Deferred Tax in Business Combinations and Equity Items

Understand Deferred Tax in Business Combinations and Equity Items

Key rules to remember

General rule (para 58)

Tax goes to P&L unless the underlying item is outside P&L or arises from a business combination

Start every question with where the underlying item was recognised.

OCI and equity rule (para 61A)

Item in OCI → tax in OCI; item directly in equity → tax directly in equity

Applies to current and deferred tax, in the same or a different period.

Deferred tax on revaluation

Deferred tax = (Revalued carrying amount − Tax base) × Tax rate

Charged to OCI (reduces the revaluation surplus) when the tax base is not adjusted. Applies when the tax base is not adjusted by the revaluation.

Deferred tax on fair value uplift in acquisition

DTL = (Fair value − Tax base) × Tax rate

Recognised at acquisition date as a liability of the acquiree. It increases goodwill.

Goodwill (para 21)

Goodwill = (Consideration + NCI + Fair value of previously held interest) − Net identifiable assets at acquisition-date amounts

Net assets are after deferred tax recognised under para 66. No deferred tax on goodwill itself.

Transfer from revaluation surplus (para 64)

Transfer to retained earnings = (Depreciation on revalued carrying amount − Depreciation on cost), net of related deferred tax

Para 64 says that if an entity makes such a transfer, the amount transferred is net of any related deferred tax. It gives no formula. As an illustration only, with a flat tax rate and deferred tax measured at that rate, the net amount works out as excess depreciation × (1 − tax rate).

Share-based payment excess (para 68C)

If (estimated future) tax deduction > cumulative remuneration expense, the excess of the associated current or deferred tax is recognised directly in equity

The excess deduction indicates it relates partly to an equity item, so the tax on that excess goes to equity (para 68C).

How to solve Deferred Tax in Business Combinations and Equity Items questions

1. 1Identify the event: revaluation, acquisition, item in equity, or share-based payment.
2. 2Find where the underlying item is recognised: P&L, OCI, equity, or goodwill and the acquisition accounting.
3. 3Compute the carrying amount and the tax base of each asset or liability affected.
4. 4Work out the temporary difference and multiply by the tax rate given in the question.
5. 5Check exceptions: no deferred tax liability on initial recognition of goodwill.
6. 6Post the entry. Deferred tax goes to the same place as the item it relates to.
7. 7For business combinations, include the deferred tax in net identifiable assets and then compute goodwill or capital reserve.
8. 8State the final figure, and add a one-line reason citing the paragraph.

Quickest way: Follow-the-item shortcut

Common mistakes in Deferred Tax in Business Combinations and Equity Items

• Charging deferred tax on a revaluation surplus to profit or loss.

  Students treat all tax as an expense.

  Fix: Revaluation surplus is in OCI, so deferred tax on it goes to OCI (paras 61A, 62).

• Recognising a deferred tax liability on goodwill in an acquisition.

  Goodwill has a nil tax base, so a difference appears.

  Fix: Paragraphs 21 and 66 prohibit it, since goodwill is a residual and the DTL would increase goodwill.

• Ignoring deferred tax on fair value uplifts when computing goodwill.

  Students compute goodwill from fair values alone.

  Fix: Where the tax base stays at the previous owner's cost, recognise a DTL (para 19) and deduct it from net assets before computing goodwill.

• Believing no deferred tax arises if the entity does not intend to sell the revalued asset.

  Students link tax to sale only.

  Fix: Para 20(a): recovery through use still produces taxable income above allowable tax depreciation, so a temporary difference exists.

• Transferring the full gross excess depreciation from revaluation surplus to retained earnings.

  Deferred tax is forgotten.

  Fix: Para 64: the transfer is net of related deferred tax.

Worked examples