The March 31, 2009 exposure draft is no longer relevant. After considering comments received in response to the exposure draft, the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) jointly agreed that the project should not proceed in its current form.
With the current proposals not proceeding and deadlines looming, Canadian companies can no longer ignore existing IAS 12. This TaxNewsFlash-Canada highlights differences and also some similarities between Canadian GAAP and IAS 12 that you should consider as part of your company’s conversion plan.
Little time is available before companies first have to report in IFRS. Within 90 days of January 1, 2011 (by March 31, 2011), companies must issue their 2010 annual Canadian GAAP financial statements, and a scant 45 days after that (by May 15, 2011), they must issue their first 2011 interim IFRS financial statements. The Canadian Securities Administrators has proposed a 30-day extension to the deadline for filing the first interim financial report in the year of adopting IFRS. Given the magnitude of work needed to make a successful changeover to IFRS, this extension may offer only minor relief.
Preparing these interim financial statements and the first-time adoption disclosures in the first quarter of 2011 can be an onerous exercise that is quite different from the usual quarterly financial reporting. With timing this tight, companies that do not start working on their conversion well in advance likely will not have enough time to catch up.
Additionally, as IFRS affects reported pre-tax profits, many IFRS standards affect tax reporting as well. The potential effect of IFRS on an enterprise’s income taxes goes well beyond IAS 12. Tax professionals need to understand the impact of all IFRS adjustments — both on adopting IFRS and on an ongoing basis. Your tax group should begin preparing for the impact of IFRS now to avoid the crises that could arise if the project needs to be completed in a rush.
Below is a summary of certain items that are treated differently under IAS 12 and existing Canadian GAAP. Other differences may also exist that will affect an entity’s income tax provision calculation.
Similar to Canadian GAAP, IAS 12 requires that deferred tax is not recognized for the excess amount for financial reporting over the tax base of an investment in a subsidiary or a corporate joint venture (i.e., outside basis difference), if certain conditions are met. Unlike Canadian GAAP, however, IAS 12 requires disclosure of the aggregate amount of temporary differences associated with investments in subsidiaries, branches, associates and interests in joint ventures for which deferred tax liabilities have not been recognized.
Under IAS 12, a deferred tax asset or liability is recognized for exchange gains and losses related to foreign non-monetary assets and liabilities that are re-measured in the functional currency using historical exchange rates. By contrast, Canadian GAAP provides that a deferred tax asset or liability is not recognized for temporary differences arising from the difference between the historical exchange rate and the current exchange rate translations of the cost of non-monetary assets and liabilities of integrated foreign operations.
The IFRS treatment will affect Canadian companies with a functional currency that is different from their tax reporting currency.
IFRS also has an exemption from recording deferred income taxes on the initial recognition of an asset or liability. There is no equivalent treatment under Canadian GAAP.
Under IAS 12, a deferred tax liability (asset) is not recognized if it arises from the initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting profit nor taxable profit at the time of the transaction. For example, such a transaction could occur where assets are transferred under a tax-free rollover or where an entity is acquired through shares in a transaction that does not constitute a business combination. Further, an entity does not recognize later changes in the unrecognized deferred tax asset or liability as the asset is depreciated, requiring companies to track the piece that is essentially a permanent difference.
Canadian GAAP differs from IAS 12 in this respect. When a transaction is not a business combination and affects neither accounting profit nor taxable profit, an entity would recognize the resulting deferred tax asset/liability and adjust the carrying amount of the asset or liability by the same amount (using simultaneous equation).
Inter-company transfers of assets
An inter-company transfer of assets (such as the sale of inventory or depreciable assets) is a taxable event that establishes a new tax base for those assets in the buyer’s tax jurisdiction. The new tax base of those assets is deductible on the buyer’s tax return as those assets are consumed or sold to an unrelated party.
Under IAS 12, a deferred tax asset or liability is recognized for the difference in tax bases between the buyer and seller on an intra-group transfer of assets and so the deferred tax is computed using the buyer’s tax rate. Under Canadian GAAP, a deferred tax liability or asset is not recognized for the difference in the buyer’s and seller’s tax bases on an intra-group transfer of assets, and any current taxes paid or recovered by the seller are deferred based on the seller’s tax rate.
In some jurisdictions, income taxes are payable at a higher or lower rate if part or all of the net profit or retained earnings is paid out as a dividend to shareholders of the entity. In other jurisdictions, income taxes may be refundable or payable if part or all of the net profit or retained earnings is paid out as a dividend to shareholders of the entity. In these circumstances, IAS 12 requires the use of the tax rate applicable to undistributed profits in measuring deferred taxes. The tax consequences of the distribution are only recognized when a liability to make the distribution is recognized.
In Canada, income taxes generally are not payable at a higher or lower rate depending on the payment of dividends, and so Canadian GAAP does not address any such rate differential. However, Canadian GAAP sets out specific guidance for tax-exempt-type entities (such as real estate investment trusts, mutual fund trusts and specified investment flow-through entities (SIFT). This guidance provides an exemption from recognizing deferred taxes if certain conditions are met (see EIC 107). Additional guidance is provided for SIFTs that will become taxable in 2011 (see EIC 167).
In a business combination, temporary differences arise when the carrying amount of identifiable assets and liabilities acquired is revalued at fair value but the tax bases are not affected by the business combination or are affected by a different amount. For example, when the carrying amount of an identifiable asset is increased to fair value but the tax base of the asset remains at cost to the previous owner, a taxable temporary difference arises. Consistent with current Canadian GAAP, IAS 12 requires companies to recognize a deferred tax liability for these temporary differences and make a corresponding adjustment to goodwill.
Further, in a business combination, the deferred tax position of both the acquirer and acquiree at the date of acquisition is assessed from the point of view of the consolidated group. For example, a previously unrecognized deferred tax asset relating to the acquiree’s or acquirer’s tax losses may be recovered by utilizing the consolidated group’s future profit.
While this treatment is consistent with current Canadian GAAP (in accordance with CICA HB 1581), the accounting for the unrecognized amounts may differ under IAS 12. Under IFRS, where previously unrecognized deferred tax assets (e.g., tax loss carryforwards) of the acquirer are recognized, the acquirer recognizes the deferred tax asset in profit or loss. Under current Canadian GAAP, previously unrecognized deferred tax assets of the acquirer that become recoverable due to a business combination are recognized as a reduction of goodwill, rather than in profit or loss. The future recognition of the deferred tax asset is reported in profit or loss under Canadian GAAP only if the acquirer’s deferred tax asset was not recognized as of the acquisition date.
From the acquiree’s perspective, under IAS 12, if deferred tax assets of the acquiree that were not recognized at the date of acquisition are later realized (by realization or reduction of the valuation allowance), the adjustment is applied to reduce the carrying amount of goodwill related to that acquisition provided that the resulting deferred tax asset is recognized within the measurement period and results from new information about facts and circumstances that existed at the date of acquisition. If the carrying amount of goodwill is zero, any remaining deferred tax benefits are recognized in profit or loss. All other acquired deferred tax benefits later realized are recognized in profit or loss.
By contrast, current Canadian GAAP requires the later recognition of the acquiree’s deferred tax assets for temporary differences that existed at acquisition to be recognized first against goodwill, then against other intangible assets before any balance is recognized as a tax recovery in profit or loss.
Like Canadian GAAP, IAS 12 does not contain specific guidance on the recognition and measurement of uncertain tax positions and practice may vary. Canadian companies adopting IFRS may need to re-measure liabilities recorded in respect of uncertain tax positions that remain unsettled at their IFRS transition date.
Under IFRS, an entity that issues compound financial instruments, such as convertible debentures, classifies the instrument’s liability component as a liability and the equity component as equity. In some jurisdictions, the tax base of the liability component on initial recognition equals the initial carrying amount of the sum of the liability and equity components, and a taxable temporary difference arises. Under IAS 12, the resulting deferred tax liability is recognized, and the deferred tax expense is charged directly to the carrying amount of the equity component. Later changes in the deferred tax liability are recognized in profit or loss.
By contrast, Canadian GAAP provides that if a compound instrument can be settled tax-free, deferred taxes would not be recorded related to the temporary difference (i.e., the tax base of the liability component is considered equal to its carrying amount, and no temporary difference arises).
IAS 12 requires the tax effects of items credited or charged directly to equity during the current year also be allocated directly to equity. IAS 12 also requires subsequent changes in those amounts to be allocated to equity (i.e., full backwards tracing). Such items may arise from either changes in assessments of recovery of deferred tax assets or changes in tax rates, laws, or other measurement attributes. One must consider where the initial transaction was recorded as they follow through on changes to the deferred tax liabilities and assets in future years.
In contrast, Canadian GAAP is different from IAS 12 in that it generally requires that subsequent changes in those amounts to be allocated to profit or loss.
IAS 12 does not permit the deferred tax assets and liabilities to be classified as current. Essentially, they are presumed to be non-current. In addition, deferred tax liabilities and assets should be presented separately from current tax liabilities and assets.
On the other hand, Canadian GAAP indicates that the classification of future income tax assets and liabilities is based on the classification of the underlying asset or liability. Where there is no related asset or liability, the classification is based on the date that the temporary difference is expected to reverse.
Below is a summary of certain items that will be treated under IAS 12 in a way that is more similar to their accounting treatment under existing Canadian GAAP.
Under IAS 12, deferred tax assets are recognized to the extent that it is probable that the benefits will be realized. “Probable” is not defined in the standard, however, in practice, the “more likely than not” definition is often used (i.e., same as Canadian GAAP).
Similar to Canadian GAAP, IAS 12 requires that deferred taxes are measured based on enacted or substantively enacted tax rates as of the balance sheet date.
Similarly, IAS 12 requires an entity to measure deferred tax liabilities and assets using the tax rate that is consistent with the expected manner of recovery or settlement of the asset or liability. IAS 12 also indicates that the measurement of deferred taxes shall reflect 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.
A deferred tax liability is not recognized if it arises on the initial recognition of goodwill that is not tax-deductible. However, any temporary difference is recognized after the acquisition if the goodwill is tax-deductible.
KPMG has helped many organizations in assessing the impact of IFRS and implementing it. We have developed tools for a quick assessment of the potential impact of IAS 12.
Our established conversion methodology incorporates all disciplines critical to a successful conversion. KPMG’s IFRS conversion services teams are multidisciplinary teams comprised of professionals, including tax advisers, knowledgeable in IFRS and Canadian GAAP and skilled in financial reporting processes and financial integration. The experience and extensive resources of our conversion services teams can provide benefits to enterprises of all sizes and to either partial or full-scale conversion projects. To learn more about our IFRS resources and our conversion services, visit the IFRS main site.
If you want to learn more or need assistance, please contact your KPMG adviser or the managing partner at a KPMG office near you.