IAS 12 Income taxes
Tax is the one figure in the financial statements that an entity does not work out for itself. The tax authority applies its own rules to arrive at the taxable profit, and those rules are not the accounting rules. IAS 12 Income Taxes deals with the consequence: how the tax an entity will pay is reported inside financial statements that have been prepared on a different basis.
The income tax expense in the statement of profit or loss has two halves. Current tax is the tax on this period's taxable profit — what the entity expects to pay to, or recover from, the tax authority. Deferred tax is an accounting adjustment for the future tax consequences of transactions that have already happened. F1 Chapter 13 covers the tax computation itself — how accounting profit is adjusted to taxable profit, and how tax depreciation replaces accounting depreciation. This chapter covers what the financial statements then do with the result.
IAS 12 – Deferred tax: the recording is heavily national in places — treat the national labels as illustrative, because F2 applies no national tax regime. There is a currency slip ($ to £1,000), and two claims it makes about F1 are not supported by the F1 notes, so read that material rather than assuming it is revision. Two small topics it omits are taught here.
This recording predates IFRS 18 Presentation and Disclosure in Financial Statements, which replaces IAS 1 for accounting periods beginning on or after 1 January 2027. Where the recording’s statement of profit or loss differs from this chapter’s, the chapter governs.
1 The income tax expense
The figure presented in the statement of profit or loss as income tax expense is rarely the same as the amount owed to the tax authority for the year. Three things go into it.
Component of the income tax expense | What it is |
Current tax for the year | The estimated tax on this year's taxable profit. The same figure is recognised as a liability in the statement of financial position, to the extent it is unpaid. |
Under- or over-provision from last year | The difference between last year's estimate and the amount finally agreed with the tax authority. Last year's financial statements are not restated; the correction is made in this year's expense. |
The movement in deferred tax | The change over the year in the deferred tax balance carried in the statement of financial position. The rest of this chapter is about that figure. |
Current tax for a period is recognised as a liability to the extent that it is unpaid, and as an asset where the amount already paid exceeds the amount due for that period and earlier ones.
an under-provision
Bramwell estimated its income tax liability for the year ended 31 December 20X4 at $180,000, and recognised that amount as both the expense and the liability. The liability was finally agreed with the tax authority at $195,000 and paid during 20X5. For 20X5 itself, Bramwell estimates a liability of $210,000.
$ | |
Current tax estimated for 20X5 | 210,000 |
Under-provision for 20X4 ($195,000 − $180,000) | 15,000 |
Income tax expense for 20X5 | 225,000 |
The $15,000 is a correction of an estimate, not the correction of an error: the 20X4 financial statements were right on the information available at the time and are not restated. Had the liability been agreed at $172,000 instead, the $8,000 over-provision would have been deducted, giving an expense of $202,000.
2 Why deferred tax exists
Accounting profit and taxable profit are different figures, and they are meant to be. Accounting rules aim at a faithful picture of performance and accept a good deal of judgement to get it; tax rules aim at a number that can be assessed and collected, so they strip judgement out. The two arrive at different answers from the same facts.
Left alone, that difference does real damage to the statement of profit or loss. An entity that earns exactly the same profit before tax three years running will report a different tax charge — and therefore a different profit for the year — in each of them, purely because the tax authority's depreciation runs on a different timetable from its own. Example 1 below shows it happening. Two things are wrong with the result: the earnings figure says the business is getting worse when it is performing identically, and the depreciation charged in a year never attracts the tax relief that belongs with it.
Deferred tax
The estimated future tax consequences of transactions and events recognised in the financial statements of the current and previous periods.
Deferred tax is not a tax payable to anyone. Nothing an entity does in accounting for it changes what it owes the tax authority by a single dollar, and the tax payable balance in the statement of financial position is untouched by it. It is an accounting entry — a debit and a credit inside the financial statements — made so that the tax charge in profit or loss matches the profit that profit or loss reports.
2.1 Permanent and temporary differences
Differences between accounting profit and taxable profit come in two kinds, and only one of them has a future tax consequence.
Permanent difference | Temporary difference | |
What it is | An amount recognised in accounting profit that will never be taxed, or an expense that will never be allowed for tax. | An amount recognised in both accounting profit and taxable profit, but in different periods. |
Example | Entertaining expenditure that the tax rules disallow; income that the tax rules exempt. | Depreciation, which is added back in the tax computation and replaced by tax depreciation at a different rate. |
Does it reverse? | No. The difference is one-off and permanent. | Yes. Over the life of the item the two treatments give the same total; only the timing differs. |
Future tax consequence? | None, so no deferred tax. | Yes, so deferred tax is recognised. |
IAS 12 is concerned only with temporary differences. A permanent difference changes the tax bill and is dealt with once, in the tax computation for the year it arises. There is nothing left over to defer.
Tracy (ignoring deferred tax)
Tracy purchased an item of property, plant and equipment on 1 January 20X5 for $5 million. It was estimated to have a useful life of 5 years, but according to the tax authority it attracted a 50% tax allowance in its first year and 20% on a reducing balance thereafter.
Tracy made an accounting profit of $2 million for the year, which is expected to continue unchanged for the next two years.
The income tax rate is 20%.
Ignoring deferred tax, calculate the profit after tax for Tracy for each of the three years ending 31 December 20X5 to 20X7.
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3 The tax base
Every temporary difference is measured in the same way: as the difference between what an item is worth under the accounting rules and what it is worth under the tax rules. The first is its carrying amount. The second is its tax base.
Two definitions
Tax base of an asset — the amount that will be deductible for tax purposes against the taxable economic benefits that flow to the entity when it recovers the asset's carrying amount. Where those benefits are not taxable, the tax base is equal to the carrying amount.
Tax base of a liability — its carrying amount, less any amount that will be deductible for tax purposes in future periods.
For the asset most F2 questions use — an item of property, plant and equipment — the two sit neatly side by side. The carrying amount is cost less accumulated depreciation. The tax base is cost less accumulated tax depreciation. Same cost, two sets of rules, two answers.
Temporary difference = Carrying amount − Tax base
Deferred tax balance = Temporary difference × Tax rate
Four items, worked. The tax rate is 20% throughout.
Item | Carrying amount $000 | Tax base $000 | Temporary difference $000 | Gives rise to |
Plant: cost 5,000, depreciation to date 1,000, tax depreciation to date 2,500 | 4,000 | 2,500 | 1,500 taxable | A deferred tax liability of 300 |
Interest receivable, taxed by the authority only when it is received | 40 | nil | 40 taxable | A deferred tax liability of 8 |
Warranty provision, deductible for tax only when the warranty is paid out | 200 | nil | 200 deductible | A deferred tax asset of 40 |
Fine payable, never deductible for tax | 50 | 50 | none | Nothing — a permanent difference |
The interest receivable will be taxed in full when the cash arrives and nothing about it is deductible, so its tax base is nil and the whole $40,000 is a taxable temporary difference. The warranty provision works the other way: the $200,000 will reduce taxable profit when it is paid, so the whole of it is deductible in the future and the tax base is the carrying amount of $200,000 less that $200,000, which is nil. The fine is deductible neither now nor ever, so nothing will be deducted in future, the tax base equals the carrying amount, and there is no temporary difference at all — which is what a permanent difference looks like on this test.
3.1 Taxable and deductible temporary differences
A temporary difference is taxable if it will produce taxable amounts in future periods, and deductible if it will produce deductible amounts. Which one you have depends on the direction of the difference and on whether you are looking at an asset or a liability.
Carrying amount greater than tax base | Carrying amount less than tax base | |
An asset | Taxable temporary difference → deferred tax LIABILITY | Deductible temporary difference → deferred tax ASSET |
A liability | Deductible temporary difference → deferred tax ASSET | Taxable temporary difference → deferred tax LIABILITY |
The reasoning is worth following once, because it makes the table unnecessary. Take Tracy's plant. Its carrying amount of $4,000,000 exceeds its tax base of $2,500,000 because Tracy has claimed tax relief faster than it has charged depreciation. Relief taken early is relief that cannot be taken again: in later years there will be less tax depreciation to claim, taxable profits will be higher than accounting profits, and more tax will be paid. More tax later is a liability, so the entity provides for it now. A deferred tax asset is the same argument in reverse — relief not yet taken is relief still to come, which will reduce future taxable profits and save tax.
“Carrying amount greater than tax base means a liability” is only true of an asset. For a liability it is the other way round. A warranty provision with a carrying amount of $200,000 and a tax base of nil gives a deductible temporary difference and therefore a deferred tax asset, because that $200,000 will reduce taxable profit when it is paid. Most F2 questions are about property, plant and equipment, so the asset version is the one you will use most — but learn which is which rather than the shortcut.
Where a question hands you the temporary difference rather than the two amounts, it will tell you which kind it is: a taxable temporary difference gives a deferred tax liability, a deductible temporary difference gives a deferred tax asset.
3.2 Recognition
A deferred tax liability is recognised for all taxable temporary differences. There is no test to pass. (IAS 12 makes a small number of exceptions — the best known is that no deferred tax liability is recognised on the initial recognition of goodwill — but they are beyond the depth F2 examines.)
A deferred tax asset is recognised only to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be used. The same test applies to the deferred tax asset arising on unused tax losses and unused tax credits. It is not a once-and-for-all judgement: the carrying amount of a deferred tax asset is reviewed at the end of every reporting period, reduced when it stops being probable that sufficient taxable profit will be available, and reinstated when it becomes probable again.
The asymmetry
A deferred tax liability is recognised in full, always. A deferred tax asset is recognised only to the extent that future taxable profits are probable.
That is deliberate, and it is prudence rather than inconsistency. A deferred tax liability is a future payment the entity cannot avoid, so it is provided for whether or not anything else goes right. A deferred tax asset is only worth something if there are future profits to set it against — and the entity most likely to be carrying large deductible differences and unused losses is precisely the entity least likely to have those profits. IAS 12 therefore makes an entity that has made a loss in the current or preceding period disclose the evidence supporting any deferred tax asset it does recognise.
3.3 Measurement
Deferred tax is measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on the rates and tax laws that have been enacted or substantively enacted by the end of the reporting period.
In practice that means: use the rate in force at the reporting date, unless a different rate has already been enacted or substantively enacted for the future, in which case use the future rate. A rate that a government has merely announced or proposed is neither, and is ignored. Current tax is measured on the same basis.
Deferred tax balances are never discounted. They will often be settled years away, so discounting them looks like the obvious thing to do — and IAS 12 prohibits it. Doing it reliably would require a detailed schedule of when every individual temporary difference reverses, which is rarely practicable; and allowing it without requiring it would make one entity's deferred tax incomparable with another's. If a question gives you discount factors in a deferred tax scenario, they are there for some other part of it.
IAS 12 – Deferred tax example: “if the carrying value is greater than the tax base, you have a deferred tax liability” is true of an asset only; for a liability it is the other way round (“Taxable and deductible temporary differences”). The recording works Tracy, Example 2, to this chapter’s answer: liabilities of $300,000, $200,000 and $80,000, and profit for the year of $1,600,000 in each year. Check one figure against the notes: the 20X5 carrying amount is $4,000,000, which gives the $1,500,000 temporary difference.
4 Calculating deferred tax
Four steps, in this order, every time.
Calculate the temporary difference, as the difference between the carrying amount of the asset or liability and its tax base.
Calculate the deferred tax balance by multiplying the temporary difference by the tax rate at which the asset will be realised or the liability settled.
Decide whether that balance is a deferred tax asset or a deferred tax liability.
Take the movement in the balance over the year to profit or loss — or, where the underlying item was not recognised in profit or loss, to wherever the underlying item went.
Step 1 — the temporary difference
$000 | |
Carrying amount | X |
Tax base | (X) |
Temporary difference | X |
Step 4 — the movement
$000 | |
Closing deferred tax balance | X |
Opening deferred tax balance | (X) |
Movement — increase / (decrease) | X/(X) |
The movement is the figure that goes through the financial statements, not the balance. The balance sits in the statement of financial position; only the change in it is charged or credited each year. Getting this wrong — taking the whole closing balance to profit or loss — is the single most common error in a deferred tax question.
4.1 The double entry
Debit | Credit | |
Increase in a deferred tax liability | Income tax expense (profit or loss) | Deferred tax |
Decrease in a deferred tax liability | Deferred tax | Income tax expense (profit or loss) |
Increase in a deferred tax asset | Deferred tax | Income tax expense (profit or loss) |
Decrease in a deferred tax asset | Income tax expense (profit or loss) | Deferred tax |
An increase in a liability increases the expense; a decrease in a liability reduces it. That is why the deferred tax movement can be a credit in the statement of profit or loss and reduce the income tax expense below the current tax figure, which surprises students the first time they see it.
4.2 Where the movement is recognised
Most of the time the movement goes to profit or loss, and Example 2 below does. But the rule is not “deferred tax goes to profit or loss”. The rule is that tax follows the transaction it relates to: current tax and deferred tax on an item that was itself recognised outside profit or loss are recognised outside profit or loss too, in the same place.
The underlying item is recognised in | So the tax on it is recognised in | The F2 case |
Profit or loss | Profit or loss | Almost everything — depreciation against tax depreciation, provisions, receivables |
Other comprehensive income | Other comprehensive income | A revaluation surplus on property, plant and equipment under IAS 16 |
Equity | Equity | An adjustment to the opening balance of retained earnings, for example on a change of accounting policy |
deferred tax on a revaluation
Kestrel owns a building with a carrying amount of $500,000 and a tax base of $400,000. On 31 December 20X6 the building is revalued to $800,000. The revaluation does not change the tax base, and the gain will not be taxed until the building is sold. The tax rate is 20%.
Before the revaluation $ | After the revaluation $ | |
Carrying amount | 500,000 | 800,000 |
Tax base | (400,000) | (400,000) |
Temporary difference | 100,000 | 400,000 |
Deferred tax liability at 20% | 20,000 | 80,000 |
The deferred tax liability increases by $60,000. All of that increase arises on the revaluation surplus of $300,000, and the surplus was recognised in other comprehensive income — so the $60,000 is charged to other comprehensive income as well, not to the income tax expense. The surplus reported is $300,000 − $60,000 = $240,000.
Presenting the full $300,000 in other comprehensive income and the $60,000 in the income tax expense is the classic error. It overstates the surplus and the tax charge, and it puts a tax charge in profit or loss that has nothing to do with the profit reported there.
Tracy (including deferred tax)
Tracy purchased an item of property, plant and equipment on 1 January 20X5 for $5 million. It was estimated to have a useful life of 5 years, but according to the tax authority it attracted a 50% tax allowance in its first year and 20% on a reducing balance thereafter.
Tracy made an accounting profit of $2 million for the year, which is expected to continue unchanged for the next two years.
The income tax rate is 20%. All movements on deferred tax are to be recognised in profit or loss.
Calculate the profit after tax for Tracy for each of the three years ending 31 December 20X5 to 20X7, and show the deferred tax balance that will appear in each year's statement of financial position.
Work through the four steps on this pro-forma before reading the answer.
20X5 $000 | 20X6 $000 | 20X7 $000 | |
Carrying amount | |||
Tax base | |||
Temporary difference | |||
Deferred tax balance at 20% | |||
Asset or liability? | |||
Opening deferred tax balance | |||
Movement |
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5 Presentation and disclosure
Current tax is presented as a current asset or a current liability, because it is due to be settled with the tax authority in the near term.
Deferred tax is never current. Deferred tax assets and deferred tax liabilities are always presented as non-current, however soon the underlying temporary difference is expected to reverse. There is no split between the part reversing next year and the rest.
Offsetting is restricted, and the restrictions are not the same for the two. Current tax assets and current tax liabilities are offset only where the entity has a legally enforceable right to set off the recognised amounts and intends either to settle on a net basis or to realise the asset and settle the liability at the same time. Deferred tax assets and deferred tax liabilities are offset only where that same legally enforceable right exists in respect of current tax, and the deferred tax balances relate to income taxes levied by the same taxation authority on either the same taxable entity, or different taxable entities that intend to settle net. In a group, that second condition matters: a subsidiary's deferred tax asset cannot simply be netted off against its parent's deferred tax liability, because they are different taxable entities.
The disclosures a student should be able to name are these.
The major components of tax expense — current tax, any adjustment for prior periods, and the deferred tax relating to the origination and reversal of temporary differences, shown separately rather than as one number.
Tax recognised outside profit or loss — the aggregate current and deferred tax charged or credited to other comprehensive income or directly to equity.
A reconciliation between the tax expense and accounting profit multiplied by the applicable tax rate — or, equivalently, between the average effective tax rate and the applicable rate. This is the disclosure that answers the reader's obvious question: why is the tax charge not simply profit times the rate? Permanent differences, rate changes and unrecognised losses are what show up in it.
Unrecognised amounts — the deductible temporary differences, unused tax losses and unused tax credits for which no deferred tax asset has been recognised.
Evidence for a deferred tax asset — where the entity has made a loss in the current or preceding period and has still recognised a deferred tax asset, the nature of the evidence supporting it.
IFRS 18 and this chapter.
IFRS 18 Presentation and Disclosure in Financial Statements replaces IAS 1 for accounting periods beginning on or after 1 January 2027. It changes presentation only — nothing in this chapter is recognised or measured differently because of it, and deferred tax is still IAS 12. The income tax expense is the whole of IFRS 18's income taxes category, and it continues to be presented immediately below profit before tax, exactly where it sits now. The categories themselves are taught in the chapter IFRS 18 – Presentation and Disclosure in Financial Statements.
Deferred tax in group accounts — what this chapter does not cover.
Deferred tax can also arise on consolidation. A fair value adjustment made to a subsidiary's assets at acquisition changes their carrying amount without changing their tax base, and eliminating unrealised profit from group inventory does something similar in reverse. Neither is developed here, and neither is developed in the group chapters.
That is a deliberate scope decision and it follows the syllabus. IAS 12 is listed as a topic to be covered under the outcome on financial reporting standards for revenue, leases, financial instruments, intangible assets and provisions — the outcome this chapter discharges. It is not in the topic list for either of the two group accounts outcomes, which name IFRS 18, IAS 27, IAS 28, IFRS 3, IFRS 5, IFRS 10 and IFRS 11, and no other standard. The consolidation adjustments themselves are taught in the group chapters, without a deferred tax overlay. This is mentioned so that you know the situations exist, not as something to prepare.
The income tax expense in the statement of profit or loss is the current tax on this year's taxable profit, plus or minus any under- or over-provision from last year, plus the movement in deferred tax. Deferred tax exists because accounting profit and taxable profit are computed under different rules, and it is recognised only on temporary differences — differences that reverse — never on permanent ones. A temporary difference is the carrying amount of an asset or liability less its tax base; multiply it by the tax rate and you have the balance. For an asset, a carrying amount above the tax base gives a taxable difference and a deferred tax liability; below it gives a deductible difference and a deferred tax asset, and for a liability it is the other way round. Liabilities are recognised in full; assets only to the extent that future taxable profits are probable. Measure at the rate enacted or substantively enacted by the reporting date, and never discount. The movement in the balance — not the balance itself — goes to profit or loss, or to other comprehensive income where the underlying item went there, as a revaluation surplus does. Deferred tax is always a non-current balance, and none of it changes a cent of what is actually paid to the tax authority.
6 Test your knowledge
IAS 12 Income taxes
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