ACCOUNTING FOR TAXATION Learning objectives 1.Account for current taxation in accordance with relevant accounting standards. 2.Record entries relating to income tax in the accounting records 3.Explain the effect of taxable temporary differences on accounting and taxable profits 1

Introduction: Companies are normally responsible for collection and payment of three types of taxes namely: 1.Pay as you earn( PAYE) – This is a payroll tax paid by the employees on their salaries and wages and other benefits and is collected and paid by the company on the employees’ behalf. 2.Corporation Tax – This is paid by corporations based on their profits. 3.Income Tax (IAS 12) A Company is a legal person and therefore is liable for income tax on its profits made for the year. The income tax is assessable and payable on the taxable income which is regulated by the tax laws in place not on the profits as reported in the statement of comprehensive income. 2

Definitions: 1.Accounting profit - Net profit or loss for a period before deducting tax expense. 2.Taxable profit(Tax loss) The profit(loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable 3.Tax expense(Tax Income) The aggregate amount included in the determination net profit or loss for the period in respect of current tax and deferred tax 4.Current tax – is the amount of income taxes payable (recoverable) in respect of the taxable profit(Tax loss) for a period. 3

Recognition of current tax liabilities and assets IAS 12 requires any unpaid tax in respect of the current or prior periods to be recognised as a liability Any excess tax paid in respect of current or prior periods over what is due should be recognised as an asset Example: In 2012 Dalton co had taxable profits of N$120,000. In the previous year (2011) income tax on 2011 profits had been estimated as N$30,000 Required: Assuming 30%tax rate, calculate tax payable and the charge for 2012 if the tax due on 2011 profits was subsequently agreed with the tax authorities as: (a) 35,000 or (b) 25,000 Any under or over payments are not settled until the following years tax payment is due 4

SOLUTION a)Tax due on 2012 profits (120,000 x 30% = 36,000 Underpayment for ,000 Tax Charge and liability 41,000 b)Tax due on 2012 profits Overpayment for Tax charge and liability

IAS 12 also requires recognition as an asset of the benefit relating to any tax loss that can be carried back to recover current tax of a previous period. This is acceptable because it is probable that the benefit will flow to the entity and it can be reliably measured. Example: Tax losses carried back. In 2011 Erasmus Co paid N$50,000 in tax on its profits In 2012 the company made tax losses of N$24,000. The local tax authority rules allow losses to be carried back to offset against current tax of prior years. Required: Show the tax charge and tax liability for

SOLUTION: The repayment due on tax losses = 30% x24,000 = N$7,200 The double entry will be: DEBIT Tax receivable( SOFP) N$ 7,200 CREDIT Tax repayment (SOCI) N$ 7,200 The tax receivable will be shown as an asset until the repayment is received from the tax authorities. 7

PRESENTATION: In the statement of financial position, tax assets and liabilities should be shown separately from other assets and liabilities. Current tax assets and liabilities can be offset but this should happen only when certain conditions apply. a)The entity has a legally enforceable right to set off the recognised amounts b)The entity tends to settle the amount on a net basis or to realise the asset and settle the liability at the same time. 8

DEFERRED TAX WHAT IS DEFERRED TAX? Deferred tax is: the estimated future tax consequences of transactions and events recognised in the financial statements of the current and previous periods. Deferred taxation is a basis of allocating tax charges to particular accounting periods. The key to deferred taxation lies in the two quite different concepts of profit: The accounting profit (or the reported profit), which is the figure of profit before tax, reported to the shareholders in the published accounts The taxable profit, which is the figure of profit on which the taxation authorities base their tax calculations 9

Accounting profit and taxable profit The difference between accounting profit and taxable profit is caused by: Permanent differences. Temporary differences. 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. differences which have no deferred tax consequences whatsoever An example of a permanent difference is client entertaining expenses. 10

Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base (the amount attributed to that asset or liability for tax purposes). Deferred tax is the tax attributable to temporary differences which are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. These can be either: a) Taxable temporary differences- results in taxable amounts in determining taxable profit of future periods when the carrying amount of the asset or liability is recovered or settled. Taxable temporary differences give rise to deferred tax liabilities b) Deductible temporary differences- result in amounts that are deductible in determining taxable profit of future periods when the carrying amount of the asset or liability is recovered or settled. Deductible temporary differences give rise to deferred tax assets 11

Before we move on let us look at these definitions 1.Tax base of an asset. The tax base of an asset is the amount that will be deductible for taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. 2. Tax base of a liability. The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods The difference between the carrying amount and tax base is called TEMPORARY DIFFERENCE. The temporary difference multiplied by the tax rate will give: The deferred tax balance in the statement of financial position. 12

Example: A non –current asset costing NS 2000 was acquired at the start of year 1. it is being depreciated straight line over 4 years, resulting in annual depreciation charges of N$500. Thus a total of N$2000 of depreciation is being charged. The capital allowances granted on this asset are: N$ Year Year Year Year Total capital allowances 2000 Required : Calculate the taxable temporary differences for years 1-4 and the deferred tax including the movement in the deferred tax liability assuming 25% tax rate. 13

SOLUTION Year Carrying amount Tax base Temporary difference nil nil nil 14

Deferred tax Year 1 = 300 x 25% = 75 Year 2 = 400 x 25 = 100 Year 3 = 260 x 25% = 65 Year 4 = Nil since carrying amount = tax base 15

DOUBLE ENTRY Year 1 Dr Tax expense ( P& L) 75 Cr Deferred tax liability ( sofp) 75 Year 2 Dr Tax expense 25 Cr Deferred tax liability 25 Year 3 Dr Deferred tax liability 35 Cr Tax expense 35 16

The movement in the liability are recorded in the income statement as part of the taxation charge 17 Year Opening deferred tax liability Increase/decrease 7525(35) (65) Closing deferred tax Liability

The movement in the deferred tax liability in the year is recorded in the income statement where: -An increase in the liability, increases the tax expense -A decrease in the liability decreases the tax expense The Closing figures are reported in the statement of financial position as the deferred tax liability 18

Continuing with the previous example, suppose that the profit before tax of the entity for each of years 1-4 is N$ 10000( After charging depreciation) since the tax rate is 25% it would be logical to expect the tax expense for each year to be N$ HOWEVER INCOME TAX IS BASED ON TAXABLE PROFITS NOT ON ACCOUNTING PROFITS. 19

The taxable profits and so the actual tax liability for each year could be calculated as follows: 20 Year 1 year 2Year 3 Year 4 Profit before tax Depreciation 500 Capital Allowance(800)(600)(360)(240) Taxable profits Tax

AS we have seen in the example, accounting for deferred tax then results in a further increase or decrease in the tax expense. Therefore the final tax expense for each year reported in the income statement would be as below 21 Year 1 Year 2 Year 3 Year 4 Income Tax Increase / Decrease due to deferred tax 7525(35)(65) Total tax expense2500

MEASUREMENT OF DEFERRED TAX. There are two methods of measuring deferred tax, although IAS 12 only refers to one. The income statement approach ;and Balance Sheet approach The latest version of IAS 12 refers only to the Balance sheet method and therefore the Income Statement method will not be amplified in this study. 22

The Balance sheet method requires deferred tax to be measured based on the difference between : The carrying amount of the entity’s assets and liabilities, and The Tax base of each of the entity’s assets and liabilities The SOFP approach thus requires that we compare the carrying amount of each of the assets and liabilities with its tax base. The carrying amount of an asset or liability is the balance recognised in the statement of financial position based in International financial reporting standards. The tax base of an asset or liability is the balance calculated based on Tax legislation. 23

The definition of a tax base of an asset refers to two types of assets 1.An asset that represents a future inflow of economic benefits that will be taxable.( e.g) plant earning taxable profits 2.An asset that represent a future inflow of economic benefits that will not be taxable( e.g an Investment earning exempt dividend income 24

If the inflow will be taxable, the tax base is the future deductions If the inflow will not be taxable the tax base will be its carrying amount. 25

The definition of a tax base of a liability refers to two types of a liability 1.Liabilities that represent income received in advance 2.Liabilities that represent expenses 26

If the liability is income received in advance, the tax base will its carrying amount less the portion that wont be taxable in the future. In the case of any other liability The tax base will be its carrying amount less any portion that represents future deductions(i.e the portion of the carrying amount that will not be allowed as a tax deduction in the future. 27

Useful format for calculating deferred Tax using the balance sheet approach 28 CARRYING AMOUNT (SOFP) (a) TAX BASE (b) Temporary Difference ( b – a ) (c ) Deferred Tax (c ) x 30% ( d)

TEST YOUR UNDERSTANDING. QUESTION 2. JULIAN 29

SOLUTION TO QUESTION 2 30 CARRYING VALUE TAX BASETEMPORARY DIFFERENCE PROPERTY PLANT & EQUIPMENT DEVELOPMENT EXPENDITURE 60 0 INTERST RECEIVABLE(55- 45) 10 0 PROVISION (40) 0

KATUTURA LIMITED 31

………………….. ASSETS If the carrying amount is greater than the tax base then it’s a tax liability LIABILITIES If the carrying amount is greater than the tax base then it’s a tax asset 32

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