HKAS 12 Income Taxes
Amendments to the initial recognition exemption of HKAS 12 Income Taxes (the “Standard”)
The International Accounting Standards Board (the “Board”) issued the amendments to IAS 12 Income Taxes - Deferred Tax related To Assets and Liabilities arising from a Single Transaction which are effective for annual reporting periods beginning on or after 1 January 2023 (the “Amendments”). Equivalent amendments to HKAS 12 have been issued by the Institute in June 2021.
What has been amended?
The Amendments narrowed the scope of paragraphs 15 and 24 of the Standard (the “Initial Recognition Exemption”, or, the “IRE”) such that they no longer apply to transactions, such as leases, that upon initial recognition, give rise to equal taxable and deductible temporary differences.
As part of the Amendments, the Board also added Example 8 in the Appendix of the Standard (the “Example”) to illustrate the accounting for deferred tax where an entity enters into a lease contract as a lessee and recognizes both a right-of-use asset and a lease liability, giving rise to equal taxable and deductible temporary differences upon entering the transaction. Applying the Amendments, the Example concludes that an equal deferred tax asset and a deferred tax liability should be recognised by the entity, if the entity determines that the tax deduction from the lease payments is attributable to the lease liability.
A closer look into the Amendments
In order to understand the rationale of the Amendments, the readers should recall the definition of temporary differences and tax base under HKAS 12:
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Tax base of an asset = carrying amount - taxable amounts + deductible amounts Tax base of a liability = carrying amount + taxable amounts - deductible amounts Temporary differences = the carrying amount of an asset or liability - tax base |
Before the Amendments, the IRE required entities to recognize deferred tax assets (when additional criteria have been met) and deferred tax liabilities for all temporary differences except where they are related to:
(a) The initial recognition of goodwill; or
(b) The initial recognition of an asset or liability in a transaction which; (i) is not a business combination; and (ii) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).
The Example illustrates that where an entity enters into a lease contract under the scope of HKFRS 16 Leases and concludes that the tax deduction that it will receive for lease payments is attributable to the lease liability, the entity, applying the definition of the Standard before the Amendments, would conclude that the tax bases of the right-of-use asset and the lease liability are zero. As a result, upon the initial recognition of a lease, equal temporary differences in relation to the right-of-use asset and the lease liability arise.
Before the Amendments were issued, there were divergent views as to whether the IRE applies to the above case. The Board therefore amended HKAS 12 and inserted paragraphs 15(b)(iii) and 24(c), which require entities to recognise deferred tax assets (when additional criteria have been met) and deferred tax liabilities for all temporary differences except when they are related to:
(a) The initial recognition of goodwill; or
(b) The initial recognition of an asset or liability in a transaction which; (i) is not a business combination; (ii) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss) and (iii) at the time of the transaction, does not give rise to equal taxable and deductible temporary differences.
Subsequent to the issuance of the Amendments, the IRE will no longer be applicable upon the initial recognition of the asset and the liability of the transaction as illustrated in the Example. The Board was of the opinion that the Amendments would not make the financial statements less transparent given that the recognition of a deferred tax asset and liability of the same amount would not require adjustment to the carrying amount of the right-of-use asset and lease liability and it would not have any effect on the statement of profit or loss of the entity.
Other accounting implications resulted from the Amendments
Readers should note that the Example made a significant accounting judgement that the tax deduction from the lease payments is attributable to the lease liability. The Standard does not provide any guidance to help entities assess whether tax deductions are attributable to the lease asset or lease liability, as the Board was of the opinion that “any such guidance could affect how entities, in other situations, consider the applicable tax laws in determining the tax base of assets and liabilities” (BC 89(b) of HKAS 12). Accordingly, financial statement preparers need to apply judgment, after considering the relevant tax laws where the entity operates, to determine whether the tax deductions are considered to be attributable to the asset or liability for a particular transaction.
In addition, the Amendments aim to reduce the diversity of the applications of HKAS 12 not limited to lease transactions but transactions that would recognize both an asset and a liability, e.g., the acquisition of assets with decommissioning obligations. Therefore, the potential effects brought by the Amendments might be wide to some of the financial statement preparers and also their users.
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About the author
Mr. Gary Cheng Man Hon is a director of GC Advisory Company Limited. He has over 15 years of professional experience in providing technical accounting advice and training in several major Hong Kong CPA firms. Before establishing his consultancy firm, he was previously an associate director of the inspection department of the Accounting and Financial Reporting Council.
