Learning Outcomes
By the end of this article, you will be able to explain the deferred tax treatment of unused tax losses and uncertain tax positions, identify when deferred tax assets should be recognised, and evaluate disclosures and risks. You will also apply these principles to scenarios commonly tested in the ACCA Strategic Business Reporting exam.
ACCA Strategic Business Reporting (SBR) Syllabus
For ACCA Strategic Business Reporting (SBR), you are required to understand and apply the accounting for deferred tax in situations where complexity arises, such as tax losses and uncertainty in tax positions. Revision for this topic should focus on:
- The recognition and measurement of deferred tax assets and liabilities on unused tax losses and tax credits
- The assessment of probable future taxable profits to support recognition of deferred tax assets
- Accounting for uncertain tax positions, including when and how to recognise and measure related tax balances
- Disclosure requirements for deferred tax, including judgements involving estimation uncertainty under IAS 12 and IAS 1
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- Under what conditions can a deferred tax asset arising from unused tax losses be recognised in the financial statements?
- When dealing with uncertain tax treatments, what key principle guides whether to recognise an additional tax liability or asset?
- True or false? Deferred tax is recognised on all unused tax losses, regardless of the company's expectations of future taxable profits.
- Briefly explain the required disclosures for uncertain tax positions and deferred tax assets under IAS 1.
Introduction
Complexities in deferred tax arise most often when an entity has unused tax losses or faces uncertainty over tax treatments. While IAS 12 provides the base rules, significant judgement is required both in determining whether deferred tax assets are recognised and in quantifying uncertainty. This area is frequently examined in the ACCA SBR exam—often with scenarios requiring both computations and justification of management judgements.
Key Term: deferred tax asset
A deferred tax asset is an amount recoverable in future periods due to deductible temporary differences, unused tax losses, or tax credits.
Unused Tax Losses and Deferred Tax Recognition
Deferred tax assets from unused losses or tax credits are not automatically recognised. Recognition is permitted only when it is probable that the entity will have sufficient future taxable profits to utilise those losses or credits.
Assessment of Recoverability
IAS 12 requires that deferred tax assets from unused tax losses or credits are recognised only if it is probable they will be realised. This involves:
- Evaluating the availability of taxable profits within the period allowed by tax law for loss carryforward
- Considering future planned operations, reversals of taxable temporary differences, and tax-planning strategies
Key Term: unused tax losses
Unused tax losses are losses incurred in prior periods that can be carried forward to offset against future taxable profits under tax laws.Key Term: probable (IAS 12 context)
Probable means more likely than not—more than a 50% chance—based on objective evidence.
Evidence Required
Objective, convincing evidence is essential, especially for entities that have recently reported losses. Evidence may include budgets, business plans, or confirmed contracts generating taxable profits.
Key Term: convincing evidence
Reliable documentation supporting the recoverability of a deferred tax asset, especially required where there is a history of losses.
Worked Example 1.1
A company has unused tax losses of $3 million at year-end. Its forecasts show taxable profits of $800,000 per year for the next five years, and tax law allows indefinite carryforward of losses. Should a deferred tax asset be recognised for the full amount?
Answer:
The total expected future taxable profits ($4 million) exceed the losses. If management can produce convincing forecasts and tax laws permit use of losses, a deferred tax asset for all $3 million is justified.
Uncertain Tax Positions
Tax positions are uncertain when an entity takes a view on the interpretation or application of tax laws that may be challenged by tax authorities. This includes positions on the availability of tax losses, transfer pricing, or whether specific deductions are allowable.
Recognition and Measurement
IAS 12 requires management to reflect the tax consequence of uncertain positions in the tax computation if it is probable that the relevant tax authority will accept the treatment adopted. If acceptance is not probable, the entity must estimate the most likely outcome or apply an expected value approach.
- If probable that a tax deduction for a loss or expense will not be accepted, no deferred tax asset is recorded for that amount.
- If the outcome is uncertain, use the amount that is most likely to be accepted, or the weighted average outcome if probabilities are meaningful.
Key Term: uncertain tax position
A tax position where the acceptability by tax authorities is unclear or depends on future events.
Worked Example 1.2
An entity claims a $2 million deduction for a disputed expense. Management believes it is only 40% likely to be accepted by tax authorities. The company uses an expected value approach in line with its policy.
Answer:
The deferred tax asset is recognised at $2 million × 40% = $0.8 million. The remaining $1.2 million is not recognised unless acceptance becomes probable.
Disclosure
Judgement in recognising deferred tax assets and measurement of uncertain positions must be disclosed if it could influence financial statement users’ decisions. This includes the nature of significant assumptions and estimates per IAS 1.
Exam Warning
Beware: Recognising deferred tax assets without sufficient evidence of future profits is a common error. Also, failing to disclose significant estimation uncertainty where outcomes are not probable can result in loss of marks.
Impairment and Reversal of Deferred Tax Assets
Deferred tax assets must be reassessed each period. If future profitability becomes less likely, the asset is reduced and an expense recorded. Similarly, if conditions improve, an increased asset (and income) may be recognised.
Worked Example 1.3
Last year, Entity X recognised a deferred tax asset for $1 million in losses. This year, market demand declines, and forecasts now predict only $600,000 of taxable profits during the permitted offset period.
Answer:
The deferred tax asset must be reduced to $600,000. The $400,000 reduction is charged to profit or loss.
Disclosure Requirements
Entities must disclose:
- The amount and expiry dates of unused losses and credits for which no deferred tax asset is recognised
- Unused losses and credits for which a deferred tax asset is recognised
- Significant judgements, including the estimation of outcomes in uncertain tax positions
Users should be able to assess the potential for tax benefits and the risks that benefits may not be realised.
Summary
Unused tax losses and uncertain tax positions present deferred tax recognition and measurement challenges. Recognition depends on convincing evidence of future profits or acceptance by tax authorities. Disclosure is required for major judgements and estimation uncertainty. Regular reassessment ensures assets and liabilities remain relevant and reliable.
Key Point Checklist
This article has covered the following key knowledge points:
- Explain when a deferred tax asset arising from unused tax losses can be recognised
- Assess the role of objective evidence and "probable" in recognising deferred tax assets
- Identify how to recognise, measure, and disclose uncertain tax positions
- Reassess and impair previously recognised deferred tax assets when needed
- Outline required disclosures for deferred tax assets and uncertain positions per IAS 1 and IAS 12
Key Terms and Concepts
- deferred tax asset
- unused tax losses
- probable (IAS 12 context)
- convincing evidence
- uncertain tax position