An opinion on deferred tax

Having (possibly) got a little too excited whilst teaching deferred tax to my P2 Online Classroom Live students, I was asked an interesting question that I hadn’t been asked before. Now this doesn’t happen very often anymore so it made me think, and I decided I should probably write a blog about it… The question was “What is your opinion on deferred tax”?

If you’re not familiar / feeling rusty with the concept of deferred tax a good place for me to start is with the basic principle. It is not actually a type of tax, but rather an accounting adjustment. One way of thinking about it is that it’s the accruals and prepayments for tax payments made which result from temporary differences in recognition. Temporary differences happen from accountants and tax practitioners doing different things when considering what tax should be paid. So here we have one point for consideration… Who is right?

The diplomatic answer is we both are… and in this case, the point is that although we disagree, it is only a temporary disagreement because in most cases we get to the same point eventually, which is why when we talk about deferred tax we talk about “temporary differences” (which require adjustment) rather than permanent differences (which don’t). It is just the timing of recognition of items that is different. As an accountant, one of our fundamental principles is the accruals concept – this says that we should recognise income and expenses, and transactions in general, in the period in which they occur, not when cash is actually paid or received.

The tax practitioner however is generally a believer of ‘cash is king’ – so we only need to worry about the tax impact when cash is actually handed over.

I read an interesting article in a newspaper when the tax avoidance scandals first kicked off a few years ago that claimed deferred tax was shocking as companies shouldn’t put off paying tax until the future if they can pay it today [article is here if you’re interested] But that isn’t what is happening!! We aren’t ‘avoiding’ tax, actually we’re being very good and recording it even though the tax man hasn’t asked for it yet! But, the next question is then should we recognise it if the tax man isn’t interested in it?

The accruals concept is a principle for when we are recognising items, but we need to go to the framework to look at the recognition criteria.

The framework’s criteria for recognition is that something:

  1. Meets the definition of an element of the Financial Statements
  2. Is probable
  3. Can be reliably measured

So, first question… does deferred tax meet the definition of an asset / liability as appropriate?

Sometimes it does, sometimes it doesn’t… If you think about accrued expenses (that would result in a deferred tax asset) there will be a benefit in future (reduced tax payable) because of a past event, so it meets the definition. However, from another perspective, let’s say we revalue a property, and therefore recognise a gain. The deferred tax treatment (under International Standards) requires us to recognise a Deferred Tax Liability. However, if there is no intention to sell, you can argue that there is no present obligation as a result of a past event that will lead to a probable outflow, and as such we should not recognise a liability…

Is it probable? Well, sometimes yes, sometimes not. In a number of situations we don’t actually end up paying anything, so although we recognise it, it just sits in the accounts ‘for eternity’ as an asset or liability (or sometimes both). So that surely means it isn’t probable, and shouldn’t be recognised? Yes as accountants we have the idea of prudence, but a real ‘just in case’ is maybe taking it too far?

Can it be reliably measured? The standard says we have to use the “tax rates that are expected to apply to the period when the asset is realised or liability is settled, based on tax rates (and tax laws_ theat have been enacted or substantively enacted by the end of the reporting period” [IAS 12, para 47] But, the impact is some way in the future, and to be honest we don’t have a crystal ball to know what the tax rates will be, so we do a ‘best guess’. This is allowed (as long as assumptions are reasonable) so we can put a value on it.

I think what I would say is that my opinion on deferred tax is mixed… it is definitely one of those ‘grey areas’ that seem to leave accountants arguing / discussing things, but that is definitely not a bad thing. I may have actually more questions than I’ve answered! The good news is that if you’re studying for an exam you won’t have to sell the virtues of deferred tax to the examiner (they generally like it well enough already), you just need to understand it, and for that I am thankful as it means I get to teach it

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