Chapter 18

Income Taxes

Fundamentals

Accounting income (per GAAP) ≠ Taxable income (per Income Tax Act)

Accounting income → Income tax expense (current and deferred)

Referred to as the tax provision

Taxable income → Income tax payable and current income tax expense

Income tax expense ≠ Income tax payable

Accounting Income and Taxable Income:

Reconciliation of Accounting Income

and Taxable Income:

Accounting income

± differences

= Taxable income * current tax rate =

Dr Current income tax expense

Cr Current income tax payable

Permanent, Timing, and Temporary Differences

• Taxable income is determined by starting with accounting income and adjusting it for permanent and timing differences in the year

• The accounting for deferred tax liabilities and deferred tax assets (on the balance sheet) is based on the tax impact of the accumulated timing differences = temporary differences

Permanent Differences - Examples

• Items, recognized on income statement, but never for income tax purposes:• Non-tax-deductible expenses (e.g. fines, golf dues,

expenses related to non-taxable revenue, disallowed portion of entertainment)

• Income/loss from associate• Dividends from taxable Canadian corporations

• Items, recognized for tax purposes, but not forfinancial accounting purposes:• Taxable capital gains

Summary of Permanent Differences

Sources of PERMANENT DIFFERENCESSources of PERMANENT DIFFERENCES

Some itemsSome items are recordedare recordedin booksin books

but neverbut neveron tax returnon tax return

Other itemsOther items are neverare neverrecorded in booksrecorded in books

but recordedbut recordedon tax returnon tax return

No deferred tax effectsNo deferred tax effectsfor permanent differencesfor permanent differences

Temporary Differences

The following represent Timing Differences that accumulate over time (becoming Temporary Differences):

• Depreciation, CCA, Gains or losses on depreciable assets• Warranty expense, warranty costs incurred• Pension expense, contributions to pension plan• Amortization of bond discount or premium• Deferred development costs• Unrealized gains/losses

Timing Differences

• Are treated the same for books and tax—but in different periods.

• Relate to income statement differences• Cause the balance of a temporary difference to

change from period to period• Timing differences will:

– Reduce a deferred tax asset (deferred tax expense)– Increase a deferred tax liability (deferred tax expense)– Increase a deferred tax asset (deferred tax recovery)– Decrease a deferred tax liability (deferred tax recovery)

Temporary Differences

= accumulated timing differences

= difference between book value of an asset or liability and its tax value

• Are either a deductible temporary differences (i.e. will be deducted from accounting income in calculating taxable income in the future), giving rise to a deferred tax asset, OR

Temporary Differences

• or…a taxable temporary difference (i.e. will be added to accounting income in calculating taxable income in the deferred), giving rise to a deferred tax liability.

Deferred Tax Asset and Deferred Tax Liability - Sources

• deferred tax accounts on the balance sheet may be a:– deferred tax liability, or– deferred tax asset

• deferred tax liability arises if the deferred recovery of an asset, or deferred settlement of a liability, that is reported on the balance sheet will result in paying deferred income taxes

• deferred tax asset arises if the recovery of an asset or settlement of a liability results in deferred income tax reductions or benefits

Deferred Tax Liability - Is it a Liability?

• Sometimes dismissed by analysts• Meets Conceptual Framework definition of a

liability:1. Results from a past transaction2. It is a present obligation3. It represents a deferred sacrifice

Deferred Tax Asset - Is it an Asset?

• Meets all necessary criteria from Conceptual Framework definition of an asset:1.It will contribute to deferred net cash flows

2.Access to benefits are controlled by the entity

3.It results from a past transaction or event

Valuation of Deferred Income Tax Asset

• Must be reviewed at year end to ensure deferred income tax asset is not reported at more than recoverable amount

• Recognized to extent that it is more likely than not that the asset will be realized in the deferred

• This depends on whether taxable income will be earned in the deferred, against which temporary differences can be deducted

Deferred Tax Rates

• IAS 12• Should use the enacted rate (or substantively

enacted) at the balance sheet date (i.e. the rates that are expected to apply when the tax assets are realized or the tax liabilities are settled)

Deferred Tax Rates

• The effect of deferred tax rate changes should be immediately recognized on all deferred tax accounts

• Rate changes are treated as an adjustment to the deferred income tax expense/benefit

• A net current or net long-term deferred tax asset (DTA) or liability (DTL) is allowed as long as all taxes relate to the same tax jurisdiction (e.g., can net a long-term DTA against a long-term DTL if same jurisdiction)

• Deferred tax amounts have no impact on current income tax expense

• On the income statement, report current income tax expense/benefit separately from deferred income tax expense/benefit

• The deferred Income Tax Asset account is periodically reassessed to ensure realizable

Deferred Taxes – Final Notes

• The amount reported is the tax calculated from the loss

• May be carried back three years, or forward for the next twenty years

• When applying the carry back, it is usually applied to the oldest available year first

• The benefit of a tax loss carryforward is recorded if it is more likely than not that taxable income will be earned in deferred periods to apply it against

Tax Loss Carryback and Carryforward

Tax Loss Carryback

• Refile prior year’s tax returns, reduce prior taxable incomes with current year’s loss

• Claim back taxes previously paid:

Income Tax Refund Receivable xx

Current Income Tax Benefit xx• If loss still remains, carry it forward

Tax Loss Carryforward

Can you recognize (book) the tax benefit of a loss carryforward?

If more likely than not (i.e. a probability of greater than 50%) that benefit will be realized (i.e. company will generate taxable income in the deferred to apply loss against), then recognize tax benefit as an asset:

Deferred Income Tax Asset xx Deferred Income Tax Benefit xx

Tax Loss Carryforward (Cont’d)

• If deferred taxable income not likely (i.e. not likely that benefit will be realized), then do not record the tax benefit

• Instead, report existence of loss carryforward in notes to the financial statements

• Disclose the amounts and expiry dates of unrecognized income tax assets related to the carryforward of unused tax losses

Tax Loss Carryforward (Cont’d)

Assuming tax benefit was recognized as a deferred Tax Asset, when co. applies the losses against taxable income in the deferred:

Deferred income tax expense xx

Deferred income tax asset xx

Tax Loss Carryforward (Cont’d)

• If benefit was not “booked” and company does generate taxable income in the deferred and uses the unrecognized losses to reduce taxable income:

Income tax payable xx

Current income tax benefitxx

Carryforward with Valuation Allowance

• Assuming a $150,000 loss carryforward where it is unlikely that benefit will be realized in the future:

Deferred Income Tax Asset 60,000

Deferred Income Tax Benefit 60,000

(150,000 x 40%)

Deferred Income Tax Expense 60,000

Allowance to Reduce DIT Asset

to Expected Realizable Value 60,000

• Allowance does not have to be 100%

Carryforward with Valuation Allowance (continued)

• The second entry indicates that the company cannot meet the criteria that it is more likely than not that the company will benefit from the tax loss in the carryforward period

• The financial statements would be the same whether the allowance method is used or the deferred income tax asset is not recognized at all

Accounting Standards for Private Enterprise (ASPE)

• Permits the recognition of income taxes based on the amount of taxes payable (“Taxes Payable Method” no recording of deferred taxes) (see next slide)

• Requires disclosure in the notes reconciling taxes payable to taxes based on statutory tax rate (disclose the effects of permanent and temporary differences)

• FIT assets & liabilities classified as current vs. L-T based on classification of underlying asset or liab.

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ASPE - Calculation of TaxesASPE - Calculation of Taxes

Two methods:1. Taxes payable method

• Allowed under ASPE only• Current Income Taxes

= Taxable income x Tax rate2.Future income taxes method

• Called balance sheet liability method in IFRS• Required by IFRS and option under ASPE• Starts with Current Income Taxes and

• Adjusts for future (or “deferred”) income tax assets and liabilities,

• To also get future (or “deferred”) income tax expense

Accounting Standards for Private Enterprise (ASPE)

• ASPE and IFRS use different terminology for the asset and liability approach to income taxes

• ASPE (where FIT = Future Income Tax)– This method called the FIT method– Related tax accounts are called FIT assets, FIT

liabilities, and FIT expense• IFRS (where DIT = Deferred Income Tax)

– This method is called the balance sheet liability method

– Related tax accounts are called DIT assets, DIT liabilities, and DIT expense

• As a result, you will see the terms “future” and “deferred”” used interchangeably.

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• Under IFRS– All deferred tax assets and liabilities are recorded as

noncurrent

• Under ASPE– Future tax asset or liability is classified as current or

noncurrent based on the classification of the underlying asset or liability giving rise to the specific temporary difference

– If the a future asset or liability is not related to specific asset or liability (e.g. expensed research costs deferred for tax purposes), classification is based on date that temporary difference is expected to reverse or tax benefit expected to be realized

Balance Sheet PresentationBalance Sheet Presentation

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Intraperiod Tax AllocationIntraperiod Tax Allocation

• Income tax expense is reported with its related item, such as discontinued operations, other comprehensive income, adjustments to RE, etc.

• Intraperiod Tax Allocation– Tax expense is allocated within the financial

statements of the current period• Interperiod Tax Allocation

– Tax expense is allocated between years, and results in the recognition of future income taxes

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Disclosure RequirementsDisclosure Requirements• IFRS has more extensive disclosure requirements

than ASPE , including: – Major components of income tax expense or

benefits– Sources of both current and deferred taxes– Amount of current & deferred tax recognized in

equity– Reconciliation of effective & statutory tax rates– Information about unrecognized deferred tax

assets– Information about each type of temporary

difference and deferred tax asset or liability recognized on the SFP

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