MEMBERS' HANDBOOK

STATEMENT 2.112
STATEMENT OF STANDARD ACCOUNTING PRACTICE
INCOME TAXES

(Issued August 2002)

The enterprise recognises the deferred tax liability in years 1 to 4 because the reversal of the taxable temporary difference will create taxable income in subsequent years. The enterprise's income statement is as follows:
		Year
		1		2		3		4		5
		$		$		$		$		$
Income		2,000		2,000		2,000		2,000		2,000
Depreciation		2,000 _____		2,000 _____		2,000 _____		2,000 _____		2,000 _____
Profit before tax		0		0		0		0		0
Current tax expense (income)		(200)		(200)		(200)		(200)		800
Deferred tax expense (income)		200 _____		200 _____		200 _____		200 _____		(800) _____
Total tax expense (income)		0 _____		0 _____		0 _____		0 _____		0 _____
Net profit for the period		0 ==		0 ==		0 ==		0 ==		0 ==

Example 2 - Deferred Tax Assets and Liabilities The example deals with an enterprise over the two year period, X5 and X6. In X5 the enacted income tax rate was 40% of taxable profit. In X6 the enacted income tax rate was 35% of taxable profit. Charitable donations are recognised as an expense when they are paid and are not deductible for tax purposes. In X5, the enterprise was notified by the relevant authorities that they intend to pursue an action against the enterprise with respect to sulphur emissions. Although as at December X6 the action had not yet come to court the enterprise recognised a liability of $700 in X5 being its best estimate of the fine arising from the action. Fines are not deductible for tax purposes. In X2, the enterprise incurred $1,250 of costs in relation to the development of a new product. These costs were deducted for tax purposes in X2. For accounting purposes, the enterprise capitalised this expenditure and amortised it on the straight line basis over five years. At 31/12/X4, the unamortised balance of these product development costs was $500. In X5, the enterprise entered into an agreement with its existing employees to provide health care benefits to retirees. The enterprise recognises as an expense the cost of this plan as employees provide service. No payments to retirees were made for such benefits in X5 or X6. Health care costs are deductible for tax purposes when payments are made to retirees. The enterprise has determined that it is probable that taxable profit will be available against which any resulting deferred tax asset can be utilised. Buildings are depreciated for accounting purposes at 5% a year on a straight line basis and at 10% a year on a straight line basis for tax purposes. Motor vehicles are depreciated for accounting purposes at 20% a year on a straight line basis and at 25% a year on a straight line basis for tax purposes. A full year's depreciation is charged for accounting purposes in the year that an asset is acquired. At 1/1/X6, the building was revalued to $65,000 and the enterprise estimated that the remaining useful life of the building was 20 years from the date of the revaluation. The revaluation did not affect taxable profit in X6 and the taxation authorities did not adjust the tax base of the building to reflect the revaluation. In X6, the enterprise transferred $1,033 from revaluation reserve to retained earnings. This represents the difference of $1,590 between the actual depreciation on the building ($3,250) and equivalent depreciation based on the cost of the building ($1,660, which is the book value at 1/1/X6 of $33,200 divided by the remaining useful life of 20 years), less the related deferred tax of $557 (see paragraph 64 of the Statement).

Current Tax Expense
		X5		X6
		$		$
Accounting profit		8,775		8,740
Add
Depreciation for accounting purposes		4,800		8,250
Charitable donations		500		350
Fine for environmental pollution		700		-
Product development costs		250		250
Provision for health care benefits		2,000 _______		1,000 _______
		17,025		18,590
Deduct
Depreciation for tax purposes		(8,100) _______		(11,850) _______
Taxable Profit		8,925 =====		6,740 =====
Current tax expense at 40%		3,570 =====
Current tax expense at 35%				2,359 =====

Carrying Amounts of Property, Plant and Equipment
		Building		Motor Vehicles		Total
		$		$		$
Cost
Balance at 31/12/X4		50,000		10,000		60,000
Additions X5		6,000 _______		- _______		6,000 _______
Balance at 31/12/X5		56,000		10,000		66,000
Elimination of accumulated depreciation on revaluation at 1/1/X6		(22,800)		-		(22,800)
Revaluation at 1/1/X6		31,800 _______		- _______		31,800 _______
Balance at 1/1/X6		65,500		10,000		75,000
Additions X6		- _______		15,000 _______		15,000 _______
Balance at 31/12/X6		65,000 =====		25,000 =====		90,000 =====
Accumulated Depreciation		5%		20%
Balance at 31/12/X4		20,000		4,000		24,000
Depreciation X5		2,800 _______		2,000 _______		4,800 _______
Balance at 31/12/X5		22,800		6,000		28,800
Revaluation at 1/1/X6		(22,800) _______		- _______		(22,800) _______
Balance at 1/1/X6		-		6,000		6,000
Depreciation X6		3,250 _______		5,000 _______		8,250 _______
Balance at 31/12/X6		3,250 ====		11,000 =====		14,250 =====
Carrying Amount
31/12/X4		30,000 =====		6,000 ====		36,000 =====
31/12/X5		33,200 =====		4,000 ====		37,200 =====
31/12/X6		61,750 =====		14,000 =====		75,750 =====

Tax Base of Property, Plant and Equipment
		Building		Motor Vehicles		Total
		$		$		$
Cost
Balance at 31/12/X4		50,000		10,000		60,000
Additions X5		6,000 _______		- _______		6,000 _______
Balance at 31/12/X5		56,000		10,000		66,000
Additions X6		- _______		15,000 _______		15,000 _______
Balance at 31/12/X6		56,000 =====		25,000 =====		81,000 =====
Accumulated Depreciation		10%		25%
Balance at 31/12/X4		40,000		5,000		45,000
Depreciation X5		5,600 _______		2,500 _______		8,100 _______
Balance at 31/12/X5		45,600		7,500		53,100
Depreciation X6		5,600 _______		6,250 _______		11,850 _______
Balance 31/12/X6		51,200 =====		13,750 =====		64,950 =====
Tax Base
31/12/X4		10,000 =====		5,000 ====		15,000 =====
31/12/X5		10,400 =====		2,500 ====		12,900 =====
31/12/X6		4,800 ====		11,250 =====		16,050 =====

Deferred Tax Assets, Liabilities and Expense at 31/12/X4
		Carrying Amount		Tax Base		Temporary Differences
		$		$		$
Accounts receivable		500		500		-
Inventory		2,000		2,000		-
Product development costs		500		-		500
Investments		33,000		33,000		-
Property, plant & equipment		36,000 _______		15,000 _______		21,000 _______
TOTAL ASSETS		72,000 =====		50,500 =====		21,500 =====
Current income taxes payable		3,000		3,000		-
Accounts payable		500		500		-
Fines payable		-		-		-
Liability for health care benefits		-		-		-
Long term debt		20,000		20,000		-
Deferred income taxes		8,600 _______		8,600 _______		- _______
TOTAL LIABILITIES		32,100		32,100
Share capital		5,000		5,000		-
Revaluation surplus		-		-		-
Retained earnings		34,900 _______		13,400 _______
TOTAL LIABILITIES / EQUITY		72,000 =====		50,500 =====		_______
TEMPORARY DIFFERENCES						21,500 =====
Deferred tax liability		21,500 at 40%				8,600
Deferred tax asset		-				- _______
Net deferred tax liability						8,600 =====

Deferred Tax Assets, Liabilities and Expense at 31/12/X5
		Carrying Amount		Tax Base		Temporary Differences
		$		$		$
Accounts receivable		500		500		-
Inventory		2,000		2,000		-
Product development costs		250		-		250
Investments		33,000		33,000		-
Property, plant & equipment		37,200 _______		12,900 _______		24,300 _______
TOTAL ASSETS		72,950 =====		48,400 =====		24,550 =====
Current income taxes payable		3,570		3,570		-
Accounts payable		500		500		-
Fines payable		700		700		-
Liability for health care benefits		2,000		-		(2,000)
Long term debt		12,475		12,475		-
Deferred income taxes		9,020 _______		9,020 _______		- _______
TOTAL LIABILITIES		28,265		26,265		(2,000)
Share capital		5,000		5,000		-
Revaluation surplus		-		-		-
Retained earnings		39,685 _______		17,135 _______
TOTAL LIABILITIES / EQUITY		72,950 =====		48,400 =====		_______
TEMPORARY DIFFERENCES						22,550 =====
Deferred tax liability		24,550 at 40%				9,820
Deferred tax asset		(2,000 ) at 40%				(800 ) _______
Net deferred tax liability						9,020
Less: Opening deferred tax liability						(8,600 ) _______
Deferred tax expense (income) related to the origination and reversal of temporary differences						420 ====

Deferred Tax Assets, Liabilities and Expense at 31/12/X6
		Carrying Amount		Tax Base		Temporary Differences
		$		$		$
Accounts receivable		500		500		-
Inventory		2,000		2,000		-
Product development costs		-		-		-
Investments		33,000		33,000		-
Property, plant & equipment		75,750 _______		16,050 _______		59,700 _______
TOTAL ASSETS		111,250 ======		51,550 =====		59,700 =====
Current income taxes payable		2,359		2,359		-
Accounts payable		500		500		-
Fines payable		700		700
Liability for health care benefits		3,000		-		(3,000)
Long term debt		12,805		12,805		-
Deferred income taxes		19,845 _______		19,845 _______		- _______
TOTAL LIABILITIES		39,209		36,209		(3,000)
Share capital		5,000		5,000		-
Revaluation surplus		19,637		-		-
Retained earnings		47,404		10,341
TOTAL LIABILITIES / EQUITY		111,250 ======		51,550 =====		_______
TEMPORARY DIFFERENCES						56,700 ======
Deferred tax liability		59,700 at 35%				20,895
Deferred tax asset		(3,000) at 35%				(1,050 ) _______
Net deferred tax liability						19,845
Less: Opening deferred tax liability						(9,020)
Adjustment to opening deferred tax liability resulting from reduction in tax rate		22,550 at 5%				1,127
Deferred tax attributable to revaluation surplus		31,800 at 35%				(11,130 ) _______
Deferred tax expense (income) related to the origination and reversal of temporary differences						822 ====

Illustrative Disclosure
The amounts to be disclosed in accordance with the Statement are as follows:
Major components of tax expense (income) (paragraph 79)
		X5		X6
		$		$
Current tax expense		3,570		2,359
Deferred tax expense relating to the origination and reversal of temporary differences:		420		822
Deferred tax expense (income) resulting from reduction in tax rate		- _____		(1,127) ______
Tax expense		3,990 ====		2,054 ====
Aggregate current and deferred tax relating to items charged or credited to equity (paragraph 81(a))
Deferred tax relating to revaluation of building		- ===		(11,130) ======
In addition, deferred tax of $557 was transferred in X6 from retained earnings to revaluation reserve. This relates to the difference between the actual depreciation on the building and equivalent depreciation based on the cost of the building. Explanation of the relationship between tax expense and accounting profit (paragraph 81(c)) The Statement permits two alternative methods of explaining the relationship between tax expense (income) and accounting profit. Both of these formats are illustrated on the next page.

(i)	a numerical reconciliation between tax expense (income) and the product of accounting profit multiplied by the applicable tax rate(s), disclosing also the basis on which the applicable tax rate(s) is (are) computed
			X5		X6
			$		$
Accounting profit			8,775 ====		8,740 ====
Tax at the applicable tax rate of 35% (X5: 40%)			3,510		3,059
Tax effect of expenses that are not deductible in determining taxable profit:
	Charitable donations		200		122
	Fines for environmental pollution		280		-
Reduction in opening deferred taxes resulting from reduction in tax rate			- _____		(1,127) ______
Tax expense			3,990 ====		2,054 ====
The applicable tax rate is the aggregate of the national income tax rate of 30% (X5: 35%) and the local income tax rate of 5%.

(ii)	a numerical reconciliation between the average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed
			X5		X6
			%		%
Applicable tax rate			40.0		35.0
Tax effect of expenses that are not deductible for tax purposes:
	Charitable donations		2.3		1.4
	Fines for environmental pollution		3.2		-
Effect on opening deferred taxes of reduction in tax rate			- _____		(12.9) _____
Average effective tax rate (tax expense divided by profit before tax)			45.5 ====		23.5 ====
The applicable tax rate is the aggregate of the national income tax rate of 30% (X5: 35%) and the local income tax rate of 5%.

An explanation of changes in the applicable tax rate(s) compared to the previous accounting period (paragraph 81(d))
In X6, the government enacted a change in the national income tax rate from 35% to 30%.
In respect of each type of temporary difference, and in respect of each type of unused tax losses and unused tax credits:
(i)	the amount of the deferred tax assets and liabilities recognised in the balance sheet for each period presented;
(ii)	the amount of the deferred tax income or expense recognised in the income statement for each period presented, if this is not apparent from the changes in the amounts recognised in the balance sheet (paragraph 81(g))
			X5		X6
			$		$
Accelerated depreciation for tax purposes			9,720		10,322
Liabilities for health care benefits that are deducted for tax purposes only when paid			(800)		(1,050)
Product development costs deducted from taxable profit in earlier years			100		-
Revaluation, net of related depreciation			- _____		10,573 ______
Deferred tax liability			9,020 ====		19,845 =====
(note: the amount of the deferred tax income or expense recognised in the income statement for the current year is apparent from the changes in the amounts recognised in the balance sheet.)

Example 3 - Business Combinations On 1 January X5 enterprise A acquired 100% of the shares of enterprise B at a cost of $600. A amortises goodwill over 5 years. Goodwill amortisation is not deductible for tax purposes. The tax rate in A's tax jurisdiction is 30% and the tax rate in B's tax jurisdiction is 40%. The fair value of the identifiable assets and liabilities (excluding deferred tax assets and liabilities) acquired by A is set out in the following table, together with their tax base in B's tax jurisdiction and the resulting temporary differences.
		Cost of Acquisition		Tax Base		Temporary Differences
		$		$		$
Property, plant and equipment		270		155		115
Accounts receivable		210		210		-
Inventory		174		124		50
Retirement benefit obligations		(30)		-		(30)
Accounts payable		(120) _____		(120) _____		- _____
Fair value of the identifiable assets and liabilities acquired, excluding deferred tax		504 ==		369 ===		135 ===
The deferred tax asset arising from the retirement benefit obligations is offset against the deferred tax liabilities arising from the property, plant and equipment and inventory (see paragraph 74 of the Statement). No deduction is available in B's tax jurisdiction for the cost of the goodwill. Therefore, the tax base of the goodwill (in B's jurisdiction) is nil. However, in accordance with paragraph 15(a) of the Statement, A recognises no deferred tax liability for the taxable temporary difference associated, in B's tax jurisdiction, with the goodwill.

The carrying amount, in A's consolidated financial statements, of its investment in B is made up as follows:
	$
Fair value of identifiable assets and liabilities acquired, excluding deferred tax	504
Deferred tax liability (135 at 40%)	(54) _____
Fair value of identifiable assets and liabilities acquired	450
Goodwill (net of amortisation of nil)	150 _____
Carrying amount	600 ===
At the date of acquisition, the tax base, in A's tax jurisdiction, of A's investment in B is $600. Therefore, no temporary difference is associated, in A's jurisdiction, with the investment. During X5, B's equity (incorporating the fair value adjustments made on acquisition) changed as follows:
	$
At 1 January X5	450
Retained profit for X5 (net profit of $150, less dividend payable of $80)	70 _____
At 31 December X5	520 ===
A recognises a liability for any withholding tax or other taxes that it will suffer on the accrued dividend receivable of $80. At 31 December X5, the carrying amount of A's underlying investment in B, excluding the accrued dividend receivable, is as follows:
	$
Net assets of B	520
Goodwill (net of amortisation of $30)	120 _____
Carrying amount	640 ===
The temporary difference associated with A's underlying investment is $40 as follows:
	$
Cumulative retained profit since acquisition	70
Cumulative amortisation of goodwill	(30) _____
	40 ==

If A has determined that it will not sell the investment in the foreseeable future and that B will not distribute its retained profits in the foreseeable future, no deferred tax liability is recognised in relation to A's investment in B (see paragraphs 39 and 40 of the Statement). Note that this exception would apply for an investment in an associate only if there is an agreement requiring that the profits of the associate will not be distributed in the foreseeable future (see paragraph 42 of the Statement). A discloses the amount ($40) of the temporary difference for which no deferred tax is recognised (see paragraph 81(f) of the Statement). If A expects to sell the investment in B, or that B will distribute its retained profits in the foreseeable future, A recognises a deferred tax liability to the extent that the temporary difference is expected to reverse. The tax rate reflects the manner in which A expects to recover the carrying amount of its investment (see paragraph 51 of the Statement). A credits or charges the deferred tax to equity to the extent that the deferred tax results from foreign exchange translation differences which have been charged or credited directly to equity (paragraph 61 of the Statement). A discloses separately:
(a)	the amount of deferred tax which has been charged or credited directly to equity (paragraph 81(a) of the Statement); and
(b)	the amount of any remaining temporary difference which is not expected to reverse in the foreseeable future and for which, therefore, no deferred tax is recognised (see paragraph 81(f) of the Statement).

APPENDIX C Comparison of SSAP 12 with International Accounting Standards This comparison appendix, which was prepared as at 31 May 2002 and deals only with significant differences in the standards extant, is produced for information only and does not form part of the standards in SSAP 12. The International Accounting Standard comparable with SSAP 12 is IAS 12 (revised 2000), Income Taxes. The following sets out the major textual differences between SSAP 12 and IAS 12 and the reasons for such differences.

Differences	Reasons for the differences
1. IAS 12 Paras 23, 62(d), Appendix A Para 9 and Appendix B Example 4   IAS 12 contains certain guidance on calculating deferred tax on a compound financial instrument that is accounted for in accordance with IAS 32, Financial nstruments: Disclosure and Presentation. SSAP 12 does not contain such guidance.	There is currently no SSAP equivalent to IAS 32 which specifies the accounting treatment for a compound financial instrument.
2. IAS 12 Para 72 SSAP 12 Para 72   IAS 12 paragraph 72 contains a reference to the offsetting criteria in IAS 32. The corresponding paragraph in SSAP 12 does not contain such a reference.	There is currently no SSAP equivalent to IAS 32.
3. IAS 12 Paras 62(b) and 80(h) SSAP 12 Para 62(b)   IAS 12 contains certain guidance and a disclosure requirement that concerns the fact that IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies, has an allowed alternative treatment for the correction of fundamental errors and change in accounting policies. SSAP 12 does not contain such guidance and disclosurerequirement.	SSAP 2, which is the Hong Kong equivalent of IAS 8, does not permit the use of the allowed alternative treatment in IAS 8.

(Note: The explanatory guidance and illustrative examples set out in the boxes within the body of SSAP 12 contain material that may not be based on the examples in IAS 12 but based on those in Australian Standard AASB 1020, Income Taxes.)

[End of August 2002 (Supp. No. 7/02)]