E.2 Initial Recognition Exception
In May 2021, the IASB issued Deferred Tax Related to Assets and
Liabilities Arising From a Single Transaction — Amendments to IAS 12. The
amendments are effective for annual reporting periods beginning on or after January 1,
2023, with earlier application permitted. If an entity applies the amendments in an
earlier period, it must disclose that fact. First-time adopters should apply the
guidance on the date of their transition to IFRS Accounting Standards.
The amendments apply to transactions that occur on or after the
beginning of the earliest comparative period presented. In addition, at the beginning of
such period, the entity recognizes:
- A DTA (if it is probable that
taxable income will be available for realizing the deductible temporary
difference) and a DTL for all deductible and taxable temporary differences
associated with:
- Right-of-use assets and lease liabilities.
- Decommissioning, restoration, and similar liabilities and the corresponding amounts recognized as part of the cost of the related asset.
- The cumulative effect of initially applying the amendments as an adjustment to the opening balance of retained earnings (or other component of equity as appropriate) on that date.
The IASB concluded that applying the amendments’ transition guidance
would be less complex and costly than applying a full retrospective approach. Under that
guidance, entities must recognize deferred tax for all temporary differences related to
leases and decommissioning obligations at the beginning of the earliest comparative
period and apply the amendments to transactions other than leases and decommissioning
obligations on or after the beginning of the earliest comparative period.
E.2.1 Before Adoption of the Amendments to IAS 12
Before adoption of the May 2021 amendments to IAS 12, deferred taxes
are not recognized on temporary differences that arise from the initial recognition
of an asset or a liability in a transaction that (1) is not a business combination
and (2) does not affect accounting profit or taxable income. Changes in the
temporary differences also are not recognized. One example given in IAS 12 is that
of an asset for which there is no deduction against taxable profits for
depreciation. If the entity intends to recover the value of the asset through use,
the tax base of the asset is nil. Therefore, a taxable temporary difference equal to
the cost of the asset arises on initial recognition. However, IAS 12 does not permit
a DTL to be recognized, because the initial recognition of the asset is not part of
a business combination and does not affect either accounting profit or taxable
income. Further, no deferred tax is recognized as a result of depreciating the
asset.
The prohibition against recognition is based on the argument that if
a DTL were recognized, the equivalent amount would have to be (1) added to the
asset’s carrying amount in the statement of financial position or (2) recognized in
profit or loss on the date of initial recognition, which would make the financial
statements “less transparent.” The exception is based on pragmatism and the desire
to avoid such financial statement effects rather than on any particular concepts.
Note that the exception has a particular effect in jurisdictions where some or all
of the initial expenditure on assets is disallowed for tax purposes.
Unlike IFRS Accounting Standards, there is no “initial recognition”
exception under U.S. GAAP. Accordingly, unless an exception applies, deferred taxes
are recognized for temporary differences on assets and liabilities. However, under
U.S. GAAP, there is guidance on temporary differences for assets and liabilities not
acquired in a business combination. See Section 3.3.
E.2.2 After Adoption of the Amendments to IAS 12
After adoption of the May 2021 amendments to IAS 12, deferred taxes
are not recognized on temporary differences that arise from the initial recognition
of an asset or a liability in a transaction that (1) is not a business combination,
(2) does not affect accounting profit or taxable income, and (3) does not give rise
to equal taxable and deductible temporary differences.
For some transactions, such as leases and decommissioning
obligations, simultaneous recognition of an asset and a liability is required under
IFRS Accounting Standards. Such recognition for financial statement reporting
purposes may, depending upon the applicable tax law, also give rise to equal amounts
of taxable and deductible temporary differences.
Before the amendments, there were different views about whether IAS
12 required recognition of deferred taxes for these offsetting temporary differences
or whether the initial recognition exception applied. If an entity applied the
initial recognition exception and did not recognize deferred taxes, subsequent
amortization of the assets and liabilities recognized for financial statement
reporting purposes resulted in permanent differences that affected the entity’s ETR
to the extent that amortization of those assets and liabilities into profit and loss
occurred over different periods and did not offset.
The amendments clarify that (1) the initial recognition exception
does not apply to transactions that create offsetting taxable and deductible
temporary differences and (2) entities should recognize any resulting DTA and
DTL.
The assessment of the recoverability of DTAs does not affect the determination of
whether there are equal and offsetting taxable and deductible temporary differences.
In addition, the IASB noted that an entity might recognize different amounts of DTAs
and DTLs for equal and offsetting deductible and taxable temporary differences if
different tax rates apply to the measurement of the associated DTAs or DTLs. The
IASB concluded that in such cases, the initial recognition exception should not
apply and that any difference must be reported in profit and loss.