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Deferred tax calculation guidelines

The deferred tax calculation shows the amount of income tax payable or recoverable in future periods in respect of temporary differences and unused tax losses. Temporary differences are differences between the accounting and tax values of assets and liabilities. Temporary differences will often exist in relation to non-current assets and provisions.

Non-current assets

The calculation of deferred tax on non-current assets, such as property, plant and equipment, is usually the most complicated part of the deferred tax calculation. The calculation would generally start with the asset values shown in the balance sheet and the value shown in the tax fixed asset register. However, adjustments will often be required for land, investment properties, goodwill and capital WIP. Adjustments may also be required for items recognised outside of the tax fixed asset register.

Buildings

The calculation of deferred tax on building assets depends on whether the entity expects to recover the value of the asset by use or sale.

Building classified as property, plant and equipment

For most buildings classified as property, plant and equipment, the entity would be expecting to recover the asset value by use, rather than sale. As a result, the deferred tax in relation to these assets should generally be calculated based on the difference between the accounting value of the asset and its tax base. The tax base of an asset is the amount that will be deductible for tax purposes.

The removal of tax depreciation on buildings in May 2010 reduced the tax base of certain building assets to zero. This resulted in the recognition of additional deferred tax liabilities for many entities. However, due to the initial recognition exception, this additional liability generally only applied to building costs recognised prior to 21 May 2010.
Legislation to reintroduce tax depreciation on commercial and industrial buildings was enacted on 25 March 2020. As a result of this change, the deferred tax liabilities previously recognised in relation to non-depreciable buildings will now be reduced.

The adjustment to reduce the deferred tax liabilities in relation to buildings should be recognised in the 2020 accounts for March and June balance dates entities. The credit associated with this adjustment should be recognised in tax expense.

In previous years, the deferred tax calculations for most entities would have included an adjustment to remove the tax book value of non-depreciable building assets. The calculation may also have included an exception adjustment to remove the cost-based accounting value of non-depreciable building costs recognised after May 2010. In general, these adjustments will now be reduced or eliminated as a result of this change.

The tax base of buildings should now generally be calculated based on the tax depreciation deductions that can be claimed over the remaining useful life of the asset. For some buildings, this figure will be less than the tax book value.

For buildings recognised after May 2010, the exception adjustment will be reduced or eliminated by the new tax base. The exception adjustment will continue to apply to the extent that the cost-based accounting value exceeds the tax base.

Buildings held for sale and investment property buildings

If the entity expects to recover the building value by sale, the deferred tax should be calculated based on the tax consequences of selling the asset at its carrying amount. This would apply to buildings held for sale and to investment properties, unless presumption of recovery by sale has been rebutted.

As any capital gain on sale will generally be exempt from tax, the deferred tax liability in relation to these assets would generally be calculated based on the amount of any tax depreciation recovery.

In the deferred tax calculation, both the accounting and tax values could be removed, and replaced with the amount of any tax depreciation recovery. Alternatively, the capital gain amount could be deducted from the accounting value.

If the presumption of recovery by sale has been rebutted, the deferred tax in relation to the investment property should be calculated on the same basis as buildings classified as property, plant and equipment.

Land

The deferred tax associated with a non-depreciable asset, such as land, should reflect the tax consequences of selling the asset at its carrying amount. In most cases, the capital gain on sale of land will be exempt from tax. As a result, there will generally be no deferred tax liability associated with the revaluation of land.

Both the accounting and tax values for land, including investment property land, should be removed from the deferred tax calculation, unless the land has been acquired for resale. No adjustment is required for land acquired for resale, as the gain on sale would be subject to tax.

Goodwill

Deferred tax is not recognised on the initial recognition of goodwill.  In the deferred tax calculation, the balance of goodwill should be deducted from the accounting value of intangible assets. Goodwill would no typically be included in the tax fixed asset register, but if it is, the amount included should also be deducted from the tax value.

Capital work in progress

If capital work in progress is included in the accounting values but not included in the tax values, either deduct capital work in progress from the accounting values or add capital work in progress to the tax values. If the tax value of capital work in progress differs from the accounting value, the tax value of capital work in progress should be added to the tax column. The accounting and tax values of capital work in progress will generally be the same. However, differences could occur if the balance includes capitalised interest, assets purchased from overseas, or assets funded by government grants.

Other adjustments

Adjustments may also be required for certain asset-related deductions claimed for tax purposes. Common examples include capital grants, customer contributions, expensed assets, internal profits and capitalised interest. Some entities calculate the tax depreciation impact of these items in a separate spreadsheet instead of reducing the cost values in the tax fixed asset register. If this is the case, the net value of these items will need to be deducted from the tax book value.

Adjustments may also be required if the tax fixed assets register includes revaluation gains or other non-depreciable balances.

Derivatives

In some cases, temporary differences will exist in relation to derivative financial instruments. The most common example is interest rate swaps. These derivatives may have a value for accounting purposes, but no value for tax purposes.

Provisions and adjustments

Most deferred tax calculations would include temporary differences associated with provisions, such as annual leave and doubtful debts. It may also include temporary differences for other tax calculation adjustments, such as work in progress or retentions receivable. The temporary differences for these items should generally agree to the closing balances shown in the current tax calculation.

Tax losses

In some cases, the deferred tax calculation will include tax losses carried forward. The figure for tax losses usually comes from the current tax calculation. It includes losses brought forward, losses for the current year, and losses from excess imputation credits, but it excludes any losses transferred to other entities.

Deferred tax on other comprehensive income

The movement in deferred tax for the year is generally charged to tax expense, unless it relates to items recognised in other comprehensive income.

Revaluations of fixed assets (other than land) typically result in a significant increase in deferred tax liability. The deferred tax expense associated with a revaluation gain should be recognised in other comprehensive income, and should be charged to the revaluation reserve, not retained earnings.

In most cases, deferred tax should also be recognised against hedge gains and losses shown in other comprehensive income.

Any deferred tax adjustment associated with a change in tax rates should also be recognised in other comprehensive to the extent that it relates to tax charged to reserves in prior periods.

Deferred tax assets

A deferred tax asset in relation to temporary differences or tax losses can only be recognised if it is probable that the entity will generate sufficient taxable profits against which the temporary differences or tax losses can be utilised.

If an entity has a deferred tax liability in relation to temporary differences, it can recognise a deferred tax asset in relation to losses to offset the deferred tax liability. However, if the deferred tax asset exceeds the deferred tax liability, the entity needs convincing evidence of future taxable income to be able to recognise a net deferred tax asset.

It would be unusual to see holding companies or local authorities with net deferred tax assets, as these entities usually generate tax losses, rather than taxable profits. However, at a group level, unrecognised tax losses in one company can be recognised to offset deferred tax liabilities in another company, provided that the losses can be transferred between these entities.

Any unrecognised temporary differences or tax losses should be separately disclosed in the tax note. However, this should exclude any losses that have been recognised as deferred tax assets.

Examples

Please refer to the Tax calculation and disclosure examples on our website for worked examples of deferred tax calculations and deferred tax note disclosures.

Disclaimer:
This document is intended only as a general guide, and should not be used or relied upon as a substitute for specific professional advice. No liability is accepted for loss or damage incurred by persons who rely on this document.

Page last updated: 28 July 2020