When a company has deductible temporary differences and taxable temporary differences pertaining to the same tax jurisdiction, there is a presumption that realization of the relevant deferred tax assets is probable, since the relevant deferred tax liabilities should be available to offset these. However, before concluding that this is valid, it will be necessary to consider further the timing of the two sets of reversals. How?
If the deductible temporary differences will reverse, say, in the very near term, and the taxable differences will not reverse for many years, it is a matter for concern that the tax benefits created by the former occurrence may expire unused prior to the latter event occurring.
Thus, when the existence of deferred tax obligations serves as the logical basis for the recognition of deferred tax assets, it is also necessary to consider whether, under pertinent tax regulations, the benefit carryforward period is sufficient to assure that the benefit will not be lost to the reporting enterprise.
For example, if the deductible temporary difference is projected to reverse in two years but the taxable temporary difference is not anticipated to occur for another ten years, and the tax jurisdiction in question offers only a five-year tax loss carryforward, then (absent other facts suggesting that the tax benefit is probable of realization) the deferred tax benefit could not be given recognition under IAS 12.
However, the company might have certain tax planning opportunities available to it, such that the pattern of taxable profits could be altered to make the deferred tax benefit, which might otherwise be lost, probable of realization.
For example, again depending on the rules of the salient tax jurisdiction, an election might be made to tax interest income on an accrual rather than a cash received basis, which might accelerate income recognition such that it would be available to offset or absorb the deductible temporary differences. Also, claimed tax deductions might be deferred to later periods, similarly boosting taxable profits in the short term.
More subtly, a reporting company may have certain assets, such as buildings, which have appreciated in value. It is entirely feasible, in many situations, for an enterprise to take certain steps, such as selling the building to realize the taxable gain thereon and then either leasing back the premises or acquiring another suitable building, to salvage the tax deduction that would otherwise be lost to it due to the expiration of a loss carryforward period.
If such a strategy is deemed to be reasonably available, even if the company does not expect to have to implement it (for example, because it expects other taxable temporary differences to be originated in the interim), it may be used to justify recognition of the deferred tax benefits.
Future Temporary Differences As A Source For Taxable Profit To Offset Deductible Differences
In some instances, a company may have deferred tax assets that will be realizable when future tax deductions are taken, but it cannot be concluded that there will be sufficient taxable profits to absorb these future deductions. However, the enterprise can reasonably predict that if it continues as a going concern, it will generate other temporary differences such that taxable (if not book) profits will be created.
It has indeed been argued that the going concern assumption underlying much of accounting theory is sufficient rationale for the recognition of deferred tax assets in such circumstances. However, IAS 12 makes it clear that this is not valid reasoning. The new taxable temporary differences anticipated for future periods will themselves reverse in even later periods; these cannot do double-duty by also being projected to be available to absorb currently existing deductible temporary differences.
Thus, in evaluating whether realization of currently outstanding deferred tax benefits is probable, it is appropriate to consider the currently outstanding taxable temporary differences, but not taxable temporary differences which are projected to be created in later periods.
Next, consider the following example of how an available tax planning strategy might be used to support recognition of a deferred tax asset that otherwise might have to go unrecognized.
Example Of The Impact Of A Qualifying Tax Strategy
Assume that Lie Dharma Company has a $180,000 operating loss carryforward as of 12/31/2011, scheduled to expire at the end of the following year. Taxable temporary differences of $240,000 exist that are expected to reverse in approximately equal amounts of $80,000 in 2012, 2013, and 2014. Lie Dharma Company estimates that taxable income for 2012 (exclusive of the reversal of existing temporary differences and the operating loss carryforward) will be $20,000. Lie Dharma Company expects to implement a qualifying tax planning strategy that will accelerate the total of $240,000 of taxable temporary differences to 2012. Expenses to implement the strategy are estimated to approximate $30,000. The applicable expected tax rate is 40%.
In the absence of the tax planning strategy, $100,000 of the operating loss carryforward could be realized in 2012 based on estimated taxable income of $20,000 plus $80,000 of the reversal of taxable temporary differences. Thus, $80,000 would expire unused at the end of 2012 and the net amount of the deferred tax asset at 12/31/2012 would be recognized at $40,000, computed as $72,000 (= $180,000 × 40%) minus the valuation allowance of $32,000 ($80,000 × 40%).
However, by implementing the tax planning strategy, the deferred tax asset is calculated as follows:
Taxable income for 2012
Expected amount without reversal of
taxable temporary differences = $ 20,000
Reversal of taxable temporary differences due
to tax planning strategy, net of costs = $210,000
Operating loss to be carried forward = (180,000)
Operating loss expiring unused at 12/31/2012 = $ 0
The deferred tax asset to be recorded at 12/31/2011 is $54,000. This is computed as follows:
Full benefit of tax loss carryforward
$180,000 × 40% = $72,000
Less: Net-of-tax effect of anticipated expenses
related to implementation of the strategy
$30,000 – ($30,000 × 40%) = $18,000
Lie Dharma Company will also recognize a deferred tax liability of $96,000 at the end of 2011 (40% of the taxable temporary differences of $240,000).