The narrow-scope amendments to IAS 12 Income Taxes will clarify how companies account for deferred tax on leases and decommissioning obligations. The change is necessary as a result of the introduction of IFRS 16 Leases which brought leases onto the balance sheet for the first time as of 1 January this year.

The proposed amendments are designed to align the accounting for the tax effects of particular transactions with the general principle in IAS 12 of recognising deferred tax for all temporary differences. IAS 12 specifies how a company accounts for income tax, including deferred tax, such as amounts of tax payable or recoverable in the future.

In specific circumstances, companies are exempt from recognising deferred tax when they recognise assets or liabilities for the first time. There has been some uncertainty in the market about whether the exemption applies to leases and decommissioning obligations.

The IASB said it had to review the tax treatment as ‘the application of IFRS 16 Leases would increase the potential for differences to arise because an entity would recognise an asset and a liability for many more leases applying that standard than when applying IAS 17 Leases. Consequently, the IFRIC Committee recommended that the IASB amend IAS 12 to narrow the application of the recognition exemption so that it would not apply to such transactions’.

The IASB expects that applying the proposed amendments will increase comparability between entities’ financial statements, as well as provide useful information for users of financial statements.

The proposed amendments would require an entity to recognise deferred tax on initial recognition of particular transactions so far as the transaction gives rise to equal amounts of deferred tax assets and liabilities. The proposed amendments would apply to particular transactions where an entity recognises both an asset and a liability, such as leases and decommissioning obligations.

Gary Kabureck, IASB board member explained: ‘IFRS 16 Leases requires a company to recognise a right-of-use asset (lease asset) and a lease liability for leases. Over the lease term, the company recognises depreciation and interest expense as it uses the lease asset and settles the lease liability.

‘However, many tax authorities provide tax deductions only when a company makes lease payments (not when a company recognises depreciation and interest expense). In these circumstances, a company needs to apply judgment in determining whether those tax deductions relate to the lease asset or to the lease liability.

‘Depending on the applicable tax law, tax deductions may relate to either: (a) the lease asset - because they relate to expenses from the lease (depreciation and interest expense); or (b) the lease liability - because they relate to the repayment of the lease liability and interest expense.'

The changes, if adopted, would mean that companies that do not currently recognise deferred tax for lease transactions would be required to do so. Under the current rules, when a company does not recognise deferred tax, the tax expense for a period will reflect tax deductions as and when they become available for tax purposes (that is, when lease payments are made), rather than as the company uses the lease asset and settles the lease liability.

According to the proposed amendments, the exemption in the standard would not apply to leases and decommissioning obligations - transactions where companies recognise both an asset and a liability. The proposed amendments would result in companies recognising deferred tax on such transactions.

The consultation closes for comment on 14 November 2019.

IASB Exposure Draft Deferred Tax related to Assets and Liabilities arising from a Single Transaction issued 17 July 2019

Sara White | 18-07-2019