IAS 12 Exchange of assets and IRE

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pub_acco
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IAS 12 Exchange of assets and IRE

Post by pub_acco »

Assume an Entity carries a Stock A at 100 (FVTPL). Its tax base is 40, so a deferred tax liability has been recognized for the temporary difference of 60. Then, Entity enters a transaction with a Third Party where Entity gives Stock A to Third Party and Third Party gives Stock B (whose fair value is 100, too) to Entity in return. It's an equal exchange of FVTPL stocks at fair value, so the Entity does not record any gain or loss on the deal day.

The thing is, in the jurisdiction, Entity doesn't need to record taxable income in this case and can continue to use 40 as the tax base of Stock B. What is the tax effect accounting in this case?

My analysis:

Stock A is derecognized for the accounting purpose while its tax base hasn't deducted taxable income, so the tax base survives. Book value 0 vs. tax base 40 results in a deductible temporary difference of 40 and a relevant deferred tax asset.

Stock B is newly recognized, but the transaction affects neither accounting profit nor taxable income. So the initial recognition exemption applies and no deferred tax is recognized.

P&L consequence: deferred tax benefit of 100 * tax rate ???

It's really counterintuitive and perhaps I'm wrong, but as long as I take the IRE provisions literally, they apply and a P&L consequence is inevitable. Is my logic flawed? Or is there any relief provision in IAS 12?
Leo
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Re: IAS 12 Exchange of assets and IRE

Post by Leo »

Hi,

If I understand correctly, you would do the following :
before the transaction, and supposing a tax rate of 30% in your country, there is a DTL of 18 LC (60 LC * 30%)

After the transaction,
first, recognise the derecognition of asset A :
Dt : DTA 12 LC (40 LC * 30%)
Cr : Income tax 12 LC (P&L)

second, derecognise the DTL related to asset A :
dt : DTL 18 LC
Cr : Income tax 18 LC (P&L)

At the end of the day, you have a DTA of 12 LC and a income tax gain of 30 LC

is that correct ?

But

From the tax accounting point of view, this transaction hasn't triggered any treatment, there is no taxable income from the exchange of asset A (60 LC of realized gain).
In parallel, the taxable base of asset B become 40 LC, and any subsequent variation of asset B's fair value will be compared to 40 LC, not 100 LC.

In that case, I would do nothing, which means to keep the DTL at 18 LC, and write it off on the day you sell asset B :
For example, you sell asset B next year and the fair value increase to 110 LC, your taxable income would be 110 LC - 40 LC = 70 LC, and will result to a income tax charge of 21 LC.

On the other hand, you'll record a DTL of 10 LC * 30% = 3 LC, the total DTL will become 21 LC. Which will be written off against P&L. Hence, your P&L will have a net impact of 0.
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Marek Muc
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Re: IAS 12 Exchange of assets and IRE

Post by Marek Muc »

For Stock A, I wouldn't say that you recognise a DTA becasue you no longer hold this asset. But you need to derecognise DTL so you end up with a credit to income tax charge.

As for the IRE relating to Stock B: you didn't acquire Stock B in a standalone transaction. Stock B is consideration received for Stock A and the whole transaction did affect P&L, although net impact was nil. I.e. the cost of Stock A was 100 (P&L debit) and received consideration was also 100 (Stock B - P&L credit). So you recognise DTL on Stock B as IRE does not apply.

How does this logic sound to you?
pub_acco
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Re: IAS 12 Exchange of assets and IRE

Post by pub_acco »

Leo,

I agree with your accounting. My point is that the IRE seemingly forbids that, and I am looking for logic to rebut IAS 12.

Marek,

As for the Stock A DTA, IAS 12 IE.B3 suggests this kind of approach, though I don't really do this in practice either. Anyway, if we can ignore the IRE, this point will not create a difference in the financial statements.

As for the logic, theoretically, every mode of asset acquisition consists of recognition of the asset and derecognition of the consideration, including payment of cash for an item of PP&E. So the net nil P&L approach doesn't really sound reasonable.

By the way, I am also wandering what if an item of PP&E is sold at its carrying amount. There will be no P&L impact in this case, but I feel it unreasonable to treat this transaction as the one without accounting profit for the IRE purposes. Similarly, perhaps I can see the Stock A/B exchange as derecognition of Stock A where the consideration happens to be equal to the carrying amount.
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Re: IAS 12 Exchange of assets and IRE

Post by Leo »

Is that possible to raise a ticket to IASB for this matter then ?
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Marek Muc
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Re: IAS 12 Exchange of assets and IRE

Post by Marek Muc »

pub_acco wrote: 28 May 2022, 08:50 As for the Stock A DTA, IAS 12 IE.B3 suggests this kind of approach
You're right, there can be temporary differences even if the asset has already been derecognised. In your scenario however, it seems that the tax base of Stock A becomes 0 after the transaction as the tax base of 40 is attributed to Stock B.
pub_acco wrote: 28 May 2022, 08:50 As for the logic, theoretically, every mode of asset acquisition consists of recognition of the asset and derecognition of the consideration, including payment of cash for an item of PP&E. So the net nil P&L approach doesn't really sound reasonable.
Interesting view! Cash is also a financial asset after all :) But I still 'feel' that you don't actually 'sell' cash but I'm not able to prove it conceptually off the bat (and I don't have time to dig into it, not to say that I'm sure I would come back with a convincing reasoning).

If you buy an item of PP&E, you cannot have an impact of P&L irrespective of the amounts involved - hence IRE applies. If you sell a security and accept another security as a means of payment, you will have an impact on P&L under IFRS 9.3.2.12 and hence I think that the IRE does not apply to this transaction. This holds true even if the proceeds received equal the carrying amount of asset sold. I don't think that the applicability of IRE depends on the amounts involved, but on the type of a transaction.
Leo wrote: 29 May 2022, 16:24 Is that possible to raise a ticket to IASB for this matter then ?
Yes! Would you like to give it a shot?
https://www.ifrs.org/supporting-impleme ... ee-process
Please submit your suggestion by email to ifric@ifrs.org
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Re: IAS 12 Exchange of assets and IRE

Post by Leo »

I'm fine with your explanation, I haven't encountered this problem in the past, if I did and came out with the accounting entries I suggested, I don't think it would raise the eyebrow of the auditors.

Maybe pub_acco would like to do it ?
pub_acco
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Re: IAS 12 Exchange of assets and IRE

Post by pub_acco »

Marek Muc wrote: 30 May 2022, 11:12 I don't think that the applicability of IRE depends on the amounts involved, but on the type of a transaction.
I agree with this idea, and perhaps in the Stock A/B exchange case, the IRE does not apply because the transaction inherently involves P&L.

At the same time, though, I'm getting to believe the IRE is simply broken, despite the recent amendment to IAS 12. Here is another edge case: assume the same Entity and Stock A and that Entity contributes Stock A to a defined benefit plan for its employees. Taxable profit is not recorded through this transaction in the jurisdiction.

This is technically an exchange (recognition and derecognition) of an FVTPL asset and DB plan asset, but no P&L can occur because the transaction is recorded at a fair value of the same stock at the same point in time. It just looks like a transfer from one broker account of Entity to another.

We'll need to make a judgment on whether the IRE applies or not based on some logic, and we're likely to just fall back on the old days P&L approach of tax effect accounting. The P&L approach better accounts for this sort of case than the IRE.
Leo wrote: 29 May 2022, 16:24 Is that possible to raise a ticket to IASB for this matter then ?
I'm sure it's not added to Agenda because the issue is not widespread or no diverse practice is observed :lol:
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Re: IAS 12 Exchange of assets and IRE

Post by Marek Muc »

I have no doubts that we could come up with several edge cases where the application of IRE would be difficult and/or yield meaningless results
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