There is currently diversity in practice for the accounting of deferred tax on transactions that involve the recognition of an asset and a liability with a single tax treatment related to both. For example:
This diversity – and the potential implications now that IFRS 16 is effective – have prompted the International Accounting Standards Board (the Board) to propose a narrow-scope amendment to the application of the initial recognition exemption in IAS 12 Income Taxes.
The proposed amendments would result in the tax accounting better reflecting the economics of the transaction in which the asset and the liability are integrally linked.
In essence, some companies reflect the future tax impacts of leases in their financial statements, whilst others do not. This existing diversity reduces comparability between companies and impairs the usefulness of the information for users of the financial statements.
The Board is proposing to limit the application of the IRE. This means that the IRE would not apply when a company recognises equal amounts of deferred tax assets and liabilities from a single transaction. More specifically, a company would not apply the IRE on initial recognition of a lease (or a decommissioning liability and its corresponding asset). Instead, it would generally recognise deferred tax on the temporary differences that arise on initial recognition.
The potential impact of the proposed amendments depends upon a company’s current approach to deferred tax accounting for a lease asset and lease liability. If it recognises deferred tax as it recovers (or settles) the associated lease asset and liability – as set out in Approach 2 above – then the impact in the primary financial statements is unlikely to be significant, although disclosures could be affected. However, for a company that follows Approach 1 and applies the IRE to lease assets and liabilities separately, recognising deferred tax could result in an increase in assets and liabilities and a change in the effective tax rate.
Our worked example (PDF 880 KB) illustrates how the proposed amendments would apply in practice and the effect on the effective tax rate. As illustrated below, the effective tax rate under the proposed amendments – i.e. where deferred tax is recognised on the lease asset and liability – will be less volatile and reflect the economics of the lease more closely.
The proposals are open for comment until 14 November 2019 and we encourage preparers and users to share their views with the Board.
For more information on the proposals, speak to your KPMG contact.
1 IFRS 16 is effective for annual periods beginning on or after 1 January 2019.
2 The proposed amendments have been explained using leases as an example; they would also apply to the recognition of decommissioning liabilities and corresponding adjustment to the asset.