Deferred tax explained

“The hardest thing in the world to understand is the income tax.” Albert Einstein

Let`s have a look at deferred tax in a nutshell. Deferred tax underlies the principles of IAS 12 Income Taxes.

1. The first dimension of the deferred tax concept is the value difference between the carrying amount (CA) of an asset or a liability and its tax base (TB). Tax base are tax rules applicable for a jurisdiction. For example, share companies registered in Switzerland are levied for federal, cantonal and church taxes. Each tax has different bases and allows for varying tax deductions.

The difference between CA and TB are temporary taxable or deductible differences which will be offset over time.

Typical items giving rise to deferred tax are:

• Assets at fair value,

• Goodwill in business combinations (other than on initial recognition),

• Revaluation of assets/ liabilities in business combinations,

• Investments in subsidiaries, branches, associates,

• Interest income/ expense,

• Depreciation,

• Development expense.

2. The second dimension of deferred tax is time (future). Temporary differences - taxable or deductible on/ from your future taxable profit or loss - must be provided for.

In this regard the accrual principle in accordance with the Conceptual Framework shall be applied by considering the tax impact of an event as it is incurred, not only when it is due. Resulting from the apllication of this principle an entity shall book a tax deferral: an asset or a liability.

Deferred tax liability:

• income taxes payable in future periods,
• recognized for all taxable temporary differences.

Deferred tax asset:

• income taxes recoverable in future periods,
• recognized for all deductible temporary tax differences and tax carryforwards.

unless it is less than probable (< 50%) that future taxable profits will be available against which the deferred tax asset can be used.

Tesla illustrates the point: As of 31.12.2022 Tesla had recorded a full valuation allowance of $ 7.3 billion on their net U.S. deferred tax assets, based on expectation that deferred tax assets will not be realized (probabililty of realization < 50%).

3️. The third dimension are tax planning opportunities, i.e. carryforwards from the past. Unused tax credits and unused tax losses - tax benefits - give rise to deferred tax assets which in turn can be used to reduce current or future tax expenses.

Measurement of deferred tax assets/ liabilities:

• At the tax rates expected to apply when the asset is realised or the liability is settled as enacted at the end of the reporting period.

No discounting but remeasure if tax rates or tax laws changed, or deferred assets are not recoverable any more.

Recognition:

Tax income/ tax expense in Profit & Loss for the period, unless an underlying item was recognized outside Profit & Loss (e.g. in Other Comprehensive Income).