FINANCIAL REPORTING 4A

By
Dr Jean Damascene Mvunabandi
([email protected] )

INCOME TAX
IAS 12; FRG 1 & IFRIC 23

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 INCOME TAX

STUDY OBJECTIVES/STUDY OUTCOMES :

1. THE NOTION OF A TAX BASE & PROVISION OF TAX ACT, Income Tax Framework
2. CAPITAL GAINS TAX
3. EXEMPT TEMPORARY DIFFERENCES
4. CHANGE IN TAX RATES
5. MEASUREMENT OF DEFERRED TAX BALANCES
6. WHERE TO RECOGNISE CURRENT AND DEFERRED TAX

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INCOME TAX

STUDY OBJECTIVES:
8. DEFERRED TAX ASSETS
9. IFRIC 23- International Financial Reporting Interpretations
Committee ((Uncertainty over Income Tax Treatments)
10. PRESENTATION & DISCLOSURE

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 BACKGROUND AND KEY POINTS TO REMEMBER

 The purpose of the various taxes levied by government such as normal tax, Dividend
withholding tax, Donations tax, Withholding taxes, VAT, Transfer duty , Estate duty, Fuel
levy, custom duty and exercise duty, and skills development levy is to generate revenue
for the state.

 Income tax “Normal tax” and VAT provide the highest amount of revenue to the
government.

 Employee tax, dividends tax and VAT are not included in the entity’s tax expenses

 This topic deals with Income tax “Normal tax”.

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 IAS 12- INCOME TAX

REFERENCES:

a) IAS 12 Income Taxes

b) Financial reporting guideline (FRG 1) Substantively Enacted Tax Rates and Tax Laws under IFRS
c) Chapter 16: Prescribed text book: Stainbank
d) Awareness
 scope
e) Excluded:
 paragraphs 38 to 45 of IAS 12 (relating to group temporary differences)

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 Provision of Tax Act

Gross Income
Less: Exempt income (section 10 of Tax Act)
Less: Tax deductions and allowances (Sections 11 to 19-amongst other of the
tax acts
Add: Taxable capital gain (Section 26A and the eighteen schedule)
EQUALS: TAXABLE INCOME

Taxable income*28% normal income tax rate

Dr: Income tax (E=expense) IAS 12:58

Cr: Current tax payable (L)
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 Income Tax Framework

 The difference between taxable profits ( calculated in terms of relevant tax

legislation (Relevant tax act- and accounting profits (calculated in terms of
IFRS) include what IAS 12 warrants:
 Permanent differences, and
 Timing differences

 Expert in accounting must convert accounting profit into the taxable profit.
 Temporary Difference = Carrying Amount – Tax base

 The current tax expense of an entity in South Africa is determined based on

the prescripts of the Income Tax Act, No. 58 0f 1962 (called the Tax Act).

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 Tax Framework……….

Gross Income XXXXXX

Recoupment Section 8 (4) XXX

Less Exempt Income XXX

Income XXXXXX
Less Deductions
Section 11 (e ), Section 12 C, Section 13 XXX

Scrapping Allowance: Section 11( o ) allowance XXX

Add Capital Gain XXX
Less Donations to Public Benefit Organisations(Section 18 A) XXX
Taxable Income XXXXX
Tax Liability [ (Companies, CC: 28% until 31 March 2022) /(Individuals: Tax per Tables XXXX
less Rebates)]
 3. Accounting profit Vs Tax profit

The differences between accounting profit and taxable profit can be caused by:
 Permanent differences (e.g. expenses not allowed for tax purposes)
 Temporary differences (e.g. expenses allowed for tax purposes but in a later accounting
period)
 Only temporary differences are taken into account when calculating deferred tax.

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 Causes of Temporary Difference

 Revenue received in advance — taxed by SARS but not included in revenue by the entity
 Capitalised borrowing costs — not recognized by SARS
 Finance leases: Interest and depreciation versus the actual lease payment
 Operating leases: The equalized lease payment versus the actual lease payment
 Allowances for credit losses (provisions for doubtful debts) versus whatever SARS allows
 Provisions for guarantees versus actual claims from customers
 Unused tax losses
Profit on sale of plant versus recoupment
Loss on sale of plant versus scrapping allowance
Prepayments - deductible for tax purposes but not included in profit and loss

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 Permanent Difference or Exempt Items

 Exempt items are permanent differences.

 They do not give rise to deferred tax as, even over a number of accounting
periods, the difference will always be there. Some examples of exempt items
are:
 Local dividends received
 Penalties and interest on late tax payments. Note that this is interest on late
payments and not interest in general
 Depreciation on buildings used for administration (up to 1st April 2007)
 Most donations
 Impairment of goodwill where this is not deductable for tax purposes

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 Direct Tax Expense

 Income tax is a direct tax levied on all registered taxpayers.

 The direct tax expense is the total amount of income tax payable by an
entity for a specific reporting period as determined by applying the
applicable tax rates to the taxable income.
 In South Africa, the direct tax expense includes corporate income tax for
companies and personal income tax for individuals, among other direct
taxes.
 The direct tax expense is recognised in the income statement of a company
and represents the tax liability for the reporting period.

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 Current Tax

 Current tax refers to the amount of income tax payable or recoverable by a company or an
individual based on taxable profits or losses for the current reporting period.
 In South Africa, current tax includes income tax payable on the taxable income earned
during the current financial year, calculated based on the prevailing tax rates (28%) and tax
laws.
 Current tax liabilities are recognized in the financial statements of a company's current
period and represent the amount owed to the SARS based on the current year's taxable
income.
Example
Based on its taxable income of R5 million and the prevailing corporate income tax rate of 28%,
LMN Ltd determines its current tax payable to be R1.4 million (R5 million * 28%).

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 Calculation of Current Tax

Current Tax
= Taxable Income x Tax Rate (28%)

Taxable Income
= Income – Allowable Deductions + Recoupments

Income
= Gross Income – Exempt Income

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 Activities: Current Tax

Example 1
 The following financial information relates to IK Ltd for 2021 financial
year.
Sales R100000
Allowable Expenditure R48000
Machinery Allowance R11000
Dividend Received from South African firm R12000

Required
 Estimate the current tax/income tax for 2021 tax year

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 Activities: Current Tax

Homework
The following information were extracted from the books of Good Days (Pty) Ltd.
Profit before tax R240000
Dividend Received from South African firm R25000
Donations R4000
Depreciation R7000
Traffic fines R3000
Penalty for tax default R18000
Interest for late payment of Tax R12000
Machinery Allowance R21000

Required: Estimate the current tax/income tax for 2023 tax year
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 Provisional Tax Payments

The total tax liability of an entity for a reporting year can only be determined once the taxable
profit/loss is known.

SARS requires entities to make at last two advance payments towards their estimated tax
liabilities for the year.

Provisional tax payments are advance payments made by taxpayers to the SARS towards their
estimated income tax liability for a particular tax year.

These payments are made in two instalments during the tax year, based on estimates of taxable
income, to prevent taxpayers from facing large tax bills at the end of the tax year.
Provisional tax payments are recorded by debiting SARS and crediting Bank with the payment.
This is a cash paid in advance, hence SARS is recognised as an asset in the books of the entity.

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 Income Tax Overprovision

An "overprovision" in provisional tax payments occurs when a taxpayer has paid more in provisional tax than their
actual tax liability for the year.
This occurs when a company has initially estimated or provisioned for its income tax liability in its financial
statements, but later finds out that the actual tax liability is lower than what was originally provided for.
Example
Based on its estimated taxable income and applicable tax rates, ABC Ltd provisionally recorded an income tax
expense of R500,000 in its financial statements for 2023.
Upon receiving the assessment from SARS, it is determined that ABC Ltd's actual tax liability for the year is ZAR
450,000, which is ZAR 50,000 lower than the initially provisioned amount.
• In this scenario, ABC Ltd would need to adjust its income tax expense in its financial statements to
reflect the actual tax liability as determined by SARS.
• The adjustment would involve reducing the provision for income tax expense by R50,000 to reflect the
lower actual tax liability.

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 Key takeaways Income Tax Framework

The income Tax Framework sets out basic structure for computation of income Tax
 Permanent differences occur where income or expense appear in computation of
accounting profit in the reporting period BUT never enters the computation of taxable
profits vice-versa.

 Timing differences occur when an amount of income or expense is included in accounting

profit in a different reporting period to which it is included for tax purposes
 Temporary differences include not only timing differences, but also other differences
between the currying amount and the tax base of asset or liability, for example
revaluation

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THE NOTION OF A TAX BASE
1. Current tax (CT) vs Deferred tax (DT)
 Current tax- the amount of tax payable to SARS for the current period.
 DT is a ‘creation’ of accounting to adjust for the difference between CT and
the tax expense per the SOP&L and OCI
 IAS 12 requires the balance sheet approach to DT, i.e. [CA - TB = temporary
difference] x tax rate = DT
 DT seeks to account for the tax consequences of the:
 (1) future recovery of the CA amount of assets; and the
 (2) future settlement of the CA amount of liabilities
 The tax base is the value attributable to an asset/liability for tax purposes
CA: Carrying amount
TB: Tax Base

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 Deferred income tax: temporary differences

Carrying amount of an Tax

asset/liability Less base

> <

TAXABLE temporary DEDUCTABLE temporary

differences differences

Deferred tax liability

Differed tax asset
-
+
Tax loss/ credit carried
forward
 Recognition of DT Adjustments

• If the TD arose due to something in P/L then the DT adjustment is recognised in P/L
• If the TD arose due to something in OCI then the DT adjustment is recognised in OCI
• If the TD arose due to something in Equity, then the DT adjustment is recognised in Equity.
The income Statement and balance sheet approaches
 The income Statement approach
DT adj= (Accounting profits- Taxable profits) * tax rate

 The Balance sheet approach.

DT A/L Bal = (CA-TB)* tax rate

The different Tax Adjustment and the balances will be the same for both approaches

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 NOTION OF TAX BASE

4.Temporary differences (TDs) vs Timing differences

• Note that not all TDs are timing differences
• e.g. (i) DT on revaluations & (ii) DT in business combinations
• Compare ‘income statement approach’ with ‘balance sheet approach’
to DT

5. Note that:
• Taxable TDs result in DT liabilities, and that
• Deductible TDs result in DT assets

6. Note the difference between current and cumulative TDs

• Current TDs result in tax expense/income, and
• Cumulative TDs give rise to DT balances

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COMPUTATAION OF DIFFERED TAX LIABILITY /ASSET
Carrying amount
Tax Base
The amount at which the asset or
Amount attributed to that asset or
liability is recognised in the entity’s SFP
liability for tax purposes
at reporting date

Temporary Difference

Measurement of temporary
difference
Key references

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 Deferred Tax Calculation

 If the carrying amount of the asset is R40,000 and the tax base of the asset is R25,000, there
is a temporary difference of R15,000.
 This temporary difference can result in a deferred tax liability or asset.
Lets assume 28% to be the tax rate.
 The deferred tax liability will be:
 Tax rate x temporary difference
 = 28% x R15000 = R4200.
 Carrying Amount (IFRS)− 𝐓𝐚𝐱 𝐛𝐚𝐬𝐞 𝐒𝐀𝐑𝐒 = 𝐓𝐞𝐦𝐩𝐨𝐫𝐚𝐫𝐲 𝐝𝐢𝐟𝐟𝐞𝐫𝐞𝐧𝐜𝐞 𝐱𝐓𝐚𝐱 𝐑𝐚𝐭𝐞 = 𝐃𝐢𝐟𝐞𝐫𝐫𝐞𝐝 𝐓𝐚𝐱
 When carrying amount is greater than the tax base, a liability is created and vice versa

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 CAPITAL GAINS TAX

1. Notion of base cost

2. Accounting for disposals
• Only the amount above base cost will attract CGT
• CGT rate is currently at 80% of normal tax
• i.e. 80% x 28% = 22.4%
• Part of capital profit is reconciling item in P/L tax note

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 ‘EXEMPT TEMPORARY DIFFERENCE’

1. In terms of IAS 12.15 – No deferred tax is recognised for TDs arising on:
• The initial recognition of goodwill;

2. Goodwill is not tax-deductible in SA – IAS 12, para 15a

3. Non-taxable government grants – result in exempt TDs

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 CHANGE IN TAX RATE

1. IAS 12.46 – Current tax liabilities/assets – use:

• tax rates enacted/substantively enacted by reporting date
2. IAS 12.47 – Deferred tax liabilities/assets – use:
• tax rates expected to apply on settlement/realization
• Based on rates enacted/substantively enacted by reporting date
3. Guidance provided by FRG 1 – Substantively enacted tax rates and laws:
•Includes announcements by the Finance Minister in Budget Speech
Proviso? Not substantively enacted if inextricably linked to other tax laws…

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 Accounting for changes in tax rates

1. Deferred tax liabilities and assets are measured base upon tax rates that
have been enacted or substantially enacted by the end of reporting date.
2. Deferred tax balances are adjusted for changes, such adjustment is
separately disclosed.
3. The effect of changes in tax rate in a reporting period will appear in the tax
reconciliation the prof and loss section.
4. Note that part of the adjustment for change in tax rate may affect other
comprehensive income and not only the profit and loss.

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 Scenario

 Company: Omega Ltd

 Year-End: 31 December 2024
 Opening Balances on 1 Jan 2024:
 Deferred Tax Liability (DTL): R90,000 (based on 30% tax rate)
 Deferred Tax Asset (DTA): R60,000 (based on 30% tax rate)
 New enacted tax rate effective from 2024: 27%

Required: Demonstrating the Effect of a Change in Tax Rate on Deferred Tax Liabilities (DTL) and
Deferred Tax Assets (DTA)

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 MEASUREMENT OF TAX LIABILITIES/ASSETS

1. Measurement of DT to reflect (IAS 12.51):

• The tax consequences that would follow from the manner in which the
entity expects to recover the asset or settle the liability
2. Recovery of assets may be by way of:
• use
• sale
• combination of use and sale

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 Income taxes: presentation and disclosures

OFFSETTING

Current income tax Deferred income tax

-Legally enforceable right - When current tax can be offset

-Intention to settle on net basis - By the same tax authority

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 OFFSETTING, PRESENTATION & DISCLOSURE

Deferred tax assets and liabilities are offset when:

 An entity has a legally enforceable right to set off current tax assets against current tax
liabilities.
 The deferred taxes relate to the same tax authority and the same taxable entity.
 Disclose separate components of tax expense separately: know IAS 12 para 79 & 80
 Tax rate RECONCILIATION!!!

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 Deferred Tax (IAS 12:5)

1. Under IFRS (accounting profits) &

2. Under tax legislation (Taxable profits)
 Where the difference will be reversed (i.e., they are temporary)

Deferred Tax Asset: the amount of taxes recoverable, in the future periods in respect of:
 Deductible temporary differences
 Unused tax losses carried forward
 Unused tax credits carried forward

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 A deferred tax liability (IAS 12:5)

The Income taxes payable in the future periods, in respect of taxable temporary
differences

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 Model Example
(Kindly check the question uploaded on Moodle, which is available in a Word document format)

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