## Learning Outcomes

After reading this article, you will understand how deferred tax arises in business combinations and through fair value adjustments in group accounts. You will be able to identify temporary differences created by consolidating assets and liabilities at fair value, calculate the resulting deferred tax, and explain the impact on goodwill, net assets, and non-controlling interests. You will also be able to apply these concepts to exam scenarios involving group restructurings and intra-group transactions.

## ACCA Strategic Business Reporting (SBR) Syllabus

For ACCA Strategic Business Reporting (SBR), you are required to understand how deferred tax is calculated and presented in complex group scenarios involving business combinations and fair value adjustments. This includes the implications for goodwill, consolidated net assets, and group tax expense. Focus your revision on:

- Explaining the calculation and recognition of deferred tax in business combinations (IFRS 3 and IAS 12)
- Identifying temporary differences arising from fair value adjustments to acquired assets and liabilities
- Evaluating how deferred tax impacts goodwill measurement
- Recognising deferred tax assets for deductible temporary differences, such as elimination of unrealised profits on intra-group inventory
- Understanding presentation and disclosure of deferred tax in consolidated accounts

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. When an asset acquired in a business combination is measured at a fair value exceeding its tax base, what type of temporary difference arises in the group accounts?
2. True or false? Deferred tax is recognised in consolidated accounts for a temporary difference caused by elimination of unrealised profits on inventory sold from a parent to a subsidiary.
3. How does recognising a deferred tax liability on a fair value uplift to net assets at acquisition affect the calculation of goodwill?
4. Give one example of an asset or liability commonly giving rise to a temporary difference on consolidation in a business combination.

## Introduction

Deferred tax becomes challenging in group accounts, especially when a new subsidiary is acquired and its assets and liabilities are consolidated at fair value. The difference between the fair value in the consolidated accounts and the tax base (typically the carrying amount in the subsidiary’s own accounts) creates temporary differences on which deferred tax must be recognised. These adjustments can significantly affect reported net assets, the calculation of goodwill, the group tax expense, and non-controlling interests.

A solid understanding of these principles is critical for SBR candidates, who must be able to identify, explain, and calculate deferred tax in group consolidation scenarios, and clearly communicate these impacts to stakeholders.

> **Key Term: deferred tax**
> A tax amount recognised in respect of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their tax bases.
>
> **Test Tip:**
> When revising Business combinations and fair value adjustments, connect each definition, method, or rule to the kind of question the assessment is likely to ask.

### Deferred Tax and Business Combinations

When a subsidiary is acquired, its identifiable assets and liabilities are consolidated at fair value as required by IFRS 3. Often, these fair values differ from the existing carrying amounts in the single-entity financial statements and from the tax base. IAS 12 requires that deferred tax is recognised on all temporary differences, except for specific exemptions, such as the initial recognition of goodwill.

> **Key Term: temporary difference**
> The difference between the carrying amount of an asset or liability in the financial statements and its tax base.

The most common situation is that fair value uplifts lead to taxable temporary differences and therefore deferred tax liabilities. For example, if property, plant, and equipment is revalued upwards for consolidation but no equivalent tax revaluation occurs, the excess is a taxable temporary difference.

In the group accounts, the deferred tax liability is recognised as part of the net assets of the acquiree at acquisition date. This, in turn, affects the amount of goodwill recognised—an essential exam point.

> **Key Term: goodwill**
> The excess of the aggregate of the consideration transferred and the amount of any non-controlling interest over the net identifiable assets acquired and liabilities assumed, measured at their fair value at the acquisition date.

### The Effect on Goodwill

All temporary differences on consolidation—such as those arising from fair value uplifts—are considered in the calculation of goodwill. Deferred tax liabilities are deducted from the fair value of net assets at acquisition date for this purpose, so higher deferred tax liabilities mean lower net identifiable assets and therefore higher goodwill.

### Worked Example 1.1

A parent acquires 100% of a subsidiary. The property, plant and equipment of the subsidiary has a carrying amount of \$500,000 and a fair value of \$650,000. The tax base remains at \$500,000. The applicable tax rate is 30%. Calculate the adjustment required for deferred tax and state the impact on goodwill.

> **Answer:**
> The fair value uplift is \$150,000 (\$650,000 - \$500,000). This creates a taxable temporary difference of \$150,000.
> The group recognises a deferred tax liability of \$45,000 (\$150,000 × 30%).
> In the goodwill calculation, the net identifiable assets increase by \$150,000 for the uplift but decrease by \$45,000 for the deferred tax liability. The net effect is an increase of \$105,000 in net assets. Higher deferred tax liability increases goodwill by reducing the net assets at acquisition.

### Deferred Tax and Intra-group Profits

Deferred tax also arises on elimination of unrealised profits in inventory from intra-group transactions (e.g., where a parent sells goods to a subsidiary at a profit and they remain unsold at year end).

> **Key Term: unrealised profit**
> Profit included in the consolidated accounts that arises from sales between group companies where the related goods remain unsold outside the group at the reporting date.

When the unrealised profit is eliminated, the carrying amount of inventory in the group accounts drops below its tax base (which remains at cost to the buyer). This creates a deductible temporary difference, giving rise to a deferred tax asset.

### Worked Example 1.2

A parent sells goods to its 80%-owned subsidiary for \$100,000, earning a gross profit of \$20,000. At year end, half the goods remain in the subsidiary’s inventory. The tax rate is 25%. Calculate the deferred tax impact in the consolidated accounts.

> **Answer:**
> The unrealised profit to eliminate is \$10,000 (\$20,000 × 50%). The carrying amount of inventory is reduced by \$10,000, but tax base is unchanged.
> Temporary difference: \$10,000 deductible —> deferred tax asset of \$2,500 (\$10,000 × 25%).
> The group recognises a deferred tax asset, reducing tax expense and increasing group net profit.

### Consolidation—Acquisition Accounting and Deferred Tax

Key steps for deferred tax in group consolidation at acquisition:

![Fair value uplift on acquired identifiable assets creating a taxable temporary difference, deferred tax liability, reduced net identifiable assets, and increased goodwill.](https://static.pastpaperhero.com/images/acca-sbr-deferred-tax-in-complex-areas-business-combinations-and-fair-value-adjustments_00.png)

_IFRS 3 fair value adjustments may create IAS 12 deferred tax liabilities, reducing acquisition-date net assets and increasing goodwill._

1. Identify all fair value adjustments to assets and liabilities (e.g., property revaluations, recognised intangible assets, contingent liabilities).
2. Calculate any resulting temporary differences (difference between fair value and tax base).
3. Recognise deferred tax assets/liabilities in the group accounts at acquisition (excluding goodwill itself).
4. Adjust net assets for deferred tax when calculating goodwill.
5. Ensure subsequent movement in deferred tax is reflected in group tax expense post-acquisition.

### Worked Example 1.3

A parent acquires an 85% shareholding in a subsidiary. At acquisition, a customer contract is recognised at fair value in consolidation of \$40,000, with a tax base of \$0. Tax rate is 20%. How does this affect net identifiable assets and goodwill?

> **Answer:**
> Temporary difference: \$40,000 taxable (fair value minus tax base).
> Deferred tax liability: \$8,000 (\$40,000 × 20%).
> Net assets at acquisition increase by \$40,000 (FV uplift) less \$8,000 (DTL) = \$32,000.
> The DTL reduces the size of net assets and increases calculated goodwill.

### Other Examples of Deferred Tax on Consolidation

Common consolidation adjustments creating deferred tax include:

- Fair value uplifts on assets, especially property, plant and equipment, or intangible assets
- Recognition of intangible assets not previously recognised by the subsidiary (e.g., brands, customer lists)
- Recognised contingent liabilities at fair value in acquisition accounting
- Elimination of unrealised profits on intra-group inventory or fixed assets
- Tax deductions available in the future for provisions or liabilities brought into the consolidated accounts

> **Exam Warning:**
> In exam questions, always check if a fair value adjustment creates a temporary difference and determine whether deferred tax must be recognised, except for the initial recognition of goodwill. Forgetting to adjust for deferred tax may lead to incorrect goodwill and net assets figures.

### Presentation and Disclosure

Deferred tax assets and liabilities recognised in consolidation should be presented as non-current and offset in the consolidated financial position when permitted under IAS 12. Disclose analysis of movement and details of temporary differences, especially those impacting acquisition accounting or the tax charge.

## Summary

In group accounts, business combinations and fair value adjustments frequently create temporary differences between the consolidated carrying amounts and tax bases of assets and liabilities. Deferred tax must be recognised on these differences, except for goodwill. Deferred tax impacts both the measurement of net assets and the calculation of goodwill. Elimination of intra-group profits in inventory also requires deferred tax assets where the carrying amount in group accounts falls below tax base. Understanding these adjustments is essential for accurate group financial reporting and for the ACCA SBR exam.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- Explain why deferred tax arises on business combinations and consolidation fair value adjustments
- Identify temporary differences in group accounts due to fair value uplifts and elimination of intra-group profits
- Recognise how deferred tax impacts goodwill, net assets, and non-controlling interest calculations
- Calculate deferred tax assets and liabilities resulting from consolidation adjustments, including those for unrealised profits
- Present and disclose group deferred tax balances correctly

## Key Terms and Concepts

- deferred tax
- temporary difference
- goodwill
- unrealised profit


Deferred tax in complex areas - Business combinations and fair value adjustments