Proposals reaffirm the underlying principle of IAS 12, which is to reflect future tax consequences of transactions or events.

• Diversity in application of IAS 12’s current initial recognition exemption
• Narrow-scope amendment would limit its application
• Effective tax rate may change

17 July 2019

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: 

• in many jurisdictions, there is one tax deduction for a lease involving the recognition of a right-of-use asset and corresponding lease liability under IFRS 16 Leases1; or 
• in some jurisdictions, there may be one tax deduction on a cash basis for a decommissioning expenditure which is recognised as a decommissioning provision and a corresponding adjustment to the cost of property, plant and equipment2. 

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.

Fred Versteeg
KPMG’s global IFRS income tax leader

At present, when a company recognises a lease asset and lease liability, for example, it either:

• applies the initial recognition exemption (IRE) separately to the lease asset and lease liability and recognises the tax impacts in profit or loss when they are incurred – i.e. does not reflect the future tax impacts of leases (Approach 1); or 
• reflects the future tax impacts of leases and recognises deferred tax (Approach 2). When recognising deferred tax a company may have assessed the lease asset and lease liability together as a single or ‘integrally linked’ transaction and assessed the net temporary difference.

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 proposed amendments would apply retrospectively but some relief from assessing deferred tax asset recoverability would be available.

Read our comment letter in response to these proposals.