the rules from tax authorities and tax laws.
- Accounting profit/loss is the profit/loss for a period determined in accordance with accounting standards.
- Current tax is income tax payable/receivable in respect of taxable profits/losses. This is the actual income tax amount to be paid for the period.
- Tax expense is the income tax amount expensed in respect of accounting profits/losses. This is the income tax expense amount recorded in the financial statements.
- Deferred tax is the income tax payable/receivable in future periods. This arises due to differences in accounting treatment and tax treatment of a transaction that affects assets/liabilities, and due to carry-forward of unusued tax losses and credits from previous periods.
- Temporary differences are differences caused temporarily between carrying amount of an asset/liability in the balance sheet and its tax base (that is, the carrying amount of the asset/liability when it's measured based on tax rules instead of accounting standards).
- Taxable or Deductible temporary differences are differences caused temporarily due to timing difference of when different portions of an asset/liability are recovered/settled due to differences in accounting treatment and tax treatments of that asset/liability.
Note: These differences are temporary because the total amount that will be recovered/settled in the end will be the same in both cases, even if there is a timing difference.
- When a deferred tax is receivable, it's a deferred tax asset. This occurs when current tax is higher than tax expense. The difference is a deferred tax asset (deductible temporary difference).
- When a deferred tax is payable, it's a deferred tax liability. This occurs when tax expense is higher than current tax. The difference is a deferred tax liability (taxable temporary difference).
- A deferred tax asset is also recognized when an unused tax loss is carried forward
- A deferred tax liability is also recognized when an unused tax credit is carried forward.
- Deferred tax assets and liabilities generally cannot be offset against each other on the balance sheet.
- Deferred tax assets and liabilities are classified as non-current assets/liabilities.
Deductible temporary differences and unused tax losses carried forward can be recognized as a deferred tax asset only if it's probable that future taxable profits will be available to set them off against.
When there is an unused tax loss to be carried forward, the current tax payable balance will be zero, because the account cannot be negative. This amount will be recorded as a deferred tax asset instead.
A note by me, the FedUp Accountant:
I have excluded a lot of details on this, because I think too many details on this leads to more confusion. Just try to understand that this standard relates to situations where transactions have tax treatments that are different from accounting treatments. Imagine a separate set of financial statements made based on the tax law. The income tax law basically says "follow the accounting standard in preparing tax-financial statements, but with these adjustments specified in the tax law, and use the resulting (taxable) profit to calculate the income tax amount by applying the tax rates and brackets". The income tax accounting standard is about calculating an income tax expense amount by applying the tax rates to the "accounting profit" instead of "taxable profit". Any differences between the two are deferred taxes.
Example double-entries:
Deferred Tax Asset
DR INCOME TAX EXPENSE 6900
DR DEFERRED TAX ASSET 300
CR CURRENT TAX LIABILITY 7200
Deferred Tax Liability
DR INCOME TAX EXPENSE 7200
CR DEFERRED TAX LIABILITY 300
CR CURRENT TAX LIABILITY 6900
BALANCE SHEET ITEM NET BOOK VALUE VS TAX BASE DEFERRED TAX ASSET/LIABILITY TTD / DTD X TAX RATE
ASSET NET BOOK VALUE > TAX BASE DEFERRED TAX LIABILITY = TTD X TAX RATE
ASSET NET BOOK VALUE < TAX BASE DEFERRED TAX ASSET = DTD X TAX RATE
LIABILITY NET BOOK VALUE > TAX BASE DEFERRED TAX ASSET = DTD X TAX RATE
LIABILITY NET BOOK VALUE < TAX BASE DEFERRED TAX LIABILITY = TTD X TAX RATE
TTD = TAXABLE TEMPORARY DIFFERENCE
DTD = DEDUCTIBLE TEMPORARY DIFFERENCE