Initial recognition exception and equal differences

Learning objectives

• Identify the three conditions of the initial recognition exception, including the absence of equal taxable and deductible temporary differences.L2
• Calculate the deferred tax asset and liability arising from a lease or a decommissioning obligation at the commencement date.L2, L3
• Analyse, in the light of the exception, an asset whose cost is not deductible, a grant deducted from the carrying amount and a compound instrument.L3, L4
• Justify, in a position paper, whether or not the exception applies under the tax legislation of the case.L4

Normative references

• IAS 12The standard does not deal with the methods of accounting for government grants (IAS 20) or investment tax credits; it does, however, deal with the temporary differences that may arise from such grants or credits.
• IAS 12 §15A deferred tax liability is recognised for all taxable temporary differences, except to the extent that it arises from (a) the initial recognition of goodwill or (b) the initial recognition of an asset or liability in a transaction that is not a business combination, that at the time of the transaction affects neither accounting profit nor taxable profit (tax loss) and that does not give rise to equal taxable and deductible temporary differences (condition (b)(iii) added in 2021).
• IAS 12 §18Temporary differences also arise when: (a) the identifiable assets acquired and liabilities assumed in a business combination are recognised at fair value (IFRS 3) with no equivalent tax adjustment (para. 19); (b) assets are revalued with no equivalent tax adjustment (para. 20); (c) goodwill arises in a business combination (para. 21); (d) the tax base of an asset or liability on initial recognition differs from its initial carrying amount, for example for a non-taxable grant related to an asset (paras. 22 and 33); (e) the carrying amount of investments in subsidiaries, branches, associates or joint arrangements comes to differ from their tax base (paras. 38 to 45). Exchange differences on non-monetary items are dealt with in para. 41.
• IAS 12 §22A temporary difference may arise on the initial recognition of an asset or liability, for example if part or all of the cost of an asset will not be deductible for tax purposes; its treatment depends on the nature of the transaction: business combination or not, effect on accounting or taxable profit, and whether or not equal taxable and deductible temporary differences arise.
• IAS 12 §22AA transaction that is not a business combination may lead to the recognition of both an asset and a liability without affecting, at the time of the transaction, either accounting profit or taxable profit: for example, at the commencement date of a lease, the lessee recognises a lease liability and a corresponding amount in the cost of the right-of-use asset. Depending on the tax law, equal taxable and deductible temporary differences may then arise; the exemption in paras. 15 and 24 does not apply to those differences and the entity recognises the resulting deferred tax liabilities and assets.
• IAS 12 §23Compound financial instrument: in some jurisdictions, the tax base of the liability component on initial recognition is equal to the initial carrying amount of the sum of the liability and equity components; the taxable temporary difference that arises from the separate recognition of the equity component is not covered by the initial recognition exception; the resulting deferred tax liability is charged directly to the carrying amount of the equity component, and subsequent changes in it are recognised in profit or loss.
• IAS 12 §24A deferred tax asset is recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised, unless it arises from the initial recognition of an asset or liability in a transaction that is not a business combination, that at the time of the transaction affects neither accounting profit nor taxable profit and that does not give rise to equal taxable and deductible temporary differences (2021 amendment).
• IAS 12 §33A deferred tax asset may arise on the initial recognition of an asset, for example when a non-taxable government grant related to an asset is deducted in arriving at its carrying amount but not its tax base: the carrying amount is less than the tax base, which gives rise to a deductible temporary difference. If the grant is presented as deferred income, the difference between the deferred income and its tax base of nil is a deductible temporary difference. Whichever presentation is adopted, the resulting deferred tax asset is not recognised, for the reason given in para. 22 (initial recognition exception).

Original summaries of the paragraphs (reference register), never a quotation of the standard.

28 questions

• The initial recognition exception may apply to an asset acquired in a business combination.L2
• At the commencement date of a lease, where the tax law gives rise to equal taxable and deductible differences, the lessee recognises both a deferred tax liability and a deferred tax asset.L2
• A transaction that changes taxable profit when it occurs may nevertheless fall under the initial recognition exception.L2
• IAS 12 sets the methods of accounting for government grants and investment tax credits.L2
• Which combination of conditions allows the initial recognition exception to be applied to a deferred tax liability?L2
• A temporary difference arises on the initial recognition of an asset part of whose cost will never be deductible. What does its treatment depend on?L2
• Which deferred taxes does the initial recognition exception cover?L2
• Which conditions must all be met for the initial recognition exception to apply?L2
• In which of these situations does the initial recognition exception not apply?L2
• On 1 January 20X6, Jassora leases a warehouse: right-of-use asset of {rou_asset} and lease liability of {lease_liability}. Under the tax law (case data), lease payments are deductible when paid: the tax bases of the right-of-use asset and of the liability are nil. Sufficient taxable profit is probable. Tax rate: {tax_rate}%. Compute the deferred tax liability and asset at the commencement date.L2
• Korvelle leases a fleet of commercial vehicles. At the commencement date, it recognises a right-of-use asset of {rou_asset} and a lease liability of {lease_liability}. The tax law (data) deducts only lease payments made, so both items have a nil tax base. Future taxable profit is probable. With a tax rate of {tax_rate}%, which deferred taxes are recognised at the commencement date?L2
• On 1 July 20X6, Lindrave commences an office lease: right-of-use asset of {rou_asset} and lease liability of {lease_liability}. For tax purposes (case data), lease payments are deductible only when paid; both tax bases are nil and future taxable profit is probable. Tax rate: {tax_rate}%. Record the deferred tax entry at the commencement date.L2
• Morvanne brings a telecommunications mast into use; it recognises a dismantling provision of {dismantling_cost} and includes the same amount in the cost of the mast (treatment used in the case). The tax law (data) deducts dismantling costs only when paid and ignores this component of cost. Future taxable profit is probable. Tax rate: {tax_rate}%. Record the deferred tax entry at the outset.L2
• An entity issues a compound financial instrument; in its jurisdiction, the tax base of the liability component equals the total of both components. How does it treat the taxable difference arising from the separation of the equity component?L3
• Nestara receives a non-taxable government grant of 90,000 for a machine costing 450,000; under the method used in the case, the grant is deducted from the carrying amount of the machine, but not from its tax base. Which statements are correct at the outset?L3
• Ostrelle issues convertible bonds for {proceeds}; the liability component is measured at {liability_component}, the balance being classified in equity. In its jurisdiction (case data), the tax base of the liability component equals the total issue proceeds. Tax rate: {tax_rate}%. Compute the difference and the deferred tax liability at issue.L3
• Querval acquires a storage facility for {purchase_cost} and initially recognises a dismantling provision of {dismantling_cost}, included in the cost of the facility (treatment in the case). For tax purposes (data), the purchase price forms the tax base of the facility, the dismantling component is not part of it and the provision is deductible only when paid. Future taxable profit is probable. Tax rate: {tax_rate}%. Compute the liability, the asset and the net deferred tax at the outset.L3
• Ressane installs a test platform bought for {purchase_cost}. It must restore the site at the end of operations: estimated cost of {dismantling_cost}, provided for and included in the cost of the platform (treatment in the case). The tax law (data) admits neither this component in the tax base nor the provision before payment. Future taxable profit is probable. Tax rate: {tax_rate}%. Compute the deferred taxes at the outset.L3
• Saltrene issues convertible bonds; the split reveals an equity component of {equity_component}. In its jurisdiction (case data), the tax base of the liability component equals the total issue proceeds, hence a taxable difference equal to this component. Tax rate: {tax_rate}%. Record the deferred tax entry at issue.L3
• At 31 December 20X5, Solvara brings a solar plant into use and recognises a dismantling provision of {dismantling_cost}, included in the cost of the plant (treatment in the case). The tax law (data) recognises neither this component nor the provision before payment. The current rate is 25%, but an enacted law sets at {enacted_rate}% the rate for the years in which the differences will reverse. Future taxable profit is probable. Record the deferred tax entry.L3
• Tirenne, lessee of a store lease, recognises at the commencement date a right-of-use asset and a lease liability of 540,000 each. Lease payments are deductible only when paid (tax data). Its accountant recognises no deferred tax, citing the initial recognition exception. Where is the error?L3
• Valdoris capitalises 300,000 of development costs (accounting treatment in the case), which the tax law (data) allows it to deduct in full in the same year. Its accountant records no deferred tax, citing the initial recognition exception. Where is the error?L3
• Aubrisse buys an office building separately, outside any business combination, for 700,000; under the tax law (data), 200,000 of this cost will never be deductible, either through depreciation or on disposal. The purchase affects no profit. The accountant recognises a deferred tax liability of 50,000 (25% rate) as an expense. Where is the error?L3
• Cellaris, a lessee, recognises a right-of-use asset and a lease liability of 210,000 each. In its jurisdiction (case data), the tax authority follows the accounting treatment: it deducts the depreciation of the right-of-use asset and the interest on the liability, so the tax base of each item equals its carrying amount. Which deferred tax is recognised at the commencement date?L3
• Dravona separately acquires an operating licence for 650,000. The tax law (data) will never allow 150,000 of this cost to be deducted; the acquisition affects neither accounting profit nor taxable profit, and no deductible difference arises. Tax rate: 25%. Which treatment applies at acquisition?L3
• Elmorra, which has recent tax losses, leases a logistics site: right-of-use asset and lease liability of 380,000 each. Lease payments are deductible only when paid (tax data); according to the schedule prepared (case assumption), the taxable difference on the right-of-use asset will reverse in the same periods, and for the same tax authority and entity, as the deductible difference on the liability. Tax rate: 25%. What is recognised at the commencement date?L4
• Faldine group enters, on the same day, into two identical leases (right-of-use asset and liability of 500,000 each) in two jurisdictions. In jurisdiction A (case data), lease payments are deductible when paid; in jurisdiction B, the tax authority deducts the depreciation of the right-of-use asset and the interest, so the tax bases equal the carrying amounts. Write a position paper on deferred tax at the commencement date of each lease, distinguishing the rules of the standard, the case data and judgement.L4
• During 20X6, Ferrovane carries out three transactions (tax rate: 25%): (1) separate purchase of a licence for 480,000, of which 120,000 will never be deductible, with no effect on profits; (2) issue of convertible bonds showing an equity component of 80,000, the tax base of the liability component being equal to the total proceeds (data); (3) capitalisation of internally developed software for 60,000, fully deducted for tax in the same year (data). Write a note analysing the deferred tax at the outset of each transaction.L4