ACC410 TAXATION SUPPLEMENT WEEK 8

ACC410 Financial Reporting
TAXATION SUPPLEMENT
ACC410 TAXATION SUPPLEMENT WEEK 8
Taxation
IAS 12 Income taxes
Contents
Main types of taxation Corporate income tax and dividends Deferred taxation Transfer pricing Tax havens
Main types of taxation

Taxation as costs to the company
Social security charges Local/regional taxes National corporate income taxes
Taxation on behalf of a third party

Value added tax VAT tax on consumer and not the company
Taxation as costs
Social Security charges
contributions from employer and employees contribution to pension schemes Private vs state pensions
Local/Regional Charges
Splitting corporate taxes: Municipality/council Regional political unit National Government
ACC410 TAXATION SUPPLEMENT WEEK 8 5
Taxation as costs (cont.)

National Corporate Income tax
Common type of tax most visible Government raise funds through this tax Can be used to encourage or penalise company behaviour Calculation of this tax depends on the tax rules vs accounting rules
Value added tax

Imposed on customers at each stage of a products value-added chain, based on the value added at that point Gross amount of VAT on sales and on purchases is netted in the accounting system and net amount is paid periodically to the tax authorities (VAT received from customers less VAT paid to suppliers) Not part of revenue or expenses, but included in receivables and payables (cash flow effect) Credit transactions and payment of VAT. Cash payment for VAT before customers can pay.
Corporate income tax

Income tax payable = Taxable profit Tax rate (e.g. 30%) Taxable profit is not equal to pre-tax accounting profit - (difference between Accounting profit and tax profit) Differences?
Some expenses are not allowed tax-wise (entertaining, fines, excess depreciation, excess provisions, etc.) Special tax allowances (for capital investment, environmental protection, etc.) Income that is non-taxable
Deferred taxes arise from these differences

Taxable profit
Reconciliation statement: Accounting profit before tax Add back: disallowed expenses Deduct: special tax allowances and non-taxable income = Taxable profit
Taxation of dividends
Problem of potential double taxation of dividends due to concurrent corporate and personal taxation Solutions:
Profits paid to shareholders are taxed at a lower rate than those retained in the company, or Tax credit on the dividend for shareholders
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Deferred taxation
Deferred taxes Income statement perspective on deferred taxes Balance sheet perspective on deferred taxes Presentation of deferred taxes in the financial statements
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Deferred taxes
Differences between objectives of measuring (accounting) profit for financial reporting purposes and basic tax raising motives of measuring taxable profit Accounting rules regarding income taxes:
Tax effects of transactions are recognised in the financial statements in the same period as the related business transactions themselves Current income tax cost (taxable profit * nominal tax rate) is only part of these tax effects
Deferred taxes (cont.)

Income statement: deferred tax cost (or benefit) complements current tax cost
Statement of financial position: deferred tax assets and deferred tax liabilities reflect future tax consequences of transactions that were not treated identically for taxation and financial reporting purposes
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Income statement perspective on deferred taxes

Reconciliation statement - two types of differences:
Permanent differences Timing differences
Timing differences arise because the timing of income and expenses in the income statement occurs in different period from taxable profit Timing differences arise in one period and reverse in one or more subsequent periods
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Income statement perspective on deferred taxes

Permanent differences
Arise because tax authorities do not permit some expenses as deduction from profits
E.g. fines, Entertainment Holding board meetings in holiday resorts Expensive consumption and supplies to management
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Illustration Tax deductible accelerated depreciation

Purchase of a fixed asset (P10,000) with tax incentive (accelerated depreciation) in 2011 Useful life = 2 years and no residual value Depreciation
Financial statements: 5,000 in 2011 and in 2012 Tax calculation: 10,000 in 2011 and 0 in 2012
Pre-tax profit of 20,000 in 2011 and 2012 and tax rate of 50 per cent
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Illustration Income tax calculation
Pre-tax profit
(includes depreciation expense)
2011 20,000
2012 20,000
Timing difference
(accelerated depreciation)
- 5,000
15,000 7,500
+ 5,000
25,000 12,500
Taxable profit Tax due at 50%
or Illustration Income tax calculation

2011 20,000 2012 20,000
Pre-tax profit
Add back depreciation

Deduct Capital allowance
5,000 -10,000
15,000 7,500
+ 5,000 0
25,000 12,500
Taxable Profit Tax due at 50%
Illustration Income statement effect without deferred taxes

2011 Pre-tax profit Corporate income taxes due Net profit after tax 20,000 - 7,500 12,500 2012 20,000 - 12,500 7,500
Illustration Income statement effect including deferred taxes

2011
Pre-tax profit Total tax expense: Taxes due Deferred tax expense Deferred tax income Net profit after tax 20,000
2012
20,000
-7,500 - 2,500 10,000
-12,500 +2,500 10,000
Illustration Deferred taxes on the statement of financial position

Deferred tax expense => Deferred tax liability
Indicates that profit in the financial statements has in the past been higher than for tax purposes Liability: reflects future taxation on the difference postponement of tax payments to future periods
At reversal of timing difference:

Deferred tax income in income statement Settlement of deferred tax liability
Alternative illustration Provision not accepted for tax purposes

Deferred tax income => Deferred tax asset
Indicates that profit in the financial statements has in the past been lower than for tax purposes Asset: reflects future tax savings on the difference taxes paid, but recoverable in future periods
At reversal of timing difference:

Deferred tax expense in income statement Use of deferred tax asset
Balance sheet perspective on deferred taxes

Deferred taxation based on balance sheet values Temporary differences: differences between balance sheet values and tax values of assets and liabilities Tax value (tax base) = the amount at which the asset or liability is recognised for tax purposes Temporary differences are broader than timing differences
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IAS 12 Income taxes

Two types of temporary differences:
Taxable differences that result in deferred tax liabilities taxable amounts in determining taxable profit of future periods Deductible differences that result in deferred tax assets amounts that are deductible in determining taxable profit in future periods
Deferred tax asset / liability is measured as the temporary difference multiplied by the tax rate (applicable when asset is realised or liability is settled)
Illustration - Tax deductible accelerated depreciation (repeat)

2011
(a) Accounting balances Asset carrying amount 1 January Additions Accounting depreciation Asset carrying amount 31 December (b) Tax values Asset tax base 1 January Additions Tax depreciation Asset tax base 31 December
(c) Temporary differences 0 10,000 -5,000 5,000 0 10,000 -10,000 0 5,000
2012
5,000 0 -5,000 0 0 0 0 0 0
Illustration - Tax deductible accelerated depreciation

Temporary difference of 5,000 in 2011 Taxable or Deductible ?
Tax base of asset < Book value of asset Future accounting depreciation will be higher than tax depreciation Future taxes due will be higher than expected on accounting profit
=> Taxable temporary difference

Deferred tax liability of 2,500 (50 per cent tax rate) Deferred tax expense of 2,500
Reversal in 2012
Settlement of deferred tax liability Deferred tax income of 2,500
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Presentation of deferred taxes in financial statements

Separate presentation of deferred tax assets (liabilities) in statement of financial position Classified as non-current items Tax expense (income) related to ordinary activities presented on the face of the income statement Additional disclosures in the notes:
Details on major components of tax expense Numerical explanation of relationship between tax expense and accounting profit Details on temporary differences and related deferred tax assets and liabilities
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Transfer pricing
Transfer prices are the prices at which goods and services change hands between subsidiaries of a group
Artificially fixing transfer prices is a way of determining where profits are taxed
Double tax treaties usually state that transfer prices must be at arms length or at market rates Intra-group charges (like royalties for use of intellectual property and interest charges) are also usually structured according to a tax treaty
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Offshore financial centres

Near relatives of a tax haven, but benefit from double tax treaties with major trading countries The corporate tax they levy is sufficiently high for developed countries not to treat them as a tax haven, but sufficiently low so as still to be attractive to companies
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Tax havens
Tax havens typically offer low tax or flat rate tax for companies which are resident but whose activities are external to the haven (off-shore)
Frequently used by a MNC to provide international services (like finance, insurance) to the group Do not generally benefit from tax treaties with other countries
Costs are not negligible and substantial throughout is needed to create tax savings
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ACC410 Financial Reporting