Question

Homer has a reporting date of 30 September 2020 and prepares its financial statements in accordance with International Financial Reporting Standards.

Homer has a majority holding in Offshore, which operates in a foreign country that is suffering an economic recession, with high inflation and a falling exchange rate. The value of the functional currency of Offshore fell by more than 54% in the current financial year, compared to Homer’s functional currency, the dollar.

Offshore had been constructing a head office building, but has temporarily ceased work because of the difficult economic conditions. Homer is negotiating to sell the development on behalf of Offshore and expects to achieve a significant gain on sale. A gain would be taxed as a capital gain in the foreign jurisdiction.

Offshore has negative equity and reported operating losses in the latest three years, including the current year. Offshore recognised a deferred tax asset for the tax losses, which may be carried forward indefinitely under local tax rules. Tax losses from operations may only be offset against profits from operations. Offshore did not disclose information to support recognition of the deferred tax asset.

Required:

Discuss the requirements for recognising deferred tax assets generally and advise on how to account for this case.

Answer 1

In case a company pays taxes in advance or overpays taxes, they create an asset in their books for the corresponding excess tax amount known as deferred tax asset. Deferred tax assets are often created due to taxes paid or carried forward but not yet recognized in the income statement. It helps in reducing company's future tax liability.

A deferred tax asset can arise when there are differences between tax rules and accounting rules or when there is a carryover of tax losses. Most companies can carry forward deferred tax assets indefinitely from 2018 onwards.

The above case is well covered by the Interpretation Committee to IAS 12.

IAS 12 covers the detailed explanantion on accounting treatment for Income Taxes including Deferred Tax Assets.

The Interpretation Committee noted that paragraph 41 of IAS 12 Incomes Taxes states that when the tax base for a non-monetary asset or liability is determined in a currency that is different from the functional currency, temporary differences arise resulting in a deferred tax asset or liability. Such deferred tax does not arise from a transaction or event that is recognized outside profit or loss and is therefore charged to profit or loss in accordance with paragraph 58 of IAS 12. Such deferred tax charges or credits should appear with other deferred taxes, instead of reflecting in foreign exchange gains or losses, in the statement of profit or loss.