Most transactions and events recorded in the financial statements have a tax consequence. The amount of tax payable on the taxable profits for a particular period often bears little relationship to the amount of income and expenditure appearing in the financial statements, as tax laws and financial accounting standards differ in their recognition of income, expenditure, assets and liabilities.
The tax charge in profit or loss reflects not only the charge based on taxable profit (or loss) for the year, but also an amount that recognises the tax effects of transactions appearing in the financial statements in one period, which will fall to be taxed in a different period.
The recognition of this additional amount gives rise to deferred taxation.
Examples where such differences arise include the following:
• capitalised stripping costs which may be deducted in the current year for tax purposes;
• there may be accelerated deductions allowed for calculating taxable income that create temporary differences between the tax written-down value of an asset and its carrying value for accounting purposes (refer to example 1 below); and
• a fair value adjustment to the accounting value of an asset acquired as part of a business combination may have nil impact on the tax value of the asset.
10.6.1 Balance sheet liability method IAS 12 requires the use of the ‘balance sheet liability method’ and requires a deferred tax liability or asset to be recognised in respect of temporary differences that exist at the balance sheet date. Temporary differences are defined as ‘differences between the carrying amount of an asset or liability in the balance sheet and its tax base’. The deferred tax expense for the period represents the amount required to adjust the net deferred tax liability or asset to the new balance at each reporting date.
The balance sheet liability method requires an asset recorded in the financial statements to be realised for at least its carrying amount in the form of future economic benefits, even where timing differences do not give rise to tax obligations in their own right. These may give rise to amounts that enter into the determination of taxable profits and result in the recognition of a deferred tax liability.
This is commonly seen on the fair value uplifts on mining licences in business combinations. IAS 12 requires the recognition of a deferred tax liability; this is released to taxation expense at the same time as the fair value adjustment is charged to depreciation.
10.6.2 Tax base
Deferred tax is calculated on the difference between the carrying amount of an asset or liability in the balance sheet and its tax base. The tax base of an asset or liability is defined as ‘the amount attributed to that asset or liability for tax purposes’.
10.6.2.1 Tax base of an asset
The tax base of an asset is the amount that will be deductible from any taxable income derived when the carrying amount of the asset is recovered.
Examples include:
• mining equipment—the tax base is usually the written-down value for tax purposes (the amount that can still be claimed as a deduction in future periods); and
• receivables from the sale of concentrate—the tax base will be equal to the carrying value in the accounts if the revenue is taxed on an accruals basis and therefore has already been included in taxable income.
10.6.2.2 Tax base of a liability
The tax base of a liability is its carrying amount minus any amount that will be deductible for tax purposes in respect of that liability in future periods. For revenue received in advance, the carrying amount will be reduced by revenue that will not be taxable in future periods.
Examples include:
• provisions for future restoration costs—the tax base will be nil if the costs are deductible at the time when the restoration work is undertaken (but not when the costs are accrued); and
• trade creditors:
– if the related expenditure has already been deducted for tax purposes, the tax base is equal to the carrying amount of the liability;
– if the related expenses will be deducted on a cash basis, the tax base is nil; and
– if the creditors relate to the acquisition of fixed assets, the payment has no tax consequences, and the tax base equals the carrying amount.
10.6.3 Recognition
A deferred tax asset or liability is recognised for a temporary difference between the accounting carrying value and the tax base of an asset or liability. For an asset to be recognised, it must be probable that when it is realised it will create future economic benefits. In other words, it must be probable that there will be a taxable profit against which the deductible temporary differences can be used. A deferred tax liability should always be recognised in full.
There are exceptions to these rules for deferred tax assets or liabilities that arise from:
• the initial recognition of goodwill; and
• the initial recognition of an asset or a liability (as long as the recognition does not affect the accounting profit or the taxable income at that time and the transaction is not a business combination).
10.6.4 Measurement
The deferred tax assets and liabilities are measured at tax rates expected to apply when the associated asset is realised or liability settled.
The measurement must reflect the manner in which the asset or liability is expected to be recovered or settled. For example, if the tax rate on gains on disposal is different from the tax rate on other income and the entity expects to sell the asset without further use, the tax rate applicable for disposals is used.
Where there is an intention for the asset to be used to generate income for a period of time and then sold, a blended rate should be utilised which reflects management’s intention of both the timing of the disposal and the carrying value which will be recovered through both use and sale. In such a circumstance, it is not appropriate to only use the tax rate applicable for disposals nor that applicable to income, rather a rate that does reflect the actual plans of the entity.
Discounting of deferred tax assets and liabilities is not permitted under IAS 12.
10.6.5 Tax losses
A deferred tax asset is recognised for the estimated future tax benefit relating to unused tax losses and unused tax credits if it is probable that taxable profits will be available against which the deferred tax asset can be used.
Mining operations often generate significant tax losses in the exploration, evaluation and development phases, which are subsequently recouped through sale of product over many years. When is it appropriate to recognise a deferred tax asset in relation to tax losses available?
In assessing the probability that the losses will be recouped and therefore whether the deferred tax asset is recognised, management must first consider if any expiry period under relevant tax legislation exists. Any assessment of future taxable profits against which these losses are recouped must not be over a longer period than the tax loss expiry period.
Cash flows used to determine future taxable profits are generally based on the same assumptions as those used for forecasting cash flows in impairment assessments.
10.6.6 Tax holidays
Governments may offer tax concessions to encourage development of mine sites in the form of temporary tax holidays or concessional tax rates. Where entities receive such benefits, an entity should record a deferred tax based on the expected future tax consequences.
Deferred tax on temporary differences reversing within the tax holiday period is measured at the tax rates that are expected to apply during the tax holiday period, which is generally the nil tax rate. Deferred tax on temporary differences reversing after the tax holiday period is measured at the tax rates that will apply after the tax holiday period.
10.6.7 Deferred tax and acquisitions of participating interests in joint operation which is not a legal entity
The deferred tax consequences of the acquisition of a participating interest in a joint operation which is not a legal entity are discussed in section 6.9. The initial recognition exemption applies and deferred tax is not recognised if the transaction is not deemed to be a business combination.
10.6.7.1 Why does deferred tax not arise on acquisition of an interest in a joint venture?
The initial recognition exemption (‘IRE’) is applicable on the acquisition of an asset and no deferred tax is recognised. The IRE applies to temporary timing differences which arise from transactions which are not business combinations and affect neither accounting profit nor taxable profit. These criteria would be considered to apply to:
• Acquisitions of participating interests in joint operations which are not legal entities; and
• Acquisitions of interests in jointly controlled entities Application of the IRE is mandatory and must be used when the tax base of the acquisition costs differs from the accounting base. The IRE is not applied where there is no such difference, but this has the same result of no deferred tax being recognised.
From a tax perspective, acquisitions of an additional interest in an asset or entity are treated the same as if the asset or entity were being acquired for the first time. The application of the IRE is required for each acquisition of an additional interest that does not provide control over the asset or entity.
In March 2012 the IFRS Interpretations Committee made a recommendation to the IASB on an amendment to IFRS 11 in relation to the acquisition of interests in joint operations. Should the IASB adopt the recommendation, deferred tax would arise for such a transaction. Section 6.9 explains this in more detail.
10.6.7.2 Timing differences arising subsequent to acquisition
Timing differences between the carrying value of the investment and the tax base will often arise subsequent to the initial acquisition for investment in jointly controlled entities. Investors should consider whether the exemption in IAS12.39 for interests in joint arrangements where the venturer is able to control the timing of reversal of the temporary difference can be applied to avoid recognition of a deferred tax liability.
The exemption allows a joint venturer or joint operator not to recognise a deferred tax liability where they are able to control the timing of the reversal of the related temporary difference and be able to conclude that it is probable it will not reverse in the future. In joint ventures, the determining factor will be whether the contractual arrangement provides for the retention of profit in the joint venture, and whether the venturer can control the sharing of profits. From a tax perspective, the ability to control the sharing of profits is viewed as the ability to prevent their distribution rather than enforce their distribution.