Question

n certain countries, the tax rate applied to a company’s tax return reporting income depends upon whether the profits for the period are distributed or undistributed. Amounts are initially taxed at the higher rate, but a tax credit is received when the profits are distributed. Therefore, companies need to determine the rate (distributed vs. the undistributed tax rate). Global Multinational Corporation (Global) is a U.S. company that owns and operates 100% of a consolidated subsidiary in a foreign jurisdiction where income taxes are payable at a higher rate on undistributed profits than on distributed earnings. For the year ending December 31, Year 1, Global’s foreign subsidiaries taxable income is $150,000. Global’s foreign subsidiary also has net taxable temporary differences amounting to $50,000 for the year, thus creating the need for a deferred tax liability on the balance sheet. The tax rate on distributed profits is 40%, and the tax rate on undistributed profits is 50%; the difference results in a credit if profits are distributed in the future. At the date of the balance sheet, no distributions have been proposed or declared. On March 31, Year 2, Global’s foreign consolidated subsidiary distributes dividends of $75,000. Instructions: Obtain and review the accounting and related measurement guidance related to anticipated tax credits in IAS12, Income Taxes, and in Sections 25 and 30 of ASC740-10, Income Taxes-Overall. Document the relevant portions of the IFRS and US GAAP related to the accounting that Global must follow for the above series of transactions. Provide the required journal entries for both Year 1 and Year 2 under both the US GAAP and IFRS for each respective date where you are provided information in the above scenario. In your explanation for each journal entry, make sure you document the basis for each journal entry amount. In other words, how did you obtain the figures? In addition, provide a detailed explanation for each respective journal entry with the appropriate Reference(s) to IAS12 and ASC 740-10, respectively.

Answer 1

As per para. 52B of IAS 12, the income tax consequences of dividends are recognised when a liability to pay the dividend is recognised. The income tax consequences of dividends are more directly linked to past transactions or events than to distributions to owners. Therefore the income tax consequences of dividends are recognised in profit & loss for the period as required except to the extent that the income tax consequences of dividends arise from the circumstances of entity having 100% subsidiary in an area having different rate of taxes for distributed and undistributed profits.

As discussed above An entity does not recognize a liability for dividends proposed or declared after the statement of financial position date i.e is in Global's case 31st December of Year 1. Hence no dividends are recognised in Year 1 and Taxable income for Year 1 will be $1,50,000. So the entity will recognise a current tax liability and a current income tax expense of $75,000 (150000*50%). No asset will be recognised for the amount potentially recoverable as a result of future dividends. Further the entity will also have to recognise a deferred tax liability and deferred tax expense of $25,000 (50000*50%) representing the income taxes that the entity will pay when it recovers or settles the carrying amount of its assets and liabilities based on the tax rate applicable to undistributed profits i.e. 50%.

Subsequently on 31st march in Year 2, when the dividend is distributed, Global will have to recognise dividends of $75,000 from previous operating profits as a liability.On 31st March in Year 2, the entity will recognise the recovery of Income Taxes of $30,000 (40% of the dividends recognised as liability i.e. 75000*40%) as a current tax asset and as a reduction of current income tax expense for Year 2.