Ind AS 12 – Deferred Tax on Parent Loan and Deemed Investment

1. Question

Apex Industries Limited (hereinafter referred to as “the company”) is engaged in the business of manufacturing of preservatives. The company advanced an interest free loan of INR 1,00,000 to its wholly owned subsidiary, Nova Engineering Limited (hereinafter referred to as “Nova”), to support its operational expansion. Based on a review of comparable market lending rates and Nova’s risk profile, the fair value of the loan at initial recognition was assessed at INR 35,000. Accordingly, the company recognised the financial asset at INR 35,000 in its separate financial statements and the difference of INR 65,000 between the transaction price and the fair value was recorded as a deemed investment in Nova, increasing the carrying amount of the company’s investment in the subsidiary.

For tax purposes, however, the loan continues to be recognised at its undiscounted amount of INR 1,00,000, as the Income-tax Act does not permit or require discounting of interest-free loans. Consequently, the tax base of the financial asset differs from its carrying amount. Likewise, the deemed investment recognised in the company’s books of account does not have a corresponding tax base, as tax legislation does not recognise such adjustments arising from fair value measurement. These differences give rise to temporary differences that the company must evaluate for deferred tax implications. The applicable tax rate on the company is 25%.

The management of the company while preparing its financial statements is in dilemma regarding the accounting of deferred tax arising from the difference between the carrying amount and tax base of the loan. Further, the management also wants to understand about the implications of deferred tax on the deemed investments recognised in its book as under Ind AS 12?

2. Relevant Provisions

Ind AS 12 – Income Taxes

Para 15 of Ind AS 12

A deferred tax liability shall be recognised for all taxable temporary differences, except to the extent that the deferred tax liability arises from:

(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).

However, for taxable temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, a deferred tax liability shall be recognised in accordance with paragraph 39.

Para 24 of Ind AS 12

A deferred tax asset shall be recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised, unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction that:

(a) is not a business combination; and

(b) at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).

However, for deductible temporary differences associated with investments in subsidiaries, branches and associates, and interests in joint arrangements, a deferred tax asset shall be recognised in accordance with paragraph 44.

Para 22(c) of Ind AS 12

If the transaction is not a business combination, and affects neither accounting profit nor taxable profit, an entity would, in the absence of the exemption provided by paragraphs 15 and 24, recognise the resulting deferred tax liability or asset and adjust the carrying amount of the asset or liability by the same amount. Such adjustments would make the financial statements less transparent. Therefore, this Standard does not permit an entity to recognise the resulting deferred tax liability or asset, either on initial recognition or subsequently. Furthermore, an entity does not recognise subsequent changes in the unrecognised deferred tax liability or asset as the asset is depreciated.

Para 71 of Ind AS 12

An entity shall offset current tax assets and current tax liabilities if, and only if, the entity:

(a) has a legally enforceable right to set off the recognised amounts and

(b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

Para 76 of Ind AS 12

In rare circumstances, an entity may have a legally enforceable right of set-off, and an intention to settle net, for some periods but not for others. In such rare circumstances, detailed scheduling may be required to establish reliably whether the deferred tax liability of one taxable entity will result in increased tax payments in the same period in which a deferred tax asset of another taxable entity will result in decreased payments by that second taxable entity.

Click Here To Read The Full Story