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Accounting for Income Taxes


According to International
FinancialReportingStandards
Dave Santerre*
Abstract
The adoption of international financial reporting standards ( IFRS) in Canada noticeably
modifies accounting for income taxes. The purpose of this chapter is to inform the reader
about accounting for income taxes in financial statements prepared according to IFRS. The
chapter begins with a brief history of accounting for income taxes under Canadian generally
accepted accounting principles (GAAP) up to the adoption of IFRS on January 1, 2011. It then
outlines the changes that affect accounting for income taxes according to IFRS, as
prescribed under IAS12. While the basics of accounting for income taxes will be looked at,
the chapter focuses primarily on the difference in accounting treatment between the
current IAS12 standard and the current practices under Canadian GAAP.

Introduction
The adoption of international financial reporting standards (IFRS) is the topic
of the day in the finance function of companies. The changeover from Canadian
generally accepted accounting principles (GAAP) to IFRS took place on January 1,
2011 for all Canadian publicly accountable enterprises.1 IFRS will apply to annual
and interim financial statements for years beginning on or after that date.
* Of PricewaterhouseCoopers LLP, Montreal.
1 Other companies will be able to select which accounting principles they apply, but Canadian
GAAP as we know them today will no longer be applied. See chapter 2 in this volume for other
possible options for non-publicly accountable enterprises (small and medium-sized businesses).

93

94 / IFRS: Adoption in Canada

The adoption of IFRS in Canada noticeably modifies accounting for income


taxes. The purpose of this chapter is to inform the reader about accounting for
income taxes in financial statements prepared according to IFRS.2 It begins with
a brief history of accounting for income taxes under Canadian GAAP. Then it
examines recent and anticipated changes to IAS 12 3 that affect accounting for
income taxes according to IFRS. Lastly, a more detailed analysis of the current
IAS12 standard is presented, comparing the accounting treatments with current practices under Canadian GAAP. Although the framework for the two
standards is similar, we will see that there are significant differences in the way
they are applied.

History of Accounting for Income Taxes


According to Canadian GAAP

Fixed Deferral Method: Income-Based Approach


Before 1968, two methods for accounting for income taxes were permitted when
there were temporary differences between accounting income and taxable income:
the tax deferral method, based on accounting income; and
the current tax method, based on taxable income.
In practically all companies, there is a difference between accounting income
and taxable income. This is primarily due to differences in timing between the
fiscal year in which certain revenues and expenses are included in accounting
income and the taxation year when they are included in the taxable income
calculation.
Depending on the method used, net income after taxes for the same company could often be very different. In light of this situation and the importance
of taxes in determining income, it made more sense to use a standard method.
As a result, the Canadian Institute for Chartered Accountants (CICA), which
established financial reporting standards in Canada, adopted section 3470
(Corporate Income Taxes) in 1968.4 Section 3470 recommended use of the
2 See the chapter by Jason Doucet in this volume for an analysis of the impacts on tax
compliance with the changeover to IFRS in Canada.
3 International Accounting Standards Board, International Accounting Standard IAS12,
Income Taxes, October 1996, as amended.
4 See the 1968 version of Canadian Institute of Chartered Accountants, CICA Handbook
(Toronto: CICA) (looseleaf ).

Accounting for Income Taxes According to IFRS / 95

deferral method when accounting for income taxes. This method ties the income tax expense or income tax recovery to the accounting income for the year,
whether the taxes were paid in a previous year or will become payable in a future
year. Thus, the tax effect of transactions is accounted for in the same year as the
underlying transactions using a tax deferral in the income statement. Under this
method, the tax deferral calculation is based on the effective rate upon initial
recognition, without being subsequently restated to take into account changes
in tax rates. This approach is based on an income statement analysis, as opposed
to the balance-sheet-based approach that is currently used (and described below).
In 1973, following the adoption of the new Income Tax Act5 (reflecting
proposals for tax reform in the Report of the Royal Commission on Taxation6 and
the 1969 white paper7), section 3471 (Corporate Income TaxesAdditional
Areas) was added to the CICA Handbook to specify the accounting treatment
resulting from certain new tax provisions, such as those dealing with refundable
taxes or a change in a companys tax status.

Liability Method: Balance-Sheet-Based Approach


In 1997, the CICA approved section 3465 (Income Taxes) to supersede sections 3470 and 3471. The introduction of this new section was the result of
several years work. In 1988, the first exposure draft proposed to modify the
accounting for income taxes as it had been practised since 1968. The exposure
draft was abandoned in 1989 owing to a lack of consensus on the amendments
to be made. The plan to amend existing standards was only relaunched in 1994.
At that time, the US Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) had published new standards for
accounting for income taxes. In 1992, the FASB published FAS 109,8 which
replaced previous interpretations of accounting for income taxes. In 1994, the
IASB published exposure draft E49,9 significantly modifying IAS12 (Accounting

5 SC 1970-71-72, c. 63; effective January 1, 1972.


6 Canada, Report of the Royal Commission on Taxation (Ottawa: Queens Printer, 1966)
(commonly known as the Carter report).
7 Canada, Department of Finance, Proposals for Tax Reform (Ottawa: Queens Printer, 1969).
8 Financial Accounting Standards Board, Statement of Financial Accounting Standards no. 109,
Accounting for Income Taxes, February 1992.
9 International Accounting Standards Board, Exposure Draft E49, Income Taxes, October 1994.

96 / IFRS: Adoption in Canada

for Taxes on Income).10 The revised version of IAS 12 (Income Taxes),11


taking the exposure draft into account, was adopted in 1996. At that time, both
standards recommended an approach based on a companys balance sheet.
Under the balance-sheet-based approach, future income tax cash flows resulting from the realization of assets and the settlement of liabilities for their
carrying amounts are recorded as future income tax assets and liabilities.12 The
calculation of future income tax assets and liabilities is based on temporary
differences between the carrying amount and the tax base of an asset or liability
on a companys balance sheet. The tax base is the amount that could be deducted in establishing the taxable profit when recovering an asset or settling a
liability. If there is no tax effect when recovering the carrying amount of an asset
or settling a liability, the tax basis is equal to the carrying amount. Future income
taxes are calculated by multiplying temporary differences by the expected income tax rate at the time the difference is going to reverse. The rate used should
be enacted or substantively enacted at the balance sheet date.
Although the CICA used the FASB and IASB working documents when drafting
the new version of section 3465, the final version of the standard was different
from FAS109 and IAS12. The general principles of the US standards and IFRS were
ultimately adopted. However, depending on the standard, there are exceptions
to accounting for income taxes that are not the same. Furthermore, depending
on the situation, the CICA would follow either the US standard or IFRS. As a
result, there were three standards founded on the balance-sheet-based approach,
but with different results.

Recent IAS 12 Developments


and Expected Changes
Over the past few years, the FASB and the IASB have worked on a convergence
project to align US GAAP and IFRS. One aspect of the project covers accounting
for income taxes. In September 2008, the FASB announced a change in its
strategy regarding its short-term convergence projects, given the possibility that

10 International Accounting Standards Board, International Accounting Standard IAS12,


Accounting for Taxes on Income, July 1979.
11 Supra note 3.
12 In this chapter, the terms future income taxes and deferred income taxes have the same
meaning.

Accounting for Income Taxes According to IFRS / 97


US listed companies may be allowed to adopt IFRS in the foreseeable future. The
IASB

was pursuing its intention to amend IAS12 in order to

reduce the differences between IFRS and US GAAP, and


remove nearly all exceptions to the recognition of deferred taxes under
IAS12.
In March 2009, an exposure draft aimed at substantially amending the current IAS12 was published.13 As a result of some rather negative comments from
practitioners in response to the exposure draft, the IASB withdrew it in October
2009. The IASB decided to opt for the publication of another exposure draft
with a more limited scope than the version submitted in March 2009. In September 2010, a limited-scope exposure draft was published with the objective
of prescribing the measurement of deferred taxes on assets revalued to fair
market value.14 It is expected that, later in 2011, another limited-scope exposure
draft will be published with the objectives of
aligning the recognition and measurement of uncertain tax positions with
the principles described in IAS37 (Provisions, Contingent Liabilities and
Contingent Assets),15 and
making various changes included in the March 2009 exposure draft that
were supported by professionals.
These amendments become generally effective 12 to 18 months after the exposure draft is adopted.

Scope of the Standard on Accounting


for Income Taxes
12 deals with accounting for income taxes. In this context, income taxes
means taxes based on taxable income. This definition does not only apply to
IAS

13 International Accounting Standards Board, Exposure Draft ED/2009/2, Income Tax,


March 2009. For more information on the amendments proposed in the exposure draft, see
Dave Santerre, Faits saillants des modifications proposes la norme IAS12 (2009) 14:3
Stratge 14-19.
14 International Accounting Standards Board, Exposure Draft ED/2010/11, Deferred Tax:
Recovery of Underlying Assets, September 2010.
15 International Accounting Standards Board, International Accounting Standard IAS 37,
Provisions, Contingent Liabilities and Contingent Assets, September 1998, as amended.

98 / IFRS: Adoption in Canada

income tax under partI of the Income Tax Act (Canada),16 its provincial equivalent, or that of another country; taxable income can also be a gross or net profit
margin. What counts is that revenues are reduced by certain expenses. This
explains why taxes based on sales or gross revenue are not considered to be income taxes. Moreover, a company can be subject to two or more income taxes.
For example, companies with mining operations in Quebec are subject to provincial mining duties and are also taxable under the federal and Quebec income
tax acts.17
Income taxes also include taxes, such as withholding taxes, that are payable
by a subsidiary, associate, or joint venture on distributions to the entity presenting its financial statements.18 However, IAS 12 does not deal with methods of
accounting for government grants or investment tax credits.19 As we will see,
IAS 20 (Accounting for Government Grants and Disclosure of Government
Assistance)20 addresses accounting for government assistance.

Accounting for Income Taxes: Similarities and


Differences Between IAS12 and Canadian GAAP
As mentioned above, the framework of IAS 12 is similar to the prevailing
framework under Canadian GAAP. This chapter covers certain important aspects
that are similar in both standards; however, emphasis is placed on the main
differences between the standards and, more specifically, those of interest to
Canadian companies. To that end, the discussion that follows includes illustrative examples, where necessary. Unless otherwise specified, the examples provided
are in the context of Canadian tax legislation.

Measurement and Valuation


DETERMINING THE TAX BASE OF AN ASSET

Under IFRS, the tax base of an asset is defined as

16 RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as ITA).


17 Mining Duties Act, RSQ, c. D-15; Quebec Taxation Act, RSQ, c.I-3.
18 IAS 12, supra note 3, at paragraph 2.
19 Ibid., at paragraph 4.
20 International Accounting Standards Board, International Accounting Standard IAS20,
Accounting for Government Grants and Disclosure of Government Assistance, April 1983,
as amended.

Accounting for Income Taxes According to IFRS / 99


the amount that will be deductible for tax purposes against any taxable economic
benefits that will flow to an entity when it recovers the carrying amount of the
asset. If those economic benefits will not be taxable, the tax base of the asset is equal
to its carrying amount.21

For example, the tax base of property, plant, and equipment is the unamortized
capital cost. For an investment, the tax base is its adjusted cost base that is used
to calculate the capital gain on disposal. Additional examples of tax base can be
found in appendixA of IAS12.
In some situations, the tax base of an asset is different depending on whether
the asset is utilized or sold. In this case, Canadian GAAP state that the tax base
of the asset to be used is the greater of those amounts.22 This method leads to
the recognition of the minimum tax effect that could result from the realization
of the asset for its carrying amount. Yet under IFRS, the assets tax base must be
determined according to managements expected manner of recovery.23 The
same treatment applies to liabilities. Thus, when the tax base associated with
managements expected manner of recovery is not the highest amount, there
will be a difference between IFRS and Canadian GAAP.
This difference arises, for example, in the accounting treatment of eligible
capital property (ECP).24 Eligible capital expenses are deductible for tax purposes
up to a maximum of 75percent of costs incurred. In addition, 75percent of the
amount received when the property is sold is included as proceeds of disposition.
The portion of the amount received that exceeds the total cost of the companys
cumulative eligible capital (CEC) is ultimately taxable at a 50percent inclusion
rate. For the purposes of calculating the tax base of an asset that qualifies as ECP
used in the company, the deductible amount is equal to 75percent of costs
incurred. However, if an asset that qualifies as ECP is sold, the cumulative eligible
capital expenditure amount will be reduced only by 75percent of the amount
received,25 thus resulting in a tax base equivalent to 100percent of costs incurred,
less tax deductions claimed in the past.

21 IAS 12, supra note 3, at paragraph 7.


22 See the current version of Canadian Institute of Chartered Accountants, CICA Handbook
Accounting (Toronto: CICA) (online, DVD, and print), at section3465.12(d).
23 IAS 12, supra note 3, at paragraph52.
24 Defined in ITA subsection 248(1).
25 ITA subsection 14(5).

100 / IFRS: Adoption in Canada

Take the example of an asset that qualifies as ECP with a historic cost of
$100,000, which will be recovered when sold. For tax purposes, $75,000 is
added to the CEC, which is deductible at an annual rate of 7percent. However,
if the asset is sold immediately for $100,000, 25percent of the proceeds of
disposition will not be taxable. The sale will have no tax consequence for the
entity.26 Under IFRS, in the event of a sale, the tax base is therefore equal to
the carrying amount of $100,000that is, the amount included in the CEC of
$75,000 plus the non-taxable portion of the proceeds of disposition ($25,000).
However, if the expected manner of recovery is through use, the tax base will
be $75,000. Under Canadian GAAP, regardless of the expected manner of recovery, the tax base will always be the higher of the two amounts$100,000
in this case.
TAX RATE TO BE USED

Under IFRS, deferred tax assets and liabilities must be measured at the tax rates
that are expected to apply to the period when the asset is realized or the liability
is settled, based on tax rates and tax laws that have been enacted or substantively
enacted by the end of the reporting period.27 This is also the case under Canadian GAAP.28 In some jurisdictions, announcements of tax rates and tax laws have
the substantive effect of actual enactment, which may occur several months
after the announcement. In these circumstances, deferred tax assets and liabilities are measured using the announced tax rates and tax laws.29
During a meeting held in February 2005, the IASB specified at what point
during the legislative process a tax law could be deemed substantively enacted.30
With reference to Canada, the IASB referred to the guidelines in Abstract EIC-111
of the CICAs Emerging Issues Committee.31 The guidelines basically state that,
under a majority government, a law is substantively enacted when a bill receives
first reading in the House of Commons. In the case of a minority government,
26 This example is based on the assumption that no property was previously included in the
entitys ECE.
27 IAS 12, supra note 3, at paragraph 47.
28 CICA Handbook, supra note 22, at section3465.56.
29 IAS 12, supra note 3, at paragraph 48.
30 PricewaterhouseCoopers, Manual of AccountingIFRS 2011 (Toronto: CCH Canadian,
2010), at chapter13, section 71.
31 Canadian Institute of Chartered Accountants, Emerging Issues Committee, Abstract
EIC-111, Determination of Substantively Enacted Tax Rates Under CICA 3465.

Accounting for Income Taxes According to IFRS / 101

a law is deemed substantively enacted when the bill passes third reading in the
House of Commons.
There are certain differences between Canadian GAAP and IFRS in terms of
the income tax rates to be used in order to establish the amount of deferred tax
assets or liabilities.
In some jurisdictions, income taxes are payable at a higher or lower rate if
part or all of the profits are paid out to holders of the entity. In these circumstances, under IFRS, deferred tax assets and liabilities are measured at the tax
rate applicable to undistributed profits.32 If income taxes can be recovered or
paid when profits are distributed to holders of the entity, the tax effect is recognized when the distribution is recorded in the financial statements.33
Under Canadian GAAP, future income tax assets resulting from a tax recovery
are recognized at the same time as the transaction that gives rise to the recovered
tax, or subsequently, when it is more likely than not that the taxes will be recovered in the foreseeable future,34 whether or not the distribution was recorded in
the financial statements. Furthermore, certain rules under Canadian GAAP apply
to determine the tax rate to be used for entities that can deduct the amounts that
they distribute to unitholders, such as income trusts and real estate investment
trusts. If such an entity plans to distribute to its unitholders all or virtually all of
its income that would otherwise have been taxable, or if it is contractually committed to do so, the entity does not account for any current or deferred tax.35
IFRS do not contain any guidelines for these entities. Thus, the general
principle described above regarding the rate applicable to distributions applies;
entities must account for income taxes without considering the tax benefit of
the subsequent distributions, and record such benefit only upon distribution.
The absence of clear guidelines can create unusual situations for certain entities.
To that end, the IASB stated in March 2010 that the topic will be addressed in the
course of the work on the limited-scope exposure draft, which, as noted above,
should be published later in 2011.36
32 IAS 12, supra note 3, at paragraph 52A.
33 Ibid., at paragraph 52B.
34 CICA Handbook, supra note 22, at section 3465.72.
35 Additional conditions must also be met to ensure that these entities do not have to account
for current and deferred tax. For more information, see Canadian Institute of Chartered
Accountants, Emerging Issues Committee, Abstract EIC-107, Application of CICA 3465 to
Mutual Fund Trusts, Real Estate Investment Trusts, Royalty Trusts and Income Trusts.
36 IASB meeting, March 15-19, 2010.

102 / IFRS: Adoption in Canada


UNCERTAIN TAX POSITIONS

Uncertainties about income taxes are not directly addressed in IAS12. IAS37
(Provisions, Contingent Liabilities and Contingent Assets)37 does not cover
income taxes in its scope. The general measurement criteria in IAS12 should be
applied instead: current or deferred tax liabilities or assets must be measured at
the amount expected to be paid to the taxation authorities or to be recovered
from them.38
No measurement method is indicated in IAS12. As a result, various practices
are accepted in authoritative accounting literature.39 A liability should be recognized for each item that is not more likely than not to be sustained on the
basis of technical merits. Acceptable practices for quantifying the liability are as
follows:
1) The liability is measured using a weighted average of probabilities for each
of the possible scenarios.
2) An estimate is made, based on the outcome most likely to occur among
the possible scenarios.
Example 1
An entity deducts $100,000 for current expenses incurred as part of a business
combination. Tax authorities may be of the opinion that the expenses are capital in
nature and should be capitalized to the cost of the shares acquired. The probabilities
that the position can be sustained are as follows:

Possible outcomes

Likelihood
of occurring

Weighted average
of possible outcomes

percent

dollars

Deduction disallowed . . . . . . . .
Deduction granted . . . . . . . . . .

40
60

0
60,000

Total . . . . . . . . . . . . . . . . . . . . .

100

60,000

Using an approach based on the weighted average of outcomes to measure the


uncertain tax provision, a liability of $40,000 (the $100,000 deduction taken less
the $60,000 deduction that can be recognized in the financial statements) should
be recorded.
37 Supra note 15.
38 IAS 12, supra note 3, at paragraph46.
39 PricewaterhouseCoopers, supra note 30, at chapter 13, section 76.

Accounting for Income Taxes According to IFRS / 103


If the entity chooses the estimate based on the outcome more likely to occur, no
provision is needed since the most likely scenario is that the full deduction of the
expenses will be granted.

The rationale is similar under Canadian GAAP, since uncertain tax positions
are not directly addressed in section 3465. However, contrary to IAS 37, its
equivalent, section 3290 (Contingencies) of the CICA Handbook, does not
exclude income taxes from its scope. In practice, the guidelines in section 3290
are used to recognize and measure uncertain tax positions. The measurement of
a liability is similar to the second of the acceptable practices under IFRS stated
above. Under Canadian GAAP, a contingent liability should be recognized for
each of the tax positions that will likely not be sustained. The degree of likelihood derived from the word likely (defined in practice as a 70 to 80percent
chance that something will occur) is stronger than the expression more likely
than not or probable under IFRS (more than 50percent).
Since there is no clear guideline on this topic under IFRS, a company may
establish its own accounting policy and continue to use Canadian guidelines to
recognize and measure its uncertain tax positions, as long as the method is similar
to either of the acceptable practices described above. This choice of accounting
method under IFRS should be applied consistently from one year to the next,
unless IAS12 is amended and the accounting treatment to be used is specified.
IAS 12 does not have any specific guideline on the classification of uncertain
tax positions. The presentation must be consistent with the general principles
above. With respect to current taxes, we are of the opinion that uncertain tax
positions from current and prior periods should be included in current tax liabilities, since the entity does not have the unconditional right to defer the
settlement of the liability by more than 12 months after the reporting period,40
even if it does not expect to pay the amount within 12 months of the end of
the reporting period.
With respect to deferred taxes, we are of the opinion that the entity should
determine the tax base in its deferred tax calculation on the basis of the amount
determined according to the prior analysis. For example, if a loss carried forward
is going to be denied by the tax authorities, no deferred tax assets should be
recorded.

40 International Accounting Standards Board, International Accounting Standard IAS1,


Presentation of Financial Statements, December 2003, as amended, at paragraph69(d).

104 / IFRS: Adoption in Canada

Canadian GAAP and IFRS do not address the presentation of interest and
penalties on uncertain tax positions in the income statement. Practices tend to
vary. Under Canadian legislation, interest and penalties on income taxes are not
deductible. Thus, some companies recognize and classify interest and penalties
as income tax expense in the income statement. Others are of the opinion that
interest and penalties are not based on the taxable income calculation and must
be recognized and classified as financing costs (interest) and operating costs
(penalties). In the March 2009 exposure draft, the IASB indicated that companies should disclose where in the income statement interest and penalties are
classifiedeither as an income tax expense or under operating costs. The exposure draft acknowledged that various practices may be acceptable.
Finally, a company needs to consider whether disclosure of uncertainties
about income taxes is required in the main sources of uncertainties with respect
to the estimates that are included in the notes to financial statements.

Recognition of Deferred Taxes


RECOGNITION AND PRESENTATION
OF DEFERRED TAX ASSETS

Unless otherwise specified, a deferred tax asset must be recognized for all deductible temporary differences to the extent that it is probable that a taxable
profit will be available against which the deductible temporary differences can
be utilized.41 Even if the term more likely than not is used in Canadian GAAP,
IFRS also provides a definition of the term probable, which means more likely
than not,42 making the two standards similar in this regard.
The two standards are also similar in terms of the criteria and guidelines used
in assessing the recognition of a deferred tax asset, which include the following:43
the entity has sufficient taxable temporary differences relating to the same
taxation authority and the same taxable entity, which will result in taxable
amounts against which deductible temporary differences, unused tax
losses, and unused tax credits can be charged before they expire;
41 IAS 12, supra note 3, at paragraph24.
42 International Accounting Standards Board, International Financial Reporting Standard
IFRS5, Non-Current Assets Held for Sale and Discontinued Operations, March 2004, as
amended, at appendix A.
43 IAS 12, supra note 3, at paragraph 36; and CICA Handbook, supra note 22, at
section3465.25.

Accounting for Income Taxes According to IFRS / 105

it is probable that the entity will have taxable profits before the unused
tax losses or unused tax credits expire;
taxable profits from prior years would entitle the entity to a tax refund,
to the extent that tax laws allow carrybacks;
unused tax losses result from identifiable causes, which are unlikely to
recur; or
tax-planning opportunities are available to the entity that will create taxable profit in the period in which the unused tax losses or unused tax
credits can be charged.
Under IFRS, if an entity is unlikely to have a taxable profit that can be offset
against deductible temporary differences, unused tax losses, or unused tax credits,
the deferred tax asset is not recognized. The amount and the expiry date, if any,
of these deductible temporary differences, unused tax losses, and unused tax
credits must be disclosed in the notes to financial statements.44
In terms of presentation, Canadian GAAP offer an alternative that is not
available under IFRS: all future income tax assets can be recognized less an
amount of valuation allowance that is sufficient to reduce deferred tax assets
to an amount that will more likely than not be realized.45 The difference between the standards, if the choice has been made, can be significant for the
disclosure in the notes to financial statements, but should have no impact on
the amount of deferred tax asset or liability recognized on the balance sheet.
DEFERRED TAXES IN A BUSINESS COMBINATION

In a business combination, the acquiree may have deferred tax assets. In certain
situations, the deferred tax assets cannot be recognized, because it is not probable that they will be realized. Canadian GAAP formerly required that if the
assets were recognized in a period subsequent to the acquisition, the resulting
deferred tax recovery reduced the goodwill and the intangible assets related to
the acquisition to zero before being recognized in the income statement.46
44 IAS 12, supra note 3, at paragraph81(e).
45 CICA Handbook, supra note 22, at section3465.30.
46 CICA Handbook, supra note 22, at section 3465.48. The adoption of new section 1582 of
the CICA Handbook eliminates the difference in accounting treatment at this level, since
Canadian GAAP adopt the accounting treatment applicable under IFRS. Since section 1582
will be applied only in 2011, the analysis addresses the prevailing accounting treatment
under the current section 1581 for business combinations.

106 / IFRS: Adoption in Canada

Under IFRS, the subsequent recognition of the acquired entitys deferred tax
assets will be accounted for in the income statement, unless the recognition
takes place during the measurement period and results from new information
about facts and circumstances that existed at the acquisition date. In this case,
the resulting deferred tax recovery reduces goodwill to zero before being recognized in the income statement.47 The measurement period is the period that
follows the acquisition date during which the acquiror can adjust amounts
temporarily recognized for the business combination. The measurement period
may not, however, exceed one year from the acquisition date.
Following a business combination, the acquiror may recognize its own deferred tax asset, which was not recognized before the business combination. For
example, the acquiror may be able to utilize its unused tax losses against the
future taxable profit of the acquiree. In these cases, under IFRS, the acquiror
recognizes a deferred tax asset but does not include it as part of the accounting
for the business combination. Consequently, the acquiror does not take the
deferred tax asset into account in measuring goodwill,48 and the asset will be
accounted for in the income statement. Under Canadian GAAP, recognition of
the asset is included in the allocation of the acquirees purchase price.49
DEFERRED TAXES ON GOODWILL
IN A BUSINESS COMBINATION

Goodwill generated by a business combination is measured as the excess of the


consideration paid over the fair value of identifiable assets and liabilities of
the acquiree. Under Canadian GAAP, any difference between the carrying amount
of goodwill and its tax base is a taxable temporary difference that normally
generates a deferred tax liability. Canadian GAAP preclude the recognition of
future income tax liability in respect of goodwill,50 because goodwill itself is a
residual and the recognition of the future income tax liability would merely
increase the carrying amount of that residual.51
The same exception to the recognition of a deferred tax liability exists under
IFRS.52 In addition, IAS12 states that if the carrying amount of the goodwill is
47 IAS 12, supra note 3, at paragraph 68.
48 Ibid., at paragraph 67.
49 CICA Handbook, supra note 22, at section 3465.46.
50 Ibid., at section 3465.22.
51 Ibid., at section 3465.23.
52 IAS 12, supra note 3, at paragraph 21.

Accounting for Income Taxes According to IFRS / 107

less than the tax base of the asset, the company must recognize the deferred tax
asset in the purchase price allocation to the extent that it is probable that this
deferred tax asset will be realized.53
DEFERRED TAXES WHEN ASSETS ARE ACQUIRED OTHER
THAN THROUGH A BUSINESS COMBINATION

A company can acquire an asset through a transaction that is not a business


combination and in which the amount paid is different from the assets tax base.
This type of transaction can be conducted through the direct purchase of one
or several assets that do not constitute a company as such, or through the
purchase of an interest in an entity that does not meet the definition of a business combination. The following are examples of this type of situation:
Allocation of a purchase price. The allocation of a purchase price for tax
purposes is different from the allocation for accounting purposes. According to tax authorities, when an asset is purchased by parties dealing at
arms length, the allocation of the purchase price stipulated in the contract
is normally used. From an accounting standpoint, a more detailed valuation of the purchased asset is often performed after the transaction is
completed, and the valuation is reflected in the purchasers financial statements. The amounts allocated to the various assets purchased may then
be different from the tax allocation.
Purchase of an asset through the shares of a separate entity. When the shares of
an entity are purchased rather than the assets, the tax base of the purchased asset is that of the acquired entity and is not the fair market value
at the time of the transaction. The fair market value is usually reflected in
the shares acquired for tax purposes, and not its assets. Consequently, the
carrying amount of the purchased asset may be different from its tax base.
Non-deductible expenses capitalized for accounting purposes, such as share-based
compensation. For a capital asset that the entity has built for its own use, the
cost may include materials, salaries, and wages, as well as overhead that can
be allocated to the capital asset. When a non-tax-deductible expense is
capitalized, the tax base and carrying amount of the asset are different.
Capitalization of capital leases. When a lease is capitalized for accounting
purposes, no depreciable asset is acquired for tax purposes.54 The asset tax
53 Ibid., at paragraph 32A.
54 Unless the company makes the election allowed under ITA section16.1.

108 / IFRS: Adoption in Canada

base is therefore nil. Conversely, since the lease payments will be deductible in the future taxable income calculation but the notional interest
expenses recognized in income will not, the liability resulting from the
obligation under the capital lease also has a tax base of nil. Note that the
amount of future lease payments less the amount of future notional interest
expenses is equivalent to the obligation under the capital lease recognized
on the balance sheet. Therefore, when an amount related to a liability is
tax-deductible in future years, its tax base is nil.
According to Canadian GAAP, deferred taxes resulting from the difference
between the carrying amount of the acquired asset and its tax base must be
recognized. The deferred income tax is then calculated using the simultaneous
equations method to determine the price of the acquired assets, as well as the
deferred tax assets or liabilities associated with them.55
Example 2
The following example from the CICA Handbook 56 illustrates the simultaneous
equations method:
An enterprise buys an asset for $8,000 cash. The maximum tax basis of the
asset on initial recognition is $2,000. The tax rate is 40 percent. In accordance
with paragraph 3465.43, the enterprise recognizes the asset at an initial carrying amount of $12,000 and recognizes a future income tax liability of $4,000.
The initial carrying amount is determined using the formula set out below:
Carrying value = Cost of the asset +

([Cost tax basis] tax rate)


(1 tax rate)

That is,
Carrying value = $8,000 +

([$8,000 $2,000] 0.40)


= $12,000
(1 0.40)

The journal entry on initial recognition is:


DR Asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,000
CR Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,000
CR Future income tax liability . . . . . . . . . . . . . . . . . . . . . $4,000

Under IFRS, deferred taxes resulting from such transactions are not recognized. For this exception to accounting for income taxes to apply, the transaction
55 CICA Handbook, supra note 22, at section 3465.43.
56 Ibid., at section 3465.44.

Accounting for Income Taxes According to IFRS / 109

cannot be part of a business combination, nor can it affect the accounting profit
or taxable profit of the company.
Note that for capital leases, a company may in practice recognize a deferred
tax liability resulting from the capital asset and a deferred tax asset resulting
from the obligation, since these assets and liabilities cancel each other out on
initial recognition.57 This practice is similar to that used under Canadian GAAP.
NON-MONETARY ASSETS AND LIABILITIES
OF INTEGRATED FOREIGN OPERATIONS

Under Canadian GAAP, no deferred tax asset or liability is recognized with regard
to the temporary difference resulting from the difference between the translations to the historic exchange rate and the current exchange rate of the cost of
non-monetary assets or liabilities of integrated foreign operations.58
The concept of integrated or independent foreign operations does not exist
under IFRS. Entities must determine their functional currency on the basis of
the criteria established in IAS21 (The Effects of Changes in Foreign Exchange
Rates).59 When the functional currency is not the same as the currency used to
prepare income tax returns in the foreign jurisdiction, this results in differences
that require the deferred tax to be recognized under IFRS. In a number of jurisdictions, the currency used for income tax purposes is the foreign countrys
currency, and the taxpayer does not have the option to use the accounting
functional currency for income tax purposes.
Contrary to Canadian GAAP, IAS12 provides no exceptions relating to these
temporary differences. Consequently, IAS12 imposes the recognition of a deferred
tax asset and/or liability for these translation differences. The temporary differences resulting from the effect of exchange-rate fluctuations on non-monetary
assets and liabilities of integrated operations must be identified and a deferred tax
recognized for them.
Example 3
The CICA Handbook provides the following example:60
On January 1, X1, CompanyP made an investment of $1,000,000 in Company S, an integrated foreign operation whose production facilities have a
57 PricewaterhouseCoopers, supra note 30, chapter 13, at section 202.6.
58 CICA Handbook, supra note 22, at section 3465.33.
59 International Accounting Standards Board, International Accounting Standard IAS21, The
Effects of Changes in Foreign Exchange Rates, December 2003, as amended.
60 CICA Handbook, supra note 22, at section 3465.34.

110 / IFRS: Adoption in Canada


fair value (and tax basis) of FC [foreign currency] 1,000,000 when the exchange rate is $1 = FC1.
At December 31, X2, the exchange rate is $1 = FC1.5.
At December 31, X2, the financial statements of CompanyS will reflect
the production facilities at FC 1,000,000. The consolidated financial statements of Company P will reflect the production facilities at $1,000,000,
based on the historic exchange rate.
In order to recover the carrying value in the consolidated financial statements,
CompanyP must realize $1,000,000 or FC 1,500,000. Realization of FC 1,500,000
would lead to a future income tax liability since the tax basis of the asset is FC
1,000,000. This future income tax liability is not recognized under Canadian GAAP.

At the time of changeover to IFRS, companies may have to make significant


changes to the deferred tax calculations of entities that do not have the same
functional currency for accounting purposes as the one used for income tax
purposes.
INTERCOMPANY TRANSACTIONS

A transfer of assets between companies in the same consolidated groupfor


example, the sale of inventory or depreciable capital assetswill not lead to any
gain or loss for accounting purposes as long as the assets are not sold or transferred to a third party. If the transaction between related parties is made for an
amount different from the accounting cost, the sellers gain or loss is eliminated
in the consolidated financial statements.
In this situation, under Canadian GAAP, no deferred tax asset or liability can
be recognized in the consolidated financial statements for a temporary difference
between the assets tax base for the purchaser and the cost indicated in the consolidated financial statements.61 However, all taxes paid or recovered by the vendor
following the transfer must be recognized as an asset or liability in the consolidated financial statements until the gain or loss from the transaction is recognized
by the consolidated entity.
This exception does not exist under IFRS. Thus, income taxes paid or recovered by the vendor are recognized in income. The same applies to deferred tax
assets or liabilities in the purchasers financial statements. This results in the
recognition of the tax consequences of a transaction for which no profit or loss
is recognized in the consolidated financial statements. Recognition by the vendor
61 Ibid., at section 3465.35.

Accounting for Income Taxes According to IFRS / 111

of the current tax on the transaction is often offset by the recognition of the
deferred tax by the purchaser. However, if the two entities have different tax rates,
or if one of the two entities does not recognize its deferred tax asset, the effect of
this type of transaction in the income statement can be significant.
Example 4
During the year, Canadian CompanyA Ltd. sold assets with an accounting and tax
cost of $60,000 to its American subsidiary, US Co., for proceeds of disposition of
$100,000. The tax rate and tax consequences are as follows:
Vendor: A Ltd.
Tax cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $60,000
Proceeds of disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000
Tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
30%
Current tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,000
Purchaser: US Co.
Tax cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000
Accounting cost (consolidated) . . . . . . . . . . . . . . . . . . . . . $60,000
Tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
40%
Under Canadian GAAP, there is no effect in the income statement, and current
tax is deferred until the assets are sold to a third party. The current tax liability is
therefore recognized and an asset is recognized in the financial statement until the
gain is recognized by the consolidated entity.
Under IFRS, the tax effects are recorded in the income statement:
Current tax expense of the vendor . . . . . . . . . . . . . . . . . . .
Deferred income tax of the purchaser . . . . . . . . . . . . . . . .

$12,000
(16,000)

Net impact in the income statement . . . . . . . . . . . . . . . . .

(4,000)

The current tax liability of $12,000 and the deferred tax asset of $16,000 are
therefore recognized.
RECOGNITION AND DISCLOSURE OF TEMPORARY
DIFFERENCES RELATED TO INVESTMENTS IN SUBSIDIARIES,
BRANCHES, ASSOCIATES, AND JOINT VENTURES

Under Canadian GAAP, no deferred tax assets or liabilities are recognized for the
difference between the carrying amount of an investment in a subsidiary or joint
venture and the tax base of the investment when it is probable that the temporary difference will not reverse in the foreseeable future.62 When deferred tax is
62 Ibid., at section 3465.37.

112 / IFRS: Adoption in Canada

not recognized for these differences, Canadian GAAP are indicating that it is
preferable that the amount of the temporary difference be disclosed as a note to
the financial statements, as well as the related deferred taxes if they can be determined after a reasonable effort is made to do so.63 In practice, very few
companies disclose this information.
IAS 12 is slightly different with respect to the terms used and the types of
investments that benefit from the exception to recognition of a deferred tax
liability.64 In addition to covering subsidiaries and joint ventures, the exception
includes branches and associates. To avoid recognizing a deferred tax liability,
the investor must be able to control the timing of the reversal of the temporary
difference, and that temporary difference should not reverse in the foreseeable
future. The conditions are similar for the recognition of a deferred tax asset. In
practice, there should not be any major difference between Canadian GAAP and
IFRS in this respect. However, for disclosures made in notes to financial statements, IFRS require a company to disclose the aggregate amount of temporary
differences associated with investments in subsidiaries, branches, associates, and
interests in joint ventures for which deferred tax liabilities have not been
recognized.65
As mentioned above, very few companies keep the carrying amounts and tax
bases of their investments up to date. The carrying amount of the investment
refers to the amount determined under the equity method and not the historic
accounting cost of the investment. In addition to the acquisition cost, the calculation therefore requires that the following be taken into account: distributions,
profits or losses realized since the acquisition, consolidation adjustments (elimination of profit, reduction in value of assets, etc.), and the fluctuation of exchange
rates if the entity has a different functional currency. As for the tax base, the
adjusted cost base of investments must be updated. Furthermore, if a company
decides to disclose the unrecognized deferred tax liability amount, the tax effect
resulting from the reversal of temporary differences must be determined, and
this may require calculation of the various surpluses under the Canadian foreign
affiliate tax regime.

63 Ibid., at section 3465.96.


64 IAS 12, supra note 3, at paragraph 39.
65 Ibid., at paragraph 81(f ).

Accounting for Income Taxes According to IFRS / 113


COMPOUND FINANCIAL INSTRUMENTS

Under IFRS, a deferred tax liability is recognized for any temporary difference
resulting from the separate initial recognition of a compound financial instrument.66 For example, the proceeds from the issuance of a $1,000 convertible
debt can be allocated between liability and equity as follows: $750 for the liability component and $250 for the equity component. Thus, the settlement of
the debt for its carrying amount of $750 has tax consequences, since the principal of the debt is greater. IFRS require that a deferred tax liability be recorded
on the temporary difference of $250. Subsequent changes in the deferred tax
liability are recognized in income.67
Under Canadian GAAP, when the enterprise is able to settle the financial
instrument without the incidence of tax, in accordance with its terms, either
through settlement on maturity or conversion, the tax basis of the liability
component is considered to be the same as its carrying amount.68 Thus, there
is no temporary difference in this situation.

Recognition and Measurement: Special Topics


RECOGNITION OF DEDUCTIONS ON SHAREBASED PAYMENT TRANSACTIONS

In certain tax jurisdictions, share-based payment transactions are deductible.


The amount of the tax deduction is not known until the stocks are issued. If a
company issues stock options to its employees, it must recognize an expense
corresponding to the fair value of the options in income over the lifetime of the
options.
Under IFRS, the company will recognize a deferred tax asset based on the
allowable tax deduction. For example, if the amount permitted by the tax authorities depends on the entitys share price at a future date, the measurement
of the deductible temporary difference should be based on the entitys share
price at the end of the current period.69 If the amount of the estimated tax deduction at the end of the period exceeds the amount of the related cumulative

66 Ibid., at paragraph 23.


67 Ibid.
68 CICA Handbook, supra note 22, at section 3465.18.
69 IAS 12, supra note 3, at paragraph 68B.

114 / IFRS: Adoption in Canada

remuneration expense, the excess current or deferred tax should be recognized


in equity.70 Canadian GAAP do not contain any guidelines on this matter.
FLOWTHROUGH SHARES

In Canada, tax legislation allows a company to issue shares known as flowthrough


shares to its investors.71 Such shares serve to transfer the tax benefit associated
with certain eligible expenses from the company to its shareholders. When flow
through shares are issued and expenses are capitalized as assets for accounting
purposes, the carrying amount can exceed the tax base, because the company
renounced its right to tax deductions in favour of its investors. Under Canadian
GAAP, the deferred tax liability associated with this temporary difference is
recognized in equity as a cost of issuing securities to investors when the company renounces its deductions.72
Under IFRS, the accounting treatment for this renunciation is not specified.

Presentation
INTRAPERIOD ALLOCATION

Under Canadian GAAP, the expense or income from current or deferred taxes is
initially recognized in the income statement, unless a different allocation is indicated.73 In general, Canadian GAAP require that tax be recognized initially in
the financial statements component where the underlying revenue or expense
is recorded. Financial statements component means the income statement,
other comprehensive income, or equity. For example, deferred tax assets resulting from share issue expenses should be recognized in the companys equity
that is, in the same item as the proceeds from the share issuance. Any change in
these deferred assets that arises in a subsequent period is recognized in the income statement.
Under IFRS, current and deferred taxes must be recognized in the income
statement or elsewhere in the financial statements, such as in other comprehensive income or equity, on the basis of the element that triggered the tax effect
in either the original period or a prior period. This intraperiod allocation
method for change in subsequent periods is known as backward tracing.
70 Ibid., at paragraph 68C.
71 ITA subsection 66(12.6) and following.
72 CICA Handbook, supra note 22, at section 3465.69.
73 Ibid., at section 3465.63.

Accounting for Income Taxes According to IFRS / 115

The amount of the deferred tax assets or liabilities can change in a period
subsequent to their recognition, even if there has been no change in the temporary differences. For example, such change can result from
a change in the tax law (tax rate or other),
revaluation of the ability to recover deferred tax assets, or
a change in the expected manner of recovery of an asset.
Contrary to Canadian GAAP, the change in value of the deferred tax asset or
liability will be allocated to the financial statements component where the
temporary difference was originally recognized. For example, a change affecting
the deferred tax assets resulting from a share issue expense will be allocated to
equity, as shown in the following example.
Example 5
On January 1, X2, the provincial government announced a reduction in the corporate tax rate from 12 to 10 percent. The federal rate remained unchanged at
15percent. At that time, the company recognized the deferred tax assets and liabilities on the following temporary differences:


Temporary
difference

Capital assets . . . . . . . . . . . . .
Share issue expenses . . . . . . .
Loss carried forward . . . . . . .

(100,000)
40,000
80,000

Total . . . . . . . . . . . . . . . . . . .

20,000

Deferred tax
Before

After

dollars
(27,000) (25,000)
10,800
10,000
21,600
20,000
5,400

5,000

The reduced tax rates generated a $400 reduction in deferred tax assets, and the
resulting income tax expense will be allocated differently to financial statement
components depending on whether Canadian GAAP or IFRS are used.
Under Canadian GAAP, the total $400 tax expense will be allocated to the income statement. Under IFRS, the origin of the temporary differences needs to be
analyzed. In the example, share issue expenses were first recognized in equity, whereas
the other differences were recorded in the income statement. Thus, the expense
resulting from the reduction of the asset by $800 in share issue expenses will be
allocated to equity, and the $400 income tax recovery will be allocated to the income statement for the other temporary differences.
IAS12 also covers circumstances in which it may be difficult to determine the

amount of current and deferred tax related to items recognized in other compre-

116 / IFRS: Adoption in Canada

hensive income or equity. In such cases, the current and deferred tax related to
items that are recognized outside the income statement are based on a reasonable pro rata allocation of the current and deferred tax of the entity, or another
method that achieves a more appropriate allocation in the circumstances.74
If a temporary difference results from several different components of the
financial statements, it will be divided among those various components. This
may be the case, for example, for deductions for financing expenses under
paragraph 20(1)(e) of the ITA, which may result from the issuance of shares or
debt. In the event of a share issue, equity is affected, and for a debt issue, the
income statement is affected.
With respect to adjustments to retained earnings resulting from the changeover to IFRS, authoritative accounting literature states that retrospective allocation
must not be made to retained earnings, but rather be based on the financial
statements component that would have been affected if the company had always
used IFRS to prepare its financial statements.75
INTRAPERIOD ALLOCATION AND CHANGE
IN THE TAX STATUS OF AN ENTITY

Under IFRS, a change in the tax status of an entity is an event that must be
recognized using backward tracing.76 For example, if an entity becomes taxable,
whereas it previously was not, and the carrying amounts of the assets and liabilities are different from their tax bases, the deferred tax assets and liabilities must
be recorded. Any resulting deferred tax income or expense must be allocated to
the financial statements component to which they would have been allocated
in that period or in a prior period if the entity had always been taxable.
Under Canadian GAAP, changes in deferred tax liabilities and assets resulting
from a shareholders initiative or a new equity contribution are recorded as
equity transactions.77 However, the effects of changes in tax status related to
initiatives or decisions by the entity (for example, a change in an entitys country
of domicile) are recognized in the income statement.

74 IAS 12, supra note 3, at paragraph 63.


75 PricewaterhouseCoopers, supra note 30, chapter 13, at section 288.8.
76 See International Accounting Standards Board, Standing Interpretations Committee, SIC
Interpretation 25, Income TaxesChanges in the Tax Status of an Entity or Its Shareholders,
July 2000, as amended.
77 CICA Handbook, supra note 22, at section 3465.68.

Accounting for Income Taxes According to IFRS / 117


INVESTMENT TAX CREDITS

Under Canadian GAAP, the recognition of investment tax credits (ITCs) is


covered in section 3805 (Investment Tax Credits) of the CICA Handbook. ITCs
are defined as a type of government assistance related to specific qualifying
expenditures that are prescribed by tax legislation.78 Section 3805 also states
that ITCs may be received as a reduction in income taxes otherwise payable or
they may be received by other means. ITCs must be recognized using the cost
reduction approach. ITCs related to the acquisition of assets must be deducted
from the cost of the related assets, or be presented as deferred credits and gradually recorded in the income statement on the same bases as the related assets are
amortized.79 ITCs relating to operating expenditures (for example, research expenses) are included in the determination of net income for the period.80
IFRS do not provide a definition of an ITC. In the absence of detailed guidance under IFRS, Canadian preparers have used a definition of ITCs similar to
Canadian GAAP, which is based on specific qualifying expenditures that are
prescribed by tax legislation. For example, the ITA includes many ITCs, such as
scientific research and experimental development tax credits. Furthermore,
there is no standard that applies directly to state how ITCs should be recognized,
since IAS12 specifically excludes ITCs from its scope.81 IAS20 excludes all forms
of government assistance granted when determining taxable income or limited
on the basis of the income tax liability.82 The scope of IAS20 with respect to the
recognition of ITCs depends on whether the ITCs are refundable or not. For
example, in Quebec, ITCs are generally refundable and not limited to income
tax payable. Quebec government assistance must therefore be recognized according to the principles of IAS20. At the federal level, ITCs are generally not
refundable and are limited to the income tax payable, unless the entity is a
Canadian-controlled private corporation.83 Thus, IAS20 does not apply to ITCs
in this situation. For ITCs that do not come directly under the scope of IAS12
or IAS20, either of the following practices is deemed acceptable:

78 Ibid., at section 3805.1.


79 Ibid., at section 3805.13.
80 Ibid., at section 3805.14.
81 IAS 12, supra note 3, at paragraph 4.
82 IAS 20, supra note 20, at paragraph 2(b).
83 In this instance, the accounting treatment is in accordance with IAS 20, ibid.

118 / IFRS: Adoption in Canada

the entity offsets the ITC against the tax expense in the income statement,
similar to the method proposed under IAS12; or
the entity offsets the ITC against the reduction of the expense that entitled
it to the credit, similar to the method proposed under IAS20.
Accounting for ITCs under IAS 20 is similar to the approach under Canadian
GAAP. The accounting policy used, including the presentation method in the
income statement, should be disclosed in a note to financial statements.
CLASSIFICATION OF DEFERRED TAX
ASSETS AND LIABILITIES

Canadian GAAP require deferred tax assets and liabilities to be classified in the
current or long-term section of financial statements on the basis of the asset or
liability to which the deferred taxes are related. In contrast, under IFRS, deferred
tax assets and liabilities are classified in non-current assets or liabilities, regardless of the underlying item to which they are related.84 However, the entity must
disclose the deferred tax balance that it expects to recover or settle in the next
12months in the notes to financial statements.85 The same applies to current
taxes recognized in current assets or liabilities that will be recovered or settled
in more than 12months.
OFFSETTING CURRENT TAX ASSETS AND LIABILITIES

Under IFRS, an entity must offset current tax assets and liabilities if it has both
a legally enforceable right to set off the amounts recognized and
the intention to settle the assets and settle the liabilities simultaneously.
Under Canadian GAAP, an entity is not obliged to have the intention to settle
assets and liabilities simultaneously in order to be required to offset the balances.
It simply needs to have the right to do it. For example, an entity is entitled to
a $100,000 federal refund for the previous year, but it records current taxes that
are $60,000 more than the tax instalments made for the current year. Under
IFRS, the entity does not have to offset these balances if it requests the previous
years refund, whereas it would be required to do so under Canadian GAAP.

84 IAS 1, supra note 40, at paragraph 56.


85 Ibid., at paragraph 61.

Accounting for Income Taxes According to IFRS / 119


OFFSETTING DEFERRED TAX ASSETS AND LIABILITIES

12 requires an entity to offset deferred tax assets and liabilities of the same
taxable entity if they are related to income taxes collected by the same tax authority and the entity has a legally enforceable right to offset current tax assets
against current tax liabilities.86 Separate taxable entities must offset deferred tax
assets and liabilities if they have the intention and ability to realize the asset and
settle the liability simultaneously. Canadian GAAP guidelines are different,87 but
the results are similar in most cases. For separate taxable entities, the focus tends
to be on implementing tax-planning opportunities that will ensure that the
entity will be the same taxable entity when deferred tax liabilities become payable. This can be accomplished, for example, through a merger or winding up
of previously separate entities.
IAS

Disclosures in Notes to Financial Statements


RECONCILIATION OF EFFECTIVE TAX RATE

IAS 12 requires that all companies explain, by way of a numerical reconciliation,

how the tax rate applicable to the company compares with the effective tax rate
for the period.88 The effective tax rate is obtained by dividing current and deferred tax expenses by the companys income before taxes. Under Canadian
GAAP, this disclosure by way of a note to financial statements is required only
for public companies and other publicly accountable enterprises.89
IAS 12 provides two methods for calculating the applicable tax rate to be used
for disclosing this information:
1) The applicable tax rate is the rate paid by the ultimate entity that prepares
its financial statements. In this case, the difference between the statutory
rate of the entity and the statutory rate of the consolidated entities is a
reconciliation item.
2) The applicable tax rate is the weighted average of the rates applicable to
the entities of the consolidated group.

86 IAS 12, supra note 3, at paragraph 74.


87 CICA Handbook, supra note 22, at sections 3465.88 and 3465.89.
88 IAS 12, supra note 3, at paragraph 81(c).
89 CICA Handbook, supra note 22, at section 3465.92(c).

120 / IFRS: Adoption in Canada

The first method is used under Canadian GAAP. Furthermore, under IFRS, the
company must explain changes made to applicable tax rates if they are different
from the rates applied in previous periods.90
DISCLOSURES: THE MAJOR DIFFERENCES

Aside from the above-mentioned differences, some major differences with respect to required disclosures may have a significant effect on the preparation of
financial statements. Under IFRS, the following disclosures must be made by
way of a note to financial statements:
any adjustments recognized in the period for current tax of prior periods
(for example, differences between the prior-period tax expense and the
amount calculated on the tax return);91
the amount of the benefit arising from a previously unrecognized tax loss,
tax credit, or temporary difference of a prior period that is used to reduce
the current tax expense or deferred tax;92
with respect to discontinued operations, the tax expense relating to the
gain or loss on discontinuance and current income from discontinued
operation for the period, together with the corresponding amounts for
each prior period presented;93 and,
when the utilization of the deferred tax asset depends on factors other
than the reversal of existing taxable temporary differences and the entity
has suffered a loss in either the current or a preceding period in the tax
jurisdiction to which the deferred tax asset relates, an indication of the
nature of the evidence supporting its recognition.94
Note that disclosures related to temporary differences will be more significant
under IFRS than under Canadian GAAP. For each category of temporary differences, tax losses, and unused tax credits, the entity must disclose the amount of
deferred tax assets and liabilities recognized on the balance sheet for each period
presented and the deferred tax income or expense recognized in the income

90 IAS 12, supra note 3, at paragraph 81(d).


91 Ibid., at paragraph 80(b).
92 Ibid., at paragraphs 80(e) and (f ).
93 Ibid., at paragraph 81(h).
94 Ibid., at paragraph 82.

Accounting for Income Taxes According to IFRS / 121

statement, other comprehensive income, or equity. This disclosure requirement


can complicate the preparation of tables in the notes to financial statements.

Conclusion
The changeover from Canadian GAAP to IFRS will involve its share of work for
tax professionals. As demonstrated in this chapter, the approach to accounting
for income taxes has not undergone any drastic changes. However, in most
companies, a financial effect of some kind will need to be recorded at the time
of changeover. The notes to financial statements related to income taxes will be
different, and more information will be needed for disclosure. In addition, the
processes and worksheets used for the preparation of the tax provision will need
to be revisited and adapted to the new IFRS requirements.