TAXATION IN ACCOUNTING

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Taxation

IAS 12 Income taxes

2ACC410 TAXATION SUPPLEMENTWEEK 8


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Main types of taxation

Taxation as costs to the company

Social security charges

Local/regional taxes National corporate income taxes

Taxation on behalf of a third party

Value added tax

VATtax on consumer and not the company



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Taxation as costs

Social Security charges contributions from employer and employees

contribution to pension schemes

Private vs state pensions

Local/Regional Charges

Splitting corporate taxes:

Municipality/council

Regional political unit

National Government

ACC410 TAXATION SUPPLEMENTWEEK 8

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Taxation as costs (cont.)

National Corporate Income tax

Common type of taxmost visible

Government raise funds through this tax

Can be used to encourage or penalise company

behaviour

Calculation of this tax depends on the tax rules vs

accounting rules


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Value added tax

Imposed on customers at each stage of a productsvalue-added chain, based on the value added at thatpoint

Gross amount of VAT on sales and on purchases is

netted in the accounting system and net amount ispaid periodically to the tax authorities (VAT receivedfrom customers less VAT paid to suppliers)

Not part of revenue or expenses, but included in

receivables and payables (cash flow effect) Credit transactions and payment of VAT. Cash

payment for VAT before customers can pay.



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Corporate income tax

Income tax payable = Taxable profit

Tax rate (e.g. 30%)

Taxable profit is not equal to pre-tax accountingprofit - (difference between Accounting profit and tax profit)

Differences?Some expenses are not allowed tax-wise (entertaining,fines, excess depreciation, excess provisions, etc.)

Special tax allowances (for capital investment,

environmental protection, etc.)Income that is non-taxable

Deferred taxes arise from these differences



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Taxation of dividends

Problem of potential double taxation of dividendsdue to concurrent corporate and personal taxation

Solutions: Profits paid to shareholders are taxed at a lower rate

than those retained in the company, or

Tax credit on the dividend for shareholders



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Deferred taxation

Deferred taxes

Income statement perspective on deferred taxes

Balance sheet perspective on deferred taxes

Presentation of deferred taxes in the financial

statements



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Deferred taxes

Differences between objectives of measuring(accounting) profit for financial reporting purposesand basic tax raising motives of measuring taxable

profit

Accounting rules regarding income taxes:

Tax effects of transactions are recognised in the financial

statements in the same period as the related businesstransactions themselves

Current income tax cost (taxable profit * nominal taxrate) is only part of these tax effects



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Deferred taxes (cont.)

Income statement:deferred tax cost(or benefit)complements current tax cost

Statement of financial position:deferred tax assetsand deferred tax liabilitiesreflect future taxconsequences of transactions that were not treatedidentically for taxation and financial reporting

purposes



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Income statement perspective on

deferred taxes

Reconciliation statement - two types of differences:

Permanent differences

Timing differences

Timing differences arise because the timing of

income and expenses in the income statement

occurs in different period from taxable profit

Timing differences arise in one period and reverse inone or more subsequent periods



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Income statement perspective on

deferred taxes

Permanent differences

Arise because tax authorities do not permit some

expenses as deduction from profits

E.g. fines,

Entertainment

Holding board meetings in holiday resorts

Expensive consumption and supplies to management


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IllustrationTax deductible accelerated

depreciation

Purchase of a fixed asset (P10,000) with tax incentive(accelerated depreciation) in 2011

Useful life = 2 years and no residual value Depreciation

Financial statements: 5,000 in 2011 and in 2012

Tax calculation: 10,000 in 2011 and 0 in 2012

Pre-tax profit of 20,000 in 2011 and 2012 and taxrate of 50 per cent



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IllustrationIncome tax calculation

2011 2012

Pre-tax profit(includes depreciation expense)

20,000 20,000

Timing difference(accelerated depreciation)

- 5,000 + 5,000

Taxable profit 15,000 25,000

Tax due at 50% 7,500 12,500


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or

IllustrationIncome tax calculation

2011 2012

Pre-tax profit 20,000 20,000

Add back depreciation 5,000 + 5,000

Deduct Capital allowance -10,000 0TaxableProfit 15,000 25,000

Tax due at 50% 7,500 12,500


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IllustrationIncome statement effect

without deferred taxes

2011 2012


Corporate income taxes

due

- 7,500 - 12,500

Net profit after tax 12,500 7,500


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IllustrationIncome statement

effect including deferred taxes

2011 2012


Total tax expense:

Taxes due

Deferred tax expense

Deferred tax income

-7,500

- 2,500

-12,500

+2,500

Net profit after tax 10,000 10,000


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IllustrationDeferred taxes on the

statement of financial position

Deferred tax expense => Deferred tax liability

Indicates that profit in the financial statements has in the

past been higher than for tax purposes Liability: reflects future taxation on the difference

postponement of tax payments to future periods

At reversal of timing difference: Deferred tax income in income statement

Settlement of deferred tax liability



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Alternative illustrationProvision not

accepted for tax purposes

Deferred tax income => Deferred tax asset

Indicates that profit in the financial statements has in the

past been lower than for tax purposes Asset: reflects future tax savings on the differencetaxes

paid, but recoverable in future periods

At reversal of timing difference:

Deferred tax expense in income statement

Use of deferred tax asset



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Balance sheet perspective on deferred

taxes

Deferred taxation based on balance sheet values

Temporary differences: differences between

balance sheet values and tax values of assets and

liabilities

Tax value (tax base) = the amount at which the asset

or liability is recognised for tax purposes

Temporary differencesare broader than timingdifferences



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IAS 12 Income taxes

Two types of temporary differences:

Taxable differencesthat result in deferred tax liabilitiestaxable amounts in determining taxable profit of futureperiods

Deductible differencesthat result in deferred tax assetsamounts that are deductible in determining taxable profitin future periods

Deferred tax asset / liability is measured as the

temporary difference multiplied by the tax rate(applicable when asset is realised or liability issettled)



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Illustration - Tax deductible

accelerated depreciation (repeat)

2011 2012

(a) Accounting balances

Asset carrying amount 1 January

Additions

Accounting depreciation

Asset carrying amount 31 December

0

10,000

-5,000

5,000

5,000

0

-5,000

0

(b) Tax values

Asset tax base 1 January

AdditionsTax depreciation

Asset tax base 31 December

0

10,000-10,000

0

0

00

0

(c) Tempo rary di fferenc es 5,000 0


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Illustration - Tax deductible accelerated

depreciation

Temporary difference of 5,000 in 2011

Taxable or Deductible ?

Tax base of asset < Book value of asset

Future accounting depreciation will be higher than tax depreciation

Future taxes due will be higher than expected on accounting profit=> Taxable temporary difference

Deferred tax liability of 2,500 (50 per cent tax rate)

Deferred tax expense of 2,500

Reversal in 2012

Settlement of deferred tax liability

Deferred tax income of 2,500



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Presentation of deferred taxes in financial

statements

Separate presentation of deferred tax assets(liabilities) in statement of financial position

Classified as non-current items

Tax expense (income) related to ordinary activities

presented on the face of the income statement Additional disclosures in the notes:

Details on major components of tax expense

Numerical explanation of relationship between tax

expense and accounting profit Details on temporary differences and related deferred tax

assets and liabilities



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Transfer pricing

Transfer pricesare the prices at which goods and serviceschange hands between subsidiaries of a group

Artificially fixing transfer prices is a way of determining whereprofits are taxed

Double tax treaties usually state that transfer prices must

be at arms length or at market rates

Intra-group charges (like royalties for use of intellectualproperty and interest charges) are also usually structuredaccording to a tax treaty



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Offshore financial centres

Near relatives of a tax haven, but benefit from

double tax treaties with major trading countries

The corporate tax they levy is sufficiently high for

developed countries not to treat them as a tax

haven, but sufficiently low so as still to be attractive

to companies



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Tax havens

Tax havenstypically offer low tax or flat rate tax forcompanies which are resident but whose activitiesare external to the haven (off-shore) Frequently used by a MNC to provide international

services (like finance, insurance) to the group

Do not generally benefit from tax treaties with othercountries

Costs are not negligible and substantial throughout isneeded to create tax savings


TAXATION IN ACCOUNTING

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