Download Deferred tax

Slide 16.1
Chapter 16
Taxation in Company Accounts
Slide 16.2
Objectives
By the end of the chapter, you should be able to:
• discuss the theoretical background to corporation
tax systems;
• critically discuss tax avoidance and tax evasion;
• prepare deferred tax calculations;
• critically discuss deferred tax provisions.
Slide 16.3
Corporation tax systems
• Classical system:
• Shareholders taxed twice – once on company’s
taxable profit, and again on dividends received
• Imputation system:
• Shareholders only taxed on dividend income. Tax
paid by coy is credited to the shareholder
• Partial imputation system:
• Only part of company tax paid is treated as a tax
credit
Slide 16.4
Classical system
Profits taxed
Dividends paid from tax paid profits, and are
taxed again in hands of shareholders.
Therefore, dividends are taxed twice.
Discourages distribution of dividends?
Slide 16.5
Imputation system
After tax profits earned by company can be:
 Retained
 or
Distributed
Tax paid by company treated as payment of tax on
dividend received. Therefore dividends are only taxed
once
Slide 16.6
IAS 12 income taxes: major components
disclosure
 Current tax expense for period
 Under/over provisions
 Previously unrecognised tax losses
 Temporary difference of prior period
 Tax expense relating to changes in accounting
policy.
Slide 16.7
Fundamentals
 The Tax Act (law relating to tax) which governs
the accounting for tax liability is not the same as
GAAP which governs financial reporting.
 As a result,
taxable income reported to the Tax Department (using
cash basis accounting) may not be the same as pre-tax
profit that is reported to shareholders (using accrual
accounting).
The amount of tax liability due to the Tax Department may
not be the same as income tax expense that is reported
on the income statement.
Slide 16.8
Fundamentals
Accounting income (per GAAP) ≠ Taxable
income (per Income Tax Act)
Accounting income → Income tax expense
(current and future)
Taxable income → Income tax payable and
current income tax expense
Income tax expense ≠ Income tax payable
Slide 16.9
Current tax expense illustration
 As the illustration shows, accounting profits and taxable profits
differ because of different treatments of items under accounting
standards and tax law.
Slide 16.10
IAS 12 income taxes – deferred taxation
Permanent differences:
 Arise because the transaction is recognised as either
accounting profit or as taxable profit, but not as both.
Timing (temporary) differences:
 Arise when revenues, or expenses, are recognised for
accounting purposes in a different time period to when
they are recognised for tax purposes
Accrual basis vs cash basis
Capital allowances
Capital investment incentive effect
Deferred tax provisions.
Slide 16.11
Permanent Differences
Sources of Permanent Differences
Some items
are recorded
in Books
but NEVER
on tax return
Other items
are NEVER
recorded in books
but recorded
on tax return
No deferred tax effects
for permanent differences
Slide 16.12
Deferred tax – alternative methods
Deferral method
 Tax effect debited/credited to income statement
 Effect of changing tax rates ignored
 Total provision has differences calculated at
different tax rates.
Slide 16.13
Deferred tax – alternative methods
Liability method
 Total amount of potential liability recalculated
each time the tax rate changes
 Keep record of the entries made to the provision
 Apply current rates of tax
 Adjust the provision.
Slide 16.14
Deferral method illustrated
Deferred tax provision using deferral method
Note: The 1999 & 2000 tax allowances (depreciation) are calculated at 25%
Figure 16.1
Slide 16.15
Summary of deferred tax provision using
deferral method
Summary of deferred tax provision using the deferral method
Note: The 1999 & 2000 deferred tax provisions are calculated at the new tax rate of
24%
Figure 16.2
Slide 16.16
Deferred tax provision using liability method
Deferral tax provision using the liability method
Note: Because the tax rate has fallen to 24%, the liability for tax has changed, so
under this approach, the deferred tax provision for each year is recalculated at the
new tax rate, i.e. the 24% rate is used for all years to calculate the deferred tax.
Figure 16.3
Slide 16.17
Accounting treatment over life of an
asset
Assume
 Equipment costs 10,000
 Straight-line depreciation over 5 years
 Tax capital allowance (depreciation rate) is 25% per
annum straight-line
 Taxable rate 40%.
Slide 16.18
Accounting treatment current tax expense
See Example p.420
Year
1
2
3
4
5
Dep’n for Accounting
2,000 2,000 2,000 2,000 2,000
Dep’n for tax purposes
2,500 2,500 2,500 2,500
0
Tax profit (loss)
(500) (500) (500) (500) 2,000
Current tax exp/(inc) at 40%* (200) (200) (200) (200) 800
 In years 1-4, tax payable is 200 less than the accounting
tax expense (total 800 over 4 years).
 In year 5, there is no tax depreciation allowance, so tax
payable is 800 more than accounting tax expense – which
counters the underpayment in years 1-4
Slide 16.19
Accounting treatment temporary
timing differences
Slide 16.20
Accounting treatment income
statement entries
Slide 16.21
Critique – do not provide deferred taxation
Not a legal liability until it accrues
 Tax expense should be equal to amount based
on income tax return for year
 Accrue as a payable any unpaid tax
 Disclose in a note differences between income tax
bases and amounts in the accounts
 Confuses investors.
Slide 16.22
Critique – provide deferred taxation
 Investors used to uncertainty of future cash flows
 Tax attaches to taxable income not accounting
income
 Deferred tax achieves income smoothing
 IASB Framework sees deferral as applying
accrual concept
 IASB Framework states ‘accounts inform of
obligations to pay cash in the future’.
Slide 16.23
Discussion
 What are the arguments for not providing for
deferred tax?
 What are the advantages to an investor of
providing for deferred tax?
 What are the implications for the statement of
financial position if a company has a consistent
annual capital investment programme?
Slide 16.24
Review questions
1. Why does the charge to taxation in a company’s
accounts not equal the profit multiplied by the current
rate of corporation tax?
4. Deferred tax accounting may be seen as an incomesmoothing device which distorts the true and fair
view. Explain the impact of deferred tax on reported
income and justify its continued use.
5. Discuss the problems in distinguishing tax evasion
from tax avoidance.
6. Distinguish between (a) the deferral and (b) the
liability methods of company deferred tax.