DEFERRED TAXATION

[bilal azhar]

I Have the following queries regarding deferred tax.if somebody can help me then please respond

<b>AT JUNE 30,2009</b>

Accounting base of total assets is RS.861,829,002. This includes lease assets of Rs.121,233,,628 and free hold land amounting to Rs. 177,425,000. Tax base is Rs. 214,445,468 excluding land.



Accounting base of Lease liability is Rs. 76,788,729 and tax base is zero.

unused losses (Minimum tax) amounts to Rs.6,633,725. on the basis of above data i am calcuating deferred tax as

<b>Deferred tax liability</b>
Accounting base of assets Rs.861,829,002-177,425,000 = 684,404,002
Tax base excluding land and lease assets = Rs. 214,445,468
Deferred tax liability = 164,485,487
<b>Deferred tax asset</b>
Accounting base of lease liability = Rs. 76,788,729
tax base is Rs. nil
Deferred tax asset @ 35% = 26,876,055 A
unused loss Rs. 6,633,725 B
Total deferred tax asset =33,509,780 A+B

Net deferred tax liability Rs.164,485,487-33,509,780=130,975,707

now i have the following queries based on the above working
1.Is the above working correct.

2. if yes then i have the following objections



(a)Tax base does not have lease assets as only rentals is allowed in tax. why are we not deducting lease assets from our accounting base. will any temporary difference be created as a result of lease assets as depreciation on lease assets will never be allowed in tax.



(b)on what basis we are creating deferred tax assets on remaining balance of lease liability. because in tax we are only taking the benefit of leased rentals paid during the current year only and not the future years.do we need to creat deferred tax asset on liability.if yes then what is the reason/logic.





i will be extremely thankful if any one can reply this query immediately.

[kamranACA]

Bilal

It is the area of my interest.

Without going into calculations and getting insight info of the above calculation, I express my concern over its accuracy.

I will come back to you tomorrow since replying this question using cellphone is irritating me.

Regards,



Kamran.

[kamranACA]

Dear,

I will treat different components separately for understanding


1. ASSETS SIDE EXCEPT FINANCE LEASE ASSETS

From the accounting base of the assets, exclude both of the free-hold land and leased asset (under finance lease). [finance lease will be seprately considered].

This will come to Rupees 563,170,374.

Against this accounting base, the tax base will also be taken excluding freehold land and leased assets (under finance lease). You have not given tax base of leased assets (USED BY YOU) so calculations will have to be made by you.

Just for assumption, if we consider that leased assets had similar tax base as they had in accounts (i.e. Rupees 121,445,468), then the net figure of tax base of assets (net of land and leased assets) would be Rupees 93,211,840.

The resultant taxable difference would be Rs. 469,958,534. Deferred tax impact on this taxable difference @35% comes to Rupees 164,485,487.

{these figures may not be correct since I dont know what is the tax base taken for leased assets and here i used assumption, as discussed above}.




2. LIABILITIES SIDE EXCEPT FINANCE LEASE LIABAILITIES

As per query, there is no liability which gives rise to deductible temporary difference. [Finance lease is seprately discussed].




3. CARRY FORWARD AVAILABLE TAX LOSSES

Tax losses are Rs. 6,633,725. These cannot simply be added/deducted form deferred tax calculation. Rather the tax impact has to be calculated at 35% (rate being used.) Since the tax losses carry a debit balance so these will give rise to a taxable temporary difference. Deferred tax impact @35% is Rupees 2,321,804.

Here your calculation was wrong.





4. TREATMENT OF FINANCE LEASE ASSETS AND FINANCE LEASE LIABILITIES

First of all you need to understand how temporary differences arise in this case. What is recognised in accounts and what is accepted in tax etc.

One important thing I let you know is, there is no tax base of finance leased assets and there is no tax base of finance lease liabilities. This is weird but is real. Tax allows only rentals and does not accept or recognise any asset or liability unless the lease term is over, liabilities are Nil and assets have been transferred to operating assets.

Here if I use the word tax base of leased asset or liability, these are merely in response to data given by you.

To simplify the things I here deliberately follow the old approach of Profit and Loss instead of accounting and tax base of assets and liabilities although both give rise to similar results. (Other approach will follow).

Profit and loss approach

In accouting profit and loss account you recognise two things i.e. depreciation charge and finance charges on lease.

In tax profit determination, you add back the both of the above (i.e. depreciation and finance chares on lease) and instead of it deduct total rentals (including financial charges and principal portion).

Here lies the difference. The "depreciation charged in accounts" does represent the principal portion of liability (since asset is accounted for equal to liability) and "finance charges in accounts" do represent the finance cost embeddded in rentals but strictly these both cannot be equal to rentals because of charging of depreciation as per useful life instead of lease term.

Now if specific to any lease contract, you add up

(1) all depreciation and finance charges accounted for in current and previous years' profit and loss accounts at one side; [accounting figure/base] and

(2) all rentals paid against such contract in current and previous years on the other side.[tax figure/base]

The difference between the above two calculated figures would be the temporary difference regarding such one lease contract. (either taxable or deductible).

To arrive at an aggregate figure, you will have to repeat this exercise for all lease contracts in running at reporting date and closed during the year.

Liability method approach

Now instead of doing such massive exercise, if we follow balance sheet liability method (new approach) instead of profit and loss method, we can do it in a far simpler way. Here it goes

Don't treat leased assets or liabilities separately at all (leases under finance arrangement). Instead treat them together as under

1. Take the figure of written down value of all leased assets at the balance sheet date. (accounting base).

2. Take the figure of finance lease liabilities including long term and current portions. (Tax base). and

3. Assume that finance charges are same both in accounts and tax (since these are included in Profit and loss (in accounts) as well as lease rentals (in tax).

………….{Mind it the WDV of leased assets carries the effect of the total depreciable amount i.e. depreciation to be charged or have been charged on all lease liabilities in past or future. Whereas, the liability carries the effect of all rentals to be paid or have been paid on all lease liabilities in past or future. If we take finance cost similar in both cases, the temporary differences remains between only these two.}………..


In your query, the WDV of finance lease assets is Rupees 121,233,628 while liability (I assume includes both current and long term portions) is Rupees 76,788,729. The difference is Rupees 44,444,899. Since the debit side is larger, it has obviously given rise to taxable difference. The deferred tax liability on this taxable difference @35% is Rupees 15,555,715.





5. CONCLUSION

Summarize the above 4,

- Deferred tax liability on taxable difference of assets side (Rs. 164,485,487)
- Deferred tax liability on deductible difference of liabilities side (Rs. Nil)
- Deferred tax asset on deductible difference of unused tax losses (Rs. 2,321,804)
- Deferred tax liability on taxable difference of finance leases arrangements (both assets and liabilities) (Rs. 15,555,715)

Total deferred tax liability as at reporting date Rupees 177,719,398.




6. OTHER MATTERS

a). You need to check the figure to be deducted from tax base of assets in respect of leased assets. I on assumption deducted the figure that you mentioned as accounting base. In other words you have to exclude any figure included by you in respct of leased assets (under finance) from the aggregate figure of tax base of assets. (You will see I also excluded it from accounting base of assets for seprate treatment).

b). Define and calculate temporary differences and deferred tax effect for all assets and liabilities separately instead of adding up all and arriving at a net result. This may lead to incorrect results as different account heads may need different treatment due to different reasons.

c). Check if any other item has been missed e.g. provisions (for employees benefits, impairments, or doubtful debts etc) and their reversals, items that make part of equity as per IAS-12 and need to be treated separately in equity (e.g. Revaluation surplus on fixed assets or Fair value gains on unquoted investments etc) and other such things.



If you have further questions, do post here.


Regards,



KAMRAN.

[bilal azhar]

Kamran bahi thanks a lot for replying.you have helped me a lot. please dont mind but My answer and objections to your reply is as follows
1. <b>Posted by you</b>"Against this accounting base, the tax base will also be taken excluding freehold land and leased assets (under finance lease). You have not given tax base of leased assets (USED BY YOU) so calculations will have to be made by you"
<b>MY REPLY</b>
i didnot give any tax base because as per ITO,2001 only leased rentals are allowed. so tax base of leased assets will always be zero. hence deferred tax liability will come as Rs.(563,170,374-214,445,468)*35%= Rs. 122,053,717 liability. please tell whether there is any possibility that tax base of leased assets will be any value other than zero in the books of lesses

2.<b>POSTED BY YOU</b>
"Tax losses are Rs. 6,633,725. These cannot simply be added/deducted form deferred tax calculation. Rather the tax impact has to be calculated at 35% (rate being used.) Since the tax losses carry a debit balance so these will give rise to a taxable temporary difference. Deferred tax impact @35% is Rupees 2,321,804.

Here your calculation was wrong."
<b>MY REPLY</b>
sir, i used the word Minimum tax with losses. this means this is the excess of turnover tax over the normal tax (although not applicable for tax year 2009 ). These amounts represent actual amount of tax paid. Hence whole tax paid will be taken as deferred tax asset amounting to Rs.6,633,725.
one thing i wana confirm from you is that when we create deferred tax asset@35% on business losses what will we do after six years. as it can only be carried forward upto six years.


3.balance deferred tax liability will come as Rs.121,233,628-76,788,729=44,444,899@35% and this will come to Rs. 15,555,715

Hence final deferred tax liability will be Rs.122,053,717+15,555,715-6,633,725=Rs.130,975,707.
i think my original calculation is right.

i will definitely look into other matters as mentioned in your reply

[kamranACA]

Dear Bilal

Thanks for your reply. I mentioned in my last post (under heading 4)

QUOTE

One important thing I let you know is, there is no tax base of finance leased assets and there is no tax base of finance lease liabilities. This is weird but is real. Tax allows only rentals and does not accept or recognise any asset or liability unless the lease term is over, liabilities are Nil and assets have been transferred to operating assets.

UNQUOTE


It's very nice if you already know this. I felt it might have not been in your knoweldge that's why I said finally calculations will have to be made by you and my working is only on assumption although I knew tax base of leased assets and liability is Nil.

So, if the tax base calculated by you does not include leased assets, then your calculation is correct.

Carry forward of minimum tax is not a carry forward of un-used tax losses. There is a huge difference between the concept and purpose. If the amount mentioned by you is minimum tax then it will wholly be taken as a deductible temporary difference without further applying any taxation rate since it itself represent the tax amount that is adjustable.


So, if it is minimum tax then you have rightly included its gross figure. Your working is therefore correct here as well and given the correct result of deferred tax liability as a whole.


Minimum tax will keep on expiring after the lapse of limitation period presceribed in law and you will maintain a tax chart in your record to update the figure annually whereby the expiring year's minimum tax will be excluded and the minimum tax deposited (in the year) will be added in it.


IAS-12 requires disclosing deferred tax effect on each of taxable temporary difference and deductible temporary difference. So it will be good if you bifurcate your working into appropriate headings of disclosure. I would suggest you to treat Finance Lease Arrangement a separate item where you will calculate the deferred tax effect on the difference of WDV and Principal liability.

Your working is correct.

Regards,



KAMRAN.

[shakilbadar]

Dear Kamran and Bilal,

with due respect i would like to draw your attention to the initial recognition exemption provided by IAS 12 through paragraph 15 and 24.

As you both agree that the tax base of both finance lease liability and finance lease assets are nil at initial recognition (at least), so at initial recognition deferred tax asset/liability arising from finance lease liability shall be set off with deferred tax asset/liability arising from finance lease asset therefore, it shall have no impact on profit and loss.

hence, it qualifies for exemption provided by IAS 12 and no deferred tax asset/liability shall be recorded either at initial recognition or thereafter.

I hope you get my point i am quoting text from IAS 12 paragraph 15 for convenience

<b>Paragraph 15 of IAS 12 states</b>

“A deferred tax liability shall be recognised for all taxable temporary differences, except to the extent that the deferred tax liability arises from…

(b) the initial recognition of an asset or liability in a transaction which

(i) is not a business combination; and

(ii) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss)….”


Regards,


Shakeel Badar

[junio]

Dear Shakeel,

i think deferred tax assets/liabilty shall arise on both liability against assets subject to finance lease and assets subject to finance lease and have an impact on profit and loss separately

Regards,

[kamranACA]

Shakil

In my view deferred tax liability of asset has to be provided on finance lease arrangement since the paragraphs referred by you don't apply to such an arrangement.

I would like to hear your point of view in detail. However, let me tell you that at initial recognition, there is an accounting base of leased asset and an accounting base of leased liability, whereas the tax base of such asset and such liability in Nil.

It has to affect accounting profit with "depreciation on asset" and "finance charge on liability" outrightly from the time of recognition. At the same time it has to affect tax profit with "lease rentals paid" (instead of depreciation and finance charge) exactly from the time of the recognition.

Further, the "charge to accounting profit" (Depreciation + finance expense) eventually has to equate the "lease rentals allowed in tax" [principal portion of liability (which you will appreciate is exactly equal to the value of the asset) plus finance charge embedded in a rental] only with the difference of some temporary timing gap.

Since this has to equate with a difference of timing gap, it is a temporary difference. It can either be a taxable difference or deductible difference depending upon a given situation and proposition. It has twofold calculation that is as under

First

ACCOUNTING BASE OF ASSET

LESS TAX BASE OF ASSET (this is zero)

Resultant difference will be deductible difference.

Second

ACCOUNTING BASE OF LIABILITY (PRINCIPAL)

LESS TAX BASE OF SUCH LIABILITY (this is zero)

Resultant is taxable temporary difference.



The net of "First" and "Seecond" will decide which difference is greater and whether deferred tax asset will arise or deferred tax liability will arise.

I lookforward to hear your view point.


Regards,



KAMRAN.

[shakilbadar]

Dear Kamran,

currently there are two approaches followed in respect of deferred taxation relating to finance lease arrangement,

Approach 1
deferred tax asset/liabilty <b>is booked</b> on finance lease and i 100% agree with treatment suggested by you for recording of deferred tax asset/liability in case of finance lease arrangement.

Approach 2
deferred tax asset/liability <b>is not booked</b> and the arguments in support of approach 2 is that transaction of such type falls under the exemption provided by para 15 of IAS 12. as far as the applicability of above mention para on finance lease arrangement i can produce the the extracts from discussion of IFRIC,

<b>Extract from the IFRIC Update April 2005</b>

"The IFRIC noted that initial recognition exemption applies to each separate recognised element in the balance sheet, and no deferred tax asset or liability should be recognised on the temporary difference existing on the initial recognition of assets and liabilities arising from finance leases or subsequently. The IFRIC took the view that IAS 12.16 is clear that all deferred tax assets and liabilities must be recognised unless they fall within an exemption specified by paragraph 15 or 24. The inception of a finance lease is clearly the initial recognition of an asset that does not arise from a business combination and does not affect profit or loss at the time of recognition. Accordingly the exemption applies and there can be no recognition of a deferred tax asset or deferred tax liability.).”


I hope i have explained my point of view to your satisfaction. further arguments are awaited ))

Thanks and Regards,

Shakeel Badar