Deferred tax

Tax rules and accounting rules recognise many items in different periods. Deferred tax (IAS 12) recognises today the tax consequences of recovering assets and settling liabilities at their carrying amounts, so the tax expense matches the profit reported.

Tax base. For an asset, the amount that will be deductible for tax against the taxable benefits it brings (for equipment: its tax written-down value). For a liability, its carrying amount less any amount that will be deductible in future (for a warranty provision deductible when paid: nil). For revenue received in advance, its carrying amount less any amount that won't be taxable in future.

Temporary difference = carrying amount − tax base. - Taxable temporary differences → deferred tax liability (DTL): an asset with carrying amount above its tax base (accelerated tax depreciation, income taxed when received, an upward revaluation). - Deductible temporary differences → deferred tax asset (DTA): a liability with carrying amount above its tax base (warranty and other provisions deductible when paid), an asset below its tax base, and unused tax losses and credits.

A DTA is recognised only to the extent it is probable that taxable profit will be available to use it. Deferred tax is measured at the rates enacted or substantively enacted at the reporting date that are expected to apply when the difference reverses, and is not discounted.

Tax expense = current tax + the movement in deferred tax. The movement goes to profit or loss unless the underlying item is in OCI or equity (for example, deferred tax on a revaluation surplus goes to OCI) or arises in a business combination (it then adjusts goodwill).

Items that are never taxable or deductible — such as non-deductible fines — create no temporary difference. There are exceptions: no DTL on the initial recognition of goodwill, and none on the initial recognition of an asset or liability in a transaction that isn't a business combination and affects neither accounting nor taxable profit — unless it gives rise to equal taxable and deductible temporary differences, as most leases and decommissioning obligations do (an amendment effective from 2023).

Pillar Two. In May 2023 the IASB amended IAS 12 with a mandatory temporary exception: entities don't recognise or disclose deferred taxes related to OECD Pillar Two global minimum top-up taxes, and instead give targeted disclosures. US GAAP (ASC 740) uses the same balance sheet approach but recognises all DTAs and then reduces them with a valuation allowance if realisation isn't more likely than not.