Income Taxes


IAS 12 deals with the accounting treatment of tax liabilities. In this chapter, it is assumed that the tax liability for the period has already been computed, and the entity now must deal with the treatment of tax in the financial statements.

The title of the standard suggests that it deals with Income Tax only, but the standard deals with any tax on company profits, regardless of what the tax is actually called (e.g. corporation tax).

This chapter looks at the following issues:

  • Current tax
  • Deferred tax


Current tax is the amount of tax payable (or recoverable) in respect of taxable profit (or allowable loss) for the period. IAS 12 states that current tax for the current and prior periods should be recognised as a liability in the Statement of Financial Position to the extent that it has not yet been settled. To the extent that the amounts already paid exceed the amount due, than an asset should be recognised.

In addition, a tax asset should be recognised in the event that the benefit of a tax loss can be carried back to recover current tax of a prior period.

Current tax liabilities should be measured at the amount expected to be paid to the tax authorities. Likewise, current tax assets should be measured at the amounts expected to be recovered from the tax authorities. This means, in both situations, the amounts involved should be calculated using the rates / laws that have either been enacted or substantially enacted at the reporting date.

Current tax assets and liabilities should be shown separately in the financial statements. They can only be offset if there is a legally enforceable right to do so and it is the entity’s intention to offset them.

Any adjustments required to reflect any under or over provisions for tax in previous years should be included in the tax charge (or credit) in the statement of comprehensive income for the current period. It is, after all, merely the correction of an estimate, and is accounted for as such (i.e. it does not necessitate a retrospective adjustment)


Deferred tax is the estimated future tax consequences of transactions and events recognised in the financial statements of the current and previous periods. The need for deferred tax arises because the profit for tax purposes may differ from the profit shown in the financial statements.

The difference between accounting profit and taxable profit is caused by:

  • Temporary differences
  • Permanent differences

Deferred tax is a means of “ironing out” the tax inequalities arising from temporary differences.

Temporary Differences

These are differences between the carrying amount of an asset or liability in the statement of financial position and the tax base of the asset or liability. The tax base is the amount attributed to that asset or liability for tax purposes (often known as the Tax Written Down Value).

A temporary difference arises when an item is allowable for both accounting and tax purposes, but there is a difference in the timing of when the item is dealt with in the accounts and when it is dealt with in the tax computations.

A common example of such a difference is capital expenditure. In the financial statements, the expenditure will be depreciated over the life of the asset and this depreciation will be deducted in arriving at accounting profit. However, in the tax computation, depreciation is not deductible. It is added back and capital allowances (or tax depreciation) are granted instead. If the accounting depreciation and capital allowances are calculated at a different rate, there will be a difference between the accounting profit and the taxable profit.

This is a temporary difference because eventually, the cause of the difference will disappear entirely. That is, the asset will eventually be fully depreciated and no further depreciation expense in respect of that asset will appear in future Statement of Comprehensive Incomes and all capital allowances will also have been claimed, leaving no further deductions in future tax computations in respect of the asset.


Permanent Differences

Some income and expenses may not be chargeable / deductible for tax and therefore there will be a permanent difference between accounting and taxable profits. That is, the difference will not reverse in the future

Therefore, permanent differences are:

  • One-off differences between accounting and taxable profits caused by certain items not being taxable / allowable
  • Differences which only impact on the tax computation of one period

An example of a permanent difference would be fines or penalties, such as interest imposed on the late payment of tax. Such an expense would appear in the financial statements but would not be allowable for tax purposes.

Deferred tax arises in respect of temporary differences only. Deferred tax is not concerned with permanent differences.                                                                                                                                                                                                                                                                                                                                            


Deferred tax is calculated using the liability method. Under this method, deferred tax is calculated by reference to the tax base of an asset (or liability) compared to its book value. IAS 12 requires full provision for all taxable temporary differences (except goodwill).

The following steps should be followed:

  • Calculate the temporary difference
  • Apply the tax rate to the temporary difference
  • The resulting tax liability (or asset) is shown in the Statement of Financial Position and the increase or decrease on the previous period is reflected in the statement of comprehensive income, as part of the tax figure (unless it relates directly to a gain or loss that has been recognised in equity, e.g. revaluations, in which case the deferred tax is also recognised in equity)

Extract from Statement of Financial Position

Non-Current Liabilities

Deferred Tax                                                                                                  158

A similar process will be followed over the remaining useful life of the asset. By the end of the assets life, the deferred tax liability will have fully reversed and there will be no remaining balance in the Statement of Financial Position.


An explanation of why deferred tax is provided lies in the understanding that accounting profit (as reported in a company’s financial statements) differs from the profit figure used by the tax authorities to calculate a company’s income tax liability for a given period.

If deferred tax was ignored, a company’s tax charge for a particular period might bear little resemblance to the reported profit. For example, if a company makes a large profit in a particular period, but because of high levels of capital expenditure, it is entitled to claim large capital allowances for that period, this would reduce the amount of tax it had to pay. The result of this could be that the company reports a large profit and a small tax charge. This situation is usually reversed in subsequent periods as tax charges appear to be much higher than the reported profit suggests they should be.

It is argued that such a reporting system is misleading because the profit after tax, which is used to calculate the company’s EPS, may appear disconnected from the pre-tax profit. This may mean that a government’s fiscal (taxation) policy may distort a company’s profit trends.

Providing for deferred tax reduces this anomaly or inconsistency but it can never be entirely eliminated due to items in the profit and loss that may never be allowed for tax purposes (permanent differences).

Where capital allowances (tax depreciation) is different from the related accounting depreciation charges, this leads to the tax base of an asset being different from the carrying value in the Statement of Financial Position. This is referred to as a temporary difference and a provision for deferred tax is created.

This “liability approach” is the general principle on which IAS 12 bases the calculation of deferred tax. The effect of this is that it usually brings the total tax charge (i.e. the provision for the current year’s income tax plus the deferred tax) into proportion with to the profit reported to shareholders.

The main debate in the area of providing for deferred tax is whether the provision meets the definition of a liability. If the liability is likely to crystallise (actually develop), then it is a liability. However, if it will not crystallise in the foreseeable future, then arguably it is not a liability and should not be provided for. The standard setters take a prudent approach and the standard does not accept the latter argument.

The main benefits, therefore, of providing for deferred tax are as follows:

  • Profit after tax, used to calculate EPS, may bear little resemblance to the pre-tax profit. If the tax charge is fluctuating because of the way in which certain items are treated for tax, the EPS will fluctuate too. Thus, providing for deferred tax reduces the fluctuation caused by temporary differences.
  • The EPS is used in the calculation of the Price Earnings (P/E) ratio, which in turn can impact on share price. Without providing for deferred tax, the share price may be adversely affected by government fiscal policy.
  • Over-statement of profit, by not allowing for deferred tax, can lead to demands for consequently overoptimistic dividends.
  • Shareholders may be misled in relation to the performance of the company.
  • Accounting for deferred tax satisfies the accruals concept in that the cost of the asset is matched with the benefit of that asset over its useful life.




IAS 12 requires that a deferred tax liability must be recognised for all taxable temporary differences (with minor exceptions). A taxable temporary difference arises where the carrying value of an asset is greater than its tax base.


IAS 12 requires that deferred tax assets should be recognised for all deductible temporary differences. A deductible temporary difference arises where the tax base of an asset exceeds its carrying value. The deferred tax asset will be recognised to the extent that taxable profit will be available against which the deductible temporary difference can be utilised.



The tax rate in force (or expected to be in force) when the asset is realised or the liability is settled should be used to calculate deferred tax.

This rate must be based on tax rates and legislation that have been enacted or substantively enacted by the reporting date.

Deferred tax assets and liabilities should not be discounted to present value.


 Revaluation of non-current assets:

Deferred tax should be recognised on revaluation gains (even where there is no intention to sell the asset or rollover relief is available on the gain).

The revaluation of non-current assets results in taxable temporary differences and therefore a liability. This is charged as a component of Other Comprehensive Income alongside the revaluation gain itself. It is therefore disclosed either in the statement of comprehensive income or in a separate statement showing other comprehensive income.


A finance lease transaction can give rise to deferred tax implications. This is caused by the temporary differences arising on the treatment of the lease for accounting and tax purposes. The Statement of Comprehensive Income will include a finance cost and depreciation expense. However, it is the lease payment itself that may be allowable for tax purposes for the period.

.      Development Expenditure:

If development costs are capitalised in the Statement of Financial Position, this situation can give rise to deferred tax implications. This is caused by the temporary differences arising on the treatment of the development expenditure for accounting and tax purposes. The expenditure is capitalised and amortised over future periods, whereas the expenditure is allowable for tax purposes immediately.

.      Unrealised inventory profit:

In consolidated accounts, an unrealised inventory profit has deferred tax implications. An unrealised inventory profit adjustment reduces the consolidated profit but has no effect on taxable profit. A temporary difference arises, which will reverse in the next year as the inventory is sold and the unrealised profit is realised.


There are extensive disclosure requirements in relation to tax. The main disclosures are:

  • The tax expense (income) should be presented on the face of the Statement of Comprehensive Income.
  • The major components of the tax expense (income) should be disclosed separately in a note.
  • Current and deferred tax charged / credited to equity
  • The amount of income tax relating to each component of other comprehensive income
  • An explanation of the relationship between tax expense (income) and accounting profit in either or both of the following forms:
  • A numerical reconciliation between tax expense (income) and the product of accounting profit multiplied by the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed
  • A numerical reconciliation between the average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed.


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