IAS 12 - Deferred taxes on investment value (consolidated FS)

[Paddy_P]

Dear community,
Is there any deferred tax to be recognised in the consolidated financial statements if:
- an investment in a subsidiary is impaired in the local financial statements,
- the impairmnet is tax deductible; and
- there is no plan to dispose the investment, or similar (i.e. the consolidated IFRS net assets are planned to be recovered through continuing use)
Best regards,
Patrick

[JRSB]

a bit confusing because the investment in subsidiary is nothing to do with the consolidated financial statements, but if that entity was acquired in a business combination then maybe you have DT movements on group level intangibles.

[Leo]

I think there is a tax proof question here, whether you explain the gap between expected tax expense and current tax expense in the tax proof, or you recognise a DT for losses carry forward maybe?

[Paddy_P]

The investment in the subsidiary is consolidated, indeed, and does not show up in the consolidated balance sheet. Thus, there will never be a future tax deductible which will materialise.
I believe I did think too much on a step-by-step approach by comparing IFRS values with taxable values.

[Paddy_P]

I actually do have another situation which I came across.

Parent entity P did acquire subsidiary S in 2022. The acquisition was accounted for as a business combination under IFRS 3. Part of the purchase price was not settled in cash, as it represents an earn-out which becomes payable in 2024. Upon acquisition, under IFRS the earn-out was recognised as follows at fair value:
- Db Goodwill
- Cr earn-out

For statutory purposes, the earn-out was not recognised. It will be recognised only upon payment and then will increase the statutory goodwill accordingly. This treatment is the same for taxation.

1. For the difference in goodwill, no DTL was recognised. This is correct from my point of view as it relates to the initial recognition of a goodwill in a business combination.
2. From my understanding, no DTA is recognised for the earn-out neither, due to the fact that the earn-out payment will not result in a tax deduction in the future.
3. I think that in 2024, the increase in goodwill in the statutory accounts for statutory accounting will still relate to the initial recognition of goodwill. Do you agree, or did I miss a requirement here?

Best regards,
Patrick

[JRSB]

The earn out was not recognised as a liability? It should have been recorded at fair value. Maybe it was a stretch target recorded at nil?

It will increase goodwill accordingly once paid later? Only if it's a measurement period adjustment, otherwise that should be to P&L.

May be worth looking at the accounting before looking at the tax.

[Marek Muc]

Just had a quick look, but please have a look at the section below, does it answer the question?

https://ifrscommunity.com/knowledge-bas ... rangements

[Paddy_P]

The earn out was not recognised as a liability? It should have been recorded at fair value. Maybe it was a stretch target recorded at nil?

It will increase goodwill accordingly once paid later? Only if it's a measurement period adjustment, otherwise that should be to P&L.

May be worth looking at the accounting before looking at the tax.

We do have a misunderstanding:
- Under IFRS; the earn-out was recognised as a liability at fair value. The difference since this date is recorded through P&L
- In the statutory accounts - where there is no difference to the tax base - the earn-out was not recorded. When it is paid, the payment will increase the statutory goodwill. The statutory goodwill itself is amortised over 5 years.

It is my intention not to recognise any deferred taxes on the goodwill and earn-out until the payment, and no deferred taxes upon payment when the statutory goodwill increases. On the other hand, it is my understanding that the amortisation of the goodwill which is tax deductible will result in a temporary difference.

[Paddy_P]

Just had a quick look, but please have a look at the section below, does it answer the question?

https://ifrscommunity.com/knowledge-bas ... rangements

Thank you Marek. I did came across this before, but I am not sure whether I understand it correctly. Thus, I try to rephrase it in my own words.

If there is no plan to sell the subsidiary, in the consolidated financial statements outside temporary differences will be treated as follows in the year after acquisition:
- If the subsidiary is profitable, distribution of retained earnings is not probable and no sale is planned: no DTL is recognised (temporary difference will not reverse in the foreseeable future)
- If the subsidiary is profitable and the profit is distributed as a dividend: DTL is recognised by the parent (reason: temporary difference will reverse when dividend is distributed)
- If the subsidiary is loss making and it cannot be demonstrated that the subsidiary will become profitable in the foreseeable future: DTA is not recognised by the parent (no taxable profit will be available)
- if the subsidiary is loss making, but management concludes that it is probable that the subsidiary becomes profitable in the foreseeable future: DTL is recognised (as temporary difference will reverse when profit will be generated)

Is above understanding - even if simplified - correct?

In my initial example:
- the impairment on the investment was recognised in the investment value of the separate financial statement as the subsidiary is loss making. The impairment is tax deductible.
- No impairment was recognised in the consolidated financial statement on the net assets of the subsidiary. Reason is that the subsidiary is part of a larger CGU, and the impairment test of the CGU does not result in any impairment requirements.
- Despite the loss making situation in the subsidiary the IFRS net assets of the subsidiary are higher than the tax base of the investment value. If the subsidiary will not become profit in the foreseeable future, this may imply that it is probable that the temporary difference will reverse in the foreseeable future and thus, a DTL would need to be recognised. If management concludes that the subsidiary will become profitable, then it is probable that the temporary difference will not reverse in the foreseeable future and the DTL should not be recognised.

I acknowledge that this situation is very specific. However, I believe if IAS 12 is applied consequently, in this situation it will mean the following:
- If the subsidiary will not become profit in the foreseeable future, this may imply that it is probable that the temporary difference will reverse in the foreseeable future as the net assets of the subsidiary will decrease with future losses --> DTL must be recognised
- If management concludes that the subsidiary will become profitable, then it is probable that the temporary difference will not reverse in the foreseeable future and the DTL should not be recognised.

Does this makes any sense to you?

[Marek Muc]

It seems that you're confusing realisation of deferred tax assets (DTA) by the subsidiary and the parent. It's the *parent* that potentially recognises DTA for the temporary difference arising on the investment, so you should be looking at:
- availability of taxable income of the *parent*, and
- whether the temporary difference will reverse in the foreseeable future

[Paddy_P]

I see your point:
- If the subsidiary is loss making and it cannot be demonstrated that the subsidiary will become profitable in the foreseeable future, and the parent is profitable: DTA is not recognised by the parent, as the subsidiary does not make any profit and thus the temporary difference will not reverse in the foreseeable future
- if the subsidiary is loss making, however, it can be demonstrated that the subsidiary becomes profitable in the foreseeable future. Parent is profitable, too. DTL is recognised as temporary difference will reverse when profit will be generated by the subsidiary)

Back to my initial example with the impairment on the tax base investment value (I believe I confused DTA with DTL before):
- If the subsidiary will not become profitable in the foreseeable future, it is probable that the temporary difference will reverse in the foreseeable future (i.e. consolidated net assets will decrease and thus the difference towards the tax base of the investment value (0) will decrease, too). If we assume the parent to be profitable, this will result in a DTA to be recognised
- Same as before, but the parent is not profitable: no DTA to be recognised, as there is no taxable profit against which the temporary difference can be utilised

This is very helpful for me to finally understand deferred taxes better - thank you for your help.

Best regards,
Patrick

[Marek Muc]

How do you think the parent will realise the DTA arising on its investment in the subsidiary?

[Paddy_P]

The parent will realise the DTA by use, rather than by sale. In my example, the tax value is lower than the IFRS carrying amount due to the impairment recognised in current year. For below, I assume in all cases that the parent will have a taxable profit:
- if subsidiary will be profitable and no dividends are paid out: difference will increase; no realisation of the DTA (does this mean that DTA should not be recognised) as I would not assume the statutory impairment to be reversed
- if subsidiary will be profitable profitable and dividends are paid out: no change in difference, but difference is realised (does this mean that deferred taxes must be recognised in this case for the timing difference between year-end and distribution in subsequent year)?
- if subsidiary will not generate any profit: difference will decrease; however, there is no change in taxation. What does this mean for the recognition of a DTA?

There is no plan to realize the investment through a sale.

We are discussing here one specific investment only. If I think about it, a group with 100+ subsidiaries will need to make the comparison between the tax base of each investment value and the IFRS consolidated net assets of the subsidiary, this seems to be quite an effort only on this balance sheet position... in the link which you shared with me earlier, it says that "in practice, these criteria often allow entities not to recognise deferred tax for the outside basis differences arising on most of their investments in subsidiaries. However, deferred tax is typically recognised when
- the distribution of retained profits is probable and has tax effects;
- a sale of an investment becomes probable
Is an in-depth analysis requried for each investment, or can above be utilised as a rule of thumb to identify that only such investments might be subject for the recognition of deferred taxes?