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

Income taxes include all domestic and foreign taxes that are based on taxable profits.

Current tax for current and prior periods is, to the extent that it is unpaid, recognised as a liability. Overpayment of current tax is recognised as an asset. Current tax liabilities (assets) for the current and prior periods are measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period.

IAS 12 requires an entity to recognise a deferred tax liability or (subject to specified conditions) a deferred tax asset for all temporary differences, with some exceptions. Temporary differences are differences between the tax base of an asset or liability and its carrying amount in the statement of financial position. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

A deferred tax liability arises if an entity will pay tax if it recovers the carrying amount of another asset or liability. A deferred tax asset arises if an entity:

• will pay less tax if it recovers the carrying amount of another asset or liability; or
• has unused tax losses or unused tax credits.

Deferred tax assets are recognised only when it is probable that taxable profits will be available against which the deferred tax asset can be utilised.

Deferred tax assets and deferred tax liabilities are measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period. The measurement of deferred tax liabilities and deferred tax assets reflects the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities. Deferred tax assets and liabilities are not discounted.

In this case a deffered tax liability has to be recorded