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ISA 12 Income Tax

ISA 12 Income Tax adopts a full provision approach to accounting for deferred taxation.It is assumed that the recovery of all assets and the settlement of all liabilities have taxconsequences and that these consequences can be estimated reliably and areunavoidable. IFRS recognition criteria are generally different from those embodied intax law and thus Temporary Difference will arise which is the difference between theCarrying Amount of an asset or a liability and its basis for taxation purposes (TaxBase). The principle is that a company will settle its liabilities and recover its assetsover time and at that point the tax consequences will crystallize.

Thus a change in an accounting standard will often affect the Carrying Value of anasset or a liability which in turn will affect the amount of Temporary Difference betweenthe Carrying Value and the Tax base. This is turn will affect the amount of DeferredTaxation Provision which is the Tax Rate multiplied by the amount of TemporaryDifferences.

The general principle is that Deferred Tax Liabilities should be recognized for allTaxable Temporary Differences and Deferred Tax Assets should be recognized forDeductible Temporary Differences, unused tax loses and unused tax credits to theextent that it is probable that taxable profit will be available against which the deductibletemporary differences can be utilized.

A deferred tax asset cannot be recognized when it arises from negative goodwill or theinitial recognition of an asset or liability other than in a business combination. Thecarrying value of deferred tax assets should be reviewed at each statement of financialposition date and reduced to the extent that it is no longer probable that sufficient

taxable profit will be available to allow the benefit of part or all of the deferred tax assetto be utilized.

The recognition of deferred tax assets result in the recognition of income in thestatement of comprehensive income. This amount cannot be reported in equity as IAS12 Income Tax does allow only deferred tax to be recognized in equity if thecorresponding entry is recognized in equity.

ISA 12 Income Tax and IFRS 2 Share Based Payments

ISA 12 Income Tax requires the deferred tax on share options to be recognized in theProfit and Loss for the period. The difference between the tax base of the servicesreceived ( that is, the amount of tax allowance in future periods) and the carrying valueof zero will be the deductible temporary difference, which results in a deferred taxasset.

IFRS 2 Share Based Payments says that estimated future deduction should be basedon the Options intrinsic value at the year end as the value at the exercise date will not

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be known. The Intrinsic Value is the difference between the Fair Value ( market value)of the share and the Exercise Prize of the share option.

It is likely that a deferred tax asset will arise which will be the difference between thetax base of the employees service rendered to date and the carrying value which will

be zero normally. The recognition of the deferred tax asset should be dealt with on thefollowing basis.

a) It the actual of estimated tax deduction is less than or equal to the cumulativerecognized expense, then the associated tax benefits are recognized in theStatement of Comprehensive Income.

b) If the actual or estimated tax deduction exceeds the cumulative recognizedcompensation, then the excess tax benefits are recognized directly in a separatecomponent of equity.

ISA 12 Income Tax and IAS 17 Leases

Plant (asset) acquired under a Finance Lease will be recorded as PPE ( property,plant and equipment) and a corresponding liability for the obligation to pay futurerentals. Rentals payable are apportioned between the finance charge and areduction of the outstanding obligation. A temporary difference will effectively arisebetween the value of the plant (asset) for accounting purposes and the equivalent ofthe outstanding obligation as the annual rental payments qualify for Tax Relief. Thetax base of the plant (asset) is the amount deducted for tax in future which is zero.The tax base of the liability is the carrying amount less any future tax deductibleamount which will give a tax base of zero.

Basic Computations

Temporary Difference = Carrying Amount Tax Base Liability( Taxable Temporary

Difference)

Temporary Difference = Tax Base Carrying Amount Asset( Deductible Temporary

Difference)

Temporary Difference x Tax Rate = +ve (Deferred Tax Asset)

Temporary Difference x Tax Rate = -ve (Deferred Tax Liability)